Chapter 10
Managing Property
and Liability Risk
Learning Objectives
1. Apply the risk-management process to address the
risks to your property and income.
2. Explain how insurance works to reduce risk.
3. Design a homeowner’s or renter’s insurance program
to meet your needs.
4. Design an automobile insurance program to meet your
needs.
5. Describe other types of property and liability insurance.
6. Summarize how to make an insurance claim.
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Introduction
• Property Insurance – The protection from
financial losses resulting from the damage to or
destruction of your property
• Liability Insurance – Protection from financial
losses suffered when you are held liable for
others’ losses.
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Risk and Risk Management
• What is the nature of risk? It is the uncertainty
about the outcome of a situation or event.
– Speculative risk – A potential for gain as
well as for loss. Ex: Investments
– Pure risk – No potential for gain only the
possibility for loss. Ex: Fire, automobile
accidents, illness and theft.
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The Risk-Management Process
• Step 1: Identify sources of risk or exposure.
– Vehicle, Home, Jewelry, illness, death
– Peril: Event that can cause a financial loss
• Step 2: Estimate risk and potential losses.
– Loss frequency – evaluate the likely number
of times that a loss might occur over a period
of time.
– Loss severity – the potential magnitude of
the loss
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The Relationship
Between Severity and Frequency of Loss
• Insurance coverage targeted for high severity loss
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The Risk-Management Process
• Step 3: Choose how to handle risk:
– Risk Avoidance – Refrain from owning items or engaging in
activities that expose risk of loss
– Risk Retention – Accept risk and plan for its possible effect
– Loss Control – Designed to reduce severity and frequency of
loss. Ex: Locks and Fire Alarms
– Risk Transfer – Insurance provides transfer of financial loss
burden to insurance provider
– Risk Reduction – Reducing risk to acceptable levels by
planning for possible loss such as a deductible for insurance
coverage
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The Risk-Management Process
• Step 4: Implement the risk-management program.
– Large-Loss Principle: Insure the losses that you
cannot afford, pay the small losses out of your own
pocket.
– Evaluate the maximum possible loss and insure
coverage meets this amount
• Step 5: Evaluate and adjust the program.
– Risk events and exposure are not static; they change over time
– Consider life events such as marriage, home purchase and
retirement planning for insurance coverage
– http://www.insure.com
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The Risk-Management Process
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Understanding How
Insurance Works
• Insurance – Method for transferring and reducing pure
risk through which a large number of individuals share in
the financial losses suffered by members of the group as
a whole.
• Premium – A small, predictable fee which individuals or
companies can replace an uncertain and possibly large
financial loss.
• Insurance Policy – A contract between the person
buying insurance (the insured) and the insurance
company (the insurer).
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Understanding How
Insurance Works
• Hazards make losses more likely to occur.
– Hazard: Any condition that increases the probability
that a peril will occur.
• Only certain losses are insurable (3 Types):
– Fortuitous losses are unexpected in terms of both
their timing and magnitude. Ex: Lightening strike or
house fire
– Financial loss – Any decline in value of income or
assets in the present or future. Ex: Lost wages,
medical bills, etc.
– Personal loss – Any loss experienced by specific
individuals or organizations rather than society as a
whole.
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Understanding How
Insurance Works
• The Principle of Indemnity Limits:
– Principle of indemnity – Insurance will pay no more than the
actual financial loss experienced.
– Policy limits – Specify the maximum dollar amounts that will be
paid under the policy.
• Factors that reduce the cost of insurance:
– Deductibles – Requirements that the policyholder pays an
initial portion of any loss
– Coinsurance – Method by which the insured and the insurer
share proportionately in the payment for a loss
– Calculated as R = (1-CP)(L-D)
R = Reimbursement, CP =
coinsurance % required of the insured, L = Loss, D = Deductible
– Ex: Assume $100 Deductible and 20% coinsurance. If loss is
$1,350, the reimbursement would be $1,000 or:
R = (1 – 0.20)($1,350-$100) = $1,000
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Understanding How
Insurance Works
• The essence of insurance:
– Law of large numbers –As the number of members in a group
increases, predictions about the group’s behavior become
increasingly accurate. Recognizes that you should buy
insurance against large losses and cover small losses yourself.
– Insurance buyers benefit regardless if they suffer a loss because
of risk reduction
• Who sells insurance?
– Exclusive Insurance agents – Representative of an insurance
company authorized to sell, modify, service and terminate
insurance contracts.
– Independent insurance agents – Business people who act as
third-party links between insurers and insured. Customer is
placed with insurance carrier which best meets their individual
needs
– Direct sellers – companies that market their policies through
mail-order promotions, newspapers and the internet.
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Homeowner’s Insurance
• Coverages:
• Property insurance
– Named-perils policies – Cover only losses
caused by perils that the policy specifically
mentions. Ex: Flood Damage, Tornado, Etc.
– All-risk (open-perils) policies – Losses
caused by all perils other than those that the
policy specifically excludes.
– This provides broader coverage due to
variety of possible events
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Homeowner’s Insurance
• Liability insurance:
– Homeowner’s general liability protection – Applies
when you are legally liable for another person’s losses, other
than those that arise out of use of vehicles or professional
duties.
– Homeowner’s no-fault medical payments
protection – pays bodily injury losses suffered by
visitors regardless of who was at fault. Ex: A visitor’s
child touches a hot stove and burns their hand.
– Homeowner’s no-fault property damage
protection – pays for property losses suffered by
visitors at your house. Ex: A playful dog chews a fine
leather coat.
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Types of Homeowner’s
Insurance Policies
•
Basic Form (HO-1) – A named policy that covers 11 property damage
causing perils
–
Coverage includes Personal Liability, Property Damage and Medical Payments
•
Broad Form (HO-2) – A named policy that covers 18 property damage
causing perils
•
Special Form (HO-3) – A named policy that provides protection for all perils
except war, earthquake and flood.
–
Coverage includes Dwelling Losses, Losses to Structures, Landscaping Losses
and additional Living Expenses.
•
Renter’s Contents Broad Form (HO-4) – Named policy that covers 17
perils and protects the insured from losses to the contents of a rented
dwelling rather than the dwelling itself.
•
Condominium Form (HO-6) – Insurance coverage for contents and
personal property, living expenses, liability losses.
•
Older Home Form (HO-8) – Insurance to replace an older home that
provides actual cash value protection to rebuild and make it serviceable
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Buying Homeowner’s Insurance
• How much coverage is needed on your dwelling?
– Replacement-cost requirement – A home must be
insured for at least 80% of its replacement value in
order for any loss to be fully covered.
– Partial Coverage Loss – Increases out of pocket
costs to insured. Ex: $200,000 Home insured for
$144,000 with $500 deductible and $80,500 damage
would result in insurance payment of:
R = ($80,500 - $500) X ($144,000/($200,000 X 0.80)
R = ($80,000) X ($144,000/$160,000)
R = $80,000 X 0.90
R = $72,000
Insurance Payment of $72,000 vs. $80,000 for 80% coverage
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Buying Homeowner’s Insurance
• How much coverage is needed on your personal property?
– Actual cash value (of personal property) – Represents the
purchase price of the property less depreciation applied.
•
Difficult as actual replacement cost is always higher
than actual cash value
•
Reduces risk exposure but does not provide full
replacement of damaged property
•
Ex: 9 year old air-conditioner with 12 year useful life
cost $2,400 new has actual cash value of:
•
ACV = $2,400 – (9 x ($2,400/12))
= $2,400 – (9 x $200)
= $600
– Contents replacement-cost protection – Optional insurance
policy that pays the full replacement cost of any personal
property. Standard coverage limit of 50% replacement would
need to be raised for full replacement insurance.
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Automobile
Insurance – Losses Covered
• Coverage A:
• Liability insurance: Insurance coverage when insured is
responsible for losses of others
– Automobile Bodily Injury Liability – Occurs when a car owner
or driver is legally responsible for bodily injury losses that other
people including pedestrians suffer. Nebraska minimum = $25K
– Automobile Property Damage Liability – Occurs when a
driver or car owner is legally responsible for damage to other’s
property such as a car, building, etc. Nebraska minimum = $25K
– Family Auto Policy (FAP) – Insurance coverage for car owner,
relatives in the household and individuals with permission to
drive the vehicle. Ex: 100/300/50 is $100K max per individual
bodily injury, $300K for all injuries to all people and $50K for
property damage liability.
– Personal Auto Policies (PAP) – All property and bodily injury
liabilities losses from an accident are paid until a limit is reached
such as $250K.
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Automobile
Liability Insurance Policy Limits
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Automobile
Insurance – Losses Covered
• Coverage B: Medical payments insurance:
– Automobile medical payments insurance – Insurance that
covers bodily injury losses suffered by the driver of the insured
vehicle and any passengers, regardless of who is at fault.
– Personal Injury Protection (PIP) – Medical payments coverage
for the driver and any passengers for bodily injury losses as well
as possibly lost wages and rehabilitation expenses common in
no-fault accident states.
– Subrogation rights – allows an insurer to take action against a
negligent third party (and their insurance company) to obtain
reimbursement for payments made to an insured.
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Automobile
Insurance – Losses Covered
• Coverage C: Uninsured and underinsured
motorist insurance:
– Uninsured motorist insurance – Protects the insured
and the insured’s passengers from bodily injury losses
resulting from an accident caused by an uninsured
motorist. Provides protection above the automobile
medical payments insurance. Nebraska minimum =
$25K
– Underinsured motorist insurance – Protects the
insured and their passengers from bodily injury losses
when the at-fault driver has insurance but that coverage
is insufficient to reimburse the losses. Nebraska
minimum = $50K
– Ex: 50/100 is $50K max coverage for one person and
$100K is max coverage for multiple bodily injuries
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Automobile
Insurance – Losses Covered
• Coverage D: Physical damage insurance:
– Collision insurance – Reimburses insured for losses to their
vehicle resulting from a collision with another car or object or
from a rollover.
•
Covers driver of another vehicle if permission granted
by owner
•
Collision insurance carries a deductible which ranges
from $100 - $1,000.
– Comprehensive automobile insurance – Protects against
property damage losses to an insured vehicle caused by perils
other than collision and rollover.
•
Fire, theft, vandalism, hail, wind, etc.
•
Deductible ranges from $100 - $1,000
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Automobile
Insurance – Losses Covered
• Other protections:
– Towing coverage – pays the cost of having a
disabled vehicle towed for repairs usually between
$25 and $50 per tow.
– Rental reimbursement coverage – provides a rental
car when the insured’s vehicle is being repaired after
an accident or has been stolen. Daily limit paid may
apply and ranges from $20 to $30 Max.
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Summary of
Automobile Insurance Coverages
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Protection for Other Property
and Liability Loss Exposures
• Comprehensive personal liability insurance – provides
coverage for others due to loss caused by insured and not related to
car or home injury
• Professional liability insurance – Protects individuals and
organizations that provide professional services when they are held
liable for their clients’ losses. Ex: Insurance coverage for Lawyers,
doctors, accountants, etc.
• Umbrella (or excess) liability insurance – Catastrophic
liability policy that covers liability losses in excess of those covered
by any underlying homeowner’s, automobile or professional liability
policy.
• Floater Policies – Provide all risk protection for accident and
theft losses to movable property regardless of where the loss
occurs. Ex: cameras, sporting equipment and clothing. Is typically
part of a home owners policy.
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How Umbrella
Liability Policies Work
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How to Collect on Your
Property and Liability Losses
• Contact your insurance agent – Follow their advice regarding next
steps for claim
• Document your loss – Take photo’s, log date purchased, price
paid, description, model number, serial number, etc.
– Keep items in a safe or deposit box
– File Police Report if needed
• File your claim – Formal written request to the insurance company
for reimbursement for a covered loss.
– Claim adjuster may be someone designated by the insurance
company to assess whether the loss is covered and determine
the dollar amount that the company will pay.
• Sign a release – An insurance document affirming that the dollar
amount of the loss settlement is accepted as full and complete
reimbursement and insured will make no future claims for the loss
against the insurance company.
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The Top 3 Financial Missteps In
Managing Property and Liability Risk
People experience challenges when they do the
following:
1. Buy only the legal minimum coverage on the
liability insurance on their car.
2. Fail to keep good records that could serve to
document insured property losses.
3. Pay high premiums because they select low
deductibles on property insurance for your
home or car.
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Good Money Habits in
Managing Property and Liability Risk
• Identifying your exposures to risk and the
magnitude of the losses that could occur. Always
insure your home and vehicle.
• Purchase insurance policies with very high
liability limits to protect against the possibility
of catastrophic losses.
• Verify that your auto insurance policy covers
rental car losses so you can wisely ignore sales
pressure to purchase such overpriced coverage.
• Always comparison shop for insurance locally as
well as online.
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Good Money Habits in Managing
Property and Liability Risk
• Maintain a verifiable inventory of all your insured
property so that you can collect what is coming
to you in the event of a loss.
• Once each year, reassess what types of and
how much insurance coverage you need.
• Buying renter’s insurance if you rent your
housing.
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