chapter 10 modified to 11th edition

8/13/2019 Chapter 10 Modified to 11th Edition

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Chapter 10

Analysis of

Insurance

Contracts

Agenda

• Basic parts of an insurance contract

• Definition of the “Insured”

• Endorsements and Riders• Deductibles

• Coinsurance

• Other-insurance provisions

Basic Parts of an InsuranceContract

• Declarations are statements that provideinformation about the particular property or activityto be insured

Usually the first page of the policy – In property insurance, it contains name of the insured,

location of property, period of protection, amount ofinsurance, premium and deductible information

• Insurance contracts typically contain a page orsection of definitions – For example, the insured is referred to as “you”

• The insuring agreement summarizes the majorpromises of the insurer

– The two basic forms of an insuring agreement inproperty insurance are:

• Named perils policy, where only those perils specifically namedin the policy are covered

• “All-risks” policy, where all losses are covered except thoselosses specifically excluded

– May also be called an open-perils policy or special coverage policy

– Insurers have generally deleted the word “all” from policies

• “All-risks” coverage has fewer gaps, and the burden of proof isplaced on the insurer to deny a claim

• Insurance contracts contain three majortypes of exclusions

Excluded perils, e.g., flood, intentional act – Excluded losses, e.g., a professional liability

loss is excluded in the homeowners policy

– Excluded property, e.g., pets are not covered as

personal property in the homeowners policy

• Exclusions are necessary because:

– Some perils are not commercially insurable

• e.g., catastrophic losses due to war

Extraordinary hazards are present• e.g., using the automobile for a taxi

– Coverage is provided by other contracts

• e.g., use of auto excluded on homeowners policy

– Moral hazard is present or it would be difficult to measure theamount of loss

• e.g., coverage of money limited to $200 in homeowners policy

– Coverage not needed by typical insureds

• e.g., homeowners policy does not cover aircraft

Definition of the “Insured”

• An insurance contract must indicate the persons orpersons from whom the protection is provided

– Some policies insure only one person, e.g., most life

insurance policies – The named insured is the person or persons named in

the declarations section of the policy

– A policy may cover other parties even though they are

not specifically named• e.g., the homeowners policy covers resident relatives under age

24 who are full-time students away from home

Endorsements and Riders

• In property and liability insurance, an endorsementis a written provision that adds to, deletes from, ormodifies the provisions in the original contract – e.g., an earthquake endorsement to a homeowners

policy

• In life and health insurance, a rider is a provisionthat amends or changes the original policy – e.g., a waiver-of-premium rider on a life insurance policy

Deductibles in Property Insurance

• With a straight deductible, the insured must pay acertain amount before the insurer makes a losspayment

– e.g., an auto insurance deductible

• An aggregate deductible means that all losses thatoccur during a specified time period are

accumulated to satisfy the deductible amount

Deductibles in Property Insurance

Straight Deductible

Aggregate Deductible

Date Claim You pay Ins co pays You pay Ins co pays

1/31 $100 $100 $0 $100 $0

3/31 $500 $200 $300 $100 $400

5/31 $2000 $200 $1800 $0 $2000

7/31 $5000 $200 $4800 $0 $5000

9/30 $100 $100 $0 $0 $100

Deductibles in Health Insurance

• A calendar-year deductible is a type of aggregatedeductible that is found in basic medical expenseand major medical insurance contracts

A corridor deductible is a deductible that can beused to integrate a basic medical expense planwith a supplemental major medical expense plan

• An elimination (waiting) period is a stated period oftime at the beginning of a loss during which noinsurance benefits are paid

• Example of $250 Calendar Year Deductible

Date Claim You pay Ins co pays

2/15 $80 $80 $0

4/17 $160 $160 $0

5/27 $500 $10 $490

8/2 $250 $0 $250

• Example of $250 Calendar Year Deductible and$200 Corridor Deductible

Date Claim Covered By Which Plan You Pay Ins Co Pays

1/30 $80 Basic $80 $0

4/17 $130 Supplemental $130 $0

5/17 $1000 Supplemental $70 $930

5/27 $400 Basic $170 $2306/14 $30 Basic $0 $30

7/15 $100 Basic $0 $100

8/2 $3000 Supplemental $0 $3000

Coinsurance in Property Insurance

• A coinsurance clause in a property insurance contractencourages the insured to insure the property to a statedpercentage of its insurable value

If the coinsurance requirement is met at the time of the loss, theinsurance company pays the total amount of the loss, up to theamount of insurance carried

– If the coinsurance requirement is not met at the time of the loss, theinsured must share in the loss as a coinsurer by only recovering:

recoveryof Amount Loss xrequired insuranceof Amount

carried insuranceof Amount

• The purpose of coinsurance is to achieveequity in rating

– A property owner wishing to insure for a totalloss would pay an inequitable premium if otherproperty owners only insure for partial losses

– If the coinsurance requirement is met, theinsured receives a rate discount, and thepolicyowner who is underinsured is penalizedthrough application of the coinsurance formula

• Examples using 80% Coinsurance,$1,000,000 hotel – If insured for $1,000,000 and have a loss of $600,000; recovery =

$600,000 – If insured for $700,000 and have a loss of $600,000 then

recovery = (700,000/800,000) x 600,000 = $525,000

– If insured for $800,000 and have a loss of $600,000; recovery =$600,000 because you carried at least the minimum 80% required

for full recovery – If insured for $900,000 and have a total loss of $1,000,000 then

recovery = $900,000 because that is how much insurance youcarried

Exhibit 10.1 Insurance toFull Value

Exhibit 10.2 Insurance to HalfValue

Coinsurance in Health Insurance

• Health insurance policies frequently containa percentage participation clause

The clause requires the insured to pay a certainpercentage of covered medical expenses inexcess of the deductible

– The purpose is to reduce premiums and prevent

overutilization of policy benefits

Coinsurance in Health Insurance

• Example of 80/20 Coinsurance, $250 Deductible,$1000 Stop Loss

Date Claim You Pay Insurance Company Pays2/14 $80 $80 $0

5/28 $160 $160 $0

7/4 $500 $10 + $98 = $108 $490 x 0.80 = $392

10/31 $260 $260 x 0.20 = $52 $260 x 0.80 = $208

11/27 $4000 $600 $3400

12/25 $500 $0 $500

Other-insurance Provisions

• The purpose of other-insurance provisions is toprevent profiting from insurance and violation of theprinciple of indemnity

– Under a pro rata liability provision, each insurer’s share of

the loss is based on the proportion that its insurancebears to the total amount of insurance on the property

– Under contribution by equal shares, each insurer shares

equally in the loss until the share paid by each insurerequals the lowest limit of liability under any policy, or untilthe full amount of the loss is paid

Exhibit 10.3 Pro Rata LiabilityExample

Exhibit 10.4 Contributionby Equal Shares (Example 1)

Exhibit 10.5 Contributionby Equal Shares (Example 2)

Other-insurance Provisions

– Under a primary and excess insuranceprovision, the primary insurer pays first, and theexcess insurer pays only after the policy limitsunder the primary policy are exhausted

– The coordination of benefits provision in grouphealth insurance is designed to preventoverinsurance and the duplication of benefits if

one person is covered under more than onegroup health insurance plan

• e.g., two employed spouses are insured asdependents under each other’s group healthinsurance plan

chapter 10 modified to 11th edition

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