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- Chapter 11
Other Insurance
1
- Chapter Goals
Determine when insurance should be used.
Describe the role property and liability insurance has
in managing potential losses in real property and
legal liability.
Indicate how personal insurance can reduce losses
in human exposures.
Explain how significant the federal and state
government are in limiting risks.
2
- When Is Insurance Suitable?
Insurance can be attractive when infrequent but
severe losses that can cause hardship to you are
present.
Hardship means the losses can have a material
impact on the household's overall financial condition
or current cash resources (severity).
Insuring against all losses is extremely costly and
therefore inefficient.
When losses happen very often (high frequency),
insurance companies end up adding on their
overhead costs to the losses.
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- When Is Insurance Suitable?, cont.
Loss frequency and severity:
High Severity Low Severity
High Frequency Retention Retention
Low Frequency Purchase Insurance Retention
4
- Risk Management and Insurance Terms
Business Risk: A risk taken for potential reward.
Pure risk: A risk that carries no financial reward.
Uncertainty: No knowledge of outcomes.
Risk: The exact outcome is unknown but the
probabilities of alternative outcomes are known.
Perils: Exposures to the risk of loss.
Hazards: Exposure to increased probability of peril.
– Physical hazard: A deficiency in physical property that
increases the possibility of loss.
– Moral hazard: Hazard that arises from actions taken by the
insured person which increase the possibility of loss.
– Morale hazard: Hazard that arises from a person behaving
negligently because he or she has insurance coverage.
5
- Risk Management and Insurance
Terms, cont.
If insurance companies had perfect information, they
could place clients in risk classes based on
probabilities of losses at the beginning of the
business relationship and provide less expensive
policies for the average client.
But due to asymmetric information, insurance
applicants know more about themselves and their
probability of future actions than their company does.
Under adverse selection the customer base drawn to
an insurance product may differ and be less
attractive than that of the population as a whole.
6
- Risk Management and Insurance
Terms, cont.
To minimize costs, the industry has instituted the
following practices:
– Insurable interest: You can only insure against loss of items
that you yourself would suffer a loss on, should they be
damaged or eliminated entirely.
– Indemnity: Your maximum reimbursement in the event of
loss of an asset you own is the value of the item.
– Screening and segregation of applicants: Involves
separating people based on their risk categories.
– Deductibles: The insurance company reimburses
individuals’ claims only for the amount above an established
minimum.
– Coinsurance: The policyholder pays a certain percentage of
the outlay along with the insurance company; often this is
subject to an overall cap on payments by the holder.
7
- Risk Management and Insurance
Terms, cont.
Coinsurance can take the following forms:
– Exclusions: Eliminating certain conditions from insurance
company payout when a new contract is drawn up.
– Waiting periods: Before reimbursements are allowed.
– Prespecified Limits: Establishes the amount the insurance
company is willing to pay contractually.
– Experience-Based Alteration in Policy Costs: Charges rates
to policy holders based on their loss experience after they
have become clients.
– Use of Group Policies: can reduce adverse selection.
Monitoring costs for moral and morale hazards are
covered, at least in part, by the business itself.
Employees may be more straightforward with their
employer.
Reduced processing and marketing costs.
8
- Risk Management and Insurance
Terms, cont.
Mutual insurance companies: Owned by the
policyholders.
Stockholder-owned insurance companies: Run for
the benefit of the stockholders.
The actions of stockholder-owned companies in their
attempt to maximize profits may conflict with the
interests of policyholders.
Stockholder-owned company actions in attempting to
maximize profits for their owners may conflict with
the interests of policyholders.
Recently, several large insurance companies have
switched from mutual to stockholder status.
9
- Needs Analysis
Some of the many factors that enter into household
insurance decision making include:
– General Characteristics: The term “need” has to do with
whether the household believes purchasing the insurance is
essential.
– Tolerance for Risk: Households with low tolerances for risk
will be more attracted to insurance.
– Personal Likelihood of Occurrence: When a person believes
he or she is at more risk for a negative occurrence than the
population at large, and the insurance cost has not been
raised for that increased occurrence, they are more likely to
take out insurance.
10
- Types of Insurance Coverage
11
- Property Insurance
Homeowners insurance covers both real property
and personal property related to the home are
covered.
Real property: Dwellings and other structures that
are affixed to land.
Personal property: Assets that are not affixed to the
land and therefore are usually portable.
Originally the individual risks involved with the home
were separately insured; now they are usually
combined in a single policy.
12
- Property Insurance, cont.
Types of policies:
Name Type Dwelling Type Coverage
HO1 Homeowner Basic coverage
HO2 Homeowner Broad coverage
HO3 Homeowner Special coverage
HO4 Tenant Contents broad form
HO5 Homeowner Comprehensive coverage
HO6 Condominium and Cooperative Unit owner’s form
HO8 Homeowner Modified Coverage
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- Property Insurance, cont.
Contract terms: Property insurance contracts
generally have structured terms.
Coverage Type Explanation
A The dwelling and other property attached to it such
as a garage.
B Structures not attached to the dwelling.
C Personal property.
D Outlays for expenses when damage does not allow
occupation.
E Personal liability, which includes the cost of
litigation and the proceeds of the suit.
F Medical payments to injured parties.
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- Property Insurance, cont.
Amount of Coverage:
– Actual cash value approach uses replacement cost but
takes into account depreciation.
– Replacement cost method does not deduct depreciation.
– When you coinsure part of the cost in the event of loss, the
policy states what percentage of replacement cost you are
required to maintain to receive full payment from the
insurer. If you are below that figure you will absorb part of
the loss according to the following formula:
Amount of
Insurance in Force
Insurance
Amount of Loss
Reimbursement
Amount of
Insurance Required
Amount of Coinsurance
Where: Replacement Cost
15 Insurance Required Percentage
- Property Insurance, cont.
Earthquake insurance may be available through a
rider to the policy. Flood insurance is supervised and
underwritten by HUD.
Title insurance reimburses you for loss in the event
the title you received is defective in whole or part.
Personal property is often included under a policy
but with significant limits on coverage available.
A floater covers the named items wherever they may
be located.
Payments as reimbursement for property losses are
not taxable. Property losses are tax deductible to
the extent they exceed $100 per occurrence and 10
percent of your adjusted gross income for the year.
16
- Automobile Insurance
The emphasis for automobile insurance has been
broadened over the past fifty years from protecting
yourself and your property to also paying for suits
from third parties.
The automobile policy is separated into six sections:
bodily injury liability, medical payments, property
damage, collision, uninsured motorist coverage, and
the comprehensive section.
Bodily injury liability covers injury to others caused
by you and injury to you and members of your family
when driving someone else’s automobile.
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- Automobile Insurance, cont.
Medical payments reimburse you for injuries to the driver
and passengers within your car.
Property damage covers damage you or a designated
driver in your car makes to someone else’s property.
Collision covers damage to your car whether through
impacting another automobile or by the vehicle turning
over.
Uninsured motorist coverage reimburses you for
uninsured, underinsured, and hit-and-run drivers who
cause losses to you.
Comprehensive insurance covers auto-related losses that
arise from theft or damage to your property, but not those
that come from another automobile.
18
- Automobile Insurance, cont.
The price of automobile coverage depends factors
such as the type of the car; the age of drivers and
their previous accident and driving violations record.
Your rate can be changed to reflect your incidence of
accidents during the time you are covered by the
company.
No-fault insurance does not assign blame for an
accident, and each person is paid for damages by
his or her own insurance carrier.
The no-fault approach is intended to reduce litigation
expenses and help protect third parties.
19
- Liability Insurance
Liability insurance (third-party coverage) protects you
personally against having to pay for a variety of
potential losses to others.
Third-party liabilities occur through personal injuries
and property damage to others caused by you. Such
liabilities extend to your home and you and other
family members and to personal operations as they
pertain to exposures to others.
Third-party coverage stands in contrast to losses to
you or to your property directly, which is sometimes
called first-party coverage.
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