1
Topic 15: Insurance Terms
 Peril: cause of loss such as fire
 Hazard: increases likelihood of loss
 Physical: ice on sidewalk
 Moral: dishonesty
 Morale: indifference to loss such as
speeding
 Law of large numbers
 More units exposed to loss, greater
predictability of loss
2
Topic 15: Insurance Terms
 Adverse selection: higher risk individuals will
seek insurance
 Self-insurance: business creates fund to pay
own losses
 Risk avoidance: don’t drive
 Risk diversification: hold harmless, shift risk to
someone else
 Risk reduction: lower chance of loss
 Take driver’s training
3
Topic 15: Insurance Terms
 Risk transfer: buy insurance
 Principle of indemnity: can’t profit from loss
 Subrogation: right to pursuit legal action to
collect from third party
 Insurance interest: insured stands to lose
 Life insurance: required only when policy issued
 Property liability: must have at start of policy
and when loss occurs
4
Topic 15: Insurance Contracts
 Contract can’t be assigned
 Aleatory: one person may get better deal than other
party
 Adhesion: non negotiable
 Good faith: both parties must be honest
 Beneficiary can be changed unless irrevocable
designation
 Need consent of beneficiary if want to change
 Conditions precedent, subsequent
5
Topic 16: Risk Exposures
 Personal
 Death, disability, health
 Property
 Reduction in value
 Or cost of replacement
 Liability:
 Business related
 Loss of income
6
Topic 17: Property Insurance
 80% rule: required insurance
 (Amount Insured/Amount Should Have Insured
x Loss) – Deductible = Insurance Payment
 Deductible subtracted last
 Amount Should Have Insured = Replacement Cost
x 80%
 Home





$400,000 replacement cost
$300,000 insurance
$1,000 deductible
Fire causes $20,000 damage
Insurance reimbursement?
7
Topic 17: Property Insurance
 Homeowners Insurance
 HO 01: fire and named perils
 HO 02: broad form covers additional perils
 Personal property covered up to 50% of dwelling
insurance
 HO 03: open perils (all risk) on dwelling; broad form
on personal property
 Most common policy
 Excludes pets, property of boarders, separately
scheduled property
 Excludes flood, sewer backup, wet basement
 Rising water versus falling water: Oakcrest
8
Topic 17: Property Insurance
 Homeowners Insurance
 HO 04: renters insurance
 Broad form coverage for personal property
 HO 05: open perils for dwelling and open perils
for personal property
 HO 06: condo insurance
 Dwelling covers interior walls
 Broad form on personal property
 HO 08: older homes
 Replacement cost > FMV
 Insures them at a lower value
9
Topic 17: Property Insurance
 Coverage A: dwelling and attachments
 Coverage B: structures separated from dwelling
 Garages, pools, fences
 Generally 10% of Coverage A amount
 Coverage C: personal property located anywhere
 Generally 50% of Coverage A amount
 Limits on high value items: jewelry, guns, etc.
 Can be increased by endorsement
 Exclusions: business property, boarders property
10
Topic 17: Property Insurance
 Coverage D:
 Additional living expenses while home repaired
 Credit cards: up to $500, no deductible
 Coverage E:
 Comprehensive personal liability for unintentional
bodily injury and property damage up to $100,000
 Covers damages off premises by insured, pets
 Not for insured
 Coverage F:
 $1,000 per person per occurrence medical payments
 Covers damages off premises by insured, pets
 Not for insured
11
Topic 17: Property Insurance
 Exclusions




Earthquake
Flood, rising water. (Falling water covered)
War, nuclear accidents
Intentional loss
 Endorsements




Scheduled personal property
Earthquake
Flood
Personal property replacement cost
12
Topic 17: Property Insurance
 Miscellaneous
 No coverage if conceal material info
 Insured can cancel at any time
 Insurer must give advance notice of cancellation,
nonrenewal
 Only one year to sue insurer
13
Topic 17: Personal Auto Policy
 Part A: liability: bodily injury and personal
property caused by insured’s negligence
 Also attorney fees to defend insurance
 Split limits: per person/per accident/property
damage
 $15,000/$30,000/$50,000
 Required? Get minimum?
 Covered individuals
 Named insured
 Spouse and family members
 Others using car with permission
14
Topic 17: Personal Auto Policy
 Covered vehicles
 All vehicles listed in policy declaration
 New vehicles
 14 days to notify
 Trailers
 Loaner cars
 Rental cars???
 Exclusions
 Intentional injury/damage
 Employees
 Motorcycles require separate coverage
15
Topic 17: Personal Auto Policy
 Part B Medical Payments: $1,000 per person
 Covers, no matter fault,
 Insured
 Insured family members

Even when pedestrians hit by car
 Others in car: flying turkeys
 Part D: Physical Damage to Your Auto
 Collision
 Other than collision (comprehensive)
 Hitting deer: not collision, covered under
comprehensive
 Deductibles
 $250 - $1,000
16
Topic 17: Personal Auto Policy
 Uninsured motorist
 Coverage applies when accident fault of individual
with
 No insurance
 Less insurance than required by law
 Hit and and run drivers
17
Topic 17: Umbrella Liability
Insurance
 Required underlying policies
 Auto, home, boat, motorcycle
 Must have required amounts of coverage
 Provides additional liability coverage

Large amount; generally inexpensive
18
Topic 17: Commercial
Insurance
 Property
 Homeowners coverage generally provides minimal
coverage for business property in home
 Endorsement
 Open perils or specified perils
 Actual cash value or replacement cost
 May have co-insurance (80%) requirement but not
mandatory
 Bars, restaurants, amusement parks not eligible for
this policy
19
Topic 17: Commercial
Insurance
 Business income coverage
 Replaces income and covers expenses due to closure
by covered peril: fire, wind, etc.
 Crime insurance
 Police must be notified
 Liability
 Occurrence basis
 Covers claims from events during policy period
 Doesn’t matter when claim filed
 Claims made
 Covers only claims made during policy period
 Will need tail coverage for claims after policy lapse
20
Topic 17: Commercial
 Liability
 Types

 Same coverage as Personal Auto Policy
 Garage Coverage: for businesses storing; selling;
servicing; parking vehicles
Umbrella
 Self insure generally first $25,000
 Occurrence basis
 Professional liability
 Physicians, attorneys, etc.
 Fail to perform as promised
21
Topic 17: Commercial



Surety bonds
 Insures party will fulfill obligations
 Insured is liable to issuing company if payment has to
be made on bond
Directors and Officers
 Covers wrongful acts
Workers Comp
 Provides benefits required under state law
 Payment for liability claims from employee injuries
 Injured on the job
22
Topic 18: Health Insurance
 Hospital, surgical and physicians
insurance
 Hospital: room and board up to $X per
day
 Surgeon: all or usual and customary
 Physicians: only in hospital
 Not the type of “health insurance” you
want
23
Topic 18: Health Insurance

Major medical insurance policy
 Covers most medical expenses
 Both in and outside of hospital
 High payment limit: $1 million/unlimited
 Deductible
 Usually $500 to $1,000 per year
 Often per person/per family ($500/$1,000)
 Coinsurance:
 For example, after deductible met, insured must pay
20% of next $5,000 of medical expenses per
person???
24
Topic 18: Health Insurance
 Major medical insurance policy
 Not covered






Chemical addictions
Cosmetic surgery
Glasses
Travel outside U.S. / Canada
Injuries covered by workers comp
Self-inflicted injuries
25
Topic 18: Health Insurance
 Medical insurance premiums
 Self-employed
 Deducted in calculating AGI
 Employees
 Must itemize
 Medical expenses must be > 7.5% AGI
26
Topic 18: Health Insurance
 Medicare
 Part A: Hospital
 Over 65
 Eligible for Social Security
 Automatically covered
 No cost
27
Topic 18: Health Insurance
 Medicare
 Part B: Doctors’ services
 Over 65
 Eligible for Social Security
 Must pay premium
 Premium increases with AGI
28
Topic 18: Health Insurance
 Medicare
 Deductibles
 Part A: Hospital
 $1,068 for first 60 days
 After 60 days, patient pays most of the cost
 No deductible for first 20 days at skilled
nursing facility
 After 20 days, patient pays most of the cost
29
Topic 18: Health Insurance
 Medicare
 Deductibles
 Part B: Doctors services
 $135 per year
 20% co-pay
30
Topic 18: Health Insurance
 Medicare
 Part D: Prescription drugs
 Anyone in Part A or B is eligible
 Annual premium $420 per year
 Covers large portion of initial costs and
extraordinary costs but not costs in the
middle (donut)
31
Topic 18: Health Insurance
 Medigap: Medicare Supplemental
 Must offer:
 Part A: up to one year hospitalization
beyond Medicare coverage
 Part B: pays 20% co-payment
 Can offer other benefits
32
Topic 18: Health Insurance
 Medicaid: provide medical care
for those who can’t afford to pay
 Administered by each state
 Must meet income/asset tests
 Five year look back rule on transfer
of assets
33
Topic 19: Disability Insurance
 Definition of disability
 Own occupation: can’t do what you normally do
 Relief pitcher: disabled even if could coach
 ETE: can’t work at any job for which education,
training and experience would qualify you
 Tiger Woods making cheeseburgers
 Partial disability: can’t work full time
 Generally 50% of total disability benefit
 Residual disability benefit: if earnings decrease by
2/3, collect 2/3 of total disability benefit
34
Topic 19: Disability Insurance





Benefit period
 To age 65
 Period of years
Elimination period
 One to six months
Benefits
 Tax-free if insured paid for policy
 Employer paid for policy: benefits taxable
 Up to 75% of income
 COLA riders available
Guaranteed renewable: pay premiums, policy stays in force
Guaranteed insurability: can increase coverage without
showing insurability
35
Topic 20: Long-Term Care
Insurance
 Medicare only covers 20 days of
skilled nursing care
 Not nursing home so Grandma can
play bingo (custodial care)
 Can generally buy coverage up
until age 84
36
Topic 20: Long-Term Care
Insurance
 Benefits payable if can’t do more than one of following:
 Dress, eat, bathe, toilet, walk
 Benefits are usually $X per day
 May be an elimination period
 Benefits paid from one year to lifetime
 Inflation rider available
 May have waiver of premium if receiving benefits
 Must be guaranteed renewable for favorable tax
treatment
37
Topic 20: Long-Term Care
Insurance
 Life insurance
 Accelerated death benefit provision and viatical
settlements allow access to funds for long-term care
if terminally ill
 Insurance premiums
 Self-employed
 Deducted in calculating AGI
 Not self-employed
 Must itemize:
 Medical expenses must be > 7.5% AGI
 Amount deductible limited based on age
 $3,180 for ages 61 - 70
38
Topic 21: Life Insurance
 Concepts
 Mortality: death rates
 Morbidity: rates of disability
 Expenses: greatest in early years
 Commissions
 Insurable interest
 Required at time of policy inception
 Not at the time benefits are paid
39
Topic 21: Life Insurance


Term insurance: temporary
 Renewable: to age 70
 Convertible: to whole life
Whole life: permanent/forced savings
 Variable: separate account invested based on policy holder’s
allocation
 Whole life funds go into general account of company
 Can increase death benefits/cash value based on investment
performance
 Universal: can change
 Premiums: can skip payments
 Death benefit
 Cash value separated from death benefit
 Variable universal: combine features
 Survivorship: second to die policy
40
Topic 21: Life Insurance
 Contract provisions
 All language contained in contract
 Backdating: can be done up to six months
 Owner may not be insured
 One month grace period for premium payments
 Misstate age: adjust death benefit
 Loans: amount borrowed subtracted from death
benefits
 Assignment: generally policies may be assigned
 Common disaster: primary beneficiary must outlive
insured by 60 – 90 days
41
Topic 21: Life Insurance
 Contract provisions
 Incontestable: insurer has two years to
challenge validity of policy
 Exclusions: suicide (one to two years)
and war
 Settlement options
 Lump sum
 Annuity
 Single or joint life; term certain
 Interest only
42
Topic 21: Life Insurance
 Dividends




Cash
Accumulate
Reduce premiums
Buy additional coverage
 Interest credits
 Portfolio method: based on insurer’s
earnings of overall portfolio
 New money method: based on insurer’s
earnings on money invested that year
43
Topic 21: Life Insurance
 Riders
 Accelerated death benefits: pay benefits if expected
to die within year; in nursing home permanently
 Long-term care: benefits rider can be added to life
insurance policy
 Waiver of premiums: if disabled
 Guaranteed insurability: can buy more coverage
without showing insurability
 Double indemnity: twice policy amount if death
accidental
44
Topic 21: Life Insurance
 Nonforfeiture options
 After policy has cash surrender value,
 Can get cash within six months
 Can get a paid-up policy with a reduced
face amount
 Can get a term policy with the same face
amount
45
Topic 21: Life Insurance
 Illustrations
 Projection of financial results
 Incorporate present value or just nominal values?
 Optimistic assumptions?
 Clearly label what is guaranteed?
 NAIC model does not apply to variable
life/annuities
 Policy replacement
 Regulated by many states
 High commissions
 May make sense due to reduced mortality charges
and in higher interest rate periods
46
Topic 21: Life Insurance
 Accelerated death benefits
 Allow terminally ill insured to obtain funds prior to
death tax-free
 Pay for custodial care
 Preferable to viatical due to discounts on viatical
 Viatical settlements
 Terminally ill insured transfers policy for lump sum
payment
 Benefits tax-free to insured if:


expected to die within two years
can’t perform two activities of daily living
47
Topic 22: Income Taxation of Life
Insurance
 Dividends: whole life policies
 Not taxable unless total dividends > premiums
paid on policy
 Loans: whole life policies
 Not taxable
 Withdrawal of cash value
 Not taxable unless withdrawals > basis
 If taxable, ordinary income
 Surrender
 Not taxable unless proceeds > basis
 If taxable, ordinary income
48
Topic 22: Income Taxation of Life
Insurance
 Death benefit: not taxable
 MECs: premiums higher than necessary for
insurance.
 Often single premium policy
 Then take cash value prior to death
 Test during first seven years of policy
 If policy is MEC,
 Death benefit is still not taxable
 Withdrawals and loans taxed as
ordinary income with penalty if under
59 ½
49
Topic 22: Income Taxation of Life
Insurance
 Transfer for value
 Sell policy to someone other than related
party (business, co-owner, family
member)
 Seller not taxed if viatical settlement
 Expected to die within two years
 Buyer will be taxed on death benefits if
greater than basis (ordinary income)
 Including premiums paid and purchase price
50
Topic 22: Income Taxation of Life
Insurance
 Section 1035 exchange
 Trade an existing policy for a new policy
 Good idea???
 Mortality/interest rate assumptions
 Trade an insurance policy for an annuity
 Makes IRS happy
 Can not trade an annuity for an
insurance policy
 Would make the IRS sad
51
Topic 23: Business Uses of
Insurance
 Buy-Sell Agreements
 Provides for the sale of business interest
on death of owner




Allows heirs to cash out of business
Keeps heirs from becoming co-owners
Keeps ownership with existing owners
Value generally based on formula
 Valid for estate tax valuation
52
Topic 23: Business Uses of
Insurance
 Buy-Sell Agreements
 Cross purchase
 Owners buy policies on each other
 Number of policies?
 Older owner
 Premiums not deductible
 Entity
 Company buys policy on each owner
 Premiums not deductible
53
Topic 23: Business Uses of
Insurance
 Key Person Life Insurance
 Insures life of valued employee:
 Pujols
 Janitor
 Business is beneficiary
 Premiums not deductible
 Benefits tax-free
54
Topic 23: Business Uses of
Insurance
 Split Dollar Life Insurance
 Employer and employee share cost of premiums
 Employer pays cash value portion
 Employee pays pure life insurance cost

If employer pays entire premium, coverage above $50,000
taxable
 Endorsement method
 Employer owns policy



Receives reimbursement for premiums paid
Employee gets balance
Employer paid premiums income to employee
 Collateral assignment method
 Employee owns policy


Again must reimburse business for premiums paid
Premiums treated as loans: employee must pay interest
55
Topic 24:Insurance Needs Analysis
 Life insurance
 Human life approach: six to ten times
annual income
 Present value of insured’s future income
 Does not consider assets, liabilities
 Financial needs: determine cash needs,
income needs, special needs and then
subtract net worth
56
Topic 25:Insurance Policy and
Company Selection
 Life insurance
 Temporary needs: term
 Permanent needs: whole life
 Participating: pays dividends when
premiums were “too large”
 Cost analysis
 Net cost method per $1,000 of coverage =
(total premiums – cash value) / number of
years policy held
 Ignores time value of money
57
Topic 25:Insurance Policy and
Company Selection
 Life insurance
 Cost analysis
 Surrender cost index =
 (future value of premiums – dividends – cash
value)/fv factor for $1 for n years at i rate)
 /$1,000 units of coverage
 Net payment cost index =
 Same as surrender cost index but cash value is not
subtracted
58
Topic 25:Insurance Policy and
Company Selection
 Life insurance
 Cost analysis
 Net payment cost index = same as surrender
cost index except does not subtract cash
value
59
Topic 25:Insurance Policy and
Company Selection
 Life insurance
 Company selection: financial ratings
 Companies rated based on financial strength
 A.M. Best, S&P, Moody’s
 Best: insurance companies only
 “A+” rating has different meanings
 Variable products provide security of
subaccounts
 Company selection: underwriting
 Some companies only want certain types of risk
 State Farm: Florida, b & b
60
Topic 25:Insurance Policy and
Company Selection
 Property and casualty insurance
 Policy selection
 Insure catastrophic losses
 Select deductibles based on
 Risk tolerance
 Risk capacity
61
Topic 26: Annuities
 Types
 Immediate: payments begin now
 Deferred: payments begin later
 Single premium: one payment
 Purchase annuity with 401(k) proceeds
 Periodic premium
 Single vs. joint and survivor
 Period certain: benefits continue for a
minimum number of years
 Even if die before period ends
62
Topic 26: Annuities
 Types
 Fixed: periodic payment known
 Turn defined contribution plan into defined
benefit plan
 Variable: periodic payments based on
investment performance
 Considered securities: must hold Series 6
and insurance license to sell
 Oversold/undersold????
63
Topic 26: Annuities
 Structured settlements
 Receive periodic payments instead of
lump sum
 For auto accident, medical malpractice, etc.
 Payments are tax-free if compensatory
including pain/suffering/wrongful death/loss
of goodwill
 Effectively makes interest tax-free
 Punitive, non-physical damages are taxable
 Companies buying structured settlements
64
Topic 26: Annuities
 Taxation of annuities
 Noncontributory-qualified plan
 All payments ordinary income
 Contributory-qualified plan
 Basis / total expected payments = percent of each
payment not taxed
 Remainder of payment ordinary income
 Subject to 10% penalty if not age 59 1/2
 After recover entire basis, all taxable
 If die before deferred annuity payments begin
 Refund of premiums paid generally not taxable
since payment equals basis
 No step-up in basis for annuities
65
Topic 26: Annuities
 Taxation of annuities
 Commercial annuity
 Ordinary income and return of capital based on expected
payments
 Corporate annuities
 Must recognize income immediately on increase in value of
annuity; no deferral
66
Topic 27: Group Term Life
Insurance
 Must be nondiscriminatory
 Amount of coverage usually multiple
of salary
 Cost of coverage above $50,000 is
taxable
 No evidence of insurability required
 Even if leave company and convert to
individual cash value policy
67
Topic 27: Group Permanent
Insurance
 Premiums
 Deductible by employer
 Taxable to employee
 GULPs: employees pay for universal life coverage
 Advantage
 Group underwriting
 Can continue as individual policy after leaving
employment
 No evidence of insurability required
 Must convert to permanent insurance
68
Topic 27: Group Permanent
Insurance
 Carve Out Insurance
 Cover top dogs only
 Employer’s cost deductible
 Top dogs taxed on premiums paid
 Pay bonus to top dogs so they can pay taxes
on premiums so they won’t be sad
 Employer paid death benefit
 Taxable
 Not funded by life insurance policy
69
Topic 28: Group Disability
Insurance



Can discriminate
Long-term plans
 Similar to individual policy features
 Benefits taxable if employer pays premiums
 Employer can deduct premiums
 Integrated with other sources of disability income such
as Social Security so don’t get rich watching Oprah
 Disability definition: can’t do job qualified for based on
training, education, experience
 If just top dogs covered, own occupation definition
more likely
Short-term disability
 Sick for a week: continue to pay salary
 Sick for up to six months: short-term disability policy pays
benefits
70
Topic 29: Group Medical Insurance
 Types of policies
 HMOs:
 Lower deductibles, co-payments
 Restricts selection of medical care providers
 PPOs:
 Lower deductibles, co-payments if select
“preferred provider”
 Point of service
 In network providers have lower
deductibles, co-payments if selected
71
Topic 29: Group Medical Insurance
 Tax advantages
 Employer deducts premiums
 Employee not taxed on premiums or
benefits received
72
Topic 29: Group Medical Insurance
 COBRA
 For businesses with more than 20 employees, insured
can continue coverage if lost coverage due to
 Termination of employment (including retirement)
 Continue coverage for 18 months
 Dependent no longer covered due to
death/divorce/Medicare eligibility/dependency
status
 Continue coverage for 36 months
 Employee must pay cost of coverage
 Government paying in 2009 65% of cost for first
nine months
73
Topic 29: Group Medical Insurance
 HIPAA
 Individuals losing group coverage must
be offered coverage without pre-existing
conditions
 HSAs
 Require high deductible health insurance
 Deductible of $2,300; out of pocket $11,600
 If individual contributes
 Can deduct from AGI up to $5,950 for family
policy
 Once eligible for Medicare, can’t contribute
74
Topic 29: Group Medical Insurance
 HSAs
 Earnings not taxed if used for medical
expenses
 Even if after covered by Medicare
 No required distributions
 Advantage for those who want to retire early
 Can roll over funds from IRA into HSA one
time up to annual contribution limit