Presentation
Certificate in the
Business of Insurance
St. John’s University
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Presentation
Day 1
Nature of Insurance
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Topics (1)
1. Insurable Risk.
2. Insurance Principles.
3. U.S. Insurance Industry.
4. Brokers, Agents, and Claims.
5. Legal Environment of Insurance.
6. Insurance Contracts.
7. Underwriting and Ratemaking.
8. Property Insurance.
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Topics (2)
9. Legal and Contractual Liability.
10. Tort Liability and Negligence.
11. General Liability Insurance.
12. Professional, Medical, and D&O Liability.
13. Specialty Lines.
14. Reinsurance.
15. Homeowners and Auto Insurance.
16. Modern Risk Management.
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Presentation
Session 1
Insurable Risk
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Question
Suppose someone offered you:
• $1 million if you would climb Mount Everest and
reach the top.
• $500,000 if you stopped at the base camp at
24,000 feet.
• Expenses would be covered in either case.
Would you accept the offer?
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Sources of Risk
Exposure. A condition that can cause a downside
loss.
Uncertainty. A negative variance from
expectations.
Missed Opportunity. The failure to accept risk
when we have the chance to improve a situation
or condition.
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Question
Assume that twenty-five people are gathered in a
room. What is the probability that two of them will
have the same birthday?
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Answer
Over 50 percent.
• Calculation starts with 1/365 or .00274.
• It builds quickly
1 - (364/365)(363/365) . . . (341/365) > 50%.
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Speculative and Pure Risk
We can identify two broad categories of risk:
 Speculative Risk. The chance where both
loss and gain are possible.
 Pure Risk. The chance of an unexpected or
unplanned loss without the accompanying
chance of a gain.
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Question
Which of the following are pure risks?
• Placing a bet on a horse at a racetrack.
• An explosion in a power plant.
• A decline in the value of a nation’s currency.
• A microwave oven emitting harmful messages
from the devil.
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Answer
Race Track Bet. Not a pure risk. Upside
possibility.
Explosion. A pure risk. Only a downside.
Currency Decline. Not pure risk. Currencies rise
and decline in value.
Microwave Devil Message. What do you
believe?
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Dimensions of Pure Risk
• Likelihood of Loss. A high probability of the
occurrence of a loss may be considered to be a
higher degree of risk.
• Size of Loss. A large potential loss may be
perceived as possessing a high degree of risk.
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Severity and Frequency
Individuals and companies are concerned
primarily with insuring important risks measured
by either:
 Severity. The intensity of a peril.
 Frequency. The likelihood of the occurrence.
Risks can be graphed, as shown on the next slide.
As we move up and to the right, we move into the
area of critical risks.
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Graphing Risk
High
|
|
|
|
SEVERITY
Increasing
|
Risk
|
|
|
Low
|_____________________________
Low
FREQUENCY
High
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Question
Black Beauty (BB) is twice as likely to win a horse
race as Charley’s Child (CC).
Charley’s Child is twice as likely to win as Desert
Dawn (DD).
These are the only horses in a race.
A $2 bet on Black Beauty will pay $5.
Is this a good risk to accept?
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Answer
Yes.
Start with the probability of DD winning at 1.
Then CC is 2, and BB is 4.
Total likelihood is 7.
BB has 4 chances out of seven to win.
The upside is $3, the downside is $2.
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Tests of Insurable Risk
Financial Loss. possibility of a decrease in
money or a decline in monetary value.
Definite Loss. We must know conclusively that a
loss took place.
Fortuitous Loss. The loss must occur as a result
of chance from the perspective of the insured.
This is also called a contingent loss.
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Question
An individual wants to purchase fire insurance to
cover a house located in a dense forest. Is this
an insurable risk under the following conditions:
 If forest fires are common in the area?
 If a fire is approaching the house?
 If a child of the owner sets a fire?
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Answer
Insurable if loss is contingent.
 Yes if forest fires are common in the area.
May have a high premium
 No if a fire is approaching the house (not a
contingent loss).
 Yes if relative of owner sets a fire as long as
owner is not an accomplice. (contingent from
point of view of owner)
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History of Risk
Two events hundreds of years apart cleared the
way for a better understanding of risk:
 Hindu-Arabic Numbering System. It came
to the West in 1202 when the Book of the
Abacus appeared in Italy. It added the
concept of “zero.” Previously, the abacus
was the only tool for arithmetic calculations.
 Protestant Reformation. It weakened the
idea that the future was in the hands of God.
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Question
In the Roman numbering system, numbers were:
I=1
V=5
X = 10
L = 50
C = 100
D = 500
M = 1000
How much is CXVI + XXIV?
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Answer
CXVI + XXIV =
1 Convert IV → IIII
2 Link together (concatenate!) CXVI + XXIIII →
CXVIXXIIII
3 Sequence high to low CXVIXXIIII → CXXXVIIIII
4 Simplify by summation of internal numerals IIIII
→ V; VV → X; CXXXVIIIII → CXXXX
5 Subtract XXXX → XL
6 Solution CXL
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Contribution of Paccioli
In 1494, Luca Paccioli published a book:
• Algebra. The principles.
• Accounting. Double-entry bookkeeping.
• Arithmetic. Multiplication tables up to 60 x 60.
• Probability. A puzzle of how to divide an
unfinished game started new thinking.
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Question
Paccioli set up a game.
• A score of 60 wins $1,000.
• One person has 50 and the other has 20.
• The game cannot be finished.
• How do they share the money?
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Answer
It depends on who you ask.
• Luca Paccioli. Total points are 70. One person
gets 50/70ths or 5/7ths.
• Grace Amend (13 years old). Nobody gets the
money. Game is not over.
• Hope Amend. (9 years old). Nobody gets the
money. Person with 20 points has a chance to
catch up.
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Question
One of our goals is to remove as much
unnecessary risk as possible from our lives.
• Either you believe in God or you do not.
• It is a 50-50 proposition.
• Can you believe in God and remove all risk
from having the wrong belief?
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Answer
This is Pascal's Wager. Risk still exists:
• The wager fails to distinguish among the Gods
of Catholicism, Mormonism or Islam. Making the
wrong choice could be bad.
• It also fails to consider whether it would annoy
God if you believe in Her based on a mercenary
expected value calculation.
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Exposure, Peril, and Hazard
An insurable risk can cause a financial loss and/or
disrupt the operations of a business. Three
terms help dimension it:
 Exposure. A condition where risk could
cause a loss.
 Peril. Immediate cause of a loss.
 Hazard. A condition increasing the likelihood
of a loss from a peril.
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Question
A company purchases a building. With respect to
the possibility of fire, what is:
 An exposure?
 A peril?
 A hazard?
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Answer
Fire in a building.
 Exposure. Purchase of the building.
 Peril. Electrical fire.
 Hazard. Storing gasoline in the building.
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Hazard Categories
We can identify four kinds of hazards:
 Physical. A condition of the real world that
creates a danger.
 Moral. A tendency of a person to lack
integrity or be dishonest.
 Behavioral. A tendency of a person to be
careless. (also called morale hazard)
 Legal. Characteristics of legal system that
increase frequency or severity of losses.
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Question
Identify each as a physical, moral, behavioral, or
legal hazard.
 A workman leaving a ladder propped against
a house.
 A witness to a bus crash who hops on the bus
and later claims an injury.
 An individual who rides to work on a
motorcycle even on rainy days.
 A business person who rents a low-cost office
in a building with antiquated electricity wiring.
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Answer
• Ladder Against House. Behavioral. Physical.
• Witness Files Claim. Moral.
• Motorcycle to Work. Physical but behavioral
on rainy days.
• Bad Rental. Physical but partly behavioral.
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Question
In violation of company policy, an employee
entered a company at night and took a truck
without permission to move some furniture.
• The regular driver never checked the brake
fluid. The brakes failed.
• The truck hit a car. The employee and car
driver were injured.
• Identify any risks, exposures, perils, or hazards.
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Answer
Risks. Injury: personal risk. Vehicle damage:
property risk. Lawsuit: liability risk.
Exposure. Availability of truck.
Peril. Accident.
Hazards. Employee taking truck without
permission: Moral hazard.
Absence of brake fluid: physical and behavioral
hazard.
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Question
What have been the largest insured losses in the
world in the period from 1963 to 2014?
 Floods.
 Hurricanes (typhoons).
 Volcanoes.
 Earthquakes.
 Other.
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Answer
Rank Year
1 2001
2 2005
3 2011
4 2012
5 1992
6 2008
7 2011
8 1994
9 2005
10 2004
Source of Loss
Insured Losses
WTC Terrorist attack
$70 billion
Hurricane Katrina
$64 billion
Japan Tsunami
$62 billion
Hurricane Sandy
$28 billion
Hurricane Andrew
$22 billion
Hurricane Ike
$19 billion
Thailand Floods
$18 billion
Northridge Earthquake
$17 billion
Hurricane Wilma
$11 billion
Hurricane Charley
$ 8 billion
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Presentation
Climbing Mount Everest
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Question
Name an exposure, peril, and hazard associated
with climbing Mount Everest.
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Answer
Exposure. Climb it.
Perils. Snow blindness.
Freezing conditions. Death.
Hypothermia. Hypoxia.
Weight loss. Severe injury.
High altitude cerebral edema (HACE).
High altitude pulmonary edema (HAPE).
Hazard. Carry no oxygen. Do not train in advance.
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Question
When did someone first climb Mount Everest?
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Answer
First to climb Mount Everest:
 George Mallory 1921.
 Lost on the mountain 1924.
 Body discovered 1999.
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Question
Who was the first to reach the peak and
return safely?
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Answer
First to reach the peak and return safely.
Sir Edmund Hilary (1953)
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Question
How many people reached the peak
between the first ascent and 2012?
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Answer
Successful 1953-1996:
615 (43 years)
Successful 1953-2006 3,000 (53 years)
Successful climbers by different routes.
Year Nepal
China
Other Success
1990 40
20
12
18%
2000 85
55
5
24%
2012 409
138
0
56%
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Altitudes
The journey from Nepal:
Base Camp
17,000 ft
Camp I
20,000 ft
Camp II
21,000 ft
Camp III
23,500 ft
Camp IV
26,000 ft
Peak
29,000 ft
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5.300M
6,000M
6,500M
7,000M
7,900M
8,900M
48
May 19, 2012
At the bottleneck just below the peak:
Hillary Step:
40-foot rock wall.
Hillary Step Delay
2 hours
Reached the Top:
234 climbers.
Died:
4 climbers.
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Deaths 1921-2013
•
•
•
•
•
•
•
•
Fall
Avalanche
Exhaustion
Altitude Sickness
Ground collapse
Exposure
Other
Total
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48
18
24
24
26
35
240
50
Deaths 2014
April 2014.
Avalanche in the Khumbu Ice Fall.
16 Sherpas dead or missing.
Season ended with 6 weeks remaining of good
climbing weather.
Claudio Tessarolo:
"We made Everest a circus. This year the Sherpas
decided that the show will not go on.”
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Question
Risk and the risk appetite are framed by people’s
attitudes. What happened to David Sharp and
Lincoln Hall while climbing Mount Everest in
2006?
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Answer (1)
David Sharp.
 34 years of age.
 Froze to death under a rocky overhang just
below the peak.
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Answer (2)
David Sharp.
 34 years of age.
 Froze to death under a rocky overhang just
below the peak.
 40 climbers walked past him while he was
still alive.
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Answer (3)
Lincoln Hall.
 50 years of age,
 Left for dead by his climbing party.
 Survived the night.
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Answer (4)
Lincoln Hall.
 50 years of age,
 Left for dead by his climbing party.
 Survived the night.
 The next morning, Dan Mazur abandoned
his own climb to help rescue Mr. Hall.
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Answer (5)
John Delaney, founder and CEO of Intrade, a
prediction market which allows individuals to
take positions (‘trade 'contracts') on whether
future events will or will not occur. Did you hear
about what happened to him?
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Answer (6)
John Delaney died while trying to climb Mt.
Everest in May 2011:
 Less than 50 meters from the top.
 He was 42
 Second attempt to climb Everest.
 Never heard that his wife had just
given birth to baby daughter, Hope.
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Presentation
Session 2
Insurance Principles
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Indemnification
Indemnity refers to a reimbursement that
compensates exactly for a loss.
• After a loss, an insured is returned to the
approximate financial position prior to the loss.
• The insurer avoids allowing an insured to make
a profit from a claim.
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Indemnity Calculation
Direct Costs. Damage or harm in its basic and
most visible context. The money to repair or
replace the asset.
Indirect Costs. Financial damages that are not so
obvious or visible. Example is loss of use until
an asset is repaired.
Consequential Expenses. Extra costs as the
result of a loss.
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Question
An owner keeps a Ferrari in a wooden barn
behind his house.
• The Ferrari cost $200,000 five years ago.
• It is worth $300,000 today.
• The owner has asked Lloyd’s of London to
insure it for $400,000.
• Is Lloyd’s likely to offer this insurance?
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Question
Three Christian women requested an insurance
policy to cover expenses they would incur if one
of them immaculately conceived a baby and
could prove that it was the child of God. The
women, who were in the age range of 50 years,
were members of a Christian group. Would an
insurance company issue such a policy?
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Answer
One did. www.Britishinsurance.com issued a
policy in 2000 with a payout of one million
pounds. The premium was 100 pounds year. In
2006, the company cancelled the policy after it
was flooded with complaints from Catholics
when the story appeared in a newspaper.
Scottish Record & Sunday Mail Limited, June 23, 2006
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Insurable Loss
Risks are insurable when the loss has the
following characteristics:
• Arises from a Pure Risk. Speculative risks are
not insurable.
• Loss not Trivial. The administrative costs make
it too expensive to insure minor losses.
• Affordable Premiums.
• Acceptable Policy Limit.
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Question
If a homeowner snaps under pressure and sets
fire to his house.
• A court-appointed psychiatrist certified that the
person suffered from temporary insanity.
• Would damages to the house be covered by
fire insurance?
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Question
A company wanted to purchase insurance to send
employees to a restful resort if they suffered
serious depression for more than 60 days.
• The insurance would cover travel and living
expenses.
• Is this an insurable risk?
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Answer
Not likely.
• It might be hard to prove that the loss is
definite.
• Depression may be fortuitous but a claim of
depression is not.
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Answer -- News Release (1)
Copyright 2005 News Limited --Where there's smoke
there's fire
A Charlotte, North Carolina, lawyer purchased a box of
rare and expensive cigars, then insured them against
fire and theft. Within a month, having smoked his entire
stockpile of the cigars and without yet having made even
his first premium payment on the policy, the lawyer filed
a claim against the insurance company. In his claim, the
lawyer stated the cigars were lost `in a series of small
fires'. The insurance company refused to pay, citing the
obvious reason: that the man had consumed the cigars
in the normal fashion. The lawyer sued and won.
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Answer -- News Release (2)
In delivering the ruling, the judge agreed with the insurance
company that the claim was frivolous. The judge stated,
nevertheless, the lawyer held a policy from the company
in which it had warranted that the cigars were insurable
and also guaranteed it would insure them against fire,
without defining what is considered to be unacceptable
fire. The insurer was obligated to pay the claim.
Rather than endure a lengthy and costly appeal process,
the insurance company accepted the ruling and paid
$15,000 to the lawyer for his loss of the rare cigars lost
in the `fires'.
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Answer -- News Release (3)
After the lawyer cashed the check, the insurance company
had him arrested on 24 counts of arson. With his
insurance claim and testimony from the previous case
being used against him, the lawyer was convicted of
intentionally burning his insured property and was
sentenced to 24 months in jail and a $24,000 fine.
This true story was the first place winner in the recent
National Association of Criminal Defense Lawyers
Contest.
www.NACDL.org
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Answer (4)
The previous story was a hoax. Some media
outlets ran it. If a person knows the rules of
insurance, the loss was not fortuitous.
 Risk Transfer.
Yes
 Pooling of Losses.
All fire, not all cigars
 Indemnification.
Yes, if for cost
 Fortuitous Loss.
No. Intentional.
Therefore, no collection of damages is possible.
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Risk Strategies
Organizations use a mixture of four strategies to
deal with frequency and severity of risk. They
always use:
 Reduction. Lower the frequency or severity.
The other strategies are:
 Avoidance. Do not accept it.
 Retention. Keep it.
 Transfer. Shift the financial burden to another
party.
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Question
Of the risk strategies (1) avoid, (20 retain, and (3)
transfer, which one is used for each of the
following?
 Low frequency, high severity.
 Low frequency, low severity.
 High frequency, high severity.
 High frequency, low severity.
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Answer
Reduce for all. Also:
Low frequency, high severity. Transfer
Low frequency, low severity.
Retain
High frequency, high severity. Avoid
High frequency, low severity. Retain
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Layering of Insurance
A layer refers to a level of retention or transfer of
an insurable exposure when coverage occurs
above a lower level of insurance.
• Each layer is the responsibility of a different
party.
• Insurance layers provide higher levels of
coverage that might be obtainable without
multiple parties.
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Policy Layering
• Insured Retention. The insured pays the first
portion of any loss. This is the deductible.
• Primary Insurance. All losses from the
retention to the policy limit are in this layer.
• Excess Insurance. The insured can buy
coverage above the primary limit.
• Umbrella Insurance. An insured can buy
broad coverage above all limits to protect
against catastrophic loss.
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Single Policy Layering
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Insurance Company Layering
• Insured Deductible. This is the level retained
by the insured.
• Primary Insurance. This is the first layer
retained by the insurer.
• Reinsurance. The insurance company can
reinsure a portion of the primary layer.
• Excess Insurance. This level covers
accumulated large above reinsurance.
• Umbrella Insurance. This protect broadly
against unforeseen catastrophes.
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Insurer Layering
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Question
An insured had insurance coverage for a major
office complex. Is it a good structure?
• $39 million market value of property.
• $25 million replacement cost.
• $8 million primary coverage with a $2 million
deductible.
• $5 million secondary above loss of $11
million.
• $9 million excess above loss of $20 million.
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Answer
Excess
Gap
Secondary
Gap
Primary
Retention
Coverage
Retention
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5 mm
4 mm
5 mm
3 mm
6 mm
_____
16 mm
2 mm
9 mm
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Question
A city has 500 buses serving residents.
• 40 passengers per bus in rush hour.
• 6 passengers per bus in mid-day.
• 22 passengers per bus in a mid-day accident in
one industrial section of the city.
Many injured parties file claims for injuries. How
should the city handle this risk?
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Question
A company unloads ships transferring electronic
products into a public warehouse in a port. In
the past year, theft and missing items equaled
5% of all shipments. How should the company
handle this risk?
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Question
A construction company must pay medical costs
for workers injured on the job and salary during
any period of disability.
• Statistics show that 95% of injured workers
return to the job within 21 days, even after
serious injury.
• The local laws occasionally require employers
to provide lifetime total pay and medical costs
for injured workers.
How should the company handle this risk?
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Presentation
Session 3
U.S. Insurance Industry
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Forms of Insurance Companies
Private insurers in terms of legal organization and
ownership can be categorized as:
 Stock Insurer.
 Mutual Insurer.
 Lloyd’s Association.
 Reciprocal Exchange.
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Property Insurance
Provides protection against most risks to property.
Includes:
 Fire flood, earthquake
 Houses.
 Commercial Buildings
 Boilers and equipment.
 Vehicles.
 Aircraft.
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Liability Insurance
Liability insurance indemnifies insured against
third party claims. It covers:
 Lawsuit judgments.
 Cost of settlement of claims.
 Legal expenses.
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Casualty Insurance
Casualty insurance is a problematically defined term not
concerned with life insurance, health insurance, or
property insurance. However, the "elastic" term has also
been used to describe:
 Property insurance for aviation, boiler and machinery,
glass breakage, and crime.
 Marine insurance for shipwrecks or losses at sea.
 Fidelity and surety insurance.
 Earthquake.
 Political risk and terrorism.
NAIC in 1946: Defined legal liability except marine,
disability and medical care, and some damage to
physical property.
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Carrier Knowledge
• Product Knowledge. What risks are covered
by different types of policies?
• Availability Knowledge. What insurance
products are available?
• Carrier Strength. How strong and reliable is
the carrier?
• Carrier Services. What is the quality of the
carrier’s underwriting, claims processing, and
other services?
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Sources of Knowledge on Carriers
• Rating Agencies. Solvency. Financial strength.
(Standard & Poor’s, A.M. Best, and others).
• Advisen. Product lines. Policy terms.
Governance. More.
• Insurance Information Institute. Trends.
Financial information. More.
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Insurance Market Cycle
A cycle refers to a course or series of events or
operations that recur regularly and usually lead
back to the starting point.
• U.S. property and liability insurance has a
tendency of insurance coverage to follow a
cyclical pattern with pricing and coverage
availability.
• In this context we identify hard and soft
markets.
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“Soft” Insurance Market
Exists when insurance coverage is relatively
plentiful and offers attractive pricing for
organizations.
• Buyers’ Market. Insurance companies are
highly responsive to the needs of clients.
• Excess Capacity. Insurers have premium and
revenues goals that exceed the needs of
buyers.
• Market Share Pricing. Insurers price coverage
to retain or increase their market share.
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“Hard” Insurance Market
Exists when insurers withdraw and become more
selective when offering coverage.
 Sellers’ Market. Insurance companies
restrict exposure and seek out only the best
risks.
 Restricted Capacity. Organizations struggle
to incorporate insurance into risk
management programs.
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Drivers of the Cycle
State of the Economy. Are economic conditions
good or bad?
Insurer Resources. Do insurers have enough
capital?
Underwriting Results. Are insurers profitable?
Cash Flow Underwriting. Are insurers lowering
premium prices to expand business?
Long and Short Tail Losses. What kind of
business is being written?
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Cash Flow Underwriting
This is a practice of granting coverage based on
rates that are designed to increase an insurance
company’s cash flows during periods when
losses and expenses are likely to exceed
premiums.
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Cash Flow Financial Results
Underwriting Results
Investment Income
Taxable Income
Tax Rate
Taxes
Net Loss
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24000
12000
0%
0
-12000
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Long and Short Tail Losses
• Long-tail Loss. Exists when an insurance
company expects to pay a claim many months
or even years after a loss.
• Short-tail Loss. Exists when a claim is likely to
be paid immediately after a loss.
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Government Regulation of Insurance
Characteristics of insurance regulation in the U.S.:
 State Level. Every state has an insurance
department. The federal government does not
regulate insurance companies.
 NAIC. Regulation is coordinated by the
National Association of Insurance
Commissioners.
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Goals of Regulation
Regulation pursues goals including:
 Increase the likelihood of insurer solvency.
 Protect consumers.
 Increase the availability of insurance.
 Encourage reasonable costs for consumers
and adequate return for insurers.
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Legislation
Insurance laws regulate:
 Formation of insurance companies.
 Financial requirements for insurers.
 Insurance rates.
 Financial distress of insurers.
 Sales and claims practices.
 Taxation of insurers.
 Licensing of agents and brokers.
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Licensing of Insurers
Insurance companies must be licensed to do
business in a jurisdiction. Three forms are:
 Domestic. Insurer is domiciled in the state.
 Foreign. An out-of-state insurer licensed in
the state.
 Alien. A non U.S. insurer licensed in the
state.
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Admitted and Nonadmitted Insurers
Admitted. An insurance company that is licensed
to do business in certain product line in the
jurisdiction in which the policy is purchased.
Nonadmitted. An insurance company not
authorized to issue insurance policies in a
jurisdiction.
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Insurer Solvency
Financial Solvency. Exists when the company
can meet all financial responsibilities and pay all
claims fully and on time.
Technical Solvency. Occurs when the insurer
has adequate assets to provide a cushion of
support for future claims.
Technical Insolvency. Describes a situation
where the insurance company fails to meet the
minimum capital requirements established by
regulators.
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Continuing Solvency
Adequate Cash Flows. Cash from operations is
sufficient to cover operating expenses and
losses incurred.
Adequate Equity. Insurer’s capital is sufficient to
support the level of premiums and other
activities.
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Factors Affecting Solvency
Sound Underwriting. Evaluate risks and set
premiums to have funds available to pay claims.
Sound Investments. Invest carefully in safe and
liquid assets.
Cost Control. Manage operating and other costs.
Strong Internal Auditing. Ensure all activities are
in accordance with company policy.
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GAAP and Statutory Accounting
Regulators pay particular attention to the financial
position of insurers. Two forms of accounting
are used:
 GAAP Accounting. For reporting financial
results to investors and the general public.
 Statutory Accounting. For reporting
financial results to regulators.
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Generally Accepted Accounting Principles
Separate Entity. Organization is a distinct and
recognizable entity.
Going-concern Basis. Expected to continue to
operate for an indefinite period of time.
Accrual Basis. Match transactions with their
economic effects.
Cost Basis. Purchase of assets, payment of
expenses, and settlement of claims are at actual
cost.
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Statutory Accounting
Statutory accounting is more conservative than GAAP:
 Liquidation Viewpoint. Recognizes relatively-liquid
assets available to pay claims. GAAP accounting
recognizes all assets.
 Conservative Capital. Because some assets are not
accepted, equity will be smaller than GAAP
accounting.
 Conservative Realization. Under GAAP accounting,
realization occurs when revenues are earned,
expenses are incurred, and losses are expected.
Regulatory accounting is more conservative.
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Admitted Asset
A high-quality asset that meets requirements of
regulators and appears on a regulatory balance
sheet.
 Liquidity. Easily converted to cash in a short
period of time.
 Certainty. Highly likely to be converted to
cash at their reported values if they are
needed to pay claims.
Only admitted assets appear on regulatory
balance sheets.
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Nonadmitted Asset
Fails to meet the regulatory standard to be an
admitted asset. Examples are:
 Furniture, Equipment, and Computers. Not
very marketable at accounting values.
 Funds Deposited with Unauthorized
Parties. Insurers not licensed locally for
example.
 Uncertain Collectibles. Includes overdue
receivables, balances due from agents or
brokers, and overdue interest and dividends.
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Categories of Accounts
Asset. A financial resource.
Reserves. Obligations to pay claims.
Liability. A debt or money owed to others.
Capital. A source of assets from owners or past
profits.
Revenue. An inflow of assets, not limited to cash,
in exchange for coverage or services rendered.
Expense. A consumption of any asset while
conducting business.
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Insurer Balance Sheet
The most important financial statement for an
insurance company.
• Assets. Cash, investments, equipment.
• Reserves. Reflect losses occurred but not paid.
• Liabilities. Debts or obligations.
• Capital. Difference between assets and
obligations. “Surplus” is title for account with
retained earnings.
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Care with Statutory Balance Sheet
• Missing Assets. Overdue assets may be quite
liquid and reliable.
• Reserves. Based on past history and future
expectations.
• Boasting about Reserves. They show high
level of assets to pay claims.
• Capital. An accounting entry, not extra “money”
in addition to assets.
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Insurer Income Statement
• Revenue. Money from normal business
activities.
• Losses. Associated with policies written during
the period.
• Nonfinancial Expenses. Operating costs.
• Financial Expenses. From borrowing or
leasing assets.
• Before-tax Income.
• Income after Taxes.
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Question
Watch out for account titles.
• Insurance analyst says, “I am concerned about
overdue premiums?”
• What type of account is that?
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Reply
Overdue Premiums:
• Asset if the company is entitled to collect the
premiums.
• Liability if premiums are owed to another party.
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Question
Underwriter says,
• “What is our strategy for deferred taxes?”
• What type of account?
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Question
Deferred Taxes:
• Asset if it will reduce a subsequent period's
income taxes.
• Liability if result of temporary differences
between tax rates and taxes payable for the
current year.
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Accrual of Losses
Known Losses.
• A claim has been filed or otherwise known.
• Actuary estimates the cost.
Incurred But Not Reported (IBNR) Losses.
• Not aware of specifics.
• Will be reported.
Also known and IBNR adjusting expense liability
accounts.
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Question
“Surplus” reflects assets not committed to pay
future claims. With the following data, what will
be the change in balance sheet surplus
account?
Net income
Dividends
Accounting reduction to surplus
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7,400
-600
122
Reply
Net income
Dividends
Change in surplus (no adjustment)
Accounting reduction to surplus
Change in surplus
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+14000
-7400
+6,600
-600
+6,000
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Question
With the following data, what was the accounting
adjustment to surplus?
Net income
9000
Dividends
4600
Starting surplus
22500
Ending surplus
29000
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Reply
Net income
Dividends
Expected change in surplus
Actual change in surplus
Accounting increase to surplus
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-4600
4400
6500
+2100
125
Question
Statutory accounting is more conservative than
GAAP accounting because insurance
companies have a greater need than other
companies to be conservative. Do you agree?
Reply
Agree. The purpose of insurance is to have money
available when a loss occurs. It is not
“insurance” if the company takes normal
business risks.
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Question
The balance sheet shows history and current
strength. It is much more valuable than the
short-term income statement. Do you agree?
Reply
Agree. Probably true. A bad year of losses can be
overcome with a strong asset position. A single
good year of underwriting does not add
sufficient strength to overcome a weak balance
sheet.
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Question
An insurance company should maximize surplus
to show financial strength. Do you agree?
Reply
It probably needs to do other things as well:
• Adequacy of Premiums. Premiums plus
investment income should exceed losses and
expenses.
• Losses and Reserves. Solid actuarial
assessments.
• Excessive Expenses. Avoid them.
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Presentation
Session 4
Brokers, Agents, and Claims
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Industry Parties
• Broker. Arranges insurance coverage and
advises on risk management.
• Agent. Performs many of the same services as
brokers.
• Claims. Adjusters, lawyers, engineers, and
others who investigate insurance claims.
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Broker
• Licensed. By insurance regulators
• Independent. Can work with a variety of
insurance buyers and insurers.
• Representative of Buyer. Accepts
responsibility to understand risks facing
organizations seeking insurance.
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Agent
• Licensed. Like a broker.
• Represents Insurer. Not legally accountable
for identifying the best insurance coverages for
specific risks.
• Exclusive or Independent. Works for a single
insurer or multiple insurers.
• Agent Binding. Can make a policy effective.
Called binding the policy.
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Question
Susan Powers sells insurance but is not an agent
for the Blue Creek Insurance Company.
• Susan tells Arnold Jenkins that his truck fleet is
covered immediately by a policy.
• Arnold called the insurer.
• A Blue Creek receptionist said “Susan Powers
sells insurance for Blue Creek.”
• A loss occurred the next day.
• Is the loss covered by Blue Creek?
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Answer
• Issue: Express versus implied power.
• Is the word of a receptionist sufficient to imply
an agency relationship?
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Question
The Gilbert Insurance Services Company
arranges insurance coverage for wind and glass
damage to commercial buildings and structures.
• Most of the coverage is placed with three
insurers, one each in London, Birmingham, and
Paris.
• How would you tell whether Gilbert is a broker
or agent?
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Answer (1)
Ask Gilbert. “Are you an employee of the insurer?”
“Are you acting as broker or an agent in this
transaction?”
Why would you care if Gilbert is a broker or
agent?
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Answer (2)
• You want to know whether the party is working
for you or an insurer.
• You care because an agent can make a policy
effective immediately.
• You may simply want to know whether you are
talking to a broker or the insurer itself.
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Claims Adjusting
Settling a claim for a covered loss. Steps vary:
• Notification. Insured must file a claim. Review
of the File. Examine information about loss.
• Verification of Coverage. Is loss covered.
• Assess Loss. What happened?.
• Assess Indemnity. Determine the
reimbursement.
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Claims Adjusters
Multi-Line Adjusters. Both property and liability
claims. Often employees of the insurer.
Third Party Administrator (TPA). Anindependent
adjuster that can work for different insurance
companies or for the insured.
Public Adjusters. Work exclusively for the
policyholder.
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Marketing Systems
Insurance companies use different approaches to
marketing property and liability products:
 Broker. A person who works for a buyer and
helps the buyer obtain coverage.
 Agent. A person who works for the insurer
and sells coverage to buyers.
 Direct Writer. An employee of the insurer
who sells coverage to buyers.
 Direct Answer. Using advertising, the media,
or the Internet to sell to buyers.
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Question
Brokers find, request, and negotiate commercial
insurance coverage.
• They work for the insured.
• They maintain good relations with the insurer.
• They may accepts contingency fees from
insurers.
• Does this create a conflict of interest?
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Marketing Strategies
With respect to a line of business, insurers pursue
marketing strategies such as:
 Segmentation. Offer a single product to a
specific portion of a market.
 Diversification. Introduce new products into
an existing market.
 Market Development. Bring an existing
product to a new market.
 Penetration. Lower the price and aggressive
seek a larger share of an existing market.
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Question
When is it appropriate for an insurer to use a
segmentation strategy?
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Reply
Use a segmentation strategy to:
 Reduce Customization Cost. The product
does not have to be modified for a variety of
buyers.
 Reduce Competition. If a segment is chosen
carefully, competitors may not yet have
entered it.
 Create a Distinctive Image. A unique
identity can be developed across the segment
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Question
When is it appropriate for an insurer to use a
diversification or market development strategy?
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Reply
Use a diversification or market development
strategy to:
 Spread the Risk. If losses appear in one
product category or market, they can be
offset by profits in another.
 Growth. Companies can move into other
lines or markets that are growing fast.
 Profits. Companies can seek high profit
business.
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Question
When is it appropriate for an insurer to use a
penetration strategy?
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Reply
A penetration strategy is not recommended.
Drawbacks are:
 Pricing Risk. The company drops prices to
build volume and then raises them later after
building market share. It is difficult to do this.
 Greater Risk. The company is likely to
reduce underwriting discipline and accept
riskier exposures.
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Specialty and Surplus Lines
• High Risk. Large policy limit or history of
higher than expected losses.
• Unique Coverage. No previous experience.
• Rare Coverage. A limited number of carriers.
• Capacity Limitations. Exceeds capacity of
conventional markets.
• Risk Expertise. Not familiar to local
underwriters.
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Question
A specialty lines broker is often call a wholesale
broker. Is this accurate?
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Answer
Yes. The wholesale broker works only with retail
brokers.
• Insured approaches a retail broker.
• Coverage may not be available in local
jurisdiction.
• Retail broker approaches a surplus lines
broker.
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Excess Insurance
Attachment Point. The lower limit of excess
coverage. Once it is reached, the excess can
begins to reimburse a loss.
Coverage Follows Form. Excess policy contains
the same exact provisions as lower layer.
Coverage Gaps.
• Attachment point higher than the policy limit.
• Exclusion because coverage does not follow
form.
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Question
A primary insurance policy covers environmental
damage with a per occurrence limit of $2 million
and a deductible of $100,000. An excess policy
covers annual aggregate losses above $2.5
million up to a maximum of $12 million. Is this a
good structure for an insurance arrangement?
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Answer
No. The problems are:
• Form. Coverage does not follow form. The
primary insurance is per occurrence while the
excess insurance is aggregate.
• Gap. The structure has a coverage gap. The
primary layer has a $2 million policy limit while
the excess coverage does not begin until a loss
reaches $2.5 million.
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Presentation
Day 2
Insurance Law and Contracts
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Presentation
Session 5
Legal Environment
of Insurance
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Insurance Law
• Common Law. Laws are created by the
decisions of courts to be inconsistent on their
rulings. Developed in Great Britain and brought
to the U.S. One-third of world’s jurisdictions.
• Civil Law. Laws approved by a legislative body
or government agency. Most widespread
system around the world.
• Religious Law. Legal system is subordinate to
laws that arise from religious beliefs.
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Basic Requirements of Contracts
All contracts require the following:
 Offer and Acceptance. One party must
make an offer. Another must accept it.
 Consideration. An inducement to enter into
an agreement. Value to each party.
 Competent Parties. Must have legal capacity
to enter binding contract.
 Legal Purpose. Cannot violate a law or be
contrary to public interest.
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Question
A company requested insurance and was given a
quote of $22,000 for the premium.
• The company requested a reduction to
$15,000.
• The insurer responded with an offer of $18,000.
Before the company could respond, a loss
occurred that was covered by the policy.
• Is the policy in effect?
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Question
A company purchased a $300,000 fire insurance
policy on a warehouse and paid a premium of
$3,000.
• After binding the contract, the agent said the
company would also cover $20,000 of the
inventory stored in a nearby barn.
• Later, the barn burned down.
• Does the insurer have to pay for the inventory
loss?
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Material Fact
This is an aspect of a risk that is significant when
assessing the exposure in an insurance policy.
The risk can be:
 Sufficient to affect the terms of an insurance
policy.
 Sufficient to cause an insurer to deny
coverage.
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Representation
Utmost good faith requires the insurer and insured
to disclose material facts affecting insurance
coverage. Representation is:
 A statement concerning a material fact made
by an applicant in the process of obtaining an
insurance policy.
 Made to induce the insurer to provide
coverage.
 Oral or written, it must be true to the best
knowledge of applicant.
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Misrepresentation
This is a statement that is false with respect to a
material fact. If intentional, it can be the basis for
an insurer to void a policy at a future time.
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Concealment
This is the failure to voluntarily disclose a material
fact.
 It goes beyond simply answering questions
that are asked.
 Insured has affirmative burden to disclose
material facts that can affect coverage.
 Concealment is basis for voiding policy.
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Warranty
This is a statement made to secure insurance
coverage that must be absolutely and strictly
true.
 It is not enough to be true to the best
knowledge of the insured.
 It does not have to involve material fact.
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Fraud
This is an intentional deception to cause a party to
give up property or a lawful right:
 Fraud exists when an insured makes willful
false representation, concealment, or
deliberate action to harm the insurer.
 It is the basis to void a policy.
 If a serious harm is possible, fraud may
violate criminal as well as civil law.
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Utmost Good Faith
Contracts may have two different legal standards
for disclosure:
 Let the Buyer Beware. Each party to a
contract should investigate the situation and
be responsible for knowing all terms and
conditions.
 Utmost Good Faith. Both parties must make
a full and fair disclosure of all facts affecting a
contract. This is the requirement for
insurance policies.
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Question
A company has refineries in Kuwait and Qatar.
• It applied for insurance on the Qatar facility and
completed a form provided by the insurer.
• The form did not ask about the safety record of
other refineries.
• The company did not report the suspension of
Kuwait refinery due to poor safety practices.
• An explosion resulting from apparent employee
negligence damaged the Qatar refinery.
• Is the policy voidable?.
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Answer
Maybe. Issues are:
 Is the information a material fact related to the
Qatar refinery?
 Is it concealment to be silent on the Kuwait
situation?
 Is a failure to add to the questions on the form
a violation of utmost good faith required for
insurance contracts?
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Question (1)
A company president purchased burglary
insurance on 24 rare paintings on the walls of
the corporate headquarters.
She told the insurer she believed the office
building had 24-hour security. This was not true,
although she saw a watchman every evening
when she left the office.
The policy included 3 paintings at the home of the
president. She warranted that a working alarm
system was installed at the house and was
connected to a local security firm.
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Question (2)
Two of the paintings in a carriage house 200
meters from the home of the president. The
president failed to tell the insurer that the
carriage house could not be locked.
Last year, the president wrote a memo reporting
the loss of 3 paintings and suggested insurance
might recover their value.
One night a fine arts burglary ring stole all the
paintings while the president was on vacation.
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Question (3)
Subsequently, the insurer learned:
 The office did not have 24-hour security.
 The alarm system on the house was not
working because of a dead battery.
 The carriage house had no lock.
 Non-existent paintings were listed on the
policy.
Does the policy cover the loss?
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Answer
It may cover the office paintings.
 Night Watchman. Misrepresentation Was it
intentional?
 House. No. Alarm system is a warranty. It
must be true.
 Carriage House. Probably not. This looks
like concealment of a material fact.
 Non-existent Paintings. Possible fraud. May
invalidate the entire policy.
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Adverse Selection
This refers to the tendency of persons with high
chances of loss to seek insurance at average
rates.
• Insurers investigate whether a party fits the
criteria for coverage.
• It seeks to exclude adverse selection.
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Question
A woman had sharp pains for a full year.
• She went to a hospital for medical tests.
• She received a phone call but did not answer.
• She increased her life insurance.
• She did not tell the insurer she had visited the
hospital.
• A month later, she died.
• Does the insurer have to pay the death benefit?
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Answer
It depends upon state law and a jury interpretation
of how concealment would be an issue with the
facts in this situation.
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Assignment
An insurance policy is a personal contract:
 Assignment. The right of a party to transfer a
claim, right, or property to another party.
Consent. Permission to assign a contractual
right.
 Personal Contract. Assignment of the rights
under an insurance policy requires consent of
other party.
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Waiver
The relinquishing of a known right. Two forms:
• Intentional. An individual or organization can
consciously surrender a right to which it is
entitled.
• Unintentional. By taking actions that the law or
a court would consider the failure to protect a
right, a party can waive the right without a
conscious decision to do so.
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Question
A large airport is considering the purchase of a
policy to reimburse it for disruption lawsuits as a
result of bad weather.
• The insurance company offered a lower
premium if the airport would waive coverage for
any interruption other than weather.
• Is this a good idea?
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Answer
Maybe not. Other disruptions:
Police Action, Terrorist Act, Congestion,
Maintenance, FAA Regulations, Technology,
Fuel Shortage, Employee Absence, Strike,
Crazy Person, Power Outage, Communications
Outage, Airport Closing, Improper Training,
Absence Of Linguists, Missing Parts, Landing
Or Takeoff Crash.
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Void and Voidable Contracts
Void. An agreement that has no legal force.
Voidable. An agreement that can be made void
• At the option of one of the parties.
• When circumstances make it impossible to
perform the contract.
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Question
How do we determine whether a contract is
voidable? Whether it is void?
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Answer
Voiding is always at the option of one of the
parties.
Contingency Occurs. If a party is unable to
perform, it may declare a contract to be void and
a court may agree.
Permitted in Contract. If a court agrees that the
contractual condition occurred, the court will
void of the contract.
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Question
A company purchased fire coverage on an office
building. The policy prohibited the use of any
part of the building as a restaurant. When
delivering the policy, the insurance agent ate
lunch in a pizza parlor on the ground floor of the
building. Nine months later, a fire in the
restaurant and damaged the building. Can the
insurer void the policy?
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Answer
Not likely.
 The insurer probably waived its right to void
by waiting 9 months.
 Estoppel will not allow a voiding of the policy.
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Strict Compliance Rule
States that a contract is enforced in accordance
with its terms.
• If terms are clear, meaning may not be
distorted by interpretations.
• Rule covers insurance policies.
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Question
A chemical company purchased a liability
insurance policy.
• The risk manager specifically requested
medical coverage for contractors on the
property.
• He did not notice that second-party coverage
was an exclusion.
• Three employees of a catering company were
hospitalized from a toxic leak on the premises.
• Does the insurer have to cover medical costs?
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Answer
Probably not.
• Contracts are interpreted on the basis of the
terms.
• If the coverage is an exclusion in the policy, a
court is not likely to enforce coverage.
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Parole
Oral evidence offered to vary the terms of a
written contract. Usually not permitted to modify
an insurance contract. Exceptions might be:
 Obvious Factual Error.
 Fraudulent Statement.
 Factual Conflict.
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Question
Prudential provided financing for eight ships
owned by United States Lines. The individual
who processed the agreement wrote down
$92,885 instead of $92,885,000. USL went
bankrupt and sold the ships for $67 million. How
much of the $67 million could be claimed by
Prudential based on the contract.
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Answer
The shipping company eventually agreed to give
Prudential the proceeds, but deducted $11
million.
Time, January 2, 1989
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191
Question
An individual purchased an expensive Italian
sports car.
• The insurance policy excluded racing the car.
• The individual and his insurance agent watched
the car racing three times.
• Then, the car was involved in an accident while
being driven home from work.
• The insurer voided the policy.
Will a court uphold the insurer?
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Answer
Probably not. Although misrepresentation or
concealment were present and strict compliance
often allows an insurer to void the policy, some
factors were:
 The car was not damaged racing.
 The knowledge of the agent might waive the
right to void.
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Contract of Adhesion
An agreement prepared by one party and
accepted or rejected by another party without
modification.
An agreement not reached by negotiation.
As insurance companies draw up the insurance
policy, it will be treated as a contract of
adhesion.
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Expectations Principle
Refers to the interpreting of a contract of adhesion
to meet the expectations of the party that did not
draw it up.
Impact. Fine print or tricky language will not
invalidate insurance coverage.
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Question
A city buys $500,000 of standard fire coverage.
On page 19, the policy contains the wording
“Coverage will not be provided if the employer
hires anyone with a prior criminal conviction.”
A fire occurs. It was started by a convicted felon
who was employed by the city. Will the
insurance company have to pay for the loss?
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Answer
Yes. The city expects insurance coverage
separately from having to audit all its hiring
practices.
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Question
A hotel had labor problems and locked out
employees. Union members picketed the hotel
and engaged in aggressive actions with guests,
security guards, and local police.
After 23 days, an employee tossed a bottle of
gasoline into the kitchen. A fire destroyed the
restaurant. The insurer denied coverage
because the loss was caused by intentional
behavior of an employee of the insured. Does
the policy covers the loss?
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Answer
The policy covers the loss. The insured does not
benefit from a renegade employee committing a
criminal act. It is not a moral hazard where an
insured can intentionally cause a loss and
benefit from it.
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Subrogation
Refers to the right of an insurance company to be
reimbursed for payments when a loss is caused
by a third party.
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200
Question
A man is visiting a family member who is a patient
in a hospital.
• The man has harsh words with another patient
and hits him causing a fall that requires surgery.
• The insurance company must pay for the
surgery as part of the injured patient’s health
care policy.
• Can the insurer obtain reimbursement for its
payments?
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Answer
Probably.
• The insurer can subsequently file a lawsuit
against the man who threw the punch.
• The lawsuit can allege assault and demand
reimbursement of the cost of the surgery.
• The insurer would be likely to win as
subrogation would support the intentional tort
liability.
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Question
A woman was in an accident with another car.
• The other driver leaped out of the car and
smashed the window of the woman’s car.
• When she filed her claim, the insurance
company asked the woman to testify about the
damage inflicted by the other party.
• The woman refused.
• Does the insurer have to pay the claim?
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Answer
The losses are likely to be covered.
• If the woman refused to testify, perhaps
because she was afraid of retaliation, the
insurance company would probably not force
testimony.
• The insurer would pursue subrogation using the
police report.
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Insurable Interest
Insurance may not be purchased without an
insurable interest, defined as a relationship
where a person would be affected by a loss.
Examples are:
 Ownership. A financial loss.
 Leasehold. Can lose if rented property is
damaged.
 Financial. Loan or investment is affected.
 Family or Oneself. Based on love and
affection.
 Business. Financial or other ties.
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Question
A company lends $300,000 to a key executive to
help her finance a new house after being
transferred by the company. She lends $30,000
of the money to her son to buy a new car. The
company applies for a life insurance policy on
each individual, one for $300,000 and the other
for $30,000. Will the insurer issue the two
policies?
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Answer
No. Two problems.
Indemnity principle. $330,000 is more than the
money owed.
Insurable interest. An insurable interest exists for
the employee. For the son, it depends on the
beneficiary.
 If the mother is beneficiary, yes, as personal
and financial insurable interests exist.
 No if the company is the beneficiary as no
insurable interest exists.
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Question
A marketing, financial, and technical executive
formed a company to develop a computer
system for a hospital. In three years, the group
plans to sell the finished system to IBM for $6
million. All three people are needed to build it
correctly but none will receive any money for
work during the three years. What is the
insurable interest of each person in each other
person?
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Answer
The loss of a person causes a future loss of one
third of $6 million. Factors affecting the financial
value of insurable interest:
 Can a lost partner be replaced?
 Can the person be paid cash rather a partner
share?
 How long will it take to find a new person?
 What is the impact of a delay?
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Presentation
Session 6
Insurance Contracts
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Contract of Indemnity
An insurance contract seeks to restore a prior
financial position before a loss.
• Life insurance policies are an exception.
• U.S. health care policies are also an exception.
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Question
A yard just delivered a new vessel to an owner:
 Cost and Time. $40 million and 3 years to
construct.
 Current Market Value: $25 million.
 Mortgage: $35 million.
 Construction Cost: If ordered today, it would
cost $45 million.
How much insurance would be available under the
indemnity principle?
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Answer
$35 million. The issue is what does it mean to
restore the owner to the pre-loss position.
 Market Value Limit. $25 million would allow
the buying of another ship.
 Mortgage. $35 million. The company would
have an immediate requirement to pay the
mortgage and accept a loss on its books.
Insurance would prevent this.
 Original and Construction Cost. Not
relevant for insurance purposes.
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Role of Deductibles
Deductibles and Participation Clauses reduce:
• Premiums. The larger the sharing, the larger
the discount on the cost.
• Administrative Costs. Deductible also
eliminates processing costs for small claims.
• Moral Hazard. Reduces the temptation to
intentionally cause a loss and benefit from it.
• Behavioral Hazard. Encourages careful
behavior if the insured pays part of the loss
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Contract Parties
Three parties to an insurance contract:
Insured. Has coverage for personal, property,
liability, or other unexpected loss.
Insurer. Provides coverage for the exposures.
Premium Payer. Pays for the promise of
compensation if a loss occurs. Most commonly,
this is the individual or organization that is
insured.
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Named Insured
• First-named Insured. Party responsible for
managing a property policy on the behalf of the
insured organization.
• Other Insureds. Partners, associated
companies, and other entities with an ownership
or other interest in the policy.
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Question
A group of investors purchased a hotel and owned
it in a stand-alone corporation.
• The first-named insured, cancelled the policy
without notifying the other insureds.
• A fire damaged the hotel.
• A minority owner demanded reimbursement for
his share of the damage directly from the
insurer.
Does the insurer have to honor the request?
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Answer
No. The insurer only has to deal with the first
named insured for:
 Negotiation of the policy terms and changes
in coverage.
 Payment of premiums.
 Cancellation of the policy.
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Sections of Insurance Policy
Declarations. Statements that provide information about
the person or property covered by the policy.
Definitions. Key terms used in the policy.
Insuring Agreement. Summary of major requirements
imposed on the insurance company.
Exclusions. Losses or causes of loss (perils) not covered.
Conditions. Provisions that change scope of coverage.
Miscellaneous Provisions. Clauses or sections with
terms that affect coverage.
Endorsements. Provisions that expand, reduce, or
otherwise modify coverage.
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219
Question (1)
Ralph Dominguez purchased a building and
garage at 14 Main Street, Calhoon, Ontario, on
January 15 and paid $600,000 in cash and gave
a promissory note for the balance of $1.2
million.
The National Insurance Company agreed to insure
the building against all loss except flood
damage.
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Question (2)
The Insurer issued a policy with the following
Declarations Section. Do you see any problems
with it?
 Insured: R. Dominguez.
 Insurer: National Insurance Company, 140
Baylor Street, Toronto, Canada.
 Location of Insured: Main Street, Calhoon.
 Time Period:12-months.
 Premium: One percent of the purchase price.
 Limit: Purchase price.
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Reply
Problems:
 Insured: Needs property identifier, not owner.
 Location of Insured: Needs exact address
including province.
 Time Period: Needs start and end of
coverage.
 Premium and Limits Needs dollar amounts,
not verbal identifier.
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Insuring Agreement
Payment for losses. The insurer will pay for
losses from certain causes.
Restrictions on Payments. Identifies limitations
on coverage.
Provision of Services. Identifies actions other
than the payment of losses.
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Categories of Exclusions
Excluded Loss. Damage not covered by the
policy.
Excluded Peril. Damage covered by the policy
but caused by a peril that is not covered by the
policy.
Excluded People and Property. Insurer must
know who and what are covered.
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224
Question
A company bought fire insurance to cover a
factory.
• It also purchased earthquake insurance to
cover structural damage from seismic tremors.
• An earthquake caused a fire that burned down
the facility.
• Which policy covers the loss?
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Answer
In at least one case, neither policy.
• The fire policy excluded fires started by
earthquakes.
• The earth movement policy excluded fires
caused by earthquakes.
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226
Question
A fire destroys a covered car dealership during a
time when the owner is temporarily holding
$500,000 of jewelry that is normally stored in a
bank safety-deposit box. Is the jewelry covered
by the fire policy?
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Answer
No. The jewelry is an exclusion. Except for a
small amount of coverage under a business
property provisions, companies must cover
money, jewelry, rare artwork, and high value
assets with endorsements to the basic policy.
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Conditions
Insurable Interest. Payment is made only up to
the limit of the insured’s interest in property
(indemnification principle).
Duties After a Loss. Requirements for insured to
take certain actions after a loss.
Loss Settlement. Conditions for settling
disagreements between insurer and insured.
Cooperation with Insurer. Requirements for
insured to help insurer mitigate the loss.
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Endorsements
Expanded Coverage. Additional property or perils
covered.
Reduced Coverage. Property or perils eliminated
from or restricted in extent of coverage.
Modified Provision. An adjustment to any basic
term of the policy.
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Question
HPR property has special characteristics. Which of
the following apply to it?
• Danger of Loss. It has a much higher
probability of loss as compared to most other
property.
• Lower Probability of Loss. It is less likely to
suffer loss than would happen in “normal”
circumstances.
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Answer
Both apply.
• Danger of Loss. It has a much higher
probability of loss as compared to most other
property.
• Lower Probability of Loss. Insurers will not
offer policies unless extraordinary steps are
taken to make it safe. HPR machines have
superior construction, special fire protection
equipment and procedures, and management
commitment to loss prevention.
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Presentation
World Trade Center Occurrence
Prior to the 2001 attack on the World Trade
Center, a property policy had not yet been issued
when the loss was incurred.
It took many years and much litigation to resolve
the legal issues.
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233
Presentation
Hartford Steam Boiler
Insurance Contracts
for
Highly Protected Risk (HPR)
Property
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Presentation
Session 7
Underwriting and Ratemaking
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Goals in Underwriting
Insurers seek to achieve the following:
 Simplicity. Easy to understand coverage and
rates.
 Consistency. Stable rates over time.
 Flexibility. Can adjust to changing
conditions.
 Loss Control. Encourage mitigation of
losses.
 Profitability. Earn a return on capital.
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Steps in Underwriting
The process followed by an underwriter includes:
 Evaluate the Exposure. Evaluate the perils
presented by the application and the hazards
that can increase the change of loss.
 Compare the Exposure with Guidelines.
The company may prohibit some exposures,
restrict others, or limit coverages.
 Recommend or Deny Coverage. After
assessing situation, accept or reject
application.
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Insurance Ratemaking
Historical Data. What is the history of prior losses
and costs?
Frequency. What is the likelihood of r partial or
total losses?
Severity. What is the likely size of major claims?
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Approaches to Ratemaking
Class. This effort does not involve merit rating.
Schedule. An indirect and partial approach to
merit rating.
Experience. Solidly based on merit rating.
Judgment. Largely based on merit rating.
Retrospective. Solidly merit rating.
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Class Rating
Base Rate. This is a single rate per $1,000 of
coverage for similar exposures.
Average Experience. Reflects average losses
and claims for the class.
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Schedule Rating
Base Rate. Starts with a class rate.
Adjustment. Upward or downward based on the
factors in the pool compared to the general
population.
Example. Male driver under the age of 25.
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Question
Dallas has 30,000 employees covered by a health
plan.
This includes 3,000 fire fighters.
An insurance company is bidding for the medical
plan contract.
Should it use a class rating or schedule rating to
recognize the increased health exposure
represented by the fire fighters?
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Answer
Whatever the answer, we must consider:
• Historical experience and current efforts to
protect the health and safety of fire fighters.
• New regulations to protect buildings and other
property from hazards to first responders.
• Is the city is facing a deterioration in the care
and maintenance of property?
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Experience Rating
Base Rate. Starts with a class rate.
Historical. What is the claims experience?
Example: Male driver with 3 accidents.
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244
Question
Would an underwriter approve the following
request for insurance?
• Auto coverage for an 18 year old male with two
accidents in the past two years.
•
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Answer
An 18 year old male who already has two
accidents?
• The individual is likely to be both careless and
immature.
• He fails the tests for both schedule and
experience.
• The underwriter would write the coverage only if
required by state law.
•
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Question
Would an underwriter approve the following
request for insurance?
• Homeowners and flood insurance for an oceanfront clapboard home in Panama City, Florida.
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Answer
Exposed to both wind damage and storm surge.
• The underwriter might accept wind risk at a high
premium.
• Flood damage is highly unlikely only if the home
being built upon pilings.
• U.S. private insurers sell flood coverage only
because the federal government reimburses
the loss.
•
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Question
Would an underwriter approve the following
request for insurance?
• Liability insurance for a pet owner with two
Komodo dragons in an outside pen.
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Answer
The underwriter has to recognize that the Komodo
dragons sound like the real possibility of liability
exposure.
• An underwriter would check on the
circumstances of the captivity of the lizard.
• Only a specialty insurer like Lloyd’s of London
would be likely to issue a policy.
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Judgment Rating
When:
• Difficult to determine a class rate.
• No experience with prior losses.
• Unique exposures.
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251
Question
An insurer has different policies to rate an
insurance request. What is each of the
following?
 10 percent discount for no losses in past five
years.
 25 percent increase for a driver under the age
of 20.
 Rates for a line of business are set based on
the reputation of the company.
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Answer
Discount no losses in five years:
Increase under age of 20:
Reputation of company:
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Experience
Schedule.
Judgment
253
Question
Peabody Coal Company is the largest privatesector coal company in the world. An insurer is
designing a liability plan for its environmental
exposures. One insurer proposed an experience
plan based on industry statistics while another
offered only a judgment based on forecasted
policies of the Environmental Protection Agency
(EPA). What would you recommend?
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Answer
You may need both for coal mining operations.
• The company will have data on past problems.
• The company can evaluate changes in working
conditions.
• The risk manager should point out any
management efforts to avoid environmental
liability.
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Retrospective Rating
Provisional Rate. A rate set initially based upon
class, schedule, or experience rating.
Final Rate. After all costs are known, a final rate is
calculated.
Basis for the Rate. The final rate rewards the
insured or charges additional premiums.
Minimum and Maximum Rate. The insurer and
organization agree to a floor and ceiling on the
rate.
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Role Of The Senior Underwriter
While property and liability insurers have
thousands of underwriters, the role of the senior
underwriter is critical to the success of an
insurance company’s solvency. This individual
plays a key management role across all lines of
business for the company.
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Financial Issues in Underwriting
Adequate Cash Flows. An insurance product
must cover losses, adjusting and operating
expenses, and provide a return on capital.
Adequate Equity. A product must have sufficient
contributed capital and surplus to support the
level of underwriting.
Adequate Profits. The product must generate an
appropriate after-tax reported income.
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Desirable Product Lines
Sound Underwriting Practices. Premiums and
other income should provide adequate funds to
pay claims.
Sound Investments. Insurer should invest funds
in a balanced relationship of risk and return.
Cost Control. Departments need processes to
control marketing and other costs.
Internal Auditing. The insurer should monitors
payments and claims.
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Underwriting Risks
Underwriting Itself. The act of issuing an
insurance policy involves costs and claims in an
uncertain world.
Investment Risks. Premiums are invested with
variable expected earnings.
Changing Circumstances. What will happen with
economic levels, climate, pollution, and other
factors.
Changing Legal Conditions. Legislation and
regulation pose risks.
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Financial Risks
Liquidity. This viewpoint seeks highly safe and
liquid assets to cover claims, and meet other
obligations for issuing and serving policyholders
and paying or otherwise resolving claims.
Profitability. This viewpoint encourages the
insurance company to monitor its ability to
achieve adequate returns for accepting risks.
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Senior Underwriter Background
Work Area
Insurance carrier
Insurance broker
Other insurance services
Consultant
Finance
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Percent
60%
10%
10%
10%
10%
262
Senior Underwriter Mobility
Years at Current Firm
Up to 5 years
5 to 10 years
11 to 20 years
Over 20 years
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Percent
15%
30%
20%
35%
263
Senior Underwriter Education
Credential
Percent
Undergraduate Degree
100%
Graduate Degree
70%
Professional Designation
90%
Took continuing education
seminars in past 3 years
80%
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Question
What is the significance of the estimates on the
educational credentials of senior underwriters?
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Answer
Educational Credentials. Successful
underwriters have them.
Continuing Education. They try to keep up with
new developments.
Graduate Degrees. Many have them.
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Advanced Underwriting Skills
Financial Qualifications. Cash flow
management, profit planning, and the
investment of capital in a risk and return
framework.
Technical Skills. Role of probability and statistics.
Broad Business Skills. Understanding of
management, marketing, and business
operations.
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Question
What is the significance of the statistics on the
compensation of underwriters after 10 years and
25 years of underwriting experience?
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Answer
Compensation for underwriters is relatively good
at earlier ages and advances, but does not
seem to advance rapidly after reaching a certain
level.
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Question
What do large insurance companies seek when
they hire entry-level underwriters?
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Answer
Large insurers may seek college graduates with a
strong work ethic.
• An MBA is a plus.
• So is experience in the insurance field.
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Presentation
Lloyd’s of London,
A Premier Insurance Marketplace
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Presentation
Day 3
Liability Law and Coverages
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Presentation
Session 8
Property Insurance
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Property Risk
Property contracts cover two categories of risk:
 Direct Loss. This occurs when the property
suffers the loss. A fire that damages a
building is a direct loss.
 Indirect Loss. This occurs when the loss
results from the consequences of property
loss. A factory is damaged and the company
suffers a loss because it is unable to
manufacture and ship goods.
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Disruption Risk
Disruption risk refers to losses that arise from an
interruption to normal business activity. It takes
two forms:
 Lost Profits. The company cannot deliver
products or services and suffers a drop in
earnings.
 Extra Expenses. The company must pay
additional costs to operate after a loss.
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Managing Property Risk
The most common risk management approach to
property risk has the following components:
 Loss Control. Take steps to make the
property safe for employees, others, and the
asset itself.
 Deductible. A requirement under an
insurance policy that limits coverage to a loss
above a specified minimum level. Also called
a retention.
 Insurance. Transfer large exposures.
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Real and Personal Property
Real Property. Rights, interests, and benefits
inherent in the ownership of land or buildings,
including houses, sheds, fences, landscaping,
air rights and easements.
Personal Property. Other property such as
furniture, machinery, vehicles, inventory, and
movable assets.
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Question
A policy insures real and personal property at an
insured location.
• The owner rented a bulldozer to repair the
parking lot.
• He knocked down a wall of the building.
• The accident destroyed a computer owned by a
tenant in the building.
• The bulldozer was also damaged.
What damage is covered by the policy?
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Answer
Building. Covered as real property.
Computer. Not covered, as personal property
neither owned by or in the care of the insured
nor owned by an employee.
Bulldozer. Covered as personal property in the
care of the insured.
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Commercial Property
Broad categories of assets:
• Buildings. Structures and their permanently
installed contents.
• Fixtures. Assets firmly attached to a building as
a permanent structural part. High-cost fixtures
may or may not be covered.
• Business Personal Property. Individual items
owned by or in the control of the company.
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Buildings
• Completed Building. Structures that are
occupied or ready for occupancy.
• Partial Building. A structure under
construction.
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Business Personal Property
• Furniture. For use in the business.
• Equipment. For use in the business.
• Removable Fixture. Not permanently attached
to the building.
• Controlled Property. Assets owned by others
but in the control of the property owner.
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Question
Identify each of the following as “building” or
“business personal property:”
• Built-in bookcase.
• Owned computer.
• Leased computer.
• Central air conditioning unit.
• Cubicle.
• Sign in front of office.
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Answer
•
•
•
•
•
•
Built-in bookcase.
Building
Owned computer.
Personal
Leased computer.
Personal
Central air conditioning unit.
Building
Cubicle.
Is it attached?
Sign in front of office
Is it attached?
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Question
A company is located next door to a college that
offers evening courses. The company allows
students to park their vehicles in its garage after
office hours. No charge is made to the students.
The roof collapsed and damaged six cars. Are
they likely to be covered by the company’s
insurance?
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Answer
Not likely. Since the cars are not business
personal property under the control of the
company, it is not likely that they qualify for
coverage.
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Question
A factory has a crane that is attached to the ceiling
and can move components among different
assembly lines. It can serve assembly lines that
are movable in flexible configurations. Are the
crane and assembly lines covered as part of the
completed building?
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Answer
The crane is covered as a permanent fixture.
Movable equipment sitting on the floor of a
factory is not part of the building.
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Property Insurance Forms
All-risk. All losses to the identified property are
covered, unless excluded.
Named Perils. Limits coverage to losses from
specified causes.
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Question
An insurance contract protects a construction
warehouse from fire and other perils.
• A separate flood policy covers water damage.
• Both policies exclude earth movement.
• Hurricane Sandy caused mud to slide down a
hill and damage the warehouse.
• The insurer denied the claim based on the
earth movement exclusion.
Would a court uphold the exclusion?
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Answer
Apparently a lawyer thought so. Upon advice from
counsel, the company accepted a settlement
that did not cover full damage.
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Property Insurance Coverage
Property insurance coverage can be:
 Specific Coverage. A policy may apply to a
single property.
 Blanket Coverage. Applies to multiple units.
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Question
Insurance covered 280 Oak Street and its 12 units
with a policy limit of $600,000.
• units were identified as units 1A, 1B, 1C, 1D,
2A, 2B, 2C, 2D, 3A, 3B, 3C, AND 3D.
• A storm caused damage of $250,000 to unit
1C, $300,000 to unit 2B, $150,000 to unit 2D,
and $400,000 of damage to unit 3A.
How much can the owner collect from the insurer?
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Answer
The owner appears to be entitled to collect the full
loss from each unit.
• Since the units were identified individually, a
court would be likely to rule that the $600,000
limit applied to each property.
• Listing the assets indicates that the insurer
intended to provide a separate coverage for
each unit.
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Question
An insurance policy covers the contents of a
warehouse identified as lawnmowers and
gardening equipment.
• The contents changed to snowmobiles and
snow throwers.
• Three months later the building burned down.
• The insurer denied the claim.
Will a court uphold the denial?
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Answer
Probably not.
• The policy is a blanket coverage for items in a
specific location.
• As long as the contents were not the source of
destruction, the blanket policy is likely to apply.
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Property Indemnification
• Actual Cash Value. Replacement cost minus
ordinary wear and tear.
• Replacement Value. Cost of replacing a
damaged asset with a comparable asset.
• Agreed Upon Value. Amount of insurance
coverage when the insured and insurer agree
on a reasonable amount for the coverage.
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Weaknesses of Actual Cash Value
Actual cash value method is not recommended.
• Indemnity Principle. It may not restore the
pre-loss condition.
• Calculation. The insured does not know in
advance the post-loss position.
• Settle of Claim. It set up a possible
disagreement with an insurer after a loss.
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Question
A computer system is destroyed by a power
surge.
• It is insured for its actual cash value.
• It was purchased for $3 million 5 years ago
when it had an estimated service life of 15
years.
• Replacement cost today will be $6 million
including upgrades.
What is the actual cash value?
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Answer
Maybe
• Straight-line depreciation would result in $2
million ($3 million times 10/15).
• Policy does not cover upgrades unless they are
included in an endorsement.
• Lesson Learned. Never buy an actual cash
value policy.
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Question
A painting by a 16th century Italian artisan was
purchased 12 years ago for $1.2 million plus a
10% auction commission.
• Three works by the same painter recently sold
at auction for $2.6, $3.2, and $6.5 million.
• The company wants $7 million in insurance
coverage.
• Is it likely than an insurer would provide it?
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Answer
It is possible.
• The insurer would probably appraise the
painting.
• If the market indicates that prices for the
painter’s work are rising, $7 million could be an
agreed upon value.
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Policy Limits
The policy limit for a property insurance policy
may be expressed two ways:
Per Occurrence. The policy limit applies
separately to each cause of loss.
Aggregate Policy Limit. The policy limit applies
to the total of all losses within the policy period.
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Question (1)
An insurance policy covers 15 hotels in 6 cities:
• $600,000 limit of liability in single occurrence.
• $1.2 million annual aggregate limit of liability.
• $200,000 deductible per occurrence.
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Question (2)
A windstorm in Brazil causes the following
damage covered by the policy:
Hotel #1: $400,000. Hotel #2: $500,000
A tidal wave in Argentina causes the following
damage covered by the policy:
Hotel #3: $800,000. Hotel #4: $350,000.
What is the likely reimbursement from the policy?
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Reply
#1:
#2:
#3:
#4:
$200,000
$400,000
$600,000
Zero
($400 loss - $200 deductible)
(No deductible same occurrence)
($800 – $200 deductible)
(already at $1.2 limit)
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Question
A full-year policy covers a building with a limit of
$200,000 and a deductible of $25,000.
• In May, a fire causes damage of $150,000.
• In October, a second fire causes additional
damage of $250,000.
How much will the policy reimburse?
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Reply
On an aggregate basis, reimbursement is the
$200,000 policy limit.
If per occurrence, the reimbursement is $300,000:
• May fire: $125,000 (150,000 – 25,000)
• October fire: $175,000 (200,000 – 25,000)
• Total:
$300,000
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Property Excluded
Common exclusions :
• Liquid Assets. Securities, and precious metals.
• Unimproved Land.
• Living Objects. Animals, trees, crops.
• Mobile Units. Vehicles, watercraft, and aircraft.
• Separate Risks. Mines, shafts, dams.
• Transit Property. Passing through or
temporarily stored on the premises.
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Question
The owner of an insured location drove his car into
the parking lot of the location.
• He was pulling a boat on a trailer.
• In the cabin on the boat was a rare and
threatened species of parrot and a Rolex watch
valued at $7,000.
• A gas line explosion destroyed the boat, bird,
and watch.
• Are the items covered?
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Answer
Boat. Excluded as a mobile unit.
Parrot. Excluded as a living object.
Watch. A transit item excluded.
• May also be a jewelry exclusion.
• If owned by others but in the control of the
property owner, it could be included as
business personal property.
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Debris and Demolition Insurance
Additional coverages in property insurance
policies:
 Debris Removal. Transporting and disposing
of damaged property.
 Contamination. Restoring property to a safe
condition.
 Demolition. Destroying parts or all of the
property prior to rebuilding it.
 Mandated Upgrades. Improving the property
to meet new laws or government regulations.
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Exercise
An insurance policy on a refinery covers removing
debris and decontamination of from an insured
loss at the insured location.
A fire caused debris in the refinery and also on a
pier owned by the port administration.
Burning chemicals polluted the refinery and two
ocean-going ships docked at the refinery.
Does the policy cover these losses?
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Response
The policy covers only the property at the insured
location.
Damage to the pier and ships owned by others are
liability exposures.
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Business Interruption Insurance
A consequential loss refers to an indirect
economic loss resulting from a different and
direct loss. Business interruption is an example.
Insurance can cover two indirect losses:
 Loss of Income. A portion of income while
property is being repaired.
 Extra Expense. Additional costs as a result
of the consequential loss.
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Question
A company lost $3.5 million last year. It hopes for
a profit of $7-10 million this year.
• It suffered a fire on its main manufacturing
plant.
• The company calculates its lost income at $1.2
million and its extra expenses at $500,000.
• The company has a business interruption policy
with a limit of $3 million per occurrence.
How much should the insurer pay?
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Answer
• Not able to tell from the information given.
• A loss in the prior year is a problem. If the
current year loss is larger than it would
otherwise be, collection may be possible.
• $500,000 if it can document the extra
expenses, separately from the loss.
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Contingent Interruption
Consequential damage from loss to property not
owned or controlled by the insured. Categories:
 Supplier. Damage stops a supplier from
providing goods to be sold by the insured.
 Customer. Damage stops a customer from
buying goods or services from the insured.
 Other. Damage to a related business that
attracts customers to the insured.
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Question
A manufacturer of souvenirs has an inventory of
$2 million for a sporting event.
• Likely sales should exceed $3 million.
• A labor strike delayed the event.
• Then, a fire caused it to be cancelled.
• The manufacturer has a contingent interruption
policy with a limit of $1 million per occurrence.
Is the loss covered by the policy?
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Answer
Yes.
• The issue is one or two occurrences.
• Obligation is to liquidate the goods as best
possible.
• After liquidation, calculate the loss.
• Coverage could be $1 or $2 million.
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Question
In October 2010, a New Jersey company
experienced a crash of the hard drive of its
primary business computer. The files were
totally backed up at an off-location site. The
company contacted Dell and ordered a rush
shipment of a new drive. What was the
promised delivery date for the computer
component?
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Answer
April 2, 2011, five months later.
• Floods in Thailand seriously damaged the
factory that made the hard drives.
• Dell did not have adequate inventory from other
locations to fill the order on an emergency
basis.
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Presentation
Session 9
Legal and Contractual Liability
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Legal Liability
An exposure to compensate another party for a
loss or damage:
• General Liability. Facing everyone from
individual agreements and business operations.
• Professional Liability. Exposures that arise
from possessing unique skills and training.
• D&O Liability. Facing officers and board
members of organizations.
• Employer Liability. Created by the employer
and employee relationship.
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General Liability
• Contractual Liability. Covers oral and written
agreements that can be enforced in the courts.
Party that fails to perform is exposed to the
payment of damages or requirement to
perform.
• Tort Liability. Covers alleged wrongful act or
omission that violates another party’s rights or
causes that party damage. The aggrieved party
can sue for compensation.
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Contractual Liability
Failure to adhere to the terms of a contract.
Agreement. Two parties mutually agreed to
engage together.
Consideration. They exchange assets or other
elements that have value.
Performance. A disagreement arises.
Enforcement. One party sues for compensation
or performance.
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Breach of Contract
A breach of contract occurs when one party does
not fulfill obligations under a contract.
• Minor Breach. This level of failure to perform
can be remedied in various ways while the bulk
of the contractual commitments remain in
place.
• Material Breach. This is more significant. If
upheld by a court, it allows one party to compel
performance or collect damages.
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Remedies for Breach of Contract
Monetary Damages.
 If possible, the judicial remedy is to award
money.
Specific Performance.
 When money is not sufficient, a court may
order the breaching party to perform a
specific act.
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Question
A contractor was building a home for a man who
just lost his mother.
• The owner gave him $1,000 and an urn that
contained his mother’s ashes. “She loves this
property. I want her ashes buried in the
concrete.”
• The contractor agreed but forgot to do it.
• He gave the ashes back to the owner.
• The owner sued for breach of contract.
• How will a court rule?
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Question
In the previous question, could the court also
award additional money because the contractual
violation caused emotional distress?
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Discharge of Contracts
Discharge refers to the point at which all
contractual obligations end. It arises from:
 Operations of Conditions. A change in the
situation.
 Performance. Task is finished.
 Breach. One party fails to perform.
 Impossibility. Cannot be performed.
 Agreement. Parties change their minds.
 Operation of Law. Legal stoppage.
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Question
Following Hurricane Katrina, an insurer received
thousands of claims for storm damage.
• The policies required insurers to begin
adjusting claims within 30 days.
• The company failed to comply.
• 18,000 insureds filed for immediate payment.
• Should the court require immediate payment of
all claims without verifying the losses?
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Answer
• A trial court awarded $104 million to be paid
immediately.
• The state and U.S. supreme courts agreed.
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Legal Fees
The legal fees involved with settling insurance
claims can be prohibitive. As a result, many
lawsuits are settled before they proceed to court
even when the claim is not likely to produce a
positive result for the plaintiff.
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Question
Two twin sister faculty members caused so much
trouble the college suspended them with one
year left on their contract.
• The college offered to pay each of them for the
full contract year.
• They refused the money and sued.
• Dozens of depositions were taken.
• The case went to a jury verdict.
What happened?
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Answer
The jury awarded the plaintiffs the salary
remaining in the contract.
• The jury took three hours to reach a verdict.
• No damages were awarded.
• The college paid $460,000 in legal fees and
deposition costs.
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Question
A plaintiff filed a lawsuit alleging bad faith because
the defendant’s insurer spent nearly $1 million
on attorney’s fees defending the claim for less
than $100,000.
• The plaintiff argued that the insurer pursued a
“bad faith litigation strategy” seeking to
discourage the filing of small value claims.
• Will the court agree?
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Answer
It did not agree. The insurer is allowed to verify the
extent of loss and the remedy to indemnify the
insured and insist upon proper documentation to
support all claims.
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Question
Police raided a medical marijuana greenhouse
and seized 15 large marijuana plants.
• The landscaper filed an insurance claim alleging
“theft” of inventory.
• The insurer denied the claim.
• The landscaper filed a bad faith claim against
the insurer.
What happened?
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Answer
The court upheld the insurer.
• The’ seizure pursuant to a search warrant was
not a “theft.”
• It was not bad faith deny the claim prior to
possible criminal action.
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Situation
A French company built a factory to produce
televisions in China. A Chinese company
agreed to a 3-year contract to supply cardboard
as packing material. A month before the start of
the contract period, the Chinese company sent
a letter indicating it would not supply the
cardboard. It had a more profitable contract to
sell the cardboard in Australia.
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Question
The French company signed a new 3-year
cardboard agreement at a higher price with a
Korean company. Six months later the Chinese
company advised the French company that it
would start delivery under the contract in one
week. The French company balked and the
matter was referred to the office of the governor
of the province. What was the outcome?
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Answer
The governor upheld the contract and demanded
that the French company accept and pay for the
Chinese cardboard.
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Question
Assume the governor took the position that the
contract was valid and the French company
must accept and pay for the cardboard from the
Chinese company. What should be the reply of
the French company?
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Answer
Many options:
 Close the plant?
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Answer
Many options:
 Close the plant.
 Call the French embassy?
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Answer
Many options:
 Close the plant.
 Call the French embassy.
 Cancel the Korean contract?
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Answer
Many options:
 Close the plant.
 Call the French embassy.
 Cancel the Korean contract.
 Hire armed guards to block delivery of the
cardboard?
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Answer
Many options:
 Close the plant.
 Call the French embassy.
 Cancel the Korean contract.
 Hire armed guards to block delivery of the
cardboard.
 Pray to Buddhist gods?
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Answer
Many options:
 Close the plant.
 Call the French embassy.
 Cancel the Korean contract.
 Hire armed guards to block delivery of the
cardboard.
 Pray to Buddhist gods.
 Pray to French gods?
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Answer
Many options:
 Close the plant.
 Call the French embassy.
 Cancel the Korean contract.
 Hire armed guards to block delivery of the
cardboard.
 Pray to Buddhist gods.
 Do the French still have gods?
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Question
Assume the French company ran out of options
and had to accept and pay for the cardboard.
Further assume that the French company told
the Korean supplier that the cardboard was no
longer needed and the Korean supplier sued for
performance or damages. Can it collect?
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Answer
Yes if it sues in a Korean or French court. Not
likely if it sues in a Chinese court.
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Question
Assume the French company went to a Chinese
court and lost the case on legal grounds. What
legal ground exists in China to support the
position of the governor?
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Answer
Possibilities in China:
 Contracts are interpreted in a framework of
mutual benefit. It is acceptable to adjust
business agreements when conditions
change.
 A contract may be voided when compliance
becomes difficult or costly or the initial
purpose is frustrated by subsequent events.
 Chinese law allows voiding of contracts that
harm China. A loss of jobs is harmful.
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Presentation
Session 10
Tort Liability and Negligence
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General Torts
Common torts are:
 Negligence. A party accidentally or
unintentionally causes harm .
 Intentional Tort. A party deliberately violates
the rights of another party.
 Strict Liability. A violation of a legal
obligation to exercise care.
 Privacy or Defamation. A violation of the
privacy rights or reputation of another party.
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Question
A woman was sitting in a car in a parking lot with
her blinker flashing.
• She was waiting for a car to pull out.
• Another car pulled in front and took the space.
• The other driver laughed and walked away.
• She rammed her car into the newly parked car.
• The man sued her for negligence.
Will he win?
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Answer
Yes but not for negligence. The damage was
caused by an intentional tort.
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Business Torts
Common business torts are:
 General. Losses incurred from business
operations.
 Employer. Injuries incurred by workers in the
course of performing their duties.
 Product. Failure of a product or service to
perform as advertised.
 Professional. Harm from faulty services.
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Quirks in U.S. Tort Liability
Accompanying legal liability in the United States
has been a tendency to use the courts to pursue
goals not strictly related to reimbursing tort
losses. We have many examples of odd
behavior.
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Question
Two lawyers in a Florida federal courtroom were
unable to agree on the location to depose a
witness. The choices were a building where
both had offices and conference rooms or the
nearby office of a court reporter. They brought
the issue to the judge for a ruling. What action
do you think was taken by the judge?
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Answer (1)
The judge stated that it was not part of the job of a
federal judge to make such a ruling. He ordered
them reach a decision by playing a game of
rock-paper-scissors on the front steps of the
federal courthouse in Tampa. The two men
quickly agreed on where to meet for the
deposition.
New York Times, June 9, 2006
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Answer (2)
D. Lee Craig, one of the lawyers, declined to
speak to the New York Times reporter. The
week before the ruling, Mr. Craig paid a
“compliment” to David Pettinato, the opposing
lawyer. ''Apparently you think it is in your client's
interest to create as much misery and bad
feeling as you are able,'' Mr. Craig wrote in a
letter. ''In those endeavors, you are most able.''
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Answer (3)
David Pettinato got into the swing of things before
the two lawyers reached their agreement. He
said he asked his daughters, 5 and 9 years old,
how to play. They suggested opening with rock.
He agreed saying his “case is solid as a rock.
Matti Leshem, a spokesperson for the USA
Rock Paper Scissors League, the governing
body of the sport headquartered in Los Angeles,
said two-thirds of lawyers open with paper.
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Answer (4)
Mr. Leshem offered to officiate the match. ''What I
don't want,'' he said, ''is some rogue element of
rock-paper-scissors coming down from the
bench. When the law takes rock-paper-scissors
into its own hands, mayhem can occur.''
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Question
Nebraska state senator Ernie Chambers sued
God to prove a point about frivolous lawsuits.
He wanted legislation to prohibit filing certain
types of suits. He sought a permanent injunction
against God saying He has inspired fear and
caused "widespread death, destruction and
terrorization of the Earth's inhabitants.“ Did the
court award the injunction?
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Answer (1)
No. The judge dismissed the lawsuit saying the
Almighty wasn't properly served because of his
unlisted home address. (10/16/2008)
Chambers appealed, claiming he found a hole in
the judge's ruling.
 The court acknowledges the existence of
God.
 This is a recognition of God's omniscience.
 Since God knows everything, God has notice
of this lawsuit.“ Did he win on appeal?
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Answer (2)
No. The Court of Appeals did vacate the lower
court ruling. It then dismissed the lawsuit itself
ruling that courts decide real controversies and
do not address abstract questions or
hypothetical or fictitious issues. (February 9,
2009)
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Question
A man was eating escargot in the Seafood Peddler
restaurant in San Rafael, California.
• He injected his cocktail fork into a snail.
• A spray of hot garlic butter hit him on the face.
• He continued eating a fish filet and lobster dinner.
• Then he alleged suffering temporary vision impairment.
• He claimed to be humiliated on his birthday and
demanded damages from the restaurant.
Does it have to pay?
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Answer
The restaurant and its insurer refused to pay.
 The man filed a lawsuit in small claims court.
 The judge scheduled a trial for December
2010.
 At the trial he dismissed the lawsuit.
 The restaurant reported that sales of the
escargot appetizer soared with the publicity of
the lawsuit.
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Sovereign Immunity
In common law jurisdictions:
 The government cannot commit a legal
wrong.
 It is immune from civil suit or criminal
prosecution.
 In many cases, the government has waived
this immunity.
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Question
Springfield State Hospital and St. Joseph’s
Hospital jointly administered a well-baby clinic.
• A health care provider administered the wrong
medication to an expectant mother causing
severe disability to a newborn child.
• The mother sued both hospitals for negligence.
• Is it likely that the hospitals will be ordered to
pay damages awarded by a court?
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Answer
The court will decide what to do.
• St. Joseph’s is a private institution and has no
exemption from being sued.
• Springfield is a public hospital. It can avoid a
trial if statutory law has not waive sovereign
immunity for state institutions.
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Negligence
This is a failure to behave with the level of
care that someone of ordinary prudence
would have exercised under the same
circumstances.
It is causing damage to another party as a
result of carelessness, not intentional
harm
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Conditions of Negligence
• Behavior. An individual or organization failed
to behave in a reasonable manner.
• Duty. The party had the duty to perform
reasonably and did not exercise a proper
degree of care in a given situation.
• Harm. The behavior caused harm to another
individual or property.
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Source of Negligence
The failure of a party to exercise a proper degree
of care in a given situation. It can arise from:
 Imprudent Behavior. A party fails to behave
as a reasonably prudent individual.
 Commission. A careless or thoughtless act.
 Omission. A failure to perform an act that
would be performed by a reasonable person.
 Legal Decision. Normally determined by a
court or arbitrator.
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Acts of Negligence
• Positive Voluntary Act. Occurs when a party
commits an imprudent act.
• Failure to Act. Occurs when a party does not
make a reasonable attempt to avoid harm to
another party.
• Vicarious Act. Occurs when negligence is
attributed to one party as a result of the act of a
different party.
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Question (1)
A teenager purchased a lift ticket:
• She signed a waiver of all rights.
• She acknowledged that skiing is a dangerous
sport.
• She said she accepted all risks.
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Question (2)
At the top of the mountain, a sign read “Closed
Trail. Dangerous Area. Do not Enter.”
• The sign had been knocked over and was lying
the snow.
• The teenager entered the closed area and was
seriously injured.
• She filed a lawsuit against the ski area, alleging
negligence.
• Did she win?
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Answer
Many such lawsuits are brought and some are
won.
 Consent. If yes, did the skier agree to accept
the risk even if negligence is involved?
 Waiver. Did the absence of the sign waive
the right of the ski area to enforce the
consent?
 Enforcement. Can an individual waive the
right to sue for negligence?
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Elements to Prove Negligence
Unreasonable Behavior. Evidence is presented
to demonstrate unreasonable behavior.
Duty and Failure to Act. A party had a legal duty
to act or not act and failed to fulfill the duty.
Occurrence of Loss. The plaintiff suffered
damage such as injury or financial loss.
Proximate Cause. The plaintiff must show a
cause and effect relationship between the act
and the loss.
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Question (1)
A repairman waited in a hotel entrance for delivery
of a replacement part.
• Two hotel employees were smoking, as was
the repairman.
• The repairman tossed a lighted cigarette to the
ground near an oxygen container left by a
departed guest.
• A few minutes later, a fire started under the
oxygen container.
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Question (2)
• In a few seconds, the container exploded
causing the three men to run into the street to
avoid an expanding fire.
• As they ran, one of the hotel employees was hit
by a bus and knocked to the ground.
• The second employee stopped to call his wife
on a cell phone.
• Then, he went to help his fellow worker.
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Question (3)
• While he was ministering to the injured man, a
car struck the uninjured worker and killed him.
• A lawsuit for wrongful death was filed, alleging
negligence on the part of the repairman.
Was anyone negligent?
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Answer
The discussion should be tested against:
• Negligent Behavior. Was it negligent to toss
the cigarette?
• Existence of Loss. A loss certainly occurred.
• Proximate Cause. Did the cigarette cause the
fire? Was the reaction to the explosion the
cause of the death?
• Linkage. Does the cell phone call break the
natural and continuous sequence of events?
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Question
A man and woman were having an argument in a
mall. The man entered a store and was making
a purchase.
The woman entered the store carrying a gun and
shot the man and a store clerk. Later, the clerk
sued the store, the man and the woman for
negligence. Was anyone negligent?
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Answer
For the store or man:
 Duty to Act. Possible but not obvious.
 Failure to Act. Not obvious.
 Occurrence of Loss. Yes.
 Proximate Cause. Not obvious.
For the woman:
 Not negligence. An intentional tort. Criminal
charges.
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Question
A man was walking through a parking garage
when he was attacked by two large dogs.
• An employee of the garage owner saw the
attack but did nothing.
• A pedestrian kept on walking.
• The man was seriously injured.
• He sued the garage owner, the employee, and
the pedestrian for negligence.
Did negligence occur?
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Defenses to Negligence Claims (1)
A defendant may argue:
Assumption of Risk. That a party has accepted a
risk and must accept the consequent loss.
Contributory Negligence. That a party is partly
responsible for the loss.
Last Clear Chance. That a party had one final
opportunity to avoid an accident caused by
negligence but failed to act.
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Defenses to Negligence Claims (2)
A defendant may argue:
Statutory Immunity. A law prohibits a negligence
lawsuit.
Comparative Negligence. Negligence should be
apportioned to two or more parties.
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Question (1)
Harry Wallace, a limousine driver, was
transporting a client to the airport.
• As requested by the client, Harry was driving
100 MPH(160KPH) in a 55 MPH(80KPH) zone.
• A dog ran in front of the car and caused an
accident.
• The dog was killed and the client was injured.
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Question (2)
• The dog owner sued the limousine company
and Harry, alleging negligence.
• The passenger (client) sued the limousine
company, Harry, and dog owner, alleging
negligence.
• Harry sued the dog owner for negligence,
claiming that the dog should not have been
crossing the highway.
Who is likely to win the lawsuits?
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Answer
Issues are:
 Harry. Negligence per se. 100 MPH in a 55
MPH zone sounds like negligence.
 Limousine Company. Negligence per se.
Responsible for Harry’s actions.
 Dog Owner. Contributory negligence. Dog
should not be on highway.
 Passenger. Contributory negligence.
Encouraged speeding.
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Question (1)
Leonard Lemieu, a 68-year old retired airline
executive, left a cruise ship in Colombia and
took a helicopter ride to the central Andes.
Before leaving the vessel, he signed a waiver of
all risks.
When the helicopter landed, a threatening group
of men walked toward it. Leonard yelled to the
pilot to take off but the pilot ignored the request.
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Question (2)
When the men got to the helicopter, they asked
Leonard for money. He refused the request and
argued with the men. The men grabbed Leonard
and led him away.
Leonard was taken to a shed where he was
beaten and robbed. Then, the men left.
Leonard caught a bus to Bogotá and reported the
crime. The police told him that the country
prohibited lawsuits in situations of kidnapping.
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Question (3)
When Leonard got back to his home in Belgium,
he sued the cruise line for negligence.
What defenses can be raised by the cruise line?
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Answer
Assumption of Risk. He signed a waiver.
Contributory Negligence. He should have given
the money and not argued.
Last Clear Chance. The pilot should have taken
off.
Statutory Immunity. It happened in Columbia
where such lawsuits are prohibited.
Comparative Negligence. Leonard and others
were partly responsible.
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Question
A restaurant left rat poison next to a dumpster on
the property of an adjacent grocery store.
A neighbor’s cat ate the poison. The cat
wandered away from the poison and was hit by
a car.
The owner of the cat filed a criminal complaint with
police against the grocery store and restaurant.
He also filed a lawsuit demanding $10,000 for
the loss of a companion. Is either complaint
valid?
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Answer
Criminal action does not appear to be valid in the
absence of a specific statute.
Civil lawsuit is a question of fact. Is it prudent to
place poison in a semi-public area?
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Exceptions to Negligence Liability
Varies by national laws. Common exceptions:
 Mental Incapacity. A party that lacks
capacity to understand prudent behavior.
 Children. Laws provide exceptions for certain
ages with respect to prudent behavior.
 Governments. Laws may provide immunity
to government agencies.
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Exceptions to Negligence Liability
Varies by national laws. Common exceptions:
 Mental Incapacity. A party that lacks
capacity to understand prudent behavior.
 Children. Laws provide exceptions for certain
ages with respect to prudent behavior.
 Governments. Laws may provide immunity
to government agencies.
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Absolute or Strict Liability
Occurs when an injured party receives damages
without anyone being at fault.
 Hazardous Activities. When an activity is
inherently dangerous, strict liability may be
enforced.
 Statutory Liability. A law may impose strict
liability, as often happens when employers
are responsible for employee injuries.
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Question
Sam Wong was walking down the street in Montreal when
he was attacked by a Bengal tiger. He was severely
injured and sued the owner.
In court, the owner testified that he would never have
allowed the tiger to be in a position to attack anyone.
Further, the owner proved the following:
 He was in Turkey at the time of the attack.
 He left the tiger in the care of a veterinarian and paid
for the care.
 He warned the vet that the tiger was dangerous and
had to be locked up.
Was the owner negligent?
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Answer
Could be strict liability:
• A hazardous event.
• No one at fault.
• Owner or vet accountable.
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Presentation
Session 11
General Liability
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General Liability Policy
In the United States, a commercial general
liability (CGL) insurance policy covers:
 Damages. Insures companies from losses
from general liability exposures.
 Duty to Defend. Pays the costs of defending
the company against liability claims and legal
fees.
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CGL Liability Damages
The CGL policy covers three categories of
lawsuits:
 Bodily Injury. Individuals harmed by the
organization. Includes sickness and disease.
 Property Damage. To tangible assets of
other parties.
 Personal or Advertising Injury. Malicious
prosecution, libel, slander, copyright
violations.
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CGL Insureds
• Individual. The owner or operator.
• Partners. Any or all of the named partners.
• Corporation. The entity itself plus officers,
directors, and employees.
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Question
A CGL policy covers Joseph Detouro as an
individual tax accountant.
• Joseph’s wife Maria does not work in the
accounting office.
• Anna is a receptionist in the office.
• Anna spills coffee on a client who sues Joseph,
Maria, and Anna.
Are these individuals insured persons for
purposes of the policy?
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Answer
All are insureds. Joe as the individual insured,
Maria as the spouse, and Anna as an employee.
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CGL Coverages (1)
The CGL policy covers lawsuits from:
• Premises. A person’s physical presence on
property owned or operated by the insured.
• Operations. Business activities on or off the
premises.
• Products. Alleged harm from faulty products
produced or sold by the insured.
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CGL Coverages (2)
• Contractual Liability. Allegations of breach of
contract.
• Completed Operations. Allegations that work
done in past periods is faulty.
• Contingent Liability. Allegations from a
relationship with the insured.
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Question
A realtor owns a building leased to a law firm.
• The law firm is responsible for maintaining the
property in a safe condition.
• A client tripped on a loose carpet and fell down
the stairs.
• He sued the realtor and law firm.
• Do the realtor’s and lawyer’s CGL policies cover
the exposure?
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Answer
Yes. It is a premises exposure.
• The realtor may be able to sue the law firm for a
contractual violation of the lease as a result of
allowing a loose carpet at the top of stairs.
• The realtor’s insurer may sue the lawyer for any
claim paid under the legal principle of
subrogation.
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Question
A maintenance employee is installing wiring on the
premises of a customer.
• He falls off a ladder breaking his leg.
• He landed on a woman who required
hospitalization for internal bleeding.
• She sued the customer and Cablevision.
Does the building’s CGL policy cover damages
from injury to the repairman and woman?
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Answer
The CGL policy:
 Covers damages awarded to the woman as a
result of her injuries.
 Covers any damages owed the customer if
the company loses the lawsuit.
 Does not cover injury to the repairman. That
is covered by employer liability laws or
policies.
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Question
Six travel agents are organized in a travel agency.
• They bought chairs for the office.
• A grandmother brought her granddaughter to
the office to book a vacation.
• When the grandmother sat down, the chair
broke and she was seriously injured.
• The family sued the agency.
Does the agency’s CGL policy cover any
damages?
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Answer
Yes. It is a products liability failure.
• By setting up the product, the agency gave an
unwritten promise that a product is fit for its
intended use.
• The agents and agency are covered for
damages.
• The insurer can sue the manufacturer of the
chairs for reimbursement of damages and legal
fees.
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CGL Coverage Forms
A CGL policy can be issued using two forms:
• Occurrence. A single event that causes a loss.
Covers injury or damage that occurs during the
policy period even if a claim is not made during
the period.
• Claims-made. Covers claims made during the
policy period regardless of when the injury
occurred.
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Occurrence Definition
Dealing with occurrence and claims-made forms
can be tricky. The definition varies widely.
• Time Period. The term can refer to all losses in
a fixed period, such as 72 hours.
• Single Source. An occurrence of loss can be
defined as coming from a single event.
• Silence. Sometimes policies are silent on the
definition.
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World Trade Center
The World Trade Center lessee insured the twin
towers for $3.6 billion, half of the replacement
cost. On 9/11 no policy had yet been written.
Two property forms were under consideration.
• Form #1. Occurrence as any loss from a single
cause within a specified time period.
• Form #2. Occurrence not defined in this form.
Was the loss of the twin towers one or two
occurrences?
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Answer
The parties were not able to agree on the form
that would eventually have been used.
• The developer took the matter to court twice.
• After many years, some insurers paid for one
occurrence while others paid for two.
• Total reimbursement was $4.6 billion.
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Claims-made Policy
A problem can arise with the renewal of a claimsmade policy.
• Suppose an insured had a bad loss when it had
a claims-made policy. If the claim is not filed, it
is not covered.
• Insurers may not be willing to cover it when the
policy is renewed or replaced.
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CGL Claims-made Time Periods
Three periods for claims-made CGL policy.
• Basic Period. Start and end time when a policy
provides coverage for claims made.
• Extended Period. Up to 5 years after the basic
period when claims may be filed for losses
during the basic period.
• Supplemental Period. An unlimited period after
the extended period converts claims-made into
occurrence coverage.
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Question
An insurance policy can be written as a
reimbursement policy, pay on behalf policy, or
indemnification policy. Pay on behalf is the
modern common form for the CGL policy. Why
is this true?
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Answer
Pay on behalf language enables the insurance
company to manage and control the claim
including the tricky task of settling or fighting
large allegations of losses arising from
negligence.
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Retroactive Date
A CGL policy commonly identifies a retroactive
date defined as the start of covered claims from
the bodily injury or property damage alleged in
the claim. The claim may be filed in the covered
policy period but losses that occurred prior to
the retroactive date are excluded from
coverage.
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Question
A visitor to a car dealership was hurt when the
ceiling fell on him in September 2012.
• He left and sought treatment at a hospital.
• In April 2013 he filed a lawsuit.
• The dealer had a claims-made policy in 2012.
• It had an occurrence policy in 2013.
Which policy covers the loss?
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Answer
Neither. The claim was not filed during the period
of claims-made coverage. The occurrence did
not occur during the time period of the
occurrence policy.
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Question
An equipment company had a CGL policy in 2013
from United Insurance and in 2014 from
Northern Insurance. It sold a boiler on
November 15, 2013. Six months later the boiler
caught fire. The purchaser won damages of
$80,000. Which policy covers the damage?
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Answer
The Northern Insurance policy.
 The key is operations coverage, not product
liability.
 The date of the occurrence of the damage will
apply.
 A defective boiler would be covered as
completed operations under the
manufacturer’s CGL policy.
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Policy Trigger
An insurance policy trigger is an event that
activates insurance coverage. Different courts
accept:
 Injury in Fact. Date when injury occurs.
 Exposure. When an injured person is
exposed to the cause of the injury.
 Manifestation. When symptoms appear or
the injury is diagnosed.
 Injurious Process. All of the three (triple
trigger).
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Presentation
Silicosis Asbestosis
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Silicosis
In 2005, “Silicosis was a big deal in the United
States. It was:
• An occupational lung disease caused by
inhaling silica dust working in quarries.
• A cause of persistent coughing , chest pain,
fever., and death.
• The focus of silica lawsuits that began in
2001 in Mississippi.
• By 2005, hundreds of cases with thousands
of plaintiffs clogged the courts.
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Question
External evidence did not seem to justify such an
explosion of silicosis claims. Legal observers
wondered what was happening. In 2005, a
federal judge consolidated 9,000 lawsuits and
met with lawyers handling the cases. What did
she learn?
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Answer
The judge learned;
• A small number of doctors diagnosed
Silicosis.
• Lawyers never met with patients.
• Doctors never met with patients.
• Secretaries completed the paperwork.
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Question
Were most of the “victims” healthy prior to
developing silicosis?
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Answer
Apparently not.
• Two-thirds of the victims had previously been
diagnosed in earlier lawsuits as having
asbestosis.
• Asbestosis is also as an occupational lung
disease arising from long-term, heavy
exposure to asbestos.
• The earlier lawsuits forced 70 companies into
bankruptcy and created billions of dollars of
legal fees.
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Question
With respect to the earlier asbestosis, were things
getting better for the “victims?”
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Answer
Apparently yes.
• Most lawsuits contained the same doctors
and patients.
• The same doctors read the same X-rays.
• Plaintiffs were diagnosed with asbestosis but
not silicosis in the earlier lawsuits.
• Now they were diagnosed with silicosis but
not asbestosis.
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Question
What did the judge do?
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Answer (1)
The judge dismissed the case.
• She accused the doctors and lawyers of
committing fraud.
• She issued sanctions against the filing of
future lawsuits.
• She required some lawyers to pay the legal
costs of the defendants.
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Answer (2)
5,500 silicosis claims were filed in Texas after
2005:
 Texas 2005 tort reform requires medical
evidence of a "minimum level of impairment.”
 54 plaintiffs attempted to meet the standard.
 24 did so.
 99 percent of the lawsuits were likely fraud.
 None of the trial lawyers have been charged
with attempted fraud.
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Premises Liability
Premises liability exposure varies with the
category of individual who enters property:
 Trespasser. Without permission.
 Licensee. With permission but not for the
benefit of the party who controls the property.
 Invitee. With permission and for the benefit of
the inviter.
 Child. Lacks capacity to protect self from
danger.
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Status of Visitor
The degree of care varies with the status of visitor:
 Trespasser. Avoid actions that cause injury.
 Licensee. Warn the visitor of danger.
 Invitee. Make the premises safe for the
visitor.
 Child. Separate the visitor from any danger.
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Question (1)
A night watchman worked in a factory that had five
burglaries in the past year. A clerk accidentally
stumbled upon two burglars and was stabbed.
The watchman spent his own money to buy bear
traps, which he set by the three back entrances
to the factory. The entrances were locked at
night.
An apparent burglar broke the lock on a back
door, entered the building, and stepped into a
trap.
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Question (2)
The watchman called the police and emergency
medical team. A medical technician accidentally
stepped into a second trap.
A woman who was passing by was curious and
walked into the factory. She stepped into the
third trap. The burglar, medical technician, and
passing woman each had serious leg damage,
pain, and medical expenses.
All three parties sued the factory and watchman.
Who is likely to win?
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Answer
Burglar is trespasser. Avoid actions that cause
injury. Watchman was afraid. Was the trap self
defense?
Medical technician is invitee. Premises had to be
safe. They were not. Likely to win.
Woman is licensee. She should have been
warned. Does the excitement and time frame
waive this requirement?
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Question
A hospital rents clinic space in an office building. A
man was sitting in the clinic waiting to see a
doctor. A sign on the wall said “no pets
allowed.” A patient sitting next to the man had a
raccoon on a leash. The raccoon bit the man on
the arm.
The doctor treated the bite, assuring the man that
the wound was clean and he would have no
problems. Two weeks later, doctors amputated
the man’s swollen leg.
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Question (2)
As he recovered from surgery, the man learned
the raccoon had rabies. He underwent an
expensive and painful series of shots.
The man sued the hospital and the doctor,
alleging negligence for (1) allowing a raccoon in
the clinic; and (2) failure to maintain the
standards expected in medicine. He sued the
hospital for unsafe premises.
Should the man win the suits?
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Answer
Animal Liability. Was the hospital or pet owner
negligent for allowing a raccoon to be in the
clinic?
Lessee Liability. Was the owner or lessee liable
to provide a safe space?
Professional Liability. Did the hospital and Dr.
Wallace provide sound professional advice on
the danger of a bite wound?
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Question
A politician told supporters that he was trying to
avoid bankruptcy.
• He and his bank tried to work out the problem.
• A newspaper called the that confirmed the
situation.
• The politician subsequently sued the bank. For
violating his right to privacy.
Who will win the lawsuit?
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Answer
Probably the bank. The issues involve consent
and waiver.
• Waiver. The public statement seems to waive
the right to confidentiality of the general
information that the record existed.
• Consent. Revealing the information to
supporters could be consent to disclosure.
• These do not apply if the bank provided nonpublic information to the press.
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Presentation
Day 4
Additional Topics
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Presentation
Session 12
Professional, Medical and
D&O Liability
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Sources of Professional Liability
A profession is a unique form of liability for several
reasons:
 Defined knowledge and skills. People know
what to expect from professionals.
 Formal training or education. It qualifies an
individual to perform at a high level.
 Performance Expectation. A failure to meet
the expectation can produce a lawsuit.
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Professional Liability Exposure
• Expectation. A client or patient engages the
services of a professional to pursue a specific
goal and agrees to pay for services.
• Action. The professional provides the services.
• Failure. The services are not provided to the
satisfaction of the client.
• Allegation. The client sues for damages.
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Professional Liability Insurance
Professional liability covers:
• Medical Professionals. Doctors, Nurses,
Dentists, Hospitals.
• Errors and Omissions. Lawyers, Accountants,
Financial Planners.
• Directors and Officers. Corporate officers and
board members.
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Medical Malpractice
Medical malpractice is an act or omission by a
health care provider that:
 Deviates from accepted standards of practice
in the medical community.
 Causes injury to a patient.
 Is a form of professional negligence.
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Medical Malpractice Coverage
Characteristics include:
• Coverage. Individuals, groups, and
organizations.
• Liability. Covers accidental acts as well as
deliberate events that are faulty.
• Per Incident. Coverage limit.
• Aggregate. Coverage limit.
• Permission to Settle. Not required.
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Question
A nurse supervisor making her rounds discovered
a patient dead in his room.
• A medication overdose was the cause of death.
• The medication was not available in the
hospital pharmacy.
• The medical staff denied administering it.
The family of the patient sued the hospital for
negligence. Who is likely to win?
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Answer
• Is it strict liability?
• Is it an abnormal event where no one is at
fault?
• Did the defendant have complete control of the
cause of death of a resident patient in the
hospital?
• Can we rule out contributory negligence or a
third party involvement?
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Question
A 17-year old woman sought a cosmetic treatment
from an oral surgeon.
• She signed a waiver acknowledging the risk.
• Surgery was performed properly but it caused
permanent partial paralysis in her face.
• She filed a lawsuit alleging negligence.
• Is the lawsuit valid?
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Answer
Consent. Is she old enough to legally give
consent? If yes, did the woman accept the risk
even if negligence was involved?
Waiver. Is she too young to waive the risk?
Enforcement. Can an individual waive the right
to sue for negligence? Will a jury ignore the
waiver and enforce a finding of wrongdoing?
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Question
A patient received medical treatment and
incurred no improvement or decline in his
condition. Subsequently he learned the
doctor:
 Made the wrong diagnosis.
 Failed to treat the ailment.
 Prescribed the wrong drug.
Which are examples of medical malpractice?
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Answer
None of the above. In order to be medical
malpractice, the patient must be harmed or
suffer a worsened condition.
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Question
In spite of efforts to reduce medical losses,
they occur. Do many people die each year
while undergoing medical treatment or
medication?
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Reply
Estimates are
Cause of Death
Annual Deaths
Unnecessary surgery:
2,000
Medication errors:
7,000
Hospital non-medication errors:
20,000
Infections in hospitals:
80,000
Adverse effects of medications
106,000
Total
215,000
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Question
The health care industry can purchase
professional liability insurance. Who are the
buyers of medical malpractice insurance?
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Reply
Three groups of buyers can be identified:
 Health Care Facilities. Hospitals, clinics,
skilled nursing centers, and rehabilitation
centers.
 Medical Professionals. Physicians,
surgeons, dentists, and nurses.
 Facilities and Professionals. Single
policy covering the facility and the medical
professionals that work in or with it.
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Question
Dentist Robert Woo used anesthesia to make a
patient unconscious.
• He inserted fake boar tusks into her mouth
and took pictures.
• She sued for damages.
• The medical malpractice insurer refused to
defend him in the lawsuit.
• Woo sued the insurer.
Should he win the lawsuit?
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Answer
The lower court awarded dentist Robert Woo
$750,000 from Fireman's Fund Insurance.
• A Washington state appeals court
overturned a decision.
• Putting fake boar tusks in a patient's mouth
as a joke "could not conceivably be
considered" covered under Woo's
professional liability insurance policy.
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Errors and Omissions
Characteristics are:
• Form. Claims made.
• Deductible. High.
• Damage. Does not cover tangible property
losses, bodily injury, libel, or slander.
• Exclusions. Few. Include dishonest,
fraudulent, criminal, and malicious acts.
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Question
A CPA prepared tax returns for a wealthy married
couple. The couple disagreeing on finances.
The ex-sued the CPA claiming he undervalued
her husband’s assets The judge awarded
$60,000 in damages. Legal costs were $72,000
for the CPA and $15,000 for the ex-wife. The
CPA had a $1,000,000 pay on behalf E&O
policy with a deductible of $12,000. Does
insurance cover any of the losses?
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Answer
The policy covers the $60,000 damages minus a
$12,000 deductible, or $48,000 plus $72,000 for
attorney’s fees. The ex-wife’s pays her own
legal fees.
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Question
An architect took a client on a tour of a home
under construction for the purpose of asking
questions about the client’s needs in the design
of the home. The client fell down a flight of
temporary stairs that had not be fixed properly
to the building structure. The client sued the
architect for damages. The architect had a $2
million E&O policy. Does insurance cover the
claim?
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Answer
No. The injury is not linked to the professional
services provided by the architect.
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Question (1)
A law firm obtained E&O insurance after
completing an application that included the
information on the next slide. The law firm
answered “no” to both questions. Subsequently,
a former client sued for a failure to consult an
expert witness in a case where the client
significant damage. Is the loss covered by the
insurance?
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Question (2)
During the past 5 years, has any professional
liability claim or been made against the
Applicant Firm or any of its past or present
lawyers?
Is the Applicant Firm or any of its lawyers aware of
any situation that might result in a professional
liability claim against the Firm?
This policy will not cover any claim set forth in the
answers to these questions.
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Question (3)
The law firm answered “no” to both questions.
Subsequently, a former client sued for a failure
to consult an expert witness in a case where the
client significant damage. Is the loss covered by
the insurance?
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Answer
The parties have to examine whether any
knowledge was misrepresented or concealed in
completing the application. If it was, the policy
may not cover the loss.
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483
Question
Federal Recovery stores electronic data. It has an
E&O policy. Global Fitness is a customer.
Global Fitness agreed to give data to another
company at a time when it was overdue paying
Federal Recovery for services provided.
Federal Recovery refused to transfer the files and
was sued.
Does the E&O insurer have a duty to defend?
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Answer
No, according to a district court.
• Federal refused to turn over the information
until Global met certain demands.
• The act was intentional and thus the loss was
not fortuitous.
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Directors And Officers (D&O) Insurance
The third form of professional liability insurance
reimburses directors and officers of a company
or the organization itself when they are accused
of failing to meet higher standards than others in
the society. The board of directors and officers
face individual liability when acting in their
official capacities.
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Fiduciary Responsibility
This refers to a legal or moral obligation when one
party relies on another in some matter
• Board members and officers of businesses and
organizations are bound to fulfill a fiduciary
responsibility.
• Any failure to fulfill fiduciary obligations is a
lapse of ethics.
• For board members and officers it is also a
source of legal liability.
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Fiduciary Lawsuits
• Breach of Fiduciary Duty. Failure to put the
interests of organization above own interests.
• Negligence. Failure to make reasonable
decisions or actions affecting stakeholders of
an organization, most commonly the
shareholders.
• Bad Faith. Actions outside the scope of the
authorized duties or with a conflict of interest.
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488
Question
What are examples of wrongful acts that could be
committed by the board of directors of an
investment bank?
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Reply
Examples are:
• Failure to buy more modern equipment.
• Ignore reports of neglect with investors.
• Allows excessive errors or omissions when
traders follow directives.
• Making misleading statements to the press.
• Refusing to provide information to regulators.
Refusing to evaluate the CEO.
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Business Judgment Rule
The business judgment rule:
• If directors acted in good faith, the directors will
be deemed innocent of liability for damages.
• Applies to actions of boards of directors.
• Requires board members to act in good faith
when making business decisions.
• Shields directors from negligence liability when
a board makes a decision that subsequently
proves to be faulty.
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491
Three Areas of Director Liability
Shareholder Lawsuits. Class-action lawsuits
where owners of common stock allege
wrongdoing by the directors.
Third Party Claims. Related or unrelated third
parties allege financial damage resulting from
board action, inaction, or decisions.
Regulatory Violations. Charges of misbehavior
by board members brought by government
agencies.
THE CENTER FOR PROFESSIONAL
EDUCATION
Question
An investor owns 30% of the stock in a company.
• He filed a petition to expand the board.
• The move would force the CEO to retire.
• The board voted down the plan.
• The investor sued the board for a breach of
fiduciary responsibility.
• Who should win the case?
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Answer
Who wins? The lawyers are almost always the
winners in liability lawsuits.
What are the issues? Did the board consider
whether the shareholders were better served by
the founder or by new board members? Did any
of the board members have conflicts of interest
in the vote?
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Question (1)
The CEO of Hancock Systems proposed to the
board the acquisition of a data-management
company.
• The board voted it down because the girlfriend
of the CEO operated the company.
• The board then fired the CEO.
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Question (2)
The CEO and girlfriend sued.
• The board claimed it was shielded by the
business judgment rule.
• The plaintiffs alleged that the personal issues
caused the board to operate outside the scope
of its fiduciary responsibilities.
• Is the board liable?
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Answer
Overall, it appears the business judgment rule
would provide a shield.
• One issue deals with the appearance of a
conflict of interest when the CEO makes a
positive recommendation for his girlfriend.
• Another issue covers the board’s fiduciary
obligation to assess the acquisition separately
from the role of the CEO.
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Question (1)
A specialty gift distributor had a board composed
of 14 members, six of whom owned delivery
vans and other shipment services.
• The CEO proposed acquiring the transport
services companies at a low price.
• If the owners would not sell, they would be
removed from the board and cut off as
shippers.
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Question (2)
The board voted 12 to two to reject the acquisition.
• Shareholders sued alleging the board had
allowed a conflict of interest.
• Is the board liable?
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Answer
Maybe.
• The transport owners probably serve on the
board to bond the organizations into a single
business operation.
• The CEO proposal poses a conflict of interest
for the six board members.
• Only a court with more facts could untangle the
situation.
• The board could be liable.
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500
Question (1)
A furniture warehousing company leased two
buildings in an industrial park.
• An explosion destroyed a neighboring plant.
• The investigation showed negligence by the
company that managed the park.
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501
Question (1)
The board voted to abandon the factory and stop
payments for the remaining period of the 7-year
lease.
• The park owners filed a lawsuit seeking
personal damages from board members.
• Is it likely that the suit will be successful?
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Answer
Probably not.
• The furniture company could be liable for
breach of contract.
• In the absence of other information, the
business judgment rule shields directors from
negligence liability.
• As long as the board acted in good faith, the
members would not be liable.
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503
Question (1)
Total Compliance Co. (TCC) sells systems
software and applications.
• The company purchased an application from a
Malaysian company.
• Larson Systems alleged infringement on its
patent by the Malaysian company.
• Larson asked TCC to cease sales.
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Question (2)
• The board voted to reject the Larson request
and authorized continuing sales.
• Larson sued for personal damages from board
members.
• Is the lawsuit likely to be successful?
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Answer
No way to know. Only a court judgment will decide
whether the board acted within the scope of its
authority when allowing continued sales of a
product purchased from a company with a
previous history of stealing trade secrets and
patent infringement.
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506
Criminal Liability
Board members are facing increasing risks of
personal criminal liability as a result of company
actions.
• Under mensa re, a person may not be
imprisoned if he did not intend to commit a
criminal act.
• This doctrine is being eroded by
unconscionable corporate actions that
prosecutors believe should have been stopped
by the board of directors.
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EDUCATION
507
Question
Swanson Industries was cited by the Department
of Environment (DofE) for failure to dispose
properly of toxic waste. The CEO continued the
violations, explaining to the board that the fines
were less costly than remedial measures. After
two years, the DofE sued Swanson for the full
cleanup costs, forcing the company into
bankruptcy. The DofE then sued the directors
individually. Is it likely that the DofE will win the
lawsuit?
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508
Answer
The DofE has a good chance to win this lawsuit. It
might be interpreted under either the business
judgment rule requiring board members to act in
good faith when making business decisions or
as negligent liability allowing the CEO to
continue to pollute. In either case, board
members could be in trouble. The exposure
could expand to criminal liability.
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509
Deepening Insolvency
The doctrine of deepening insolvency refers to a
situation where a board keeps a company alive
after it no longer has realistic prospects to
recover from financial loss. The erosion of
assets causes creditors to lose money they
would have received if the company had been
dissolved and the assets sold. Creditors or
shareholders may file a lawsuit alleging
misrepresentation or gross negligence that
caused them harm.
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EDUCATION
510
Question (1)
An airline experienced operating losses for 11
straight years.
• In year 3, it sold its food-catering subsidiary.
• In year 5, it sold its cargo services unit.
• In year 7, it sold half of its gates at six airports.
• In year 9, it sold its maintenance hangers and
leased them back for 20 years.
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Question (2)
The airline used all the funds from the sale of the
various units to cover operating deficits.
• In year 11, the airline filed bankruptcy.
Shareholders received nothing and then filed a
class action suit alleging gross negligence.
• Is it likely that the shareholders will win the
lawsuit?
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512
Answer
This is a question of deepening insolvency. The
facts of the case may give the shareholders a
victory but it is not likely because of the
business judgment rule.
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513
D&O Liability Insurance
Companies, other organizations, officers of a
corporation, and members of the board of
directors can purchase liability insurance to
indemnify them for legal liability losses and legal
costs when officers or directors are sued.
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EDUCATION
514
Corporate Indemnification
Corporate indemnification refers to arrangements
where organizations indemnify (protect against
financial loss) directors and officers who make
business decisions for the organization.
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EDUCATION
515
Primary and Secondary Indemnification
The organization is the primary source of
indemnification for officers and directors. D&O
insurance is a secondary protection.
• In some cases, the company may not have
sufficient funds to indemnify losses.
• The D&O policy reimburses the company and
protects its earnings.
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Areas of Indemnification
Companies can indemnify directors for:
Defense Costs. Expenses of lawyers, discovery
proceedings, and other defense costs.
Settlements. Funds paid to settle without the
formal decision of a court.
Judgment. Damages paid when a court,
arbitrator, or regulatory body awards money to a
plaintiff to end a lawsuit.
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517
Forms of Indemnification
Mandatory Indemnification. Laws require a
company to cover judgments, settlements,
defense costs, and other legal obligations that
arise from directors and officers performing their
official duties for the company
Permissive Indemnification. A company
voluntarily agrees to cover defense costs,
settlements, or judgments.
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518
D&O Insurance
A D&O policy provides liability coverage:
Official Capacity. Covers allegations of
misbehavior taken as an officer or director of an
organization.
Wrongful Act. Coverage is triggered by a claim of
an improper behavior by the board.
Scope. The policy will provide indemnity for
damages, settlements, and legal expenses.
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519
D&O Insuring Agreement Indemnity
Three indemnities:
• Coverage A. Protection where the company
will not provide indemnification.
• Coverage B. Reimburses the organization after
it indemnifies an individual.
• Coverage C. Reimburses the organization
itself if it is deemed liable for damages.
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520
Side A-only Coverage
The insured will be reimbursed directly if the
company or its insurer fails to provide coverage.
To be effective Side A-only should have:
• Follow Form. The same coverage as the
company’s indemnification agreement.
• Drop Down. It should become primary
insurance when the primary carrier cancels or
rescinds coverage.
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521
Defense Costs in the Policy
Two approaches to cover legal costs in D&O
policies:
Defense within Limits. Limit reflects both
defense costs and damages. This is common
with D&O policies.
Defense Outside Limits. Limit applies only to
damages. The insurer will pay all legal costs
separately. This is common with most general
liability policies.
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EDUCATION
522
Defense Cost Issues
Full or Limited Indemnification. Does the policy
cover full defense costs?
Defense Allocation Provisions. Does the policy
specify defense costs limited to a fixed
percentage of the policy limit?
Timing. When does the carrier have to advance
funds for the payment of defense costs?
Conduct. What happens if the insurer believes
the the party was engaged in a crime or fraud?
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523
Defense of Claims
Choices of the party that controls claims.
• Insured. With some policies, the insured
controls the settling of or defending against
claims.
• Insurer. With some policies, the insurer controls
the handling and settling of claims. The insurer
pays legal fees, investigation costs, and other
defense costs directly on behalf of the company
or individuals.
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EDUCATION
524
D&O Exclusions
Routine n exclusions include:
• Profits or advantages to which an insured is not
entitled to gain.
• Legal fines or regulatory penalties.
• Costs when a court has determined that the
insured engaged in criminal or fraudulent acts
• Damages resulting from service on other
boards, claims by one insured against another,
and losses from a public offering of securities.
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EDUCATION
525
D&O Coverage Forms
As with other liability policies, two coverage forms:
Claims Made. This policy applies to claims that
are made and reported to the insurer during the
period of the policy. Most D&O policies use this
form.
Occurrence. This policy applies to claims that
arise from alleged wrongful acts (occurrences)
that happened during the policy period.
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EDUCATION
526
Aggregate Limit of Liability
Most commonly a D&O policy will have an
aggregate limit of liability:
• The maximum that will be paid for all claims
during the policy period.
• When losses, damages, and legal costs reach
the limit, the company is liable for
indemnification of directors or the side A-only
coverage is activated.
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527
Question
An insurer refused to settle a claim for $500,000
under a D&O policy it issued with an aggregate
limit of $2.5 million.
• The jury imposed damages of $4 million.
• The insured then had another unrelated claim
asking for damages of $700,000.
• The insurance company refused to cover the
new claim and was sued by the insured.
• Is the insured likely to win?
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528
Answer
No. If the insurer is allowed to refuse to settle a
claim:
• It does not affect the issue of an aggregate
limit.
• The carrier has no further obligation in
connection with defense costs that may
continue to be incurred.
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EDUCATION
529
Severability
This legal term refers to a provision in a contract
with two purposes:
 Essential Clauses. For some clauses that
are critical to the agreement, voiding the
clause voids the contract.
 Non-essential Clauses. For less critical
clauses, voiding them does not void the
remainder of the contract.
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EDUCATION
530
Rescission
This legal term is defined as the unmaking of a
contract between parties. It is a voiding of the
contract that brings the parties, as far as
possible, back to the position in which they were
before they entered into a contract.
THE CENTER FOR PROFESSIONAL
EDUCATION
531
Question
A D&O policy has a provision that voids the
contract if any of the directors or officers
commits fraud resulting in a lawsuit. What is the
issue of severability or rescission in such a
situation?
THE CENTER FOR PROFESSIONAL
EDUCATION
532
Answer
The issue of severability or rescission arises for
directors and officers who did not participate in
the fraud.
• A severability or rescission clause is needed.
• It should state that directors and officers with
no knowledge of the fraud are covered if other
directors or officers misrepresented material
facts or committed fraud.
THE CENTER FOR PROFESSIONAL
EDUCATION
533
Question
Brandon Industries has been served a lawsuit.
• The Brandon directors lost $125,000 in salary
when they took unpaid leave from their own
companies to attend the trial.
• The directors also denied themselves Brandon’s
customary $200,000 year-end “Holiday gift” for
board members.
• Is the loss of salary and bonus covered under
the D&O policy?
THE CENTER FOR PROFESSIONAL
EDUCATION
534
Answer
Not likely. Salary is an employee benefit. A holiday
gift sounds like a bonus.
THE CENTER FOR PROFESSIONAL
EDUCATION
535
Presentation
Lehman Repo Fraud
THE CENTER FOR PROFESSIONAL
EDUCATION
536
Balance Sheet
Assets
Cash
Securities
Toxic Assets
Total
300B
500B
50B
850B
THE CENTER FOR PROFESSIONAL
EDUCATION
Debt & Capital
Debt
400B
Capital
450B
Total
850B
537
Repurchase Agreement
Sell $50B of toxic assets
Buy back one week later.
Fee: $1B.
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EDUCATION
538
Balance Sheet at Closing
Assets
Cash
Securities
Toxic Assets
Total
350B
500B
0
850B
THE CENTER FOR PROFESSIONAL
EDUCATION
Debt & Capital
Debt
400B
Capital
450B
Total
850B
539
Balance Sheet after One Week
Assets
Cash
Securities
Toxic Assets
Total
299B
500B
50B
849B
THE CENTER FOR PROFESSIONAL
EDUCATION
Debt & Capital
Debt
400B
Capital
449B
Total
849B
540
Presentation
Session 13
Specialty Lines
THE CENTER FOR PROFESSIONAL
EDUCATION
541
Specialty Line Market
A segment of the insurance industry where
individuals and organizations seek to cover
difficult and unusual risks.
• Characterized by a high degree of
specialization.
• Insurers have specialized expertise and
experience.
• Brokers also have specific knowledge and
experience.
THE CENTER FOR PROFESSIONAL
EDUCATION
542
Specialty Line Products
The specialty lines market focuses on two types of
products:
•Unusual or Difficult Risk. An example is
professional liability for a trustee who manages or
administers the estate of a wealthy person.
•Higher Level of Danger. An example is a firm
that manufactures fireworks.
THE CENTER FOR PROFESSIONAL
EDUCATION
543
Specialty Insurers
The specialty lines market has two components as
the result of a regulatory distinction:
• Admitted Insurers. Insurance in the specialty
lines market can be provided by insurance
companies that are licensed in a jurisdiction.
• Surplus Lines Insurers. These carriers are
not licensed in the jurisdiction.
An insurance company can be an admitted and
surplus lines carrier in a jurisdiction
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Surplus Lines Regulation (1)
State insurance departments regulate surplus
lines insurers. Requirements:
 Availability of Coverage. Regulations may
place restrictions if coverage is available from
licensed insurers.
 Solvency Requirements. Insurer must be
approved by the state regulators.
 Licensed Broker Involvement. Insurance
requests must be placed through licensed
brokers
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545
Surplus Lines Regulation (2)
 Fees or Taxation. Surplus lines brokers and
insurers may be required to pay fees in lieu of
taxes.
 No Solvency Relief from State Guarantee
Funds. The states do not reimburse losses
from insurer insolvency.
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546
Non-admitted and Reinsurance Reform
Act of 2010
This Act provides guidelines for non-admitted
insurance placement:
• Forbids states from taking regulatory actions in
violation of a set of national standards.
• Makes use of standards of the National
Association of Insurance Commissioners
(NAIC).
• Covers specialty and surplus lines.
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547
Specialty Coverages
Many lines of insurance are covered as specialty
lines. We will examine:
• Boiler and machinery.
• Business interruption.
• Inland and ocean marine.
• Earth movement.
• Fine arts.
• Crime insurance.
• Cyber Risk Liability Insurance.
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548
Boiler and Machinery Coverage
Two basic coverages:
• Insured’s Property. The insurance reimburses
costs of replacing destroyed property and
repairing damaged machinery.
• Third-party Property. Insurance reimburses
the insured for liability exposures when a loss to
covered property damages or destroys the
property of other parties.
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EDUCATION
549
Question
A company rents space in an office building.
• The area contains a large computer, file server,
and auxiliary devices.
• The building owner asked the company to
purchase B&M insurance on the equipment.
• The company claims the equipment is
protected under a building and premises policy.
• The building owner says no.
• Who is right?
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550
Answer
We cannot tell from the information given.
• A general property policy could offer at least
partial coverage.
• Computer equipment does not have all the
safety issues associated with engines, motors,
boilers, refrigeration units, and pressurized
systems.
• We have to read the policy to know for sure.
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EDUCATION
551
Question
Titan Fabrication has B&M coverage in an
industrial park shared with other tenants.
• An explosion in a Titan pneumatic injection
machine destroyed a neighboring company’s
compressor.
• Does the policy cover?
o Compressor Repair. $ 9,000.
o Food Spoilage:
$ 6,000.
o Lost Income:
$22,000.
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EDUCATION
552
Answer
Compressor Repair. This is probably covered as
third-party property.
Food Spoilage: This is covered only if Titan has
additional coverage for consequential damage.
Lost Income: It is not likely that this loss will be
reimbursed. A consequential loss. Policy covers
property. Income is not property.
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553
Business Interruption
Negative effects:
• Lost Profits. A decline in sales or revenues
with a resulting loss of profits.
• Fixed Costs. Expenses that cannot be reduced
in the short term when operations shut down
after a loss.
• Extra Expenses. Costs to allow an operation to
continue with temporary systems while assets
and systems are being repaired.
•
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EDUCATION
554
Question
A company wants business interruption insurance
for the Olympics.
• The number of earning days is 12.
• The expected profit is $600,000 a day.
The insurer offered two policy choices:
• Payment of $450,000 a day.
• Payment of actual calculated loss each day.
Which approach would be better for the company?
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555
Business Interruption Insurance
Considerations are:
Valued Form. Insurer agrees to pay a stated
amount for each day that an operation is shut
down. No actual loss must be documented.
Actual Loss. An insured must show a calculation
of lost income and extra expense. This effort
can require extensive documentation.
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556
Inland Marine Insurance
Inland marine insurance indemnifies loss to
moving or movable property when it is moving
on land.
• “Marine” is historical.
• Inland marine covers railroads and trucks.
• It applies mostly to land shipments and
transport.
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557
Floater
A common name for an inland marine policy.
• Transit Property. Any asset in the process of
moving from one location to another.
• Bailee Property. Reimburses the owner of
property for damage or loss during transport by
another party (bailee).
• Movable Property. Assets that can be found at
different locations at different times.
• Transport Property. Assets used to move
other assets.
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558
Breadth of Inland Marine (1)
Accounts Receivable. Sales not collectible.
Bailee Customer's Goods. Insured destroyed
goods in transit owned by another party.
Builders' Risk. Loss of materials, fixtures and
equipment on a site.
Camera and Photographic Equipment. Used by
professional photographers.
Exhibitions. Events and trade shows.
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559
Breadth of Inland Marine (2)
Fine Arts. Paintings, sculptures, and antiques.
Jewelers. Owned stocks and property of others in
custody of the jeweler.
Museums. Objects owned and held with the
permission of their owners.
Scheduled Property. Property list by name and
value.
Trip Transit. Loss or damage on a single
shipment of property.
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EDUCATION
560
Question
A company has a trip transit property policy.
• It was taken out last year.
• An employee regularly takes to a sales
conference a laptop computer, computer plug
and play projection unit, and portable screen.
• At the hotel, the equipment was lost in a fire.
• Is the equipment covered by the insurance
policy?
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561
Answer
Probably not.
• A trip transit Loss or damage on a single
shipment of property.
• Is this the trip that was covered.
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562
Question
A limousine company has full property coverage
on all its vehicles.
• A vehicle transported guests to a wedding at a
hotel.
• The driver used valet parking while he waited in
the hotel.
• The car was damaged when a reckless
attendant lost control while parking it.
• Does the company’s insurance cover the loss?
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563
Answer
Maybe not. It depends upon the property policy.
• Bailee. One to whom personal property is
entrusted for a particular purpose by another,
the bailor, under an express or implied
agreement.
• Exclusion. The basic policy may not cover the
loss when a bailee is responsible for causing it.
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564
Ocean Marine Insurance.
Hull and Offshore Property. The vessel itself and
other structures at sea such as container
terminals, ports, oil platforms, and pipelines.
Protection and Indemnity (P&I). Liability losses
for claims against the owners or operators of
vessels or offshore facilities.
Cargo. When a ship is actually sailing in oceanic
waters, not when loading or discharging.
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EDUCATION
565
Question
Jonathan Grubbs worked as an engineer on a
tugboat.
• The company had a P&I policy to pay the
medical bills of injured employees.
• Grubbs’ tug was towing two barges in rough
seas in Galveston Bay, Texas.
• Grubb’s was injured in a storm.
• Did the insurer have to pay his medical
expenses?
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EDUCATION
566
Answer
No. A Louisiana court ruled the policy did not
apply because Grubbs's injuries occurred
outside the United States.
A Court of Appeals agreed that the insurance was
an ocean marine policy and was therefore
excluded altogether from U.S. employee injury
law.
Lesson Learned. Ocean marine is a different kind
of insurance.
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EDUCATION
567
Question
A ship owner has cargo insurance for the full value
of transported goods.
• During a storm, the captain intentionally
ordered two trucks to be pushed overboard to
lighten the vessel for safety reasons.
• Are the trucks covered by the cargo insurance
policy?
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568
Answer
Yes.
• A unique aspect of ocean marine insurance is
that safety of the vessel is a factor in coverage.
• Another unique aspects is that all cargo owners
must share in the loss of cargo abandoned at
sea to protect the security of a vessel.
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EDUCATION
569
Earth Movement Insurance
Natural Causes. Nature can produce movements
of earth that are catastrophic to people and
property. These sources of loss obviously
include earthquake, tsunamis, and landslides.
Man-made Causes. The activities of individuals
and organizations can also cause damaging
shifts in the earth. Examples include any activity
involving machinery at construction sites and
cave-ins in mining operations.
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EDUCATION
570
Question
An insurance policy insures a port warehouse
against earth movement.
• An earthquake does not damage the structure.
• The earthquake does start a fire that destroys
the warehouse roof.
• Then, a tidal wave puts out the fire but damages
the building’s foundation.
• Is the roof damage covered?
• Is the foundation damage covered?
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EDUCATION
571
Answer
It depends upon the wording of the policy and
court interpretation.
• Fire and explosion from earth movement can
be exclusions.
• Other exclusions can affect the foundation.
• Does the wording allow coverage for flood,
rising waters, waves, tides or tidal water, or the
breaking of boundaries by water?
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EDUCATION
572
Fine Arts Insurance (1)
Individuals Only. Works not covered if owned by
dealers or auction firms.
All-risk Coverage. Exclusions include wear and
tear, breakage, war, and nuclear.
Agreed Upon Value. It will not replace with like
kind and quality nor reimburse restoring or
repairing the item.
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573
Fine Arts Insurance (2)
Scheduled Property. Each item can be
specifically listed.
Unscheduled Property. Policy can be written for
a collection.
Location. Coverage applies at the insured
location and in transit.
Additional Coverage. Purchased separately or
added as a endorsement on a property
insurance policy.
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EDUCATION
574
Question
An insurance policy covers fine art for the insured.
• A truck was carrying three collection pieces.
• They were a Picasso painting, a diamond
crown worn by Louis XIV, and a 1910
Mercedes classic car.
• The truck is hijacked and the articles are lost.
• Will the policy replace the items?
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575
Answer
Probably not.
• Picasso Painting: It is a one of a kind. It
cannot be replaced by another painting of like
kind and quality.
• Crown. Same question. Also, is a crown
jewelry or precious stones? Policy may have
exclusions or limits on such items.
• Car. Classic automobiles are a common
exclusion in fine arts policies. They must be
insured separately.
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EDUCATION
576
Crime Insurance
An organization can purchase insurance to cover
losses from wrongdoings by employees,
criminals, and others. Such coverage has
expanded rapidly as the world and conduct of
business become more complex and as
technology facilitates new transactions and
activities.
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EDUCATION
577
Employee Dishonesty
This coverage reimburses losses when dishonest
employees misbehave in the workplace.
Named Individual. Reimburses loss caused by a
single person identified by name.
Position Coverage. Covers anyone who holds a
position identified in the organization.
Blanket Coverage. Covers specified wrongdoing
by all employees in a named unit.
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EDUCATION
578
Question (1)
Martin Elliott was hired as CFO.
• An employee dishonesty insurance policy was
transferred from his previous employer.
• It covered theft, fraud, or embezzlement up to
$1 million.
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EDUCATION
579
Question (2)
• Martin died while the policy was still in effect.
• His assistant was named acting CFO.
• The assistant forged three wire transfers to an
offshore bank and then flew to Brazil.
• The company suffered a loss of $1.6 million.
• Does the policy cover the loss?
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580
Answer
The policy does not appear to cover the loss.
• The real issue is whether the policy was written
as a named individual or named position.
• If the policy was amended to a named position
policy, it covers the loss up to the policy limit.
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581
Theft, Disappearance, and Destruction
Theft. Covers stealing the goods or property of an
insured.
Burglary. Covers breaking and entering and
stealing property.
Disappearance: Covers the vanishing of insured
property in an unexplained manner.
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582
Question
An employee was angry with his boss.
• The employee knew the company kept cash in
a locked box in a locked desk.
• He returned to the office after hours and stole
the box which contained $26,000.
• The company has theft, disappearance, and
destruction insurance.
• Does the policy cover the loss?
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EDUCATION
583
Answer
It depends upon the terms of the policy.
• Normally, such coverage is for third parties
rather than employees.
• Since the individual entered the premises
without authority, this could be covered as a
third-party crime.
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584
Robbery and Safe Burglary Insurance
This covers property other than money, securities,
and motor vehicles taken by forcible means.
• The coverage includes taking property from the
premises of the insured.
• It also includes assets taken from an employee
or messenger .
• It includes property taken from a locked safe.
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EDUCATION
585
Riot and Civil Commotion Insurance
Riot. This is defined by most state laws as a
violent disturbance involving three or more
persons.
Civil Commotion. This is a more serious and
prolonged disturbance or violent uprising.
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EDUCATION
586
Kidnap and Ransom (K&R)
Coverage. Employees who travel on company
business or work permanently outside the
United States.
Geographic Locations. Operating in high-risk
areas around the world.
Perils Covered. Kidnap, extortion, wrongful
detention, and hijacking.
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EDUCATION
587
Question
A company has kidnap and ransom insurance on
“key employees traveling in North America,
Europe, and Asia.”
• An executive vice president and junior
accountant were kidnapped in Indonesia.
• The wife of the accountant said on television,
“We are fortunate that the company has ransom
insurance. I hope my husband will be home
soon.”
Does the policy cover the ransom?
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EDUCATION
588
Answer
Probably not.
The wife should not have knowledge of the policy.
By disclosing the information to his spouse, the
accountant probably invalidated coverage.
A second issue. Are both individuals “key
employees” as defined in the policy.
A third issue. Did the kidnapping occur in a
covered territory. Part of Indonesia is in Asia.
Part is in Oceania.
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EDUCATION
589
Cyber Risk Liability
Cyber risk insurance can cover losses arising out
of data or privacy breaches including:
• Expenses to manage an incident.
• Business interruption.
• Extortion.
• Network damage.
• Regulatory investigation costs.
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EDUCATION
590
Question (1)
A hospital suffered a data breach involving 32,500
confidential medical records.
• It occurred with records stored on a system
fully accessible to the Internet but lacking
encryption or other security measures.
• A class action lawsuit produced a $4 million
settlement.
• The insurer paid it under a cyber insurance
policy less a $100,000 deductible.
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EDUCATION
591
Question (2)
Subsequently, the insurer sought reimbursement
under an exclusion that precluded “failure to
follow minimum required practices.” The insured
alleged failure to:
• Continuously implement risk controls identified
in the insurance application.
• Regularly maintain security on its system.
• Regularly reassess security exposure
• Regularly enhance risk controls.
• Detect unauthorized access.
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EDUCATION
592
Question (3)
Does the hospital have to reimburse the insurer?
Columbia Casualty Co. v. Cottage Health System
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593
Presentation
Session 14
Reinsurance
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EDUCATION
594
Reinsurance Parties
Reinsurance is purchased to spread an insurer’s
own risk. The parties are:
Primary Insurer. Issues an insurance policy and
pays claims that arise from it.
Ceding Insurer. Primary insurer when it transfers
(cedes) a portion of the risk to a reinsurer.
Reinsurer. Insurance company that accepts risk
under a policy written by a ceding insurer.
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EDUCATION
595
Reinsurance Purpose
• Increase Capacity. More coverage than
allowed based on its financial strength.
• Stabilize Profits. Reduce chance of a single
large loss.
• Higher Limits. Accept risks that exceed its
capacity to pay the claim.
• Specialized Coverage. Reinsurers have a
broad perspective on risk.
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EDUCATION
596
Question
One goal of reinsurance is to increase
underwriting capacity. How does reinsurance do
this?
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597
Answer
A company can offer policy limits that exceed its
retention limits without exposing itself to an
inappropriate level of risk. A company with a $1
million capacity per policy can offer a $3 million
limit and reinsure $2 million of the exposure.
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598
Question
Another goal of reinsurance is to stabilize profits.
How does reinsurance do this?
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599
Answer
The primary insurer can use reinsurance to avoid
large fluctuations in earnings when one year has
few losses and another has many losses. One
example would be a policy that reimburses all
losses above a loss to premiums ratio of 70%.
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600
Question
Another goal of reinsurance is to allow higher
limits on individual policies. How does
reinsurance do this?
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601
Answer
The primary insurer can use reinsurance to limit
the loss from a single catastrophic occurrence.
One example would be a policy that reimburses
all losses above a certain point as a result of a
class action lawsuit.
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602
Reinsurance Mechanism
Ceding company and reinsurer enter into a
reinsurance agreement:
• Contains the conditions that must arise before
the reinsurer would pay a share of the claims.
• Ceding company pays the reinsurer a
"reinsurance premium" that is less than the
premiums collected by the primary insurer.
• Two companies share the economic
consequences of an unexpected loss.
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603
Reinsurance Language
Cession. This the amount of insurance that is
transferred, or in the language of reinsurance, it
is the amount that is ceded.
Ceding Company. This is the primary insurer that
issues the policy and accepts the risk of claims
against it.
Reinsurer. This is the party that accepts the
cession from the primary carrier.
Retrocession. This is the amount of insurance
that the reinsurer cedes to another reinsurer.
THE CENTER FOR PROFESSIONAL
EDUCATION
604
Question
Union Insurance, Western Insurance, Northern
Insurance, and Asian Insurance are engaged
together with a $45 million limit insurance policy.
Union writes the policy and sends $25 million to
Western Insurance and $10 million to Northern
Insurance. Western Insurance sends $15 million
to Asian Insurance. Name the primary, ceding,
and reinsuring parties to this agreement.
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605
Answer
Union.
Western.
Northern.
Asian.
Primary. Ceding.
Reinsuring. Ceding
Reinsuring.
Reinsuring.
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606
Reinsurance Fronting
Issues a policy to be substantially reinsured.
Restrictive Local Laws. Many countries require
the purchase of insurance from locally licensed
carriers.
Low Rates. Insurer outside a local market may
offer lower premiums.
Better Terms or Service. A reinsurer may be a
specialist or be more flexible.
Hard-to-place Risks. For some exposures, only
highly-skilled underwriters will write the risk.
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EDUCATION
607
Question
A company operates in a country where all
property insurance must be purchased locally.
• A local insurer agreed to provide $30 million in
coverage
• Reinsurance would cover 80% of any loss.
• The CFO proposed buying only 10% locally
and secretly buying the balance outside the
country.
• Is this is a good strategy?
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EDUCATION
608
Answer
Not necessarily.
• This is a tricky situation.
• The recommendation of the CFO does not
comply with local laws and is risky itself.
• At the same time, if the local insurer gets in
trouble, the insured has no direct access to the
reinsurance money.
• The company needs expert advice on how to
proceed in this situation.
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EDUCATION
609
Question
With reinsurance, what should be the most
important consideration when a primary insurer
is selecting a reinsurer?
THE CENTER FOR PROFESSIONAL
EDUCATION
610
Answer
The two most important factors are:
• Financial Strength. The reinsurer needs
resources to pay when losses occur. Will the
reinsurer be financially available if the large
loss occurs?
• Expertise. For an unusual risk, the reinsurer
should have the capability to assist in the
underwriting, particularly the pricing.
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EDUCATION
611
Categories of Reinsurance
Facultative. In this market, the primary insurer
seeks reinsurance on a case by case basis
when an application requests a high limit of
coverage.
Treaty. The primary insurer writes a policy and
then cedes a portion of all policies to a reinsurer
under a contract written in advance.
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EDUCATION
612
Facultative Reinsurance
Large Single Risk. Coverage for large risks that
can be Identified separately.
Unusual Exposure. Primary insurers want
another look at factors affecting underwriting.
Individual Underwriting. Reinsurance
underwriter really knows the exposure.
Individual Ratemaking. Premium is calculated
directly to fit unique aspects of the exposure.
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613
Question
A reinsurer has to take care so it does not accept
more risk than it can handle in a facultative
reinsurance agreement. How can a reinsurer
protect against catastrophic exposure?
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EDUCATION
614
Answer
Two ways can protect the reinsurer:
Underwrite the Risk. If the exposure is a refinery,
large office building, or general liability
exposure, the reinsurer can conduct its own
underwriting review to ensure it is accepting a
sound risk.
Reinsure the Risk. Just like the primary insurer, a
reinsurer can shift a portion of a reinsurance
agreement to another reinsurer.
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EDUCATION
615
Treaty Reinsurance (1)
Broad Coverage. The agreement states a
category of risks rather than a single asset.
Exclusions. Identifies assets, perils, time periods,
locations, and other exclusions.
Shared Premiums and Losses. Rights and
responsibilities of the two parties.
No Advance Approval by Reinsurer. Applies to
all primary insurance policies that fit the
description of the agreement.
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EDUCATION
616
Treaty Reinsurance (2)
Maximum Liability per Treaty. Spells out
maximum exposure for the reinsurer for all
losses under the agreement.
Minimum Retention by Primary Insurer.
Provides for a substantial retention of risk by the
primary insurer.
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617
Question
A reinsurer has to take care so it does not accept
more risk than it can handle in a treaty
reinsurance agreement. How can a reinsurer
protect against its own catastrophic exposure?
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618
Answer
Two ways can protect the reinsurer:
Advance Approval. Require that the reinsurer
approve all policies in advance of accepting
them. This is impractical for thousands of
policies.
Limitations and Boundaries. Apply the treaty to
all policies that fit a specific description. Both the
insurer and reinsurer are at risk.
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EDUCATION
619
Question
A primary insurer asked a reinsurer to accept a
treaty where the primary insurer accepted five
percent of a loss and the reinsurer would cover
95 percent. The reinsurer could then reinsure its
portion with another reinsurer. Should the
reinsurer agree to the treaty? Why or why not?
THE CENTER FOR PROFESSIONAL
EDUCATION
620
Answer
The reinsurer should be careful about the small
primary insurer obligation.
• Maybe the resurer should require a larger
retention by the primary insurer.
• Otherwise, the primary insurer could be
tempted to relax underwriting standards and
accept risks that are excessive or under priced.
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EDUCATION
621
Question
Identify each of the following as suitable for
facultative or treaty reinsurance.
• $20 million death benefit life insurance policy.
• $100,000 personal liability coverage for 15,000
lawyers.
• Losses in the Philippines resulting from
insurgency.
• Liability coverage from meltdown of nuclear
power plant.
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EDUCATION
622
Answer
$20 million death benefit.
15,000 lawyers.
Philippines insurgency.
Nuclear meltdown.
THE CENTER FOR PROFESSIONAL
EDUCATION
Facultative.
Treaty.
War risk. Too large.
Facultative with limit.
623
Pro Rata Treaty
The primary insurer and reinsurer share premiums
and losses according to a formula.
• Quota Share. Uses a formula. Example:
Primary insurer retains 60%. reinsurer accepts
40%.
• Surplus Share. Each party’s portion is
expressed as a multiple of “lines.” A line is the
amount of retention by the primary insurer. This
is explained shortly.
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EDUCATION
624
Quota Share Treaty
Fixed Percentages. The formula for sharing
premiums and losses.
Variable Dollar Commitment. The amount of
premiums and payments for losses vary with the
size of each policy.
Reinsurer Stated Limit. Most treaties specify a
maximum that will be paid by reinsurer.
Ceding Commission. The reinsurer pays a fee
called a ceding commission to the primary
insurer.
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625
Surplus Share Treaty
Primary Line. The treaty identifies the “line” as
the full retention for the primary insurer.
Upper Limit in “Lines.” The reinsurer has an
exposure expressed in terms of the number of
“lines.” A 4-line reinsurance agreement has a
primary insurer retention of one line and has
three lines ceded to the reinsurer.
Ceding Commission. A fee paid by the reinsurer
to cover primary insurer marketing and
administrative costs.
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626
Excess of Loss Insurance
Excess insurance exceeds a specified amount in a
primary insurance policy.
• Triggered only when the underlying insurance
policy limit has been exceeded.
• An attachment point is the lower limit of excess
insurance coverage.
• It may be expressed as a dollar amount or in
terms of financial ratio.
• This is often called excess of loss reinsurance.
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627
Characteristics of Excess
Excess per Risk. In this case, the attachment
point occurs in an individual policy.
Excess per Occurrence. This insurance attached
for each separate event as defined in the policy.
Aggregate Excess. This applies to the total of all
losses covered by an agreement. It is also
called stop loss insurance.
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628
Stop Loss Characteristics
No Cession to Reinsurer. The excess loss
carrier simply agrees to indemnify another
carrier if losses meet the attachment point.
No Pro Rata Retention. No sharing takes place.
Excess begins at the attachment point..
No Pro Rata Sharing of Premium. The
underlying carrier is charged a negotiated
premium.
No Ceding Commission. A commission is not
needed because the premium is negotiated.
THE CENTER FOR PROFESSIONAL
EDUCATION
629
Question
An excess of loss treaty covers all liability losses
at an Olympics. The attachment point is $5
million and treaty limit is $15 million. Three
injured spectators filed lawsuits producing
losses as shown. What is the insurer and
reinsurer share of each loss?
Loss #1
$4 million
Loss #2
$6 million
Loss #3
$8 million
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630
Reply
It is excess per risk. The share of loss:
• Total Loss at Event
$18 million
• Attachment Point
$5 million
• Treaty Limit
$15 million
• Insurer Share
$8 million (1)
• Reinsurer Share
$10 million
(1) $5 million retention plus $3 million above limit.
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EDUCATION
631
Umbrella Insurance
Umbrella insurance is the highest layer of
coverage. We noted that commercial umbrella
insurance usually does not have an upper limit.
It does not contain exclusions that found in
lower layers. It can drop down to fill gaps in
coverage in lower layers.
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EDUCATION
632
Insurer Layering
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EDUCATION
633
Presentation
Insurance Securitization
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EDUCATION
634
Role of the Capital Markets
Financial Market
Amount of Capital
Global insurance companies
$600 billion
U.S. property values
$30 trillion
Global capital markets
$50 trillion
Derivative markets
$550 trillion
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EDUCATION
635
Solution
Bring in the capital markets. (2008)
 U.S. Property Values
$30 trillion
 Global capital markets
$50 trillion
 How to do it?
Create Derivatives. A security whose
value derives from another asset.
Sell Derivatives. Capital markets can
purchase securities and share in the profits
and risks.
THE CENTER FOR PROFESSIONAL
EDUCATION
636
Catastrophe Bond Explained
Insurer fears a $300 million loss if a hurricane
damages covered property.
• Insurer. Creates 2-year Cat bond paying 15%
interest. Sells it to investment banker. Invests
cash received in secure assets.
• Investors. Purchases slices. Collect interest
during 2 years principal at maturity.
• Contingency. Hurricane causes $175 million.
Investors get back $125 million.
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EDUCATION
637
Actual Loss on Cat Bond
For a hurricane catastrophe bond, a mild season
can offer a return on investment of 20 to 30
percent. In the 2005 season, the Olympus
Reinsurance cat bond lost its entire $650 million
in capital as a result of a heavy hurricane
season.
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EDUCATION
638
Insurance Securitization
Transfers underwriting risks to capital markets
• Tradable Security. Create a security and sell it
in smaller tranches to investors.
• Contingency. Investors agree to waive
principal repayment if a contingent loss occurs.
• Interest Rate. Pay above market rates of
interest to holders of the security.
• Principal Repayment. Return it to investors,
either periodically or at maturity.
THE CENTER FOR PROFESSIONAL
EDUCATION
639
Insurance Securitization Terms
Terms to describe insurance securitization:
 Alternative Risk Transfer. A broad term that
includes traditional insurance and insurance
securitization components.
 Catastrophe Bond. Issued to transfer
massive loss from smaller insurance markets
($billions) to larger capital markets ($trillions).
 Reinsurance Sidecar. An agreement similar
to a catastrophe bond in a reinsurance
structure.
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EDUCATION
640
Future of Insurance Securitization
• Derivatives. They will continue to be used.
Investors will seek profits while protecting
insurers against their own catastrophic loss.
• Insurance. A derivative can actually be a form
of insurance. It can provide money to pay
insurable losses if they occur.
• Trouble. An insurer is not likely to get into
trouble with insurance securities if they are
designed properly and issued.
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EDUCATION
641
Presentation
Session 15
Homeowners and
Automobile Insurance
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EDUCATION
Question
In addition to the named insured, are any of the
following also an insured under a homeowners
policy?
o Spouse of the person named.
o Relatives of the person named.
o Children in the care of the person named.
o Other residents of the property.
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Answer
The status of each person:
o Yes. Spouse of the person named.
o Maybe. Relatives if they are residents of the
property.
o Maybe. Children in the care of the person
named (Under age 21 and residents of the
property).
o Maybe. Other residents (Under 21 in the care
of an insured).
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Question
Homeowners policies identify the residence
premises. What is the meaning of the term?
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Answer
The residence premises consist of the primary
dwelling, other structures, and the grounds
where the insured resides.
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HO-3 Homeowners Policy
HO-3 is the most common homeowners policy in
the U.S. Characteristics:
o Package Policy. It covers property and
liability exposures.
o All Risk. It does not spell out the specific
risks that are covered. This is also called an
"open perils" or “all risks” policy.
o Exclusions. Some risks are not covered.
o Limits of Liability. Some risks are covered
up to specific limits.
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Residence Premises Coverage
Two HO-3 coverages for the residence premises
are:
o Coverage A. Dwelling. A house or similar
structure used for human habitation, generally
having walls and a roof to shelter its enclosed
space from precipitation, wind, heat, and cold.
o Coverage B. Other Structures. Buildings on
the residence premises such as a garage or
shed.
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EDUCATION
Question
Do you think coverages A or B cover the
following?
o Backyard swimming pool.
o Screened cage around the swimming pool.
o Attached garage.
o Unattached workshop.
o Shutters on the dwelling.
o Mailbox.
o Land or landscaping (bushes, trees).
o Fences.
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Answer
Coverages A covers:
o Screened cage around a swimming pool.
o Attached garage.
o Shutters on the dwelling.
Coverage B covers:
o Unattached workshop.
o Mailbox.
o Fence if it is not attached to the dwelling.
Neither A nor B cover damage to land or
landscaping.
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Question
A homeowner has an HO-3 policy that covers
property with a house and a barn. The
homeowner rents the barn to a neighbor who
charges others to board horses. Four neighbors
are paying for boarding at a time when a fire
destroys the barn and horses. Is the loss
covered under the HO-3 policy?
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Answer
No.
o Other structures are not covered if they are
used as a business.
o The horses are not covered.
o If sued for negligence, HO-3 provides liability
coverage up to $100,000 plus legal fees.
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Question
An individual has an HO-3 policy with a $200,000
limit of coverage. A windstorm causes $40,000
of damage to the home and $30,000 damage to
an unattached garage and apartment. The HO-3
policy places a limit on how much will be
reimbursed for a single loss. In this case, how
much do you think is reasonable as a
reimbursement for the loss?
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Answer
Aside from what is reasonable, the HO-3 policy
limits Coverage B Other Structures to 10% of
the dwelling coverage. It will reimburse $40,000
for the home and $20,000 for the unattached
garage and apartment.
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Personal Property and Loss of Use
HO-3 covers two other losses linked to the
residence premises.
o Coverage C. Personal Property. Damage to
items such as clothing and furniture.
o Coverage D. Loss of Use. Additional living
expenses when a covered loss forces an
individual or family to move temporarily from
their home temporarily as a result of a
covered loss.
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Question
Do you think the HO-3 policy places a limit on the
coverage for personal property or loss of use? If
yes, what do you think is a reasonable limit for
each?
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Answer
Aside from what is reasonable, HO-3 covers:
o Coverage C. Personal Property. Up to 50%
of the policy limit.
o Coverage D. Loss of Use. Up to 30% of the
policy limit.
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EDUCATION
Question
A fire damaged a covered premise with a
$200,000 policy limit. The insured had serious
problems with the contractor who did the
reconstruction work on the house. He paid
$65,000 to live in a Ritz-Carlton hotel and eat
out in fancy restaurants while waiting for the
house to be repaired. He also lost $3,000 in
rental income from a tenant in the attic. Are
these losses likely to be covered by HO-3?
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Answer
Read the policy. Considerations are:
o Limited Benefits. Policies limit payments
and have other restrictions.
o Limited Time. A policy may limit the amount
of time that expenses are reimbursed.
o Rental Income. The policy may reimburse
lost rental income.
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Question
Do you think HO-3 covers the following?
o Personal property off the premises.
o Clothing and furniture.
o Cash and securities.
o Watercraft and trailers.
o Jewelry.
o Silverware.
o Firearms.
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Answer
HO-3 covers the following with percentages up to
50% of the policy limit:
o Personal property anywhere.
o Clothing and furniture.
o Cash (limit $200). Securities (limit $1500).
o Watercraft and trailers (limit $1500).
o Jewelry (limit $2500).
o Silverware (limit $2500).
o Firearms (limit $2500).
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Question
Do you think HO-3 covers business property
stored:
o On the premises.
o Off the premises.
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EDUCATION
Answer
HO-3 covers business property stored:
o On the premises (limit $2500).
o Off the premises (limit $500).
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EDUCATION
HO-3 Liability Coverage
HO-3 is a package policy which means that it
covers both property and liability losses. Two
coverages are:
o Coverage E. Personal Liability. Provides
liability coverage if a claim is made or suit is
brought against an insured because of bodily
injury or property damage.
o Coverage F. Medical Payments. Pays
medical expenses for bodily injury of others.
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Question
Which of the following do you think should be
covered under HO-3 Coverage E Personal
Liability?
o On the Premises. Lawsuit judgments for
negligence by any insured.
o Off the Premises. Lawsuit judgments for
negligence by any insured.
o Defense Costs. Legal fees to defend a
lawsuit.
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Answer
HO-3 Coverage E Personal Liability covers
o On the Premises. Lawsuit judgments for
negligence by any insured or any other
person.
o Off the Premises. Lawsuit judgments for
negligence by any insured anywhere.
o Defense Costs. Paid above the policy limit.
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Question
HO-3 Coverage E Personal Liability has a limit of
$100,000 per occurrence, which may be
increased for an additional premium. Do you
think the coverage should include?
o Expenses incurred providing first aid to
injured parties.
o Damage to property of person who files
lawsuit.
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Answer
HO-3 Coverage E Personal Liability covers both of
the below above the $100,000 limit of basic
coverage.
o Expenses incurred providing first aid to
injured parties.
o Damage to property of person who files
lawsuit.
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Question
Under its liability coverage provisions, is HO-3
likely to cover lawyers fees when the insured is
sued by a third party if the insured is at fault for
the loss.
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EDUCATION
Answer
Yes. Coverage E pays legal fees without regard to
whether the insured is at fault for the loss.
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Question
Coverage F Medical Payments offers medical
payment coverage that reimburses a
policyholder for physical harm to individuals. Is it
likely to cover:
• Guest on Property. When a visitor is
accidentally injured on the premises.
• Injury Off the Premises. When someone is
injured by the insured or a family member.
• Family Member. When a family member is
injured on the property.
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Answer
Coverage F. Medical payments up to $1,000 per
person and $5,000 per occurrence.
• Yes. When a visitor is accidentally injured on
the property.
• Yes. When someone is injured off the
property by the insured or a family member.
• No. When a family member is injured on the
property.
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Additional Coverages
The coverage under a basic insurance policy can
be modified or customized two ways:
o Endorsement. This is a written provision that
modifies an insurance policy. It is also called
a rider.
o Supplemental Policy. This is a second
policy that expands the coverage under an
insurance policy.
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Scheduled Personal Property
This is an endorsement to HO-3 to cover direct
loss of valuable items. Scheduled property can
be insured for any amount the insured desires
up the value of an item.
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EDUCATION
Question
What are some examples of scheduled property
items?
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EDUCATION
Answer
Examples of scheduled property items are:
o Jewelry.
o Furs.
o Cameras.
o Musical instruments.
o Silverware.
o Golf equipment.
o Collectibles (Fine arts, postage stamps and
rare coins).
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EDUCATION
Question
Are earthquake and flood covered in a
homeowners policy?
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EDUCATION
Answer
No. Earthquake and flood are always excluded
coverage in a homeowners policy. Both can be
added as endorsements.
THE CENTER FOR PROFESSIONAL
EDUCATION
Question
What is the best way to buy homeowners
insurance?
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EDUCATION
Answer
Match policies to your exact situation. Cover
losses that affect the property. Talk to an agent
if questions arise.
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EDUCATION
Other U.S. Insurance
In addition to HO-3, U.S. insurers sell:
o HO-1. Covers specific named items.
o HO-2. Named perils for dwelling, other
structures, and personal property.
o HO-4. Contents of dwelling only.
o HO-5. All risk for dwelling et al, with named
exclusions.
o HO-6. Condominium and coops.
o HO-8. Designed for older homes.
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EDUCATION
Question
A burglar broke into an apartment rented by a
young couple and stole a big-screen television,
diamond ring, video camera, and $2,000 in cash
hidden in a desk drawer. The couple sued the
landlord but lost the case. Could they have
purchased insurance to cover the loss?
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EDUCATION
Answer
HO-4 is designed for individuals who rent
premises and covers:
o Personal property such as furniture and
clothes.
o Perils including fire, windstorm, and
vandalism.
o Additional living expenses if the apartment is
not habitable.
o Personal liability up to $100,000.
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EDUCATION
Question
An individual buys a condominium in a large
building. The homeowner's association
purchased a blanket insurance for the entire
building. Does it cover each individual
condominium?
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Answer
Partly. It covers the building and common property
but HO-6 is needed to cover the gaps. HO-6
covers:
o Personal property in the condo from theft, fire
or water damage or other forms of loss.
o Liability for residents and guests of the condo
owner.
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EDUCATION
Question
An individual has an expensive peacock that was
stuffed by a taxidermist. It sits in the living room
of her home. It was damaged by a small child
who painted it a dark blue. Is the damage
covered by her HO-3 policy?
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Answer
No. She needs HO-1 which is a limited policy that
offers varying degrees of coverage but only for
items specifically outlined in the policy. These
might be used to cover a valuable object found
in the home, such as a painting or medical
equipment.
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EDUCATION
Question
A named perils policy covers weight of objects that
cause the collapse to a dwelling. During a freak
arctic storm, 28 inches of snow was dumped on
a covered roof. The property owner takes no
steps to remove the snow. Four days later, the
roof collapsed. Is the loss covered?
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Answer
Yes. The property owner is under no obligation to
remove the heavy weight.
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Question
A policy covers fire, lightning, windstorm, hail,
explosion, riot, civil commotion, aircraft,
vehicles, smoke, vandalism, malicious mischief,
theft, falling objects, weight of ice, snow, or
sleet, some equipment failures that cause
damage, and volcanic eruption. The house has
a large southern exposure with four glass sliding
doors, 2 French doors, and 4 plate glass
windows. Is this a good policy for this house?
Why or why not?
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Answer
No. No glass breakage coverage from perils not
named.
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EDUCATION
Question
A policy covers all perils except losses from
freezing in unheated homes, theft during
construction, mold, fungus, or rot, rust,
discharge or seepage, pollutants, settling,
shrinking or bulging, insects, rodents, or pets. A
hurricane damaged furniture in the living room,
a garden tractor on the lawn, a computer on the
floor in the basement, and a storage shed in the
yard. Mud and tree branches covered most of
the property. Are these losses likely to be
covered?
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Answer
o Furniture. Personal property up to 50% of
policy limit. (Does not reduce dwelling limit.)
o Tractor. Personal property of insured or
owned by others but on the premises. Not if
owned by paid landscaper.
o Computer. Yes. (up to specified limit)
o Mud and Trees. Maybe. Policy must provide
for debris removal.
o Shed. Yes. Other structure.
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Liability Coverages
Homeowners policies can cover:
o Personal Liability. ($300,000 limit?) Pays:
• Damages. When others allege bodily injury or
property damage.
• Legal Fees. Above limit of the policy.
o Medical Payments. Pays:
• At Insured Location. Whether caused by insured
or not.
• Elsewhere. Injury caused by insured.
• Animal. Injury caused by animal owned or in care
of insured.
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Liability Exclusions
Homeowners policies do not cover:
o Business Pursuits. Except an occasional
activity such as a garage sale or Tupperware
party.
o Motor Vehicles. Separate policy needed.
o Watercraft and Aircraft. Separate policy
needed.
o Nuclear Activity or War.
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Question
An insured’s dog chased a deer across the yard
and through a sliding glass door. Inside, the
deer destroyed a TV and damaged equipment in
an office used for designing software for clients.
The deer raced onto a neighbor’s property
where it stepped on a small child. The dog was
cut by the glass and bled on the couch. The
owner had losses from broken glass, ruined
couch, TV, software equipment and vet
expenses for the dog. He was sued by the
parent of the child. Are any of these losses
covered by homeowners insurance?
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Answer
Glass. Yes. If glass breakage is additional
coverage.
TV. Yes. Personal property.
Dog Injury. Maybe.
Couch. Yes. Personal property
Software Equipment. No. Business property.
Lawsuit. Yes. On or off insured property.
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Amount of the Loss
A policy will spell out the amount of the loss,
either:
o Replacement Cost. The amount needed to
construct a new and similar house on the site
of the destroyed house.
o Actual Cash Value. Replacement cost minus
depreciation on the damaged portion.
The recommended approach is replacement cost.
We will not cover actual cash value.
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Underinsurance
Underinsurance occurs when the policy limit is
below 100% of replacement cost. Effects are:
o Total Loss. Failure to provide enough money
to replace the dwelling.
o Partial Loss. Most losses are partial. An
important caveat is that an insured must
maintain a policy limit of at least 80% of the
replacement cost. If this is done, the insurer
will pay 100% of partial losses up to the limit
of the policy.
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Partial Loss Below 80 Percent
With a replacement cost policy and a policy limit
below 80% of replacement cost, a partial loss is
paid using the formula:
o Have/Should x Loss. A formula that
multiplies the policy limit divided by 80% of
the policy limit times the replacement cost.
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Partial Loss Formula
Use the following formula for partial losses
Have/Should
$______/$_______ = ____%
Reimbursement $_______ x ____% = $____
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Question
A dwelling has a replacement cost of $500,000. It
is insured by a replacement cost policy with a
limit of $300,000 and a $10,000 deductible. A
fire causes $50,000 in damage to part of the
house. The have/should formula at 80% applies.
How much will be reimbursed by the policy?
Have/Should
$_______/$______ = ____%
Reimbursement $______ x ____% = $____
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Answer
Have/Should
$300,000/400,000 = 75%
Reimbursement $50,000x75%
= $37,500
Less Deductible
-10,000
Net Reimbursement
$27,500
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Presentation
Cats Question
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Pet Insurance Rider
Coverage Highlights
o Annual Exam
o Accidents and Illnesses.
o MRI, CAT Scans, and X-Rays
o Surgeries Cancer Treatments
o Prescription, medication, hospitalization,
vaccinations, heartworm protection
o Flea Control Spay & Neuter
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Pet Cancer Rider
Extends the cancer protection for cats and dogs.
o Studies show that dogs and cats may be the
family members most likely to get cancer.
o Use any licensed veterinarian even when you
are out of town.
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Presentation
Automobile Insurance
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Compulsory Insurance
In compulsory insurance states, motorists must
carry minimum amounts of liability insurance
before a vehicle can be licensed or registered.
Problems that arise include:
o Uninsured Motorists. Many still exist.
o Loss Experience. Does not improve.
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No Fault
In no fault states, injured parties collect from their
own insurer without having to prove fault. In
many states, lawsuits are allowed if the injury
exceeds a minimum threshold:
o Monetary Threshold. Bodily injury claim
must meet a certain amount ($2000?)
o Verbal Threshold. Bodily injury claim must
be serious, involving death, dismemberment
or permanent physical loss.
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Question
Lawsuits with auto insurance distribute funds as
follows:
o Medical Bills.
_____
o Pain and Suffering.
_____
o Fraudulent and Excessive Claims. _____
o Attorneys Fees.
_____
o Selling Fees.
_____
o Overhead and Other.
_____
Estimate the percentage in each category.
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Answer
o Medical Bills.
15%
o Pain and Suffering.
17%
o Fraudulent and Excessive Claims. 13%
o Attorneys Fees.
28%
o Selling Fees.
15%
o Overhead and Other.
12%
o Total
100%
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Categories of Auto Loss
Major categories of loss to autos are:
o Injuries or Death to Insureds. Individuals
who own or operate a vehicle.
o Third Party Injuries or Death. Injuries to
others.
o Damage to the Auto. A loss on the vehicle
itself.
o Damage to Other Property. Loss of value of
property that encounters the vehicle.
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PAP Covered Auto
In the PAP, a covered auto may be:
o Named Vehicle in the Policy. This may be
an owned automobile, van, or pickup (all
under a weight limit) or it may be a vehicle
leased for over 6 months.
o Newly Acquired Vehicle. Owned or leased
during the policy period.
o Trailer Owned by the Insured. Designed to
be towed by an auto.
o Temporary Substitute Vehicle. Borrowed
because of short-term need.
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PAP Newly Acquired Vehicle
For a newly acquired vehicle under the PAP, the
following generally applies:
o Additional Vehicle. Must notify insurer within
14 days to be covered from day one.
o Replacement Vehicle. Coverage is
automatic for liability coverages. For damage
to the auto itself, the insured has 4 days to
notify the insurer. Some caveats apply,
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Question
An insured purchases a vehicle on April 1. Without
removing it from the dealership or notifying his
insurance company, the insured leaves on a
three-week cruise. On April 26, he picks up the
vehicle and has an accident on the way home.
Is the vehicle covered by his insurance policy?
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Answer
No. If the insurer declines to pay, the insured is
not likely to be reimbursed for any loss.
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PAP Insuring Agreement
The insurer agrees to pay bodily injury or property
damages for which an insured is legally
responsible because of an auto accident. The
PAP can express the policy limit two ways:
o Single Limit. The policy will reimburse losses
up to a total limit for bodily injury and property
damage liability.
o Split Limit. The policy reimburses bodily
injury and property damage liability
separately.
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PAP Legal Costs
The PAP handles legal costs as follows:
o Outside Limits. The insurer will defend
against the claim and pay legal costs at the
insured’s expense.
o Judgments or Settlements End Defense
Obligation. When the insurer has made
payments equal to the policy limit, the insurer
has no further obligation to pay legal or
defense costs.
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Insured Person
The PAP identifies an insured person as:
o Named Insured and Resident Family
Members. Includes children and spouse who
was resident in past 90 days.
o Others Using Covered Auto. With
permission of the named insured.
o Responsible Organization. Responsible for
acts of covered person while using a covered
auto.
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Question
A boyfriend is on vacation. His girlfriend’s car
breaks down so she borrows his covered car
and has an accident. Her insurance has lapsed
so she has no coverage under her own policy. Is
she an insured person under his PAP policy?
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Answer
An insured person. The guideline is that she can
establish a reasonable belief that permission
exists. Express permission is not needed. Her
policy is not an issue.
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Exclusions
The PAP has a long list of exclusions, including:
o Intentional Injury or Damage. Loss must be
fortuitous.
o Personal Property in Auto. Coverage does
not extend to items in the auto.
o Business Uses. Other coverage is needed.
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EDUCATION
Question
A man drives off from a tavern and has an
accident. The police test shows his alcohol level
exceeds the state allowable level. He is given a
ticket for driving under the influence. Is he
covered under his PAP?
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Answer
Yes. Accident was still fortuitous. The penalty will
come when he seeks to renew his policy.
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EDUCATION
Question
A man changed lanes abruptly without signaling
causing a woman in another car to hit the
brakes.
• She speeded up and bumped him, causing
both them to lose control.
• Both are insured persons under their own PAP
policies.
• Are both parties covered by their own policies?
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Answer
The man is covered in spite of the careless
driving. The woman is not, as the bump is
intentional damage.
THE CENTER FOR PROFESSIONAL
EDUCATION
Question
A woman takes her car to an auto shop to be
repaired. After fixing the vehicle, a mechanic
tests it on the road and has an accident. The car
is damaged and an injured party sues the
owner. Is the accident covered by the PAP?
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Answer
No for the damage. The auto body company’s
insurance applies.
Yes for the bodily injury lawsuit. The PAP will
defend against the claim.
THE CENTER FOR PROFESSIONAL
EDUCATION
Question
A family goes on an exchange program to Europe
and leaves the family car with a friend who is
told to drive it regularly. The friend does not list
the vehicle on his PAP. Is it covered anyway?
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Answer
No. If used regularly, a vehicle must be identified
as a covered auto on a policy.
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EDUCATION
Question
An insured person borrows a motorcycle from a
friend. He rode to a farm where he drove a
snowmobile across a mountain. While on the
snowmobile, he broke his leg. He got back to
the farm and started for home on the cycle. He
was in an accident because his broken leg did
not allow him to stop in time. In the second
accident, he broke his arm. Are the medical
expenses covered by the PAP?
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Answer
No. Vehicles with less than four wheels are an
exclusion.
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Uninsured Motorist
Uninsured motorist coverage pays for bodily injury
and maybe property damage where legal
responsibility lies with:
o Uninsured Motorist. Irresponsible individual
who does not have auto insurance.
o Motorist with Insolvency Insurer. Insurer
unable to pay.
o Hit and Run Driver. Responsible party not
known.
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Damage to Own Auto
The PAP provides coverage for damage to an
insured person’s vehicle:
o Collision. A loss resulting from the upset of a
covered auto or non-owned auto or its impact
with another vehicle or object.
o Comprehensive. Theft of the vehicle or parts
of the vehicle or damage from non-collision
causes.
THE CENTER FOR PROFESSIONAL
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Question
Identify each of the following as collision or
comprehensive losses.
o Sliding into a tree on an icy road.
o Car catches on fire while driving down the
road.
o The car hits a deer crossing the road at night.
o Finding a dent in the fender of a car you
parked an hour ago.
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Answer
Identify each of the following as collision or
comprehensive losses.
o Tree on an icy road.
Collision
o Fire while driving.
Comprehensive
o Hits a deer.
Comprehensive
o Dent in parked car.
Collision
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Question
Automobile Statistics. How many automobiles are:
o On U.S. Highways
____
o Insured in the U.S.
____
o Uninsured on U.S. Highways
____
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Answer
Automobiles:
o On U.S. Highways
o Insured in the U.S.
o Uninsured on U.S. Highways
http://www.iii.org/media/facts/statsbyissue/auto/
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EDUCATION
199M
175M
24M
Question
Which of the following states have the most
uninsured drivers? The least?
o Mississippi
_____
o Maine
_____
o California
_____
o Massachusetts
_____
o Arizona
_____
o New York
_____
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Answer
Percent of uninsured drivers:
o Mississippi
26%
o Maine
4%
o California
25%
o Massachusetts
6%
o Arizona
22%
o New York
7%
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EDUCATION
Question
What percent of automobile insurance premiums
are used for each of the following?
o Medical expenses for injuries.
___%
o Damage to automobiles.
___%
o Insurer administrative costs.
___%
o Lawyers fees.
___%
o Claims costs.
___%
o Insurance company profits.
___%
100%
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EDUCATION
Answer
Percent of automobile insurance premiums:
o Medical expenses for injuries.
17%
o Damage to automobiles.
23%
o Insurer administrative costs.
24%
o Lawyers fees.
10%
o Claims costs.
16%
o Insurance company profits.
10%
100%
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EDUCATION
Question
What percentage of automobile accidents involved
death or disability in each year? What was the
average economic loss resulting from an
accident?
Year
% Serious Injury
$ Loss
1977
___%
$____
1987
___%
$____
1997
___%
$____
2002
___%
$____
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Answer
Automobile accidents involving death or disability.
Average economic loss from an accident.
Year
% Serious Injury
$ Loss
1977
60%
$1200
1987
52%
$3000
1997
32%
$5000
2002
30%
$5800
THE CENTER FOR PROFESSIONAL
EDUCATION
Question
For each of the following states, estimate the
annual average cost for automobile insurance
for one car. Match each state with its ranking
among 50 states in terms of the cost of
automobile insurance.
o States: California, Iowa, New Jersey, New
York, North Dakota.
o Rank (1=highest cost). 1, 2, 20, 48, 50.
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Answer
Ranking among 50 states in terms of the cost of
automobile insurance:
State
Average Cost
Rank
California
$ 825
20
Iowa
$ 580
49
New Jersey
$1200
1
New York
$1160
2
North Dakota.
$ 536
50
Average for U.S.
$ 820
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EDUCATION
Question
For each of the following cities, which is the most
costly in terms of auto insurance? The least
costly?
o Detroit
Green Bay
o Philadelphia
Raleigh
o Newark
Chattanooga
o New York City
Roanoke
o Los Angeles
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Answer
Cost of insurance for one automobile – top five
and bottom four cities:
Average for the U.S.
o Detroit.
$5200
Green Bay $950
o Philadelphia $4100
Raleigh
$950
o Newark
$3500
Chattanooga $910
o New York
$3100
Roanoke
$750
o Los Angeles $3200
THE CENTER FOR PROFESSIONAL
EDUCATION
Presentation
Session 16
Modern Risk Management
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EDUCATION
Framework for Risk Management
A SWOT Analysis:
• Strengths.
• Weaknesses.
• Opportunities.
• Threats.
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Framework for Risk Management
A TWOS Analysis:
• Threats
• Weaknesses.
• Opportunities.
• Strengths.
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Threats
National Association of Insurance
Buyers
Global Association of Risk
Professionals
Institute of Internal Auditors
Casualty Actuarial Society
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Threats
NAIB. Risk managers primarily buy
insurance.
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Threats
NAIB. Buyers of insurance.
GARP. Financial risk management is
the only risk management.
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Threats
NAIB. Buyers of insurance.
GARP. Only financial risk
IIA. Risk management is violation of
policies caught on audits.
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Threats
NAIB. Buyers of insurance.
GARP. Only financial risk
IIA. Violations.
CAS. Its all in the numbers.
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Weaknesses
Internal
Environment
•What is the internal philosophy and
culture?
Objective Setting •What are we trying to accomplish?
Event
Identification
•What could stop us from
accomplishing it?
•How bad are these events?
Risk Assessment •Will they really happen?
Risk Answer
•What are our options to stop those
things from happening?
do we make sure they don’t
Control Activities •How
happen?
Information and
Communication
•How [and from/with whom] will we
obtain information and communicate?
Monitoring
•How will we know that we’ve achieved
what we wanted to accomplish?
THE CENTER FOR PROFESSIONAL
EDUCATION
Source: Committee of Sponsoring Organizations
of the Treadway Commission www.coso.org.
Used with permission.
COSO ERM Framework
Internal
Environment
•What is the internal philosophy and
culture?
Objective Setting •What are we trying to accomplish?
Event
Identification
•What could stop us from
accomplishing it?
•How bad are these events?
Risk Assessment •Will they really happen?
Risk Answer
•What are our options to stop those
things from happening?
do we make sure they don’t
Control Activities •How
happen?
Information and
Communication
•How [and from/with whom] will we
obtain information and communicate?
Monitoring
•How will we know that we’ve achieved
what we wanted to accomplish?
THE CENTER FOR PROFESSIONAL
EDUCATION
Source: Committee of Sponsoring Organizations
of the Treadway Commission www.coso.org.
Used with permission.
COSO Implementation
Multinational Corporation ERM program:
• 800 Business Risks. Consolidated into 20
categories:
• 2100 Common Risks Group-wide exposures.
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Results of Business Risk Consolidation
- Business risks in the external environment, operational processes, and internal environment External
environment
Country-specific
risks
Natural
disasters
Laws and
regulations
Operational
processes
Business partners
Customers
Technica
Subcontractor Supplier
l
s
s
partners
Delayed
technological
development
Manufacturing
Lack of
differential
technology
Increasing
competition
due to competitors'
products
Falling market
prices
Dependence on
specific business
partners
Inadequate business
partner handling
R&D
Failures to respond
to changing
customer needs
Marketing & Sales
Delayed
production
Failures of sales
channel
strategies
PL and quality issues
Cost increases (increasing inventory, soaring material costs, declining yield)
Delayed collaboration due to insufficient linkage between divisions
Internal
environment
Informatio
n
Organization
Human
resources
Internal
infrastructure and
organization
operations
Insufficient
manufacturing reforms
and IT innovations
Staff allocation and
Structural reformdevelopment
related issues
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EDUCATION
Competitors
Failures of sales
promotion
Business Structure
Segment
AVC
Networks
Global
and
Group
Head
Office
Home
Appliances
Business domain
AVC
Panasonic AVC Networks Company
Fixed-line communications
Panasonic Communications Co., Ltd.*
Panasonic Mobile Communications Co., Ltd.*
Mobile communications
Panasonic System Solutions Company
Systems
Panasonic Shikoku Electronics Co., Ltd.*
Home appliances, household equipment,
healthcare systems
Matsushita Home Appliances Company,
Matsushita Refrigeration Company*
Healthcare Business Company
Lighting Company
Matsushita Ecology Systems Co., Ltd.*
Lighting
Environmental systems
CISC
Components
and Devices
Panasonic
Design
Company
R&D divisions
Semiconductor Company
Display devices
Matsushita Battery Industrial Co., Ltd.*
Batteries
Panasonic Electronic Devices Co., Ltd.*
Electronic components
Motor Company
Motors
Solutions
Panasonic Automotive Systems Company
Automotive electronics
Semiconductors
Head Office
Business Domain Companies and Group Companies
FA, Corporate eNet Business Division
Others
Panasonic Factory Solutions Co., Ltd.*, and others
Sales division
Overseas
divisions
MEW and PanaHome
JVC
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EDUCATION
Matsushita Electric Works, Ltd.*, PanaHome Corporation*
Victor Company of Japan, Ltd.*
Group-wide Risk Management System for General Contro
(2) Establish a G&G Risk Management Committee to address the current problems
After the Committee's
establishment
Establishing and improving Group-wide RM system
Instructing risk assessment
<Roles of the Committee>
[1] Establishing and improving
Group-wide RM system
[2] Conducting Group-wide risk
assessment
[3] Reporting to the President,
and Board of Corporate
Auditors
[4] Studying possible measures
to prepare for major risks;
suggesting such measures to
President and Corporate
Functional Divisions
[5] Improving Group-wide
support systems against
emergencies
G&G
RM
Commit
tee
Committee
Corporate Functional
Division A
Domains
Support
Subsidiaries
Committee
Corporate Functional
Division B
Support
Corporate Functional
Division C
Corporate Regional
Management
Divisions /
Regional HQs
Results of Groupwide risk
assessment
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EDUCATION
Secretariat
Collecting risk information from
across the Group
Clarify Sections Responsible for Each Risk
(4) Information systems
1. Disasters and accidents
Earthquakes, typhoons, tsunamis, floods, and
other natural disasters
General Affairs Group, Overseas
Security management Office
Fires, explosions, airplane crashes, terrorist
attacks, and other major destructive or violent
events
General Affairs Group, Corporate
Personnel Group, Overseas Security
Management Office
2. Politics, economy, and society
Shutdown or malfunction of information
systems and communication networks
General Affairs Group, Corporate
Information Security Division
Unauthorized use of information systems
General Affairs Group, Corporate
Information Security Division
Inadequate security measures related to
information systems
General Affairs Group, Corporate
Information Security Division
(5) Environment
Wars, civil wars, conflicts, etc.
General Affairs Group, Overseas
Security Management Office
Corporate threats, abduction, and violent civil
unrest
General Affairs Group, Overseas
Security Management Office
Environmental pollution
Corporate Environmental Affairs Group
Waste treatment
Corporate Environmental Affairs Group
Environmental regulations
Corporate Environmental Affairs Group
(6) International relations
3. Operations
(1) Quality, CS, and intellectual property
PL and recall issues, other quality problems
Corporate Quality Administration
Division
Failure in complaint-handling
Corporate CS Division
Intellectual property right infringements
Corporate Intellectual Property Division
(2) Sales and procurement
Violation of security export control
Corporate Legal Affairs Division
Trade issues
Corporate Legal Affairs Division
(7) Finance
Bad loans and business partner bankruptcy
Corporate Accounting Group
Tax and accounting system changes
Corporate Accounting Group
Exchange rate fluctuations
Corporate Finance & IR Group
Violation of antitrust (competition laws)
Corporate Legal Affairs Division
Interest fluctuations
Corporate Finance & IR Group
Bribery
Corporate Legal Affairs Division
Stock price fluctuations
Corporate Finance & IR Group
Violation of Subcontractors Act
Corporate Procurement Division
Corporate Accounting Group
Soaring raw material prices and unavailability
Corporate Procurement Division
Impairment of long-term assets and deferred tax
assets
(8) Labor issues
(3) Information
Human rights issues, including sexual
harassment
Industrial Relations Group, Corporate
Personnel Group, Overseas Security
Management Office
Corporate Information Security
Division
Employment
Corporate Personnel Group, Industrial
Relations Group
Corporate Information Security
Division
Industrial accidents
Industrial Relations Group
Trade secret leakage
Corporate Information Security
Division
Private data leakage and violation of privacy
Information security incidents related to products
and services
Insider trading
HealthEducation
issues such as infectious diseases
Center for Professional
General Affairs Group
Industrial Relations Group, Overseas
Security Management Office
Spreadsheet Risk Listing (1)
Administration risk. Design risk.
Business support risk. Distribution risk.
Capital budgeting
Efficiency risk.
risk.
Financial reporting
Capital structure risk. risk
Communications risk. Finance risk.
Compliance risk.
Credit risk.
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EDUCATION
Spreadsheet Risk Listing (2)
Information systems
risk
Key initiative risk.
Marketing risk.
Needs risk.
Performance risk.
Portfolio risk.
Pricing risk.
Process risk.
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EDUCATION
Production risk.
Records management
risk.
Supply risk.
Technology risk.
Valuation risk.
Volume risk.
Opportunity
What is the right
Road?
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Opportunity.
Is it This?
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EDUCATION
Or this?
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To where. . . ?
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EDUCATION
Into the Office of the CFO
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EDUCATION
Organizational Chart
Chief
Executive Officer
Chief
Finance
Chief
Marketing
Risk
Manager
THE CENTER FOR PROFESSIONAL
EDUCATION
Chief
Production
Everybody
Else
Influence Structure
Chief
Financial Officer
Chief
Executive
Chief
Marketing
Risk
Manager
THE CENTER FOR PROFESSIONAL
EDUCATION
Chief
Production
Everybody
Else
CFO Decision Style #1
Morrie’s Style.
“Behind the back.”
THE CENTER FOR PROFESSIONAL
EDUCATION
CFO Decision Style #1
Morrie’s Style.
“Behind the back.”
“Delete Key”
THE CENTER FOR PROFESSIONAL
EDUCATION
CFO Decision Style #2
Mel’s Style.
“Bury yourself in numbers.”
THE CENTER FOR PROFESSIONAL
EDUCATION
CFO Decision Style #2
Mel’s Style.
“Bury yourself in numbers.”
“Get buried in numbers.”
THE CENTER FOR PROFESSIONAL
EDUCATION
Opportunity
Sell
modern risk management
to the CFO
THE CENTER FOR PROFESSIONAL
EDUCATION
Opportunity
How does Cinderella become the fairy
princess?
THE CENTER FOR PROFESSIONAL
EDUCATION
If we do it wrong?
Get stuck in the kitchen.
Auditors go to the ball.
THE CENTER FOR PROFESSIONAL
EDUCATION
If we do it wrong?
Get stuck in the kitchen.
Nasty stepsisters go to the ball.
THE CENTER FOR PROFESSIONAL
EDUCATION
Let’s bring risk opportunity to the CFO
We need modern risk management:
• Non-legacy technology.
• Big data.
• Communication links.
• Relationships among risk factors.
• Mobile devices.
THE CENTER FOR PROFESSIONAL
EDUCATION
CFO Response
Non-legacy technology?
Big data?
Communication links?
Relationships among risk factors?
Mobile devices?
Why?
THE CENTER FOR PROFESSIONAL
EDUCATION
Answer
Everybody is implementing ERM.
Rating agencies like ERM.
ERM is in all the newspapers.
THE CENTER FOR PROFESSIONAL
EDUCATION
More Support
Ben Stiller was a risk manager in the movie
All About Polly.
THE CENTER FOR PROFESSIONAL
EDUCATION
CFO Response
•
•
•
•
Everybody is implementing ERM.
Rating agencies like ERM.
ERM is in all the newspapers.
The Ben Stiller thing.
• What’s your point?
THE CENTER FOR PROFESSIONAL
EDUCATION
Try some details
• Operational Risk. Reduce it.
• Strategic Risk. Better business decisions.
• More Profit. Pursue opportunities more
quickly.
• Lower Costs. Tax benefits, lower cost of
insurance and claims administration.
THE CENTER FOR PROFESSIONAL
EDUCATION
CFO Response
• Lower Costs. Tax benefits, lower cost of
insurance and claims administration.
Did you say lower costs?
THE CENTER FOR PROFESSIONAL
EDUCATION
Tell me more . . .
Give me one example of how your risk
management area can help us lower
costs.
THE CENTER FOR PROFESSIONAL
EDUCATION
Tell me more . . .
Give me one example of how your risk
management area can help us lower
costs.
And prove it!
THE CENTER FOR PROFESSIONAL
EDUCATION
Strength
Behavior: Talk Finance
Ask the CFO: Should we use a captive to
fund workers compensation?
THE CENTER FOR PROFESSIONAL
EDUCATION
Maybe, if you can tell me . . .
What happens in a hard market?
What happens in a soft market?
Who covers catastrophic risks?
What specific coverages make sense?
What happens if the tax position changes?
How do we work with financial markets?
THE CENTER FOR PROFESSIONAL
EDUCATION
Give me a moment . . .
• We are investing capital.
• A captive decision is more of a financial
rather than insurance decision.
Here’s where we need financial tools.
THE CENTER FOR PROFESSIONAL
EDUCATION
We need Financial Tools that . . .
• Tell a compelling story.
• Are relevant.
• Provide a foundation for further
discussion.
THE CENTER FOR PROFESSIONAL
EDUCATION
Decision Point
Let’s look at some numbers.
THE CENTER FOR PROFESSIONAL
EDUCATION
Decision Point
Let’s look at some numbers.
Are we really going to look at numbers?
THE CENTER FOR PROFESSIONAL
EDUCATION
Decision Point
Let’s look at some numbers.
Are we really going to look at numbers?
Just answer 4 questions.
THE CENTER FOR PROFESSIONAL
EDUCATION
Four Questions
1. What is the cost of retention/insurance?
2. What would be the cost of a captive?
3. What is the captive net present value?
4. What is the total cost of risk?
THE CENTER FOR PROFESSIONAL
EDUCATION
1. Cost of Retention/Insurance
Yr. 0
Yr. 1 Yr. 2 Yr. 3
Losses/Adjusting
-3500 -3500
Retention Admin
-800 -800
Excess Premiums
-500 -500
Cash Flows
-4800 -4800
Present Values* 8% -4594 -4237
Present Value -16336
* mid-year factors
3.74
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EDUCATION
0.57
Yr. 4
-3500 -3500
-800 -800
-500 -500
-4800 -4800
-3905 -3599
1.62
2.68
2. Cost of a Captive? (Claims 5%)
Yr. 0
Yr. 1
Invested Capital
-1200
Captive Premiums
Admin with Captive
Tax Savings 6%
Reduced Claims 5%
Parent Deductible
Cash Flows
-1200
Present Values 8% -1200
Present Value
-17373
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EDUCATION
Yr. 2
Yr. 3
Yr. 4
-4850 -4850 -4850
-400 -400 -400
291
291
291
243
243
243
-300 -300 -300
-5017 -5017 -5017
-4801 -4428 -4082
1200
-4850
-400
291
243
-300
-3817
-2862
3. Captive Net Present Value
Yr. 0
Yr. 1
Invested Capital
-1200
Captive Premiums
Losses/Adjusting
Parent Deductible
Captive Admin
Excess Premiums
Cash Flows
-1200
Present Values 8% -1200
Net Present Value 1572
Internal Rate
of Rtn 56%
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EDUCATION
Yr. 2
Yr. 3
Yr. 4
4850 4850 4850
-3500 -3500 -3500
300
300
300
-600 -600 -600
-500 -500 -500
550
550
550
526
486
447
1200
4850
-3500
300
-600
-500
1750
1312
4. Total Cost of Risk?
Claims 5%
Cost of Retention
-16336
Cost of Captive
NPV of Captive
Net Cost of Captive
-17373
1572
-15801
Difference
THE CENTER FOR PROFESSIONAL
EDUCATION
535
4. Total Cost of Risk?
Claims 5%
Cost of Retention
Claims 15%
-16336
-16336
Cost of Captive
NPV of Captive
Net Cost of Captive
-17373
1572
-15801
Difference
THE CENTER FOR PROFESSIONAL
EDUCATION
535
-15723
1572
-14151
2185
Now we are Ready to Discuss . . .
What happens in a hard market?
What happens in a soft market?
Who covers catastrophic risks?
What specific coverages make sense?
What happens if the tax position changes?
How do we work with financial markets?
THE CENTER FOR PROFESSIONAL
EDUCATION
Other Questions
We can also discuss
Is the cost forecast realistic?
Who absorbs larger than expected losses?
Everything else.
THE CENTER FOR PROFESSIONAL
EDUCATION
We can examine . . .
Would a captive help us make better
decisions on the risk we retain?
Can a captive provide us valuable
benefits?
Would a captive be right for us?
THE CENTER FOR PROFESSIONAL
EDUCATION
The Message?
Does it make a
Difference
Whether we speak the
Language of the
Chief Financial Officer?
THE CENTER FOR PROFESSIONAL
EDUCATION
Career Path?
Chief
Financial Officer
Controller or
Treasurer
Accountant
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EDUCATION
Career Path?
Chief
Financial Officer
Competent Risk
Manager
Risk Analyst
THE CENTER FOR PROFESSIONAL
EDUCATION
Small Conclusion
Better decisions on risk.
Is it
Risk Management?
Finance?
Both?
THE CENTER FOR PROFESSIONAL
EDUCATION
Larger Conclusion
On the
Importance of
Language
THE CENTER FOR PROFESSIONAL
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Video
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Message #1
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Message #2
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