Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
Principles of P-C, Special
Chapter 1: Ethics, Professionalism and the Insurance Industry…………1
Chapter 2: Law and Insurance Contracts…………………………….....56
Chapter 3: Automobile Insurance and the Auto Policy…………………80
Chapter 4: Introduction to Homeowners Insurance…………………...140
Chapter 5: Fire Insurance……………………………………………...208
Chapter 6: Surety Bonds………………………………………………231
Chapter One
Ethics, Professionalism, and the Insurance
Industry
© American Education Systems, LC
Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
RISK AS THE BASIS OF INSURANCE
Risk is a small word, but one that can make the stomach tighten and
shoulders rise. It holds a powerful influence over us because human nature is
fascinated with uncertainty. Despite its fascination, however, it is difficult for
most persons to think clearly about risk. Naturally, we feel uncomfortable
contemplating the loss of a loved one, or the unintentional injuring of a
stranger, or the loss of a home. On the other hand, some persons are
fascinated with risks that present the possibility of gain. The “professional”
gambler, the day-trader, and the land speculator are examples of those who
thrive on risk.
The consequences of any significant risk can be so devastating that we are
compelled to face the fact that risk is a force in our lives that must be
reckoned with. As we examine the risk in our lives, we find that it possesses
distinct properties, and these can be analyzed and classified. From our
analysis, we find that risk also follows some general laws, and that knowing
these laws, risk can be managed, and our lives can be lived with a little less
anxiety.
Risk can be defined as an uncertainty of loss. Typically, the loss is of a
financial nature. It can also be termed a danger that one insures against. The
questions that arise as we analyze risk and how it operates are the following:
What categories of risk exist? What rules or principles can risk follow? What
kinds of risk can be avoided, what kinds can be managed?
One type of risk affects everyone. This is fundamental risk. For example,
every area can experience severe or damaging weather. A severe dislocation
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in the economy is a fundamental risk, as is the threat of war. These types of
risk are usually met with social insurance and government involvement.
Fundamental risks are very different from particular risks. Particular risk is
specific to an individual, and subject to choices. For example, if Joe Client
chooses to skydive as a hobby, only he bears the risk of this activity.
Risk can also be classified as static and dynamic. A static risk has to do with
human error, wrongdoing, and acts of nature. A dynamic risk is connected
with the volatile nature of the economy. Most dynamic risks are also
speculative risks. This means that both loss and gain are possible. Investing
in a limited partnership is an exposure to a dynamic, speculative risk.
Static risks are pure risks, and can be further subdivided. For example, there
are personal risks affecting individuals through the loss of their property, their
income, and their health. One way a family experiences pure risks is through
the premature death of one of its members. Being held legally liable for a
person’s loss is another form of pure risk. This variation of risk touches
professionals through accusations of malpractice, business persons through
accusations of product defects, and anyone who operates an automobile
through accusations of negligence. Of course, this list could go on and on.
A final classification can be used when considering risk. The world of risk
includes both objective and subjective risks. Subjective risk is uncertainty
based on an individual’s emotional reasoning and state of mind. Objective
risk, on the other hand, is the relative difference between the actual loss and
the expected loss.
Objective risk follows a very specific mathematical principle---it is inversely
proportional to the square root of the number of items observed. In practical
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terms, this means that the more exposures, the less the objective risk. This is
very important because it means that objective risk can be measured.
Risk is also subject to the law of large numbers. This is another mathematical
principle. It states that the greater the number of exposures, the more certain
one can be in predicting the outcome. When speaking in terms of losses, we
can state that actual losses will be less than expected losses as the number
of exposures increases.
While most people are not aware of the mathematical principles that are used
to analyze and measure risk, all people—and all businesses—practice some
form of risk management. For example, risk can be avoided. Any nonswimmer will probably take pains to avoid the water. Choosing not to
participate in high-risk hobbies like sky-diving is another example of avoiding
risk.
Typically, most people passively retain a wide variety of risks. A risk is
passively retained when it is not recognized or understood, when the cost of
treating it is prohibitive, or when the severity of the loss is deemed
inconsequential.
For example, many consumers do not believe that they need disability
insurance, and are satisfied with the level of their life insurance. Most studies,
however, statistically demonstrate that most people are more likely to face
disability than they believe. In addition, it can be shown that the face value of
the life insurance in force is in many cases inadequate.
The reasons for these example of passive retention are various and complex,
and are as different as the individuals at risk. In some cases, consumers
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understand the threat presented by disability, but mistakenly believe that their
health insurance provides extensive disability income benefits. In other cases,
the consumer may believe that the cost of purchasing a disability policy would
be more that he could afford.
Risk can also be handled by a non-insurance transfer. This strategy can shift
risk from one party to another by contractual agreement. For example, a
company may lease photocopiers. The lease agreement can stipulate that
maintenance, repairs, and physical losses to the equipment are the
responsibility of the company leasing out the photocopiers. Another example
of non-insurance transfer is using a hold harmless agreement.
Loss control is another form of risk management. Loss control attempts to
lower the frequency and severity of a loss. Loss control is an active retention
of risk.
Examples of loss control could be safety training, posting of safety
regulations, and an active policy of enforcing safety regulations. These
practices would all fall under the category of controlling the frequency of the
loss. An example of controlling the severity of a loss would be installing a
perimeter alarm system.
The purchase of an insurance coverage (or coverages) is what most people
consider as risk management. For a company or organization, a commercial
insurance package will be employed. This insurance will cover the essential
insurance that is mandated by law. It may also include desirable insurance
that covers losses that would threaten the company’s survival, and available
insurance that covers losses that are not serious, but would present major
inconvenience.
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THE FAMILY OF RISK
SUBJECTIVE
OBJECTIVE
SUBJECTIVE
STATIC
OBJECTIVE
DYNAMIC
PURE
FUNDAMENTAL OR PARTICULAR
RISK
FUNDAMENTAL OR PARTICULAR
SPECULATIVE
STATIC
SUBJECTIVE
REVIEW QUESTIONS
OBJECTIVE
© American Education Systems, LC
SUBJECTIVE
DYNAMIC
OBJECTIVE
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NOTES
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RISK AS THE BASIS OF INSURANCE
REVIEW QUESTIONS
1. Objective risk is the relative difference between actual
loss and expected loss.
a. true
b. false
2. Fundamental risks are the same as particular risks.
a. true
b. false
3. Fundamental risks affect everyone, while particular
risks are specific to individuals.
a. true
b. false
4. The possibility of a fire in one's home is an example
of:
a. fundamental risk.
b. speculative risk.
c. dynamic risk.
d. none of the above.
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5. Most dynamic risks are also speculative risks.
a. true
b. false
6. A hold harmless agreement is an example of a noninsurance transfer.
a. true
b. false
7. Not going into the water because one cannot swim is
an example of avoiding risk.
a. true
b. false
8. Loss control is a risk management strategy that ignores
lowering the frequency of losses and concentrates solely
on minimizing the severity of losses.
a. true
b. false
9. Following a loss control program in one’s risk
management strategy is an example of active retention of
risk.
a. true
b. false
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10. When people do not apply for disability insurance
because they falsely believe that such coverage is already
provided by the state, we can say that they have passively
retained some level of risk.
a. true
b. false
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ANSWERS TO THE REVIEW QUESTIONS
1. true
2. false
3. true
4. fundamental risk
5. true
6. true
7. true
8. false
9. true
10. true
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Licensing and Appointing Relationships
The State Government
Licensure
The State Insurance Department
The
Producer / Agent
Appointment
An insurer appoints the agent to an agency agreement. This agreement is a
contract that describes the agent’s working relationship with insurer. The
insurer may cancel the appointment by notifying the state and the agent.
The Insurer
© American Education Systems, LC
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Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
INSURANCE AS AN INDUSTRY
The needs insurance meets are tremendous. Without insurance, the burden
to society would be enormous. Individuals and societies are confronted daily
by forces largely beyond anyone’s control. A look at the evening’s news
broadcast provides clear examples of the varieties of fortuitous losses that
occur regularly. Although the insurance agent may not see it on a daily basis,
his or her work is absolutely vital.
In order to effectively classify risks, design appropriate insurance coverages,
and distribute the product, the insurance industry is a massive enterprise.
Some of its constituent elements are briefly outlined in the following.
TYPES OF INSURANCE COMPANIES
Stock insurance companies are corporations with stockholders. The type of
insurance that the stock company writes is spelled out in the corporation’s
charter. The stock insurance company has a board of directors, and the clear
purpose of earning a profit for the stockholders.
Mutual insurers are corporate entities owned by the policy owners. The board
of directors of a mutual insurer operates the corporation –at least in theory-for the benefit of the policy owners. There are a wide variety of mutual
companies. These forms can include factory mutuals (which insure only
certain properties), farm mutuals (which insure farm property in a relatively
limited geographic area), as well as assessment mutuals and advance
premium mutuals.
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Assessment mutuals have the right to assess policy owners for losses and
expenses. In this type of insurance company, no premium is paid in advance,
and each policy owner is assessed a portion of the actual losses and
expenses. An advance premium mutual, on the other hand, charges its policy
owners a premium at the beginning of the policy period. If the initial, collected
policy premiums exceed losses and expenses, the surplus is returned to the
policy owners in the form of dividends. On the other hand, should the amount
of collected premiums fall short of the amount needed to cover losses and
expenses, additional assessments can be levied on the members.
Reciprocal insurers are unincorporated mutuals. Reciprocals are owned by
their policyholders, and the policyholders insure the risks of the other
policyholders. The reciprocal is managed by an attorney-in-fact that is usually
a corporation.
Reinsurers are the big “behind the scenes” players in the insurance industry.
The reinsurance company insures the insurance company that deals directly
with the public. Through a reinsurer, an insurance company is able to spread
its risks and limit the loss it would face should it have to pay a claim.
A major reinsurer can be found in the Lloyd’s Association, the most famous of
which is Lloyd’s of London. Lloyd’s Associations are technically not insurance
companies, but an association of individuals and companies. Besides
reinsurance, underwriters who are members of Lloyd’s will provide coverages
to specialized, “exotic” risks.
Fraternal insurers are the insurance arms of fraternal benefit societies. To be
a fraternal benefit society, an organization must be non-profit, have a lodge
system, and a representative form of government with elected officials.
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Typically, the fraternal organization is organized around ethnic or religious
lines. Fraternals usually sell only to members.
TYPES OF INSURANCE SALESPERSONS
Insurance is sold primarily through professional salespersons. Mass
marketing without the use of human representatives is another marketing
system employed by insurance companies. Mass marketing may employ
direct mail, radio, television, or opt-in e-mail. Nevertheless, despite the growth
of new media technologies, the field force remains the backbone for the
majority of insurance sales.
The majority of insurance salespersons are agents. Agents can be referred to
as
field
agents,
field
representative,
field
underwriters,
insurance
representatives, and insurance salespersons. Whatever the title, agents are
salespersons that possess some form of agent authority. The three forms of
agent authority are express, implied, and apparent.
Express authority is the authority an agent receives from the insurer in the
form of a contract. For example, an agent’s contract will give the express
authority to solicit and sell the company’s product. Implied authority is not
contractually outlined, but assumed to exist. For example, the contract may
not say that the agent can use company letterhead, but it is assumed that this
is acceptable. Apparent authority is authority created by the actions of the
insurer. For example, if the insurer supplies an agent with forms and software
to generate premium quotes, it is apparent that an agency relationship exists
between the agent and the insurer.
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
Property and Casualty
The property and casualty field employs three varieties of salesperson: the
independent agent, the exclusive (or captive) agent, and salespersons for
direct writers. The independent agent is an independent businessperson who
represents several companies. The independent agent is compensated by
commissions, and owns the expirations or renewal rights to the business.
The exclusive agent represents only one company (or company group).
Generally, exclusive agents do not own the expirations or renewal rights to
the policies. On the other hand, exclusive agents do receive strong supportive
services from their companies.
Salespersons for direct writers are employees of the insurer. Salespersons for
direct writers usually receive the majority of their compensation in the form of
a salary. Like the exclusive agent, direct writer salespersons represent only
one company.

Life, Accident and Health
The life and health field uses primarily two forms of agent sales systems: the
branch office system and the personal producing general agency system
(PPGA). The branch office system makes use of career agents who are
contracted to represent one insurer in a specific area. Career agents are
recruited, trained, and supervised by a general agent (GA) or a manager who
is an employee of the company.
PPGAs, on the other hand, typically do not recruit, train, or manage career
agents. They may recruit a sales force, but these agents are employees of
the PPGA, not the insurance company.
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INSURANCE SPECIALISTS
Actuaries provide the statistical modeling and mathematical computations
necessary for determining the correct premiums for policies. Closely
connected to the actuary is the underwriter. The underwriter analyzes data
from actuaries and field agents to decide whether the risk involved in writing a
policy is desirable.
Should a loss occur, a insurance claims adjuster will be brought into play.
Claims adjusters determine if losses are covered by policies. If the policies do
cover the loss, the claims adjuster needs to estimate the cost of the repair or
replacement.
Whatever the role one plays in the insurance industry, all participants are
ultimately involved in a complex process of determining if a risk is insurable,
transferring all or a portion of the risk, and pooling the losses. When the
stipulations of the contract are met, insurance ultimately leads to the payment
for a loss, either in the form of an indemnification or a benefit from a valued
contract. An indemnification is a payment that seeks to restore an insured to
their approximate financial condition before a loss occurred. A benefit from a
valued contract, such as a life insurance policy, pays a predetermined
amount.
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In determining if a risk is insurable, it should ideally have the following
characteristics:

The risk should be a part of a large number of similar risks (or
homogeneous exposures)
In order for the insurer to make use of the law of large numbers, there must
be a sufficient body of exposure units to allow for an accurate prediction. The
group or exposure units do not have to have exactly the same characteristics,
but they should be roughly similar.

The loss must be fortuitous
Insurance cannot indemnify a loss that an insured purposely caused. For a
loss to be insurable, it must ideally be largely beyond the insured’s control,
and/or accidental.

The loss should not be catastrophic
Ideally, an overwhelmingly large number of losses should not occur at the
same time.

The loss should be determinable
A loss should be definable; one should be able to point to a specific time and
place when the loss occurred, pinpoint the cause, and determine the amount
of the loss.

The possibility of loss should be calculable
In situations where the loss is very difficult to predict, and the severity of loss
is extreme, insurance is often (though not always) unavailable through private
insurers. When it is, the insurance is usually backed by federal assistance.

The premium should make sense economically
For example, a term life policy on a 96-year-old male smoker would be
enormously—or prohibitively—expensive. Theoretically, a policy could be
written, but it would typically not make sense to do so. The same situation
would apply to an insurance policy on the normal wear and tear of property.
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INSURANCE AS AN INDUSTRY
REVIEW QUESTIONS
1. An assessment mutual charges premiums in advance.
If losses and expenses are lower than expected, it
returns surplus to the policyholders; if losses and
expenses are higher, it charges an additional
assessment.
a. true
b. false
2. Reciprocal insurers are a form of stock company.
a. true
b. false
3. Lloyd’s of London is a large stock insurance company
that specializes exclusively in reinsurance.
a. true
b. false
4. Personal producing general agents, or PPGAs, staff
and run their own offices. Agents and support staff are
usually employees of the PPGA, and not an insurance
company.
a. true
b. false
© American Education Systems, LC
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5. Ideally, an insurable
characteristics.
loss
should
have
six
a. true
b. false
6. An indemnification is a form of restoration.
a. true
b. false
7. For a risk to be insurable, it must be a part of a large
number of homogeneous exposures, the loss should
not be catastrophic, the chance of the loss should be
calculable, the nature of the loss should be measurable,
the loss must fortuitous, and the premium must make
economic sense.
a. true
b. false
8. A group of homogeneous exposure units is a group of
people or items with the exact same characteristics
exposed to the same risks.
a. true
b. false
9. The express authority of an agent is stated specifically
in the contract provided by the insurance company.
a. true
b. false
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10. Independent agents own the expirations or renewal
rights to their business.
a. true
b. false
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ANSWERS TO THE REVIEW QUESTIONS
1. false
2. false
3. false
4. true
5. true
6. true
7. true
8. false
9. true
10. true
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NOTES
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ACTING AS THE LICENSED PROFESSIONAL
A profession is defined as an occupation that requires specialized study,
training, and knowledge. In addition, professions are regulated by a
governmental or non-governmental body that grants licenses to practice in
the field. The license not only indicates a level of competence, but an
expectation of ethical behavior.
In most states, the Insurance Commissioner is responsible for the licensure of
insurance agents and solicitors. In order to earn an insurance license, the
applicant must show completion of state mandated education requirements.
In addition to mandated CE, many agents choose to advance their insurance
credentials by earning professional designations. These designations require
coursework that is usually at the college level of difficulty, and often require
the passing of a series of exams. Typically, designations are sponsored by
professional industry associations such as the American Institute for
Chartered Property Casualty Underwriters or the Society of Certified
Insurance Counselors. Most professional associations also have their own
specific Code of Ethics that all members and designation holders are required
to uphold.
While licensing, CE requirements, and designations are all important, they are
all only a part of the insurance professional’s equation. The license, the CE
certificate of completion, and the letters that correspond to an agent’s earned
designation all are symbolic representations of the specialized knowledge that
the agent possesses and which is necessary for meeting consumer needs.
Despite the hype in the popular media touting “do-it-yourself” planning for
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everything from estates to stock-picking, most people have neither the time
nor the inclination to be their own insurance advisor. Furthermore, even if the
“average person” were to dedicate a significant block of time to analyzing his
or her insurance needs, chances are the main result would be frustration.
Insurance is a difficult, confusing topic. Like it or not, the public needs
qualified, professional agents to help analyze their insurance needs and
provide them with viable options for their individual needs.
In order for the agent’s knowledge to be used effectively, he or she needs to
become an outstanding communicator and educator. Many insurance
concepts are difficult, and the dynamics of the insurance industry can seem
counter-intuitive to the consumer. For example, unless told, the average
consumer might well believe that damage caused by flooding and sewage
back-up is a part of their basic homeowners coverage (after all, why did the
buy the protection?)
In recent years, the insurance industry has moved to make insurance policies
more “user friendly” and has limited much of the legalese of the past.
Nevertheless, the typical consumer will be hard pressed when reading
through any insurance policy. The agent is the only expert on hand that can
effectively answer the consumer’s questions.
To be an effective communicator, the agent needs to be more than a
salesperson. While explaining a coverage (or a need for coverage) to a
consumer, the agent must always be completely candid and open. To
understand something as difficult as insurance, the consumer needs to be
given accurate and complete information.
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The agent must also be willing to answer questions as fully and respectfully
as possible. The old adage that there is no such thing as a stupid question
was never more apparent than when dealing with insurance. Finally, to be an
effective communicator, the agent must be responsive. Consumers are owed
as quick a reply to questions as is practically feasible.
Another aspect of professionalism that is important for the insurance agent is
an open and tolerant attitude toward competition. The agent should treat
other agents as professional colleagues, and refrain from negative comments
about other agents, agencies, companies, or products. Another old adage is
applicable here: if you do not have anything good to say about someone, do
not say anything at all.
By respecting one’s competitors and taking the high-road, one simply comes
across in a more professional light. Furthermore, stressing the negative in
others creates a negative atmosphere that ultimately taints the entire industry.
As an insurance professional, it is always best to only speak about companies
and industry associations in a positive light.
Occasionally, an agent may be approached by a consumer concerning a
company’s financial strength, reserves, and general outlook. Even if one is
quite knowledgeable about industry trends and a company’s current financial
status, it is always best to refer the questioner to a professional rating
company such as A.M. Best or Standard & Poor’s. Not only will their reports
give a more complete and accurate picture, it will help keep one free of any
appearance of wrongdoing.
In the final analysis, being a professional is ultimately dependent upon one
taking their business and their industry seriously as a professional endeavor.
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No amount of licensing, CE courses, designations, or positive communication
skills can outweigh a negative attitude. Only a positive attitude toward--and a
sincere belief in--the professionalism of one’s occupation will result in others
perceiving one in a professional light.
Agents can take many practical steps to enhancing their professionalism. At
the basis of their efforts, they must meet all minimum standards of licensing
and abide by all applicable laws in their state. But in addition, an agent can be
constantly involved in the process of self-improvement. Whether in the form of
additional, specific insurance education as is found in a designation track, or
in general skill improvement, such as involvement in Toastmasters, the agent
possesses a myriad of possibilities to improve their professional skills.
Finally, a true professional should act as an ambassador for their industry. At
a minimum, this means striving to never embarrass or “drag down” the
industry by negative comments. On the positive, active side, being an industry
ambassador can include association involvement, charity work, and political
activism on behalf of the industry.
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ETHICS AND THE INSURANCE AGENT
Ethics is a frustrating topic for many people. A standard dictionary definition
will state that an “ethic” is a principle, or body of principles, for good behavior.
The word stems from the Greek ethos, meaning customary conduct. While
this definition is very precise, it causes one to inquire about which principle or
principles. It also assumes an understanding of “right or good conduct.”
Furthermore, supposing that a body of principles for good conduct has been
established, one still needs to know how these principles can be lived.
Ethics is a highly complex subject. Issues of right and wrong, when
considered in terms of basic principles, force us to consider fundamental
questions of truth and justice. These questions, when seriously considered,
push us to think beyond our own limited personal experiences and subjective
values and come to terms with general experiences and universal values.
The study of ethics is usually divided into two major fields. The first is the
more purely philosophical, and is called meta-ethics. This is the study of
terms as they relate to moral philosophy. This area of ethics finds its home on
college campuses and university symposiums.
The second field of ethics is what concerns most people. This is called
normative ethics. As the name would indicate, this is a study of what is the
norm for right and wrong action.
Normative ethics is further broken into two branches. The first branch is the
theory of value. The theory of value seeks to determine the nature of “the
good.” As noted above, to state that an action is ethical because it is “good”
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or upholds “the good” opens the question of what “the good” actually is and
how it can be known. A theory of value may be monistic, and define “the
good” as a single principle, such as Aristotle’s “happiness,” Epicurus’s
“pleasure,” and Cicero’s “virtue.” It is also possible for a theory of value to be
pluralistic, and find a number of principles possessing intrinsic value.
The theory of obligation is the second branch of normative ethics. The theory
of obligation is divided into two opposite groups. The first is the teleological
viewpoint, which points to the consequences of actions as the measure for
determining their morality. The second viewpoint of the theory of obligation is
the deontological viewpoint. It focuses on motives, and sees morality and
immorality as ultimately outside the realm of action.
Despite which approach one takes while thinking about ethics, any serious
examination requires patience and honesty. A 17 th century ethicist determined
that ethical action was the pursuit of one’s self-interest “rightly understood.”
To “rightly understand” one’s true self-interest, however, is not an easy task.
Without careful thought and rigorous self-honesty, the rule of enlightened selfinterest is no more than a charade.
Business and professional ethics follow the same lines as general ethics, and
are really just extensions of moral philosophy. Business and professional
ethics are the standards, or norms, by which their industries are regulated.
In the insurance field, ethical action rests largely upon “The Golden Mean”—
Do unto others as you would have done unto you. This means being open
and sensitive to the needs of the client, and not placing one’s own needs
before those of the client. Within this basic tenet, one can also incorporate the
“First, do no harm” maxim of the medical profession.
© American Education Systems, LC
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Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
Examples of the ethical dilemmas that arise in insurance exist in many forms.
They can come in the form of selling the wrong coverage. For example,
selling an expensive whole life policy to a man of middling income with three
dependents is arguably the wrong coverage; a more modestly priced term
policy with a higher face value would probably be a more appropriate policy.
Another area of ethical dilemma for the agent can take the form of selling
insufficient coverage. For example, selling an auto policy to a client with
minimum liability coverage can present the insured with risk exposures that
he or she does not fully understand or appreciate.
Failing to recognize a need and not offering any choices of coverage can also
be a source of ethical concern for the agent. For example, not asking a client
with a homeowners policy about the size and extent of their home-based,
side-line business may create a belief that the business is adequately
insured.
Each of the above examples is fraught with ethical tensions. These tensions
can range from the serious argument to the self-serving rationalization. Are
any of our examples as clearly unethical as churning? No. Do any of them
pose potential ethical issues? Yes.
Because the agent has the specialized knowledge of the product, he or she
has the clear advantage in any transaction with the overwhelming majority of
consumers. If the agent is to act ethically, this advantage cannot be exploited.
Obviously, the agent must offer insurance products on the basis of the client’s
needs rather than his or her commission. But the agent must do more than
© American Education Systems, LC
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that. He or she is responsible for offering an analysis of the client’s insurance
needs and explaining them in a matter that can be understood.
Most insurance industry associations have a code of ethics that is meant to
serve not only as a guideline for ethical action, but also as a roadmap for
professional excellence and success. Some of the exhortations common to
most of the ethical codes include the following:

Treat all associates—prospects, clients, managers, employers, and
companies—fairly by submitting applications which give all appropriate
and pertinent underwriting information

Exercise due diligence in securing and submitting the necessary
information for the issuance of insurance

Present all policies fairly and accurately

Keep informed of and abide by applicable laws and regulations that
pertain to insurance

Hold one’s profession in high esteem and work to enhance its prestige

Cooperate
with
other
professionals
complementary services to one’s clients

Meet client needs to the best one’s ability

Keep all private information personal and confidential; never do anything
that would betray a client or employer’s trust and confidence

Constantly improve one’s skills and knowledge through lifetime learning
and continuing professional education
© American Education Systems, LC
providing
constructive,
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ETHICS
REVIEW QUESTIONS
1.
An example of an ethical guideline is “The Golden
Mean” of “Do unto others as you would have them do
unto you.”
a. true
b. false
2.
Most insurance industry organizations produce their
own codes of ethics that serve as professional
guidelines for their members.
a. true
b. false
3.
Normative ethics is a branch of ethics and concerns
right and wrong action.
a. true
b. false
4.
Ethical action only demands “book-work” and a lot of
reading. It is not necessary to approach ethics on a
personal level, nor are self-honesty and introspection
much needed in this pursuit.
a. true
b. false
© American Education Systems, LC
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Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
5.
The deontological position is a branch of normative
ethics that views morality and immorality as existing
primarily outside of, and prior to, action.
a. true
b. false
6.
It is important to always bear in mind that a legal action
is not necessarily a moral action.
a. true
b. false
7.
Business ethics is simply the application of ethics to the
field of business; it is bringing ethics out of the ivory
tower and square into the middle of the "real world."
a. true
b. false
8.
Failing to recognize a need and not offering insurance
is a potential area of ethical concern for the agent.
a. true
b. false
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
9.
Exercising due diligence is acquiring submitting all
pertinent information for the issuance of insurance is an
important example of an agent acting in an ethical
manner.
a. true
b. false
10.
As long as an agent has provided all the sales literature
recommended by his or her company to a client, one
can say that they have met their ethical obligation to
inform the prospect. Clear verbal explanations and the
answering of questions are polite, and serve as good
sales techniques, but are not required from an ethical
standpoint.
a. true
b. false
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
ANSWERS TO REVIEW QUESTIONS
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
true
true
true
false
true
true
true
true
true
false
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
NOTES
© American Education Systems, LC
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Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
COMPETITION IN THE INSURANCE INDUSTRY
One of the great strengths of the American economy is that it allows for
competition.
There is no central government telling consumers that "You
must buy this form of insurance," or "Only this company can make cars."
Instead, many companies may offer the same service or product, seeking
always to do the job better than the other person. This is the basis of the free
market system.
The idea is that the cream rises to the top. The consumers -- those who buy
the service or product -- see to it that the strong survive. The companies that
best serve the public gain the upper-hand and thrive, while those offering
shoddy products or poor service are driven out of business. Theoretically,
competition will maintain (and even improve) quality.
In many situations, competition has a positive effect on the economy. In many
cases, however, pure competition can have negative effects on the public
welfare. For example, if one company drives out all of its competitors and
establishes a monopoly, it is usually agreed that the majority of consumers
will suffer. The monopoly, unconstrained by competition, will not be inclined to
provide
quality
service,
fair
pricing,
or
product
innovation.
Because a true free-market tends to produce economic winners in the form of
monopolies, modern economies typically rely on state involvement to keep a
level playing field and avoid monopolistic practices. For this reason,
competition cannot be left alone as the sole mechanism guaranteeing the
efficient running of the insurance industry.
Another reason that competition is problematic in the insurance field is that
the product possesses a long-term nature that is often hard to assess and
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compare. The old adage "Let the buyer beware" hardly holds true when
dealing with insurance, for the quality of what the consumer buys is only
apparent many years down the road. Obviously, it is a very different
transaction from a "normal" state of business affairs when one buys
insurance. For example, when one purchases shares in a mutual fund, the
results and performance of that fund are accessible daily. Buying insurance
is very different from hiring contractors to put in a sprinkler system, or having
a dentist fill a cavity, or leasing a car. In all of these cases, the results are
readily and immediately observable. The performance of an insurance policy,
on the other hand, is observable only after the passage of time. More than
almost any product, insurance is bought on faith.
Because the performance of the insurance product is rarely immediately
apparent, it would be potentially possible for a company to gain an unfair
competitive advantage by offering products with premiums so low that they
could never cover a reasonable number of losses. In a pure free-market, with
a pure “buyer beware” culture, one could expect the result to be a great
number of companies failing, and a great number of insureds facing hardship
or economic ruin. If an insurance company does not accumulate adequate
capital to meet its obligations, all of which are temptingly distant in the future,
it will be insolvent when claims finally come due -- as they ultimately will.
True, these failed companies would by driven from the market—but at what
cost? Unlike most products, where low prices are thought of as a benefit to
the consumer, insurance is in greater danger of being under-priced than overpriced.
Any financial mistakes the insurance company makes, from charging
insufficiently low premiums to paying too lucrative a commission to its agents,
will ultimately be carried by the consumer. The great competition among the
© American Education Systems, LC
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Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
multitude of active insurance companies creates tremendous pressure to offer
the lowest rate to attract customers, pay the best commission to motivate
agents, etc. In other words, competition can create pressure to do what is
best in the short run for a minority of people, but is potentially ruinous in the
long run for the majority.
© American Education Systems, LC
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Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
COMPETITION IN THE INSURANCE INDUSTRY
REVIEW QUESTIONS
1.
In free-market theory, competition helps maintain
quality by driving the weak and unscrupulous from
business.
a. true
b. false
2.
One problem with pure, unregulated free market
competition is that it tends to produce monopolistic
situations.
a. true
b. false
3.
Competition is a necessary but insufficient mechanism
for the efficient running of the insurance industry; it is
needed, but its very nature is potentially ruinous for
insurance.
a. true
b. false
4.
One of the limiting factors of free-market competition in
the insurance industry is the long-term nature of the
product.
a. true
b. false
© American Education Systems, LC
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5.
The insurance industry today is one characterized by
ever-increasing competition.
a. true
b. false
6.
Since policy forms are clear and easy to read, the
consumer does not have to study a policy in-depth in
order to understand it, and can act as an informed
economic agent with confidence and ease.
a. true
b. false
7.
Human nature demonstrates that most consumers will
actively study the available insurance products on the
market and seek out all the information about those
products.
a. true
b. false
8.
As the performance of insurance is not readily
apparent, there is a great deal of room in which the
unscrupulous may operate.
a. true
b. false
© American Education Systems, LC
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9.
If insurance premiums are too high, both the insurer
and consumer will ultimately suffer, as the insurance
company will likely become insolvent.
a. true
b. false
10.
Insurance companies must charge just the right amount
for premiums and pay just the right amount of
commission for competition to work in the insurance
industry.
a. true
b. false
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
ANSWERS TO REVIEW QUESTIONS
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
true
true
true
true
true
false
false
true
false
true
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
THE USE AND MECHANICS OF REGULATION
By regulation, we mean a set of laws that a governing body can employ to set
a standard of service and competence for the industry it monitors. Its intent is
to preserve the public interest, protect the consumer, and promote the
general welfare of the industry.
It prohibits abusive acts, establishes
guidelines for practice, set minimum standards, and provides a mechanism
for the enforcement of those standards. Effective insurance regulation will
insure the financial solvency of private insurance providers, and create a
business environment that is fair for all consumers.
Insurance entities are regulated through four vehicles. First, legislation in all
states sets the boundaries of acceptable insurance practices. These laws
determine the requirements and procedures for the formation of insurance
companies, the licensing of insurance practitioners, the financial practices of
insurers and their taxation, the rates charged by insurers and their general
sales and marketing practices, and the liquidation of insurers.
Also, the federal government can play a role in the regulation of insurance
company practices. For example, the sale of annuities is regulated by the
Securities and Exchange Commission. The private pension plans of insurers
come under the scope of the Employee Retirement Income Security Act of
1974, and Social Security has insurance programs that affect every
American.
The insurance industry is also occasionally subject to the power of judicial
review. Both state and federal courts can determine the constitutionality of
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
any insurance practice, and the decision handed down by the court must be
respected as the law of the land.
Third and finally, state insurance departments regulate insurance companies'
business practices. In many states, an elected or appointed official known as
the insurance commissioner administers the state's insurance laws.
The state insurance commissioners belong to the National Association of
Insurance Commissioners (NAIC).
Although this body bears no legal
authority to enforce decisions, it can make recommendations. Indeed, it is
largely through the NAIC that state regulations possess a workable level of
uniformity. When the NAIC creates model laws, state legislatures and
insurance departments often move swiftly to adopt these recommendations.
The states regulate five principle areas of insurance practice.
The first,
contract provisions, clearly show the influence of the NAIC’s work. One of the
reasons for the regulation of contracts is the complexity of the language. The
NAIC has helped mitigate this problem. Indeed, it has led the way to high
level of uniformity by getting the states to employ standardized policies and
provisions.1
The state keeps close scrutiny over any insurance policy contract because
the language is technical, and can contain so may complex clauses that there
is too much room for the unscrupulous to operate within. Therefore, the state
insurance commissioner has the authority to approve or reject any policy form
before it is sold to the public.
A “high degree of uniformity” does not, of course, mean complete uniformity. Terminology, for
example, can vary. For example, uninsured motorist coverage can come under a “family protection
coverage.”
1
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Regulation serves to address the shortcomings of competition. As insurance
is a knowledge product, any consumer would have to possess a broad,
general understanding of the insurance he or she desires in order to make an
intelligent decision regarding its quality.
Unfortunately, consumers simply
lack the necessary information to adequately compare and determine the
relative merits of different contracts. As consumers lack the knowledge
needed to select the best product, the competitive incentive for the insurers to
constantly improve their product is lessened. Regulation steps in to produce
a market effect that imitates what would ideally occur naturally if consumers
were informed, rational, economic actors.
Another area of state regulation is that of rates. This is largely an attempt at
managed competition. It must be noted, however, that rate regulation is not
uniform. Despite the lack of uniformity, the regulatory goal is to see that rates
are adequate, meaning they are not too low. The insurer has the
responsibility of meeting significant financial claims in the future.
At the same time, rates cannot be excessively expensive. The industry
operates with a notion of the fair and correct range of prices for insurance.
Rates cannot be discriminatory in any way. Thus, while not everyone pays the
same amount for insurance, the insured at a higher premium cannot unfairly
subsidize the other insureds at a lower premium when virtually the same risk.
Rating laws are diverse and multitudinous. There are state-made rates, prior
approval laws, mandatory bureau rates, file-and-use laws, open competition
laws, and flex rating laws.
State-made rates are those set by the state agency. All licensed insurance
practitioners must follow these rates.
© American Education Systems, LC
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Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
The majority of states employ some form of prior approval law for the
regulation of rates. This simply means that rates must be filed and approved
by the state before they can be offered to the public.
Mandatory bureau rates are those rates determined by a rating bureau. A
small number of states employ this system.
Open competition laws are sometimes referred to as no-filing laws, and are at
the opposite end of the spectrum of the above three varieties of rate
regulation. Under this scheme, insurers do not have to file their rates, based
upon the premise that competition in the market will ensure reasonable rates.
This does not mean, however, that the rates are made without any oversight.
The regulatory body maintains the right to require the insurance companies to
provide a schedule of rates if there is a perceived problem or abuse, but this
is a very liberal scheme that leans upon a trust of the market's efficacy.
Flex rating law is another liberal rating law. This situation requires that rates
be submitted to the state for prior approval only when the rate increase or
decrease exceeds a predetermined range.
The states also seek to maintain insurer solvency. Insurance, as we have
discussed, is a product bought upon faith as a hedge against potentially
serious occurrences. The insurance bureau seeks to allay any fears about
insurance companies not being able to meet their obligations.
To this effect, the state regulatory commission seeks to guarantee that the
insurance companies can demonstrate their solidity, or fiscal health. Even
before an insurance company can form, it must meet minimum capital and
surplus requirements. The insurer's balance sheet must reflect a certain level
of admitted assets. These can consist of cash, bonds, stocks, real estate, and
© American Education Systems, LC
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various other legal investments. Only those assets classified as admitted
assets can be used to show the company's financial situation.
Opposite admitted assets on the company's balance sheet are reserves.
These are liability items, and represent the company's financial obligations.
The difference between the insurance company's assets and its liabilities is
called the policy owner's surplus. This figure is very significant, as it is the
basis for how much insurance the company can safely offer. Even more
important, the policy owners' surplus is the fund used to offset any potential
underwriting or investment loss.
The state also regulates the securities that insurance companies hold. The
state discourages high-risk investments, as these run contrary to the
insurance mission.
The financial condition of an insurance company is an ongoing affair of the
state. It is strictly and consistently monitored. Insurance companies must file
an annual statement with the Insurance Commissioner. This statement is also
called the Annual Convention Blank, and shows the current status of
reserves, assets, total liabilities, and investment portfolio. In addition to this,
an insurer is normally audited at least every three to five years.
If a company becomes insolvent, the state is obligated to act. The company
becomes managed by the state. If the company cannot be fiscally
restructured into solidity, it is liquidated.
The states also provide the licensing for the insurance industry. In many
ways, this is the "big stick" for the regulating body. For example, a new
insurer is normally formed in incorporation. It can only receive its charter or
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Combination Course 1
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certificate of incorporation from the state, and it is only through the state office
that its legal existence can be formed. After being formed, the company must
then get licensed to be able to conduct business.
In addition, all states demand that agents and brokers be licensed. A written
examination generally has to be passed, and many states are requiring
continuing education requirements to maintain a licensed status.
Simply put, a license is a badge that indicates a base level of trustworthiness
and competence to operate in a profession. Secondarily, it is a badge that
can and will be taken away if both or either the base level of trustworthiness
and competence are found wanting.
The major area that most people think of in regards to insurance regulation is
centered on trade practices. Trade practices have to do with the interactions
of the public and the representatives of insurance entities. The state
insurance bureau will seek to stop all trade practices it deems to be unfair.
Most states have adopted the NAIC model Unfair Trade Practices Act. Some
examples of prohibited trade practices include:
 Misrepresentation
 Failure to remit insurance funds
 Falsifying financial statements and records

Unfair discrimination
Misrepresentation can occur willfully or by accident. Misrepresentation occurs
when untrue statements of material facts are made, or failing to state a
material fact that would prevent other statements from being misleading.
Misrepresentation also occurs when an insurance representative fails to make
all the disclosures required by law. An example of misrepresentation is an
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Combination Course 1
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agent telling a prospect that he represents many companies, when in fact he
represents only one. Another example of misrepresentation would be telling a
prospect that the premiums of a life insurance policy are payable for only a
limited period of time when they are actually payable for life.
Another form of misrepresentation is twisting. Twisting happens when an
agent convinces a policyholder to surrender an in force life policy and
purchase a new policy that is not in the policyholder’s best interests. Twisting
is also called external replacement.
Failure to remit insurance funds is a major trade practice violation. Obviously,
agents must turn in any premiums collected in order for the insurance policy
to be in force. This is of major significance for the first premium submitted with
an insurance application.
Whether communicating with a state government official or a consumer, it is
illegal to alter records or make statements that falsify the financial condition of
an insurer. Willfully omitting pertinent financial information is also considered
an effort to deceive, and is prohibited.
Another major area of
concern for insurance
regulation is
unfair
discrimination. Redlining is an example of an unfair underwriting practice that
is discriminatory and illegal.
Originally, redlining was said to have occurred when an insurer refused to
underwrite (or continue to underwrite) risks in a specific geographic area. The
phrase “redlining” came from the drawing of red lines around areas on a map.
Today, redlining can refer to a variety of discriminatory practices. For
© American Education Systems, LC
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Combination Course 1
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example, refusal to underwrite based on marital status or prior terminations
can be called redlining.
THE USES AND MECHANICS OF REGULATION
REVIEW QUESTIONS
1.
Four influences on insurance regulation are: legislation,
the federal government, judicial review, and the state
insurance bureau.
a. true
b. false
2.
The aim of state regulation is solely to preserve the
financial strength of insurance companies; issues of
fairness and consumer rights are only handled by the
local courts.
a. true
b. false
3.
Regulation is necessary, because human nature, the
dynamics of the insurance product, and the limits of
competition as a regulatory mechanism create an
environment in which consumers can be mistreated.
a. true
b. false
© American Education Systems, LC
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4.
Redlining is an example of unfair discrimination.
a. true
b. false
5.
One area that the federal government plays a role in
regulating insurers is through the ____________. This
organization regulates the sales of annuities.
6.
State insurance commissioners belong to an advisory
body called the
___________________.
This
organization work toward providing functional uniformity
in state regulation.
7.
Failing to state a material fact necessary to keep other
statements from being misleading is an example of
misrepresentation.
a. true
b. false
8.
The state regulation of insurance rates is an effort at
managed competition, and seeks to provide that rates
are not too high.
a. true
b. false
© American Education Systems, LC
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9.
Rating laws are uniform and mandated solely by the
state.
a. true
b. false
10.
Failure to remit insurance funds collected for an
insurance premium is an example of a prohibited trade
practice.
a. true
b. false
© American Education Systems, LC
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Combination Course 1
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ANSWERS TO REVIEW QUESTIONS
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
true
false
true
true
Securities and Exchange Commission (SEC)
National Association of Insurance Commissioners
(NAIC)
true
false
false
true
© American Education Systems, LC
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Combination Course 1
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NOTES
© American Education Systems, LC
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Chapter Two
Law and Insurance Contracts
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THE LEGAL CONTRACT
In using an insurance policy, the insured has transferred the risk of some peril
to an insurer. This is done through a contract. For the contract to be binding, it
must possess five basic elements. Without these elements being present, the
contract is without legal power, and is considered void
CONSIDERATION
For a contract to be binding, it must carry a consideration, or something of
value that is exchanged for the promise to perform some service or meet
some obligation. In insurance, a consideration is the insured’s promise to pay
the premiums specified in the contract, while the insurer promises to meet all
the obligations that the contract outlines in event of a loss.
COMPETENT PARTIES
A contract can only be considered valid if both parties are deemed
competent. The general test of competence is whether the parties are able to
understand the terms and obligations present in the contract. Generally,
adults are competent to enter an insurance contract. The mentally ill and
minors are usually excluded from entering contracts.
LEGAL PURPOSE
For a contract to be valid, it must not involve an illegal activity. Any act that is
deemed contrary to the general welfare is outside the boundaries of legal
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protection, and no court will uphold contractual claims that concern such an
activity.
ACCEPTABLE FORM
Binding contracts usually have to possess specific elements that are
designated by state law. Furthermore, if the state government has issued a
standard policy with standard provisions, any contract issued privately must
contain the same substance as the standardized contract. In addition, if a
state government requires filing and approval of a contract form, then any
issued contract must be filed and accepted by the state following the
appropriate legal procedures.
OFFER AND ACCEPTANCE
The final element that must be present in the formation of a contract is an
offer and acceptance. It is important to understand that both the offer and the
acceptance must be clear, definite, and without qualifications.
The formation of a contract for property insurance begins with an offer and
acceptance. The insurance agent may play the role of solicitor. In this case,
he or she invites a prospect to apply for insurance. The prospect fills out an
application, and the information in the application is used as information by
the insurance company for underwriting and identification. In applying, the
prospect is making an offer that the insurance company will accept or reject.
The offer and acceptance can be oral.
When dealing with property insurance, an accepted offer is usually handled
through a binder. This is really a temporary contract that serves in lieu of the
actual contract that will be ultimately issued with the policy.
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Again, a binder does not necessarily have to be written. Still, it is generally in
everyone’s best interest to obtain a written binder, as this provides more
accurate documentation.
Binders are used as a matter of convenience. A policy can take time to
prepare and issue, and a binder is a way for the insured to gain protection
immediately. It is important for the consumer to make certain that the agent
he is dealing with does indeed have the power to bind the company. Some
policies must be approved by the company, and there always exists the
potential of a confused (or unethical) consumer claiming coverage through a
binder when, in fact, none exists.
A binder should contain some basic elements. The names of the insurer and
the insurance should be present. The specific risk covered should be
identified along with the amount of insurance for limiting loss. The timeframe
of coverage needs to be stated, and it should also be stated that the binder
coverage only applies until the policy goes into effect. All applicable clauses
should be identifiable and apparent, and the binder must specify that the
insurance provided is subject to the terms in the policy.
With life insurance, binders are not applicable. All life insurance applications
must be in writing. Instead of a binder, life insurance makes use of a
conditional receipt, which is roughly analogous to the binder in property and
casualty insurance.
Like the binder, a conditional receipt is a temporary contract that obliges the
insurance company to provide coverage while the application is being
processed. A conditional receipt is issued with an application and an initial
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premium payment. It is not a guarantee that the insurer will accept the
application.
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THE LEGAL CONTRACT
REVIEW QUESTIONS
1.
For a contract to be binding, there must be clear
evidence of a (an)
.
2.
A (an)
is something of
value that is exchanged for the promise to perform
some service or meet some obligation.
3.
Whether the signee of a contract is capable of
understanding the provisions of the agreement is a
test of
.
4.
Generally, adults are competent to enter a legal
agreement, but the presence of mental illness may
invalidate that status.
a. true
b. false
5.
In many circumstances, minors are not deemed
competent to enter contracts.
a. true
b. false
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Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
6.
A contract that insures against loss from an illegal
activity is still a legally binding agreement if it is made
between competent parties and follows an
acceptable legal form.
a. true
b. false
7.
For a contract to be valid, it must involve a legal
activity, and it cannot provide coverage for actions
that are deemed detrimental to the public interest.
a. true
b. false
8.
For contracts to be enforceable, they usually must
follow an acceptable form.
a. true
b. false
9.
A (an)
is
a
temporary
contract, and provides the insured coverage while
the policy contract is being drawn up. It is used as a
matter of convenience.
10. In life insurance, binders are not used. The
temporary contract that is analogous to the binder is
the
, which states
that the insurance company will provide coverage
while the actual contract is being processed.
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
ANSWERS TO THE REVIEW QUESTIONS
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
offer and acceptance
consideration
competence
true
true
false
true
true
binder
conditional receipt
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
CONTRACT LAW SPECIFIC TO INSURANCE
CONTRACTS
INDEMNITY
Insurance contracts that handle property or liability risks are products
designed for indemnification of the contract holder. Indemnity is simply the
compensation of a loss. A contract of indemnity is an agreement on the part
of the insurer to restore the insured to their financial position prior to the loss.
It is vital to understand that one cannot profit from an indemnity contract. The
principle of indemnification is one of restoration, not gain.
Unfortunately, human nature is such that the insurance company must
actively guard the integrity of the indemnity principle. To achieve this aim,
both legal devices and policy provisions are employed.
INSURABLE INTEREST
The principle of insurable interest is a legal doctrine that maintains a contract
is only legally binding when an interest is insurable. For example, one could
not insure the property of another, hope for (or cause) damage, and then
subsequently collect on the contract. This would represent a gain for the
insured that had suffered no actual loss.
For an interest to be insurable, the insured must have an aspect of ownership
in that which is to be insured, because the insured must suffer harm should a
loss occur. By protecting the principle of indemnity, the insurance industry is
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promoting the public welfare, and protecting society from gambling and moral
hazard.
ACTUAL CASH VALUE
The way that a property loss is indemnified is to make use of the principle of
actual cash value. Actual cash value can be arrived at by subtracting the
depreciation level from the replacement value of the property in question. The
actual cash value is what the insurance company will pay the insured for their
loss, regardless of the amount of insurance that has been purchased.
The principle of cash value is so very important because, like the principle of
insurance interest, it helps to protect the public. Without the application of
actual cash value as the basis for indemnification, it would be possible for an
insured to purchase a great deal of insurance protection and then destroy the
property in order to realize a financial gain.
PRO RATA LIABILITY
Pro rata liability is a policy clause designed to protect the indemnity principle
of the contract. This clause protects against an insured profiting from a loss
by using several insurance companies to cover a single loss. Instead of
receiving the actual cash value of the loss from all of the insurance
companies for a total payment greater than the cash value, only the actual
cash value is paid out. The various insurance companies only pay an
appropriate percentage based upon the percentage of insurance that they
have written on the policy.
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Combination Course 1
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SUBROGATION
Subrogation is an important policy provision to understand. It is a device that
not only upholds the principle of indemnification, but advances the public
welfare by holding the negligent part responsible for an incurred loss. In
addition, it also helps in controlling the price of insurance.
Subrogation is a policy provision that is a surrender of rights against a third
person by the insured. These rights are then transferred to the insurance
company. In the event of a loss, it will be the insurance company that will take
legal action. This prevents the insured from profiting from a loss by only
allowing the insured to receive an indemnity payment; legal action cannot be
taken to sue the injuring third party to gain still more money.
The insurer, however, can pursue the third party and see to it that the
individual that caused the loss will be held accountable. The monies that are
won from such cases then flow to into the insurance company’s account and
help defray the cost of insurance for everyone.
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CONTRACT LAW SPECIFIC TO INSURANCE
CONTRACTS
REVIEW QUESTIONS
1.
One term for the compensation for an insured’s loss
is called
.
2.
An indemnification is a return of the insured to their
approximate financial position before a loss occurred.
a. true
b. false
3.
The principle of indemnification can present the
insured with the possibility of a financial gain.
a. true
b. false
4.
Because of the danger of dishonesty, the principle of
indemnity must be guarded by the insurance
company through specific policy provisions and legal
devices.
a. true
b. false
5.
The principle of
maintains that a contract is only legally binding when
an interest is actually insurable.
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
6.
By protecting the principle of indemnity, the principle
of insurable interest guards the public interest by
helping limit moral hazard.
a. true
b. false
7.
A property’s actual cash value is usually the same as
its current retail market value.
a. true
b. false
8.
The
is the amount of
money that the insurance company will pay the
insured in the event of a loss.
a. true
b. false
9.
Pro rata liability is a policy clause that protects
against an insured profiting from a loss by obligating
several insurance companies to cover a single loss.
Instead of receiving payment of the actual cash value
of the loss from ALL of the insurance companies for
total that would be LARGER than the actual cash
value, each company pays only a percentage of the
losses’ actual cash value.
a. true
b. false
© American Education Systems, LC
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Combination Course 1
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10. Subrogation is a policy provision that is a surrender
of rights against a third person by the insured to the
insurance company.
a. true
b. false
© American Education Systems, LC
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Combination Course 1
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ANSWERS TO REVIEW QUESTIONS
1. indemnity
2. true
3. false
4. true
5. insurable interest
6. true
7. false
8. actual cash value
9. true
10. true
© American Education Systems, LC
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Combination Course 1
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FURTHER CHARACTERISTICS OF INSURANCE
CONTRACTS
PERSONAL NATURE OF THE CONTRACT
An insurance contract is a contract between an insured and an insurer. While
one insures property against a loss, the contract does not adhere to the
property itself, but to the individual and his or her relationship to the property.
Thus, if one were to sell his or her condominium, the insurance coverage
would not be included in the sale.
UNILATERAL CONTRACT
In most commercial contracts, both parties exchange something of value.
Insurance contracts, on the other hand, are characterized by their unilateral
nature. This means that only one of the two parties has promised to provide a
service or pay a claim.
CONDITIONAL NATURE OF THE CONTRACT
A conditional contract is one in which the provisions of the agreement only
have to be met within specified conditions. Typically, this means that the party
that has promised to provide services is only obligated insofar as the
beneficiary of the services meets stated conditions.
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Combination Course 1
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Conditions are really a set of duties. The policy contract with conditions does
not legally force the insured to meet the stated conditions, but the insurer
need not meet their obligations if the conditions of the contract have not been
fulfilled.
ALEATORY CONTRACT
Insurance contracts are aleatory contracts. As such, they are different from
commutative contracts that are typical with most commercial arrangements. A
commutative contract specifies the conditions of what is to be an exchange of
(presumably) equal value. The exchange can be in the form of goods or
services. An aleatory contract, on the other hand, specifies the conditions of a
transaction that is not necessarily an equal value exchange.
This “unequal” exchange occurs in insurance contracts when the policy
provides more in benefits than the total of the premiums that were paid. This
situation can certainly happen in life insurance. On the other hand, many
property insurance contracts never pay a benefit, because a loss never
occurs during the time of coverage. In this case, it is the insurance company
that enjoys the “better deal” in the contract.
It is important for both parties to understand the nature of an aleatory
contract. In our example of the insurance company “making out” in a property
insurance contract that never pays out a benefit, one should keep in mind the
benefits that the insured received while paying their premiums: confidence
that their property was protected, meeting any mandated financial
responsibility laws, and protection of their property’s value.
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One might ask, if the insured and insurer know that the probability of a loss
occurring is actually quite low, are they not simply employing a gambling
strategy? Could not one call aleatory arrangements simply elaborate games
of chance?
Certainly, chance is at the basis of all aleatory contracts. This is not surprising
or unusual, however, for we have already defined insurance as a method of
dealing with risk, and defined risk as uncertainty regarding the chance of loss.
What is important to understand is that while all gambling arrangements must
be aleatory, not all aleatory arrangements are gambling.
The difference between a pure gambling arrangement and an aleatory
contract is the intent. Gambling is done to realize gain; an aleatory contract is
made to guard against loss. An aleatory contract is an acknowledgment of the
risk that is a part of normal life, not the deliberate seeking out of additional
risk for the possibility of reaping a profit.
CONTRACT OF ADHESION
A contract of adhesion is one in which the provider of the service writes the
contract, and the receiver accepts or rejects it. In the case of insurance, the
insurer presents the contract to the prospect, and the prospect accepts the
entire contract or refuses it.
Although the substantive nature of the contract cannot be changed, elements
can be amended by the use of forms and endorsements. Even so, these
amendments are still essentially controlled by the insurance company. Like
the contract itself, the amendments are presented to the insured by the
company to be accepted or rejected.
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
Because the insurer has the advantage in setting the groundwork of the
insurance agreement, the insurance contract is treated as a contract of
adhesion. This means that any area of ambiguity in the contract tends to be
decided in favor of the insured.
It should be mentioned, however, that this propensity to favor the insured in
court has limits. Only circumstances when the contract (or application) is
unclear favor the insured. A lack of understanding, or improper interpretation
of the meaning of the contract by the insured, do not obligate a court to favor
the insured. The strict compliance nature of a contract of adhesion is meant to
be a protection to the insured, but not a free ride or a door for abuse.
UBERRIMAE FIDEI (utmost good faith) CONTRACT
Insurance contracts are considered uberrimae fidei contracts, or contracts of
utmost good faith. This means that the parties to the contract operate on a
high level of trust and honesty, and that all relevant information has been
disclosed in an appropriate and timely manner. It also means an honest intent
to meet the obligations of the contract exists in both parties.
The purpose of defining an insurance contract as a contract of utmost good
faith is to underline the necessity of trust that must be present in any
insurance arrangement. Without complete and accurate information, the
actuarial principles upon which insurance is based become little better than
empty promises, and the industry cannot perform its function.
Because of the necessity of accurate information, any false statement made
by an individual applying for an insurance contract can lead to the insurers
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
canceling the contract. Information that is knowingly concealed is also
grounds for voiding an insurance contract. Neither misrepresentation nor
concealment can be tolerated by an insurance company, as their
consequences are so damaging to every concerned party.
© American Education Systems, LC
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Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
FURTHER CHARACTERISTICS OF INSURANCE
CONTRACTS
REVIEW QUESTIONS
1.
A property insurance contract is a personal contract,
and as such cannot be assigned without the consent
of the insured.
a. true
b. false
2.
A property insurance contract cannot be assigned
because the assignment could cause a substantially
greater risk to the insurer.
a. true
b. false
3.
While commercial contracts are generally bilateral
agreements, insurance contracts are typically
unilateral.
a. true
b. false
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4.
Insurance contracts generally carry a list of
conditions that must be met in order for the insurer to
provide the promised service.
a. true
b. false
5.
The insured legally must meet the conditions
specified in an insurance contract.
a. true
b. false
6.
Insurance contracts are unilateral, which means that
the conditions of the transaction are not necessarily
characterized by an equal exchange of equal value.
a. true
b. false
7.
An aleatory contract is not a gambling arrangement
because it is not formed with the intent of realizing a
gain, rather it seeks to guard against a loss.
a. true
b. false
8.
In a contract of adhesion, the terms and language of
the agreement are worked out through the
negotiation of both parties.
a. true
b. false
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Combination Course 1
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9.
In a contract of adhesion, any area of ambiguity is
usually decided in favor of the insurance company.
a. true
b. false
10. An uberrimae fidei contract is a contract of “utmost
good faith,” which means that both parties to the
contract are expected to operate on a high level of
trust and honesty.
a. true
b. false
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
ANSWERS TO THE REVIEW QUESTIONS
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
false
true
true
true
false
false
true
false
false
true
© American Education Systems, LC
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Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
Chapter Three
Automobile Insurance and the Auto
Policy
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Combination Course 1
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AUTOMOBILE INSURANCE AND THE PERSONAL
AUTO POLICY
INTRODUCTION TO AUTOMOBILE INSURANCE
The automobile has been called "the machine that changed the world.” This is
a very accurate description of the power that the motor vehicle provides. The
personal passenger car gives one unprecedented freedom. With the modern
automobile, one can make a journey in a matter of hours that would have
taken the 19th century American pioneer weeks. On a whim, one can use the
automobile to make a trip that would have required major planning and
expense during the horse and buggy era.
Because the freedom that the automobile provides is so desirable, it has
dramatically changed the economic landscape. Automobile production and its
supporting industries led the growth of American industry for most of the
twentieth century. The demand for automobiles has been so strong that today
it is by far the most common form of transportation in the United States.
With this freedom, however, comes responsibility. There are very real risks
associated with driving. Furthermore, the rapid growth of the total number of
vehicles on America’s roads has increased the dangers that the American
motorist faces.
It is shocking to note that any given year will produce nearly as many
American fatalities from automobile accidents as occurred during the entire
course of the Vietnam War. This loss of life is simply catastrophic. With the
loss of life comes the accompanying pain and sorrow.
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Combination Course 1
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There is also a steep material cost to automobile accidents. The high rate of
loss costs untold billions in property damage, loss of productivity, and legal
expenses.
Yet, the lure of the automobile's freedom and mobility keep Americans tied to
their automobiles. The power of the auto simply outweighs the potential
dangers. The pace of life in America is such that we can expect to see more,
rather than fewer, automobiles on the highways.
To meet the inherent risk of the motor vehicle, the insurance industry has
developed the automobile policy. Today, the personal auto policy (PAP) is
employed. This policy largely replaces the older family auto policy (FAP) and
special auto policy (SAP). Naturally, it has gone through a number of
revisions since its inception. These changes reflect the fluid legal and
sociological environment of the automobile. The present form is the most
readable and "user friendly" auto policy to date.
Still, the auto policy is a complex and difficult document, combining three
forms of insurance-accident, property, and liability-into a single policy. In fact,
most states require their drivers to have some type of auto insurance.
Mandatory auto insurance is result of a state’s financial responsibility laws. By
requiring motorists to demonstrate ability to pay for auto-related losses, the
general welfare is protected. As one finds it hard to live without an
automobile, it is hard to drive without auto insurance.
BASIC STRUCTURE OF THE AUTO POLICY
Today’s personal auto policy has a defined structure. It begins with a
declarations page, which provides information about the property to be
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Combination Course 1
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insured. This is usually followed by a definitions page.2 Here, the important
terms in the contract are listed and defined in an outline form. Often, these
terms are then bolded or bracketed throughout the remainder of the policy in
order to call one's attention to them. Typical examples of definitions in auto
policy include the following:
 “named insured”—Means the individual name in the
declarations and also includes the spouse, when the spouse is
a resident in the same household
 “relative”---Means a person related to the named insured by
blood, marriage or adoption who is a resident of the same
household (provided that neither such relative owns a private
passenger auto). The definition of relative can include minors
while away from home or attending an educational institution
 “automobile”—Means a four wheel motor vehicle with a wheel
base of 56 inches or more designed for use primarily on public
roads
 “owned automobile”—Means a private passenger, farm, or
utility automobile described in the policy; a trailer owned by the
insured; a temporary substitute automobile
 “non-owned automobile”—Means an auto or trailer not
owned by or furnished for the regular use of either the named
insured or any relative, other than a temporary substitute auto
 “private passenger automobile”—Means a four-wheel private
passenger, station wagon, or jeep-type automobile
 “farm automobile”—Means an automobile of the truck type
with a load capacity of two thousand pounds or less and is not
2
A common alternative is to list the definitions after each section of the policy.
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Combination Course 1
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used for business or commercial purposes (except, of course,
farming)
 “utility automobile”—Means an automobile, other than a farm
automobile, with a load capacity of fifteen hundred pounds or
less of the pick-up body, sedan delivery, or panel type truck not
used for business or commercial purposes
 “use”—Means operation, loading, and unloading of the vehicle
In order to make the policy more readable and accessible to the policyholder,
the auto policy uses fewer words and less complicated sentences than most
contracts. In addition, the insured is referred to as "you" and "your.” The
insurer is referred to as "we" and "us" and "our.” By eliminating much of the
"legalese" of the contract, the insurance industry has made an important step
in empowering the consumer. Better consumer understanding of the
parameters of the insuring agreement is not only a benefit for the general
public, but for the insurance industry as well.
The auto policy typically consists of six parts that form the content area of the
contract. These six parts can be labeled I, II, III, etc. or A, B, C, etc. The first
four parts concern the specific coverages. This is what the consumer buys
while they form a totality within the policy. Each part is a separate coverage
with individual provisions, exclusions, and premiums.
The final two parts of the auto policy apply to the contract as a whole. These
parts discuss the duties of the insured and the general operational framework
of the contract, such as what occurs if there is a change in the information
used to create the policy, or how a policy may be terminated.
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
LIABILITY COVERAGE
Liability coverage is the first and most important part of the contract. It is the
contract's most difficult and complicated section. It is also a coverage that
is required by law. The liability portion of the auto policy possesses two
components: bodily injury liability, and property damage liability. These
parallel coverages perform the following: payment, on the behalf of insured, of
all sums that the insured becomes legally obligated to pay as damages
because of bodily injury or property damage arising out of the ownership,
maintenance, or use of the owned automobile or any non-owned automobile.
This part of the auto policy will also a series of supplementary payments.
Supplementary payments are a provision in a liability policy that pay for
specific aspects of the insured’s expenses. Supplementary payments in the
auto policy typically include the following:

All expenses incurred by the insurance company, all costs taxed against
the insured in a lawsuit; this includes interest that accrues after a
judgement is entered.

Premiums on appeal bonds and bonds to release attachments in any suit
the insurance company defends (up to $250).

Up to $200 for loss of earnings because of attendance at hearings or trials
at the insurance company’s request.

Expenses incurred by the insured for immediate medical and surgical
relief to others that is imperative at the time of an occurrence involving an
insured automobile
Of course, there are specific limitations to these benefits listed explicitly in the
contract. Should damages exceed the policy limit, the insurer will not be held
legally accountable for the excess amount. The insured benefits only along
the lines of the contract's terms.
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Combination Course 1
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The consumer often has little or no understanding of this concept. Even
though a liability limit has been stated and agreed upon, some consumers are
under the mistaken impression that being insured—especially in the era of
no-fault--means that they are "covered for everything.” It is vital that they
understand that this is simply not so. Should damages resulting from an
accident exceed the policy limit, the insured, and not the insurer, has the
responsibility of paying for these damages.
It is also significant to note that the insurer will defend the insured only up to
the limits of the policy's liability. The insurer also maintains the right to settle
the suit in the manner it deems fair and correct. Such settlements are not
always to the insured's satisfaction.
Most states demand a minimum amount of liability insurance, but these
minimums have proven to be far too low to meet the costs of typical
judgments. This is an unfortunate situation because higher liability limits need
not grossly increase the cost of a consumer's premium. Unfortunately, the
cost-averse natures of many persons leads them down a path of minimum
liability limits in the auto policy, causing them to carry more risk than they
should.
The liability coverage in an auto policy can be designed in one of two ways.
The coverage can be written with a single limit. Under this variation, a single
amount of coverage is available to apply as needed, and this can be used for
bodily injury or property damage.
A second method for writing liability coverage is the split limits form. This
method is both more flexible and more complicated. The insurance
arrangements for property damage and for bodily injury are considered
separately, handled separately, and stated separately. One of the major
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Combination Course 1
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criticisms of the split limits arrangement is that the entire coverage cannot be
used, and the minimum amounts are often insufficient.
For example, a state may set the liability limits of a split limits personal auto
policy are 20/40/10, meaning that there is $20,000 of coverage available for
each person, and $40,000 for each accident. There is also $10,000 for
property damage in per accident. When one stops to consider the current
costs of medical services or motor vehicles, it is easy to see why many
insurers are critical of the split limits plan. It provides a false sense of security
on the part of the consumer that is a benefit neither to the general public nor
to the insurance industry.
PERSONS COVERED
The liability coverage of the auto policy provides strict limitations on who is
covered. Obviously, the named insured is covered. This is the "you" referred
to in the policy. But "you" here also includes one's spouse. In addition,
family members are covered under this agreement. To be considered a family
member, there must be relation by blood, marriage, or adoption. Residence in
the same home is another way to convey a familial relationship, as in the
case of a ward of the family.
Also, any person using the insured's auto is covered provided that there is
reasonable belief that permission was given. This coverage also extends to
any individual or organization that is legally responsible for the acts of an
insured while using the insured's auto. An example of this type of situation
refers to when an insured's automobile is used during working hours for
errands, and an accident occurs. The insured and the employer are both
covered.
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Combination Course 1
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VEHICLES ELIGIBLE FOR COVERAGE
With automobile coverage, one must be specific about the type of vehicle that
is being covered. Most, but not all, varieties of four wheeled motor vehicles
are eligible for this coverage.
First, the auto policy refers to motor vehicles with four wheels. The passenger
car is the most typical and obvious vehicle in this group. But jeeps, pickup
trucks and vans are also eligible, provided they meet some specific criteria.
They cannot, for example, be used primarily as transport vehicles for a
company's materials when those materials are primary to the business. The
van or pickup also cannot have a gross weight of more than a figure specified
in the policy and still be eligible for this coverage.
As for as what specific vehicles can be considered "covered vehicles,” four
possibilities exist. First, any vehicle listed in the declarations page of the
contract is covered. This is obvious, and does not have to be elaborated. But
what happens if one buys a new vehicle that is eligible for coverage? If it is
purchased while the auto policy is in effect, then it is considered an additional
vehicle and is automatically covered. The coverage provider is the broadest
coverage available, but certain stipulations exist for this arrangement to
continue.
To begin with, the insured must tell the company that an additional auto has
been purchased. Secondly, a premium must be paid to continue coverage.
The insurance for the second vehicle will not come free of charge.
If the insured purchases a new auto that replaces an old auto that is already
covered, then the coverage that already exists extends to the new vehicle. If
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the insured wants to add or maintain physical damage insurance, then the
insurance company typically must be notified within 30 days.
Two other possibilities exist where a vehicle can be considered covered. A
temporary substitute auto is a covered vehicle. This situation applies when
one is using a company's auto because the owner's auto is being repaired,
recovered after a theft, or replaced.
Lastly, a trailer, while not an auto in the strict sense of the word, can be
considered a covered vehicle for insurance purposes. The type of trailer is
one designed to be attached to a passenger auto, van, or pickup. Typically, a
“heavy duty” truck trailer intended for commercial purposes is excluded.
EXCLUSIONS TO THE LIABILITY COVERAGE
Exclusions are the perils, losses, and properties listed in an insurance
contract that will not be covered. Exclusions are necessary, because the
actuarial principles used in assigning premium rates refer to specific
information about calculated risk levels.
Also, not all risks are the same. The risk of the personal auto used for normal,
day-to-day travel is much different than that of a taxi, and both the taxi and
personal auto are exposed to different risks than a vehicle that is primarily
an off-the-road, recreational vehicle.
To attempt to provide insurance coverage for three disparate risks would
result in inadequate premiums for the insurer. Ultimately, this situation could
lead to the insurer being unable to meet its financial obligations. Also at stake
is fairness! For the three different risks to share the same premium level, the
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risk at the lowest end of the spectrum would be unfairly supplementing the
risk that encounters a greater level of hazard.
Because of the complexity and variable nature of risks, exclusions in the auto
policy are legion. It is important that the agent explains the concept of
exclusions to the insured, and reviews the important exclusions that affect his
or her policy coverage. Some typical exclusions in the liability portion of the
auto policy include the following:
Basic Auto Insurance Exclusions
1. The insurer will not provide coverage for any injuries or damages that are intentionally caused. Intentional
losses are not fortuitous loss, and receive no indemnification.
2. The insurer does not cover the additional property of the insured, whether it is personally owned or merely
transported. The motor vehicle is the only property that receives coverage .
3. Any property in the insured's care or for the insured's use is not covered. This includes rental property.
4. The auto policy does not supplant or supplement workers compensation laws. Employees injured during
employment hours are not covered under the auto policy.
5. With the exception of car-pooling and ride-sharing programs, the auto policy does not extend coverage
when one is carrying passengers for a fee.
6. The auto policy cannot take the place of liability insurance for a business that is centered on the servicing,
repairing, selling, parking or storing of automobiles. Vehicles used in such a business are not covered
under the auto policy.
7. The auto policy does not apply when reasonable belief exists that a covered vehicle was used without the
owner's permission.
8. Vehicles that are provided for use of a covered person are excluded when they are not the covered
vehicle, and when they are provided on a regular, consistent basis
9. Liability coverage also does not extend to vehicles furnished for regular use to a family member (except
for a spouse), or when the vehicle is a temporary substitute.
10. Vehicles with less than four wheels are excluded without a miscellaneous-type vehicle endorsement. The
auto policy by itself is limited to four wheeled vehicles.
© American Education Systems, LC
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Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
GEOGRAPHICAL BOUNDARIES OF LIABILITY COVERAGE
In addition to financial limits of liability, the personal auto includes some
geographical limits. This is handled in the out-of-state coverage component of
the auto policy. The auto policy allows for coverage in all fifty states, Puerto
Rico, and Canada. The auto policy automatically covers the insured to the
necessary state minimums if the insured's policy is below those minimums.
This way, one need not purchase "extra insurance" every time he or she visits
or travels through another state.
NOTES
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
LIABILITY COVERAGE
REVIEW QUESTIONS
1. Most states demand a minimum amount of liability
insurance. Unfortunately, these minimums have seldom
proved to be adequate.
a. true
b. false
2. Liability coverage is that part of the auto policy
that protects one against the negligent ownership and
operation of an automobile.
a. true
b. false
3. In a personal auto policy, the “named insured” is
typically defined as the individual named in the policy’s
declarations, plus the spouse (if the spouse is a
resident of the same household).
a. true
b. false
4. An auto policy with split limits liability of 200/400/100
would mean there is $200,000 of coverage for each
ACCIDENT, $400,000 of coverage for each PERSON,
and $100,000 of coverage for PROPERTY DAMAGE.
a. true
b. false
© American Education Systems, LC
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5. The supplementary payments applicable to a liability
policy can include premiums on appeal bonds and
interest that accrues after a judgment is entered in any
suit that the insurance company defends.
a. true
b. false
6. The auto policy refers only to passenger vehicles such
as automobiles. Jeeps and vans can be covered, but
only under a special endorsement.
a. true
b. false
7. When a new auto is purchased, the coverage that was
already in effect carries over to the new vehicle. If
physical damage insurance is desired, one must notify
the insurance company within 30 days.
a. true
b. false
8. Trailers, most utility vehicles, and all farm vehicles are
excluded coverage under the typical personal auto
policy.
a. true
b. false
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9. The liability section of the personal auto policy is only in
force in the continental United States. The coverage
does not extend to Alaska, Hawaii, Canada, Puerto
Rico, or Mexico.
a. true
b. false
10. If the insured is involved in an accident in a state with
higher liability minimums than present in the insured’s
auto policy, the insurance company automatically
expands coverage to meet the minimum limits.
a. true
b. false
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
ANSWERS TO REVIEW QUESTIONS
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
true
true
true
false
true
false
true
false
false
true
© American Education Systems, LC
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Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
MEDICAL PAYMENTS COVERAGE
The second portion of the auto policy, Part B, is the medical payments
coverage. Some insureds will reduce the cost of their premium by
coordinating this coverage with their health and disability coverage. In these
cases, their insured’s medical insurance will pay up to a certain limit, and the
auto policy covers the remaining amount. Typically this is done with
coverages termed excess medical and excess wage loss.
The medical payments insurance section in an auto policy is an agreement on
the part of the insurer to pay all reasonable expenses incurred for necessary
medical services because of bodily injury suffered by an insured. The benefits
extend to injuries sustained in any state. The company will pay for expenses
incurred by an insured within three years of the date of the accident.
The medical payments coverage will pay regardless of which party is at fault
in the accident. In this sense, it is a no-fault coverage. The benefit limits
typically range no higher than $10,000, but cover a wide range of treatments,
including surgery, X-rays, and dental work.
The medical payments coverage also pays for any funeral services that result
from an accident. Again, the payments occur within the level of the named
amount of benefit limits. This is an important element of the medical
payments coverage, because most health policies do not cover funeral
expenses.
There are two groups covered under the medical payments section. The first
is the insured and any family member injured while in a motor vehicle. Also
within this first class are persons other than family members who are injured
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while in a covered motor vehicle. If the insured drives any non-owned vehicle
and suffers an accident, however, only the insured and his family members
receive coverage through the auto policy. All other passengers are excluded
from this coverage under the auto policy.
The second group of covered persons under the medical payments coverage
includes the insured and his or her family members as pedestrians. They are
covered if they suffer bodily injury from a road vehicle. A "road vehicle" here
means autos, pickups, vans, and trucks. But, an off-road recreational vehicle
could cause an injury to the insured's wife, but this would not be covered.
EXCLUSIONS TO THE MEDICAL PAYMENTS COVERAGE
As with liability coverage, there are many exclusions to the medical
payments agreement in the auto policy.
1.
Injuries occurring while riding motor
vehicles with less than four wheels, such
as the mopeds that are so popular
on college campuses, are excluded.
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2. When carrying persons for a fee, the
medical payments coverage does not
apply, except in the context of a carpool.
3. If
the insured suffers injury while
occupying a motor vehicle regularly
furnished for his or her use, medical
payments coverage do not apply.
4. Medical
payments coverage is also
excluded to vehicles furnished for regular
use by any family member, other than
the covered auto.
5. Medical payments are not extended to
those who have used the motor vehicle
without reasonable belief that the insured
gave permission.
6. Injuries sustained while using the motor
vehicle as a residence are excluded from
coverage.
7. Injuries caused while working one's job.
Again, this is a situation for workers
compensation laws, and not the auto
policy.
8. Injuries caused by the use of nuclear
weapons or
excluded.
a
nuclear accident
are
There are several other limitations that apply to medical payments in
the auto policy. We have mentioned the first two in passing, but it is
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significant enough to be brought up again: the amounts payable are listed in
the insurance agreement and generally range up to $10,000. Also, this is an
optional portion of coverage that must be selected by the insured in order to
be in force.
When payments are made for medical expenses by more than one company,
the payment is on a pro rata basis. Lastly, medical payment recoveries are
subject to subrogation clauses in the policy.
© American Education Systems, LC
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Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
MEDICAL PAYMENTS COVERAGE
REVIEW QUESTIONS
1. Since medical payments coverage under the auto
policy is not required by law, many insureds choose not
to carry this kind of coverage so they can reduce their
premiums.
a. true
b. false
2. The medical payments coverage of the auto policy is
designed to pay for medical expenses incurred for an
auto accident within three years of the date of the
injury.
a. true
b. false
3. Part B of the auto policy only pays for medical
expenses; funeral costs are never covered.
a. true
b. false
4. Under Part B of the auto policy, the insured and his or
her family members are covered for injuries suffered
while driving a non-owned vehicle, but other
passengers are not covered.
a. true
b. false
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5. The medical sections part of the auto policy also
covers the insured and his or her family if they are
injured as pedestrians as long as the injury was
incurred by a road vehicle.
a. true
b. false
6. An injury sustained while using the motor vehicle as
a residence are excluded from the medical payments
section of the auto policy.
a. true
b. false
7. In most cases, an injury caused by an auto accident
while one is working their job is excluded from
coverage under the personal auto policy, because
_________________ takes precedence over the auto
policy.
8. An injury suffered while driving a moped is covered
under the auto policy, but an injury suffered while
driving a motorcycle is excluded.
a. true
b. false
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9. Since medical benefits are extended to anyone driving
a covered auto, a car thief could theoretically claim
benefits from an injury suffered while driving a stolen
auto.
a. true
b. false
10. If an injury is suffered by an insured with more than
one policy, the benefit is paid on a pro rata basis.
a. true
b. false
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
ANSWERS TO REVIEW QUESTIONS
1. false
2. true
3. false
4. true
5. true
6. true
7. workers compensation
8. false
9. false
10. true
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UNINSURED MOTORIST COVERAGE
When people act irresponsibly and drive motor vehicles without insurance, a
major risk exposure is created. Few people have sufficient personal
resources to pay for damages caused in auto accidents. Because the
potential cost to society would be catastrophic if restitution for auto accidents
was easily avoidable, each state has taken serious measures to try and
control this situation. Typically, these actions are found in the passing of
financial responsibility laws that demand some basic forms of insurance
coverage.
Despite the best efforts of legislators and regulators, however, the problem
continues. To protect one from an injury caused by an uninsured motorist, a
hit-and-run driver, or a negligent driver insured by an insolvent company, the
insurance industry offers (an optional) uninsured motorists coverage.
The purpose of this kind of coverage is to pay the amount the insured would
have received if the situation had been "normal," and the uninsured driver
was insured or the insuring company was not insolvent. This is the basis of
settlement for this coverage, but there is often disagreement between the
insurer and the insured on the amount paid out. Often, this is a situation that
goes to arbitration. When this occurs, the insured and the company each
choose an arbitrator. The two selected arbitrators choose a third, and the
decision reached by two of the three is binding, providing the damage award
does not exceed the state's minimum financial responsibility law limits.
The damages that the insurance company compensates the insured for can
include medical bills, lost wages from time missed at work, and compensation
for physical disfigurement. It is important to note that damages can be
pursued only in those cases where the uninsured motorist can be
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demonstrated to be legally liable. Uninsured motorist coverage is firmly
locked into the tort liability system.
Those covered under the uninsured motorists section of the auto policy are as
follows: the named insured and family; any other person in the insured's auto;
any person who is legally entitled to receive payment for damages. The last
situation occurs when a family member is lost due to a car accident. The wife,
husband, etc. can pursue damages even though they were not there when
the accident occurred.
EXCLUSIONS TO THE UNINSURED MOTORISTS COVERAGE
The exclusions to the uninsured motorists coverage are divided into
two groups. The first handle exclusions based upon the vehicle. The second
concern exclusions based upon actions or situations.
1. Vehicles that do not have uninsured
motorists coverage.
2. Vehicles owned or operated by self-
insurers or government bodies.
© American Education Systems, LC
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UNDERINSURED MOTORISTS COVERAGE
3. Farm equipment, off-road vehicles, rail and
crawler tread vehicles are excluded.
4. Any auto used for a fee, except in the case
of a carpool.
5. If the insured settles with the negligent
party without the insurer's consent, the
coverage does not apply.
6. The
uninsured motorists coverage is
excluded if it provides benefits for a
workers compensation insurer. The auto
policy cannot act as a supplement to
workers compensation insurance.
7. The
uninsured
motorists
coverage
provides no benefits to a person operating
the vehicle without reasonable belief that
he or she has the owner's permission.
If one has opted for uninsured motorists coverage, they can also add
underinsured motorist coverage. This creates a very complete form of
automobile coverage, without significantly increasing the premium.
This form of coverage is designed to provide insurance against accidents
caused by a motorist who has liability coverage, but whose coverage will not
be sufficient to meet the costs of the bodily injury incurred. This compensates
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for other motorists who may have elected liability minimums due to lack of
personal resources or poor planning.
The underinsured motorist coverage is usually written for the same limit as
the uninsured motorist coverage, and it usually pays the remaining difference
left after the negligent driver has paid whatever portion of the damages they
could. Uninsured and underinsured motorist coverage cannot overlap in any
way; the insured can collect on one of the two coverages, but not both. Like
uninsured motorists coverage, it is subject to arbitration. The arbitration
process is the same as for an uninsured motorist coverage claim.
© American Education Systems, LC
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Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
UNINSURED MOTORIST COVERAGE
REVIEW QUESTIONS
1. Uninsured motorist coverage is a mandatory
supplement to no-fault; its sole purpose is to cover hitand-run situations.
a. true
b. false
2. The idea behind uninsured motorist coverage is to pay
the amount of benefits the insured would have received
if the uninsured driver had been insured.
a. true
b. false
3. A situation in which a motorist could receive payment
for compensatory damages is when an injury accident
occurs with a party whose insurance company is
insolvent.
a. true
b. false
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4. The damage award named through arbitration can be
quite substantial, but it cannot exceed the state's
minimum financial responsibility law limits.
a. true
b. false
5. Uninsured motorist coverage pays the insured for all
medical bills, lost wages, and physical disfigurement
caused by a automobile accident with an uninsured
driver, but only when the other driver can be shown to
be legally liable.
a. true
b. false
6. Unlike uninsured motorist coverage, underinsured
motorist coverage is never subject to arbitration.
a. true
b. false
7. If one chooses uninsured motorist coverage, then
underinsured motorist coverage can be purchased as
well. This coverage is designed for situations when an
accident occurs with a driver who has insufficient
insurance coverage.
a. true
b. false
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8. In certain instances, an insured can collect damages
from both the uninsured and underinsured sections of
the auto policy.
a. true
b. false
9. Underinsured motorist coverage is usually written for
the same limit as uninsured motorist coverage and
pays difference left from the underinsured driver's
insurance.
a. true
b. false
10. Exclusions to the uninsured motorist section of the auto
policy are never based upon the vehicle; rather, they
concern exclusively the actions of the participants in
the accident.
a. true
b. false
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
ANSWERS TO REVIEW QUESTIONS
1. false
2. true
3. true
4. true
5. true
6. false
7. true
8. false
9. true
10. false
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PHYSICAL DAMAGE COVERAGE
Part D of the auto policy concerns coverage for physical damage to the
insured's motor vehicle. It is broken into two parts, collision and other-thancollision (usually referred to as comprehensive). Both of these are separate
coverages, written with separate deductibles. Neither needs to be included in
the auto policy. Thus, an insured that has a motor vehicle that is quite old
might opt for no collision insurance. Or, one might opt for collision insurance
with a high deductible and pass on the other-than-collision insurance. It is
entirely up to the consumer, but it is vitally important that the consumer
understand that he or she will only receive collision insurance and other-thancollision insurance if these coverages have been chosen and appear in the
contract. Many consumers erroneously believe that an auto policy
automatically provides physical damage coverage.

Collision Coverage
Collision coverage affords payment by the insurer for any loss to a covered
auto, less the deductible. Collision loss is defined as the loss or damage of
the policyowner's covered auto or nonowned auto. The damage or loss can
occur through impact with another auto or an object. This impact could occur
when the auto is running, as on the open highway, or it could occur while the
auto is stationary in a parking lot.
Collision loss can be paid regardless of who is at fault; in this case, liability is
not the issue. If, however, the insured is not liable for the accident and
collects a collision benefit, he or she must give up subrogation rights to the
insurer. In doing so, one secures the possibility of regaining part or all of their
deductible, depending on whether the company wins the court decision. Also,
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the principle of indemnity is secured, as the insured will not collect from the
insurer and the negligent party.
VARIETIES OF COLLISION COVERAGE
1) Limited Collision
Pays damages caused by collision (with another vehicle or a
stationary object) IF the driver of the insured vehicle is NOT more
than 50% (“substantially”) at fault. This coverage does not pay any
damages should the insured be more than 50% at fault.
2) Standard (or Regular) Collision
Pays collision damages on the insured vehicle REGARDLESS of
which party is at fault. However, the insured must pay the
deductible.
3) Broad Form Collision
Pays for collision damages on the insured vehicle REGARDLESS
of who caused the accident. IF the insured is NOT more than 50%
at fault, the insured does not have to pay the deductible. However,
if the insured must pay the deductible when more than 50% at
fault.

Other-Than-Collision Coverage
As the name implies, other-than-collision coverage handles physical damage
not caused by collision. Again, this is optional coverage that is separate from
collision coverage. The deductible is separate, and generally lower, than for
collision coverage.
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Other-than-collision coverage handles such a wide variety of situations it is
usually called comprehensive coverage. Comprehensive possesses two
parts: protection of the automobile and personal effects. Typically,
comprehensive coverage pays for loss caused by the following:
 Missile objects
 Falling objects
 Fire
 Theft or larceny
 Explosions
 Earthquakes
 Windstorms
 Hail
 Water
 Flood
 Malicious mischief or vandalism
 Riot or civil commotion
 Collision with animals
HOW A LOSS IS PAID OUT
In paying an insured for a physical damage loss, it is important to
remember that the insurer is providing an indemnification. Simply put, the
insurer is restoring the insured to their approximate condition before the loss
was incurred. The insurer is obligated to pay only the actual cash value of the
damaged or stolen property, or the amount needed to restore or repair that
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property. The insurer also has the choice of the less costly of these two
options.
Sometimes, a "stated amount endorsement" is added to the auto policy. This
is generally done when one has an exceptionally valuable auto. In this case, a
stated amount of value is declared. If a physical damage loss occurs, then the
insurer refers to the stated amount in the policy endorsement. If the stated
amount is less than the actual value of the auto, the stated amount is paid. If
the stated amount is greater than the auto's actual cash value, the insurer
pays the actual cash value.
PHYSICAL DAMAGE EXCLUSIONS
Physical damage exclusions are among the most extensive in the auto policy.
The exclusions range from types of property not covered to situations in
which the coverage is not applicable.
1. There is no physical damage for normal
wear and tear. This includes freezing,
mechanical breakdowns, and electrical
failures.
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2.
Sound reproduction equipment not
permanently installed in the vehicle is
excluded, as is any electronic reception
equipment. This includes CB's, car
phones, televisions, etc
3. CD's, cassette tapes, VCRS, and any of
their support materials are excluded.
4. Camper bodies and trailers not specifically
listed in the declarations are not covered.
5. Radar detection equipment is not covered.
6. Customized furnishings, whether interior
such as refrigerators or sleeping devices,
or exterior such as awnings or cabanas,
are excluded.
7. Losses due to radiation, whether from war
or a nuclear accident, are excluded.
8. A vehicle used as a temporary substitute
for an owned vehicle is not covered.
9. A vehicle used for a public fee, except in a
carpool situations, is excluded
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10. A vehicle confiscated or damaged by civil
authorities is not a covered vehicle
11. Physical damages to a nonowned vehicle
are not covered if no reasonable belief
exists that permission was granted for its
use by the owner.
PHYSICAL DAMAGE COVERAGE AND THEFT
Automobile theft is a growing problem for our society. Daily we read about
stolen-car rings and car-jackings. The news can be numbing to our senses,
but it is a part of our world. Insureds can play a vital role in reducing theft and
vandalism in conjunction with civil authorities and insurance companies. In
order to facilitate this process, the agent needs to educate the insured on how
insurance companies handle loss situations due to theft.
First, if a covered auto or non-owned auto is stolen, the insurer will help
provide transportation to the insured in the form of a supplementary payment.
After 48 hours from the point of notifying the police and the insurer that an
auto has been stolen the insurer will pay for damages—typically to the tune of
$15 daily, up to a maximum of $450, for the insured's transportation costs.
If the stolen car is non-owned and is a rental car, the insurance company will
pay for the loss-of-use liability the insured has incurred. (Loss-of-use liability
refers to the money the rental company would normally earn on the stolen
vehicle.)
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If the car is stolen and belongs to the insured, the insurance company will pay
the expense of returning the stolen car to the insured, and repair any
damages that occurred as a result of the theft, as well as the process of
recovering the auto.
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.
PHYSICAL DAMAGE COVERAGE
REVIEW QUESTIONS
1.
Physical damage coverage can typically takes three
forms: limited, regular (or standard), and broad form.
a. true
b. false
2.
Collision and other-than-collision coverage often
overlap one another, and are paid out on a pro to
rata basis.
a. true
b. false
3.
Physical damage is an optional form of insurance
coverage, and can be added or deleted from the
auto policy at the owner's discretion.
a. true
b. false
4.
The deductible for other-than-collision coverage is
connected to the collision coverage deductible, and
is always the same figure.
a. true
b. false
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5.
A collision with an animal or a bird is an example of
a collision accident that is not carried under the
collision coverage.
a. true
b. false
6.
An insured with broad form collision possesses
coverage that never requires a deductible to be paid.
a. true
b. false
7.
An insured with limited collision coverage will not
receive any benefits if he or she is substantially at
fault in a collision accident.
a. true
b. false
8.
In cases of an exceptional auto, a stated amount
endorsement is typically added to the auto policy. If
physical damage occurs to the automobile, one of
two possibilities occurs. If the stated amount is
___________ than the actual cash value of the
automobile, then the stated amount is paid. If the
stated amount is ________ than the automobile's
actual cash value, then the insurer pays the actual
cash value.
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9.
In cases when a covered auto is damaged by a “civil
authority” (which usually means the police), the
physical damage coverage is excluded.
a. true
b. false
10.
If one's auto is stolen, the insurance company will
pay for the cost of returning the auto to the insured,
but any damages that occurred during the theft and
repossession of the auto are excluded.
a. true
b. false
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ANSWERS TO REVIEW QUESTIONS
1. true
2. false
3. true
4. false
5. true
6. false
7. true
8. less, greater
9. true
10. false
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POLICY CONDITIONS AND DUTIES AFTER AN
ACCIDENT OR LOSS
It is vitally important that the insured knows what to do at the scene of an
accident. Personal responsibility obligates the insured to take steps to learn
the proper duties, as both the law and the auto policy demand certain
minimum actions. Without accepting this responsibility, the insured may
create legal problems or have the claim refused. It is important that the agent
educate the insured on the duties that follow an accident or loss.
After an accident, one should determine if anyone has been injured. If an
injury occurred, proper steps should be taken such as calling 911. Obviously,
the police must be notified. If the situation is a hit-and-run, this information
needs to be immediately offered to the police. It is important to take steps to
protect the auto from further damage; if possible, the area of the accident
should be protected. This can be done by roping off the perimeter or igniting
flares.
When dealing with the other party to the accident, one should never admit to
responsibility. This prejudices the insurance company's right to recover
payment. One should merely give the other driver one's name and address,
and the name of one's insurer. It is appropriate to request the same
information from the other driver. Finally, one needs to inform the insured
about the accident as soon as possible.
Furthermore, one is expected to cooperate with the insurer during the
investigation and settlement of the claim. All legal papers need to be copied
and forwarded to the insurer. If the insurer so requests, one should take a
physical examination, authorize the release of medical records, and submit
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proof of a loss. All of these activities are designed to help the consumer, and
quickly and efficiently process a claim.
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POLICY CONDITIONS-DUTIES AFTER AN
ACCIDENT OR A LOSS
REVIEW QUESTIONS
1. After one has had an accident, he or she must attempt
to protect the covered vehicle from any additional
damage, and if possible, try to secure the place where
the accident occurred.
a. true
b. false
2. It is vitally important that one not admit responsibility for
an accident to the other party, because this prejudice's
the insurance company's right to recover payment
a. true
b. false
3. After an accident, one is responsible for seeing whether
any of the parties has been injured and calling the
police and an ambulance if an injury has taken place. If
no one has been injured, the police do not need to be
notified.
a. true
b. false
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4. To be certain that one's claim can be processed, one
should inform their insurance agent and company as
soon as possible when an accident has occurred.
a. true
b. false
5. It is appropriate to request the name, address, and
insurance company of the other party to an accident,
and give that same information concerning oneself if
asked.
a. true
b. false
6. To process a claim, one might be asked to release
medical records, take a physical exam, and submit
some proof of a loss.
a. true
b. false
7. One is expected to cooperate with the insurance
company during the handling of a claim, but they need
not forward legal papers or notices. This only needs to
occur when there is a court order to do so.
a. true
b. false
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8. Most people know what to do at the scene of an
accident, so it is a rare occasion when a policy claim is
denied because of action one failed to take after an
accident.
a. true
b. false
9. The police must only be notified about an accident if
criminal behavior was involved, such as a hit-and-run
accident.
a. true
b. false
10. A hit-and-run accident does not result in a serious
injury, the police do not have to be notified.
a. true
b. false
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ANSWERS TO REVIEW QUESTIONS
1. true
2. true
3. false
4. true
5. true
6. true
7. false
8. false
9. false
10. false
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COMMON GENERAL PROVISIONS
POLICY TERRITORY AND PERIOD
This section refers to the geographical limitations of the policy. It is important
to note the auto policy will be honored in all fifty states, Puerto Rico, and
Canada. It does not apply in Mexico, however, and one driving in Mexico
needs to purchase special insurance just for that event. Also, it states the
policy only applies for the period assigned in the declarations.
CHANGES
The auto policy cannot change unless an endorsement is added. Any change
in information given to the insurance company regarding the number of
insured vehicles, the operators using the vehicles, the place of garaging the
vehicles, etc., may result in a change in premium.
BANKRUPTCY
If the insured goes bankrupt, the insurer is not freed from its obligations. The
policy is in force regardless of the insured’s solvency or insolvency.
FRAUD
Coverage is not provided if any statements made by the insured in connection
with any accident or loss for which coverage is sought are found to be untrue.
Coverage is not provided if any actions taken by the insured in connection
with any accident or loss for which coverage is sought are fraudulent.
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LEGAL ACTION
The insurer cannot take any legal action against the insured until there has
been full compliance with all the terms and provisions in the policy. No right
exists for any person or organization to bring the insurer into action in order to
determine the insured's liability.
TRANSFER OF INTEREST
This provision simply states that the policy cannot be assigned without the
written consent of the insurer. But if the insured dies, the insurer agrees to
provide automatic coverage to the insured's spouse.
RIGHT TO RECOVER PAYMENT
Under this provision, the insured agrees to assign any right to recovery
against a third party to the insurer, to the extent that payment is made to the
insured. In other words, it requires the insured do whatever is necessary to
enable the insurer to exercise its right to recover payment, and to do nothing
that would prejudice this right.
TERMINATION
The termination provision applies to the ending of the insurance agreement
by the insurer or the insured. The insured may cancel the policy at any time.
All that needs be done is to return the policy, or send written notice of
cancellation.
The insurer is more restricted when pursuing a policy cancellation. Unless the
policy was obtained through misrepresentation, the insurer must follow certain
steps for cancellation. If the policy was in effect for less than sixty days, then
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a ten-day notice must be issued. If the policy has been in effect for more than
sixty days, the insurer can only cancel the policy if the insured's driver’s
license was revoked during the policy period, or if the insured has failed to
make premium payments. Even so, a ten-day notice must be issued in both
instances.
An insurer can, however, decide to not renew a policy. If the insurer chooses
to do this, a 20-day written notice must be given to the insured. And, if the
policy is less than a full year period, it can only be refused for renewal on the
anniversary of the policy's original date. A policy is automatically terminated if
a company offers to renew a policy and the insured does not accept the
company's offer.
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GENERAL PROVISIONS
REVIEW QUESTIONS
1. The duration of policy coverage is stated in the
declarations, and the general provisions section states
that the policy only applies for the specific period
assigned.
a. true
b. false
2. Normally, the personal auto policy cannot change
without the addition of an endorsement.
a. true
b. false
3. If the insured goes bankrupt, the insurer is freed of its
obligations to perform services.
a. true
b. false
4. If an insured lies or makes false statements concerning
material facts, or intentionally does not offer material
facts to the insurance company while making a claim,
the insurance company usually need not provide any
coverage.
a. true
b. false
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5. In most cases, an insured can take legal action against
his or her insurer only after there has been full
compliance with the terms written in the policy.
a. true
b. false
6. The general provisions of the auto policy state the
agreement is a personal contract, and as such cannot
be assigned without the explicit written consent of the
insurer.
a. true
b. false
7. The auto policy requires that the insured cooperate with
the insurer in every way possible in order for the insurer
to exercise its _____ __ _______ _______.
8. An auto policy can be canceled either by the insured or
the insurer at any time. The only stipulation is that a 60day notice must be given by the insurer.
a. true
b. false
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9. If an auto policy has been in effect for under 30-days
and an insured's driver's license is revoked, the insurer
can cancel the policy. However, the insurer must give
the insured a ten-day notice of its intention to do so. If
the insured’s license is revoked after the initial 30-day
period, the insurer cannot cancel the policy.
a. true
b. false
10. A policy can be automatically cancelled if a company
offers to renew the agreement and the insured does not
accept.
a. true
b. false
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ANSWERS TO REVIEW QUESTIONS
1. true
2. true
3. false
4. true
5. true
6. true
7. right to recover payment
8. false
9. false
10. true
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NO-FAULT AUTOMOBILE INSURANCE
Insurance is generally considered to be a necessary evil. As such, complaints
about its structure and operation are commonplace amongst its users. The
people who have suffered losses in automobile accidents are certain that their
settlements are inadequate. Young drivers feel the strain of finding an insurer
who will cover them at an affordable rate. All purchasers of auto insurance
insist their rates are too high, and any consumer that has had a claim is
certain that the insurance company could have produced a check a little bit
faster, or paid out a little bit more.
The method for handling auto insurance is aimed at compensation in the form
of indemnification. It had traditionally been a multi-stepped process within the
tort liability system. In many respects, it was very cumbersome In order to
begin action, the injured driver had to make a claim against the other driver's
insurer. The victim then needed to demonstrate that the other driver had been
negligent.
This system led to over-crowded courts and lengthy delays before any
compensation was realized. All too often, it depended more on the skill of an
attorney than the relevant facts of the case -- many of which had grown less
clear in the mind's of the participants due to the long duration of the process.
Such entanglements also produced high expenses, both to pay the attorneys
and sustain the system.
There are other flaws with the tort liability system. The difficulty in proving
negligence left many under-compensated or even uncompensated for their
losses. The traditional auto insurance process made no room for the selfnegligent. Nor could it handle the unknown party in a hit-and-run situation. A
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guilty party who was insolvent was also not adequately compensated
for under the tort liability system.
Such weaknesses seemed glaring to many. Critics also pointed to the
inequity within the system. Small claims were often overpaid in order to avoid
litigation. The large claim for the seriously injured, on the other hand, were
resisted wholeheartedly. This made them rather rare and, when payment
came, it was only after substantial delay.
The traditional system of auto insurance ultimately became so fragmented
with confusion and distrust, the insurance industry actively sought out
alternatives. One was found—and, in many states, implemented--with no-fault
insurance.
No-fault is contrasted to the tort system in a number of ways. In the tort
system, only the driver at fault in the accident is eligible for compensation. If
an injury occurs through one's own negligence, the situation is one's own
individual responsibility. Under no-fault, on the other hand, there is no blame
and no burden. Each party collects under its own insurance company. Fault is
not the issue for coverage. Given the imperfect nature of humans and the
hazards of driving, many find this very equitable.
The typical benefits for no-fault insurance are manifold. All medical payments
up to a maximum amount are paid. Loss of earnings can be paid out for a
specified duration and to a specified level. And essential services, such as
housework, yard-work, etc., are broken down and expensed out. Funeral
expenses can also paid up to a maximum limit.
There are, however, multiple variations in no-fault insurance. For example, a
pure no-fault law essentially abolishes the tort system for the purpose of auto
insurance. Under a pure no-fault system, an injured party cannot sue, no
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matter how grievous the injury. All benefits to the injured party come from the
insurance company.
Other types of no-fault insurance maintain a tort liability window. These are
known as modified no-fault laws. They normally make no payments for pain
and suffering per se, but allow the injured party to sue under two conditions.
These conditions are listed as "thresholds.” A dollar threshold in a modified
no-fault insurance arrangement means that the injured party can only sue if
their claim is above a stated dollar amount. A modified no-fault insurance with
a verbal threshold allows the injured party to sue for damages when specified,
serious injuries have been sustained.
A third possibility of insurance that mirrors no-fault is an add-on plan. This
system has the insurance company pay-out regardless of who is at fault in an
accident, but keeps open the right to sue for pain and suffering. As this plan
does not restrict the right to sue, it is not a true no-fault insurance system.
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NOTES
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Chapter Four
Introduction to Homeowners Insurance
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INTRODUCTION TO HOMEOWNERS INSURANCE
For most people, a home represents many things. A goal to be realized, a
place of security and nurturing, or fond memories of time spent with loved
ones. On a practical level, it is also the major form of wealth that most people
will acquire in their lifetimes. Homeownership is not, however, only a source
of tax deductions and equity; it is an investment that must be maintained and
protected. As such, it is a source of risk exposures, some based on physical
damage to the structure itself, others that have to do with personal liability.
At present, homeowner’s policies are standardized and preprinted. They are
an outgrowth of the movement toward multi-line package policies. Today, the
homeowner's policies available are the product of the ISO's work, and
combine the old, mono-line policies of property insurance, theft insurance,
and liability insurance into a single policy.
There are at present six homeowners forms, and three types of coverage.
The forms relate to the types of structures and property covered. The
coverages relate to particular perils. The basic form, for example, covers 10
named perils listed in the property coverage section of the policy. The broad
form insures against the above 10 named perils plus six more perils. The
special form is an inclusive form. It covers any peril not specifically excluded
in the policy contract.
Homeowners insurance is so broad that we will restrict our discussion of the
topic to the most popular homeowner’s policy, the Homeowners 3 Special
Form. This form provides the fullest coverage for property available today. It
is an open perils policy, meaning that it covers all perils except for those
specifically excluded.
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BASIC STRUCTURE OF THE HOMEOWNERS 3 SPECIAL
FORM
In structure, it is the same as all the homeowner's forms, possessing two
distinct parts. The first part is the declarations page, which includes
definitions. The second part is the policy forms.
The declarations page is what sets the boundaries of the policy in regards to
who is covered, and during what time-frame. Section I of the policy covers
three groups. Obviously, the named insured is covered. His or her spouse is
also covered, but only if the spouse is currently living at the residence.
(Residence is a significant factor in this form or coverage, and extends
protection to relatives as well.) In addition, minors are covered when they are
the insured's legal responsibility. The number and types of persons covered is
stable throughout the life of the contract.
The life of the contract is determined by the named policy period. This is the
time frame in which the policy is in force. It is typical for the policy to be
written for a one-year period, although it is possible to write a three-year
period.
When a loss occurs, and the insurance company deems that it is insurable
under the terms of the policy, a deductible generally will be paid. The typical
deductible is $250.00. This amount is changeable, however, and can be
written for higher or lower amounts.
The declarations page also names the location of the covered property.
Obviously, this named location is generally the insured's dwelling place.
There are other possibilities, however, such as other structures used as a
residence that are not actually the insured's house. The insured location is
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also called the described location. This suggests its broadness, and really
describes the residence in whatever form it takes.
Finally, the perils and situations that are covered are named by stating the
specific forms and endorsements used to provide coverage. This section will
state the premium and the amounts of available insurance.
The policy form is issued by the insurer, and consists of two sections. The
first section, Section I, describes property coverages. This section lists what
property is covered, and for what perils. It lists the conditions under which the
policy is honored, and details the responsibilities of the insured and the
insurer.
The second section of the policy form, Section II, concerns liability coverage.
Liability situations that are covered are named, as are those which are
excluded. The conditions under which the policy is honored are again listed,
as are the responsibilities of the insured and the insurer. The responsibilities
of any injured person are listed. And, finally, any additional related expenses
are clearly spelled-out.
THE FIVE BASIC COVERAGES-SECTION I
Following the declarations and definitions, the specific coverages are
described. The Homeowners 3 Special form lists five basic coverages. The
first four are named, specific coverages, and the fifth is a bundle of additional
coverages.
The first basic coverage is termed "Coverage A", and handles the insurance
for the actual dwelling. It is also covers structures that are attached to the
dwelling, the most common being the garage. This coverage also extends to
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any material on the residence premises that is ultimately intended to become
a part of the dwelling or its attached structures. The minimum amount of this
coverage varies by company.
"Coverage B" is the second of the five basic coverages. This coverage
concerns structures other that the dwelling and its attached structures. This
means that any building that is on the residence premises gains coverage as
long as a clear space separates it from the dwelling (although a fence is not
considered an attachment). The amount of coverage for these additional
structures is determined by a simple formula. The insurer takes 10 percent of
the insurance amount for the dwelling and applies that to any loss to
additional structures on the residence premises.
The third area of coverage, personal property, is extremely broad, and
includes numerous exclusions that will be discussed in detail later. It is
important to note that "Coverage C" in Section I of the Homeowners 3 Special
policy covers the insured's personal property anywhere in the world. The
amount of insurance on personal property is equal to 50 percent of insurance
on the dwelling. This full amount is available for personal property on the
residence premise, and for property being moved into the residence premise.
Thus, the property is insured during the process of moving.
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1. Money and its related forms: $200.00
This includes cash, bank notes, bullion of any type, medals, and coin collections. Coin
collections are exceptionally important to note, because they are fairly common and can be
valued up to thousands of dollars. To insure a valuable coin collection for its true amount of
worth, it must be scheduled for a specific amount.
2. Theft of firearms: $2000.00
3. Theft of silverware and goldware:
$2500.00
4. Theft of jewelry, watches, and furs: $1000.00
As theft becomes an increasingly large problem in our society, it is important that the
insured be aware that certain property articles are "target items," and that there is a named
limit on the liability for these items. These limits are applicable only in the case of theft,
however, and the full amount is available if a loss occurs by other means. All of the above
items can be scheduled for a specific amount.
5. Electronic apparatus used in motor vehicles that can also be used in other places
and operated from other sources: $1000.00
This coverage refers to cellular phones, recording devices, computers, etc.. This limit is
also the result of high rates of occurrence. The limit can be increased by endorsement
when deemed appropriate.
Property that is borrowed, rented, or in the insured's care is also covered.
This includes when the property is in the dwelling or with the insured
anywhere in the world.
"Coverage C" will also specify an extensive list of property that is subject to
special limits of liability. Most of these can be increased by an endorsement
or scheduling, but whether higher limits are pursued or not, it is vital that the
insured by aware of those items which have specific limits. We will list some
of the most common, and briefly discuss their implications.
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Loss of use is the fourth area of coverage. "Coverage D" provides the
insured with options should the insured's dwelling suffer a loss that makes
living in it impossible. The options available are described as benefits, and
are threefold.
First, the fair rental value of the residence premise can be paid to the insured.
This is the equivalent of the rental value of the dwelling that has been made
unlivable. This applies when the insured rents a portion of the dwelling to
others.
The second benefit available is an additional living expense. This is simply
the amount of money needed by the insured to maintain an expected and
reasonable standard of living. Thus, the cost of finding a temporary apartment
and the rent for that apartment would be covered as an additional living
expense.
The insured has the choice of benefits after a loss has made the dwelling
unlivable. The payment is made for the shortest time to repair or replace the
damage, or to relocate.
A third benefit is available under "Coverage D" when a government official
prohibits the insured from occupying his or her dwelling. (This occurs most
typically because of gas leakage.) Should the government order an insured
to temporarily move, then the insurance company will pay additional living
expenses or fair rental value, but only for two weeks.
The Additional Coverages section supplements Coverages "A" through "D".
This section names ten additional coverages that the insurance company is
obligated to meet.
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1. Fire department charge
If an insured is liable for a fire department
service charge after calling the fire department in
order to save covered property from an insured
peril, the insurance company will pay the charge
Ten
Additional
(up to
$500.00). Coverages
2. Stolen or lost credit cards
The additional coverages section of the
Homeowners 3 Special form covers the named
insured for up to $500.00 for the loss, theft, or
authorized use of any credit cards.
Both of the above two coverages are considered
additional insurance. They are both provided
without a deductible. All of the following coverages
are subject to the policy's stated deductible.
3. Debris removal
The Homeowners 3 Special form will pay the
expenses for removing debris from a covered
property. Debris removal covers a broad variety of
materials. The debris could be dust, ash, shattered
glass, or trees.
In the case of fallen trees, however, a number of
conditions are present. For one, the cost of
replacing a fallen tree is not covered; only the
removal of the tree is covered. Furthermore, the
cause of the tree's falling cannot be intentional. The
damages must occur because of an action of nature
that is covered in the policy.
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5. Property removal
Whenever property must be removed from the
insured's dwelling because a loss is threatened
from a peril named in the policy, it is covered
against any loss. This expansion of coverage is
very temporary, lasting no more than thirty days.
6. Collapse
First of all, we must state emphatically that collapse
is not settling, shrinking or bulging. Rather,
collapse is the falling or damaging of a building
caused by specific reasons. These reasons might
include any of the perils named in "Coverage C,"
the use of defective material or techniques,
excessive weight on the building's structure, or
hidden decay, whether caused by natural aging or
vermin and insects.
7. Loss assessment
When property is collectively owned, any loss
assessment charged to the insured can be covered
up to $1000.00 if this loss is caused by a peril
insured against in "Coverage A" of the policy.
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8. Reasonable repairs
When a covered loss occurs, certain repairs might
be necessary to protect the property from additional
damage. This is a "reasonable repair" that is
temporary in nature, and does not permanently alter
the structure of the building. All such repairs are
covered under the policy.
9. Glass and safety glazing material
The breakage and damage of glass or safety
glazing material that is a part of a covered building
is covered. This coverage is only good when the
building is actually being used, however, and does
not apply when the building has been vacant for
more than 30 consecutive days directly before the
loss is experienced.
10. Landlord's furnishings
Except for theft, Homeowners 3 Special form covers
all losses caused by perils insured against to the
furnishings in a rental unit. This coverage pays up
to $2500.00 for the appliances, carpets, and
furnishings inside a rental unit that are the property
of the rental unit's owner.
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THE FIVE BASIC COVERAGES
REVIEW QUESTIONS
1. Coverage A only covers the basic structure where
people actually live in the home. Materials and supplies
located on or next to the residence premises used to
construct, alter, or repair the dwelling are never
covered.
a. true
b. false
2. Coverage B covers the attached structures to the
principal residence. The level of coverage is 25% that
of the residence premise.
a. true
b. false
3. Coverage C covers the insured's personal property
anywhere in the continental United States, but not in
other countries such as Canada and Mexico.
a. true
b. false
4. Coverage C can only cover personal property; rental
property is never afforded coverage.
a. true
b. false
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5. Coverage C provides $1000 for loss of jewelry,
watches, and precious stones. The loss must occur
through a forced-entry theft, and the insured must file a
police report during the claims process.
a. true
b. false
6. The section of coverages that supplements Coverages
A-D is called:
a. supplemental coverage.
b. umbrella coverage.
c. additional coverages.
d. All of the above
7. Trees and plants are covered up to $5000 per plant.
a. true
b. false
8. Stolen credit cards are covered up to $500, and
this coverage comes without a deductible.
a. true
b. false
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9. Coverage D will provide an additional living expense
benefit if a loss has made the dwelling unlivable.
a. true
b. false
10. Should a civil authority force an insured to move
temporarily because of a perceived hazard, the policy
will pay living expenses up to one month.
a. true
b. false
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ANSWERS TO REVIEW QUESTIONS
1. false
2. false
3. false
4. false
5. true
6. additional coverages
7. false
8. true
9. true
10. false
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THE NAMED PERILS INSURED AGAINST
The Homeowners 3 Policy form insures against all losses except those that
are specifically excluded in the policy. In one sense, it is easier to see what
the policy excludes from coverage than what it specifically covers.
Despite the open perils nature of the policy, there are specific named perils
that the policy explicitly protects against. These are perils concerning
personal property.
The homeowner's policy covers property damaged by fire. This includes
damage not only caused directly by the fire's flame, but by the heat
generated, the smoke caused, and all efforts made to stop the blaze.
Lightning is also covered under the homeowner's policy, as is wind and hail.
Even the insides of a building can receive coverage if reasonable steps were
taken to avoid damage (like closing and bolting windows) and the storm
caused the opening to the inside of the building.
Property damage caused by explosions is covered in very broad terms. Most
explosions, whether from gas lines or faulty furnaces, are usually covered.
Riots are insured against as well, but the definition of a riot is fluid, and
dependent upon the state in which coverage is sought.
Vandalism is another area that is covered, along with theft. Both theft and
vandalism are increasing problems in today's world, and insurance is one of
the most common methods of handling this risk.
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Physical damage caused by aircraft is covered. The definition of aircraft is
quite broad, extending from private airplanes to commercial jets to missiles
and spacecraft. Thus, in the unlikely event that another space shuttle accident
should occur and damage an insured's property, the loss would be covered.
Damage to personal property by a motor vehicle is covered. This damage
could happen to one's house, for example, if a vehicle actually struck the
building. But the coverage also applies to one's personal property inside of an
automobile. Hence, if one's skis were destroyed in an auto-accident, the
homeowner's policy, not the PAP, would cover the loss.
Falling objects that damage personal property are also insured against. This
damage can be to the outside of a building, for example, when a tree falls and
damages a section of the roof and awnings. The damage can also be to the
inside of the building, such as when the impact of the falling tree on the roof
causes a hanging lamp to come crashing down. The key for damage to the
inside of the building is that this damage must somehow be related to
damage initiated by a falling object outside the house.
Property damage that results from the accidental discharge or overflow of
water is covered by the policy, but the cost of repairing the system or device
from which the water emerged is not covered. Water damage here can be
from water in the form of liquid or steam.
Water damage is also covered against when water takes the form of snow,
ice and sleet. The damage protected against here is usually caused by
excessive weight. Any collapse or changing of a structure caused by ice,
snow, or sleet receives protection under this coverage.
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Combination Course 1
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When steam or hot water cause bulging, tearing apart, or cracking, the
property damage is covered. This kind of damage usually comes from water
heaters, fire sprinklers, or air conditioners.
Freezing is covered when proper steps have been taken to prevent damage.
Thus, if pipes freeze and cause damage to the building's plumbing system,
the loss is covered provided the water was not shut off, and the building's
heat was set on some minimum level.
Accidental damage that occurs from artificially generated electrical currents
are covered. This generally occurs through power surges and shorts.
Finally, losses that are caused by volcanic eruptions, however unlikely this
might seem in comparison to our other named perils, are covered. This
damage could occur through the actual explosion, lava flow, or ash.
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NAMED PERILS
REVIEW QUESTIONS
1. The Homeowners 3 Special policy insures against all
losses except those that are specifically listed in the
exclusions portion of the policy.
a. true
b. false
2. Usually, for the Homeowners 3 Special policy to cover a
loss caused by a fire, two conditions must be present:
the fire must be hostile and there must be evidence of
combustion or rapid oxidation.
a. true
b. false
3. Damage that occurs to the interior of an insured’s
dwelling during a storm is not covered by the
Homeowners 3 Special policy; only damage that occurs
to the exterior receives covers.
a. true
b. false
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4. While property damage resulting from a riot is covered
under the Homeowners 3 Special policy, it is important
to note that the definition of a riot is flexible, and
depends on the state in which the coverage is pursued.
a. true
b. false
5. Vandalism is not covered under the homeowner’s form,
unless it occurs in conjunction with a theft.
a. true
b. false
6. If a tree were to fall and strike a covered dwelling, thus
causing damage to the roof and glass breakage to
mirrors in the home’s interior, only the property damage
occurring outside would be covered.
a. true
b. false
7. Water damage is covered, but only in the form of a
fluid. Thus, damage due to sudden overflow or
discharge is covered, but damage from steam is not.
a. true
b. false
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8. Freezing that causes damage is covered by the policy
provided that the proper and reasonable steps to avoid
this damage have been taken.
a. true
b. false
9. Losses caused by volcanic eruptions are not covered,
but can be covered through an endorsement.
a. true
b. false
10. Damage that occurs through electrical shorts or power
surges is covered.
a. true
b. false
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
ANSWERS TO REVIEW QUESTIONS
1. true
2. true
3. false
4. true
5. false
6. false
7. false
8. true
9. false
10. true
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CONDITIONS
The part of the policy that lists the general rules and regulations for the
insurance coverage described throughout is called the conditions section.
There are conditions in the homeowners policy forms that apply solely to
Section I and Section II, and there are conditions that are applicable to both
sections.
CONDITIONS APPLICABLE TO SECTION I AND II
 Policy period
Losses are only covered when they occur during the active policy period. The
beginning and ending of the policy period is explicitly stated in the policy's
declarations. It is put in terms of standard time for the insured location.
 Fraud
The insurer will not make payments on claims that are shown to be
fraudulent.
Any
concealment
of
material
facts,
any
intentional
misrepresentation, or any false statement made by the insured in connection
with making a claim gives the insurer license to challenge payment or
services.
 Waiver of Change of Provisions
Changes or waivers of any item or provision in the policy must be done in
writing. The written request for change or waiver must then be approved in
writing by the insurer. Oral agreements that change or waive provisions on
the homeowner’s policy are not held to be valid.
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 Liberalization clause
The liberalization clause does just what its name implies: it "liberalizes"
coverage by broadening it. This is accomplished when a revised policy has
been accepted by an insurer without an additional premium either within 60
days before the activation of a policy, or during the active policy period. This
expanded coverage then applies automatically to the policy.
 Assignment
The homeowner’s policy is a personal contract, an agreement between the
insured and the insurer. As such, the policy cannot be assigned to another
party without the expressed, written consent of the insurer. On the other
hand, the payment of a loss can be assigned to whomever the named insured
desires, as this represents no change in the risk situation for the insurer .
 Death of the insured or the insured's spouse
An exception to the above condition is an assignment htat has been made
due to the death of the insured and/or his or her spouse. In such a situation,
coverage automatically continues, causing a de facto assignment. In cases
where a person has taken temporary custody of the deceased insured's
property while a legal representative is being appointed, the custodian is
covered as an insured.
 Subrogation
You will remember that the principle of subrogation is brought to bear when
the insured surrender's his or her rights to seek reimbursement for an injury
from another party to the insurance company. The insurance company pays
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the loss and then seeks to recover the cost of its benefit payment from the
injuring party. This principle is incorporated into all insurance policies, but the
homeowner's policy presents an exception to this rule. The insured may
waive rights of recovery against another if the waiver is made in writing before
a loss occurs.
 Nonrenewal
A policy need not be renewed by the insurer, provided the insured is
given written notice or nonrenewal. The notice period is 30 days before the
expiration date.
 Cancellation
1. Any policy can be canceled by the insurer if the
insured has failed to pay the premium, with notice
ten days before cancellation;
2. Any policy that is in effect for less than sixty days
that is not a renewal can be canceled for any reason,
with notice ten days before cancellation;
3. Any policy with a policy period that is longer than
one year can be canceled for any reason at the
anniversary date of the policy, with notice thirty days
before cancellation;
4. Any policy older than sixty days can only be
changed
when
there
is
evidence
of
misrepresentation or fraud or a substantial change in
risk, with notice thirty days before cancellation.
The homeowner's policy can be canceled. Should the insured wish to cancel,
he or she need only notify the insurer or return the policy. The insurer must
follow certain guidelines, however, in order to cancel a homeowner's policy.
The possibilities are as follows:
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CONDITIONS SPECIFIC TO SECTION I
 Insurable interest and limit of liability
This condition applies to situations where more than one person has an
ownership interest in an insured dwelling. How does the insurance company
determine the liability for any one loss? It is limited to whatever the insured's
insurable interest in the property at the time of loss is, within the maximum
amount of insurance stated in the policy.
 The insured’s duties after a loss
The insured is expected to perform certain duties in the event of a loss.
Failure to perform these duties can lead to a claim being denied. The first two
sets of duties are performed more or less at the time of loss; the second two
sets of duties are carried-out after a loss while a claim is being processed.
1. Report the loss
a. Notify the insurer as soon as possible
b. Notify the police in the event of theft
c. Notify the credit card company in event of theft
2. Take steps to limit the loss
a. Protect the property from further damage
b. Make reasonable repairs to limit additional
damage
c. Keep an accurate record of repair expenses
3. Submit proof of loss within 60 days
a. Keep an inventory of damaged property
b. Submit a signed and sworn statement of loss
to the insurer
4. Cooperate with the insurer
a. Exhibit the damaged property when requested
b. Submit to separate questions under oath
c. Provide any additional data as requested
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 Loss settlement
Covered losses are settled on the basis of either the actual cash value or the
replacement cost of the property. Generally speaking, personal property items
are paid-out at the actual cash value of the item at the time of loss. The actual
cash value is determined by subtracting the depreciated value from the
replacement cost. This protects the principle of indemnification, for to replace
the lost or damaged property at its current new market value would result in a
net gain for the insured. (It is, however, possible to add an endorsement to
cover personal property on the basis of replacement cost.)
More and more situations where property losses have occurred have had the
losses considered under the broad evidence rule. A result of case and state
law decisions, the broad evidence rule expands the possibility of true
indemnification by compelling the insurer to consider everything relevant to
the specific situation when determining actual cash value. The idea is that
replacement cost and depreciation alone are insufficient for returning the
insured to the same economic position that existed prior to a loss.
In most cases, covered losses to the insured's dwelling and other structures
on the residence premises are paid on the basis of replacement cost.
Moreover, replacement cost is paid with no deduction for depreciation.
Two possibilities occur with replacement cost insurance on a dwelling. The
first is in effect when the amount of insurance is equal to 80 percent of the
replacement cost of the structure at the time of loss. When this situation
applies, the full cost of repair or replacement is paid with no deduction for
depreciation, up to the limits stated in the policy.
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If, on the other hand, the insurance carried is less than 80 percent of the
replacement cost, then the insured receives either the actual cash value of
the section of the building damaged, or a payment based upon this formula:
insurance carried ÷ insurance required x amount of
loss
 Loss to a pair or set
When a pair or a set of personal property has been lost, the insurer can select
to replace a part of the pair or set, repair the damaged part of a pair or set, or
pay the difference between the actual cash value of the property before and
after the loss.
 Glass replacement
In most cases, an additional cost that is the result of a law or ordinance is not
covered under the homeowner's policy. The exception to this rule concerns
glass replacement. In this case, any damage to glass from an insured peril
will be replaced with the safety glazing material if required to do so by law or
ordinance.
 Appraisal clause
Occasionally, the insured and the insurer will disagree on the amount of a
loss. In order to reduce legal costs and delays, and to allow for a fair
procedure for resolving disagreement regarding the amount of a loss, the
homeowner's policy contains an appraisal clause.
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When a loss is disputed, either party can demand to resolve the dispute by
appraisal. Each party selects an appraiser, and the two appraisers select an
umpire. If they cannot agree on an umpire within 15 days, a judge will name
one. The decision, made in writing by two of the three is binding on the
amount of the loss to be paid.
 Other insurance
If an insured has insurance in addition to their homeowner's policy that covers
the same property, then only a proportion of the loss will be paid by the
homeowner's policy, with the other insurer paying the remaining amount. This
is a payment on the basis of pro rata liability.
 Legal action against the insurer
Until all policy provisions have been complied with, an insured cannot bring
suit against the insuring company. Furthermore, legal action must be started
within one year after a loss occurs.
 Option to repair or replace
The insurer has the option of repairing or replacing any part of the damaged
property with like property. Written notice must be given to the insured by the
company if this option is exercised. Also, while exercising the replacement
option allows the insurer to meet its contractual obligation to pay a covered
loss, this loss settlement cost may be lowered.
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 Loss payment
This condition simply states that it is the insured that receives loss payment
unless another person has been named in the policy.
 Abandonment of property
This provision frees the insurer from having to accept an insured's abandoned
property after the occurrence of a loss. The insurer may take the damaged
property and repair it, or it may pay the actual cash value of the damaged
property and take the property itself as salvage.
 Mortgage clause
The mortgage company has an insurable interest in the insured property. The
mortgagee protects its insurable interest through the mortgage clause in the
homeowner's policy. Put simply, the mortgage clause can name the
mortgagee as entitled to receive loss payments from the insurer to the level of
its interest in the property regardless of any policy violation by the insured.
The obligations of the mortgagee under this arrangement are fourfold. The
insurer must be immediately notified of any change in ownership, or any
change in risk regarding the insured property. Secondly, the mortgagee is
required to pay the premium if the insured fails to do so. Next, the mortgagee
must submit proof of loss when the insured fails to do so. Finally, the
mortgagee must give subrogation rights to the insurer.
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CONDITIONS AND DUTIES AFTER A LOSS
REVIEW QUESTIONS
1. While the homeowners policy is a personal contract,
and cannot be assigned, the payment of a loss can be
assigned to whomever the insured desires.
a. true
b. false
2. Oral agreements that change or waive provisions on
the homeowners policy are to be just as valid as written
changes.
a. true
b. false
3. A policy does not have to be renewed by the insurer, as
long as the insured is given written notice of
nonrenewal thirty days before the expiration date.
a. true
b. false
4. An exception to the rule of nonassignment of the
homeowner's policy occurs when an insured's spouse
dies. In this case, coverage automatically continues,
and creates a de facto assignment.
a. true
b. false
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5. The insurer, like the insured, can cancel the policy any
time at will.
a. true
b. false
6. The insured is expected to do the following when
reporting a loss:
a. notify the insurer as soon as possible.
b. notify the police if a theft occurred.
c. notify the credit card company if a credit card
is stolen.
d. all of the above.
7. In most situations, the insured can expect a covered
loss to be paid on the basis of replacement cost.
a. true
b. false
8. Payment in terms of replacement cost for a loss is done
without making a deduction for depreciation.
a. true
b. false
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9. While in most cases, a loss resulting from a low or
ordinance is not covered, an exception is made for
glass replacement. In this instance, damage to glass
from an insured peril will be replaced with safety glazing
if the local law or ordinance demands this.
a. true
b. false
10. Until the full frame of policy provisions have been
complied with, an insured cannot bring suit against the
insurance company, not can legal action be started any
earlier than one year after a loss has occurred.
a. true
b. false
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
ANSWERS TO REVIEW QUESTIONS
1. true
2. false
3. true
4. true
5. false
6. all of the above
7. true
8. true
9. true
10. false
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EXCLUSIONS FOR SECTION I
Exclusions to the coverages in the homeowner's policy can be divided into
several groups. The first set of exclusions is built into the named perils and
specific coverages.
PROPERTY NOT COVERED UNDER COVERAGE C
1.
Motor vehicles that are subject to motor vehicle
registration are excluded, as is the equipment specific to
the motor vehicle. The idea here is to have the coverage
fall under the personal auto policy and its appropriate
endorsements.
2.
Separately described and specifically insured items
cannot be covered. This is done on the part of the
insurer from providing duplicate coverage.
3.
Pets are not insurable under "Coverage C".
4.
Business records are
homeowners policy.
5.
Aircraft and aircraft parts are excluded under "Coverage
C".
not
insurable
under
the
6. The property of tenants not related to the insured is
excluded unless specifically covered by the insured.
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EXCLUSIONS TO THE ADDITIONAL COVERAGES
1. Trees and shrubs damaged by wind are not covered by the
policy.
2. The unauthorized use of a credit card by a resident of the
named insured's household is not covered, nor are the credit
card losses of an insured covered if he or she has not
complied with all the terms and conditions of the cards.
EXCLUSIONS BUILT INTO THE NAMED PERILS
1.
1.
Damage
caused and
by freezing
a vacant building,
or a building
is
Freezing
its in proximate
causes
thatthatdamage
under construction, is not covered. "Vacant" here means that the
specified outdoor property is excluded.
building is not furnished, and/or has not been occupied for 30 days.
2.
Theft is excluded under several circumstances. First, theft
by an insured is excluded. In other words, an insured
cannot collect on a loss caused by an insured. This
generally occurs when a family member steals. Also, theft
in a dwelling under construction is excluded. Lastly, theft
that occurs in a part of the dwelling that is rented to
someone not insured is not covered.
3.
Vandalism that occurs during vacancy of a dwelling is
excluded.
4.
Damage from smoke that is the result of agricultural
smudging or industry is excluded from coverage.
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EXCLUSIONS
FOR
NON-FORTUITOUS
EVENTS,
PREVENTABLE LOSSES, AND EXTRAHAZARDOUS RISKS
The next set of exclusions is twofold. It includes exclusions shared by all of
the homeowners forms, and exclusions specific to Homeowners 3 Special
form.
1.
Normal wear and tear is excluded. A physical loss that is
the result of normal, restorable deterioration such as
marring, chipping, and peeling does not receive coverage.
2.
Defects and mechanical breakdowns do not receive
coverage. This is a matter for warranties rather than the
homeowner's policy.
3.
Smog, rust, and all corrosive processes are excluded.
4.
Named pollutants do not receive coverage for the damage
they cause.
5.
The settling, shrinking, bulging and cracking of pavements,
patios, foundations, walls, floors, and ceilings of the named
property is excluded.
6.
Damage caused by birds, rodents, vermin and insects is
excluded from coverage
EXCLUSIONS COMMON TO ALL FORMS
1. Ordinance or law
Any loss that is caused by a law or ordinance is not
covered. This loss may take the form of the actual
demolition of a building, or it may occur in the form of a
repair or improvement that must be made.
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2.
Earth movement
Earth movement can take many forms, and the
earthquake is the most spectacular. It seems that
every year one hears of the tragic losses suffered by
persons who have lost their homes to earthquake
damage, and are not covered because they did not
add the necessary endorsement to carry this
coverage.
Other forms of earth movement that cause damage
are also excluded, however, and these include
landslides, earth sinking, ground shifting, and
shockwaves from volcanic eruptions.
3.
Water damage
Some forms of water damage are covered, and we
have detailed these situations in the preceding
sections. Other potential forms of water damage are
not extended coverage. These include floods, waves
and tidal water, water back-up from sewers, drains, or
sumps and below-the-surface water that causes
damage through pressure or seepage.
4.
Power failure
Coverage is not extended to losses that occur
because of power failures that originate off of the
residence premises.
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5.
Insured's own neglect
The insurance company will not provide coverage for
a loss when the insured does not take reasonable
steps to preserve the property after a loss has been
realized.
6.
War
As with most property insurance contracts, war is
considered a catastrophic loss, and is not insurable. It
is not covered under any homeowner’s policy.
7.
Nuclear hazard
Nuclear radiation, contamination, and explosions are
not covered by the homeowner's policy. This
exclusion applies to slow contamination from leakage
as well as the more apparent damage that occurs
through a major accident or malfunction in a nuclear
power plant.
8.
Intentional loss
Any loss intentionally committed by the insured, or
anyone under the direction or pay of the insured, is
not covered. Only unexpected and accidental losses
can enjoy insurance protection.
CONCURRENT CAUSATION EXCLUSIONS
Concurrent causation is a doctrine that states when a property loss can be
shown to have been caused by two agents -- one that is covered and one that
is not -- then the policy will provide coverage. The next three exclusions are
particular to the Homeowners 3 Special form and are specifically designed to
eliminate coverage for losses that previously would have received coverage
under the doctrine of concurrent causation. The three exclusions possible
here are as follows:
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1. Weather conditions--when the weather conditions that
contribute to a loss that would be otherwise excluded
from coverage.
2. Acts or failure to act--when a plan to limit a potential loss
is not developed, property damage that results from the
failure to make and implement a needed plan is not
covered.
3. Faulty, inadequate, or defective actions, designs, or
material-losses that occur because of faulty planning or
defective materials are excluded.
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EXCLUSIONS
REVIEW QUESTIONS
1. Trees and shrubs damaged by wind are not covered by
the policy.
a. true
b. false
2. Freezing that causes damage to specified outdoor
property is always covered.
a. true
b. false
3. Theft is excluded coverage under the following
circumstances:
a. theft by an insured is not covered.
b. theft at a dwelling under construction is not
covered.
c. theft that occurs in part of a dwelling that is
rented to someone not insured is not covered.
d. all of the above
4. The property of tenants NOT related to the insured is
excluded unless specifically covered by the insured.
a. true
b. false
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5. Separately described and specifically insured items
cannot be covered, as this would provide duplicate
coverage.
a. true
b. false
6. Normal wear and tear, such as marring, chipping and
peeling does not receive coverage.
a. true
b. false
7. Losses incurred by a law or ordinance, such as
specific named improvements to the structure of the
building, are not covered by the policy.
a. true
b. false
8. Damaged caused by earth movement, ranging from
earthquakes to mudslides, is not covered.
a. true
b. false
9. As war is considered a catastrophic event, damage
caused by war is excluded coverage.
a. true
b. false
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10. The unauthorized use of a credit card by resident of the
named insured’s household is not covered.
a. true
b. false
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ANSWERS TO REVIEW QUESTIONS
1. true
2. false
3. all of the above
4. true
5. true
6. true
7. true
8. true
9. true
10. true
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NOTES
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Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
HOMEOWNERS 3 SPECIAL FORM - SECTION II
Section II of the homeowner's policy, a brief review of law is necessary.
General law is divided into two categories: criminal law and civil law.
Criminal law involves a legal wrong committed against an individual or
society. It can involve the various levels of government, from the local all the
way up to the federal. Criminal law handles wrongdoings that are punishable
by fines, imprisonment, or execution.
Civil law, on the other hand, concerns legal wrong doings that are not typically
violations of criminal laws. In addition, civil wrongs are generally settled by an
award of money damages. Breach of contract and torts are the two classes of
legal wrongs that are covered by civil law. Torts are the most common form of
legal wrongdoing in the insurance field. There
are
four
areas
of
torts:
negligence, intentional interference, absolute liability, and strict liability.
NEGLIGENCE
Negligence is also referred to as unintentional tort. It is defined as the failure
to use the care necessary and required by law to protect others from harm. In
this situation, a hypothetical "reasonable" person is conjured up who provides
the standard of prudent, responsible action by which others are measured.
This hypothetical, reasonable person is not the product of any one mind.
Rather, it is a personified standard that has been slowly constructed out of the
subjects involved in the particular suit, the degree and seriousness of the
injury, the skill and imagination of the litigants, and, most important of all,
legal precedent, which is an amalgamation of interpretations and decisions.
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For a negligent act to have occurred, four elements must be present and
apparent. No damages can be collected until a court is convinced that all four
elements are involved. Foremost, a legal responsibility to protect others from
injury or harm must exist. Also, it must be shown that one has failed to carry
out this responsibility. This failure could be active (or "positive"), meaning one
has done something that our hypothetical reasonable person would avoid. Or,
the failure could be passive (or "negative"), meaning no reasonable action
was taken.
Third, someone must have suffered damages, injuries, or both for an act to be
negligent. These damages are determined along varying levels of severity,
and carry varying dollar amounts.
Finally, a causal relationship must be present for an act to be negligent. This
is specifically called a proximate cause, and means that the connecting
sequence of events that begins with the alleged negligent act and the
occurrence of damages must be clear and unbroken.
When people incur legal liability through being deemed negligent by court
decision, they must pay a named amount to the wronged party. These costs
can be devastating, and most people seek protection from them through
insurance. Sometime this insurance is found in a separate, self-standing
policy. For the homeowner, it can function through Section II of the
homeowners policy.
Section II provides liability coverage for protection against lawsuits that
concern the bodily injury or property damage of another. This coverage pays
the cost of defending the insured as well as any damages decided on upon
the court, up to the party limit.
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WHO IS COVERED?
Section II coverage of personal liability is extremely broad, and extends the
range of benefits in a wide circle. Of course, the named insured and his or her
spouse are covered. (It should be noted, however, that the spouse must be a
resident of the household in order to enjoy coverage.)
Those family members who reside in the household are covered. This
residence is a significant factor, for whereas a son or daughter of the insured
is covered while away at college, the cousin who visits for the holidays is not.
Minors who are the legal responsibility of the named insured are also given
coverage. Again, they must be residents of the household, not just guests or
visitors.
THE TYPES OF COVERAGE
 PERSONAL LIABILITY
Coverage E in Section II of the homeowners policy is for protection against
torts of negligence. In other words, if someone sues the insured for property
damage or personal injury, this is the part of the homeowner's policy that
"goes to bat" for the insured.
Coverage E also pays for the costs of defending the insured, and
prejudgment interest. Prejudgment interest is a sum that the injured party
requests on top of the actual judgment. The idea is that the process of coming
to a legal decision takes time, and deprives the injured party use of the
money that ultimately will come from the damage award. To make up for this
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loss of use, the injured party is awarded interest for that period when he or
she could not use the claim money.
The minimum of liability is $100,000. This amount applies to legal costs, the
damage claim for property damage and personal injury, and prejudgment
interest. Naturally, with a higher premium, the minimum level can be
increased.
A number of items are important to keep in mind when considering Coverage
E. First of all, since this coverage is based upon legal liability and the law of
negligence, the insured must be shown to be legally liable. This is not
accident insurance, and the company will not pay for damages without the
appropriate legal conditions of liability present and apparent.
Sometimes, the legal action brought against the insured is utterly groundless.
One can rest assured that all claims will be vigorously investigated by the
insurance company for fraud. Many such claims are defused early on.
Even when it is apparent that liability on the part of the insured does indeed
exist, the claim need not go to court. The conditions of liability need to be
present and apparent, but it does not always take a court to resolve the
situation. As a matter of fact, it should be noted that a high percentage of
personal liability suits are settled out of court.
The homeowners policy will provide the insured personal liability coverage
anywhere in the world. This is an impressive range of protection, and extends
an element of "home's security" wherever the insured goes.
Lastly, the insurance company will pay up to the liability limit for each
separate occurrence. This is significant to note because of the definition of
occurrence in this context. Simply put, an occurrence means that some
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damaging action has occurred. It might have occurred all at once, as when a
satellite dish one has set up falls over into the neighbor’s yard and destroys a
section of their fence. Or, more subtly, an occurrence can be a damaging
action that has slowly built up over time. Think of a series of actions that are
damaging, but damaging on such a small scale that they are initially not
noticed. If the ultimate result of their repetition is a sizable accident, the policy
will count this as an occurrence that is insured up to the liability minimum of
the coverage.
 MEDICAL PAYMENTS TO OTHERS
Coverage F of the homeowners policy is different from Coverage E in a
number of ways. It is not based on negligence and the tort liability system,
and is effectively an accident policy. Certainly, a lawsuit might arise from an
injury, but often suits have a time delay effect. In other words, an injury
occurs, and the injured party only sues after "thinking about it." In such a
situation, the policy would pay medical expenses for the injured party (up to
the policy limit) under Coverage F immediately after the accident occurred. If
the insured were subsequently sued, Coverage E would take over.
Coverage E is also different from the medical payments to others coverage in
that payments are made on per person rather than per occurrence rates. In
addition, the liability limit is significantly lower. The minimum liability level is
$1000. This limit can naturally be increased with a higher premium, but
generally $5000 is the maximum.
Coverage F is designed to pay the necessary and reasonable expenses of an
injured party. The idea is that the expenses are paid directly after the injury,
as the level of coverage is relatively low. Still, some injuries possess
characteristics that require treatment over a period of time. Coverage F will
pay its full liability limit up to three years after an accident.
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The types of medical treatments available are quite broad. The possibilities
include hospital services, surgery, X-rays, dental care, ambulance services,
and prosthetics. Furthermore, the costs of funeral services are also covered
up to the liability limit under the policy.
The individuals covered under this section of the policy are found in two
groups. The first group consists of any persons injured while on the insured
location with the insured's permission. This element of permission is
significant, and disallows absurd situations as trespassers seeking coverage
for injuries sustained while trying to rob an insured's home.
The second group that can potentially seek coverage is made up of persons
who are injured off the insured location, but meet a number of conditions.
If another person is injured because of the actions of an insured, that person
is covered. In this case, the insured carries his or her policy anywhere in the
world.
Any animal owned by the insured also carries the policy with it off of the
insured location. Thus, if an insured's dog wanders off the yard and bites a
neighbor's child in the street, the child is covered.
And finally, any residence employee of the insured is protected by Coverage
F of the homeowner's policy. This coverage applies to the residence
employee whether the injury occurred on or off of the insured location.
 ADDITIONAL COVERAGES UNDER SECTION II
Section II of the homeowners policy also provides an Additional Coverages
section. These benefits extend beyond Coverages E and F, and are common
to all the homeowners policy forms.
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The first of the Additional Coverages is the payment of claim expenses. This
is the section of the policy that pays the expenses of the liability process. The
most obvious of these expenses are found in court costs and attorney's fees.
But there are other possible expenses that can be incurred, including
premiums on appeal bonds when a decision is appealed to a higher court, the
expenses the insured incurs at the insurer's request, and interest on a
judgment that has been made, but has not begun payment. In addition to all
of this, the company will compensate the insured for up to $50 per day for
loss of earnings due to time off of work.
First aid expenses are also paid under the Additional Coverages section of
the homeowners policy. First aid expenses are those immediate expenses
incurred when helping someone that has been injured. The most common
example of this is the cost of calling an ambulance.
There is an additional amount of insurance that can be applied to property
damage of others that is caused by the insured. This is for situations where
the law of negligence is not employed, and the intent is to avoid difficult and
uncomfortable legal proceedings between friends and neighbors. The amount
of coverage is no more than $500.
The fourth and final benefit found under the Additional Coverages section of
the homeowners policy pertains to loss assessment.
 SECTION II EXCLUSIONS
The three various coverages in the Section II portion of the homeowners
policy are not without exclusions. There are four sets of exclusions in the
Section II portion, and they are divided as follows:
personal liability
exclusions; medical payments to others exclusions; personal liability and
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medical payments exclusions; and lastly, exclusions for the damage to
property of others portion of the Additional Coverages.
 COVERAGE E EXCLUSIONS
Coverage E of Section II excludes coverage to the property damage of the
insured's own personal property. The broad definition of the insured also
catches the insured's spouse, children, and resident, dependent minors in its
net. While at first this exclusion seems confusing, one need only bear in mind
the principle that underlies it. The insured cannot be liable to itself. Property
that the insured has temporarily "owned" through renting, borrowing, or
occupying is also excluded from coverage.
If an insured receives a bodily injury, he or she is not covered. In other words,
an insured that is negligently injured cannot collect damages under this
coverage. The injured party would have to pursue action through the legal
system in the form of a lawsuit.
In most cases, the policy will not cover the insured when liability arises out of
the insured's own contractual liability. The only time when the liability under a
contract or agreement is not excluded is when the contract relates in some
direct way to the ownership or maintenance of an insured location. Another
possibility where this exclusion will not apply is when the insured has willingly
assumed the liability of others prior to an occurrence. An example of such an
assumption of liability is providing coverage to renters under the written lease.
Another occasion for exclusion arises out of the insured's involvement in a
legal association, such as an apartment cooperative or a lake owner's
association. Any loss assessed and leined on the insured is not paid for under
Coverage E of the policy.
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Furthermore, as in the case of most forms of personal property insurance, the
homeowner's policy can in no way pay out benefits when the injured person is
eligible for workers compensation. It does not matter whether the workers
compensation benefits are voluntary or mandatory; bodily injury liability is
excluded
whenever
there
is
eligibility
for
benefits
under
workers
compensation.
Also excluded are liability losses caused by nuclear energy accidents and
radioactive contamination. Protection from liability that is caused by nuclear
energy is best sought for under a nuclear energy liability policy. Such a policy
is available through a nuclear energy pool, and offers broad coverage
specifically for nuclear energy losses.
 COVERAGE F EXCLUSIONS
Two areas of exclusion are very similar to those discussed above for
Coverage E. First, medical payments are not made whenever the injured
person is eligible for benefits under workers compensation. It does not matter
whether the workers compensation coverage is voluntary or mandatory.
Also, as in Coverage E, nuclear energy incidents that result in losses are
excluded coverage. In this case, medical payments would not be paid for any
bodily injury sustained from a nuclear accident or contamination.
Another exclusion for Coverage F occurs when a regular resident of the
insured location is injured. In this case, unless that person is also employed
by the insured, he or she will not receive medical payments.
Likewise, an employee of the insured who is injured off of the residence
premises is not afforded coverage. Thus, the policy is not mobile for the
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insured's employees, and is bound to injuries occurring on the insured
location.
EXCLUSIONS APPLICABLE FOR PERSONAL LIABILITY AND
MEDICAL PAYMENTS
Foremost among the exclusions that are valid for both personal liability and
medical payments to others is the intentional injury exclusion. Because
intentional damage to property and intentional injuries are both actions
contrary to the public interest, they are excluded coverage.
Business related losses are also not covered. This is applicable in situations
where the home is also the office, or site of business activity. This exclusion
extends from such "typical" home-business as daycare to the professional
activities of lawyers and doctors.
Rentals are a form of business activity that are generally excluded, but may
be covered under certain situations. They are generally excluded so as to
prevent the large landlord from insuring at a rate identical to the individual
homeowners. For the homeowner can rent a portion of the insured location
and still retain coverage so long as the rental is to no more than two persons
in a single family unit. Also, coverage is not excluded if the residence is only
occasionally rented.
Liability occurring through an incident with a motor vehicle is generally
excluded. The homeowner’s policy cannot overlap with the personal auto
policy. The situations where motorized vehicles are not excluded are as
follows: trailers not towed by a motor vehicle; off-road recreational vehicles
owned by the insured and on the insured location; golf carts while in use on
the golf course; motor vehicles not subject to registration that are used for the
maintenance of the residence, or by the handicapped.
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Watercraft are broadly excluded by the homeowners policy. This broad
exclusion is followed by a series of exceptions, all of which are based upon
factors having to do with the watercraft. For example, if the watercraft is a
sailing vessel, it is covered when less than 26 feet in overall length and
owned or rented by the insured.
When powered by a motor, horsepower becomes a crucial factor in
determining whether or not the watercraft is excluded. Thus, watercraft with
an inboard or inboard-out-drive engine of more than 50 horsepower are
covered if not owned or rented by the insured. If the motor is an outboard and
less than 25 horsepower, it can be covered even if it is owned or rented by
the insured. On the other hand, if the watercraft is powered by more than one
outboard motor of less than 25 horsepower, it generally cannot be covered if
the insured owns or rents it. But if the insured purchased the watercraft before
the policy period, or if a written intention to insure was made to the insurance
company within 45 days from the point of purchasing the watercraft, it can be
covered.
Any liability arising out of incidents with aircraft is also excluded. In this case,
aircraft is the term that designates any vehicle that flies and is used for
transportation.
Acts of war are not covered under the policy. Losses arising out of the
(accidental or intentional) use of nuclear weapons are not covered.
The AIDS crisis has led to another exclusion; the liability originating from the
transmission of disease is excluded for both personal liability and medical
payments coverage. While AIDS is the most dramatic example, the exclusion
applies to any transmittable disease.
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 EXCLUSIONS UNDER THE ADDITIONAL COVERAGES
The section of Additional Coverages that requires a list of exclusions is the
damage to property of others. The possibilities for exclusion here a fivefold:
1. Property damage supplements that of Section I- Section II coverage
only begins after Section I has paid out, less its deductible;
2. Any intentional damage by an insured, aged 13 or older, is excluded
coverage;
3. Property damage caused by motor vehicles, aircraft, and watercraft is
not covered;
4. Property damage that results from an insured's home-based business
is excluded;
5. The insured is excluded coverage on damage to its own property.
Illegal activities, such as drug abuse, physical abuse, and sexual misconduct
are also explicitly excluded under both personal liability and medical
payments to others. Drug abuse in this context is a broad category, and refers
to not only the use of illegal drugs, but to their manufacture, sales, and
delivery as well. An illegal drug is any classified as such by the Food and
Drug Law. (Obviously, the use of any drug prescribed by a licensed physician
is not subject to this exclusion.)
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SECTION II
REVIEW QUESTIONS
1. The minimum liability in Coverage E is $100,000, but
this amount can be increased by paying a higher
premium.
a. true
b. false
2. All family members who reside in the house are
extended coverage under Section II of the Homeowners
3 Special Policy. This would include the minor at
boarding school during the school year.
a. true
b. false
3. Coverage E is based upon the concept of legal liability.
For it to pay a loss, the insured must be shown to have
been negligent.
a. true
b. false
4. It is vital that a causal relationship exists in order for an
act to be negligent. This is called a proximate cause,
and means that an unbroken, connecting chain of
events occurs that lead to damages.
a. true
b. false
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5. The homeowners policy provides the insured personal
liability insurance only in the United States.
a. true
b. false
6. Coverage F of the policy is for medical payments. Like
coverage E, it will only provide coverage in cases of
negligence.
a. true
b. false
7. Coverage F's minimum liability level is $100, but it can
be increased all the way up to a maximum of $100,000
in almost all incidents.
a. true
b. false
8. Any animal owned by the insured "carries" Coverage F
with it. Thus, if it bites the neighbor in the neighbor's
own yard, the neighbor will be covered up to the limit of
the policy.
a. true
b. false
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9. Coverage F will pay up to its liability limit up to three
years after the occurrence of an accident.
a. true
b. false
10. The payment of claim expenses, such as court costs,
legal fees, and appeal bonds, are provided for under
the Additional Coverages' portion of Section II.
a. true
b. false
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ANSWERS TO REVIEW QUESTIONS
1. true
2. true
3. true
4. true
5. false
6. false
7. false
8. true
9. true
10. true
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PERSONAL UMBRELLA POLICY
It is hardly a well-kept secret that we live in a litigious society. Each day, the
newspapers are filled with stories about persons taking legal action, while the
television blares-out the latest sensational lawsuit. Such catastrophic lawsuits
have become a part of the cost of living.
The most obvious class of persons who are in danger of being slapped with a
potentially ruinous suit would be the professionals. Doctors, surgeons, dental
workers, attorneys, and a whole host of other workers who perform vital,
specialized tasks are in constant danger of being sued. Yet, in today's world,
they are hardly alone.
Another category of persons needing protection are not defined by
occupation, but rather financial resources. Anyone with significant assets can
find him or herself the target of an opportunistic lawsuit, often with ruinous
results.
Our culture has become so prone to legal action, however, that it is now not
only the wealthy that need to guard against being sued. Today, even
"ordinary people" are finding themselves on the receiving end of lawsuits that
exceed the liability limits of their basic insurance. The outcome is often
financial difficulty, up to and including catastrophe.
One popular strategy to meet this challenge is to make use of the personal
umbrella policy. A non-standard contract, the umbrella policy is a broadbased coverage that handles liability exposures connected with the home and
automobile, as well as recreational vehicles and sports activities.
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The personal umbrella policy is, in a nutshell, "extra" insurance; it is insurance
that extends over and beyond what one's basic, underlying insurance
contracts cover. Generally, it is written for $1 million to $10 million dollars.
One of the elements that has made the umbrella policy popular is that it is not
perceived to be overly expensive for the amount of protection it affords. Often,
a premium of $250 can buy a $1 million policy that significantly expands one's
coverage.
The most striking aspect of the umbrella policy is its underlying coverage
requirements, and its self-insured retention component. The underlying
coverage amounts vary from company to company. What is important to
emphasize here is that an umbrella policy cannot be purchased instead of a
homeowner’s policy or a personal auto policy. The umbrella policy will "kick
in" and pay only after the base amount of the underlying contracts have paidout to their full limits. If for some reason the underlying amounts are not
maintained, the umbrella policy will not make-up the difference. Instead, what
occurs is the umbrella policy acts as though the underlying amounts had been
maintained, and only pays out the amount it would have been expected had
the underlying amounts remained active and current.
When a loss occurs that is not covered by the underlying insurance, but is
included in the umbrella policy, then the insured must pay a self-insured
retention fee. This is roughly analogous to a deductible. Such losses
generally occur from libel and slander cases, but many more possibilities
exist, such as humiliation, defamation of character, false arrest and
imprisonment, and invasion of privacy.
The coverage afforded through the umbrella policy is extremely broad. It
includes property damage, personal injury, and liability property damage. The
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definition of personal injury is generously inclusive, and embraces bodily
injury, disability, shock, mental anguish, and disease.
Still, the umbrella policy, like all insuring agreements, comes with exclusions.
These can be far-reaching, and this course will cover just a few of the most
common.
1. Workers compensation
As with most insuring agreements, workers compensation cannot
be supplemented by a policy. Any obligation that the insured owes
under workers compensation is not covered.
2. Intentional acts
A covered person who intends to cause personal injury or
property damage will not receive coverage.
3. Business operations
Liability arising out of a business pursuit is not afforded
coverage.
4. Professional liability
Liability that occurs from professional activities is generally
excluded. It can be purchased, however, by a special
endorsement.
5. Aircraft
Liability resulting from any aspect owning, maintaining, or
using aircraft is most always excluded from the umbrella
policy.
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PERSONAL UMBRELLA POLICY
REVIEW QUESTIONS
1. The personal umbrella policy is a self-standing policy
that effectively replaces other insurance with a
comprehensive coverage.
a. true
b. false
2. Since we do not live in a legalistic society that provides
many opportunities for exposure to lawsuits, the
umbrella policy has become fairly superfluous.
a. true
b. false
3. One of the attractive features of the personal umbrella
policy is that it can be had for a fairly low premium that
greatly expands one's coverage.
a. true
b. false
4. If an insured has not kept the underlying insurance
required by the umbrella insurer, then no amount of
coverage is afforded at all.
a. true
b. false
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5. Umbrella policies include slander and libel under their
definition of personal injury, and extend coverage for
losses resulting from such attacks.
a. true
b. false
6. When an insured incurs a loss covered by the umbrella
policy, but excluded from the basic underlying
insurance,
he
or
she
must
pay
a
_____________________ fee.
7. The personal umbrella policy can supplement any
payment for which the insured is legally liable for under
workers compensation.
a. true
b. false
8. The personal umbrella policy coverage is extremely
broad, and includes all forms of automobiles, recreation
vehicles, and aircraft.
a. true
b. false
9. Generally, professional liability is excluded from the
personal umbrella policy, but it may be purchased with
an endorsement.
a. true
b. false
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10. Most companies write personal umbrella
coverages for $100,000 to $300,000.
policy
a. true
b. false
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ANSWERS TO REVIEW QUESTIONS
1. false
2. false
3. true
4. false
5. true
6. self-insurance retention
7. false
8. false
9. true
10. false
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NOTES
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Chapter Five
Fire Insurance
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OVERVIEW AND BACKGROUND OF FIRE
INSURANCE
Prior to analysis of the Standard Fire Policy, it is important to explore the
beginnings of the fire insurance industry and the reasons underlying the
standardization of the fire insurance form.
The fire insurance industry, like so many other branches of property
insurance, grew out of immediate necessity. Businessmen and homeowners
alike felt the need for protection of their properties from natural occurrences,
like fire, that were largely beyond their control.
The first fire insurance policies were written by individual underwriters or
small companies to insure those of whom they had personal knowledge. The
policy was generally very short in form, consisting of a property description,
an amount of insurance, the term of duration, and the premium. This early
policy, as it was applied with varying terms, restrictions, and conditions
created a great amount of litigation and very little satisfaction for both insurer
and insured. The need for standardization quickly became apparent.
Another factor contributing to the need for standardization was the growth and
expansion of the American economy in the nineteenth century. The rise of
American business represented a greater financial stake in property and
physical wealth. With more people having more goods to protect, the need for
fire insurance increased drastically. Financially, the business of fire insurance
grew beyond the means of individual and small insurers.
As corporations began to enter this arena, the need for standardization grew
into a necessity. The result of increased underwriting over a larger area left
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many companies open to dishonest or ignorant agents, who contracted
overinsurance or underinsurance. The resulting uncertainty led to large
contracts filled with endless provisions and restrictions to protect the insurer.
Some of these contracts were so large and detailed that it sometimes took
multiple insurance professionals to decipher the actual coverage! This
problem was multiplied by the tendency to use multiple terms.
These factors led to multiple legal actions that, more often than not, led to still
more litigation. The logical answer to this problem was the creation of a
standard form with standardized terms. The form would, in time, be tested by
the courts to further define a standard terminology. The National Board of
Underwriters is credited with the first attempt at adopting such a form in 1867.
In 1880, the State of Massachusetts required the use of their standard form
for all companies writing fire insurance in their state. By 1887, the legislature
of New York adopted a standard form that soon became the model for many
other states. The New York Standard Fire Policy of 1887 became the
standard fire policy most of the United States. This contract has been
modified many times since its inception, but continues to be the basis of
today’s fire policies. The following sections of this chapter identify and explain
the provisions of the New York Standard Fire Policy of 1943.
The New York Standard Policy is divided into two parts. The first is the
agreement and the second consists of provisions and stipulations.
The agreement portion contains the actual agreement and can serve alone as
a complete contract. The agreement contains the establishment of two
principles of fire insurance. The fire insurance contract is personal, and it is a
contract of indemnity. Because the agreement is a contract, it is necessary to
establish the required provisions of a contract.
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The policy limits rights of assignment, excludes consequential losses, and
establishes the policy as an interest policy. The agreement also outlines the
coverage, and states the available protection against direct loss by fire,
lightning, and removal.
The second part of the Standard Policy explains stipulations and conditions.
Specifically, this sections covers fraud, uninsurable property, perils not
covered, and property not covered without special provision. Provisions are
also make for the suspension or restriction of insurance, waiver of contract
provision, policy cancellation, limiting other insurance, and addition of
coverage for perils other than those outlined in the agreement.
Special provisions can also be added to contend with the interest and
obligations of third parties such as mortgage holders. This section also
contains the rights and obligations of all parties after a loss occurs, including
the rights of the insurer to subrogation.
A key area of the Standard Fire Policy is the covered hazards. These are
outlined in detail in the policy. The covered hazards are fire, lightning, and
debris removal. The definitions of these hazards are not necessarily spelled
out in the policy. “Fire” for the purpose of the Standard Fire Policy is an
intense combustion that results in flame or a glow. Excessive heat, scorching,
or blistering without a flame or a glow is not considered fire, nor is the
damage resulting from this heat considered fire damage. Lightning is defined
as the discharge of electrical energy from the atmosphere. Debris removal is
defined as the removal of physical objects from the insured location.
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An important stipulation of the Standard Fire Policy is that fire damage is only
covered in the event of a hostile fire. A hostile fire is one that occurs outside
of its normal environment. It is an unforeseen, fortuitous condition. A friendly
fire, on the other hand, is a planned event that is confined to a specific area.
For example, a fire in the fireplace, grill, or furnace are all varieties of friendly
fire.
A fire becomes hostile at the moment that it escapes the intended confines.
For example, flames escaping through a crack in a wood-burning furnace can
cause a hostile fire. Damage from this fire would most likely be covered by
the Standard Fire Policy. On the other hand, if the furnace grows excessively
hot and singes a wall, the damage is not covered, because the friendly fire
was still contained in its proper environment.
The Standard Fire Policy covers losses that are directly caused by one of the
covered perils. The causal chain of events is therefore crucial for determining
whether the policy will cover the loss. The fire must be the primary cause of
damage, and the fire must be unfriendly.
An insurer may be liable for damage on an uninsured property if a hostile fire
spreads from a location they have insured. In this case, damage that is direct
or proximate may be the insurer’s responsibility. The following are two
examples of such promixate damages.
1. A fire destroys the bottom level of a bi-level apartment complex.
The damage to the beams supporting the top-level is sufficient to
significantly weaken the building structure. The beams crumble,
and the upper level crashes down upon the lower level two days
after the initial fire.
2. A fire in an electrical plant causes the turbines to malfunction.
During the malfunction, the turbines rotate too rapidly, and cause
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an overload. The overload subsequently destroys sensitive
computer equipment in an adjacent building.
In the above examples, the fire was not the direct cause of damage to the
upper level of the apartment complex or the computer equipment in the
adjacent building. In both cases, however, the fire was the proximate cause of
the damage, and may be covered by the Standard Fire Policy.
Elements of the Standard Fire Policy

Right of Assignment
In many other types of insurance agreements, the insured is allowed to
assign the interest to another party. This act is forbidden in the fire policy, and
would invalidate the contract. The reason that assignment is not allowed is
simple. The Standard Fire Policy is a personal contract, and assigning it to
another would deny the insurer the opportunity to assess the new risk. Fire
insurers must take significant measures to investigate the risks they will
insure.

Indemnity
A fire insurance policy is an indemnity contract. Following a loss, the insured
will be indemnified by the insuring company, meaning that he will be restored
to his financial standing prior to the loss. This compensation can take different
forms.
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One possibility is reimbursing the actual cash value of the loss. Actual cash
value is usually interpreted as the cost to replace minus depreciation. Loss of
merchandise for sale is replaced at market value plus cost of labor and
administrative costs. The loss of physical property is more difficult to
determine, and must go through an appraisal process.
The payment of cash value for a loss is only valid up to the limit of the policy.
Under no circumstances is the insurer required to provide compensation
beyond the limits spelled out in the contract.
The insuring company may also choose to repair or replace the damaged
property. If the insuring company elects to repair damaged property, it must
give notice of this intention to the insured within thirty days after receipt of the
proof of loss.

Pro Rata Liability
The insurer will limit its own losses when the insured has more than one
policy. Each fire policy should possess a pro rata liability clause. This
provision spreads the obligation to pay a claim to the various insurers
covering the claim. The obligation to pay is spread in proportion to the
insurance that each company has written. Therefore, if a property owner has
four fire insurance policies from four different companies on one building,
each policy is only liable to pay a maximum one quarter of the actual total
damage to the property. This limit would hold true even if only one of the four
companies financially capable of paying.
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
Uninsurable Property, Perils Not Covered, and the Insured’s
Obligations After a Loss
There are several hazards that are considered uninsurable and excluded
coverage under the Standard Fire Policy. For example, the policy excludes
losses caused by military attack. The policy also excludes loss by any nuclear
hazards. Losses caused by the enforcement activities of a civil authority
typically are not covered.
Two exclusions under the Standard Fire Policy deserve particular attention—
losses due to neglect, and losses due to intentional damage. To receive
protection under the Standard Fire Policy, the insured must protect the
property by using all reasonable means during and after the time of loss.
Failure to meet this obligation excludes the insured from indemnification.
The Standard Fire Policy also treats certain property as uninsurable. For
example, personal records, currency, bank notes, deeds, evidence of debt,
passports, securities and precious metals are not covered. Most policies also
exclude motor vehicles and aircraft unless the vehicle is used to service the
property or aid the handicapped.
The Standard Fire Policy also excludes loss of credit cards and data. The
exclusion for loss of data holds regardless of the type of storage used by the
insured. This exclusion pertains to account books, drawings, blueprints,
computer disks, CDs, reel to reel and audio-cassettes, and other data
processing material.
In order for a claim to be paid, the several conditions must be satisfied. First,
the loss must occur during the policy period specified in the contract. Second,
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it is understood that the contract is void in the event of concealment or fraud.
Thus, the policy is void if the insured made false statements regarding the
policy, withheld or concealed important information, or intentionally engaged
behavior with the intent to defraud the insurer.
Duties of the insured after a loss also must be met for a claim to be paid. The
insured is required to contact the insuring company immediately after a loss
occurs. The insured is also instructed to protect the property from further
damage, to make reasonable repairs for the purpose of protecting the
property from further damage, and to keep accurate records of all expenses
related to this repair.
The insured is also required to prepare an accurate inventory of all personal
property, whether it is undamaged, damaged, or destroyed. The inventory
should show in detail the quantities, costs, and amount of loss claimed. The
insured must also furnish proof of loss upon demand and submit to
examination under legal oath.
Within sixty days of a loss the insured is required to submit legal
documentation detailing the time and cause of loss, the interest of the insured
and other parties in relation to the loss, the actual cash value of the loss, the
amount of loss, other insurance covering the loss, any changes in the title of
the property, specifications of the damaged building including repair
estimates, the purpose of occupation, and whether the building stood on
leased property.
Upon completion of the above requirements the subject of loss settlement
may be approached. As a principle, the covered property losses are settled at
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actual cash value but not for more than the cost to repair or replace the loss.
The settlement cannot exceed the policy limit.
In the event that the valuation of the loss is challenged, either party may
request that the property be appraised. In event of a dispute, both parties
must hire a competent appraiser within 20 days. Both sides appoint separate
appraisers and one impartial umpire. If an umpire cannot be agreed upon
within 15 days an umpire may be appointed by a judge of the court of record.
The disputing parties pay for their appraisers individually and the judge jointly.
During the appraisal process, each appraiser submits an amount for the loss.
If the appraisers reach an agreement on the amount, then the matter is
settled. If the appraisers disagree on the amount, the differing figures are
submitted to the umpire.

Cancellation
The cancellation clause details the rights of parties to cancel the contract. At
the insured’s request, a policy can be cancelled at any time. This can be done
by returning the policy or providing written notification with the date of
cancellation. When the policy is cancelled at the insured’s request the
company can bill on a short rate basis. This allows the company to keep a
greater than proportionate share of the premium as a penalty.
In the event the insuring company wishes to cancel the policy, the premium is
returned on a pro rata basis. The insurer keeps a share of the premium
proportionate with the expired period of the policy.
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The insurer’s power to cancel fire policies is limited. The insurer may also
cancel the policy for any reason, but the cancellation must be done within
sixty days of the inception of the policy. This right of cancellation does not
apply to a policy renewal. However, the insurer does have the option of not
renewing an existing policy. An instance of non-renewal must be
accompanied by timely written notice.
After the sixty-day trial period, the insurer can only cancel the policy if there is
a material misrepresentation of fact that would have caused the insurer to not
issue the policy. In this case, the insurer would only need to notify the policy
holder thirty days prior to the cancellation.
Obviously, the insurer can cancel a policy if the premiums are not paid.
However, even in this event the insurer is required to notify the insured at
least ten days prior to cancellation.

Endorsements to the Standard Fire Policy
The 165-line Standard Fire Policy is not complete for most insurance
situations. For these reasons, it is typical to add multiple forms and
endorsements. These additional endorsements cover additional risks and
“round out” the policy.
There are three accepted methods of describing property for the purposes of
the form. These methods are called specific, blanket, or reporting. Based
upon the method, the form falls into one of five categories. These categories
are called specific, blanket, floater, automatic, and schedule.
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The specific coverage form insures one type of property in a single location
for a defined amount of coverage. Blanket coverage, on the other hand,
insures the same type of property at different locations. Blanket coverage can
also insure different properties at one location. An example of this option
would be a policy holder insuring multiple types of property within a
warehouse or a particular type of merchandise within multiple warehouses.
Obviously,
this
allows
greater
latitude
for
insurance
coverage
for
merchandisers and wholesalers.
A floater policy covers property so long as it is located within a general
geographic area. This type of policy protects the property as it moves or
“floats” form location to location within prescribed limits. An example of this
situation is an art exhibit traveling from museum to museum. In this example,
the art exhibit may be protected under this type of coverage no matter the
location of the loss as long as it is within the limits of the policy.
Automatic coverage is used when the value of insured property fluctuates.
This type of form automatically adjusts the amount of coverage to the limit of
inventory that is reported at specified, regular intervals. This coverage is used
for an accurate accounting of the value of the protected property, and helps
avoid over and underinsurance.
The schedule form provides blanket coverage for a specific amount to a large
number of properties. This form allows organizations with multiple land
holding to have specific amounts of insurance on each property, but within a
single form. This limits the amount of work an organization must undertake in
order to protect its holdings.
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
Provisions commonly found in the various forms
The debris removal clause typically extends coverage to the costs of
removing covered property when a named peril has caused a loss. The
expense of removal is under the policy liability limit that applies to property
loss. This means that while coverage is extended to debris removal, it cannot
increase the amount of insurance.
The coinsurance clause allows the insured to risk partial damage for a lower
premium. Under the coinsurance clause the insured agrees to carry insurance
of not less than a certain percentage of the actual cash value of the property.
At the time of loss, a formula is used to find the actual liability of the insurance
company. An example of the coinsurance clause in action can look like the
following:
A book store carries a $50,000 fire policy. The actual cash value of the
covered merchandise is $100,000. Because the insured agreed to an 80%
coinsurance clause, the amount of required insurance is $80,000. To find the
liability of the insurer, we divide the amount of insurance carried by the
amount of insurance required (expressed as IC/IR). We multiply this figure by
the amount of actual loss to find the total of actual liability (expressed as IC/IR
 AD= AL). In our example, the result of $50,000 divided by $80,000
multiplied by $100,000 gives us a total liability of $62,500.
The coinsurance clause encourages the insured to carry the proper amount of
coverage and maintain accurate records. If the proper percentage of
insurance is carried, the insured is entitled to full coverage (up to the policy
limit) in the event of a loss. Many states limit or prohibit a coinsurance clause
on certain dwellings or risks.
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The liberalization clause allows for the application of state statute, regulation,
or ruling that would modify or broaden a fire policy or endorsement. This
allows the policy to remain valid without rewriting the policy.
The pro rata distribution clause is common to blanket policies. When one
wishes to cover multiple buildings, this clause allows each building to be
covered with a specific maximum coverage. At the same time, the company’s
liability is limited to the percentage value of the building in the overall policy.
For example, the actual cash value of four properties are as follows:
Building A = $5,000
Building B = $5,000
Building C = $10,000
Building D = $20,000
Suppose a blanket policy for $25,000 covers all four of these properties.
Following the pro rata distribution clause, the actual liability for this situation
would be the value of the damaged location divided by the overall value of all
covered locations multiplied by the value of the policy. For example, if building
B is destroyed the equation would be $5,000 (the value of building B) divided
by $40,000 (the total value of all the buildings), multiplied by $25,000 (the
value of the policy). Following the figures in this formula, the insurer’s liability
is $3,125.
The above equation would only be applied if the insured accepted a
coinsurance clause. If the policy covered 100% of the actual cash value, the
insurer’s liability would be for the entire amount of the cash value up to the
limit of the policy.
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In many areas it is possible to insure property on a replacement basis. In
order to cover property for the actual cost of replacement, it is necessary to
base the value of the coverage on the replacement value rather than the
actual cash value. Normally this type of form requires a coinsurance clause
with a non-increase in rate. This type of coverage also requires the insured to
replace the property within a defined time frame.
The building and contents form is a special form designed for commercial
properties. The form begins with providing coverage for machines used in the
service of the building. These include wiring, plumbing, ventilation systems,
lighting, boilers, doors, windows, and other associated items. The form also
extends coverage to all personal property inside the building, including
property that is entrusted to the owner of the policy.
The building and contents form naturally excludes some property from
coverage. The type of excluded property varies from state to state, and tends
to rely on the presence of a coinsurance clause. If the insured agrees to a
coinsurance clause, he me also opt for a foundation exclusion. This clause
generally excludes loss of sub-basement or foundation damage. If there is not
a coinsurance clause, the foundation is considered a part of the building
structure.
The building and contents form also outlines a number of special obligations
that must be met by the insured. One such obligation is the work and
materials clause. This clause allows the insured to use the property in any
manner that is usual to the regular business described in the policy. Without
this clause the introduction of new materials may be considered an increase
in risk and would invalidate the coverage. What is important here is how the
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use is classified—usual, or incidental to the regular business. The insured can
cover a wide range of risks as long as it can be classified as “usual.”
A vacancy and unoccupancy clause is also found in the dwelling and contents
form. Under the Standard Fire Policy, a contract is suspended if the property
is unoccupied or vacant for a period of sixty days. The vacancy and
unoccupancy clause allows the insurer to grant an exclusion to this rule,
usually for a specific time period. Each state regulates this type of clause
separately with regard to time limits.
Because the forms attached to the policy broaden the coverage of the
insured, they also make demands on the insured. These demands may
require the insured to monitor the property at all times and/or maintain and
monitor the sprinkler and fire alarm system. Some states require yearly
inventory reports and a fire safe area for keeping records. Fairly to comply
with demands can void the policy agreement.
The dwelling and contents form applies specifically to the protection of a
home or an apartment and the contents within. The trend in insurance has
been to create special multiple-peril policies for homeowners. While we
recognize this trend in the evolution of insurance, it is important to note the
principles within this fire insurance form, as it serves as the foundation for
modern policy developments.
The dwelling and contents form extends coverage to all contents of the
household except for motor vehicles. As long as the items remain within the
policy’s jurisdiction, the form offers coverage even in the process of moving.
Once the move is complete, the insurance coverage at the previous
residence ends and is automatically extended to the new location. In addition
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to covering the internal contents of the household, this forms also covers noncommercial plants, trees, and shrubs outside the building structure.
The dwelling and contents form can also allow the insured to collect rent
insurance on untenantable property. The general rule is up to 10% of the
amount of insurance can be applied per calendar year to lost rent. This clause
only pays the indemnity on a monthly basis, not does not allow the insured a
lump sum payment. Therefore, the insured can only collect 1/12 th of 10% of
the amount of insurance per month.
The need for different types of coverage to handle special risks has given rise
to a number of extended coverage contracts. These contracts provide
protection for perils unnamed and not excluded in the standard fire policy.
Extended coverage contracts can cover a wide range of risks, and some of
the most common are business interruption coverage, natural disaster
coverage, vandalism and theft coverage, and water damage coverage.
One of the legal principles required for a valid fire insurance policy is the clear
presence of an insurable interest. It is not hard to imagine multiple parties
with an insurable interest on a single property. One of the most common
examples of this would be the relationship of the mortgagee and mortgagor in
the context of fire coverage.
Both the mortgagor, as property owner, and mortgagee, as trustee, have an
individual, definable interest in the same property. Insurance companies and
courts have come to recognize this relationship and address it with a standard
mortgage clause that can be written into the basic fire form.
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This clause allows the mortgagor to take out a policy for his own benefit and
also protect the interest of the mortgagee. The key provision of this clause
protects the interest of the mortgagee regardless of the conduct of the
mortgagor, so long as the mortgagee is unaware of any actions that would
invalidate the policy. In other words, the agency holding the mortgage is fully
insured even if the primary holder of the policy acts in a way that would void
the coverage. This clause also directs the insurer on the subject of payment
to the mortgagee, premium liability, and subrogation.
When there is a mortgagee, payment for a loss can be problematic. Many
companies make settlement by draft, allowing both parties to submit
inventories of their interest in the property. When the actual cash value of the
loss is determined, a joint draft is issued to the mortgagor and mortgagee. At
this point, both sides attempt to reach agreement as to the application of the
indemnity.
The options in this situation are numerous. The owner may take the indemnity
in full and continue to pay under the terms of the original mortgage, or the
mortgagee may apply the entire amount of the principle. Another option is the
right of the insurer to pay the mortgage in full and become subrogated to
collect the balance from the mortgagor.
The mortgagee clause also makes the mortgagee liable for the premium if the
policy holder neglects to make payment. The rationale for this clause is to link
financial responsibility for maintaining the policy to the party that receives the
most benefit from the coverage. This clause also requires the insurer to notify
the mortgagee ten days prior to a cancellation. This allows the mortgagee to
protect his interest in event of cancellation.
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Rate-making for fire insurance can be regulated by statute, state regulation,
or case law. Many companies rely on the services of professional rate-making
organizations to inspect, analyze, and set rates for a risk. Some states require
the rates to be set by state agencies, and some states maintain a board for
insurance rate-making.
Regardless of the organizational vehicle used to set rates, the same factors
are employed to determine insurance rates. The basic tactic is to classify the
risk by possible hazard(s). An example of this would be to classify the fire
hazard of a brick building versus the hazard of a wooden building.
A second tactic differentiates the hazard of like risks. An example of this
would be making the differentiation between a wooden building with a
sprinkler system versus a like building without a sprinkler system.
Other issues that factor into the rate equation include the hazards of
occupancy, the hazards of exposure, and the element of time. Of these, the
time element is the most difficult to calculate. For example, suppose a rate is
based upon results of one, two, or three years. Experience shows that fire
loss varies greatly from year to year. A company may only pay out a small
number of minor claims over a period of years, but in any twelve month period
it could conceivably experience an avalanche of claims. It is important as a
rate-maker to account for these occurrences in order to protect the insuring
company’s assets. The integrity of the industry rests upon the ability of the
company to pay the promised indemnity. A run of claims following a period of
low premiums can strain an insurance company’s reserves.
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FIRE INSURANCE
REVIEW QUESTIONS
1.
The growth of industry and personal business
ownership in America had little to do with the
development of the fire insurance industry.
a. true
b. false
2.
New York was the first state to begin standardizing
the fire insurance form.
a. true
b. false
3.
The Standard Fire Policy stipulates payment for a
loss from both friendly and hostile fire.
a. true
b. false
4.
The agreement portion of the Standard Fire Policy
can stand as a complete contract.
a. true
b. false
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5.
A wide range of uninsurable hazards can be found in
the Standard Fire Policy.
a. true
b. false
6.
It is possible to base the fire policy on the
replacement value of a property rather than on the
actual cash value.
a. true
b. false
7.
Fire damage caused by electrical wiring would most
likely be covered in a Building and Contents Form.
a. true
b. false
8.
The Building and Contents Form is typically used in
Homeowner’s Insurance.
a. true
b. false
9.
The Dwelling and Contents Form provides coverage
on losses due to explosions.
a. true
b. false
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10. Fire insurance rates are determined in part by both
hazards covered and time.
a. true
b. false
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ANSWERS TO THE REVIEW QUESTIONS
1.
false
2.
false
3.
false
4.
true
5.
true
6.
true
7.
true
8.
false
9.
true
10.
true
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Chapter Six
Surety Bonds
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SURETY BONDS
A significant sector of the insurance industry is bonding. Bonding for
insurance purposes is a form of suretyship. They provide a method of
reimbursement for financial losses.
Surety bonds are a type of insurance, but they are different than insurance
contracts. First, an insurance contract typically has two parties. The surety
bond, on the other hand, is an agreement with three parties: the surety, the
obligee, and the principal. Secondly, the insurance contract is designed with
the expectation of a loss. The bonding contract, on the other hand, expects to
not see a loss, and goes so far as to reserve the legal right to collect from the
principal. Also, in insurance agreements, the insuring party generally does not
have the right to recover losses from the insured. In the bonding contract,
however, the situation is quite different. Should the principal default and the
surety pay the obligee, the surety can legally “go after” the principal. Surety
bonds are sometimes called financial guaranty bonds.
A key element in which surety bonds and insurance contracts differs rests in
the measure of control that the interested parties possess in relation to the
risk involved. For insurance contracts, insured losses have to do with
fortuitous events. The bonding agreement, on the other hand, protects
against losses that the covered individual possesses a great deal of control
over.
In most cases that a surety bond is employed, the party with the primary
responsibility for completing a task (the principal), does what has been
agreed to. When this occurs, the bond becomes void. Should the party with
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the secondary responsibility (the surety) have to step in, another phase of the
bonding agreement is activated. The surety, through its right of exoneration,
will pursue the principal for reimbursement of the expenses incurred while
performing the contracted obligation.
Obviously, the bonding business is one that is based upon large sums of
capital. Without significant financial backing, the guarantees made by the
bond agreement would be meaningless. Due to the capital-intensive nature of
bonding, the surety will often demand collateral from the principal before
issuing the bond. The surety is essentially transferring its own outstanding
credit to the principal for a premium payment.
Surety bonds come in a variety of forms, and provide protection for a number
of economic activities. Some examples of possible bonds include public
official bonds, litigation bonds, judicial bonds, fiduciary bonds, auctioneer
bonds, and lost instrument bonds.
A more common example of surety bonding occurs when a municipal
government issues bonds for persons engaged in activities that could
threaten the common welfare. Bonds of this nature are called license bonds.
Such instruments guarantee that the bonded individual will obey all the laws
and regulations applicable to the activity. An example of license bond is found
in bar and liquor licenses.
Another common form of bond is the contract bond, of which there are
several varieties. The most common is the bid bond, through which the
obligee is guaranteed that the party awarded the bid will sign a contract and
provide a performance bond. The performance bond guarantees the
conditions and time under which the project will be completed.
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The bail bond is perhaps the most widely recognized form of bond. The bail
bond is a variety of court bond, and guarantees the appearance of the
bonded person in court at a specific time under threat of forfeiting the entire
bond penalty.
Bail bonds can be issued by a fidelity and surety insurance company or
obtained through a property bondsman who operates through his or her own
assets. While property bondsmen must obtain prior approval of their financial
condition and ethical character by the jurisdiction in which they operate, they
do not represent a fidelity and surety insurer and do not have to be licensed
by the Insurance Bureau. A bondsman who does represent a fidelity and
insurance company, however, must be licensed for this qualification by the
Insurance Bureau.
Bondsmen cannot delegate their signature authority, nor can they
employ non-licensed persons to solicit bonds or take application. Bondsmen
can, however, employ solicitors licensed by the Insurance Bureau. Licensed
solicitors in the bond arena may perform all the actions of the licensed
bondsman except binding the surety company.
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SURETY BONDS
REVIEW QUESTIONS
1.
A surety bond is the same instrument as an
insurance contract. The only difference is an
insurance contract is issued by an insurance agent
and the surety bond is issued by a bondsman.
a. true
b. false
2.
Persons issuing bail bonds NEVER have to be
licensed by the Insurance Bureau.
a. true
b. false
3.
Collateral is generally required by the surety before it
issues a bond.
a. true
b. false
4.
The three parties to a surety bond are: the principal,
the surety, and the obligee.
a. true
b. false
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5.
A bondsman’s solicitor can perform ALL of the duties
of the bondsman.
a. true
b. false
6.
An example of a license bond is a liquor license,
which allows an establishment to legally sell liquor
within strict guidelines.
a. true
b. false
7.
A performance bond does not have to be issued after
a bid has been awarded.
a. true
b. false
8.
Surety bonds are also referred to as financial
guarantee bonds.
a. true
b. false
9.
When the principal completes his or her contracted
duty, the surety bond becomes void.
a. true
b. false
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10. The party to whom compensation is owed in a surety
arrangement is called the obligee.
a. true
b. false
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ANSWERS TO THE REVIEW QUESTIONS
1.
false
2.
false
3.
true
4.
true
5.
false
6.
true
7.
false
8.
true
9.
true
10.
true
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Contents – Principles of LH, Special
Chapter One
The Specter of Premature Death
Estate Planning
The Role of Life Insurance in the Financial
Planning Process
Chapter Two
Fundamental Elements of Life Insurance
The Concept of Cash Value
Cash Value Versus Term
Chapter Three
Term Insurance Fundamentals
Chapter Four
Whole Life Insurance Fundamentals
Traditional Whole Life Variations
Endowment Policies and MECs
Chapter Five
Universal Life
Adjustable Life
Current-Assumption Whole Life
Variable Life Insurance Products
Chapter Six
Basic Contract Elements for Life Insurance
Contract Provisions in Life Insurance
Other Features of the Life Contract
Loans and Options
The Cost of Living and Double
Indemnity Riders
239
251
261
267
273
280
285
301
307
315
319
326
329
332
347
357
367
373
382
Chapter One
THE SPECTER OF PREMATURE DEATH
Two things in life, we are told, are certain and
unavoidable: death and taxes. It is not surprising that
people, being the stubborn creatures that they are, have
developed a tool to help handle these unpleasant
realities. That tool is life insurance.
Unfortunately life insurance, much like death and taxes,
can be bewildering and difficult to explain. To begin
with, it is a product that is euphemistically named.
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Certainly, "death insurance" is a more accurate term.
What we would gain in precision, however, we would no
doubt lose in the offense of our sensibilities.
A dictionary definition will describe life insurance as
protection against the premature death of an individual.
"Protection" here refers not to stopping the death, but
to a payment of a beneficiary. Again, the confusing
nature of life insurance rears its ugly head: this is a
product that one buys for the peace of mind it engenders
while contemplating death. The inevitable has not been
avoided, but one's loved dependents are at least provided
for.
Another of life insurance's perplexing qualities arises
out of how the government views the product. While the
consumer, more often than not, sees this insurance
purchase as a vehicle to save his or her dependents from
financial need, Uncle Sam sees only death's ugly twin-taxes.
Indeed, for the government, life insurance is defined
through the manner in which it is taxed. This definition
is found in the Internal Revenue Code Section 7702 of the
Deficit Reduction Act of 1984, also known as DEFRA. It is
important at this time to keep in mind that cash value
insurance policies are best thought of as containing a
dual nature regarding money. First, there is the money
that belongs to the policy-owner _ the cash value. In
addition to this, there is also money paid into the
policy that goes to pay for the insurance costs. It is
money from this account that is paid-out if the insured
dies. This is the
insurance company's money.
Internal Revenue Code Section 7702 insists that life
insurance contain a certain net amount of money at risk.
Three tests exist to determine if the net amount at risk
meets
the
government’s
standards.
(Should
the
government’s standards not be met, the insurance becomes
endowment insurance, and loses its tax advantages.)
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First, there is the so-called cash value accumulation
test. This test states that the policy-owner's current
cash value, or the "net cash surrender value," cannot be
greater than the value of the net single premium that
could Compound to the face amount of the policy at age 95
(with a net single premium discount factor of either 4%
or the contract's minimum guaranteed rate).
A second test is the cash corridor test. The corridor
test is simply relationship expressed as a percentage
difference between the policy's cash value and the
policy's face value. This ratio is found in the Internal
Revenue Code Section 7702(d)(2).
Finally, there is the guideline premium test. This method
can take the form of a guideline single premium or
guideline level premium test. The guideline single
premium test simply means that the policy-owner may not
invest more into his or her policy than the current net
value of the benefits to be paid out at age 95, less a
discounted 6% rate that assumes the stated mortality
charges and expenses of the contract. The guideline level
premium, on the other hand, states the level annual
amount necessary to fund future benefits to age 95, while
assuming the contract's mortality and expense charges,
plus 4% interest.
Even to the professional in the field, such aspects of
life insurance as the government's income tax definitions
can seem inarticulate, unwieldy, and simply unclear. To
the consumer, such details about life insurance are more
often
than
not
cryptic,
complicated,
and
simply
confusing.
Nevertheless, the total amount of life insurance in force
continues to grow. This should not be surprising,
however, when we reflect upon the needs that life
insurance seeks to address: premature death, payment of
estate taxes, an income readjustment fund, emergency
monies, college funding, and a mortgage fund, to name a
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few. Confusing or not, these concerns are real, apparent,
and pressing to most people.
These needs can be broken into two categories, the first
constant, and the second fluctuating. Constant needs
include a death fund to handle premature death, emergency
savings, and estate planning. Fluctuating needs are those
that change as one ages, and include such financial
planning issues as funding a college education, buying
out a business partner, or handling a mortgage after the
death of one's spouse.
While not all of these needs are created by death, death
remains the dominant factor in the life insurance
equation. While life expectancy has increased -- it is
currently 73 for a male and 79 for a female in the United
States, according to the U.S. Bureau of the Census -- no
one
seriously
believes
that
they
can
avoid
the
inevitable. It is this inevitability that creates many
(though not all) of the constant and fluctuating needs
that life insurance is designed to meet.
Moreover, while actuaries can gain a surprisingly
accurate picture of when one will die, death at an age
earlier than expected is not so rare as to be overlooked.
Indeed, premature death is a more likely event than most
persons believe. Since the time of death is uncertain, it
is a form of risk. It is the temporal uncertainty of this
event that is covered by the life insurance's valued
policy contract.
While we have named some of the concerns that life
insurance attempts to address, the real-life consumer's
needs are as unique as only individuals can be. One
aspect of life insurance is, however, uniform: the
underlying reason for its purchase, premature death, is a
risk that touches everyone. Also, at least one cost of
death is familiar to everyone: the loss of a loved one
that can never be replaced. The emotional impact of death
can be as heavy as the event is final.
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In
addition
to
the
loss
of
another's
love
and
companionship, there are also multiple, difficult hard
realities that premature death can create. Foremost, of
course, is the loss of financial support. Should the
principal "breadwinner" die without a life insurance
policy in place, it is quite possible that his or her
dependents will face desperate financial straits.
It is vital to underscore his or her dependents here, as
demographic and cultural changes in the United States
have helped turn life insurance into more than a "man's
product." Indeed, with the growth of female-headed
households, life insurance is needed by a more diverse
public than ever before.
In addition to the changes in heads of households,
dependents are becoming more diverse as well. When the
responsibility of an aged parent, for example, or the
children of a divorced and remarried spouse are added to
one's responsibilities, the need for coverage expands.
The soaring divorce rates that this country has
experienced in recent years, as well as our aging
population, make both of these situations less than
unusual, and can dramatically alter a family's financial
planning.
Furthermore, premature death can have costs beyond
emotional bereavement and financial ruin. For many twoincome households, for example, the death of a spouse
causes financial juggling and insecurity rather than
complete destitution. Life insurance in this case plays
the role of a readjustment fund.
The need for a readjustment is also not limited to a twoincome household. Many "traditional" households that lose
a spouse who is not the principal supporter of the family
still face the loss of the skills and services which that
person provided while living. A readjustment fund can
play an invaluable in this situation as well.
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Even the single person with no children often "needs"
life insurance. This is because one may not carry any
other insurance coverages that pay for funeral costs,
which can run as high as $10,000. Furthermore, unforeseen
and unpaid expenses can occur, such as bills relating to
an extended final illness. In addition, unpaid bills may
also be present at the time of death. Life insurance is
also an acknowledgment and assumption of personal
responsibility.
Lastly, life insurance is an acceptance of another
unpleasant reality in addition to death and taxes: we
generally do not save enough money. We generally think
primarily about today, and depend upon our earning
capacity to meet both our current and future obligations.
Ultimately, though, that all-important earning power will
end.
While pursuing a life insurance policy does not mean one
no longer needs to save, it is an important tool with a
vital roll. Along with savings, Social Security, and
pension benefits, it helps provide peace of mind -- and
financial security -- for the inevitability of tomorrow.
Fortunately, unlike death and taxes, financial insecurity
can be avoided through proper planning and the effective
use of such instruments as life insurance.

Why People Purchase Life Insurance
The primary purpose of life insurance is to provide a sum
of money to a beneficiary at the death of an insured. The
uses of this money, however, can be quite varied. Also,
not all life insurance policies function equally well for
all goals. The specific purpose of the policy will help
determine the type of life insurance policy that one will
purchase. The following is a list of the most common uses
of life insurance for individuals.
1.
Creation of an Estate
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For the majority of persons purchasing life insurance,
the life insurance policy is used to “create an estate.”
The estate in this instance is the sum of money paid to
the beneficiary at the
death of the insured. Through
life insurance, the insured determines the exact size of
the estate by selecting the face amount of the policy.
2.
Protection of an Estate
Some individuals already possess sizeable assets. These
assets may be in a variety of forms, such as property,
investments,
collectibles,
etc.
Depending
on
the
valuation of the estate, their heirs may face substantial
costs at the time of death. Without proper planning, the
estate’s heirs can be forced to sell assets in order to
meet their tax obligations. Life insurance can be used to
provide available cash to meet necessary estate costs.
3.
Final Expense Fund
When a person dies, a number of expenses will invariably
come due. These can include, but are not limited to, the
following: state and federal death taxes, outstanding
debts, funeral costs, unpaid hospital and medical bills,
and potential host of legal fees (e.g. executor’s fees).
4.
Mortgage or Rental Fund
In a household with only one wage-earner, the premature
death of the wage-earner can force the sale of a home or
a relocation from an apartment due to the loss of income.
Even as the American economy has moved to a two-wageearner model, the death of a spouse usually causes
serious cash flow problems for the survivor. A life
insurance policy can provide the liquidity necessary in
order to give the survivor the flexibility to pay off the
mortgage or continue mortgage or rent payments.
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5.
Monthly Income Supplementation
When a wage-earning spouse dies, his or her monthly
income is subtracted from the family budget. However, the
monthly income needs and expectations of the surviving
family members remain. Generally, the most pressing need
is maintaining an adequate income stream for housing (as
discussed above). In addition to housing, the remaining
income needs include all the items typical for a
household
budget:
food
and
clothing,
utilities,
entertainment, etc.
The insurance industry classifies two specific “needs
periods” that follow the death of a wage-earner: the
dependency period and the blackout period.
The dependency period is that flexible time-frame when
dependent children are still living at home. This timeframe is when a family’s income need is the usually the
most significant.
The blackout period occurs when no Social Security
benefits are available for the surviving spouse. If the
family has no children, the blackout period begins
immediately, and continues until age 60.3
6.
Education Fund
Post-secondary education is important for enhancing
economic opportunities. The costs of post-secondary
education are significant, and their annual increases
continue to outpace inflation. Life insurance can play an
important role in guaranteeing the availability of
education funds.
7.
Emergency Fund
Because of its guaranteed nature, insurance is also
valuable as an emergency fund for unforeseen expenses.
3
If the family has children, Social Security benefits can be available upon the death of a primary wageearning spouse. However, these benefits will usually expire as soon as the child turns 16.
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8.
Retirement Income Supplement
Depending on the type of policy, life insurance can play
a role in supplementing retirement income.
9.
Business Uses
Life insurance is able to deliver a guaranteed amount at
a specific time, and can enjoy a range of tax benefits.
For these reasons, life insurance is often used for a
variety of business purposes.
REVIEW QUESTIONS
1.
Life insurance is needed by many people, in no small part because
premature death is often more common than realized.
a. true
b. false
2.
The life insurance product is very easily understood. One generally
does not even need an agent to explain it.
a. true
b. false
3.
A definition of life insurance for income tax purposes is found in
the Internal Revenue Code Section 7702 of the Deficit Reduction
Act of 1984.
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a. true
b. false
4.
In order to be classified as insurance and receive the tax benefits
of the product, a certain net amount at risk must be present.
a. true
b. false
5.
The cash value accumulation test for life insurance states that the
policy-owner's current cash value cannot be greater than the value
of the net single premium that would compound to the face value
of the policy at age 95 (with a single premium discount factor of 4%
or the contract's minimum rate).
a. true
b. false
6.
The percentage ratio needed to determine the cash value corridor
of a policy is found in the Internal Revenue Code Section
7702(d)(2).
a. true
b. false
7.
Confusion over the product has resulted in a continual shrinkage
of the total amount of life insurance in force over the years.
a. true
b. false
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8.
Life insurance can be used to meet both constant and fluctuating
needs that are caused by premature death.
a. true
b. false
9.
As opposed to a valued contract, life insurance is an indemnity
contract.
a. true
b. false
10.
As a result of the changing demographics and economy of the
United States, life insurance has ceased to be an exclusively "male
product.”
a. true
b. false
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ANSWERS TO THE REVIEW QUESTIONS
1. a
2. b
3. a
4. a
5. a
6. a
7. b
8. a
9. b
10. a
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ESTATE PLANNING

Determining How Much Life Insurance One Needs4
Life insurance needs fall into three broad categories:
individual and family income needs, business needs and,
estate preservation and liquidity needs. Especially in
relation to estate planning, it is important that a
sufficient sum is available, and that it is directed in
the proper manner.
Today, a wide variety of resources are available to help
one calculate the “correct” amount of life insurance,
from computer software programs to Internet websites.
However, relative ease of calculation is not sufficient
for proper life insurance planning. One must also adopt
an approach that supplies a rationale for the coverage
proposed.
For example, a common “rule of thumb” for individual life
insurance is the following: most people require at least
6 to 8 times their annual gross income for adequate
coverage. Thus, a person earning $38,000 per year would
require an approximate range of $225,000 to $300,000 of
life insurance. Naturally, this model can break down
fairly quickly. For example, what if the spouse also
works, and makes $50,000? Is all of the income from the
$38,000 per year earner vital to the family’s financial
needs
and
objectives?
Does
the
household
carry
significant debt? If so, what kind of debt (i.e.,
mortgage, student loan, consumer loan, etc.)? Obviously,
this general rule of thumb is only a basic starting point
for assessing life insurance needs.
Many life insurance companies employ one of two specific
needs approaches for determining life insurance needs—the
human life value approach and the human needs approach.
Neither is demonstrably superior to the other,
but the
4
Determining life insurance needs is a very complex process, and different companies use different
approaches and different models. Furthermore, each insurance case is unique, and subject to a wide
array of influencing factors. This section is only a broad overview of the process.
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needs approach has gained ascendancy among the majority
of today’s insurance practitioners.
Human Value Approach
The human value approach was developed by the late Dr.
S.S. Huebner. This is an income replacement reproach. It
offers a method for expressing the economic value a human
life. The “economic value” that this approach uses is a
dollar valuation.
In its most basic outline, the human life value approach
makes use of several assumptions for its calculations:
the current annual after-tax earnings, the number of
working years prior to retirement, and a reasonable
after-tax discount rate.
A weakness of the human life value approach is that it
does not factor inflation and salary increases into its
estimates. The human life value approach tends to produce
a static analysis of insurance needs. As such, it can
overstate or understate the amount of life insurance
needed.
Needs Analysis Approach
The needs approach determines the appropriate level of
life insurance coverage through analyzing specific needs.
The second step in this approach is to measure the
family’s ability to meet these needs in the event that a
wage-earner should die.
Needs are categorized as immediate and multi-period.
Immediate needs can include, but are not limited to, the
following:
1.
2.
3.
4.
Final expenses
Estate settlement expenses
Tax liabilities
Debt liquidation
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Multi-period needs include, but are not limited to,
temporary adjustment income for the household, the
children’s and spouse’s income needs, and the spouse’s
retirement needs.
To meet the immediate and multi-period needs, this
approach includes the family’s existing capital (i.e.
savings, investments, pensions, etc.), Social Security,
and the spouse’s income in its calculations. Usually, the
total dollar amount for needs will exceed the total
dollar amount available from existing capital. This
difference will be addressed by the appropriate amount of
insurance.
REVIEW QUESTIONS
1.
The human value approach for determining life insurance needs is
an income replacement strategy. This approach uses the estimated
after-tax earnings plus the total number of years worked to find an
appropriate amount of life insurance.
a) true
b) false
2.
All of the following are usually classified as immediate needs under
the needs analysis approach except:
a)
b)
c)
d)
final expenses
estate settlement expenses
spouse’s retirement needs
debt liquidation
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ANSWERS TO THE REVIEW QUESTIONS
1.
a
2.
c
NOTES
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
Life Insurance and Estate Planning
Estate planning is no more than a plan to accumulate and
then distribute wealth to named heirs. At the death of
the owner, a well-conceived estate plan will experience
only the necessary minimum loss in taxes and expenses.
The legal nature of our society has turned estate
planning into a science, and many professionals need to
play a role in its development. In addition to a
qualified life insurance agent, a lawyer, a banker, and
an accountant may all serve in formulating an effective
estate plan.
The life insurance product itself typically plays one of
two parts in the estate "game." First of all, it can be
used to create an estate. The money that the death
benefit from a high value life insurance policy creates
instantly upon the death of the insured would take many
years of shrewd investing for the average consumer to
amass. Moreover, the benefits from a life insurance
policy are not subject to probate costs. You will
remember of course that probate is nothing more than that
legal process by which money and property is transferred
to the deceased's heirs.
In cases where the proceeds of the policy's death benefit
are not the sole estate, life insurance performs a
different function. Here, the monies generated by life
insurance serve the purpose of liquidity. Non-liquid
assets are preserved that in other circumstances might
have been sold for death taxes, funeral costs, and estate
clearance costs.
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When the named insured in the policy has any "incidents
of ownership" at the time of death, the paid out death
benefit can and will be taxed according to the federal
estate tax. Furthermore, the monies paid out by the
policy are attached to the insured's gross estate when
their payment is directed to the estate.
"Incidents of ownership" are those powers that are
typical to ownership of a policy. Such powers might
include policy loans and partial surrenders, optional
modes of settlement, and the right to change a
beneficiary.
Should an absolute assignment be made, however, these
incidents of ownership are waived, the death benefit's
monies are potentially separated from the gross estate.
We say potentially because the assignment must be made
three years prior to the insured's death in order to
avoid federal estate taxes.
At this point, the consumer will wonder what has happened
to his or her tax benefits. We must emphasize that it is
the federal income tax that is waived for the death
benefit in a life insurance policy, not all taxes. The
wishful thinking of consumers often lulls them into
believing that every financial aspect of their life
insurance contract is tax-sheltered.
Again, the lump sum payment of a life insurance death
benefit is free of federal income tax. Alternative modes
of settlement, however, may not escape federal income
tax. For example, periodic distribution of an insurance
policy's death benefit are subject to tax on the interest
income (the principal remains tax free).
Lastly, life insurance is a way to provide an estate that
is fair to all one's heirs. In cases where one's assets
are tied up in property, a life insurance death benefit
provides a method to keep ownership of property in the
hands of one heir, with an equal value in cash proceeds
from the policy going to other heirs.
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REVIEW QUESTIONS
1.
Estate planning is really no more than commonsense, and is a
matter that one can easily take into their own hands without the
counsel of professionals.
a. true
b. false
2.
Life insurance proceeds avoid all taxes when disbursed to the
beneficiary in a lump sum.
a. true
b. false
3.
One benefit of life insurance is that it can help provide fair and
equal transferring of an estate to one's heirs.
a. true
b. false
4.
Life insurance is often used as a way of providing liquidity in
estate planning, as it avoids probate and provides immediate cash.
a. true
b. false
5.
Federal estate tax, death taxes, and funeral expenses are some of
the expenses associated with estate planning.
a. true
b. false
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6.
Generally, when an insured has some form of incidents of
ownership in a policy, he or she can expect that the death benefit
will be attached to the gross estate.
a. true
b. false
7.
One device to avoid attaching a life insurance's proceeds to the
gross estate is to make an absolute assignment at least three years
prior to an insured's death.
a. true
b. false
8.
For the typical consumer, life insurance is often used to actually
create an estate at death.
a. true
b. false
9.
Incidents of ownership simply means that one has rights to make
policy loans, partial surrenders, choose a beneficiary, and decide
upon the mode of settlement.
a. true
b. false
10.
Probate is nothing more than a legal process through which money
and property is transferred to one's heirs.
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a. true
b. false
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ANSWERS TO THE REVIEW QUESTIONS
1. b
2. b
3. a
4. a
5. a
6. a
7. a
8. a
9. a
10. a
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THE ROLE OF LIFE INSURANCE IN THE FINANCIAL
PLANNING PROCESS
Obviously, a death fund which pays for final expenses is
a part of one's financial planning. Providing for
dependents is also within the domain of financial
planning, whether in delivering a specific lump-sum that
avoids federal income tax and "creates" an estate, or in
efficiently disbursing an estate.
All of these elements of financial planning focus on
life's end. As such, they are permanent needs. Life
insurance can play an additional role in financial
planning, however, and as such is indeed a tool for the
living, and not just one's heirs.
Foremost, life insurance can form an effective savings
vehicle that can either serve as an account geared to a
specific goal, an emergency cash fund, or both. Life
insurance is effective in such a capacity because of a
unique tax advantage of this product. Like an IRA, or an
annuity, its account can grow tax-deferred. Unlike the
IRA or annuity, however, many cash value life insurance
policies retain a level of penalty-free liquidity that
make them the envy of these other investments. Even with
the expense fees and loads of the insurance policy, the
tax-deferred build-up of interest over time is a powerful
tool for financial planning, and an effective method for
many families searching for a tax-advantaged tool to meet
changing goals.
In addition to providing an emergency savings account,
life insurance can be used as a mortgage fund. In this
capacity, life insurance is designed to protect a
survivor from the burden of mortgage payments. This
feature allows one to remain in a home that under other
circumstances would have to be sold or rented out.
Life insurance can also be a means of saving for a
college fund. The cash value universal variable insurance
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is perhaps the best vehicle for this task, as the
flexibility
of
this
product
with
its
aggressive
investment portfolio allows for an attractive build-up of
tax-deferred, liquid funds.
Finally, life insurance can play a useful role for
continuing business operations. For example, the policy
can be used to hire a replacement for the owner in event
of his or her death, it can repay business loan
obligations, or buy-out a partner.
The Strengths of the Life Insurance Product
Life insurance is a form of valued property, and is in
many ways unique. It offers numerous advantages over
other types of property for meeting specific financial
planning needs.

Favorable Tax Treatment
Cash values in a whole life policy will grow tax-free.
The proceeds from any life insurance policy, whether
whole life or term, are exempt from federal income tax
when paid in a lump sum.

Guaranteed Values
The majority of life insurance policies will guarantee
the face value of the death benefit. Depending on the
type of policies, other guarantees may be available.
These can include cash values, minimum interest rates,
and premium rates. Guaranteed sums and expenses are very
valuable for the financial planning process.

Appreciation
The payment of a death claim represents a significant
appreciation in value over the total of premiums paid
into the policy.
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
Direct Payment to Beneficiaries
The proceeds from a life policy are payable directly to
the beneficiary. In most cases, an insurance company will
issue payment for a death claim within 24 hours after the
claim work has been completed.

Flexible Income Options
Death benefits are available to the beneficiary in a
variety
of
formats,
called
“settlement
options.”
Settlement options are the choices presented to a
beneficiary for collecting the death benefit. These can
include a lump sum payment, an interest option, a fixed
amount option, a fixed period option, and a life income
option.
With an interest option, the death benefit is left on
deposit with the insurance company with earnings paid the
beneficiary annually. A fixed amount option is a death
benefit paid in a series of fixed installments until the
proceeds are exhausted. A fixed period option occurs when
the death benefit proceeds are left on deposit with the
insurance company and paid out in equal payments for a
specified period of time. A life income option is a life
annuity; with this option, payments occur for the life of
the insured.
If the insured possess a cash value life insurance
policy, he or she will also have access to the policy’s
cash value in the form of loans, surrender values, and,
in some cases, partial surrenders.

Protection from Creditors
A life insurance policy is valued property, however,
unlike most forms of property, proceeds from a death
benefit receive protection from creditors in the majority
of instances.
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REVIEW QUESTIONS
1.
Clarence is single, but has a sizeable amount of debt. Some of these
loans have been co-signed by his girlfriend. One definite use that
Clarence could make of a life insurance policy is
a)
b)
c)
d)
2.
Life insurance is often used to provide a monthly income stream to
dependents when a wage-earning spouse dies. The insurance
industry classifies two specific “needs periods” following the death
of a household wage-earned. These two periods are:
a)
b)
c)
d)
e)
f)
3.
an education fund
an estate conservation tool
a final expense fund
none of the above
the dependency period
the secondary period
the blackout period
the Social Security
a&e
a&c
The proceeds from a life insurance policy, when paid in a lump sum,
are exempt from federal income taxes.
a) true
b) false
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4.
In most cases, the death benefit proceeds from a life insurance
policy cannot be attached by creditors.
a) true
b) false
ANSWERS TO THE REVIEW QUESTIONS
1.
c
2.
f
3.
a
4.
a
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Chapter Two
Traditional Life Insurance
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FUNDAMENTAL ELEMENTS OF LIFE INSURANCE
All life insurance agreements have fundamental elements
that make the policy workable. Simply put, in order to
provide
their
service,
which
is
essentially
a
disbursement
of
monies,
they
must
first
somehow
accumulate money. The most obvious payment of money to
the consumer by the insurance company comes through the
death benefit, or face value of the policy. However,
money can flow from the insurance company to the consumer
in other ways. Two examples of payment to the insured are
survivorship benefits, and the treatment of cash values.
The survivorship benefit is a feature of cash value
insurance policies that allows insureds who do not die or
surrender their policy to receive the face value of the
policy. The accumulated cash value is not paid out to the
insured, but remains with the company.
Another possibility of cash flow from the insurance
company to the insured occurs in the case of dividends.
In a participating policy, the insurance company will
credit the insured with gains made from the company's
investment accounts.
Money flows into the insurance company through a number
of paths. These are various charges to the insured.
First, there is the "cost of insurance" itself, the socalled mortality charge. This charge is based upon
mathematical principles used by the company's actuary to
calculate the probability of an insured's death. The
actuary uses what are termed mortality tables that factor
an insured's age, sex, state of health and habits in
order to provide a statistical snapshot. The underwriter
then classifies the applicant into risk categories based
upon the actuarial information.
This information allows the insurance company to have a
good sense of its expected losses. Knowing this allows
the company to charge the insured proper rates so that
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each is bearing his or her proper amount of cost. The
actual cost of the premium is derived by a use of a rate
that assumes a cost per thousand dollars of insurance.
That rate times one thousand dollars of coverage equals
the premium that the insured will need to pay for
coverage.
The insurance company carries still other costs for doing
business which it will pass on to the insured. One such
area of cost it that of general administration. The state
premium tax and overhead office costs are both a part of
this charge. The cost of managing the investments,
distributing the dividends, and collecting premiums also
play a large part in this expense.
Insurance also needs to pay for what is termed its
acquisition expenses in order to function efficiently.
This is the cost of getting the product out before the
consumer and processing the applicant. General sales
costs such as advertising, promotions, and the printing
of sales literature all play a part in this expense. In
addition, the payment of agent's commission comes under
the acquisition expense heading, as does the printing of
the policies and application forms. Lastly, the services
which the insurance company uses to guard itself against
adverse selection also fall under this rubric.
In short, it is not useful to think of the premium as the
cost of insurance. The premium is more than this. It
reflects the cost of pure insurance by covering the
mortality costs of the insured, but it also pays for the
insurance company's operations. In addition to this, a
portion of the premium is credited to the general or
separate accounts of the company. This portion of the
premium generates the cash value of the insured.
Traditionally, premiums were paid annually, but the
emergence of flexible premium policies such as universal
and variable universal life have altered this situation.
Even though the newer, flexible policies offer more
choices on how the premium can be paid, the cost of
insurance must still ultimately be paid. Should the
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premiums paid into the policy be insufficient for
insurance coverage, the accumulated cash value will be
tapped to meet the insurance company's costs.
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REVIEW QUESTIONS
1.
A survivorship benefit is a way in which the insured who has
neither died nor surrendered his or her policy can receive the death
benefit's face amount.
a. true
b. false
2.
The insured can receive a credit from the insurance company if the
company's investment account earned a profit. This credit can
come in the form of a dividend.
a. true
b. false
3.
The mortality charge is the actual cost of pure insurance protection.
a. true
b. false
4.
The mortality cost is arrived at by the sales agent assessing the
health, age, and habits of the insurance applicant.
a. true
b. false
5.
The information provided by the applicant and used by the actuary
and underwriter provide a statistical picture that allows the
company to adequately classify the risk and charge an appropriate
premium.
a. true
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b. false
6.
The cost of general business administration is another charge that
the insured will assume in order to receive coverage.
a. true
b. false
7.
Acquisition expenses pay for general overhead, the cost of
managing investment accounts, collection of premiums, and the
state premium tax.
a. true
b. false
8.
Advertising, sales promotions, and the printing of sales literature
are all elements of the insurance company's acquisition costs.
a. true
b. false
9.
Premiums include more that the cost of pure insurance coverage.
a. true
b. false
10.
Premiums must always be paid on an annual basis.
a. true
b. false
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ANSWERS TO THE REVIEW QUESTIONS
1. a
2. a
3. a
4. b
5. a
6. a
7. b
8. a
9. a
10. b
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THE CONCEPT OF CASH VALUE
Cash value is the concept that is often the most
confusing concept of insurance to consumers, and the most
decisive feature that distinguishes whole life and its
various innovations from term insurance. While the cash
value element of the whole life family has many qualities
which make it potentially more attractive than term
insurance, ironically the mysterious functioning of this
policy feature sometimes drives customers away. Simply
put, it is challenging to sell a product in which the
most exciting benefit is not always readily comprehended.
While
the
mathematical
computations
and
financial
prognoses that support cash values accounts are rather
mind-boggling, the basic concept is not. In his or her
role as educator, the insurance agent needs to be able to
explain effectively the cash value idea to the consumer.
Cash value in a whole life policy is the result of the
overpayment of the premium. Initially, these premiums do
no more than cover the insurance company's cost of doing
business with the insured. Subsequently, the cash
surrender value of the policy is little or nothing in the
contract's early stages. The passage of time, however,
has a powerful effect on the money wisely handled. In
other words, the cash value in the policy grows.
This growth occurs because the vehicle in which it is
invested grows. In the broadest terms, this investment
vehicle will take the form of either a general account or
a separate account.
A general account in life insurance is the investment
account of the life insurance company. That it is not a
single account should not be surprising, because an
insurer bases its risk assessments upon calculations
derived from the law of large numbers and the pooling of
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risks. Individual
useful.
accounts
in
such
a
scheme
are
not
The insurance company's general account, or investment
account, is geared toward conservative vehicles. This is
at least partially due to the fact that insurance
companies
face
oversight
and
regulation
from
the
Insurance Commissioner in their state (or states) of
operation. The state regulator will usually set a ratio
of what percentage of the insurance company's policyowner's surplus, or admitted assets, can be in any one
form of investment.
The investments that comprise the equity of the insurance
company's general account may include stocks, bonds,
mortgage accounts and speculative real estate. Typically,
the State will limit an insurance company's holdings in
preferred stocks to 20% of a single company, with not
more than a 2% holding of a company's admitted assets,
while common stock holdings cannot be larger than 1% of
admitted assets. Bonds tend to be debentures rather than
convertibles. Speculative real estate holdings are
limited to 10% of the company's admitted assets.
Both traditional whole life and universal life insurance
make use of the insuring company's general account for
the investment purposes of the excess premium. While this
can provide a safe rate of return (providing the insuring
company is stable and well-funded), many consumers desire
to forego a certain amount of safety in order to reap
higher returns. To this end, variable and variable
universal life insurance were formed.
Unlike
traditional
whole
life
and
universal
life
insurance, variable and variable universal products make
use of a separate account. The separate account for these
products is an investment portfolio (or portfolios)
maintained or attached to the insurance company. These
portfolios are essentially mutual funds, and like mutual
funds, they can follow a specified investment strategy.
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As
mutual
fund
vehicles,
these
portfolios
are
professionally managed, and can be matched in order to
provide diversification. Also, the cash value can be
moved through the various portfolio options in order to
take advantage of market shifts. The policy owner can
make these decisions, or control can be handed to an
asset allocation service. The investment possibilities in
this arrangement are numerous, and can include such
strategies as listed below.
Income Funds
Income funds invest in dividend-paying stocks, bonds, and
money-markets. Their goal is not growth of capital, but
the payment of income through dividends and interest
earnings.
Growth Funds
Growth funds are the opposite of income funds. They
invest in common stocks with the goal of capital
appreciation. The emphasis might be on sustained, stable
growth, with investments geared toward established
companies. Another approach would be to target emerging
companies for a more volatile – and hopefully, more
aggressive -- rate of return.
Money Market Funds
A money market fund is one that invests in short term
securities characterized by a high level of liquidity and
security. These funds produce comparatively low rates of
return because of the short duration of the investment
vehicles, but are valued for their low degree of risk.
Bond Funds
Bond funds aiM to produce income. They invest in debt
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securities, and possess long term rates. They are riskier
than growth and stock funds, but the risk level can be
raised or lowered in accordance with the type and grade
of bonds in which the fund invests.
As the monies in separate accounts are securities, they
must be handled and regulated as securities. In order to
sell variable life insurance policies (or variable
annuities), an agent needs to be licensed by the National
Association of Securities Dealers. The NASD is a group of
brokers and dealers that operates under the umbrella of
the Securities and Exchange Commission. The exams to sell
this product line are taken in addition to the Life and
Health
Examination.
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REVIEW QUESTIONS
1.
Along with the duration of the insuring agreement, the cash value
accumulation in the policy is a decisive difference between whole
life and term insurance.
a. true
b. false
2.
The general account is the investment account of the life insurance
company.
a. true
b. false
3.
The investment account of the insurance company is subject to
little or no regulation by the State Insurance Bureau.
a. true
b. false
4.
While an insurance company's investment account may include
speculative real estate in addition to bonds and long term
mortgages, the real estate investments usually make up no more
than 10% of the company's admitted assets.
a. true
b. false
5.
"Admitted assets" is a term that describes the policy owners'
surplus in the insurance company's account.
a. true
b. false
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6.
Traditional whole life invests policy owner surplus in the general
account. Universal life and all the other variations of whole life
invest in separate accounts.
a. true
b. false
7.
A separate account operates like a mutual fund.
a. true
b. false
8.
Variable and variable universal are insurance policies that make
use of separate accounts to attain a higher rate of return.
a. true
b. false
9.
Separate accounts, like pure mutual funds, are professionally
managed and have a targeted investment strategy.
a. true
b. false
10.
Separate accounts are essentially securities, and are regulated as
such by the SEC.
a. true
b. false
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ANSWERS TO THE REVIEW QUESTIONS
1. a
2. a
3. b
4. a
5. a
6. b
7. a
8. a
9. a
10. a
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CASH VALUE VERSUS TERM
The
title of this part is perhaps misnamed, as it
generates a sense of controversy and antagonism by the
use of "versus." That is not our intent, but we thought
it appropriate to try and capture a feel for the content
of the plethora of pop financial planning books and
magazine articles current in the market.
To read some of today's popular financial planning
literature targeted to the general consumer, one would
think that the purchase of life insurance is best
achieved by following some magic formula. Depending on
the prejudice of the writer, this all-purpose template
would lead the consumer to invariably buy either term or
some form of whole life.
The problem with such an approach is obvious to the
professional in the field. Appropriate insurance coverage
is completely dependent upon the consumer's unique needs.
Obviously, not all consumers have the same needs (or
lifestyles, spending habits, expectations, etc.)
Indeed, we approach the problem entirely off-center when
we think in terms of cash value "versus" term insurance.
The comparison is without meaning when an understanding
of the consumer's specific needs and desires is lacking.
Naturally, we can speak in some broad generalities. Term
insurance, for example, does tend to be cheaper. Again,
however, so much of this can change when we apply the
generalities to a specific case. Furthermore, cheaper is
not always better. While this may sound quaint in a cost
conscious world, it is nevertheless a maxim which often
holds true. In addition, "cheaper" may be a temporary
condition, especially as the insured ages.
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One of the recent rallying cries for term insurance is
BTID -- "buy term, invest the difference". While this
tragedy can have definite merits, it simply will not
suffice as an axiom.
Especially in the case of a policy replacement, it is
vital that the insurance agent be keenly aware of the
consumer's needs, desires and expectations. To avoid a
situation of twisting, it is imperative that the new
policy will clearly present a gain for the insured.
Typically, policy replacement can present a new two year
contestable period and higher premium rates. The insured
must know what he or she is getting into when replacing a
policy, and should be pursuing some recognizable and
coherent financial planning strategy rather than the cant
of the pop financial media. Another general rule is that
it seldom makes sense to replace a cash value policy that
an insured has held for a long period.
Finally, cash value and term insurance are complementary
products. Each can play a role in life insurance, and
each can be appropriate or inappropriate based upon the
specifics of the situation.
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REVIEW QUESTIONS
1.
Term insurance is always more appropriate than cash value
whole life, and should always replace such outmoded contracts.
a. true
b. false
2.
The concept "cash value versus term insurance" is really
inappropriate. Instead of an antagonistic relationship, a
complementary one exists, as each product serves specific
needs.
a. true
b. false
3.
While term insurance does tend to be less expensive than whole
life and its Innovations, it is not necessarily the best choice for
the consumer.
a. true
b. false
4.
BTID, or "buy term and invest the difference" is a strategy that
is never appropriate for life insurance consumers.
a. true
b. false
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5.
Policy replacement can present a number of risks for a
consumer, such as a higher premium and new two year
contestable period.
a. true
b. false
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ANSWERS TO THE REVIEW QUESTIONS
1. b
2. a
3. a
4. b
5. a
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Chapter Three
The Traditional Products -Term Insurance
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TERM INSURANCE FUNDAMENTALS
Term Life Insurance provides life insurance coverage for
a specified period of time, or “term.” Term life is the
most basic form of life insurance. Often, term life is
thought of as “pure” insurance because it offers only a
death benefit. Because term life is a temporary, “nofrills” policy, it is generally used for limited, timesensitive periods—for example, a young couple may carry
term insurance until their children can earn their own
incomes. The duration of the policy depends on the design
offered by the insuring company. Typical terms include 1,
5, 10, and 20 years.
Another method of specifying the policy’s time period is
to define the age at which the policy will expire.
Usually age-based expirations include 60, 65, or 70. Such
policies are referred to as “term to age” plans, such as
“term to age 65.”
The primary advantage of term life insurance is based on
cost. One can usually acquire the largest death benefit
through the smallest premium with this policy design. *
This is an attractive feature for young people who have
insurance needs but are just entering the workforce or
have limited financial means. Because of its initial low
cost, term life insurance coverage finds enthusiastic
proponents among those who believe life insurance should
be no more than pure insurance coverage.
The primary disadvantages of term life are fivefold: 1)
the policy does not provide life insurance coverage for
the insured’s entire life; 2) the policy does not provide
tax-free accumulation of cash value; 3) since no cash
value can accumulate, the policy cannot provide living
benefits; 4) the policy’s premiums become progressively
more expensive at later ages; 5) it is generally not
available to persons in extremely poor health, while
persons in moderately poor health (termed “substandard”)
*
This does NOT mean that term insurance is always the most affordable or least expensive form of life
insurance over the entire duration of needed coverage. Since term premiums increase with each
renewal as the insured grows older, the premium cost for term insurance will ultimately exceed the
level premium charged for a whole life policy.
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often can find ordinary whole life policies easier than
term life policies.
 Characteristics of Term Life
All term life insurance has these three characteristics:

Death benefit5

Protection for a specified time period

Decreasing, level, or increasing face amount
Decreasing Term Insurance
Decreasing term life insurance provides death benefit
protection in decreasing increments for a specified
period of time. At the end of the specified time period,
the death protection is $0.
TABLE 1-1
$100,000
$100,000 Ten Year Decreasing Term Policy
$75,000
$50,000
$25,000
$5,000
$0
Premium
1
5
10
$100
$100
$100
Policy
Year
$0
5
A death benefit is a sum, stated in the life insurance contract, that is to be paid upon the death of the
insured. The death benefit equals the face value of the policy, less any outstanding loans.
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In Table 1-1, the decreasing term concept is visually
described. In this example, a $100,000 decreasing term
policy with a ten-year term period has been purchased.
The features of the policy are the following:



The duration of the policy is ten-years
Available
amount
of
insurance
protection
decreases yearly
The amount and frequency of the premium remain
the same, or level, throughout the ten-year
life of the policy—thus, the same premium is
buying
increasingly
smaller
amounts
of
insurance protection
Uses of the product
Decreasing term is used when a need for life insurance
decreases on a regular, predictable basis. A commonly
shared decreasing need is a mortgage balance. Because it
is used so frequently in this capacity, decreasing term
is often called mortgage cancellation insurance. Although
a mortgage is the most typical situation met with
decreasing term, any large loan that is paid in
installments could create a need for this type of term
coverage.
An
example
of
decreasing
term
providing
mortgage
protection functions as follows: Kerry purchases a home
with a $100,000 30-year fixed-rate mortgage. Kerry’s wife
does not work, and he is concerned that she could not
meet the house payments if he were to die. Kerry reviews
the amortization schedule of his mortgage and purchases a
decreasing term policy that keeps pace with the declining
balance of the mortgage.
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PRACTICE QUESTIONS
1.
Morrie Monie and his wife, Penny, have just purchased a 20-year
decreasing term policy to pay off their mortgage in case Moose
passes away. Which of the following statement(s) is/are correct?
a)
b)
c)
d)
2.
The Monie’s have purchased a mortgage cancellation policy.
The Monie’s premiums will decrease each year because the
level of insurance protection will decrease.
While the premium will remain the same over the policy’s life,
the Monie’s will annually be buying less insurance .
The Monie’s purchased their policy in 1980. Morrie passes
away in 2002. Unfortunately, their policy will have expired and
Penny will not receive any proceeds.
Which of these two cases is the better choice for a decreasing term
policy?
a)
b)
Sammy has just taken out a 15-year mortgage. Because his
wife’s job would not allow her to meet the house payments if
he were to die, he wants to purchase a policy that will pay the
mortgage for her.
Eddie wants to purchase a policy that will last his entire life
and provide a supplement to his retirement fund.
ANSWERS TO THE REVIEW QUESTIONS
1.
a, c, d
2.
a
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Level Term Insurance
Like all term policies, level term life provides pure
insurance protection for a specified period of time.
Level term also provides a level death benefit and a
level premium for the duration of the policy.
TABLE 2-1
$100,000 Ten Year Level
Term Policy
$100,000
(End of
Term)
$0
Policy
Year
Premium
1
5
$100 …
$100 …
10
$100
(End of
Term)
$0
In Table 2 – 1, the level term concept is visually
described. In this example, a ten-year level term policy
has been purchased. The death benefit remains $100,000
throughout the ten years that the policy is in effect.
The premium of $100 also remains the same for each year
of the policy. After the tenth year, the policy expires—
no more premium is due, and no death benefit is
forthcoming. If the insured were to reapply for a new
policy, the premium would be more expensive, because the
insured was now ten years older.
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An example of a level policy in action is as follows:
Gerry and his wife, Corrine, have two children, aged 8
and 6, plus a new mortgage. Gerry is an electrician and
Corrine works part-time as a teacher’s aide. Gerry wants
to make sure that the following needs would be met if he
were to die: one, that enough income would be generated
so that Corrine could continue to work part-time and
still meet all the household bills, including the
mortgage, and two, that enough money would be available
to help fund the children’s college education. Gerry’s
agent reviews Gerry’s household income, debt, and assets.
The agent suggests a 20-year level term policy with a
$300,000 face value as a low-cost, temporary insurance
solution.
Uses of the Product
Level term insurance is called for when one has a
specific,
time-sensitive
need
for
life
insurance
protection. Level term is popular among younger persons
who can purchase a relatively large face amount for a
specific premium. Often this type of policy is used to
meet the life insurance needs of a family during the time
when the children are dependent.
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REVIEW QUESTIONS
1.
Jose has a wife and one twelve-year old child. Even though his wife,
Gertrude, has a good job, Jose is worried that she and their child,
Marie, will be hard put to enjoy the lifestyle they are accustomed to
should he die. Jose’s agent suggests he purchase insurance that will
pay Marie $250,000 if Jose dies at anytime in the course of the next
ten years. Jose is also told that the premium for this insurance will
be the same each year for the ten years that the policy is in force.
Which of the following most completely describes the kind of policy
has Jose purchased?
a)
b)
c)
d)
2.
term life insurance
decreasing life insurance
level term life insurance
ten-year level term life insurance
Steve believes he is a shrewd insurance buyer. Five years ago, he
purchased a five-year level term policy because “the price was
right.” The policy has just expired, and he wishes to purchase the
same policy again. He is surprised to find that, even though the
policy is for the same face value and same duration of time, the
premium has gone up. This increase is because of:
a)
b)
c)
d)
inflation
unscrupulous agent practices
Steve is now five years older
none of the above
ANSWERS TO THE REVIEW QUESTIONS
1.
d
2.
c
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Increasing Term Insurance
Increasing term life insurance is essentially the
opposite of decreasing term insurance. Increasing term
insurance provides an increase in the amount of death
benefit on an annual basis. Unlike decreasing term,
however, increasing term insurance is usually not sold as
a self-standing policy. Instead, increasing term is
usually a rider to an existing policy.6 As a rider,
increasing term acts as an additional benefit to the base
policy. A common example of increasing term is a return
of premium policy in which the sum paid at death is the
face amount plus an amount that is equal to all or a
portion of the premium paid.
 Major Features of Most Term Products
Option to Renew and Varieties of Renewable Term Life
In most cases, a term life insurance policy offers the
policy owner the option to renew the contract without
showing evidence of insurability. This means that,
regardless of the physical health of the insured, the
insured must be allowed to renew the contract and the
premium cannot be increased in response to any physical
condition. However, the renewed premium will be higher to
reflect the insured’s new age.
To control its risk level, the insurance company will set
parameters when a policy may be renewed. These parameters
could be a set number of times, or specified ages. On a
practical level, whatever the parameters of renewal, a
term policy will only be renewed while it is cost
effective to do so. Ultimately, the premium will become
prohibited based on the insured’s attained age and life
expectancy.
A policy that is renewable will cost more than a
nonrenewable policy because the insurance company assumes
more risk. A nonrenewable term policy is the most basic
form of life insurance. It provides a level death benefit
6
A rider is an endorsement to a life insurance policy that adds additional features and benefits to the contract.
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with a level premium. At the end of the term, the policy
expires.
Renewable policies, however, give the policy owner
choices based on the policy design. For example, annually
renewable term, or ART, provides coverage for one year
with
the
option
to
renew
(without
evidence
of
7
insurability) at the end of the policy. Because the
premium increases, or “steps up” each year, an ART’s
premium is called a “step-rate.” Most designs of this
product limit the number of times the policy can be
renewed, and the final age at which can be insured under
the policy.8
Another renewable term policy design is called re-entry
term. A re-entry policy offers the insured the option to
renew, without evidence of insurability and at a
specified premium rate. Usually, the renewal occurs every
five years. The insured agrees to submit evidence of
insurability at specified periods. If the insured is in
good health, the renewal premium rate will be lower than
the guaranteed rate. If the insured’s health is not good,
he or she may still renew, but at the contract’s
guaranteed rate.
Option to Convert
It is not uncommon for a term insurance policy to be
“convertible.” This means that an insured may convert
their current term contract into a permanent, or whole
life, insurance contract.9 Usually, a time-limit is
stated in the policy for converting.
The option to convert is a valuable privilege in the term
contract because it allows the insured to replace a
temporary insurance coverage with a permanent coverage
without evidence of insurability. Thus, an insured who
purchased a ten-year level policy could convert his
7
Annually renewable term is also called yearly renewable term, or YRT, by some companies.
Again, these limits are based on the insurance company’s design choices. However, while a policy
may be renewable to ages beyond 65, it becomes less and less cost-effective for the insured to pursue
this option.
8
9
A term policy that does not possess the option to convert is called a nonconvertible policy.
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policy into a permanent policy without having to provide
any information about his health history and current
physical condition, let alone undergo a physical. Even if
one developed a physical condition that would create a
greater risk for the insurance company, this information
does not have to be revealed to the company, and the
company cannot refuse coverage.
Naturally, this does not mean that the insured will pay
the same premium for his new, converted policy that he
paid for his original policy. When an insured converts a
policy, the conversion will be based on either the
attained age or original age of the insured.
An attained age is the insured’s age at a particular
point in time. An original age is the insured’s age at
the date that a term policy was issued. A conversion
based on attained age raises a premium to reflect the
insured’s current age and reduced life expectancy. A
conversion based on original age is sometimes called a
retroactive conversion. The premium in this type of
conversion is lower, but the policy owner must pay an
additional sum to make up for the difference between the
term and whole life insurance from the date of the term
policy’s original issue to the time of conversion.
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Combination Course 1
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REVIEW QUESTIONS I
1.
Clara is 26, divorced, with two children. In talking with her agent, she
believes a $500,000 face amount would be adequate. She would like
to purchase a whole life policy, but is feeling strapped for cash while
she finishes law school. The insurance strategy her agent could
suggest that would make the most sense is:
a) A non-convertible ART policy with a face amount of $1,000,000.
b) A non-convertible ten-year level term policy with a face amount of
$750,000.
c) A $500,000 decreasing term policy with a ten-year term period.
d) A ten-year convertible term policy with a face amount of $500,000.
2.
Duke purchased a 20-year renewable term policy with an option to
convert within five years of the policy’s expiration date. It is now ten
years since the policy’s inception, and Duke has developed high
blood pressure and diabetes. Will he be able to convert his policy to
permanent insurance?
a) Yes, provided the conversion occurs within five years of the
policy’s expiration.
b) Yes, provided he passes a physical examination.
c) No, because his health situation has changed dramatically.
3.
Graham has an ART policy that is renewable to age 70. Graham is
now 40, and has renewed for five years in a row. Which statement is
true?
a) Graham’s premiums have increased with each renewal.
b) Graham’s premiums have stayed the same, because the policy
has the option to renew until age 70.
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4.
Trent has a renewable term policy with a re-entry option. Trent’s
policy requires that he take a physical at specific times. Trent is in
excellent physical condition, and continues to be insurable. When he
renews his policy, his rates are:
a)
b)
c)
d)
lower than the policy’s guaranteed rates
the rate guaranteed by the policy
higher than the policy’s guaranteed rate
none of the above
ANSWERS TO THE REVIEW QUESTIONS I
1.
d
2.
a
3.
a
4.
a
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REVIEW QUESTIONS II
1.
Term insurance has only a small slice of today's life insurance
market.
a. true
b. false
2.
Term insurance is pure insurance protection.
a. true
b. false
3.
Because it does not possess a cash value component and exists for
only a limited, time frame, term insurance tends to be relatively
inexpensive.
a. true
b. false
4.
While it may begin as a good buy, term insurance does become
progressively more expensive as the insured grows older and
becomes more of a risk.
a. true
b. false
5.
Term insurance is best suited to meet specific, temporary needs.
a. true
b. false
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ANSWERS TO THE REVIEW QUESTIONS II
1. b
2. a
3. a
4. a
5. a
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Combination Course 1
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Chapter Four
The Traditional Products (B) -- Whole Life
Insurance
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WHOLE LIFE INSURANCE FUNDAMENTALS
Whole life insurance is the direct opposite of term
insurance.10 While term insurance is designed to expire
after the end of a specified period, whole life insurance
is designed to be “permanent.” Permanent in this context
means for the whole life of the insured, or until the age
of 100.11
Whole life insurance can be represented visually by the
following chart:
TABLE 3 – 1
The Policy’s Duration
Issue Age
Age 100
The Policy’s Premium
$1500
$1500
$1500
$1500
$1500
The Policy’s Face Amount
$100,000
$100,000
The Policy’s Cash Value
$100,000
$0
Other terms for whole life are “straight life,” “ordinary level-premium whole life,” and “traditional
whole life.”
11
The use of the age 100 as a “cut off” is an actuarial device. While some persons obviously do live to
100, the number is statistically insignificant; it is presumed that by age 100 that the insured will be
dead.
10
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A whole life policy has premiums that are payable to age
100. The premiums are level, so unlike term insurance, a
whole life policy does not become prohibitively expensive
as the insured ages.
A whole life policy can offer level premiums because it
initially overcharges the insured for the cost of the
chosen face amount. The excess amount is invested by the
insurance company, and credited to the cash value in the
insured’s policy. This cash value accumulates tax-free,
and earns interest. Cash value provides a savings
element, and is a major source of the policy’s living
benefits.12
The living benefits from a life insurance policy can
include loans against the accumulated cash value.
Typically, insurance companies will allow up to 98% of
the cash value in form of a loan with simple interest.
The loan does not have to be repaid, but an unpaid loan
plus its accumulated interest will be subtracted from the
face amount before it is paid as a death benefit or an
endowment.
Typical uses for a whole life policy’s cash values are
the following:





Providing collateral for a loan
Paying off a mortgage
Supplementing retirement income
Providing an emergency cash fund
Establishing a college fund
A whole life policy provides insurance protection until
age 100, when the policy reaches maturity. At maturity,
the whole life policy endows. This means that the cash
value in the policy has accumulated to equal the face
amount of the policy. If the insured is still living, he
or she will receive the face amount as an endowment. When
a whole life policy reaches maturity and endows, the
contract is completed and expires. The insured no longer
12
Living benefits are benefits provided by a whole life policy that the policy owner can access while
alive. In addition to cash value, they can include disability income and waiver of premium.
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owes premiums, and
insurance coverage.
the
company
no
longer
provides
Just like term insurance, whole life insurance possesses
relative strengths and weaknesses. The primary advantages
of whole life insurance are the following:





A whole life policy provides guaranteed cash values.
The cash values are not subject to the market risk
associated with other conservative investments such as
longer-term municipal bonds.
Cash value interest accumulates tax-free or taxdeferred,
depending
on
whether
the
gains
are
distributed during lifetime or at death.
A whole life policy can be used as collateral for
personal loans.
A fixed and known premium for lifetime life insurance
coverage.
The primary disadvantages of whole life insurance are the
following:




The premium may be too expensive for the level of
coverage needed.
The rate of return on the cash value may not be
competitive with higher-risk investments.
Cash values are subject to inflation.
If the policy is surrendered within the early years of
the contract (typically up to five to ten years from
the policy’s inception), the insured can face a
considerable loss.
Uses of the Product
For most consumers, the essential purpose of the whole
life product is very similar to term life. Like term
insurance, whole life can provide an immediate estate.
Typically, this estate is used to provide income for
dependents. Whole life can also be used for specific
goals such as funding a college education, funding a
charity, or providing cash for federal estate and state
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Combination Course 1
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inheritance tax purposes. Other uses include providing
cash for business debts, mortgages, and funeral expenses.
Like term insurance, whole life insurance helps preserve
the confidentiality of one’s financial affairs. Proceeds
from an insurance policy’s death benefit payable to
someone other than the deceased’s estate avoid probate
and are not part of the public record.
Term insurance focuses on providing an insurance solution
for short term needs. Whole life, on the other hand, is
best suited for long term needs. Because whole life
provides a series of “knowns” (fixed premium, guaranteed
ceiling on mortality and expense and guaranteed cash
value), it meets the financial and psychological security
needs inherent in long term planning.
Whole life, however, is a more complex product than term
insurance, and is often more useful for meeting more
diverse needs. Whole life tends to be an excellent
product for meeting various business life insurance
needs.
Some
examples
include
split
dollar
and
nonqualified deferred compensation arrangements, funding
buy-sell agreements, and key person insurance.
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
REVIEW QUESTIONS
1.
Ira has a $100,000 level premium whole policy. Ira has a massive
heart attack and unexpectedly dies at 57. Ira had recently borrowed
$5000 from his policy’s cash value. How much will his beneficiary
receive?
a)
b)
c)
d)
2.
Which of the following are not (a) feature(s) of whole life insurance?
a)
b)
c)
e)
3.
$100,000
$0
$95,000 plus the interest
$95,000 less any unpaid interest
temporary protection
cash values
maturity at age 100
initial low cost, with escalating
premiums as one grows older
Otto has a whole life policy with a $25,000 face value. Otto has just
turned 100, and is as healthy as ever. He has never missed a
premium payment, and has never borrowed from his policy. Based
on this profile, Otto will soon receive a check from the insurance
company to the amount of:
a) $25,000 plus interest
b) $25,000
4.
Which of the following can be counted part of a whole life policy’s
living benefits?
a) loans from the policy
b) the policy’s face amount
c) disability income
d) waiver of premium
f) a & b only
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g) a, c, d
ANSWERS TO THE PRACTICE QUESTIONS
1.
d
2.
a
3.
b
4.
f
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Combination Course 1
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Traditional Whole Life Variations
In addition to traditional whole life with level premiums
to age 100, the whole life product exists in a range of
variations. These modifications have been introduced by
the insurance industry over time in order to better meet
the specific needs of consumers. Some of these product
variations include limited pay whole life, modified whole
life, indexed whole life, graded premium whole life, and
indeterminate premium whole life.
Limited pay whole life is a whole life policy that
provides the same benefits as a traditional whole life
policy, but with pre-defined limit on the number of
required premium payments. Typical limited pay whole life
policy designs include 15, 20 and 30 pay plans. The
number of “pays” equals the number of years that the
insured must pay a premium. Thus, a 15-pay whole life
policy requires premium payments for 15 years.13
Another variation on the limited pay policy design is to
state an age, short of 100, to which an insured must pay
premiums. A typical age-based limited pay life policy is
“to age 65.” This type of policy is usually referred to
as “life paid up at age 65 (LP65).”
Still another form of limited pay whole life is 1-pay
whole life, which is also known as single premium whole
life. Because a 1-pay policy funds the entire contract
with one premium, the premium must be very large.
However, the real cost of this premium is actually less
than what the total of premiums spread over a 15, 20, 30,
or 100 year period would be. This reduction in premium
occurs because of the interest that the lump sum payment
will accrue and the minimized expenses realized by the
company.
Single premium whole life policies are rarely purchased
in today’s environment. Current tax legislation defines
13
Limited pay policies are subject to a 7-pay test for determining the tax status of a policy loan or
partial surrender. If the total premiums paid into the policy during its first year exceed the total amount
of premiums that would have been payable to provide a paid-up policy in seven years, the policy is
classified a modified endowment contract.
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single premium policies as modified endowment contracts,
which are discussed in the following sections.14
Because the premium payment period is reduced in a
limited pay policy, the required dollar amount is higher
than in a comparable traditional whole life contract.
Within this structure, a higher percentage of the limited
pay premium dollar is credited to the policy’s cash
value. The shorter the premium-paying period, the faster
the growth in cash value. After the premium paying
period, the cash value growth slows down, as it is driven
solely by interest earnings. At this point, the policy
functions like a traditional whole policy, in that the
cash value increases until it matches the face amount and
the policy matures.
TABLE 4 – 1
COMPARISON OF 20-PAY AND TRADITIONAL WHOLE LIFE POLICIES
WITH $100,000 FACE AMOUNTS
GROWTH IN CASH VALUE
$ 0
$100,000
AGE
28 …
48 …
100
14
In most cases, single premium life insurance contracts issued on or after June 21, 1988 are modified
endowment contracts.
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Lifetime Protection
Premium payments end
PREMIUM
PERIOD –
20-PAY
LIFE
Lifetime Protection
PREMIUM
PERIOD –
TRAD.
WHOLE
LIFE
Another example of a whole life variation is modified
whole life. This product offers a low period at the start
of the contract, and then increases once. The new premium
rate remains level for the duration of the policy period
(age 100). The initial low-premium period usually lasts
from three to five years.
During the initial period, the premium is only slightly
more than for a term policy. When the premium increases,
it is higher than the whole life rate at the age of
issue, but lower than the term rate for the insured’s
attained age at the time of the transition.
TABLE 5 – 1
$50,000 MODIFIED WHOLE LIFE
Age 30
Age 35
Age 100
Initial low premium
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Subsequent premium
Graded premium whole life is similar to modified whole
life, but adds an additional “spin.” Like a modified
whole life policy, a graded premium plan will offer an
initial period of lower premiums that ultimately level
off to a level rate for the remainder of the contract
(age 100).
The difference between the graded and modified whole life
is in the duration and format of the initial premium
period. First, the lower premium period lasts longer –
usually ten years. Second, the lower premium period has a
step-rate design. This means that the premium gradually
increases each year until the level premium period is
reached.
Both the modified and graded whole life policy are
designed for consumers who want to lock in the benefits
of a whole life design, but are initially “cash
challenged.” While their premium structure helps meet one
of the primary disadvantages of whole life insurance –
the cost of the policy – they can only function if the
insured is in a position to eventually pay a higher
premium. These policies are ultimately not more or less
expensive than level premium whole life. Actuarially, the
premium rates are equivalent to traditional whole life.
Indeterminate premium whole life is another whole life
design that seeks to meet the premium price objection.
This variety of whole life insurance has a premium rate
that is adjustable based upon the company’s anticipated
future experience. In this form of whole life, a maximum
premium is stated, with an initial rate that is both
lower and fixed for a guaranteed short-term (typically
two to three years.)
When the guaranteed short-term expires, the premium rate
is reviewed in light of the insurance company’s expected
and realized earnings and expenses. If the situation is
favorable, the premium may be adjusted down. If the
situation is unchanged, the premium may remain level. If
the company’s situation is worse, the premium may be
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increased. Some of the factors the company reviews are:
mortality
experience,
administrative
expense,
and
investment returns.
Whole life variations all possess a number of advantages
for the consumer. First, limited pay plans help the
consumer with financial planning by providing a known
dollar amount for the premium outlay. By providing a
limited time-frame during which premiums must be paid, a
limited pay policy also reduces the chances that the
policy might lapse. The major reason that the limited pay
design is popular, however, is that the cash values build
faster than a traditional whole life policy.
The main disadvantage of any limited pay whole life
policy is that it will be even more expensive than
traditional whole life coverage. By compressing the
payment period, these types of policies are often
unaffordable for consumers with limited means.15
Modified whole life plans make whole life insurance more
affordable for consumers that are just beginning their
careers or returning to the workforce and have yet to
experience significant earning power. These policies seek
to meet the major obstacle many consumers find when
trying to purchase whole life coverage – the cost of the
premium.
Using
modified
whole
life
policies
requires
good
planning. If the insured does not manage their expenses
properly, they will be in a difficult position when the
premium increases.
Uses of the Product
Limited pay policies are effective instruments for a
number of cases. These policies are often used to provide
insurance protection after retirement without the need of
paying premiums. Limited pay policies are also good
15
From an asset allocation standpoint, it can also be argued that limited pay plans suffer a major defect
in the early years of the contract. This is because the amount of life insurance protection – the
difference between the face amount and the cash value – is lower relative to the premium than with
traditional whole life or term.
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choices for persons with a brief working lifetime, such
as professional athletes.
Another use of limited pay policies funding insurance is
for juveniles. Parents can purchase basic insurance
protection for their children, and have the policy paidup before they leave the household to begin their own
lives.
Modified whole life policies, as we have already
mentioned, are geared to consumers that recognize the
value of whole life insurance, but lack the
means to
comfortably meet the premium required for adequate
protection. These policy designs can be very valuable for
persons in training programs or defined pay structures
who are confident about future salary increases.
While the modified plan will ultimately provide the same
coverage as a traditional whole life plan, the insured
will be “stuck” with little to no cash value in the
policy for a longer time than in a traditional whole life
policy. Furthermore, the insured will have some period of
higher premiums than would have been paid with a level
premium policy.
NOTES
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REVIEW QUESTIONS
1.
Hank has a 20-pay limited life policy. His twin brother Skippy has a
traditional whole life policy. Both policies were purchased at the
same time and for the same face amount.
Which brother pays the higher premium?
Whose policy will earn cash value quickest?
2.
Most single premium whole life policies are :
a)
b)
c)
d)
3.
Which of the following are true for limited pay whole life policies?
a)
b)
c)
d)
4.
sold to low- to middle-income consumers
modified endowment contracts
slightly more expensive than whole life policies
all of the above
they provide lifetime protection until age 100
they endow at age 100
their premiums are payable for limited, stated time period
all of the above
Cosmo has a LP65 policy. This means:
a) he will be finished with premiums at age 65
b) he has lifetime protection with a face amount of 65,000
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5.
Renaldo has just graduated from McDonald College and taken a
position as management trainee. He has a wife and child, and would
like to purchase life insurance. Renaldo wants a policy that, should
he die, can help provide income to his wife and child plus pay all
final expenses. Renaldo’s training period lasts two years, after which
he will earn a sizable pay increase. Of the following options, Renaldo
is a good candidate for:
a)
b)
c)
d)
6.
Declining term life
Graded premium whole life
Single premium whole life
Re-entry term life
Louie has purchased an indeterminate premium whole life policy.
Which of the following is probably true about his coverage:
a) his premium will be higher for the first years of the contract, and
then decline to a constant lower level
b) his policy will state a maximum premium that can be charged
c) his premium will be fixed for the initial few years, and then raised,
lowered, or kept the same, based upon the company’s expected
mortality, expense, and investment projections
d) a & b
e) b & c
ANSWERS TO THE PRACTICE QUESTIONS
1.
Hank; Hank
2.
b
3.
d
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4.
a
5.
b
6.
e
Endowment Policies and MECs
Endowment policies are yet another type of ordinary life
insurance. Unlike a traditional whole life policy,
however, an endowment policy does not mature at age 100;
the endowment policy does not provide lifetime insurance
protection.
An endowment policy offers life insurance for a specific
period of time. Typical time periods include 10 years, 20
years, and “endowment at age 65.” The premium during the
time that the policy is in force is level, just like a
traditional whole life policy. Should the insured die at
any point during the premium paying period, the endowment
policy will pay the face of the policy as a death benefit
to the beneficiary.16
At the maturity date, an endowment policy will pay the
face amount as an endowment. Like a whole life policy,
the endowment is paid to the policy owner.
Endowment policies increase their cash value extremely
quickly. Because of their abbreviated accumulation
period, endowment policies have very expensive premiums.
16
The premium paying period is called the endowment period.
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TABLE 6 - 1
Policy Comparison – Endowment and Traditional Whole Life
Endowment
Traditional
Whole
Life
Policy Begins
Age 35
Endowment Matures
Age 65
WL Matures
Age 100
The modified endowment concept originated from changes in
the tax code. The United States Congress enacted the
Technical and Miscellaneous Revenue Act (TAMRA) in 1988.
TAMRA determined that all life insurance policies issued
on or after June 21, 1988 must meet the 7-pay test or be
classified as modified endowment contracts (MECs).
As an MEC, any amount that is withdrawn in the form of a
loan or partial surrender is taxed as ordinary income and
return of premium (if there is any gain in the contract
over premiums paid). In addition, there is a 10 percent
penalty tax on withdrawals if they occur before the
policy-owner reaches age 59 ½ .
MECs can potentially occur with single pay and limited
pay
policies.
Avoiding
an
MEC
situation
is
the
responsibility of the insurance company home office, but
the agent needs to be aware of the concept and how it can
affect consumers.
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REVIEW QUESTIONS
1.
Endowment contracts are known as (circle one) expensive /
inexpensive policies.
2.
Endowment contracts share all of the following characteristics as
traditional whole life polices except for:
a)
b)
c)
d)
level premium
level death benefit
matures at age 100
builds cash value
ANSWERS TO THE PRACTICE QUESTIONS
1.
expensive
2.
c
NOTES
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Chapter Five
New Worlds of Life Insurance
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 Whole Life Variations
A variety of forces emerged that challenged the life
insurance industry to develop alternatives to product
designs that had received little more than “fine tuning”
for nearly 100 years.
First, the consumer movement led
to a greater demand from consumers for knowing how their
premium dollars would be invested. Second, the weakening
of the “endowment” ethos and the growth of the
“lifestyle” ethos, coupled with the increase in life
expectancies, has greatly altered the perceived need for-as well as the anticipated uses of—life insurance.17
Some of these forces have been driven by the post-World
War II Baby Boomer generation that numbers more than 78
million. Because of the influence that their sizeable
numbers and affluence command, their tastes and demands
have forced the insurance industry to develop products to
meet such needs as college planning, retirement income
supplementation, and estate planning.18
In addition to demographics, the volatility of the
economy has exerted a
powerful influence upon life
insurance innovation. Such factors as the experience of
hyper-inflation
in
the
1970s,
“stagflation,”
the
subsequent changes in the interest-rate environment, and
the “irrational exuberance” of the Bull Markets of the
late 1980s and 1990s all have affected the product
designs offered by life insurance companies.
Universal Life
Universal life insurance emerged out of the hyperinflation and high interest rates of the late 1970s. As
consumers were able to earn 10% or more on cash in bank
and money market accounts, the insurance industry
witnessed a massive withdrawal of funds from traditional
An “endowment” ethos is a value system that places primacy on furthering the economic position of
one’s offspring; a “lifestyle” ethos focuses on one’s own well-being throughout the various stages of
life.
18
The Baby-Boomer generation will represent the largest transfer of assets in history.
17
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whole life policies. As these policies were built upon
the assumption of low, stable interest rates, the 3 to 4%
returns they were generating looked meager to many policy
owners.
Universal life (UL) was created to meet this challenge.
While UL operates like a whole life policy, and enjoys
the same tax advantages as whole life, it is essentially
a level or decreasing term life insurance policy with an
investment account. Following this design, universal life
is an unbundled policy. As an unbundled policy, the
investment,
mortality,
and
cost
features
are
all
separated and reported annually in a yearly statement.
The universal life policy is unique among life policies.
This is because universal life is based upon current,
available cash value rather than regularly scheduled
premiums. In a term or traditional whole life policy, the
insurance company determines a premium based upon a
series of assumptions and underwriting information. The
policy is dependent upon regular, scheduled premium
payments by the policy owner.
With universal life, however, the policy owner possesses
wide latitude as to the frequency and level of premiums.
As long as the cash value within the investment account
is sufficient to pay the monthly mortality expenses for
the insurance coverage and the necessary policy expenses,
the policy stays in force. The policy owner may
occasionally
skip
premium
payments,
make
partial
payments, or increase premium payments. With universal
life, the policy may be funded in pattern that can be
continually revised. In this type of policy, the policy
owner has significant control over the amount and
frequency of the premium payments.19
In addition to being able to skip payments, the policy
owner may also increase or decrease coverage. If the
policy owner desires, the death benefit can be decreased
to a level at which the existing cash value would carry
19
While the policy owner possesses wide latitude for making decisions, the company sets guidelines
by which the policy owner must abide. These guidelines conform to company policy and statutory
requirements. In addition, loans from the company’s cash values are capped, typically at 90% of the
current cash value. Policy loans do not decrease the death benefit.
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the policy to maturity. In this type of policy, the
policy owner has significant control over the level of
death benefit.
The universal life policy also possesses a variety of
other flexibility features that benefit the policy owner.
For example, the policy owner may let the cash values
accumulate, make partial surrenders, or surrender the
policy for the entire cash value. In addition, various
riders can be added to a policy to further shape it to
the policy owner’s specific needs. Riders that are
commonly added to a universal life policy include the
following:
cost-of-living,
additional
insureds,
children’s, guaranteed insurability, and waiver of
premium.
The reason that the universal life policy can offer these
flexibility options is because the cash values in the
investment account reflect “current interest rates.” For
universal life policies, “current interest rates” are
determined by the company’s own investment earnings
return rate, the sale of 90-day U.S. Treasury bills, or a
bond index. In a high-interest rate environment, the
monies in the investment account can grow tax-deferred at
a rate faster than many traditional whole life policies.
Because the performance of the universal life policy is
tied to current interest rates, the policy owner is
exposed to a measure of volatility.20 When interest rates
are high, the policy performs well and the flexibility
options described above can be employed by the policy
owner. When interest rates fall, however, the universal
life design is presented with some challenges.
First of all, low interest rates can cause a funding
problem for the universal life policy. Even though the
policy design allows the policy owner to skip payments,
make partial payments, etc., the assumption is always
that the cash value in the investment account is
sufficient to allow for a monthly withdrawal that will
meet both the mortality charge (the cost of the
20
While possessing an element of volatility, universal life policies are nevertheless typically
guaranteed policies. They provide a minimum guaranteed interest rate and death rate.
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insurance) and
sustained period
can destroy the
premium specified
monthly basis in
in force.
the policy’s operating expenses. A
of lower-than-expected interest rates
policy’s flexibility, as the target
by the company will have to be met on a
order to keep the insurance protection
Secondly, low and/or declining interest rates and the
increasing age of the insured will increase the cost of
pure death protection. The result is that the amount of
cash value allocated to the mortality charge will
increase and the amount entering the investment account
will decrease.
On a more positive note, however, universal life policies
use a back-end load rather than the front-end load
typical of most traditional whole life policies.21 Because
of the back-end load structure of the universal life
policy, a larger portion of the policy owner’s initial
premiums go into the cash value account. This means that
the cash values in the universal life’s investment
account will grow quicker than a traditional whole life
policy.
Universal Life Death Benefit Options
Option 1 (or A)
The Option
traditional
investment
decreases.
Option 1 is
1 (or A) death benefit
whole life policy. As the
account grows, the net
The total death benefit
thus a level death benefit
is similar to a
cash value in the
amount at risk
remains constant.
policy.
However, if the cash value growth approaches the face
amount before the policy matures, the universal policy
automatically provides an increased death benefit. This
additional insurance is called the “corridor.” It is
maintained in addition to the cash values, and is done to
avoid negative tax consequences.
21
A load refers to the sales charge imposed by an insurance company to recover its initial policy
expenses. “Front” and “back” refer to when the policy expenses are paid.
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Death Benefit
Age 40
Age 100
Cash Value
Option 2 ( or B)
The Option 2 (or B) death benefit equals the face amount
plus the cash values in the investment account. This
makes the Option 2 death benefit similar to that found in
a traditional whole life policy with a term insurance
rider that equals the current cash value. The result is
that the death benefit grows along with the cash values.
Age 40
Age 100
The primary advantages of the universal life policy are
the following:



The policy owner has flexibility in premium payments
The policy owner has flexibility in changing the death
benefit, and may select from two design options
Most universal life policies are back-end loaded, with
the result that cash values tend to build faster than
in traditional whole life policies
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

The unbundled design provides the policy owner with a
clear presentation of the policy’s performance on an
annual basis
Universal
life
policies
offer
the
cash
value
advantages typical of traditional whole life: taxdeferred build-up of the cash value and low-interest
policy loans
The primary disadvantages of the universal life policy
are the following:


The policy owner is exposed to a greater deal of risk
than a traditional whole life policy, as sustained low
interest rates can cancel the policy’s flexibility
features
The flexibility of the policy can create unforeseen
circumstances.
For
example,
the
policy
can
inadvertently become a MEC through over-funding. The
ability to skip premium payments takes away the
“forced savings” element of traditional whole life and
can encourage under-funding and/or policy lapses
Uses of the Product
The flexibility of universal life makes it suitable for
many insurance needs. However, the cash value element of
this policy design generally makes it more appropriate
for long-term needs.
A universal life policy can be designed to change with a
person’s developing needs. For example, the initial phase
of the policy can emphasize insurance protection, with
lower premiums and a high death benefit. As insurance
needs change, the emphasis can switch to build-up of cash
value with an increase in premiums.
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REVIEW QUESTIONS
1.
Theo would like a cash value policy that allows him to easily change
the death benefit level because of life-events like the birth of a child.
His best option is:
a)
b)
c)
d)
2.
Increasing term life
Traditional whole life
Universal life
Industrial life
Melissa is 46, and has a universal life policy with a $100,000 face
value. When she purchased the policy, current interest rates were
8%. Interest rates have been falling steadily since she purchased the
policy. Which of the following statement(s) reflect Melissa’s
situation:
a) The policy’s features—death benefit, rate of cash value
accumulation, target premium—will be unaffected
b) The death benefit will most likely be unaffected, but the cash
value will not grow as fast
c) The death benefit and cash values will most likely decrease
d) None of the above
3.
Felipe quits his job to start up an internet-service company. As his
income stream is temporarily interrupted and his business start-up
costs are high, he would like to not make life insurance premium
payments for a brief period -- without surrendering his policy. Is this
possible with a universal life policy?
a) No
b) Yes, if the policy has sufficient
4.
The universal life policy possesses
designs of death benefit options.
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a) Two
b) Three
ANSWERS TO THE PRACTICE QUESTIONS
1.
c
2.
b
3.
b; cash values
4.
a
Adjustable Life
Adjustable life, or ALI, is a flexible premium policy
with an adjustable death benefit. Adjustable life is a
whole life variation that has features similar to
universal life and traditional whole life. Adjustable
life is an example of a hybrid policy. As such, the
adjustable life policy allows the policy owner the
following options:




Increase
Increase
Increase
Increase
or
or
or
or
decrease
decrease
decrease
decrease
the
the
the
the
premium22
premium payment period
death benefit
protection period
These features mirror the flexible nature of the
universal life policy. However, unlike the universal life
design, an adjustable life policy is bundled. This means
that the death protection and cash value components are
not
segregated.
Unlike
a
universal
life
policy,
withdrawals from the cash values are not permitted
without a partial surrender of the policy.
Increases in the policy’s premium naturally require that the policy’s face amount state within
statutory guidelines. Increases in premium typically require evidence of insurability.
22
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Other features of the adjustable life policy that are
consistent with a traditional whole life design include
the following:







Guaranteed maximum mortality charges
Cash values
Guaranteed minimum interest
Nonforfeiture options
Settlement options
Dividend options
Policy loan provisions
In addition, a
whole life may
These commonly
and accidental
variety of riders typical for traditional
be attached to the adjustable life policy.
include waiver of premium, cost-of-living,
death & dismemberment.
Another element that differentiates the adjustable life
policy from a true universal life policy is how the death
benefit and premium level may be adjusted. Unlike the
universal life design, changes in death benefit and
premium level can only occur at specific intervals. All
changes must occur with advanced notice to the insurer.
The schedule of cash values, which is based upon the
current program of premiums, face value, and duration of
coverage, is recomputed each time the death benefit or
premium payment is adjusted. During the time period
between changes, the adjustable life policy functions
like a traditional whole life level death benefit and
level premium policy.
Adjustable life is simply another policy design created
by the insurance industry to meet the public’s demand for
greater flexibility. It is appropriate for a wide range
of life insurance needs. However, because of its cash
value component, adjustable life is typically better for
long-term insurance needs.
Adjustable life is often sold on a money purchase basis.
This means that a specific premium dollar figure is
selected, and this figure is matched with an appropriate
whole life policy.
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NOTES
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Current-Assumption Whole Life
Current-assumption whole life (CAWL) is also known as
interest-sensitive whole life or fixed premium universal
life.23 Current-assumption whole life is another hybrid of
universal life and traditional whole life.
The current-assumption whole life policy is usually
issued with a level (i.e. fixed) premium and death
benefit.
The premiums, however, will reflect changing
conditions in two broad categories: the insurer’s
assumptions and actual experience with mortality and/or
expenses, and current interest rates.24 The company will
usually tie the policy’s performance to a specified index
or yield.
The result is that premiums for a current-assumption
policy can become higher or lower than those stated at
the policy’s issue. High interest rates will tend to
produce lower premiums, while lower interest rates will
produce
higher
premiums.
Typically,
the
currentassumption policy presents a guaranteed minimum interest
rate as well as a maximum charge for mortality expenses.
The current-assumption policy is similar to traditional
whole life in the following features. Most currentassumption policies possesses such elements as guaranteed
maximum mortality charges, minimum guaranteed cash
values, nonforfeiture options, settlement options, policy
loan provisions, and a guaranteed minimum interest level.
Between determination periods, the policy functions as a
level premium, level death benefit policy.
Current-assumption whole life resembles universal life
through the following two major features. First, the
The other terms for current-assumption whole life are problematic. “Fixed premium universal life” is
only partially accurate, as the premium and death benefit levels are only fixed for a limited period,
based upon anticipated interest, mortality, and expenses. “Interest sensitive” is also incomplete, as the
policy is not only sensitive to interest rates but also to the company’s mortality and expense
experience. Some current-assumption policies, however, are exclusively interest-sensitive.
24
Some current-assumption policies do not have stand-alone expense charges. Instead, the policy’s
expenses are folded into the mortality charge, or they may be included as “adjustments” to the current
rate credited to the cash values.
23
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policy is unbundled. Second, the
policy is generally back-end loaded.
current-assumption
Like adjustable life, current-assumption whole life
blends aspects of the traditional whole life and
universal life designs. The strengths of the policy
include the following:






Cash values that grow tax deferred
An interest rate that is often higher than
traditional whole life
Low-interest policy loans
Annual reports on the policy’s performance
Back-end loads
Withdrawal of the excess cash value accumulations
The weaknesses
following:



of
this
policy
design
are
in
the
The policy owner is exposed to a level of risk in
the form of volatile interest rates that can
create higher premiums
The policy only guarantees maximum mortality
and/or expense rates
Unlike a universal policy, the current-assumption
policy will ultimately lapse if the scheduled
premium payments are not paid, regardless of the
accumulated cash values
Because
of
its
cash-value
features,
the
currentassumption whole life policy is best for long-term life
insurance needs. It is well suited for the client who
wishes to make use of the “forced savings” aspect of
traditional whole life policy, but still wants an annual
report detailing the policy’s performance as well as the
potential for higher interest rates on the cash values.
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REVIEW QUESTIONS
1.
Another term for current-assumption whole life is interest sensitive
whole life.
a) true
b) false
2.
Jack has a current-assumption whole life policy. Since he purchased
the policy, interest rates have increased several times and are now
5% higher than when the policy originated. It is reasonable to believe
that Jack’s premiums are
than (as) before.
a) higher
b) lower
c) the same
3.
Samson has an adjustable life policy. He has recently taken a new
sales
job for a major wig manufacturer. With the costs of relocation and
establishing a new territory, he believes his cash flow will be
strained
for a temporary period. Can he decrease his premiums with this type
of
policy design?
a) yes
b) no
4.
Adjustable life and current-assumption whole life are both
unbundled policies.
a) true
b) false
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ANSWERS TO THE PRACTICE QUESTIONS
1.
a
2.
b
3.
a
4.
b
VARIABLE LIFE INSURANCE PRODUCTS
Variable life (VL) and variable universal life (VUL) are
policy designs derivative of traditional whole life that,
like universal life, evolved out of the economic
conditions of the late 1970s and early 1980s. December of
1976 the SEC issued Rule 6E-2, which provided a limited
exception from sections of the Investment Company Act of
1940. This rule requires that insurance companies provide
an accounting to contract holders, imposes limitations on
sales charges, and requires that the insurers offer
refunds or exchanges to variable life purchasers under
certain circumstances, including an option of returning
to a traditional whole life policy.25 Rule 6E-2 defines
variable life as a contract in which the life insurance
element is predominant, the cash values are funded by
separate accounts of a life insurance company, and death
benefits and cash values vary in response to investment
experience.
The first variable life policy was issued in the United
States in 1976. The growth of the product was initially
slow. In 1981, only ten companies sold the product. In
1992, variable products only accounted for nine percent
of total life insurance market share. However, with the
25
There are no SEC limitations applicable in whole life or universal life sales charges.
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strong bull market of
universal life have
1998, the sale of
surpassed traditional
in history.

the nineties, variable and variable
grown steadily in popularity. In
variable life insurance products
whole life sales for the first time
Variable Life
Variable life is also referred to as scheduled premium
variable life. It is characterized by three main
features.
First, the policy owner’s cash values are placed in a
separate account (or accounts) that is (or are) different
from the company’s general account. These separate accounts
are investment vehicles that mirror mutual funds.26 The
variety of separate accounts dependent upon the company’s
choices and policies. They can essentially include any
form and style of mutual fund, such as a stock fund and
its relevant variations (e.g. growth stock, foreign
stock, small cap stock, etc.).
Policy owners may choose the initial mix of funds, and
can switch funding options one or more times per year.
Other policies allow for a managed account, in which an
investment manager is in charge of the asset allocation
of the cash values. Today’s products offer not only the
money markets and common stock accounts typical of the
earliest variable policies, but also aggressive growth
accounts, global and international equity accounts, and
various bond accounts.
Like a traditional whole life policy, cash values grow
tax deferred. However, the investments that are allowed
in a variable life’s separate account can be much more
aggressive than those that fund an insurance company’s
general account. Thus, the opportunity for returns that
are significantly better than a traditional whole life
policy are possible.
26
The separate account that backs a variable life insurance contract is usually classified as an
investment company and registered as such with the appropriate government regulatory bodies.
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In addition, since the policy owner may invest in a mix
of separate accounts, a level of diversification can be
achieved. Furthermore, since switching funding options is
not considered a taxable event, the policy owner may
periodically alter the mix in reaction to the changing
economic climate.
The second defining feature of the variable life policy
is its lack of guarantees. Unlike a traditional whole
life policy, the variable life policy does not guarantee
the cash value in the separate account. The policy owner,
not the company, will bear the risk of the separate
account’s performance.
The third defining feature of the variable life policy is
the functioning of the death benefit. The variable life
policy requires the payment of a level, scheduled
premium, and this supports a guaranteed minimum death
benefit. However, the realized face amount of the death
benefit is flexible. If the investment performance of the
separate account is positive, the death benefit can
increase. Conversely, it can also decrease if the
investment performance is negative (but the death benefit
will
never
be
lower
than
the
stated
guaranteed
27
minimums).
In most other respects, variable life is like a
traditional whole life policy. It has fixed and
guaranteed mortality charges, does not allow partial
surrenders from the policy, and has a “forced savings”
element in its scheduled level premium. In addition, the
variable policy will allow for low interest policy loans,
nonforfeiture and settlement options, and a reinstatement
period.

Variable Universal Life
Variable universal life is also called universal variable
life, flexible-premium variable life, and universal life
27
There are two methods of determining the death benefit level in a variable life policy. The corridor
percentage approach periodically adjusts the death benefit so it is at least equal to a specified
percentage of the cash value. The net single premium approach periodically adjusts the death benefit so
that it matches the amount of insurance that could be purchased with a single premium equal to the
cash value, assuming guaranteed mortality rates and a stated rate of return.
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II. The first variable
introduced in 1985.
universal
life
product
was
This policy blends the features of universal life and
variable life for a whole life hybrid that offers
flexibility and the possibility for aggressive growth of
cash value. The key concept of variable universal life is
policy owner control. The policy owner selects, within
the guidelines of the company, the face amount, the
premium allocation, and the investment vehicle.
Variable universal is like regular variable life in that
the policy owner’s premiums are invested in separate
accounts that are (usually) registered as mutual funds.
The policy owner will usually have a choice of separate
accounts, each representing a different investment style
or objective. As with a variable policy, these accounts
can be equity or bond accounts with such objectives as
aggressive growth, growth and income, international
growth, etc. Furthermore, the policy owner will be
periodically able to alter the mix of separate account
monies. The benefit of the variable life features is that
they offer the possibility of aggressive cash value
growth.
Variable universal life is like regular universal life in
the following:





Premium payments are flexible within limits
specified by the company
The policy owner can choose from two death
benefit options: Option 1 (or A) with a level
death benefit
and Option 2 (or B) with a death
benefit that is equal to a specified level of
pure insurance and the current cash value in the
separate account(s)
The
face
amount
of
the
death
benefit
is
adjustable by the policy owner (within limits
specified by the company and statutory law)
The policy owner may make partial withdrawals of
the cash value without a policy loan
The policy is unbundled, and provides an annual
report on performance and expenses
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Because of the blending of variable and universal life,
the variable universal life product is considered a
“second generation” product. As a relatively new product,
it is often poorly understood. In addition, by combining
the best features of two products, it is subject to a
variety of expenses that have received a great deal of
attention in the financial and consumer-oriented press.
It is vital to understand what these expenses are to
properly explain this type of product.
Expenses in Variable Universal Life Insurance
Variable universal life expenses are found at two levels:
the policy level and the investment account level. At the
policy level, expenses have to do with the policy owner’s
premium dollar before it reaches the sub-account(s) or
separate account(s). Expenses at the policy level are
what the company charges in order to cover its costs of
doing business. Expenses at the investment account level
include the cost of life insurance and the management of
the underlying funds.

Expenses at the Policy Level
Front-End Sales Load
This expense is charged against the policy owner’s going
into the policy. Some companies charge a front-end sales
load, others do not. The legal limit for a front-end
sales load is 8.5 percent.
Back-End Sales Loads
The back-end sales load is the amount the policy owner
forfeits when he or she surrenders the policy. A back-end
load can be in force for the life of the contract, or it
may have an expiration period. When a back-end load
phases out after a period of time, it is referred to as a
contingent deferred sales charge.
State Premium Taxes
State premium taxes are mandatory expenses levied by the
state government. In most cases, when there is a front© American Education Systems, LC
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end sales
there.
load,
the
state
premium
tax
is
taken
from
Administration Fees
Administration fees can take two forms—first year and
ongoing. First year administration fees cover the costs
of setting up the policy and any costs incurred in
underwriting. The ongoing administration fees go to
company services such as mailing confirmation notices,
periodic reports, and production of such materials as the
prospectus and annual report.
Other service fees can also exist with this type of
policy. For example, even though a policy owner may move
his or her funds between accounts without incurring a
taxable event, the company may or may not allow such
changes to be made free of charge. Typically, companies
allow a certain number of fund shifts per year free of
charge; any number above this amount requires a fee.

Expenses at the Investment Account Level
Cost of Insurance
The cost of insurance is referred to as the mortality
cost. This cost is a monthly expense, and is based upon
age, sex, health, use or non-use of smoking products,
occupation, and avocation. Once the applicant’s mortality
status is determined, it usually remains constant for the
life of the policy. Future changes in health cannot
increase the insured’s rates. However, the costs for
insurance increase naturally during the life of the
policy as the insured ages.
Mortality and Expense Charges
The insurance company will provide a number of guarantees
within the policy; the cost of these guarantees are
reflected in the mortality and expense (M&E) charges.
Typical guarantees include maximum monthly administrative
charges, maximum monthly cost of life insurance charges,
guaranteed annuity factors within the contract, and
continuing lifetime service.
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Investment Management and Fee Advisory
This is the fee that is charged for the overall
management of the underlying mutual funds. This fee is
derived daily from the funds’ daily net assets. It varies
from fund to fund, and can decline as the size of funds
under management grows.
Policy Loans and Withdrawals in Variable Universal Life
Insurance
In most cases, policy owners are permitted to borrow up
to ninety percent of the cash surrender value of the
policy (the cash surrender value is the gross value of
money in the policy less the surrender charge.) Loans are
typically available for a stated percentage of interest.
While the policy owner is not forced to pay the
accumulated interest (or the loan principle) back within a
certain time, if the sum owed is not repaid during the
policy owner’s life, it will ultimately be taken from the
death benefit.
Partial withdrawals are also possible with the variable
universal policy. Depending on the company’s operating
guidelines and policy design, there may be a minimum and
maximum on the amounts that can be withdrawn. In
addition, withdrawals normally carry a service fee to
complete the transaction. Even though partial withdrawals
are usually contractually possible in variable universal
policies, current tax legislation has made partial
withdrawals less attractive than loans in many cases.
Death Benefit Options in Variable Universal Life
Insurance
The
variable
universal
life
death
benefit
is
a
combination of the policy’s cash value and some portion
of pure insurance coverage. The pure insurance coverage
represents the company’s amount at risk.
Like universal life, the variable universal has two death
benefit options, usually termed option one and option two
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(or “A” and “B”). The choice of death benefit is not
irrevocable; the policy owner may switch death benefit
option as life circumstances change.
Option One – Level Death Benefit
Under the level death benefit option, the insured selects
a total death benefit amount. This face amount will
remain level until one of two events: the policy owner
decides to alter it, or the growth of cash value forces
the death benefit to increase to maintain the legally
required ration of cash value to death benefit.
Option Two – Variable Death Benefit
With the variable death benefit option, the policy owner
selects the amount of pure insurance coverage desired
rather than the total death benefit. The amount of pure
insurance remains constant; as the cash value of the
policy increases or decreases, the total death benefit
varies.
This
option
most
closely
represents
the
increasing death benefit option in universal life.
LEVEL DEATH BENEFIT OPTION
$
DEATH BENEFIT
----------------PURE INSURANCE
CASH VALUE
Age 30
35
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50
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VARIABLE DEATH BENEFIT OPTION
$
DEATH BENEFIT
CASH VALUE
Age 30
35
Sales
and
Regulatory
Insurance Products
40
45
Aspects
Because of the nature of their
variable life and variable universal
as securities as well as insurance
they are regulated by both the state
and state securities commissions.
50
of
Variable
separate accounts,
life are classified
products. As such,
insurance department
Securities
products
are
also
subject
to
federal
regulation. The federal agency charged with regulating
all securities offered to the public is the Securities
and
Exchange
Commission
(SEC).
This
five-member
commission was created by the Securities Exchange Act of
1934 for the purpose of enforcing the Securities Act of
1933. The SEC also sets disclosure and accounting rules
for most issuers of corporate securities, and oversees
the actions of securities firms, investment companies,
and investment advisers. The SEC has authority to issue
its own rules and regulations.
Along with state and federal regulation, securities
products are self-regulated by the securities industry.
This
self-regulation
is
managed
by
the
National
Association of Securities Dealers (NASD), which is a notfor-profit membership organization of securities firm
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authorized by Congress in 1939. Membership in the NASD
entitles firms to participate in the investment banking
and over-the-counter securities business for distributing
new issues underwritten by NASD members and to distribute
shares of investment companies sponsored by NASD members.
The NASD was created to promote the investment banking
and securities industry, standardize its principles and
practices, promote high ethical standards, and help its
members achieve maximum compliance with applicable state
and federal securities laws and regulations. The NASD can
issue rulings that are binding on its members.
In order to sell variable insurance products, an agent
must be a registered representative for a broker/dealer.
The broker/dealer is a firm (or individual) registered
with the SEC to buy and sell securities. Generally,
insurance companies that sell variable life products
establish a broker/dealership for distribution of their
product.28
In order to become a registered representative, an agent
must maintain an active life insurance license and pass
either the NASD Series 6 or NASD Series 7 exam and the
NASD Series 63 exam. All applicants for these NASD tests
must be thoroughly investigated to determine that he or
she has not violated any federal or state law or any NASD
exchange rule that would prohibit him or her from
entering the securities business. As part of the
background check, the applicant is finger-printed by the
local police department.
The NASD Series 6 exam is titled the Investment Company
Products/Variable Contracts Representative Examination.
This is the exam most insurance agents selling variable
life products opt to take. Unlike the life insurance
license, there is no mandatory education component
required to sit for the exam. However, as the exam is
very rigorous, most agents choose to take an exam
preparation course before sitting for the test. This exam
28
To sell variable life insurance products, an agent must also have a variable contracts license. This
license qualification can be earned at the same time that one sits for the life insurance exam. Should
the agent successfully pass this section of the exam, the variable contracts qualification will appear on
his or her license. Thus, one exam can potentially yield two qualifications for the life insurance agent.
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only qualifies the individual for sales of mutual funds
and variable products. The exam consists of 100 questions
with a 2 hour and 15 minute testing time.
The NASD Series 7 exam, titled the General Securities
Representative Examination, is an even more extensive
exam. In addition to qualifying the applicant to sell
mutual funds and variable products, successful completion
also allows one to sell stocks, municipals, options, and
direct purchase programs. This exam consists of 250
questions, administered in two equal parts of 125
questions each. The allowed testing time is 3 hours for
each part.
The NASD Series 63 exam is titled the Uniform Securities
Agent State Law Examination. It is also referred to as
the “Blue Sky Laws Exam.” This exam consists of 50
questions with a one hour testing time.
It is vital to understand that until one has passed the
appropriate exams and been appointed as a registered
representative of a broker/dealer, one cannot even
approach prospects about variable life insurance products
Just as the sale of life insurance is subject to specific
trade practice regulation, the sale of securities must
meet certain regulatory requirements. Two of the most
important regulatory requirements for the sale of any
securities product are the prospectus and suitability.
A prospectus is a document summarizing the information
contained in a security’s SEC registration statement. It
is important to understand that, with the exception of
certain, limited advertisements and direct mail pieces
that meet NASD and SEC requirements, contact with a
prospect regarding variable life insurance products must
be accompanied with a prospectus. This means that sales
literature, illustrations, mailers, and face-to-face
meetings must include a prospectus.
Suitability means that when an agent recommends a
variable insurance product to a prospect, it must be
suitable for the prospect’s specific financial needs,
circumstances, and objectives. Suitability for a variable
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life policy includes, but is not necessarily limited to,
such elements as a need for permanent life insurance
protection, the willingness to be exposed to a risk level
greater than traditional whole life, the financial
capacity to assume this risk, and the ability to afford
the required premium.
Uses of the Product
Variable life products are best suited to persons with a
long-term life insurance need and an understanding of
basic investments. Since variable products present an
element of risk, and it is possible for the death benefit
and cash values to decline, it is imperative that the
prospect understand the volatility that these products
possess. Because of the element of risk inherent in
variable life products, these policy designs are often
used as supplements to existing life insurance policies
that provide the minimum base level of coverage that
prudent planning would recommend.
NOTES
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REVIEW QUESTIONS
1.
Amory has a sound basic life insurance package from his employer.
He is currently enjoying high earnings at work would like to boost
his insurance coverage AND see his cash value account grow as
aggressively as possible. Amory is a good candidate for:
a)
b)
c)
d)
2.
traditional whole life
current-assumption whole life
interest sensitive whole life
variable life
The variable life policy presents no guarantees: mortality expenses,
cash values, and death benefit are all variable.
a) true
b) false
3.
Earl would like to start selling variable life products. Which of the
following must Earl secure before he can sell these products?
a)
b)
c)
d)
e)
f)
Life insurance license
NASD Series 6 license
Variable contracts license
NASD Series 63 license
All of the above
a, b, and d
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4.
A life insurance agent without the appropriate NASD license can still
solicit clients for variable life products as long as he or she provides
a prospectus.
a) true
b) false
5.
Variable universal life possesses all of the following features except:
a)
b)
c)
d)
two benefit options
guaranteed cash values
flexible premium
partial surrenders
ANSWERS TO THE REVIEW QUESTIONS
1.
d
2.
b
3.
e
4.
b
5.
b
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Chapter Six
The Life Insurance Contract
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BASIC CONTRACT ELEMENTS FOR LIFE INSURANCE
For a life insurance contract to be valid, five
conditions must be present. The contract must possess an
offer and acceptance, a consideration, competent parties,
and a legally acceptable form. The power of the contract
to be binding is conditional upon the existence of these
elements. The absence of even one eliminates the
contract's power to bind the parties to the agreement.
When a contract is without legal power, it is termed
void, and is essentially a worthless piece of paper.
Legal Capacity to Enter a Contract
The first element that must be present for a contract to
be valid is the existence of legally competent parties.
The law attempts to protect the vulnerable from the
actions of the unscrupulous by this provision. Generally,
in the area of contract law, the term "competent parties"
refers to adults who have the mental capacity to
understand the terms and conditions of a legal agreement.
Thus, the mentally infirm, retarded, and insane are not
generally deemed competent parties. Furthermore, minors
typically are not held competent to engage in a legal
contract. We have hedged our statements with such words
as "typically" and "generally" because the world of law
is so complex and fraught with exceptions. As always, we
are best advised to leave law to the lawyers, and keep to
the plain of generalities rather than risk getting mired
in the swamp of
exceptions.
Consideration
The consideration is the second element that is vital to
the legal power of a contract. A consideration should be
thought
of
that
which
make
the
whole
agreement
worthwhile. A consideration is simply something with real
value that the two parties exchange. What is exchanged
could be a service, an amount of money, or the promise to
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meet a specified obligation. For example, an insured
agrees to pay a certain premium in exchange for the
insurer's agreement to perform all the duties outlined in
the contract should a loss occur. Thus, in a life
insurance contract, an insured's premiums lead to the
beneficiary's receiving a named death benefit following a
premature death -- the paid premium, or consideration,
secures the valued contract.
Offer and Acceptance
If legally competent parties and a consideration are
present, the third essential element of the legal
contract can be approached -- an offer and acceptance.
The offer and acceptance is, remarkably for the world of
law, just what it sounds to be, one party making an offer
and the other party accepting it. The reason it is stated
is that the offer must be clear, definite, and free of
qualifications. Again, the intent of this condition is to
protect honest business persons and the consumer from
those who are less than honest and attempt to do business
by "scams." Also, it is important to note that in life
insurance, an offer and acceptance cannot be oral.
Legal Purpose
Another layer of protection to the consumer supplied by
contract law is that an activity must be legal in order
to be insurable. In this case, a contract's power is
irrevocably bound to the legality of the goods, services,
or obligations stipulated in the agreement. The general
welfare is obviously protected by this legal provision,
and absurd situations avoided.
Insurable Interest
An
insurable
interest
exists
when
there
is
the
expectation of a monetary loss that can be covered by
insurance. For life insurance, an insurable interest must
exist at the outset of the contract. Individuals are
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considered to automatically have an insurable interest in
their own lives. An insurable interest also exists
between a parent and his or her child, and between
spouses.
Other forms of insurable interest can include the
relationship between a creditor and a debtor, and an
employer and a key employee.
Acceptable Form
Another element of a contract's power has to do with its
legally acceptable form. Both the format and language of
life insurance contracts must meet specific parameters
outlined by the State Insurance Bureau. Furthermore, if a
state government requires filing and approval of a
contract form, then any issued contract must be filed and
accepted by the state following the appropriate legal
procedures.
Often in life insurance, a contract is not immediately
signed. Rather, a conditional receipt is used instead.
This conditional receipt is analogous to a binder in the
Property and Casualty line of insurance. Like a binder,
the conditional receipt is a temporary contract that
makes the insurance company provide some agreed-upon
coverage
while
the
application
is
processed.
A
conditional receipt is issued with an application and
initial premium payment, but it is not a guarantee of
acceptance. Still, it must follow acceptable legal form,
just like a contract, and temporarily obligates the
insurer, just like a contract.
Beyond
these
basics,
the
life
insurance
contract
possesses some additional fundamental features that make
it different from contracts particular to their types of
business. For example, most commercial contracts are
commutative contracts. A commutative contract simply
means that an agreement has been made that follows
acceptable legal format, and specifies conditions for an
exchange of more-or-less equal value.
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An insurance contract, on the other hand, is an aleatory
contract. Here, "aleatory" is really no more than a
fifty-cent adjective meaning that the result of a
contractual agreement is dependent upon an uncertain
outcome or event. Also, in an aleatory contract, the
conditions of the transaction may or may not be an equal
exchange of value.
The "uncertain event" of a life insurance contract
concerns the specific age at which the insured dies. The
potentially unequal exchange pertains to the level of
benefits paid out in relation to the total value of
premiums paid in to the policy.
It is worthwhile to point out that an aleatory contract
is not just an elaborate game of chance. First of all, as
we have previously mentioned, a contract's legal validity
rests in no small part upon it handling a legal activity.
In addition, we should not focus overly much on the
element of chance alone. Certainly, chance is at the
basis of the aleatory contract, but this is not
surprising or unusual when we think about the situation.
Insurance as we have defined it is a method of handling
risk, and risk is no more than uncertainty regarding a
loss. What we should realize is that while all gambling
arrangements
must
be
aleatory,
not
all
aleatory
arrangements are gambling.
The difference here has to do with intent. Pure gambling
is done to realize a gain, and has nothing to do with the
general welfare. An aleatory contract for insurance
purposes, on the other hand, is designed to guard against
loss. It is a frank and rational acknowledgment of the
risk that is a part of normal life, not the willful
seeking-out of additional risk for the possibility of
profit.
A further feature of life insurance contracts is that
they are characterized by the principle of adhesion. This
concept is significant, as it is yet another facet of the
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insuring contract that make it different from other legal
agreements.
All that is meant by a contract of adhesion is that the
legal agreement is not built from scratch in equal giveand-take between parties. Instead, in a contract of
adhesion, the party which makes the offer to deliver
services or meet obligations accepts
the entire
contract, or refuses it.
Obviously, the offering party in the contract of adhesion
has a great deal of power in this arrangement. Everything
seems to be formed according to the offerer's terms. In
reality, however, the situation is not necessarily so
one-sided. For example, areas of ambiguity in the
contract that are contested tend to be decided in favor
of the party accepting services, in our case, the
insured. (Of course, this favoritism has its limits: a
failure to understand or properly interpret the contract
on the part of the insured does not necessitate that the
court rule in the insured's favor.)
Furthermore, as a general rule, all arrangements are
subject to compromise. The same is true of the contract
of adhesion. Thus, while the substantive elements and
overall nature of the contract in life insurance cannot
be altered, a wide range of features can be amended by
the use of riders. Even though the language and terms of
these riders are controlled by the insuring party, the
contract is not without flexibility.
Along with being an aleatory contract characterized by
the principle of adhesion, the life insurance contract is
a unilateral contract. This is yet another feature which
separates
the
life
insurance
contract
from
most
commercial
business
contracts.
Typically,
business
contracts are bilateral, meaning that both parties to the
contract exchange something of value along specific
terms. In the unilateral life insurance contract, on the
other hand, only the insurer promises to provide a
service. The insured's premium payment is not seen in
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this case as a service or payment of a claim, but only as
part of the consideration of the contract.
The life insurance contract, is also characterized by a
conditional nature. This means that it is a contract in
which the provisions of the agreement need only be
fulfilled if the insured has met certain, specific
conditions. In this sense, conditions may be seen as a
set of duties. The insured is not legally bound to meet
the agreed upon conditions, but the insurer need not meet
its obligations if the contract's conditions have not
been realized.
Finally, it should be stated that unlike property
insurance contracts, life insurance contracts are not
characterized by the principle of indemnity. Simply put,
a property insurance contract attempts to return an
insured to his or her approximate position before a loss.
With property loss, a dollar figure can be arrived at to
determine how much was at risk. Human life, on the other
hand, is not so easily measured.
Life insurance contracts do not attempt to put a dollar
value on human life. While various methods do exist to
determine the "right" amount of life insurance, these
methods are not in any way a form of indemnification.
Rather, the life insurance contract is a valued contract.
This means that a stated amount of money is paid
contingent upon the death of the insured.
It is also worthwhile to note that since the life
insurance contract is not an indemnity contract, the
principle of subrogation does not apply. You will
remember that subrogation is a legal principle by which
the insuring party attains rights to pursue damage losses
from the negligent party.
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REVIEW QUESTIONS
1.
Life insurance contracts, like all insurance contracts, are
characterized by the principle of indemnity.
a. true
b. false
2.
In life insurance, the temporary contract tool that is analogous to
the binder in property insurance is called the______________.
a. conditional contract
b. conditional receipt
c. temporary receipt
d. life binder
3.
Since the insurance contract is an aleatory contract, it is
essentially a sophisticated and legal form of gambling.
a. true
b. false
4.
Life insurance contracts are termed valued contracts, meaning
that the insuring party will pay a stated amount of money if an
agreed upon event -- in this case, premature death -- occurs.
a. true
b. false
5.
For any contract in the insurance field to be legally valid, it is vital
that it follows a form acceptable to the State Insurance Bureau.
a. true
b. false
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6.
If it can be demonstrated that one of the parties to a contract was
not mentally competent when he or she entered the agreement, it
is held that the contract is void due to the lack of legal capacity.
a. true
b. false
7.
Since life insurance contracts are contracts of adhesion, entirely
new contracts are not crafted out of equal give-and-take between
the two signing parties. Rather, a contract is offered by the
insurer, and it is accepted or rejected by the customer.
a. true
b. false
8.
The conditions in a life insurance contract legally bind the insured
to a specific set of duties. The insurer can not only withhold
payment of obligations and services, but can even bring suit
against the insured if the contract's conditions have been violated.
a. true
b. false
9.
For a life insurance contract to be valid, there must be some
consideration, meaning a monetary amount exchanged for a
promised value to be paid out at the event of an agreed upon
contingency.
a. true
b. false
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
10.
Life insurance contract, like most business contracts, are bilateral,
because both parties agree to perform a certain set of duties.
a. true
b. false
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
ANSWERS TO THE REVIEW QUESTIONS
1. b
2. b
3. b
4. a
5. a
6. a
7. a
8. b
9. a
10. b
© American Education Systems, LC
356
Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
CONTRACT PROVISIONS IN LIFE INSURANCE
The insured's rights, as well as the duties of the
insurer, are outlined in the life insurance contract.
These rights and duties are termed the policy's contract
provisions. These provisions operate in conjunction with
contract law, and provide the operative parameters of the
insuring agreement.
It is important to note that life insurance policy's
contract provisions are not universal. Varying from state
to state, they are subject to the jurisdiction of the
state legislature and the State Insurance Bureau.
Nevertheless, there are standard elements to the common
contract provisions in the life insurance contract, and
this makes a general discussion of them possible.
As the life insurance contract's provisions serve such
functions as demonstrating ownership of the contract,
availability of policy loans, entitlement of the death
benefit, etc., it obviously benefits one to possess a
thorough understanding of them. Now, as the typical
consumer
of
life
insurance
products
has
rarely
distinguished him or herself by making a strong effort to
read and master these provisions, it is vital that the
insurance professional be able to succinctly explain them
to his or her clients.
For life insurance, there are seven provisions that are
absolutely vital for the operation of the contract. We
will briefly go over each in turn.
Entire-Contract Clause
The entire-contract clause is essentially a device to
protect the consumer. The way that the entire-contract
clause
protects
the
consumer
is
to
block
any
incorporation by reference.
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
The incorporation by reference concept is actually a
device to make contractual agreements less cumbersome by
including other stipulations and agreements that are
based upon the language of other legal documents. This is
accomplished simply by reference to those documents.
The potential problem with the incorporation by reference
device is that limitations which negatively affect the
insured can be effectively hidden. Thus, the entirecontract clause guarantees that the policy is the entire
contract between the insurer and the insured. Any changes
and attachments made to the policy are considered
modifications.
We should note here that the entire-contract clause
pertains to the actual policy application as well as the
contract. Therefore, all of the pertinent underwriting
and medical information supplied by the insured is
included. Generally speaking, the information in the
application is treated as representation rather than
warranty, and most states do not allow the insurer to
contest the contract on the basis of statements in the
application which are not attached to the actual policy.
This helps protect the insurance consumer, as the insurer
cannot deny a claim to a beneficiary based upon
information in the application (unless, of course, the
statement is a material misrepresentation).
Ownership Clause
The clause in the life insurance policy that states who
owns the contract is the ownership clause. But this
clause does still more than list the name of the owner.
The ownership clause is in many ways the most significant
clause in the contract as it details the owners rights in
the insuring agreement. Such rights include the naming of
the beneficiary, the changing of the named beneficiary,
accessing the policy's accumulated cash value, and
selection of an optional mode of payment. In addition,
the policy-owner can transfer ownership of the policy,
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
which can be done by simply filing a form with the
insurer that creates an "absolute assignment," or a
change of policy ownership free of conditions. The owner
of the policy is free to exercise any of these powers
unless he or she is constricted by the right of
irrevocable beneficiary.
Incontestable Clause
Although
life
insurance
contracts
are
supposedly
contracts of utmost good faith, fraud and dishonesty do
occur. In order to protect themselves from unscrupulous
consumers, insurers employ an incontestable clause.
Simply put, the incontestable clause gives the insurance
company a two year time-frame in which to discover
fraudulent activities or statements of an insured.
The intent of this clause is to provide a deterrent to
fraud. It is reasoned that if a dishonest consumer knows
that the insuring company is vigilantly searching for
fraud for a full two years, the person will seek some
other angle to earn a dishonest dollar.
But the incontestable clause also protects the consumer.
Through this provision, the insuring company cannot
challenge a contract after a reasonable period of time.
The beneficiary is spared the corroding sense of
insecurity and potential hardship that would occur if an
insurer could contest and void a policy years after the
underwriting information should have been made plain.
Lastly, the incontestable clause is designed to promote
the general welfare. By providing a guard to the rights
of the consumer and the insurer, both benefit. Also,
actions that are grossly immoral, such as insurance
contracts taken out for the intent of collecting a death
benefit from the murder victim are of course not extended
protection by the incontestable clause.
Grace Period
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Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
The grace period can literally by like an act of grace.
This important provision is that stated period of time
that the policy remains in force even though the premium
has not been paid. This allows the insured to keep his or
her insurance protection and avoids the complications of
having to reapply for a policy. This device helps guard
against tragedies that could occur out of mistakes,
failures to communicate, or temporary financial short
falls.
When a policy is operating during the grace period, all
the rights and privileges contained in the contract are
in effect. Should benefits need to be paid out, they
would be paid less the amount of the "missing" premium.
After the grace period has elapsed, the policy is no
longer valid. The normal period for a grace period is 31
days, but because of the nature of such flexible policies
as universal life, the grace period may well be longer.
Reinstatement Clause
The reinstatement clause allows for the return of a
lapsed contact to its original terms within a specified
period of time. This normally occurs after an insured has
opted for a non-forfeiture option, such as paid-up
conversion or an extended term conversion.
For an insured to be reinstated, evidence of insurability
is generally expected. Also, the insured can expect to
pay any overdue premiums from the previous due date with
an additional interest charge.
Some states legally demand that insurance contracts carry
a reinstatement clause. Whether required by law or not,
however, most insurance companies carry a reinstatement
clause in order to retain customers.
Misstatement-of-Age Clause
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
The most significant information used for life insurance
underwriting is the age of the prospective insured. If an
inaccurate age is used to compute the insured's premium,
it stands to reason that the result will not be adequate
for the risk-level of the prospect. Here, an inaccurate
premium means potential danger for an insurer, as the
actuarial basis for the company's financial decisions
depends on statistical precision.
Lacking some means to guarantee that the correct age be
stated in life insurance contracts, it is reasonable to
assume that understatement of age would by quite common
in the field. The result of lower than necessary premiums
on a mass scale could prove ruinous to the industry when
the belated claims started coming due.
What then occurs when an insured has misstated his or her
age in the policy application? This depends primarily on
the time when the error is discovered. For if the correct
age is found before the incontestable clause comes into
effect, the policy may simply be voided. The insurance
company can correctly state that the prospect is not one
with whom it cares to conduct business, and send him or
her on their way.
The situation is somewhat different if the waiting period
of the incontestable clause has elapsed. As mentioned
above, the contract is now considered incontestable, and
the insurance company cannot cancel it, even though it
has discovered fraud.
Still, the company need not remain victimized simply
because it was not able to discover the misstatement
until some time after the waiting period expired. Rather,
the policy remains in force, but the premiums are altered
so that they reflect the correct and truthful age of the
insured. If the insured has died, benefits are still paid
out, but they are paid out at an adjusted level that
reflects the correct amount of insurance.
Suicide Clause
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
The suicide clause mirrors the incontestable clause, in
that a two-year window exists during which a claim can be
legally denied by the insurer. However, after the two
years has expired, the insurer must pay out benefits to
the beneficiary even if the cause of death was suicide.
(Even in the event of suicide, the named beneficiary does
receive back the equivalent of the premiums paid into the
policy, without interest.)
The suicide clause provides a dual purpose. Foremost, it
is a shield for the insurer against adverse selection.
Obviously, an insurer has no desire to sell life
insurance coverage to a prospect who intends, for
whatever reason, to commit suicide. Furthermore, it is
certainly difficult to screen for potential suicides.
The suicide clause also protects the named beneficiary as
well. By returning the paid premiums before the
expiration of the waiting period and the full benefits
afterwards, the best possible situation is made out of a
tragedy.
© American Education Systems, LC
362
Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
REVIEW QUESTIONS
1.
The purpose of the entire-contract clause is to protect the
consumer from the potentially adverse elements of incorporation by
reference.
a. true
b. false
2.
The entire-contract clause only pertains to the contract, it does not
encompass the actual policy application.
a. true
b. false
3.
The ownership clause outlines the policy owner's rights and
privileges in the contract.
a. true
b. false
4.
A policy owner's powers are constricted if there is an irrevocable
beneficiary.
a. true
b. false
5.
The incontestable clause states that a policy cannot be dropped by
the insurer after the expiration of a two year waiting period.
a. true
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
b. false
6.
The incontestable clause protects the consumer by guaranteeing
that the insurer cannot challenge a contract after a reasonable
amount of time.
a. true
b. false
7.
The grace period normally lasts for 31 days, and allows the policy
to stay in force even if the last premium has not been paid.
a. true
b. false
8.
Because of the flexible nature of universal life policies, the grace
period is often shorter than 31 days.
a. true
b. false
9.
The ____________ allows for the return of a lapsed contract to its
original terms within a specified period of time.
a. replacement clause
b. reinstatement clause
c. reinforcement clause
d. retro clause
© American Education Systems, LC
364
Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
10.
If a misstatement of age is found in an insured's policy after the
waiting period has elapse, the policy stays active, but the premium
is recalculated to reflect the accurate level.
a. true
b. false
© American Education Systems, LC
365
Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
ANSWERS TO THE REVIEW QUESTIONS
1. a
2. b
3. a
4. a
5. a
6. a
7. a
8. b
9. b
10. a
© American Education Systems, LC
366
Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
OTHER FEATURES OF THE LIFE CONTRACT
Beneficiary Status
A significant aspect of the life insurance contract
concerns how the beneficiary is named. The beneficiary is
that party who is named in the contract to receive the
death benefit in event of the death of the insured. There
are generally few limits on who or what can be named as
the beneficiary to a life insurance contract. A pet, a
charity, a partnership, or a trustee are just some of the
more unusual potential beneficiaries of a life insurance
contract. As would be expected, however,
most often
named beneficiary is a relative of the insured, usually a
child or a spouse.
In regards to children, a couple of situations can occur.
When the child is still that, a minor, then the death
benefit cannot be received directly. In this case, a
trustee or guardian should be named as the beneficiary.
When the insured has many children, another situation
arises if no one specific is named as the beneficiary,
but rather the "children" are to receive the policy's
proceeds. In this case, the monies are divided equally
among the multiple beneficiaries. This is termed the
payment of a class beneficiary.
The class beneficiary is different from the two more
typical varieties in life insurance:
primary and
contingent beneficiaries. The primary beneficiary is
first in line for the death benefit. The contingent
beneficiary is the secondary beneficiary. He or she is
next in line, or is entitled to the death benefit
proceeds should the primary beneficiary die before the
insured.
Generally speaking, the named beneficiary can be changed.
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
This is a policy with a revocable beneficiary status. The
tricky (and dangerous) element
here is that the
beneficiary need not be informed that they have been
dropped from the policy.
A life insurance policy with an irrevocable beneficiary,
on the other hand, constricts the freedom of the insured
to exercise his or her ownership. To begin with, the
named beneficiary of this form of policy cannot be
changed without his or her written consent. Secondly,
when an irrevocable beneficiary is named, the policy is
effectively placed outside the estate of the insured, who
subsequently surrenders incidences of ownership as they
relate to the federal estate tax.
Change Of Plan Provision
Another example of the life insurance contract's ability
to change in order to adapt to new needs and conditions
is the change of plan provision. Simply put, this
provision is a feature that allows for the insured to
change his or her contract. Should the exchange go for
the policy with a lower premium than the policy it
replaces, and if the insured has an amount of cash value
built up in the former policy, he or she will have that
amount refunded. Conversely, should a higher premium
policy be desired, the difference in cash value would be
corrected in favor of the insurance company.
Assignment
An insurance policy is also modified when it is assigned.
Two varieties of assignment exist, absolute assignment
and collateral assignment. This is a feature that is not
available to the property insurance contract, and can
have important business ramifications for the life
insurance policy-owner.
When an absolute assignment is made, a situation is
formed in which all ownership is transferred to the named
party. A collateral assignment, on the other hand, is
partial and temporary. In this situation, a part or all
of a life insurance's death benefit is assigned to
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
another party as collateral. An example of this is a bank
making a loan to a policy-owner. This is a common enough
practice that many banks possess assignment forms on
file.
© American Education Systems, LC
369
Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
REVIEW QUESTIONS
1.
Who can be named a beneficiary of a life insurance policy is limited
to living persons. Pets, partnerships, and charities are excluded.
a. true
b. false
2.
Generally, the named beneficiary in a life insurance policy is the
insured's spouse or children.
a. true
b. false
3.
Should the named beneficiary be a minor at the time of the
insured's death, the proceeds from the policy are paid out in a lump
sum and placed into a account. A trustee or guardian are useful, but
not required.
a. true
b. false
4.
A policy with an insured's children listed as the beneficiary has a
class beneficiary. The proceeds in this case are split into equal
portions and disbursed.
a. true
b. false
5.
Should both the primary and contingent beneficiary be deceased
before the death of the insured, the monies from the death benefit
are attached to the insured's estate.
a. true
© American Education Systems, LC
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Combination Course 1
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b. false
6.
A life insurance policy with a revocable beneficiary provision allows
for the insured to change his or her beneficiary without gaining
their consent or informing them or the change in status.
a. true
b. false
7.
The reason for the change of plan provision is to aid in the practice
of twisting.
a. true
b. false
8.
An absolute assignment is a fairly common practice in both life and
property insurance.
a. true
b. false
9.
A collateral assignment is a procedure by which the holder of a life
insurance policy may obtain a loan from a bank by assigning all or
part of the death benefit to the bank as collateral.
a. true
b. false
10.
When a policy possesses an irrevocable beneficiary, the insured is
said to have surrendered all incidences of ownership as they relate
to the federal estate tax.
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
a. true
b.false
ANSWERS TO THE REVIEW QUESTIONS
1. b
2. a
3. b
4. a
5. a
6. a
7. b
8. b
9. a
10. a
© American Education Systems, LC
372
Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
LOANS AND OPTIONS
Policy Loans
One
of the outstanding features of the cash value life
insurance contract is that it builds monies that the
contract holder can access. The methods of accessing
these funds are diverse. One of the most popular is the
policy loan.
The life insurance loan will be at interest rates that
are much lower than those available from traditional
lenders. The interest rate to be charged is stated in the
policy loan provision section. It is possible that some
contracts will have variable interest rates that are tied
to a bond index. Most important, gaining a policy loan is
much
easier
than
loaning
money
from
a
banking
institution. One is not subjected to the necessary but
inconvenient hassle of a credit check. Also, the
repayment schedule is set by the contract holder.
If the interest on a policy loan is not paid at the
year's end, it is rolled into the outstanding loan. The
loan amount should of course be paid in full before a
death benefit is distributed. If it is not paid, then the
death benefit is reduced by the amount necessary to pay
the loan back in full.
Dividend Options
When we speak of a "participating policy" we are
referring to a policy that pays dividends to its owner. A
dividend is nothing more than a surplus that the insuring
company receives when there is a positive difference
between expected and actual expenses. This difference
could arise from operating expenses, or mortality
experience. As the consumer expects a dividend, even
though it is not guaranteed, calculations of predicted
losses and investment returns are made sufficiently low
to make a dividend easy to generate. The money that
© American Education Systems, LC
373
Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
arises in form of a dividend needs to take some form of
pay-out. There are five methods of dividend pay-out.
One method of paying the dividend is to apply it to the
next premium. Using this method, the contract holder
receives a notice when there is a dividend stating the
dividend's value. He or she then need only pay the
difference between their premium and the dividend to
continue coverage.
Also, a dividend can be paid out in cash. Naturally, this
is a popular form of pay-out structure at first glance.
Upon examination, however, cash payments tend not to be
taken because the recipient must pay tax on these sums.
The cash option is generally paid out on the anniversary
date of the policy.
Dividends may also be used to buy increments of paid-up
insurance. This can be used in a single premium whole
life policy. Using a paid-up insurance dividend option
circumvents the policy's load, effectively purchasing
insurance at net rates.
Another option with dividends is to let them stay with
the insuring company and accumulate at interest. These
dividends may be withdrawn at any time by the insured, or
they may be left in the account with the purpose of being
ultimately added to the death benefit pay-out. It is
interesting to note that the interest that accumulates
under this system of dividend option is taxable, and must
be reported.
Lastly, there is the so-called Fifth Dividend Option.
This is a form of term insurance. The dividend in this
option buys an annual, renewable term insurance, or a one
year term contract that is equal to the cash value of the
underlying policy. If a difference is left over under the
second option, it is usually left in the insuring
company's account to accumulate at interest.
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
While dividend options are generally the province of life
insurance contracts, some health insurance contracts also
present dividend options. All in all, a dividend option
can be thought of as a refund of some portion of the
contract's gross premium whenever the insurance company
has had a favorable year.
Nonforfeiture Options
Nonforfeiture options are applicable to cash value life
insurance policies. These options are a form of policy
provision that protects the policy-owner from losing the
cash value that has accumulated in the account. This
option provides four methods of protecting the policyowner's equity.
First, the policy can be surrendered for its cash value.
This surrender will be for the full amount of the cash
value account, less any outstanding loans and interest on
the loans. It is technically feasible that an insurance
company can reserve the right to withhold the cash value
for up to six months. This is, however, a left-over from
the Depression era, when devices were needed to slow the
draw of cash from insurers. Today, this is rarely if ever
used.
Another nonforfeiture option takes the form of extended
term insurance. The cash value buys a paid-up term policy
for a specified period of time under this strategy.
Also possible is a paid-up insurance option. This option
uses the cash value to buy a reduced, paid-up policy with
a net single premium. This creates a policy that is
essentially the same as the policy that was replaced, but
with a smaller death benefit -- and the absence of any
future payments!
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
Lastly, there is the loan value option. This option
allows the insured to borrow from the company, with the
cash value used as collateral for the loan.
Settlement Options
Sometimes, an insured may not want to receive the life
insurance's proceeds in a single payment. When this
occurs, we say that an optional mode of settlement has
been decided upon. Optional modes of settlement have four
main forms, with the fourth posing a number of variations
within its own structure.
When a sizable amount of money is not needed immediately,
the beneficiary may elect an interest option as the mode
of settlement. This is a highly flexible form of pay-out.
The benefit proceeds are left with the insurance company,
and gain interest. The accumulated interest is paid-out
to the beneficiary monthly, quarterly, or annually. Also,
the principal can be accessed at any time. In addition,
the beneficiary can alter this settlement to another form
at any time. This option provides a small, regular cash
flow.
Another type of flexible settlement option is the fixed
amount option. As the name would indicate, the death
benefit is paid out in installments until the monies are
exhausted.
This
strategy
allows
the
beneficiary
considerable room to tailor the plan to his or her
changing needs. For example, the fixed amount can be
raised or lowered at any point. Withdrawals from the
benefit proceeds above and beyond the fixed amount can be
made, and this mode of settlement can be changed at any
time.
A mode of settlement which is not flexible is the fixed
period option, and is not to be confused with the fixed
amount option. This strategy allows for the disbursement
of the death benefit proceeds over a specific, fixed
period of time. The structure is not adjustable, and
withdrawals are rarely permitted.
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
Lastly, there are the life income options. Life income
options are methods of disbursement through an annuity,
and as such they mirror an annuity's structure.
Thus, a pure life income option is a pay-out format in
which the proceeds are paid out only when the beneficiary
is alive. When the beneficiary dies, proceeds cease and
are kept by the insuring company.
On the other hand, a life income with period certain
option allows for a secondary beneficiary to receive
payments for some stated period after the death of the
primary, named beneficiary. This provides a guarantee
that someone will receive the benefit proceeds in the
event of the primary name beneficiary's death, but the
payments are smaller than under that of the life income
option.
A married couple, however, would probably choose a jointand-survivor option. This structure allows for the
payment of the benefit to two persons, and payments
continue when one of the two dies.
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
REVIEW QUESTIONS
1.
A loan from a cash value insurance policy really presents no
advantage over a loan from a bank. One must still be approved, a
credit check is run, etc.
a. true
b. false
2.
Dividend options are a feature of insurance contracts in nonparticipating policies.
a. true
b. false
3.
Essentially, a dividend payment is a type of refund that an
insurance company offers to the policy holder because expenses or
mortality were less than anticipated.
a. true
b. false
4.
The Fifth Dividend Option is a method of purchasing annually
renewable term insurance with the dividend.
a. true
b. false
5.
Nonforfeiture options are policy provisions designed to protect the
contract holder's equity in a cash value insurance policy.
a. true
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
b. false
6.
Perhaps the most common nonforfeiture option is the surrender of
the policy's cash value, less any outstanding loans or interest
payments due the insuring company.
a. true
b. false
7.
Settlement options are policy provisions that allowed for a mode of
distributing a policy's proceeds in a manner other than a single,
lump sum payment.
a. true
b. false
8.
Interest option and fixed amount option are two types of settlement
options that are characterized by a high degree of flexibility.
a. true
b. false
9.
A life income option is a settlement option that turns the policy
proceeds into a type of annuity.
a. true
b. false
10.
The interest rate for a policy loan is stated in the contract's loan
provision section. It is not uncommon for the rate to be tied to an
index.
a. true
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
b. false
© American Education Systems, LC
380
Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
ANSWERS TO REVIEW QUESTIONS
1. b
2. b
3. a
4. a
5. a
6. a
7. a
8. a
9. a
10. a
© American Education Systems, LC
381
Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
THE COST-OF-LIVING AND DOUBLE INDEMNITY
RIDERS
Cost-of Living Rider
The cost-of-living rider, or cost of living increase, is
just that -- an increase in benefit level designed to
ward off the corroding effects of inflation. This is a
policy provision that is typically added to life
insurance policies at the demand of an extremely
inflation-conscious public.
In short, the cost-of-living rider allows the insured to
buy a year's worth of term insurance that is equal to the
percentage change in
the Consumer Price Index (CPI).
This additional insurance can be had without the
insured's providing evidence of insurability.
The level of this additional term insurance is linked to
the CPI, and will vary on a constant basis, just as does
the CPI. Theoretically, this adjusted amount can go up or
down. The rider is not designed to handle hyperinflation, however, as the adjusted increase is generally
capped to reflect some percentage of the policy's face
amount.
Double Indemnity Rider
Double-indemnity is also known as the accidental death
clause. It provides an additional (double) death benefit
should the insured die from an accident. There is also a
triple indemnity, in which case three times the face
value of the contract is paid out in event of accidental
death.
The double-indemnity rider can be had for a relatively
small charge. Even though it is affordable, however, it
is not usually as valuable as it is popular. Foremost, it
provides an illusion of expanded coverage. The increase
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
in benefits are accessible only after having met a number
of exclusionary objections. Secondly, disease and not
accidental injury is the killer of most insureds.
Nonetheless, the double-indemnity rider remains in
demand.
In order to be eligible for the added benefits of a
double-indemnity claim, it must be demonstrated that the
insured died as a direct result of an accidental injury.
Next, the death has to occur soon after the accidental
injury. Typically, the insured must die within 90 days of
the injury. And finally, the rider will state the highend age at which the benefit will be paid out.
As with so many insuring agreements, the double-indemnity
rider outlines a list of exclusions to prevent abuses of
this provision. For example, as the rider is limited to
accidents, deaths from disease or insanity are not
eligible for benefits. Suicide is also an excluded death,
as is any death that occurs while committing a crime.
Finally, death that arises out of the inhalation of
poison fumes, flying in a non-commercial airplane, or
during an act of war cannot receive benefits from this
rider.
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
REVIEW QUESTIONS
1.
The cost-of-living rider is a provision that will increase or decrease
the face amount of a policy in conjunction with shifts in the
Consumer Price Index.
a. true
b. false
2.
The additional protection of the cost-of-living rider comes through
the purchase of additional term insurance.
a. true
b. false
3.
The primary goal of the cost-of-living rider to protect the insured
from the negative effects of inflation by keeping his or her face
value in tune with current prices.
a. true
b. false
4.
The adjusted level of insurance in the cost-of-living rider is usually
capped to reflect a stated percentage of the policy's face amount.
a. true
b. false
5.
The double-indemnity rider is a valuable contract provision for most
consumers, but is often not purchased because it is so expensive.
a. true
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b. false
6.
The double-indemnity rider is generally a good deal for most
consumers because most people today die of accidents rather than
disease.
a. true
b. false
7.
In order for an insured to claim benefits through a double-indemnity
rider, it must be shown that the death occurred as the direct result
of an accidental injury.
a. true
b. false
8.
The double-indemnity rider usually covers accidental death caused
by inhalation of poisonous fumes.
a. true
b. false
9.
If an insured with a double-indemnity rider dies exactly one year
after an accidental injury, his or her policy will probably not pay
double the face amount of the policy.
a. true
b. false
10.
The double-indemnity rider is not subject to any exclusions.
a. true
b. false
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
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ANSWERS TO THE REVIEW QUESTIONS
1. a
2. a
3. a
4. a
5. b
6. b
7. a
8. b
9. a
10. b
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Ethics
Table of Contents
Part One. The Field of Insurance…………………389
Part Two. The Producer’s Role: Ethics and
Professionalism………………………..405
Part Three. Issues of Fairness in Insurance……….443
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Combination Course 1
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The Field of Insurance
Varieties of Risk: The Underlying Basis for Insurance
Risk. It is a small word, but one that draws attention. It has such a
powerful influence because human nature dislikes uncertainty. Our riskadverse natures can make it difficult to think willingly about risk. We feel
uncomfortable contemplating the loss of a loved one, the unintentional
injuring of a stranger, or a fire in our home. Yet, whether the threat of risk
makes us feel uncomfortable or not, we must face up to it. Risk is pervasive.
The concept of risk also includes a sense that while a loss may occur,
it is not likely to occur. Little security comes from knowing that losses seldom
happen. After all, it is probable that some improbable events will occur. In
addition, the loss could be minor (misplacing some costume jewelry) or
devastating (wrecking one’s car).
Because of risk’s pervasiveness, it must be confronted and managed.
As we examine risk, we quickly find that it possesses distinct properties, and
these can be analyzed and classified. Risk possesses general laws, and
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
knowing these laws, it can be managed. The better we can manage risk in
our lives, the less anxiety we will experience, and we will be able to pursue
our endeavors with greater confidence.
Risk can be defined as an uncertainty of loss. Typically, the loss is of a
financial nature. It can also be termed a danger that one insures against. The
questions that arise as we analyze risk and how it operates are the following:
What categories of risk exist? What rules or principles can risk follow? What
kinds of risk can be avoided? What kinds of risk can be managed?
One type of risk affects everyone. This is fundamental risk. For
example, every area can experience damaging weather. A severe dislocation
in the economy is a fundamental risk, as is the threat of war. These types of
risks are usually met with social insurance and government involvement.
Fundamental risks are very different from particular risks. Particular
risk is specific to an individual, and subject to choices. For example, if Joe
Client chooses to skydive as a hobby, only he bears the risk of this activity.
Risk can also be classified as static and dynamic. A static risk has to
do with human error, wrongdoing, and acts of nature. A dynamic risk is
connected with the volatile nature of the economy. Most dynamic risks are
also speculative risks. This means that both loss and gain are possible.
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
Investing in a limited partnership is an exposure to a dynamic, speculative
risk.
Static risks are pure risks, and can be further subdivided. For example,
there are personal risks affecting individuals through the loss of their property,
their income, and their health. One way a family experiences pure risks is
through the premature death of one its members. Being held legally liable for
a person’s loss is another form of pure risk. This variation of risk touches
professionals through accusations of malpractice, business persons through
accusations of product defects, and anyone who operates an automobile
through accusations of negligence. Of course, our list could go on and on.
A final classification can be used when considering risk. The world of
risk includes both objective and subjective risks. Subjective risk is uncertainty
based on an individual’s emotional reasoning and state of mind. Objective
risk, on the other hand, is the relative difference between the actual loss and
the expected loss.
Objective risk follows a very specific mathematical principle—it is
inversely proportional to the square root of the number of items observed. In
practical terms, this means that the more exposures, the less the objective
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
risk. This is very important because it means that objective risk can be
measured.
Risk is also subject to the law of large numbers. This is also a
mathematical principle. It states that the greater the number of exposures, the
more certain one can be in predicting the outcome. When speaking in terms
of losses, we can state that actual losses will be less than expected losses as
the number of exposures increases.
Risk Management Strategies
While most people are not aware of the mathematical principles that
can be used to analyze and measure risk, all people—and all businesses-practice some form of risk management.
For example, risk can be avoided. Any non-swimmer will probably take
pains to avoid the water. Choosing not to participate in high-risk hobbies like
sky-diving is another example of avoiding risk.
Typically, most people passively retain a wide variety of risks. A risk is
passively retained when it is not recognized or understood, when the cost of
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treating it is prohibitive, or when the severity of the loss is deemed
inconsequential.
For example, many consumers do not believe that they need disability
insurance, and are satisfied with the level of their life insurance. It can be
statistically demonstrated, however, that disability is a very real risk and
occurs at a greater frequency than the “average consumer” believes. It is also
statistically demonstrable that the face value of the life insurance in force is in
many cases inadequate.
The reasons for these examples of passive retention are various and
complex, and are as different and complex as the individuals at risk. In some
cases, consumers understand the threat presented by disability, but
mistakenly believe that their health insurance also provides extensive
disability income benefits. In other cases, the consumer may believe that the
cost of purchasing a disability policy would be more than he could afford.
A similar scenario can occur with life insurance. After a visit from an
insurance representative, the breadwinner of a family may recognize the need
for life insurance. They discuss options with the agent, and decide a whole life
policy makes the most sense. A needs assessment shows that $100,000 of
coverage would be ideal, but the cost is prohibitive. A policy with a $50,000
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Combination Course 1
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face value is purchased instead. In other cases, the agent may not be able to
convince the prospect that life insurance is needed.
Risk can also be handled by a non-insurance transfer. This strategy
can shift risk from one party to another by contractual agreement. For
example, a company may lease photocopiers. The lease agreement can
stipulate that maintenance, repairs, and physical losses to the equipment are
the responsibility of the company leasing out the photocopiers. Another
example of non-insurance transfer is using a hold harmless agreement.
Loss control is another form of risk management. Loss control attempts
to lower the frequency and the severity of a loss. Loss control is an active
retention of risk.
Examples of loss control could be safety training, posting of safety
regulations, and an active policy of enforcing safety regulations. These
practices would all fall under the category of controlling the frequency of the
loss. An example of controlling the severity of a loss would be installing a
perimeter alarm system.
The purchase of an insurance coverage (or coverages) is what most
people consider as risk management. For a company or organization, a
commercial insurance package will be employed. This insurance will cover
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
the essential insurance that is mandated by law. It may also include desirable
insurance that covers losses that would threaten the company’s survival, and
available insurance that covers losses that are not serious, but would present
major inconvenience.
A similar pattern exists for individuals and families. Some insurance
will be purchased that is essential, such as PLPD coverage for automobiles
and homeowners’ insurance when a house is purchased. Other insurance,
such as health coverage, may be considered desirable. A life policy for a
single person with no dependents could be considered available insurance.
Insurance is not always an option, however, when devising a risk
management strategy. In order for a risk to be insurable, it must meet specific
criteria. The requirements for a risk to be considered insurable are: a) the loss
is definable; b) the loss is fortuitous; c) the loss can be insured for a premium
that is reasonable; d) the loss is part of a large number of homogeneous
exposures. Only when these requirements are met can we say that the loss
can be underwritten.
Underwriting
Underwriting is the process of selecting, classifying, and rating risks.
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Combination Course 1
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Underwriting occurs in the field by the agent and at the home office by a lay
underwriter.
Field underwriting occurs when the agent collects information from the
policy applicant. The agent as field underwriter helps protect the insurance
company from adverse selection. Adverse selection occurs when a company
insures someone who is a greater than average risk at a standard premium
rate. In order to avoid this situation, the agent must ask the correct questions
and supply the proper information so the policy can be denied (if uninsurable)
or issued at the proper rate.
For insurance applications, the agent will typically ask for such information
as the applicant’s name and address, and pursue relevant background
information on the applicant. For life insurance, specific information on the
applicant’s health will be asked, and a medical examination may be required.
For health insurance, detailed information on the applicant’s medical history
may or may not be required.
For property and casualty insurance, the agent will need to find out what
kind of property (or hazard) is to be insured. The location of the property, as
well as prior loss experience (if any), is vital information.
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Throughout the field underwriting process, the agent should be on guard
for evidence of moral hazard and morale hazard. Moral hazard refers to
circumstances in which the probability of a loss is increased because of the
applicant’s personal habits or morals. For example, an applicant who has
shown an unwillingness to meet financial obligations and is excessively
absent from work may present a greater chance of abusing disability leave.
A morale hazard is a situation in which the probability of loss is
increased because of the applicant’s indifferent attitude. For example, an
applicant that routinely leaves the keys in an unlocked car, or keeps the car
running when filling the gas tank, creates a morale hazard.
When acting in the capacity of a field underwriter, it is the responsibility
of the agent to be sure to ask clear questions in order to get accurate and
precise answers. If potential problems arise, the agent should ask probing
questions to ascertain the truth. If suspicions remain, these should be outlined
for the home office underwriting department.
It is absolutely imperative that the agent keep in mind that the signed
and witnessed application is a part of the legal contract between the insured
and the insurer. Fraud can occur during the application process when the
applicant withholds material facts.
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
The accuracy of information during the application process is important
because the lay underwriters in the home office depend on these facts when
determining the policy’s rates. The guidelines used for underwriting policies
must have an accurate actuarial basis for the company to stay competitive.
The Ethical Tension in Insurance
Insurance is a product that consumers love to hate. At best, it is
viewed as a necessary evil. At worst, it is considered a “scam.” The quick
response the average consumer has toward insurance is that it cannot be
issued for what he or she would like to cover (like stock market losses), and
the company never wants to pay for losses that it has covered.
This dislike of insurance stems from multiple sources. First, the
purchase of insurance requires an outlay of money that does not result in an
immediate and readily perceived benefit. The consumer often feels that
money is being spent for nothing. In cases where financial responsibility laws
compel one to carry insurance coverage, as in the case of no-fault automobile
insurance, the consumer chaffs at being forced to act—even if it is in his or
her own best interests.
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Second, when insurance pays out benefits, it does so only in the event
of a loss. The situations in which consumers “enjoy” the benefits of adequate
insurance coverage are never joyful ones.
Third, despite the growth of a vigorous consumer movement and an
explosion of readily available information in the print media and the Internet,
insurance remains a mystery to most consumers.
Compared to investments, real estate, and consumer goods like
automobiles, insurance is a product that consumers often purchase without
significant research. Whether because it is perceived as “boring” or just too
complicated, the only thing many consumers know about their insurance is
that they have to have it, and it is “too expensive.”
Along with the animosity many consumers feel toward insurance, it has
been shown that even people that consider themselves trustworthy are more
likely to defraud an insurance company than other institutions or industries.
Why is this?
Besides resenting having to spend hard-earned dollars on what
amounts to a promise, consumers also perceive insurance companies as
being unimaginably (and unjustly?) rich. Because of this perception,
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consumers often adopt an entitlement attitude when filing for a claim. They
may inflate the loss so that they can collect more than they know
they
should, but feel that they are entitled to. Often this behavior is rationalized
with the argument that everyone inflates their claims, and the insurance
companies know this and therefore inflate their premiums.
These attitudes help to create a vicious circle of mistrust. But it is more
than mistrust that forms the foundation for this mistrust. Rather, the
fundamental interests of the insured and the insurer are at odds. The insured
wants to collect everything he or she can; the insurance company wants to
pay only what it is legally obligated to, and wants to shape all of its
procedures, from underwriting to marketing, so that it is in as strong a position
as possible. A “strong position” in this case means pulling in premium dollars
for insureds that do not suffer insurable losses. The tension is so palpably
obvious that it even leads to jokes, such as the abbreviation “HMO” standing
for “healthy members only”—implying that sick people need not apply for
health coverage.
The idea that all insurance companies never will pay claims is
obviously not true. But the notion that the insurance company wants to cover
favorable risks is true. What arises is a struggle between actuarial needs, our
social concepts of fairness, and the pursuit of individual interests.
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Combination Course 1
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This struggle is best seen in the underwriting issue known as redlining.
Redlining is a term that refers to the process of denying coverage to areas
deemed too risky to insure. During the 1970s, the NAIC amended its Unfair
Trade Practices Act to prohibit unfair discrimination based on the geographic
location (and age) of residential property. The concept of redlining now
imbues a host of other potential risks.
The problem is obvious—not all risks are equal! In many instances, the
increase in the level of risk is based on geographic area, and for the
insurance company to remain viable, it must be able to charge premium that
is correct for the increased level of risk. The insurance company must
discriminate. The challenge is for its underwriters to discriminate fairly, based
solely on sound actuarial information and staying completely within the letter
and the spirit of the law.
Insurance can be defined as a mechanism whereby the burdens of a
number of pure risks are shifted through legal contract by pooling them. This
sterile definition, however, does not convey the intrinsic conflict that can exist
in this arrangement: those who have employed the insurance vehicle are
going to wish to collect, while those who have assumed the burden are
hoping to avoid paying.
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
If everyone plays by the rules—meaning the spirit as well as the letter
of the legal agreement—all would be in order. Unfortunately, money can all
too often weaken the will to “play by the rules.”
Review Questions
1.
Fundamental risks affect everyone, while particular risks are
specific to individuals.
2.
a)
true
b)
false
Adverse selection occurs when a company insures someone
who is a lesser than average risk at a standard premium
rate.
3.
a)
true
b)
false
Moral hazard refers to circumstances in which the probability
of loss is increased because of the applicant’s personal
habits or morals.
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4.
a)
true
b)
false
The accuracy of information during the application process is
important because underwriters in the home office depend
on the facts for determining policy rates.
5.
a)
true
b)
false
A morale hazard is a situation in which the probability of a
loss is decreased because of an applicant's indifferent
attitude.
a)
true
b)
false
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
Answers to Review Questions
1.
true
2.
false
3.
true
4.
true
5.
false
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Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
The Agent’s Role: Ethics and
Professionalism
Staying within Acceptable Guidelines
The inherent conflict of interest in insurance is well known to the agent.
The agent is expected to adhere to the highest ethical standards, and put the
interest of the consumer first. Unfortunately, the agent is paid by
commission—he or she is expected to sell. In addition, the industry heaps its
honors and rewards not on the most ethical, most educated, most diligent
providers of policy service, but on its top producers, i.e. salespersons.
Because the agent is the key figure in the insurance transaction, the
weight of insurance’s inherent ethical tension falls on his or her shoulders.
The agent must sell enough to survive and, ultimately, prosper; at the same
time, he or she must play by the rules, and obey both the letter and the spirit
of the law. When staying within appropriate ethical guidelines, there are a
number of areas that agents must pay special attention to.
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
Some of these areas are outlined under the Unfair Trade Practices Act,
and can include issues in marketing and claims. Others are hot-button issues
in insurance that have led to lawsuits and additional regulations.
Twisting, Churning and Replacement
Twisting occurs when an agent induces an insured to drop an existing
policy in order to purchase similar coverage with a different company. This is
typically done by giving incomplete—or inaccurate—comparisons of policies.
Twisting can also be termed external replacement.
Churning occurs when a policy is replaced with a new policy from the
same company. This typically happens to policies that have built up
significant cash value. The cash value is used to pay all, or most, of the
premiums in the new policy, often entirely depleting the entire cash value of
the old policy. Churning is also called internal replacement.
Policy replacement is a very controversial issue for life insurance. The
NAIC model act views replacement as any transaction that results in new life
insurance or a new annuity, and a series of factors are involved. For example,
if it is known to the agent or insurer that an in-force life insurance or annuity
contract will be lapsed, forfeited, surrendered, or terminated, replacement has
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Combination Course 1
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occurred. If an in-force policy is converted to reduced paid-up insurance that
will continue as term coverage, replacement has occurred. If a policy is
reduced in value through the use of non-forfeiture benefits or other policy
values, replacement has occurred. If a policy is amended so benefits are
reduced, replacement has occurred. Likewise, if a policy is amended so that
benefits are reduced in the term that coverage would be in force, or that the
benefits would be paid, it has been replaced. Finally, a policy is replaced if it
is reissued with reduction in cash value.
Whenever replacement is involved, the agent needs to secure a signed
statement form the applicant that insurance is to be replaced. The agent must
give the applicant a Notice to Applicants Regarding Replacement of Life
Insurance and Comparison Statement that has been completed and signed
by the agent. The applicant should receive a copy of these two documents.
In addition, the agent must give the insurer a copy of all existing life
insurance policies to be replaced, along with any proposals made. A copy of
the Comparison Statement and the name of the insurer that is going to be
replaced must also be submitted to the proposed insurer.
Most important of all, the agent needs to be careful not to mislead or
misinform the applicant. This is a time when the agent wears the hat of
© American Education Systems, LC
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Combination Course 1
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educator, and must be sure that the applicant fully understands the
ramifications of his or her decisions. Finally, the agent must be sure that the
applicant does not purchase a policy that is not to his or her advantage.
Misrepresentations
It is against the law, and an ethical failure, to misrepresent oneself,
one’s company, or one’s product. Misrepresentations can occur verbally, or
they can be in the form of policy illustrations and sales materials. The areas
that are typically misrepresented during the insurance sales transactions are
the benefits and features of policies. Misrepresentations might include
presenting an incomplete comparison, using misleading terms, or implying a
feature or benefit exists when it does not.
False Advertising
False advertising is a form of deception. It occurs any time sales and
advertising materials contain statements that are untrue, deceptive, or
misleading. Because of recent concerns over false advertising, more and
more insurers are allowing only the use of pre-approved sales materials and
eliminating, or severely curtailing, individualized presentations.
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
Policy Illustrations
The 1980s saw significant changes in the economy, in interest rates,
and in the development of new insurance products. Along with these changes
came policy illustrations that are rife with problems. In many instances, these
illustrations employed unrealistically optimistic interest rates, or highly
favorable but non-guaranteed assumptions. These flaws created a potentially
distorted picture, and when “vanishing premiums” failed to vanish, and cash
values failed to accumulate at the implied rate, consumer groups went on the
offensive.
While the agent understands that policy illustrations are just that—
illustrations—the applicant is often unable to keep the proper perspective.
The illustration tends to leave a stronger impression than the accompanying
disclaimers. In addition, the applicant is much more likely to read and
remember the policy illustration than the detailed sales literature (or, when
applicable, the prospectus).
As a result of the concern surrounding policy illustrations and their use,
the NAIC adopted new model regulation for illustrations in 1995. The goal of
© American Education Systems, LC
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Combination Course 1
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these illustrations is to make them easier to understand, less subject to
misunderstandings, and help increase consumer confidence in the industry.
Illustrations following the new NAIC model must be “self-supporting,”
and interest rates used for determining non-guaranteed elements may not be
greater than the earned interest rate underlying a scale that is reasonable and
based on actual recent historical experience. The illustrations are to have
three clearly delineated columns that separately illustrate guaranteed values,
current values, and the current return minus 1%.
Under the guidelines of the new NAIC model, agents cannot represent
the policy as something other than a life insurance policy. The nonguaranteed elements must be clearly noted as non-guaranteed. Agents
cannot present premium payments as not being required each year. The term
“vanishing premium” may no longer be used.
Furthermore, the applicant who has been shown an illustration must
sign a copy stating this. If no policy illustration was used, the applicant and
agent must certify this in writing. The applicant must also be provided with an
annual report on the policy’s status.
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
Defamation
Defamation is derogatory or malicious criticism about another
individual or company. It is illegal, and can occur by written or oral statement.
Most often it occurs when speaking about another company and its products.
While some companies allow comparisons, it is best to limit comparisons to
professional rating organizations like A.M. Best.
Disclosure
Another controversial issue for insurance has been “disclosure.”
Disclosure is the “telling it like it is” portion of the insurance transaction, during
which the benefits and the risks of the policy are to explained.
To help protect all parties, agents should ideally make use of
disclosure forms and disclosure letters. The disclosure form outlines and
explains the important elements of the policy, from information on the
company to the policy’s features. It can also include any illustrations used, the
prospectus (if applicable), and a life insurance buyer’s guide.
The disclosure letter recaps what occurred during the sales
presentation. This is not only an excellent follow-up tool, but it also helps form
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a paper trail of what was discussed, what was recommended and why, and
what decisions were made.
The life insurance industry has three hot points in the area of
disclosure, all of which have to do with terminology. The first is the use of the
word “agent.”
As the life insurance, banking, and securities industries both
compete—and combine—with each other, agents begin to wear several hats.
Nevertheless, when selling life insurance, the agent is a life insurance agent
representing a life insurance company. They should not refer to themselves
as financial planners, retirement planners, financial consultants, or any other
of a host of titles. An agent may refer to the fact that he or she sells a variety
of financial products to meet a variety of needs, but it is imperative to be
explicit and clear about being a life insurance agent who represents a life
insurance company.
A related area of concern in disclosure for life insurance is the
distinction between investments and insurance. Even though cash value
insurance has an investment element, it is an insurance product that is
purchased primarily for protection. While cash value life insurance may be
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used for a wide variety of purposes, it should not be called an investment
product.
Finally, cash value and premiums should only be referred to by their
proper names. Thus, the agent should refrain from calling cash value equity,
earnings, savings, or any related term. The premium is also not a deposit,
payment, or contribution.
As the primary link between the consumer and the industry, the
insurance agent is under constant pressure to both produce and stay within
the rules. While the product that the agent sells is extremely important, it is
also difficult to sell. The difficulty of building an adequate book of business,
coupled with pressure from the home office, can make ethical sales
challenging. How is the agent to make good decisions, to serve the customer,
benefit the company, and write enough business to survive?
The formula for writing insurance business is the Holy Grail of the
industry. While sales techniques come and go, ethical standards are
constant. While maintaining high ethical standards may not lead directly to
sales success in the short run, they can lead to sales success in the long run,
and can help maintain success.
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The Ethical Vision
Ethics is difficult word for many people. A standard dictionary definition
will state that an “ethic” is a principle, or body of principles, for right or good
behavior. The word stems from the Greek ethos, meaning customary
conduct. While this definition is very precise, it causes one to inquire about
which principle or principles. It also assumes an understanding of “right or
good conduct.” Furthermore, supposing that a body of principles for good
conduct has been established, one still needs to know how these principles
can be lived.
Perhaps one reason whey ethics is deemed a difficult subject is that it
is highly complex. Issues of right and wrong, when considered in terms of
basic principles, force us to consider fundamental questions of truth and
justice. These questions, when seriously considered, push us to think beyond
our own limited experiences and personal values and come to terms with
general experiences and universal values.
Properly speaking, ethics is moral philosophy. Moral philosophy
examines the foundation of moral action. Ethics is the lens through which
moral action is determined, and the template through which it operates.
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Most often, when people are asked to consider ethics, they focus on
specific actions, and give their opinion as to whether they believe them to be
ethical. Also, people’s response to ethical questions tends to be highly
personal and emotional. While the response may be justified by a connection
to some guiding principle (such as the “Golden Rule”) or a set of principles
(such as the Ten Commandments), more often than not the response is
primarily heartfelt and subject to the specifics of a situation.
When ethical issues are examined solely in terms of specific actions,
ethical standards are approached indirectly. This means that ethical questions
are pursued indirectly, solely through personal experience. Unfortunately,
ethical questions always involve the wider world, transcending the personal
experience.
It is important for all people, but especially for professionals, to
seriously approach ethical questions. While initially difficult, the study of ethics
is like any other field—it can be broken into categories and analyzed. To
better understand the realm of ethics, it is helpful to have an understanding of
how philosophers and ethicists have studied ethics in the past.
The study of ethics is divided into two major fields. This first is the
more purely philosophical, and is called meta-ethics. This is really the study of
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terms as it relates to moral philosophy. This area of ethics finds its home on
college campuses and university symposiums.
The second field of ethics is what concerns most people. This is called
normative ethics. As the name would indicate, this is a study of what is the
norm for right and wrong action.
Normative ethics is further broken into two branches. The first branch
is the theory of value. The theory of value seeks to determine the nature of
the “good.” As we mentioned above, to state that an action is ethical because
it is “good” opens the question of what the “good” actually is, and how can it
be known? A theory of value may be monistic, and define the “good” as a
single principle, such as Aristotle’s “happiness,” Epicurus’s “pleasure,” and
Cicero’s “virtue.” It is also possible for a theory of value to be pluralistic, and
find a number of principles possessing intrinsic value.
The theory of obligation is the second branch of normative ethics. The
theory of obligation is divided into two opposite groups. The first is the
teleological viewpoint, which points to the consequences of actions as the
measure for determining their morality. The second viewpoint rejects this
position, and insists that morality and immorality occur outside of action, and
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concentrate on such aspects as motives. This is called the deontological
position.
We have not presented this section on ethics to merely provide a list of
fifty-cent words. This brief overview of moral philosophy is meant to
demonstrate that the question of ethical value is one that possesses many
sides.
Despite which approach one may take while thinking about ethics, any
serious examination of ethics and ethical behavior requires patience and
honesty. A 17th century ethical philosophy determined that ethical action was
the pursuit of one’s self interest “rightly understood.” To “rightly understand”
one’s true self-interest, however, is not an easy task. Without careful thought
and rigorous self-honesty, the rule of enlightened self-interest is no more than
a charade.
Business and professional ethics follow the same lines as general
ethics, and are really just extensions of moral philosophy. Business and
professional ethics are the standards, or norms, by which their industries are
regulated. The existence of a professional standard leads to a stronger, more
stable industry, and benefits the society as a whole by helping guarantee the
highest level of service possible for the public.
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Being a Professional
A profession is defined as an occupation that requires specialized
study, training, and knowledge. In addition, professions are regulated by a
governmental or non-governmental body which grant a license to practice in
the field. The license not only indicates a level of competence, but an
expectation of ethical behavior.
In most states, a commissioner of insurance is responsible for the
licensure of insurance agents/producers and solicitors. The licensing process
typically consists of two parts. The first part is licensing examination, and
second part is the qualification review.
In order to earn an insurance license, some states will demand the
completion of state mandated education requirements.
Sometimes, the pre-licensing education requirement can be waived.
This usually can occur when a professional designation has been earned, or
when a concentration of credits in insurance have been taken at an
accredited college.
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A waiver may also be granted to an applicant who is currently licensed
in another state or jurisdiction, or who was previously licensed within the
previous 24 months, and who is moving to a new state.
When an applicant has successfully completed the license qualification
exam, he or she is reviewed by the state’s Department of Insurance. The
Department of Insurance may require reasonable questions to assist in the
approval decision. The information provided by the applicant on the license
application and the responses to any interrogatories is used to determine
whether a license will be granted. (If an application is denied, the applicant
may seek review of the decision.)
Most states have adopted mandatory insurance continuing education
(CE) laws. For an insurance agent/producer or solicitor to maintain his/her
license in good standing, these educational requirements must be met in a
timely fashion.
In addition to mandated CE, many agents choose to advance their
professional credentials by earning professional designations. These
designations require coursework that is at the college level for difficulty, and
may require specified CE courses in order to maintain.
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The premier designation for the Property & Casualty agent is the
Chartered Property Casualty Underwriter (CPCU). The CPCU curriculum is
determined
by
the
American
Institute
for
Property
and
Casualty
Underwriters/Insurance Institute of America. The program includes a study of
property and liability loss exposures and coverages, principles of risk
management, accounting, finance, economics, and law. The curriculum
requirements for CPCU designation include five Foundation Courses and
three courses in either Commercial or Personal Concentrations. To earn the
designation, the candidate must pass a total of eight courses and eight
examinations, adhere to the CPCU Code of Ethics, and meet an experience
requirement.
Agents can also pursue the Certified Insurance Counselor (CIC)
designation. The CIC is primarily geared to the Property & Casualty agent,
although it can have a Life & Health component. It is awarded by the Society
of Certified Insurance Counselors.
The CIC designation requires applicants to attend five two-and-onehalf-day seminars. These seminars cover property insurance, workers
compensation, commercial and general liability, auto coverages, homeowners
coverages, management issues, life insurance, and health insurance. In
addition, the applicant must pass five examinations. To be eligible to earn a
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CIC designation, the applicant must: be a licensed agent or solicitor, and/or
have two year experience in the insurance industry, and/or have served for
two years on an insurance faculty at an accredited college.
For Life and Health agents, there are several choices for additional
credentials. A fraternal agent, for example, may pursue the Fraternal
Insurance Counselor (FIC) designation.
Many life agents pursue the Life Underwriter Training Council Fellow
(LUTCF) designation. The LUTCF designation is sponsored jointly by The
American College and the National Association of Insurance Financial
Advisors (NAIFA). The LUTC curriculum forms a foundational program for
insurance professionals, agents and managers. To earn the LUTCF
designation, one must do the following:

Earn 300 Designation Credits (DCs) by successfully completing courses
within the LUTC program.29

Complete and pass the examination for one of the LUTC Program ethic’s
courses: “Piecing Together the Ethical Puzzle,”
“Charting an Ethical
Course,” or “Charting an Ethical Course for the Multiline Agent.”

Be a member in good standing of a local association of NAIFA in the year
of conferment.
29
60 of the 300 total credits required may be elective credits. Elective credits may be earned by
earning the CLU, ChFC, CPCU, CFP or FIC designation.
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Another prestigious designation for the Life agent is the Chartered Life
Underwriter (CLU). The CLU is awarded by the American College at Bryn
Mawr. Its curriculum is designed to teach advanced knowledge about life
insurance and financial planning for individuals, business owners, and
professionals. The content area of the CLU program covers individual life
insurance, family financial management, tax and estate planning, insurance
law, and accounting. The CLU designation is maintained by periodic
completion of PACE courses. The CLU designation requires successful
completion of eight classes and eight examinations.
Many Life agents are also involved in financial planning and securities.
These agents may choose to pursue a designation pertinent to their financial
planning. Two popular choices are the Chartered Financial Consultant
(ChFC) and Certified Financial Planner (CFP). The ChFC is awarded by the
American College, and the CFP is sponsored by the Certified Financial
Board of Standards, Inc.
The ChFC curriculum concentrates on the entire financial planning
process. It is earned by successfully completing eight courses and eight
examinations. The CFP® is earned by completing a 180-hour financial
planning course of study with an institution that is registered with the CFP®
board. The course of study covers financial planning, estate planning,
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employee benefits, retirement, and insurance. In addition, the candidate for
the CFP® must successfully complete an examination and meet an
experience requirement.
Agents who are very involved in Health insurance can pursue the
Registered Health Underwriter (RHU), which is sponsored by the American
College at Bryn Mawr. To earn the RHU, a candidate must pass three
independent study courses and pass three examinations. The course
curriculum includes individual health insurance, group health insurance, and a
course in selected health insurance topics. To maintain the RHU, one must
meet a continuing education requirement every three years.
Professional designations are not limited to the above, nor are they
restricted to sales agents, producers, and managers. Designations also exist
for the following:

Accredited Advisor in Insurance (AAI)
Sponsoring Organization: Insurance Institute of America

Associate in Life Underwriting (AALU)
Sponsoring Organization: Academy of Life Underwriting

Associate in Automation Management (AAM)
Sponsoring Organization: Insurance Institute of America

Associate, Casualty Actuarial Society (ACAS)
Sponsoring Organization: Casualty Actuarial Society
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
Associate Customer Service (ACS)
Sponsoring Organization: Associate Customer Service

Accredited Customer Service Representative (ACSR)
Sponsoring Organization: Independent Insurance Agents of America

Associate in Fidelity and Surety Bonding (AFSB)
Sponsoring Organization: Insurance Institute of America

Associate, Insurance Agency Administration (AIAA)
Sponsoring Organization: Life Office Management Association

Associate in Insurance Accounting and Finance (AIAF)
Sponsoring
Organization:
Jointly
sponsored--Insurance
Institute
of
America and the Life Office Management Association

Associate in Claims (AIC)
Sponsoring Organization: Insurance Institute of America

Associate Insurance Data Manager (AIDM)
Sponsoring Organization: Insurance Data Management Association

Associate in Management (AIM)
Sponsoring Organization: Insurance Institute of America

Associate in Insurance Services (AIS)
Sponsoring Organization: Insurance Institute of America

Associate in Loss Control Management (ALCM)
Sponsoring Organization: Insurance Institute of America

Associate, Life and Health Claims (ALHC)
Sponsoring Organization: Life Office Management Association

Associate in Marine Insurance Management (AMIM)
Sponsoring Organization: Insurance Institute of America

Associate in Premium Auditing (APA)
Sponsoring Organization: Insurance Institute of America

Associate in Reinsurance (ARe)
Sponsoring Organization: Insurance Institute of America
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
Associate in Risk Management (ARM)
Sponsoring Organization: Insurance Institute of America

Associate in Research and Planning (ARP)
Sponsoring Organization: Life Office Management Association

Associate of the Society of Actuaries (ASA)
Sponsoring Organization: Society of Actuaries

Associate in State Filings (ASF)
Sponsoring Organization: Society of State Filers

Associate in Underwriting (AU)
Sponsoring Organization: Insurance Institute of America

Casualty Claim Law Associate (CCLA)
Sponsoring Organization: American Educational Institute

Casualty Claim Law Specialist (CCLS)
Sponsoring Organization: American Educational Institute

Certified Employee Benefit Specialist (CEBS)
Sponsoring Organization: International Foundation of Employee Benefit
Plans

Chartered Financial Analyst (CFA)
Sponsoring Organization: Association for Investment Management and
Research

Certified Fraud Examiner (CFE)
Sponsoring Organization: Association of Certified Fraud Examiners

Certified Insurance Data Manager (CIDM)
Sponsoring Organization: Insurance Data Management Association

Certified Insurance Service Representative (CISR)
Sponsoring Organization: Society of Certified Insurance Counselors

Certified Pension Consultant (CPC)
Sponsoring Organization: American Society of Pension Actuaries

Certified Professional Insurance Agent (CPIA)
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Sponsoring Organization: Certified Professional Insurance Agents Society

Certified Professional Insurance Woman/Man (CPIW/M)
Sponsoring Organization: National Association of Insurance Women
(International)

Fellow of the Academy of Life Underwriting (FALU)
Sponsoring Organization: Academy of Life Underwriting

Fellow, Casualty Actuarial Society (FCAS)
Sponsoring Organization: Casualty Actuarial Society

Fraud Claim Law Specialist (FCLS)
Sponsoring Organization: American Educational Institute

Fellow, Life Management Institute (FLMI)
Sponsoring Organization: Life Office Management Associate

Fellow, Society of Pension Actuaries (FSPA)
Sponsoring Organization: American Society of Pension Actuaries

Health Insurance Associate (HIA)
Sponsoring Organization: Health Insurance Association of America

Legal Principles Claim Specialist (LPCS)
Sponsoring Organization: American Educational Institute

Managed Healthcare Professional (MHP)
Sponsoring Organization: Health Insurance Association of America

Member, Society of Pension Actuaries (MSPA)
Sponsoring Organization: American Society of Pension Actuaries

Property Claim Law Associate (PCLA)
Sponsoring Organization: American Educational Institute

Property Claim Law Specialist (PCLS)
Sponsoring Organization: American Educational Institute

Qualified Pension Administrator (QPA)
Sponsoring Organization: American Society of Pension Actuaries

Registered Professional Liability Underwriter (RPLU)
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Sponsoring Organization: Professional Liability Underwriting Society

Senior Claim Law Associate (SCLA)
Sponsoring Organization: American Educational Institute

Society of Insurance Licensing Administrators Associate (SILAA)
Sponsoring Organization: Society of Insurance Licensing Administrators

Society of Insurance Licensing Administrators Fellow (SILAF)
Sponsoring Organization: Society of Insurance Licensing Administrators

Workers Compensation Claim Law Associate (WCLA)
Sponsoring Organization: American Educational Institute

Workers Compensation Claim Law Specialist (WCLS)
Sponsoring Organization: American Educational Institute
While designations are very worthwhile pursuits, the most important
aspect of professionalism is putting the client’s interests first. Only when the
agent is actively striving to benefit the client to the absolute best of his or her
ability can the agent be considered a professional.
In some ways, high volume sales and professional designations are
easy to attain, because they are actively awarded and recognized. On the
other had, an action’s virtue is often known only to the person who made the
ethical choice. As Cicero tells us, “Virtue is its own reward.” To be a
professional, one must have a strong internal desire to do the right thing, and
to be the best that one can be.
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Ethical,
professional
action
never
possesses
glamour.
It
is
conservative and staid. It cannot guarantee success in terms of gaudy sales.
But without high ethical standards that inform consistently professional
behavior, success is always at risk. Professional ethics form the foundation
upon which all lasting and fulfilling success must be built.
Competition in the Insurance Industry
One of the great strengths of the free-market economy is that it allows
for competition. There is no central government telling consumers that "You
must buy this form of insurance" or "Only this company can make cars."
Instead, many companies may offer the same service or product, seeking
always to do the job better than the other person.
The idea is that the cream rises to the top. The consumers -- those
who buy the service or product -- see to it that the strong survive.
The
companies that best serve the public gain the upper-hand and thrive, while
those offering shoddy products or poor service are driven out of business.
Competition, then, should help maintain quality.
In many cases it
does, but with insurance, competition cannot be left alone as the sole
mechanism guaranteeing the efficient running of the insurance industry.
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Much of competition's limitations in this area has to do with the longterm nature of what you sell as an insurance agent. The old adage "Let the
buyer beware" hardly holds true when dealing with insurance, for the quality
of what your customer has purchased is only apparent many years down the
road.
This expanded time-frame of insurance is why the professional trust
that we discussed earlier is so very important. Your customer often does not
know how long it will take him or her to collect on his or her benefits; in the
case of death benefits, he or she will not be around to see if the contract they
have formed with you will be honored.
We already discussed how insurance is a knowledge product. Most of
your customers would have to really study their policy to fully understand all
its aspects. Human nature informs us most will not; rather, they will trust you
to tell them the truth, and trust you that your company is solvent and ethical,
and trust that you are competent.
Obviously, it is a very different transaction from a "normal" state of
business affairs when one buys insurance.
For example, when one
purchases shares in a mutual fund, the results and performance of that fund
are accessible daily.
Buying insurance is very different from hiring
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contractors to put in a sprinkler system, or having a dentist fill a cavity, or
leasing a car. In all of these cases, the results are readily and immediately
observable.
The performance of an insurance policy, on the other hand, is
observable only after the passage of time. More than almost any product,
insurance is bought on faith.
Moreover, the very dynamics of competition create a scenario in which
abuses can occur. For example, unlike most products, where low prices are
thought of as a benefit to the consumer, insurance is in greater danger of
being under-priced than over-priced.
Again, it is the long-term nature of the insurance product that creates
this seeming reversal of common sense. For if an insurance company does
not accumulate adequate capital to meet its obligations, all of which are
temptingly distant in the future, it will be insolvent when claims finally come
due -- as they ultimately will. Any financial mistakes the insurance company
makes, from charging insufficiently low premiums to paying too lucrative a
commission to its agents, will ultimately be carried by the consumer. The
great competition among the multitude of active insurance companies creates
tremendous pressure to offer the lowest rate to attract customers, pay the
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best commission to motivate agents, etc. In other words, competition can
create pressure to do what is best in the short run for a small group of people,
but is potentially ruinous in the long run for a large group of people.
Insurance Regulation
By regulation, we intend here to mean a set of laws that a governing
body can employ to set a standard of service and competence for the industry
it monitors. Its intent is to preserve the public interest, protect the consumer,
and promote the general welfare of the industry. It prohibits abusive acts,
establishes guidelines for practice, set minimum standards, and provides a
mechanism for the enforcement of those standards.
Insurers are regulated through three vehicles. First, legislation in all
states covers insurance practice in a regulatory mode. These laws determine
the requirements and procedures for the formation of insurance companies,
the licensing of insurance practitioners, the financial practices of insurers and
their taxation, the rates charged by insurers and their general sales and
marketing practices, and the liquidation of insurers.
Also, the federal government can play a legislative role in the
regulation of insurance company practices.
For example, the sale of
annuities is regulated by the Securities and Exchange Commission, and the
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private pension plans of insurers come under the scope of the Employee
Retirement Income Security Act of 1974.
The insurance industry is also occasionally subject to the power of
judicial review.
Both state and federal courts can determine the
constitutionality of any insurance practice, and the decision handed down by
the court must be respected as the law of the land.
Third and finally, state insurance departments regulate insurance
companies' business practices.
In many states, an elected or appointed
official known as the insurance commissioner administers the state's
insurance laws.
The state insurance commissioners belong to the National Association
of Insurance Commissioners (NAIC).
Although this body bears no legal
authority to enforce decision, it can make recommendations. Indeed, it is
largely through the NAIC that state regulations possess a workable level of
uniformity.
The states regulate five principle areas of insurance practice. The first,
contract provisions, is in which the fruits of the NAIC's efforts are readily
apparent. One of the reasons for the regulation of contracts is the complexity
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of the language. The NAIC has helped mitigate this problem. Indeed, it has
led the way to high level of uniformity by getting the states to
employ standardized policies and provisions.
Nevertheless, the state keeps close scrutiny over any insurance policy
contract because the language is still technical, and can contain so may
complex clauses that there is too much room for the unscrupulous to operate
within.
Therefore, the state insurance commissioner has the authority to
approve or disapprove any policy form before it is sold to the public.
This is an example of how regulation serves to address the
shortcomings of competition.
As insurance is a knowledge product, any
consumer would have to possess a broad, general understanding of the
insurance he or she desires in order to make an intelligent decision regarding
its quality. Unfortunately, consumers simply lack the necessary information to
adequately compare and determine the relative merits of different contracts.
And, as consumers lack the knowledge needed to select the best product, the
competitive incentive for the insurers to constantly improve their product is
lessened.
Regulation steps in to produce a constant market effect that
imitates what would ideally occur naturally if consumers were informed,
rational, economic actors.
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Another area of state regulation is that of rates. This is largely an
attempt at managed competition.
It must be noted, however, that rate
regulation is not uniform. Still, despite the lack of uniformity, the regulatory
goal is to see that rates are not inadequate, meaning they are not too low.
Remember, the insurer has the responsibility of meeting significant financial
claims in the future.
At the same time, rates cannot be excessive, or too expensive. The
industry operates with a notion of the fair and correct range of prices for
insurance. And lastly, rates cannot be discriminatory in any way. Thus, while
not everyone pays the same amount for insurance, the insured at a higher
premium cannot unfairly subsidize the other insureds at a lower premium if
they are representative of virtually the same risk.
Rating laws are diverse and multitudinous. There are state-made rates,
prior approval laws, mandatory bureau rates, file-and-use laws, open
competition laws, and flex rating laws.
State-made rates are those set by the state agency. All licensed
insurance practitioners must follow these rates.
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The majority of states employ some form of prior approval law for the
regulation of rates. This simply means that rates must be filed and approved
by the state before they can be offered to the public.
Mandatory bureau rates are those rates determined by a rating bureau.
A small number of states employ this system.
Open competition laws are sometimes referred to as no-filing laws, and
are at the opposite end of the spectrum of our above three varieties of rate
regulation. Under this scheme, insurers do not have to file their rates, based
upon the premise that competition in the market will ensure reasonable rates.
This does not mean, however, that the rates are made without any oversight.
The regulatory body maintains the right to require the insurance companies to
provide a schedule of rates if there is a perceived problem or abuse, but this
is a very liberal scheme that leans upon a trust of the market's efficacy.
Flex rating law is another liberal rating law. This situation requires that
rates be submitted to the state for prior approval only when the rate increase
or decrease exceeds a predetermined range.
The states also seek to maintain insurer solvency. Insurance, as we
have discussed, is a product bought upon faith as a hedge against potentially
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serious occurrences; insurance seeks to allay our fears of the uncertainty that
risk bears.
To this effect, the state regulatory commission seeks to guarantee that
the practicing insurance companies are able to evince solidity, or fiscal health.
Even before an insurance company can form, it must meet minimum capital
and surplus requirements. The insurer's balance sheet must reflect a certain
level of admitted assets. These can consist of cash, bonds, stocks, real
estate, and various other legal investments. Only those assets classified as
admitted assets can be used to show the company's financial situation.
Opposite admitted assets on the company's balance sheet are
reserves. These are liability items, and represent the company's financial
obligations.
The difference between the insurance company's assets and its
liabilities is called the surplus. This figure is very significant, as it is the basis
for how much insurance the company can safely offer. Even more important,
the surplus is the fund used to offset any potential underwriting or investment
loss.
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
The state also regulates the securities that insurance companies hold.
The state discourages high-risk investments, as these run contrary to the
insurance mission.
The financial condition of an insurance company is an ongoing affair of
the state. It is strictly and consistently monitored. Insurance companies must
file an annual statement with the state insurance commissioner. This
statement is also called the Annual Convention Blank, and shows the current
status of reserves, assets, total liabilities, and investment portfolio. In addition
to this, an insurer is normally audited at least every three to five years.
If a company becomes insolvent, the state is obligated to act. The
company becomes managed by the state. If the company cannot be fiscally
restructured into solidity, it is liquidated.
The states also provide the licensing for the insurance industry. In
many ways, this is the "big stick" for the regulating body. For example, a new
insurer is normally formed in incorporation. It can only receive its charter or
certificate of incorporation from the state, and it is only through the state office
that its legal existence can be formed. After being formed, the company must
then get licensed to be able to conduct business.
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
In addition, all states demand that agents and brokers be licensed. A
written examination generally has to be passed, and many states are
requiring continuing education requirements to maintain a licensed status.
Simply put, a license is a badge that indicates a base level of
trustworthiness and competence to operate in a profession. Secondarily, it is
a badge that can and will be taken away if both or either the base level of
trustworthiness and competence are found wanting.
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
Review Questions
1.
Churning occurs when a policy is replaced with a new policy
from the same company. This typically happens to policies
that have built up significant cash value.
2.
3.
a)
true
b)
false
Churning is also referred to as external replacement.
a)
true
b)
false
Areas that are typically misrepresented during the insurance
sales transaction are the benefits and features of the policy.
Misrepresentations might include presenting an incomplete
comparison, using misleading terms, or implying a feature or
benefit exists when it does not.
a)
true
b)
false
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
4.
Illustrations following the new NAIC model must be selfsupporting, and must use interest rates based on actual
recent historical experience.
5.
a)
true
b)
false
Under the guidelines of the new NAIC model, agents cannot
represent the policy as something other than a life insurance
policy. However, the non-guaranteed elements do not have
to be noted as non-guaranteed.
6.
a)
true
b)
false
To help protect all parties, agents should ideally make use of
disclosure forms and disclosure letters.
7.
a)
true
b)
false
Cash value possesses an investment element. Therefore, it
is okay to refer to cash value as equity, earnings, or savings.
a)
true
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
b)
8.
false
The life insurance agent should refrain from calling
premiums deposits, payments, or contributions.
9.
a)
true
b)
false
A profession can be defined as an occupation that requires
specialized study, training and knowledge.
10.
a)
true
b)
false
Mandated continuing education is a typical licensing
requirement for most states.
a)
true
b)
false
© American Education Systems, LC
441
Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
Answers to Review Questions
1. true
2. false
3. true
4. true
5. false
6. true
7. false
8. true
9. true
10. true
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
Issues of Fairness in Insurance
Various Issues in Fairness
Insurance touches multiple aspects of an individual’s life that are
essential. Because of the essential aspect of insurance, questions of fairness
can occur.
One of the classic areas of insurance that has been challenged is
underwriting. Underwriting is also one of the primary areas that regulators
review during market conduct examinations.
Redlining is an example of an underwriting practice that results in
discrimination. Originally, redlining was said to have occurred when an insurer
refuses to underwrite (or continue to underwrite) risks in a specific geographic
area. The phrase redlining came from the drawing of red lines around areas
on a map. Today, redlining can refer to a variety of unfair discriminatory
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
practices. For example, refusal to underwrite based on marital status or prior
terminations can be termed redlining.
Accusations of redlining typically arise out of economically depressed
areas. During the late 1960s, Fair Access to Insurance Requirements (FAIR)
Plans were created to make property insurance more readily available to
those were shut out of the regular market. Persons unable to find coverage
typically found their property was held to be too high risk. FAIR plans have
sought to redress this imbalance and ensure that essential insurance
coverages are available to all property owners (provided they can meet
certain requirements). FAIR plans are operated by the insurance industry in
thirty four states. They are based on the stop loss reinsurance method.
1970s, the Unfair Trade Practices Act was amended to prohibit unfair
discriminatory behavior that would fit under the description of redlining. The
Act does not, however, prohibit discrimination that is based on actuarially
sound information. Nevertheless, the perception remains that insurers do not
adequately provide fair underwriting in economically depressed areas.
The use of credit reports for underwriting purposes is another area of
controversy for insurers. Because some studies have shown a correlation
between credit history and insurance losses, some insurance companies
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
incorporate information from consumer’s credit history into their underwriting.
This practice has been criticized by consumer advocacy groups, and
reviewed by the NAIC.
The 1980s were a difficult decade for the life insurance industry, as
allegations grew that agents routinely misrepresented their qualifications, the
method of paying premiums, and the products they sold. Along with the
negative press, the industry was forced to pay billions of dollars in legal
defense and class action lawsuits. In the 1990s, the American Council of Life
Insurers (ACLI) created a self-policing membership organization to help
clean-up the industry and restore the public’s confidence. This organization is
known as the Insurance Marketplace Standards Association (IMSA).
To became a member of IMSA, a company must go through a two-part
process. The first step is for the insurer to answer a 73-item questionnaire.
Some of the policies and procedure areas covered by the questionnaire
include the following:

handling and answering consumer complaints;

training agents;

maintaining policies in state guidelines.
© American Education Systems, LC
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Combination Course 1
Principles of Property-Casualty, Special; Principles of Life-Health, Special; Ethics
Insurers are required to provide a “yes” response to all 73 questions. If they
are not able to respond in the affirmative, the insurer must provide a plan to
bring it into compliance with IMSA standards.
The second step for IMSA approval requires the company to secure an
independent assessor who will conduct a review to learn whether all
mandatory procedures are in place. If a company passes the review, it
becomes an IMSA member. The IMSA membership must be renewed every
three years. Currently, more than 200 life insurance companies have become
IMSA members.
© American Education Systems, LC
446