Property and Motor Vehicle Insurance
What will this mean for me?
1. Develop a risk management plan using insurance.
2. Discuss the importance of property and liability insurance.
3. Explain the insurance coverages and policy types available to homeowners and renters.
4. Analyze factors that influence the amount of coverage and the cost of home insurance.
5. Identify the important types of automobile insurance coverages.
6. Evaluate factors that affect the cost of automobile insurance.
While hurricanes, tornadoes, ice storms, and wildfires are the most visual disasters faced by people, losses from other hazards are much more common. Your insurance coverage for losses due to property damage and liability should be considered carefully. Planning your home and auto insurance program is a vital element in your overall
financial planning activities.
Chapter 10 Property and Motor Vehicle Insurance 317
Insurance and Risk Management: An Introduction
Insurance involves property and people. By providing protection against the risks of financial uncertainty and unexpected losses, insurance makes it possible to plan for the future.
WHAT IS INSURANCE?
Insurance is protection against possible financial loss. Although many types of insur-ance exist, they all have one thing in common: They give you the peace of mind that comes from knowing that money will be available to meet the needs of your survivors, pay medical expenses, protect your home and belongings, and cover personal or prop-erty damage caused by you when driving.
Life insurance replaces income that would be lost if the policyholder died. Health insurance helps meet medical expenses when the policyholder becomes ill. Automobile insurance helps cover property and personal damage caused by the policyholder’s car. Home insurance covers the policyholder’s place of residence and its associated finan-cial risks, such as damage to personal property and injuries to others.
Insurance is based on the principle of pooling risks, in which thousands of policy-holders pay a small sum of money (premium) into a central pool. The pool is then large enough to meet the expenses of the small number of people who actually suffer a loss.
An insurance company , or insurer, is a risk-sharing firm that agrees to assume financial responsibility for losses that may result from an insured risk. A person joins the risk-sharing group (the insurance company) by purchasing a policy (a contract). Under the policy, the insurance company agrees to assume the risk for a fee (the pre-mium) that the person (the insured or the policyholder) pays periodically.
Insurance can provide protection against many risks of financial uncertainty and unexpected losses. The financial consequences of failing to obtain the right amount and type of insurance can be disastrous.
TYPES OF RISKS
You face risks every day. You can’t cross the street without some danger that you’ll be hit by a car. You can’t own property without taking the chance that it will be lost, sto-len, damaged, or destroyed. Insurance companies offer financial protection against such dangers and losses by promising to compensate the insured for a relatively large loss in return for the payment of a much smaller but certain expense called the premium.
Risk, peril, and hazard are important terms in insurance. While in popular use these terms tend to be interchangeable, each has a distinct, technical meaning in insurance terminology.
Basically, risk is uncertainty or lack of predictability. In this instance, it refers to the uncertainty as to loss that a person or a property covered by insurance faces. Insurance companies frequently refer to the insured person or property as the risk.
Peril is the cause of a possible loss. It is the contingency that causes someone to take out insurance. People buy policies for financial protection against perils such as fire, windstorms, explosions, robbery, accidents, and premature death.
Hazard increases the likelihood of loss through some peril. For example, defective house wiring is a hazard that increases the likelihood of the peril of fire.
The most common risks are classified as personal risks, property risks, and liability risks. Personal risks are the uncertainties surrounding loss of income or life due to premature death, illness, disability, old age, or unemployment. Property risks are the
Develop a risk management plan using insurance.
insurance Protection against possible financial loss.
insurance company A risk-sharing firm that assumes financial respon-sibility for losses that may result from an insured risk.
insurer An insurance company.
policy A written contract for insurance.
premium The amount of money a policyholder is charged for an insurance policy.
insured A person covered by an insurance policy.
policyholder A person who owns an insurance policy.
risk Chance or uncertainty of loss; also used to mean “the insured.”
peril The cause of a pos-sible loss.
hazard A factor that increases the likelihood of loss through some peril.
318 Part 4 INSURING YOUR RESOURCES
uncertainties of direct or indirect losses to personal or
D I D Y O U K N O W ? real property due to fire, windstorms, accidents, theft, and other hazards. Liability risks are possible losses
Alien abduction protection and coverage if you turn due to negligence resulting in bodily injury or prop-into a werewolf are some of the strange but real-life erty damage to others. Such harm or damage could
policies available for a price. Wedding disaster insur- be caused by an automobile, professional misconduct, ance paid for an entire wedding party to reassemble
at the original location—Hawaii—to re-create the Personal risks, property risks, and liability risks are types of pure risk, or insurable risk, since there would be a chance of loss only if the specified events occurred. Pure risks are accidental and unintentional
a certified race time for an event that’s risks for which the nature and financial cost of the loss 5K or longer. can be predicted.
A speculative risk is a risk that carries a chance of either loss or gain. Starting a small business that may or may not succeed is an example of speculative risk.
So is gambling. Most speculative risks are considered to be uninsurable.
pure risk A risk in which there is only a chance
of loss; also called insurable risk.
speculative risk A risk in which there is a chance of either loss or gain.
Various actions can result in
reduced financial risks.
RISK MANAGEMENT METHODS
Risk management is an organized strategy for protecting assets and people. It helps reduce financial losses caused by destructive events. Risk management is a long-range planning process. People’s risk management needs change at various points in their lives. If you understand risks and how to manage them, you can provide better protec-tion for yourself and your family. In this way, you can reduce your financial losses and thereby improve your chances for economic, social, physical, and emotional well-being. Since you will probably be unable to afford to cover all risks, you need to under-stand how to obtain the best protection you can afford.
Most people think of risk management as buying insurance. However, insurance is not the only method of dealing with risk; in certain situations, other methods may be less costly. Four general risk management techniques are commonly used.
1. RISK AVOIDANCE You can avoid the risk of being in an automobile acci-dent by not driving or being a passenger. McDonald’s can avoid the risk of product failure by not introducing new products. Risk avoidance would be practiced in both instances, but at a very high cost. You might have to give up your job, and McDonald’s
might lose out to competitors that introduce new products.
In some situations, however, risk avoidance is practical. At the personal level, people avoid risks by not smoking or by not walking through high-crime neighborhoods. At the business level, jewelry stores avoid losses through rob-bery by locking their merchandise in vaults. Obviously, no person or business can avoid all risks.
2. RISK REDUCTION While avoiding risks completely may not be pos-sible, reducing risks may be a cause of action. You can reduce the risk of injury in an auto accident by wearing a seat belt. You can install smoke alarms and fire extinguishers to protect life and reduce potential fire damage. You can reduce the risk of illness by eating a balanced diet and exercising.
3. RISK ASSUMPTION Risk assumption means taking on responsibil-ity for the loss or injury that may result from a risk. Generally, it makes sense to assume a risk when the potential loss is small, when risk management has reduced the risk, when insurance coverage is expensive, and when there is no other way to
obtain protection. For instance, you might decide not to purchase collision insurance on an older car. Then, if an accident occurs, you will bear the costs of fixing the car.
Chapter 10 Property and Motor Vehicle Insurance 319
Self-insurance is the process of establishing a monetary fund to cover the cost of a
loss. Self-insurance does not eliminate risks; it only provides means for covering losses. self-insurance The process Many people self-insure by default, not by choice. of establishing a monetary
fund to cover the cost of 4. RISK SHIFTING The most common method of dealing with risk is to shift, or a loss.
transfer, it to an insurance company or some other organization. Insurance is the pro-tection against loss afforded by the purchase of an insurance policy from an insurance company.
Exhibit 10-1 summarizes various risks and appro-
priate strategies for managing them. D I D Y O U K N O W ?
PLANNING AN INSURANCE PROGRAM
Because all people have their own needs and goals, many of which change over the years, a personal insur-ance program should be tailored to those changes. In
Deductibles are a combination of risk assumption and risk shifting. The insured person assumes part of the risk, paying the first $250, $500,
or $1,000 of a claim. The majority of the risk for a large claim is shifted to another party, the insurance company.
Exhibit 10-1 Examples of risks and risk management strategies
Risks Possible Strategies for Reducing Financial Impact
Loss of one’s income Loss of services Increased expenses
Loss of one’s income Catastrophic hospital
Loss of one’s income Loss of services
Decreased income Unplanned living
Cost to repair damage to property
Repair or replacement cost of theft
Claims and settlement costs
Lawsuits and legal expenses
Loss of personal assets and income
Savings, investments Family observing
Estate planning Risk reduction
Savings Investments Hobbies, skills Part-time work
Property repair and upkeep
Observing safety precautions
Health insurance Health maintenance
Retirement and/or pensions
Flood insurance (joint program
Automobile insurance Malpractice insurance
Disability insurance Social Security
Military health care Medicare, Medicaid
Veteran’s life insurance
Social Security survivor’s benefits
Social Security Pension plan
for government employees
Flood insurance (joint program with business)
State-operated insurance plans
320 Part 4 INSURING YOUR RESOURCES
the early years of marriage, when the family is growing, most families need certain kinds of insurance protection. This protection may include property insurance on an apartment or a house, life and disability insurance for wage earners and caretakers of dependents, and adequate health insurance for the whole family.
Later, when the family has a higher income and a different financial situation, pro-tection needs will change. There might be a long-range provision for the children’s education, more life insurance to match higher income and liv-
ing standards, and revised health insurance protection. Still later, when the children have grown and are on their own, retirement benefits will be a consideration, further changing the family’s
Various risk management actions may be pe The Financial Planning for Life’s Situations feature on page 321 suggests several guidelines to follow in planning your
A wide range of insurance coverages exist in insurance program. Exhibit 10-2 outlines the steps in developing our society. Talk with an insurance agent or
financial planner to obtain recommendations
about the types of insurance you may need. STEP 1: SET INSURANCE GOALS In managing risks, your goals are to minimize personal, property, and liability risks. Your insurance goals should define what to do to cover the
basic risks present in your life situation. Covering the basic risks means providing a financial resource to cover costs resulting from a loss.
Suppose your goal is to buy a new car. You must plan to make the purchase and to protect yourself against financial losses from accidents. Auto insurance on the car lets you enjoy the car without worrying that an auto accident might leave you worse off, financially and physically, than before.
Exhibit 10-2 Creating a personal insur-ance program
Set Insurance 1 Goals
Develop a Plan to Reach Your