· provided by insurance education division real estate institute (800) 289-4310 each course...

Provided By INSURANCE EDUCATION DIVISION

REAL ESTATE INSTITUTE (800) 289-4310

www.InstituteOnline.com

EACH COURSE PROVIDES 12 CREDIT-HOURS OF ILLINOIS STATE-APPROVED CONTINUING EDUCATION

Course One

Managing Individual Risks And

Guiding Consumers 12 Credit Hours, Approved In Illinois For The Following Licensees: Life, Accident/Health, Property, Casualty, Fire, and Motor Vehicle

Updated Illinois Law: Total CE Requirement Is Now 24 Credit-Hours

3 Credit-Hours of Instructor-Led “Ethics” Training Is Required

Earn Credit By Completing The Courses Provided In This Book, Then Register to Complete Your “Ethics” Course Requirement. Call or Visit Our Website For Our Upcoming Class Schedule.

INSURANCE CONTINUING EDUCATION Earn Credit in 3 EASY STEPS:

1 – READ this book. 2 – COMPLETE the open-book exam. 3 – SUBMIT for scoring via Fax, Mail, or Online!

12 Hours – $49.00 * ● 24 Hours – $69.00 *

* Plus Mandatory Illinois Department of Insurance Credit Reporting Fee

Course Two

Managing Commercial Risks And

Ethical Practice 12 Credit Hours, Approved In Illinois For The Following Licensees: Life, Accident/Health, Property, Casualty, Fire, and Motor Vehicle

FREQUENTLY ASKED QUESTIONS

How can I enroll and submit my exam(s) to the school? You can enroll and submit your course exam(s) by fax or mail using either the form on page 114 or the form on the back cover. Courses may also be completed at our website. Online exams are identical to those printed in this book.

What is the passing score required to earn credit for each of the courses in this book? The state of Illinois requires a passing score of at least 70% on each exam. Most students pass on the first attempt. However, course enrollments include a second attempt, if necessary.

How quickly will you grade my exam and report my course completion(s) to the state of Illinois? We will process your course enrollment and grade exams within one business day of receipt. All successful course completions are reported to the state within two business days.

Why does the school charge a credit reporting fee? The Illinois Department of Insurance requires a fee to be paid for each course credit-hour reported. Students are required to pay this Department-mandated fee. State fees are subject to change without notice. Please visit our website or call for current fees.

How can I keep records of courses I have completed with your school? Upon successful course completion, we will provide you with a Certificate of Completion for your records.

How can I be sure that I have not already completed these courses? If you are concerned about course repetition, please call us to review your state transcript (which provides a history of your course completions). If necessary, we’ll suggest an alternate course.

I want to take advantage of the discounted 21 credit-hour program, but I don’t need that many credit hours. What should I do? If completing both courses in this book will cause you to exceed your 21 credit-hours that may be completed by self-study, up to 12 credit hours may be carried forward to your next renewal period. However, you may also take advantage of our discounted 21 credit-hour program and complete only one course at this time to satisfy your current requirement. You can then submit the other exam within six months of your enrollment to be used toward your next renewal period.

I sell long-term care insurance. Is there a special requirement I need to consider? Yes, a special training and continuing education requirement affects all resident producers who sell or solicit any type of long-term care insurance. We offer the required training course and continuing education through convenient self-study. Please contact us or visit our website for additional information. Illinois requires 3 credit-hours of instructor-led “Ethics” training. How do I satisfy this continuing education requirement? We offer programs to satisfy this requirement. Please call or visit our website to learn more.

PLEASE CALL US WITH ANY ADDITIONAL QUESTIONS!

INSURANCE EDUCATION DIVISION REAL ESTATE INSTITUTE

(800) 289-4310 www.InstituteOnline.com

MANAGING INDIVIDUAL RISKS

AND GUIDING CONSUMERS

Continuing Education for Illinois Insurance Professionals

MANAGING INDIVIDUAL RISKS AND GUIDING CONSUMERS COPYRIGHT © 2005 – 2013 by Real Estate Institute All rights reserved. No part of this book may be reproduced, stored in any retrieval system or transcribed in any form or by any means (electronic, mechanical, photocopy, recording or otherwise) without the prior written permission of Real Estate Institute.

A considerable amount of care has been taken to provide accurate and timely information. However, any ideas, suggestions, opinions, or general knowledge presented in this text are those of the authors and other contributors, and are subject to local, state and federal laws and regulations, court cases, and any revisions of the same. The reader is encouraged to consult legal counsel concerning any points of law. This book should not be used as an alternative to competent legal counsel.

Printed in the United States of America. P8

All inquires should be addressed to: Real Estate Institute 6203 W. Howard Street Niles, IL 60714 (800) 289-4310 www.InstituteOnline.com

MANAGING INDIVIDUAL RISKS AND GUIDING CONSUMERS

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INTRODUCTION .................................................................. 1 CHAPTER 1 – MOTOR VEHICLE INSURANCE .................. 1 Introduction ........................................................................... 1 The Tort Liability System and Automobile Insurance ............ 1 Personal Auto Policy: Overview ............................................ 1

The Declarations Page ................................................. 1 Insuring Agreement and Definitions ............................. 1 Eligible Vehicles ........................................................... 2

Personal Auto Policy: Liability Coverage .............................. 2 Insured Persons ........................................................... 2 Supplementary Payments ............................................ 3 Exclusions .................................................................... 3 Limit of Liability ............................................................. 4 Out of State Coverage .................................................. 4 Other Insurance ........................................................... 5

Personal Auto Policy: Medical Payments Coverage ............. 5 Exclusions .................................................................... 5 Limit of Liability ............................................................. 6 Other Insurance ........................................................... 6

Personal Auto Policy: Uninsured Motorists Coverage ........... 6 Exclusions .................................................................... 7 Limit of Liability ............................................................. 7 Other Insurance ........................................................... 7 Underinsured Motorist Coverage ................................. 7

Personal Auto Policy: Coverage for Damage to Automobile . 7 Exclusions .................................................................... 8 Limit of Liability ............................................................. 9 Payment of Loss .......................................................... 9 No Benefit to Bailee ..................................................... 9 Other Insurance ........................................................... 9 Appraisal ...................................................................... 9

Personal Auto Policy: Duties After an Accident or Loss ...... 10 Personal Auto Policy: General Provisions ........................... 10

Legal Action Against Us ............................................. 10 Our Right To Recover Payment ................................. 10 Policy Period And Territory ......................................... 10 Termination ................................................................ 10 Two Or More Auto Policies ......................................... 11

Personal Auto Policy: Insuring Motorcycles and Other Vehicles .............................................................................. 11 Approaches for Compensating Automobile Accident Victims .................................................................. 11 Automobile Insurance for High-Risk Drivers ....................... 12 Cost of Automobile Insurance ............................................. 13

Territory ...................................................................... 13 Age, Sex ..................................................................... 13 Use of The Automobile ............................................... 13 Driver Education ......................................................... 13 Good Student Discount .............................................. 13 Number and Type of Automobiles .............................. 13 Individual Driving Record ........................................... 13 Purchase Higher Deductibles ..................................... 13 Improved Driving Record ............................................ 13

Conclusion .......................................................................... 13 CHAPTER 2 – HOMEOWNERS AND PERSONAL PROPERTY INSURANCE .................................................. 13 Introduction ......................................................................... 13

The History of Property Insurance .............................. 13 Negligence ................................................................. 14 The Language of Liability Insurance .......................... 14 Summary .................................................................... 15

Homeowners Insurance – Introduction ............................... 15 Coverage and Limits of Liability ................................. 15 Types of Homeowners Policy Forms and Their Coverages .................................................................. 15 HO-1 and HO-2 Policy ................................................ 15 HO-3 Policy ................................................................ 15 HO-5 Policy ................................................................ 16 HO-4 and HO-6 Policies ............................................. 16 HO-8 Policy ................................................................ 16

Homeowners Insurance – Property Coverage – Section I .. 16 The Dwelling .............................................................. 16 Detached Structures Located on the Property ........... 16 Personal Property ...................................................... 16

Loss of the Use of the Structure ................................. 17 Additional Coverage ................................................... 17

Homeowners Insurance – Liability Coverage – Section II ... 18 Personal Liability Exclusions ...................................... 18

Filing the Homeowners Insurance Claim ............................. 18 Replacement Cost Coverage...................................... 19 Dwelling Claims .......................................................... 19 Personal Property Claims ........................................... 20

Other Homeowners Insurance Concepts ............................ 20 Subrogation ................................................................ 20 Statements ................................................................. 20 Salvage ...................................................................... 20 Non-Waiver Agreement .............................................. 20 Cancellation ................................................................ 21

Homeowners Insurance – Concluding Thoughts ................. 21 Personal Property Insurance – Introduction ........................ 21 Inland Marine Insurance ...................................................... 21

Inland Marine Insurance – Definition .......................... 21 Inland Marine Floater Characteristics ......................... 21 Inland Marine Floater Provisions ................................ 21 Inland Marine Floater Exclusions ................................ 22

Personal Articles Floater ..................................................... 22 Personal Property Floater ................................................... 23

Scheduled Personal Property Floater ......................... 23 Unscheduled Personal Property ................................. 24 Newly Acquired Property ............................................ 24 Property Not Covered ................................................. 24

Personal Effects Floater ...................................................... 24 Personal Effects Coverage ......................................... 24 Property Excluded ...................................................... 24 All-Risks Coverage ..................................................... 25 Other Exclusions ........................................................ 25 Limitations on Certain Personal Effects ...................... 25

Personal Umbrella Liability Insurance ................................. 25 Nature of Personal Umbrella Insurance ...................... 25 Excess Liability Insurance .......................................... 25 Broad Coverage ......................................................... 25 Self-Insured Retention ................................................ 26 Personal Umbrella Coverages .................................... 26 Personal Umbrella Exclusions .................................... 26

Watercraft Insurance ........................................................... 26 Hull and Trailer Loss Exposures ................................. 27 Homeowners Policy Physical Damage Coverage ....... 27 Personal Auto Policy Personal Damage Coverage .... 27 Liability Loss Exposure ............................................... 27 Homeowners Policy Liability Coverage ...................... 27 Outboard Motor and Boat Insurance .......................... 27 Outboard Motor and Boat Insurance Exclusions ........ 27 Watercraft Package Policies ....................................... 28

Personal Yacht Insurance ................................................... 28 Uninsured Boaters Coverage .............................................. 29

Uninsured Boaters Coverage – Exclusions ................ 29 Specialized Coverages ........................................................ 29

Ocean Marine Specialized Coverage ......................... 29 Inland Marine Specialized Coverage .......................... 29

Ocean Marine Insurance ..................................................... 31 Hazards Covered ........................................................ 31 Other Types of Ocean Marine Coverage .................... 32

Conclusion – Personal Property Insurance ......................... 33 CHAPTER 3 – UNDERWRITING PROPERTY AND CASUALTY INSURANCE ................................................... 33 Major Underwriting Goals .................................................... 33

Underwriting Gains ..................................................... 33 Contribution to Society ............................................... 33 Maintaining a Strong Insurance Industry .................... 34

Individual and Class Underwriting ....................................... 34 Underwriting Individuals ............................................. 34 Underwriting By Class ................................................ 35

Specific Underwriting Factors and Practices ....................... 35 Loss History ................................................................ 36 Accident Record ......................................................... 36 Fault ........................................................................... 36 Number of Accidents .................................................. 36 Commercial/Personal Risks ....................................... 36


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Property Losses .......................................................... 36 Liability Losses ........................................................... 37 Recommendations for Improvement ........................... 37 Traffic Violations ......................................................... 37 Non-Verifiable Record ................................................ 37 Sources of Information ................................................ 37 Driving Record ............................................................ 37 Condition of Property .................................................. 37 Age of Buildings .......................................................... 38 Value of Buildings ....................................................... 39 Occupancy of Buildings .............................................. 39 Neighborhood ............................................................. 40 Age of Insured ............................................................ 40 Sex ............................................................................. 40 Marital Status .............................................................. 40 Occupation ................................................................. 40 Stability ....................................................................... 41 Social Maladjustment .................................................. 41 Attitude ....................................................................... 41 Criminal Record .......................................................... 41 Mental Incompetence ................................................. 41 Physical Impairments .................................................. 41 Alcohol and Drugs ...................................................... 42 Foreign Born ............................................................... 42 Related Business ........................................................ 42 Prior Insurance ........................................................... 42 Prior Cancellation ....................................................... 43

Conclusion ........................................................................... 43 CHAPTER 4 – LIFE INSURANCE ....................................... 43 The Life Insurance Policy .................................................... 43 Uses of Life Insurance ......................................................... 43 Life Insurance as a Property ................................................ 43 The Life Insurance Application ............................................ 43

Three Parties to an Application ................................... 43 Insurable Interest ........................................................ 44 The Application Form .................................................. 44 Minor Applications ...................................................... 44 Correcting Applications ............................................... 44 Incorrect or Incomplete Applications ........................... 44 Representations and Warranties ................................ 45 Fraud .......................................................................... 45 Concealment .............................................................. 45 Conditional Receipt..................................................... 45 Policy Effective Date / Backdating .............................. 45

How Much Life Insurance Do I Need? ................................. 45 Types of Life Insurance ....................................................... 45

Term Insurance .......................................................... 45 Whole Life Insurance .................................................. 46 Universal Life Insurance ............................................. 46 Variable Life Insurance ............................................... 46 Adjustable Life Insurance ........................................... 46 Modified Life Insurance ............................................... 47 Family Life Insurance .................................................. 47

Types of Insurance Companies ........................................... 47 Stock Life Insurance Company ................................... 47 Mutual Insurance Company ........................................ 47 Fraternal Benefit Society ............................................ 47 Government Insurance Programs ............................... 47 Reciprocals ................................................................. 47 Lloyd’s of London ....................................................... 48

Insurer’s Financial Status .................................................... 48 Life Insurance – Policy Provisions ....................................... 48

Ownership Clause ...................................................... 48 Entire Contract Clause ................................................ 48

Incontestable Clause .................................................. 48 Suicide Clause ............................................................ 48 Grace Period ............................................................... 48 Reinstatement Clause ................................................. 48 Misstatement of Age ................................................... 49 Beneficiary Designation .............................................. 49 Change of Plan Provision ........................................... 49 Exclusions and Restrictions ........................................ 49

Premiums ............................................................................ 49 Parts of the Premium .................................................. 49 Net and Gross Premium ............................................. 50 Mortality ...................................................................... 50 Level Premiums and Reserves ................................... 50 Insurance Age ............................................................. 50 Payment of Premiums ................................................. 50

Settlement Options .............................................................. 50 Lump Sum Settlement ................................................ 50 Proceeds and Interest ................................................. 50 Fixed Years Installments ............................................. 50 Life Income ................................................................. 51 Joint Life Income ......................................................... 51 Fixed Amount Installments .......................................... 51 Other Mutually Agreed Method ................................... 51

Non-Forfeiture Options ........................................................ 51 Cash Surrender Value ................................................ 51 Reduced Paid-Up Insurance ....................................... 51 Extended Term Insurance ........................................... 51 Automatic Premium Provision ..................................... 51 Dividend Accumulations to Avoid Lapse ..................... 51

Dividend Options ................................................................. 51 Cash Payment ............................................................ 52 Reduction of Premium ................................................ 52 Accumulation of Interest ............................................. 52 Paid-Up Additions ....................................................... 52 One-Year Term ........................................................... 52

Life Insurance Policy Riders ................................................ 52 Waiver of Premium ..................................................... 52 Accidental Death and Dismemberment ....................... 52 Guaranteed Purchase Option ..................................... 52

Life Insurance Underwriting ................................................. 52 Underwriting Factors for Individual Coverage ............. 52 Underwriting Actions ................................................... 53

Delivering the Policy ............................................................ 53 Policy Effective Date ................................................... 53 Delivery ....................................................................... 53 Agents Responsibilities Regarding Delivery ............... 53

Income Tax Benefits of Life Insurance ................................. 53 Annuities .............................................................................. 54

Types of Annuities ...................................................... 54 Premium Options ........................................................ 55 Settlement Options ..................................................... 55 Number of Annuitants ................................................. 55 Surrender Terms ......................................................... 55 Determining the Mathematics of Fixed Annuities ........ 56 Investor Considerations – Fixed Annuities .................. 56 Variable Annuities ....................................................... 56 Choosing an Annuity Type .......................................... 57 Accumulation Units ..................................................... 58 Annuity Units ............................................................... 58 Risk Considerations for Variable Annuities ................. 58

Life Insurance Terms and Definitions .................................. 59 Conclusion ........................................................................... 60 Final Exam .......................................................................... 61


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INTRODUCTION Insurance professionals can impact customers’ lives in many different ways. Whether providing a renters policy for a young adult moving into his or her first apartment or providing long term care insurance for a senior citizen, insurance producers walk side by side with their customers through life’s various stages. In these materials we examine some of the insurance policies and services which can be offered throughout a customer’s lifetime. First we discuss motor vehicle insurance, often the first occasion for interaction between a customer and an insurance professional. Next we discuss homeowners and personal property insurance. Following that discussion, we discuss underwriting issues related to property and casualty insurance. We then explain life insurance and annuities, products which the insurance customer will require when reaching certain life milestones. By understanding many different insurance products and underwriting rationale, you will develop a better capacity for advising your insurance prospects and customers regarding their options for optimal insurance protection.

CHAPTER 1 – MOTOR VEHICLE INSURANCE Introduction Automobile accidents can cause financial and economic havoc to individuals and families. Legal liability arising out of the negligent operation of an automobile can reach traumatic levels. Medical expenses, pain and suffering, the death of a family member, and the damage or loss of property, or loss of the automobile itself can be devastating. The insurance buying public relies on insurance producers for guidance toward the proper insurance policy. The Tort Liability System and Automobile Insurance Each individual has certain legal rights. A legal wrong is a violation of the individual’s legal rights or a failure to perform a legal duty owed to an individual or to society as a whole. A tort is a legal wrong. Specifically, a tort can be defined as a legal wrong, other than a breach of contract, for which the law allows a remedy in the form of money damages. The person who is injured or harmed (called the plaintiff or claimant) by the actions of another person (called the defendant) can sue for damages. Torts can generally be classified into three categories: Intentional torts.

An intentional act or omission that results in harm or injury to another person or damage to the person’s property. (For example, assault, battery, trespass, false imprisonment, fraud.)

Absolute liability. Absolute liability exists when a party is liable for damages even though that party’s fault or negligence cannot be proven. Examples of circumstances giving rise to absolute liability include occupational injury, blasting operations that injure another person, manufacturing of explosives, and crop spraying by airplanes.

Negligence. Negligence is a tort that results in harm or injury to another person. Negligence typically is defined as the failure to exercise the standard of care required by law to protect others from harm. The meaning of the term “standard of care” is based on the care required of a reasonably prudent person. Actions are compared with the actions of a reasonably prudent person under the same circumstances. The standard of care required by law is not the same for each wrongful act.

Liability coverage is the most important part of the Personal Auto Policy. It protects a covered person against a suit or claim arising out of the negligent ownership or operation of an automobile.

Personal Auto Policy: Overview The Personal Automobile Policy (also referred to as the “Personal Auto Policy”) is designed to be the most commonly purchased insurance policy for the average family automobile. The Insurance Services Office (ISO) first introduced the Personal Auto Policy in 1977. The ISO form of the Personal Automobile Policy is written in simplified English, making it easier to read and understand than earlier contracts of automobile insurance. It contains simple definitions and short sentences. Highly technical terms have been eliminated from the policy, and the policy language is informal and personal. The Personal Auto Policy emphasizes liability protection, making it the first coverage in the policy. (As a comparison, a Homeowners Policy provides liability protection as the last coverage in the policy.) The nature of the property covered, mobile rather than stationary, makes the Personal Auto Policy quite different from a Homeowners Policy. The potential number of non-family members using an automobile is greater than those potentially living in the family house. The possibility that the insured may drive several different non-owned automobiles also makes the Personal Auto Policy a more complicated policy with respect to defining the “insured.” The Personal Auto Policy begins with a Declarations page, an Insuring Agreement, and Definitions. (Examples of policy language appear in shaded boxes throughout this chapter.) The Declarations identify the named insured, the vehicles covered, and the premium charged for the coverage. The Insuring Agreement makes the contract effective. The Declarations Page The Declarations Page is the first part of most insurance contracts. Declarations are statements that provide information about the property being insured. Information contained in the Declarations Page is used for underwriting and rating purposes and for identification of the property to be insured. The Declarations section can be found on the first page of the policy or on a policy insert. In some contracts the declarations are part of the written application that is attached to the policy. In property insurance, the declarations section contains information concerning the identification of the insurer, name of the insured, location of the property, period of protection, amount of insurance, amount of the premium, size of the deductible (if any), and other relevant information. The Declaration Page lists a single limit of liability for the insurer, such as $100,000. This is the limit for all types of damage an insured may cause, including bodily injury and property damage. If judgments are greater than this limit, the insured, not the insurer, pays the excess. The Personal Auto Policy may also be written on a split limit basis (e.g. $50,000 / $100,000 / $25,000). When coverage is written with split limits of $50,000 / $100,000 / $25,000, the insurer will pay only $50,000 to any one individual and only $100,000 for one accident for bodily injury liability. The $25,000 indicates the maximum amount which the insurer will pay for property damage liability. Insuring Agreement and Definitions After the Declarations Page, the Personal Auto Policy sets forth the Insuring Agreement and Definitions. The Insuring Agreement states that, “In return for payment of the premium and subject to all the terms of the policy, the insurer agrees with the insured as follows:” The definitions and body of the insurance policy then follow that Insuring Agreement. Definitions in a standard Personal Auto Policy may include the following:

Throughout this policy, “you” and “your” refer to: The “named insured” shown in the Declarations; and The spouse if a resident of the same household.


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“We,” “us” and “our” refer to the Company providing this insurance. For purposes of this policy, a private passenger type auto shall be deemed to be owned by a person if leased: Under a written agreement to that person; and For a continuous period of at least 6 months.

Bodily injury means bodily harm, sickness or disease, including death that results.

Business includes trade, profession or occupation. Family member means a person related to you by

blood, marriage or adoption that is a resident of your household. This includes a ward or foster child.

Occupying means in, upon, getting in, on, out or off. Property damage means physical injury to, destruction

of or loss of use of tangible property. Trailer means a vehicle designed to be pulled by a: Private passenger auto; or Pickup or van. It also means a farm wagon or farm implement while

towed by one of the above.

Eligible Vehicles Only certain types of vehicles are eligible for coverage under the Personal Auto Policy. An eligible vehicle is a four-wheel motor vehicle (other than truck-type) that is owned by the insured or is leased by the insured for at least six continuous months. Pickups and vans are also eligible for coverage if the vehicle is not customarily used in the insured’s business or occupation other than farming or ranching. A vehicle that is owned by a family farm or ranch partnership or corporation is eligible for coverage if the vehicle is garaged principally on the farm or ranch, and other eligibility requirements are met. A private passenger automobile owned by two or more resident relatives or two or more non-related individuals living together can be insured by adding a miscellaneous type vehicle endorsement to the policy. Motorcycles, motor homes, motor scooters, golf carts, and similar vehicles can be insured under the Personal Auto Policy by adding the same endorsement to the policy. The actual definition for eligible vehicles may include the following:

“Your covered auto” means: Any vehicle shown in the Declarations. Any of the following types of vehicles on the date you

become the owner: A private passenger auto; or A pickup or van. This provision applies only if: You acquire the vehicle during the policy period. You ask us to insure it within 30 days after you

become the owner. With respect to a pickup or van, no other insurance

policy provides coverage for that vehicle. If the vehicle you acquire replaces one shown in the Declarations, it will have the same coverage as the vehicle it replaced. You must ask us to insure a replacement vehicle within 30 days only if: You wish to add or continue Coverage for Damage

to Your Auto. It is a pickup or van used in any “business” other

than farming or ranching. If the vehicle you acquire is in addition to any shown in the Declarations, it will have the broadest coverage we now provide for any vehicle shown in the Declarations.

Any “trailer” you own. Any auto or “trailer” you do not own while used as a

temporary substitute for any other vehicle described in this definition which is out of normal use because of its: Breakdown; Repair; Servicing; Loss; or Destruction.

Personal Auto Policy: Liability Coverage After the Declarations Page, Insuring Agreement and Definitions, Part A of the Personal Auto Policy then sets forth Liability Coverage. Part A sets forth its own Insuring Agreement which describes the major promises of the insurer regarding liability coverage. In the Insuring Agreement, the insurer agrees to pay damages for bodily injury or property damage for which the insured is legally responsible because of an automobile accident. The insuring agreement in Part A may read as follows:

We will pay damages for bodily injury or property damage for which any covered person becomes legally responsible because of an auto accident. We will settle or defend, as we consider appropriate, any claim or suit asking for these damages. In addition to our limit of liability, we will pay all defense costs we incur. Our duty to settle or defend ends when our limit of liability for this coverage has been exhausted. We have no duty to defend any suit or settle any claim for “bodily injury” or “property damage” not covered under this policy.

Liability coverage is generally written as a single limit that applies to both bodily injury and property damage liability. That is, the total amount of insurance applies to the entire accident without a separate limit for each person. The Personal Auto Policy can also be written with split limits. Split limits mean the amounts of insurance for bodily injury liability and property damage are stated separately. In addition to the payment for damages for which the insured is legally liable, the company also agrees to defend and pays all legal defense costs. The defense costs are paid in addition to the policy limits. However, the company’s duty to settle or defend the claim ends when the limit of liability has been exhausted. Once the policy limits are paid out, the company has no further obligation to defend the insured. The company also has no obligation to defend any claim not covered under the policy. Insured Persons Part A of the Personal Auto Policy provides liability coverage for four different categories of parties:

Category 1 – You or any “family member” for the ownership, maintenance or use of any auto or “trailer.”

In Category 1 the named insured and resident family members are covered for the ownership, maintenance, or use of any auto, whether it is owned or borrowed, unless exclusions apply.

Category 2 – Any person using “your covered auto.”

Category 2 relates to any person using a covered auto. The car owner’s insurance, not the driver’s insurance, would pay a claim if the owner allows another party to borrow his or her car. Coverage on the auto involved in an accident is considered primary coverage. If the owner’s insurance is exhausted by the claim, then the driver could turn to his own insurer to pay the remainder of the claim until his own insurance was exhausted.


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Category 3 – For “your covered auto,” any person or organization but only with respect to legal responsibility for acts or omissions of a person for whom coverage is afforded under this part.

Category 4 – For any auto or “trailer,” other than “your covered auto,” any other person or organization but only with respect to legal responsibility for acts or omissions of you or any “family member” for whom coverage is afforded under this Part. This provision applies only if the person or organization does not own or hire the auto or “trailer.”

Categories 3 and 4 recognize that in some situations, people or organizations other than a driver can be sued due to a driver’s negligence. In some of these instances the Personal Auto Policy will cover the liability of these people. Assume that a trade union sends a member, John, to buy some supplies for a union picnic. Also assume that John uses his own car. If an accident occurs during this trip, the Personal Auto Policy would cover the trade union’s liability in a suit resulting from the accident. The union’s liability arises because John was technically an agent of the union while on his way to purchase supplies for the picnic. The difference between Categories 3 and 4 is the difference between the insured driving an owned or non-owned vehicle. Supplementary Payments Under the Personal Auto Policy, the insurance company may provide liability coverage beyond its stated limit of liability by making certain supplementary payments. Part A of the Policy describes five categories of supplementary payments:

Up to $250 for the cost of bail bonds required because of an accident, including related traffic law violations. The accident must result in “bodily injury” or “property damage” covered under this policy.

Premiums up to $250 may be paid for bail bonds arising out of an automobile accident that results in property damage or bodily injury. Payment would not be made for a traffic violation such as a speeding ticket except if an accident occurs.

Premiums on appeal bonds and bonds to release attachments in any suit we defend.

Interest accruing after a judgment is entered in any suit we defend. Our duty to pay interest ends when we offer to pay that part of the judgment, which does not exceed our limit of liability for this coverage.

Premiums on appeal bonds and any bond to release an attachment of property in any suit defended by the insurer are also paid as supplementary payments. If interest accrues after a judgment is handed down, the interest is also paid as a supplementary payment. However, any prejudgment interest is subject to the policy’s liability limits.

Up to $50 a day for loss of earnings, but not other income, because of attendance at hearings or trials at our request.

Other reasonable expenses incurred at our request.

The insured may be a defendant in a trial and be requested to testify, and the policy will cover up to $50 per day for loss of earnings. If the insured incurs meal or transportation expenses as a result of requests by the insurer, those expenses would be paid as a supplemental payment. Exclusions Part A of the Personal Auto Policy next details the specific exclusions to liability coverage.

Specifically, the insurance company will not provide liability coverage for any person:

Who intentionally causes “bodily injury” or “property damage.”

For example, if the insured intentionally runs over a bicycle with his car, the property damage is not covered.

For damage to property owned or being transported by that person.

For example, if a suitcase or camera were damaged in an automobile accident while a person is on vacation, the damage would not be covered.

For damage to property: Rented to; Used by; or In the care of… that person. This exclusion does not apply to damage to a residence or private garage.

For example, if the insured rents skis that are damaged in an automobile accident, the property damage is not covered by the policy. However, if the insured rents a house and carelessly backs into a partly opened garage door, the property damage would be covered by the policy.

For “bodily injury” to an employee of that person during the course of employment. This exclusion does not apply to “bodily injury” to a domestic employee unless workers compensation benefits are required or available for that domestic employee.

The intent here is to cover the employee’s injury under a workers compensation law. However, a domestic employee injured during the course of employment would be covered if workers compensation benefits are not required or available. There is no liability coverage on a vehicle while it is being used to carry persons or property for a fee. If bus drivers or taxicab drivers are on strike and the insured transports passengers for a fee, the policy’s liability coverage does not apply to that circumstance.

For that person’s liability arising out of the ownership or operation of a vehicle while it is being used to carry persons or property for a fee. This exclusion does not apply to a share-the-expense car pool.

While employed or otherwise engaged in the “business” of: Selling; Repairing; Servicing; Storing; or Parking vehicles designed for use mainly on public

highways. This includes road testing and delivery. This exclusion does not apply to the ownership, maintenance or use of “your covered auto” by: You; Any family member; or Any partner, agent or employee of you or any

“family member.”

If a person is employed or engaged in the automobile business, liability arising out of the operation of vehicles in the automobile business is excluded from coverage under the policy. The automobile business refers to the selling, repairing, servicing, storing, or parking of vehicles designed for use mainly on public highways. This also includes road testing and delivery. If an automobile mechanic has an


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accident and injures someone while road testing an insured’s car, the Personal Auto Policy liability coverage does not apply to that circumstance. However, if the insured is sued because he is the owner of the car, coverage applies. The intent of this exclusion is to exclude loss exposures that should be covered under the employee’s liability policy, such as a garage policy.

Maintaining or using any vehicle while that person is employed or otherwise engaged in any “business” (other than farming or ranching) not described in the prior exclusion. This exclusion does not apply to the maintenance or use of a: Private passenger auto; Pickup or van that you own; or Trailer used with a vehicle described in above.

The purpose here is to exclude liability for commercial vehicles and trucks that are used in a business. However, if a party drives your car on company business, the Personal Auto Policy liability coverage remains in force.

Using a vehicle without a reasonable belief that the person is entitled to do so.

For example, if the insured’s car is stolen, and someone is injured in an ensuing accident, the injured party is not covered under the insured’s liability policy.

For “bodily injury” or “property damage” for which that person: Is an insured under a nuclear energy liability policy;

or Would be an insured under a nuclear energy liability

policy but for its termination upon exhaustion of its limit of liability.

A “nuclear energy liability policy” is a policy issued by any of the following or their successors: American Nuclear Insurers; Mutual Atomic Energy Liability Underwriters; or Nuclear Insurance Association of Canada.

Each of the above exclusions relate to the actions of a person, whether the insured or another party using the insured’s vehicle. The Personal Auto Policy also presents exclusions which are tied to a particular type of property. Specifically, the Personal Auto Policy does not provide liability coverage for the ownership, maintenance or use of:

Any motorized vehicle having fewer than four wheels.

Motorcycles, motor scooters, mini-bikes, mopeds, and trail bikes are excluded under the policy; however, the insured may add a miscellaneous vehicle endorsement to the policy in order to cover these types of vehicles.

Any vehicle, other than “your covered auto,” which is: Owned by you; Furnished or available for your regular use.

The insured may occasionally drive another person’s car and still have coverage under the policy; however, if a non-owned vehicle is driven regularly or is furnished or made available for regular use, the Personal Auto Policy liability coverage will not apply to use of that vehicle. If the insured’s employer furnishes the insured with a car, or if a car is available for regular use in a company carpool, the liability coverage will not apply to use of that vehicle.

Any vehicle, other than “your covered auto,” which is owned by, furnished or available for the regular use

of any “family member.”

If a son or daughter drives a non-owned vehicle on a regular basis, or the vehicle is furnished or made available for their regular use, the liability coverage does not apply.

However, this exclusion does not apply to your maintenance or use of any vehicle, which is: Owned by a “family member;” or Furnished or available for the regular use of a “family

member.”

The exclusion does apply to the named insured and spouse, or if a mother occasionally drives a car owned by another household member, (for example, a son or daughter), the mother’s Personal Auto Policy provides coverage while driving her son’s or daughter’s car. Limit of Liability The next portion of Part A of the Personal Auto Policy explains the limits of liability under the policy:

The limit of liability shown in the Declarations for this coverage is our maximum limit of liability for all damages resulting from any one-auto accident. This is the most we will pay regardless of the number of – “Insureds;” Claims made; Vehicles or premiums shown in the Declarations; Vehicles involved in the auto accident.

We will apply the limit of liability to provide any separate limits required by law for bodily injury and property damage liability. However, this provision will not change our total limit of liability.

The company’s maximum limit of liability from any single automobile accident is the amount stated in the Declarations. This is true regardless of the number of insureds, claims made, vehicles or premiums shown in the declarations, or vehicles involved in the auto accident. Out of State Coverage The Personal Auto Policy next provides details regarding out of state liability coverage:

If an auto accident to which this policy applies occurs in any state or province other than the one in which “your covered auto” is principally garaged, we will interpret your policy for that accident as follows: If the state or province has: A financial responsibility or similar law specifying

limits of liability for “bodily injury” or “property damage” higher than the limit shown in the Declarations, your policy will provide the higher specified limit.

If an accident occurs in a state that has a financial responsibility law with higher liability limits than the limits shown in the declarations, the Personal Auto Policy automatically provides the higher specified limits.

A compulsory insurance or similar law requiring a nonresident to maintain insurance whenever the nonresident uses a vehicle in that state or province, your policy will provide at least the required minimum amounts and types of coverage.

If the state has a compulsory insurance or similar law that requires a nonresident to have insurance whenever he or she uses a vehicle in that state, the Personal Auto Policy also provides the required minimum amounts and types of coverages.


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No party will be entitled to duplicate payments for the same elements of loss.

Other Insurance The final section of Part A of the Personal Auto Policy explains the policy’s liability coverage benefits in the event the insured carries other, additional insurance:

If there is other applicable liability insurance we will pay only our share of the loss. Our share is the proportion that our limit of liability bears to the total of all applicable limits. However, any insurance we provide for a vehicle you do not own shall be in excess over any collectible insurance.

In some cases, more than one automobile liability policy covers a loss. If other applicable liability insurance applies to an owned vehicle, the company pays only its pro rata share of the loss. The company’s share is the proportion that its limit of liability bears to the total applicable limits of liability under all policies. However, if the insurance applies to a non-owned vehicle, the company’s insurance is in excess over any other collectible insurance. Personal Auto Policy: Medical Payments Coverage Part B (or sometimes included as Part B1) of the Personal Auto Policy sets forth Medical Payments Coverage for the insured. Part B’s insuring agreement sets forth the company’s promises regarding its coverage of medical payments required as a result of bodily injury arising out of an automobile accident. Specifically, the policy may provide:

We will pay reasonable expenses incurred for necessary medical and funeral services because of “bodily injury:” Caused by accident; or Sustained by an “insured.”

We will pay only those expenses incurred within 3 years from the date of the accident.

The company will pay all reasonable medical and funeral expenses incurred by an insured within three years from the date of the accident. The benefits limits apply to each insured that is injured in the accident. Medical payments coverage is not based on fault. If an individual is injured in an automobile accident and that individual is at fault, medical payments can still be paid to the individual and to other injured passengers in the car.

The Personal Auto Policy defines “Insured” as used in this part B as: You or any “family member:” While “occupying” or As a pedestrian when struck by: a motor vehicle designed for use mainly on public roads or a trailer of any type.

The named insured and family members are covered if they are injured while occupying a motor vehicle or are injured as pedestrians when struck by a motor vehicle designed for use mainly on public roads. If a farm tractor, snowmobile, or bulldozer injures an individual, that individual’s injury is not covered.

Any other person while “occupying” “your covered auto.”

If an individual owns his car and is the named insured, all passengers in his car are covered for their medical expenses under his policy. However, if the insured is operating a non-owned vehicle, other passengers in the car (other than family members) are not covered for their medical expenses under his policy. The reason for this is to cause the other passengers in the non-owned vehicle to seek protection

under the medical expense coverage that applies to the non-owned vehicle. Exclusions Part B of the Personal Auto Policy provides specific exclusions to medical payments coverage. The insurer will not provide medical payments coverage for any person for “bodily injury”:

Sustained while “occupying” any motorized vehicle having fewer than four wheels.

If the insured is injured while operating a motorcycle or moped, medical expense coverage does not apply.

Sustained while occupying your covered auto when it is being used to carry persons or property for a fee. This exclusion does not apply to a share-the-expense car pool.

Sustained while occupying any vehicle located for use as a residence or premises.

If the insured owns and occupies a house trailer as a residence, medical expense coverage does not apply to injuries arising out of use of that vehicle.

Occurring during the course of employment if workers compensation benefits are required or available for the “bodily injury.”

Coverage does not apply if the injury occurs during the course of employment and workers compensation benefits are required or available.

Sustained while occupying or when struck by, any vehicle (other than your covered auto) which is: Owned by you; Furnished or available for your regular use.

The purpose here is to exclude medical payments coverage on an owned or regularly used car that is not described in the policy and for which an appropriate premium has not been paid.

Sustained while “occupying,” or when struck by, any vehicle (other than “your covered auto”) which is: Owned by any “family member;” Furnished or available for the regular use of any

family member. However, this exclusion does not apply to you.

If a son living at home owns a car that is separately insured, and the parents are injured while occupying the son’s car, the parent’s medical expenses would be covered under their policy.

Sustained while “occupying” a vehicle without a reasonable belief that that person is entitled to do so.

If a covered auto is stolen, the thief has no coverage for medical payments.

Sustained while occupying a vehicle when it is being used in the business of an insured. This exclusion does not apply to “bodily injury” sustained while “occupying” a: Private passenger auto; Pickup or van that you own; “Trailer” used with a private passenger auto or

pickup or van that you own.


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The purpose here is to exclude medical payments coverage for non-owned trucks and commercial vehicles used in the business of an insured person. The exclusion does not apply to a private passenger auto (owned or non-owned), an owned pickup or van, or trailer used with any of the preceding vehicles.

Caused by or as a consequence of: Discharge of a nuclear weapon (even if accidental); War (declared or undeclared); Civil war; Insurrection; Rebellion or revolution.

From or as a consequence of the following, whether controlled or uncontrolled or however caused Nuclear reaction; Radiation; Radioactive contamination.

If the insured drives his car in the vicinity of a nuclear power plant and a nuclear meltdown occurs, the radiation exposure is not covered. Limit of Liability The next portion of Part B of the Personal Auto Policy explains the limits of liability for medical payments coverage:

The limit of liability shown in the Declarations for this coverage is that our maximum limit of liability for each person injured in any one accident. This is the most we will pay regardless of the number of: “Insureds;” Claims made; Vehicles or premiums shown in the Declarations; Vehicles involved in the accident.

Any amounts otherwise payable for expenses under this coverage shall be reduced by any amounts paid or payable for the same expenses under Part A or Part C. No payment will be made unless the injured person or that person’s legal representative agrees in writing that any payment shall be applied toward any settlement or judgment that person receives under Part A or Part C. Other Insurance The final section of Part B of the Personal Auto Policy explains the policy’s liability coverage benefits in the event the insured carries other, additional insurance:

If there is other applicable auto medical payments insurance we will pay only our share of the loss. Our share is the proportion that our limit of liability bears to the total of all applicable limits. However, any insurance we provide with respect to a vehicle you do not own shall be excess over any other collectible auto insurance providing payments for medical or funeral expenses.

Personal Auto Policy: Uninsured Motorists Coverage Some people drive without liability insurance, causing exposure to risk for other parties in the event of an automobile accident. Part C of the Personal Auto Policy sets forth Uninsured Motorists Coverage for the insured. The uninsured motorists coverage is designed to pay for the bodily injury (and property damage in some states) caused by an uninsured motorist, hit-and-run driver, or by a driver whose company is insolvent. Part C’s insuring agreement sets forth the company’s promises regarding uninsured motorists coverage. Specifically, the policy may provide:

We will pay damages which an “insured” is legally entitled to recover from the owner or operator of an “uninsured motor vehicle” because of “bodily injury:” Sustained by an “insured;” Caused by an accident.

The owner’s or operator’s liability for these damages must arise out of the ownership, maintenance or use of the “uninsured motor vehicle.” Any judgment that is for damages arising out of a suit brought without our written consent is not binding on us. The company pays the damages that an insured person is legally entitled to receive from the owner or operator of an uninsured motor vehicle because of bodily injury caused by an accident. However, the coverage applies only if the uninsured motorists are legally liable. If the uninsured motorists are not liable, the company will not pay for the bodily injury. For purposes of Uninsured Motorists Coverage, “Insured” means: You or any “family member”; Any other person “occupying” your covered auto; Any person for damages that person is entitled to

recover because of “bodily injury” to which this coverage applies sustained by one of the above parties.

“Uninsured motor vehicle” means a land motor vehicle or trailer of any type: To which no bodily injury liability bond or policy applies

at the time of the accident; To which a bodily injury liabilities bond or policy

applies at the time of the accident. In this case its limit for bodily injury liability must be less than the minimum limit for bodily injury liability specified by the financial responsibility law of the state in which “your covered auto” is principally garaged.

This means the maximum amount paid for a bodily injury usually is limited to the state’s financial responsibility or compulsory insurance law requirements.

Which is a hit and run vehicle whose operator or owner cannot be identified and which hits: You or any family member; A vehicle which you or any family member are

occupying or; Your covered auto.

If a hit-and-run driver strikes the named insured or any family member while occupying a covered auto, non-owned auto or while walking, the uninsured motorists coverage will pay for the injury.

To which a bodily injury liabilities bond or policy applies at the time of the accident and the bonding or insuring company: Denies coverage; Is or becomes insolvent.

However, “uninsured motor vehicle” does not include any vehicle or equipment: Owned by or furnished or available for the regular use

of you or any “family member”; Owned or operated by a self-insurer under any

applicable motor vehicle law; Owned by any government unit or agency; Operated on rails or crawler treads; Designed mainly for use off public roads while not on

public roads; While located for use as a residence or premises.


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Exclusions Part C of the Personal Auto Policy also provides exclusions to its Uninsured Motorists Coverage. Specifically, the Personal Auto Policy states that the insurer will not provide Uninsured Motorists Coverage for “bodily injury” sustained by any person:

While “occupying,” or when struck by, any motor vehicle owned by you or any “family member” which is not insured for this coverage under this policy. This includes a trailer of any type used with that vehicle.

This exclusion was designed to prevent “free” uninsured motorists coverage on automobiles owned by the named insured or family member.

If that person or the legal representative settles the “bodily injury” claim without our consent.

If a person settles a bodily injury claim without the company’s consent, coverage does not apply. The purpose of this exclusion is to protect the company’s interest in the claim.

While “occupying” “your covered auto” when it is being used to carry persons or property for a fee. This exclusion does not apply to a share-the-expense car pool.

Using a vehicle without a reasonable belief that that person is entitled to do so.

If a thief steals the insured’s car and is later injured by an uninsured motorist, the thief is not covered under the insured’s policy.

The exclusions also state that uninsured motorists coverage shall not apply directly or indirectly to benefit any insurer or self-insurer under any of the following or similar law: Workers compensation law; Disability benefits law.

The uninsured motorist coverage cannot directly or indirectly benefit a workers compensation insurer or self-insurer. A workers compensation insurer may have a legal right of action against a third party who has injured an employee. If an uninsured driver injures an employee who receives workers compensation benefits, the workers compensation insurer could sue the uninsured driver or attempt to make a claim under the injured employee’s uninsured motorist coverage. This exclusion prevents the uninsured motorist coverage from providing benefits to the workers compensation insurer. Limit of Liability The next portion of Part C of the Personal Auto Policy explains the limits of liability for uninsured motorists coverage under the policy:

The limit of liability shown in the Declarations for this coverage is our maximum limit of liability for all damages resulting from any one accident. This is the most we will pay regardless of the number of: “Insureds”; Claims made; Vehicles or premiums shown in the Declarations; Vehicles involved in the accident.

Any amounts otherwise payable for damages under this coverage shall be reduced by all sums: Paid because of the “bodily injury” by or on behalf of

persons or organizations that may be legally responsible. This includes all sums paid under Part A; and

Paid or payable because of the “bodily injury” under any of the following or similar law: Workers compensation law; Disability benefits law.

Any payment under this coverage will reduce any amount that person is entitled to recover for the same damages under Part A.

The amount paid under the uninsured motorist’s coverage can be reduced under certain conditions. The amount paid is reduced by any sums paid by the negligent driver or organization legally responsible for the accident or by any benefits payable under workers compensation, disability benefits, or similar law. Other Insurance The next section of Part C of the Personal Auto Policy explains the policy’s liability coverage benefits in the event the insured carries other, additional insurance:

If there is other applicable similar insurance we will pay only our share of the loss. Our share is the proportion that our limit of liability bears to the total of all applicable limits. However, any insurance we provide with respect to a vehicle you do not own shall be excess over any other collectable insurance.

Underinsured Motorist Coverage In addition to uninsured motorist coverage, underinsured motorist coverage can be added to the Personal Auto Policy to provide more complete protection. This coverage pays damages for a bodily injury caused by the ownership or operation of an underinsured vehicle. The maximum amount paid under this coverage is the underinsured motorists limit less the amount paid by the negligent driver’s insurer. Underinsured Motorist Coverage and Uninsured Motorist Coverage are exclusive and do not duplicate each other. An insured can collect on one coverage or the other, but not both. The conditions that must be satisfied before an underinsured motorist’s coverage can be written are: Higher uninsured motorist coverage limits must be carried

than the limits required by the state’s financial responsibility or compulsory insurance law.

Both the uninsured and the underinsured motorist coverage must be written for the same amount of insurance.

The underinsured motorist coverage must apply to all automobiles covered under the policy.

Personal Auto Policy: Coverage for Damage to Automobile Part D of the Personal Auto Policy sets forth coverage in the event of damage to the insured’s automobile. Part D’s insuring agreement explains the company’s promises regarding its coverage of damage to the auto. Specifically, the policy may provide:

We will pay for direct and accidental loss to “your covered auto” or any “non-owned auto,” including their equipment, minus any applicable deductible shown in the Declarations. We will pay for loss to “your covered auto” caused by: Other than “collision” only if the Declarations indicate

that Other Than Collision Coverage is provided for that auto;

Collision only if the Declarations indicate that Collision Coverage is provided for that auto.

If there is a loss to a “non-owned auto,” we will provide the broadest coverage applicable to any “your covered auto” shown in the Declarations.


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The company agrees to pay for any direct and accidental loss to a covered auto or any non-owned auto, including its equipment, less any applicable deductible. A covered auto can be insured for both (1) a collision loss and (2) an other-than-collision loss (formerly called comprehensive coverage). A collision loss is covered only if the declaration page indicates that collision coverage is provided for that auto. Coverage for an other than collision loss is in force only if the declarations page indicates that other than collision coverage is provided for that auto. If both coverages are selected, the premium for each coverage is shown separately on the declaration page. Part D of the Personal Auto Policy contains certain definitions:

“Collision” means the upset of your covered auto or its impact with another vehicle or object.

Collision losses are paid regardless of fault. If the insured causes the accident, the insurer will pay for the damage to his car, less any deductible. If another driver damages his car, he can collect from the negligent driver (or the negligent driver’s insurer), or from his insurer. If an insured collects from his own company, he must give up subrogation rights to his company, thus allowing the company to seek reimbursement from the other driver’s insurance company.

Loss caused by the following is considered other than “collision”: Missiles or falling objects; Fire; Theft or larceny; Explosion or earthquake; Windstorm; Hail, water or flood; Malicious mischief; Riot or civil commotion; Contact with bird or animal; Breakage of glass.

If breakage of glass is caused by a “collision,” the insured may elect to have it considered a loss caused by “collision.” This is important because both coverages (collision loss and other-than-collision loss) may be written with deductibles. Without this qualification, an insured would have to pay two deductibles if the car had both body damage and glass breakage in the same accident (assuming both coverage’s are elected). By treating glass breakage as part of the collision loss, only one deductible has to be satisfied.

“Non-owned auto” means any private passenger auto, pickup, van or trailer, not owned by or furnished or available for the regular use of you or any family member while in the custody of or being operated by you or any family member. However, “non-owned auto” does not include any vehicle used as temporary substitute for a vehicle you own which is out of normal use because of its: Breakdown; Repair; Servicing; Loss; Destruction.

A non-owned auto is defined as any private passenger auto, pickup, van or trailer not owned by or furnished or made available for the regular use of the named insured or family member, while it is in the custody of or is being operated by the named insured or family member.

The key point is not how frequently an insured individual drives a non-owned auto, but whether the vehicle is furnished or made available for that individual’s regular use. Note that Part D coverages that apply to a covered auto also apply to a temporary substitute vehicle for that auto. Part D also provides that the insurer will pay the insured certain amounts for transportation expenses. The policy may specifically provide the following:

In addition, we will pay up to $10 per day, to a maximum of $300, for transportation expenses incurred by you. This applies only in the event of the total theft or “your covered auto.” We will pay only transportation expenses incurred during the period: Beginning 48 hours after the theft; Ending when “your covered auto” is returned to use or

we pay for its loss.

Payments can be for a train, bus, taxi, rental car, or any other transportation expense. Exclusions As with other coverages in the Personal Auto Policy, Part D’s auto damage coverage is subject to specific exclusions:

We will not pay for: Loss to “your covered auto,” which occurs while it is

used to carry persons or property for a fee. This exclusion does not apply to a share-the-expense car pool.

Damage due and confined to: Wear and tear; Freezing; Mechanical or electrical breakdown or failure; Road damage to tires. This exclusion does not apply if the damage results from the total theft of “your covered auto.”

The intent of this exclusion is to cover tire defects under the tire manufacturer warranty and to exclude normal maintenance costs of operating an automobile.

Loss due to or as a consequence of: Radio active contamination; Discharge of any nuclear weapon (even if

accidental); War (declared or undeclared); Civil war; Insurrection; Rebellion or revolution.

Loss to equipment designed for the reproduction of sound. This exclusion does not apply if the equipment is permanently installed in “your covered auto” or any “non-owned auto.”

Loss to tapes, records or other devices for use with equipment designed for the reproduction of sound.

An endorsement can be added that covers tapes, records, or other devices owned by the named insured or family members.

Loss to a camper body or “trailer” you own which is not shown in the Declarations. This exclusion does not apply to a camper body or “trailer” you: Acquire during the policy period; Ask us to insure within 30 days after you become the

owner. Loss to any non-owned auto or any vehicle used as a

temporary substitute for a vehicle you own, when used by you or any family member without a reasonable


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belief that you or that family member is entitled to do so.

Loss to: TV antennas; Awnings or cabanas; Equipment designed to create additional living

facilities; or Loss to any of the following or their accessories; Citizens band radio; Two-way mobile radio; Telephone; Scanning monitor receiver. This exclusion does not apply if the equipment is permanently installed in the opening of the dash or console of “your covered auto” or any “non-owned auto.” The auto manufacturer for the installation of a radio must normally use this opening.

Losses to any custom furnishings or equipment in or upon any pick-up or van. Custom furnishings or equipment include but are not limited to: Special carpeting and insulation, furniture, bars or

television receivers; Facilities for cooking and sleeping; Height-extending roofs; Custom murals, paintings or other decals or

graphics.

A special customizing equipment endorsement can be added that covers the excluded furnishings or equipment by payment of an additional premium.

Loss to equipment designed or used for the detection or location of radar.

This exclusion has been incorporated into the policy because radar detection equipment is designed, and has been used, to circumvent state and federal speed laws.

Loss to any “non-owned auto” being maintained or used by any person while employed or otherwise engaged in the “business” of: Selling; Repairing; Servicing; Storing; Parking …vehicles designed for use on public highways. This includes road testing and delivery.

The above are business loss exposures that should be covered under a commercial garage policy.

Loss to any “non-owned auto” being maintained or used by any person while employed or otherwise engaged in any “business” not described in the prior exclusion. This exclusion does not apply to the maintenance or use by you or any “family member” of a “non-owned auto” which is a private passenger auto or “trailer.”

The above is a business loss exposure that should be insured by a commercial policy covering the “business.” Limit of Liability The next portion of Part D of the Personal Auto Policy explains the limits of liability for auto damage coverage under the policy:

Our limit of liability for loss will be the lesser of the:

Actual cash value of the stolen or damaged property; or

Amount necessary to repair or replace the property. However, the most we will pay for loss to any “non-owned auto” which is a “trailer” is $500.

The actual cash value of the vehicle at the time of loss is determined by adjusting for depreciation and the physical condition of the damaged property. If the vehicle is declared a total loss, the amount paid is the actual cash value of the vehicle (less any deductible).

An adjustment for depreciation and physical condition will be made in determining actual cash value at the time of loss.

Payment of Loss The next section of Part D describes the manner in which the insurer will pay for loss resulting from damage to the auto:

We may pay for loss in money or repair or replace the damaged or stolen property. We may, at our expense, return any stolen property to: You; The address shown in this policy.

If we return stolen property we will pay for any damage resulting from the theft. We may keep all or part of the property at an agreed or appraised value.

In the case of an expensive antique or customized car, a stated amount endorsement can be inserted in the policy. If the stated amount of insurance is less than the actual cash value of the car, only the amount of insurance is paid (less any deductible). If the stated amount of insurance exceeds the actual cash value of the car, or the amount necessary to repair or replace the car, the lower of these latter two figures is the amount paid (less any deductible). No Benefit to Bailee Next, Part D of the Personal Auto Policy states that auto coverage shall not directly or indirectly benefit any carrier or other bailee for hire. In other words, any hired driver will not be entitled to collect from the insurance company for any damage to the automobile. Only the owner of the car is entitled to collect from the insurer for damage to the automobile. Other Insurance As with other sections of the Personal Auto Policy, Part D discusses the consequences of the insured carrying additional automobile coverage:

If other insurance also covers the loss we will pay only our share of the loss. Our share is the proportion that our limit of liability bears to the total of all applicable limits. However, any insurance we provide with respect to a “non-owned auto” or any vehicle used as a temporary substitute for a vehicle you own shall be excess over any other collectible insurance.

Appraisal The final section of Part D of the Personal Auto Policy covers the use of an appraisal to determine the amount of loss:

If you and we do not agree on the amount of loss, either may demand an appraisal of the loss. In this case, each party will select a competent appraiser. The two appraisers will select an umpire. The appraisers will state separately the actual cash value and the amount of loss. If they fail to agree, they will submit their differences to the umpire. A decision agreed to by any two will be binding. Each party will:


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Pay its chosen appraiser; Bear the expenses of the appraisal and umpire

equally. We do not waive any of our rights under this policy by agreeing to an appraisal.

The appraisal provision is intended to set forth an equitable solution to determine the amount of the loss in the event that the parties can not agree on their own. Personal Auto Policy: Duties After an Accident or Loss Part E of the Personal Auto Policy describes the duties and obligations of the insured in the event of an accident or loss. The individual insured must follow these procedures in order to obtain the benefits of the policy. A typical Personal Auto Policy may set forth the duties and obligations as follows:

We must be notified promptly of how, when and where the accident or loss happened. Notice should also include the names and addresses of any injured persons and of any witnesses.

A person seeking any coverage must: Cooperate with us in the investigation, settlement or

defense of any claim or suit. Promptly send us copies of any notices or legal

papers received in connection with the accident or loss.

Submit, as often as we reasonably require to physical exams by physicians we select and to examination under oath. We will pay for these exams.

Authorize us to obtain: Medical reports; Other pertinent records.

Submit a proof of loss when required by us. A person seeking Uninsured Motorist Coverage must

also: Promptly notify the police if a hit and run driver is

involved; Promptly send us copies of the legal papers if a suit

is brought. A person seeking Coverage for Damages to Your Auto

must also: Take reasonable steps after the loss to protect “your

covered auto” and its equipment from further loss. We will pay reasonable expenses incurred to do this;

Promptly notify the police if “your covered auto” is stolen;

Permit us to inspect and appraise the damaged property before its repair and disposal.

Under no circumstances should the insured admit that he caused the accident. The question of negligence and legal liability will be resolved by the insurers involved (or court of law if necessary) and not by the insured. The insured does not have the right to admit that he is responsible for the accident.

Personal Auto Policy: General Provisions Part F of the Personal Auto Policy contains a list of general provisions which apply to the policy. The following are examples of provisions which appear in Part F:

Bankruptcy Bankruptcy or insolvency of the “insured” shall not relieve us of any obligations under this policy. Changes This policy contains all the agreements between you and us. Its terms may not be changed or waived except by

endorsement issued by us. If a change requires a premium adjustment, we will adjust the premium as of the effective date of change. We may revise this policy form to provide more coverage without additional premium charge. If we do this, your policy will automatically provide the additional coverage, as of the date the revision is effective in your state. Fraud We do not provide coverage for any “insured” that has made fraudulent statements or engaged in fraudulent conduct in connection with any accident or loss for which coverage is sought under this policy. Legal Action Against Us No legal action may be brought against us until there

has been full compliance with all the terms of this policy. In addition, under Part A, no legal action may be brought against us until: We agree in writing that the “Insured” has an

obligation to pay; or The amount of that obligation has been finally

determined by judgment after trial. No person or organization has any right under this

policy to bring us into any action to determine the liability of an “Insured.”

Our Right To Recover Payment If we make a payment under this policy and the person

to or for whom payment was made has a right to recover damages from another we shall be subrogated to that right. That person shall do: Whatever is necessary to enable us to exercise our

rights; and Nothing after loss to prejudice them. However, our right in this paragraph does not apply under Part D, against any person using “your covered auto” with a reasonable belief that that person is entitled to do so.

If we make a payment under this policy and the person to or for whom payment is made recovers damages from another that person shall: Hold in trust for us the proceeds of the recovery; and Reimburse us to the extent of our payment.

Policy Period And Territory This policy applies only to accidents and losses, which

occur: During the policy period as shown in the

Declarations; or Within the “policy territory.”

The “policy territory” is: The United States of America, its territories or

possessions. Puerto Rico. Canada.

This policy also applies to loss to, or accidents involving, “your covered auto” while being transported between their ports.

Termination This policy may be cancelled during the policy period as follows: The named insured shown in the Declarations may

cancel by: Returning this policy to us; Giving us advance written notice of the date

cancellation is to take effect. We may cancel by mailing to the named insured

shown in the Declarations at the address shown in this policy: At least 10 days notice;


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If cancellation is for nonpayment of premium; If notice is mailed during the first 60 days this policy

is in effect and this is not a renewal or continuation policy; or at least 20 days notice in all other cases.

After this policy is in effect for 60 days, or if this is a renewal or continuation policy, we will cancel only: For nonpayment of premium. If your drivers license or that of Any driver who lives with you Any driver who customarily uses your covered auto

has been suspended or revoked. This must have occurred: During the policy period; or Since the last anniversary of the original date if the

policy period is other than 1 year. If the policy was obtained through material

misrepresentation. Two Or More Auto Policies If this policy and any other auto insurance policy issued to you by us apply to the same accident, the maximum limit of our liability under all the policies shall not exceed the highest applicable limit of liability under any one policy.

Personal Auto Policy: Insuring Motorcycles and Other Vehicles The basic Personal Auto Policy does not provide coverage for motorcycles, motor homes or off-road vehicles; however, a miscellaneous-type vehicle endorsement can be added to the Personal Auto Policy to provide coverage for motorcycles, motor homes, mopeds, golf carts, dune buggies, and other vehicles. Snowmobiles and large trucks, however, cannot be added to the policy with the miscellaneous type vehicle endorsement. The endorsement provides the same coverages that are found in the Personal Auto Policy, and it has a schedule that describes the vehicle to be covered, the limits of liability for each coverage, and the premium owed. If the miscellaneous type vehicle endorsement is added to the Personal Auto Policy, there are certain conditions that should be brought to the policyholder’s attention: First, liability coverage generally does not apply if the

insured is operating a non-owned motorcycle. Second, property damage to a non-owned vehicle is

excluded; a borrowed or rented vehicle would not be covered.

Third, passenger hazard exclusion is available; this excludes liability for bodily injury to any passenger on the vehicle. The election of this exclusion reduces the premium.

Finally, the amount paid for any physical damage loss to the vehicle is limited to the lowest of: The stated amount shown in the endorsement. The actual cash value. The amount necessary to repair or replace the property

(less any deductible). Approaches for Compensating Automobile Accident Victims The Personal Auto Policy provisions described above have evolved as a balance between the insurance companies’ requirements to operate a profitable insurance business and public policy considerations with respect to society and the individual consumer. The following concepts have affected the development of the standard Personal Auto Policy and may also supplement or modify the standard form insurance policy in some states. Financial Responsibility Laws. These types of laws

require persons to furnish proof of financial responsibility up to certain minimum dollar limits.

Financial responsibility laws can be divided into two broad categories: Security-type. Security and proof method.

Under a security-type law, a person involved in an automobile accident is required to furnish proof of financial responsibility up to certain minimum dollar limits. Purchasing an automobile liability policy for the specified limits, posting a bond, or depositing securities or money in the amount required by law can establish proof of financial responsibility. The person may also establish responsibility by showing that the person is a qualified self-insurer. Under the security-and-proof method, the driver’s license and vehicle registration can be suspended unless the involved person submits security to pay for a judgment arising out of a current accident and also shows proof of financial responsibility for future accidents. Both conditions must be met before the driver’s license and registration is restored.

Some flaws in the financial responsibility laws are: There is no guarantee that all accident victims will be

paid. Financial responsibility laws normally have no penalties other than the loss of driving privileges.

Accident victims may not be fully indemnified for their injuries. Most financial responsibility laws require only minimum liability insurance limits. If the bodily injury exceeds the minimum limit, the accident victim may not be fully compensated.

There may be considerable delay in compensating the accident victim if the case goes to trial.

Compulsory Insurance Laws. These laws require the owners and operators of automobiles to carry automobile liability insurance at least equal to a certain amount before the automobile can be registered and licensed. More than half of the states have enacted some type of compulsory automobile liability insurance law as a condition for driving within the state. Compulsory insurance laws are considered superior to financial responsibility laws because they provide a stronger guarantee of protection to the public against loss. However, compulsory insurance laws also have certain flaws: A compulsory insurance law may not reduce the

number of uninsured motorists. Drivers may let their insurance lapse after the vehicle becomes licensed.

Compulsory laws do not provide complete protection. The laws require only a minimum amount of liability insurance, which may not meet the full needs of the victims.

Payment to all injured persons is not guaranteed. Some injured victims may not be compensated because they are injured by an out-of-state, uninsured driver.

Compulsory laws do not prevent or reduce the number of automobile accidents, which ultimately is the heart of the automobile accident problem.

Unsatisfied Judgment Funds. Some states have established unsatisfied judgment funds for compensating innocent accident victims. An unsatisfied judgment fund is a fund established by the state to compensate victims who have exhausted all other means of recovery. To receive compensation from the unsatisfied judgment fund, the accident victim first must obtain a judgment against the negligent motorist who caused the accident and must show that the judgment cannot be collected. The negligent motorist is not relieved of legal liability when payments are made out of the fund. The negligent


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motorist must repay the fund or lose his or her driver’s license until the fund is reimbursed.

Uninsured Motorist Coverage. The insurer agrees to pay the accident victim who has a bodily injury (or property damage) caused by an uninsured motorist, by a hit-and-run driver, or by a driver whose company is insolvent.

No-Fault Automobile Insurance. No-fault insurance means that after an automobile accident each party collects from his or her own insurer, regardless of fault. It is not necessary to determine who is at fault and prove negligence before a loss payment is made. A true no-fault law places some restrictions on the right to sue the negligent driver who actually caused the accident. If a claim is below a certain dollar threshold, ($2,500 for example) the motorist would not be permitted to sue but would instead collect from his or her own insurer. If the injury exceeds the threshold amount, the injured person has the right to sue the negligent driver for damages. A “verbal threshold” means that a suit for damages is allowed only in serious cases, such as those involving death, dismemberment, disfigurement, or permanent loss of a bodily member or function. Under a pure no-fault law, the injured cannot sue at all, regardless of the seriousness of the claim, and no payments are made for pain and suffering. In effect, the tort liability system is abolished. The insured person receives unlimited benefits from his or her own insurer for medical expenses and the loss of wages. Under a modified no-fault law an insured person has the right to sue a negligent driver only if the claim exceeds the monetary or verbal threshold. An add-on plan pays benefits to an accident victim without regard to fault, but the injured person still has the right to sue the negligent driver who caused the accident.

Arguments for no-fault laws. Difficulty of determining fault. Most accidents occur

suddenly and unexpectedly, and details surrounding them can seldom be accurately determined.

Limited scope of reparations system. Smaller claims may be overpaid, while serious claims may be underpaid. Small claims may be over-compensated because inflated settlements cost insurers less than taking claims into court.

Large proportion of premium dollars used to pay legal costs.

Delay in payments. Large numbers of claims may not be promptly paid because of investigations, negotiations, and wafting for court dates. Seriously injured persons or their survivors had to wait an average of sixteen months for final payment from automobile liability insurance.

Arguments against no-fault laws. The defects of the negligence system are exaggerated. Claims of efficiency and premium savings are

exaggerated. Safe drivers may be penalized. The present system needs only to be reformed, rather

than completely overhauled. Basic characteristics of no-fault laws. About half the states have some type of no-fault

insurance plan in existence. The majority of states have modified no-fault plans where restrictions are placed on the right to sue.

No-fault benefits are provided by adding an endorsement to the automobile insurance policy. The endorsement is typically called personal injury protection coverage. The following no-fault benefits are typically provided:

Medical expenses usually paid up to some maximum limit.

No-fault benefits are made for a stated percentage of the disabled person’s weekly or monthly earnings, with a maximum limit in term of time and duration.

Benefits are also paid for essential service expenses for certain services ordinarily performed by the injured person.

Funeral expenses are also paid up to some limit. Survivors’ loss benefits can also be paid to eligible

survivors, such as a surviving spouse and dependent children.

Automobile Insurance for High-Risk Drivers Drivers who have difficulty obtaining automobile insurance through normal market channels have an opportunity to obtain automobile insurance in the residual market (the shared market). In this market automobile insurers participate to make insurance available to drivers unable to obtain coverage in the standard market. Assigned Risk Plans. Under this arrangement, all

automobile insurers in a state are assigned their proportionate share of high-risk drivers based on the amount of automobile liability insurance premiums written in the state. Persons applying for insurance in an automobile

insurance plan must show that they have tried but were unsuccessful in obtaining automobile insurance within sixty days of the date of application.

Premiums paid for the insurance are substantially higher than the insurance obtained in the voluntary markets.

A company is not required to insure a high-risk driver for more than three years.

The major advantage of the Assigned Risk Plan is that a high-risk driver generally has at least one source for obtaining liability insurance. The major disadvantages of Assigned Risk Plans include the following: Despite higher premiums paid by high-risk drivers, the

automobile insurance plans have incurred substantial underwriting losses.

High premiums may cause many high-risk drivers to remain uninsured.

The driver does not have a choice of insurer, since the state assigns the driver to a particular insurer.

Joint underwriting associations. A joint underwriting association is an organization of automobile insurers in which high-risk business is placed in a common pool, and each company pays its pro-rata share of pool losses and expenses. Some states have established joint underwriting associations to make automobile insurance available to high-risk drivers.

Reinsurance facilities. Under this arrangement, the company must accept all applicants for insurance, whether both good and bad drivers. If the applicant is considered a high-risk driver the company has the option of placing the driver in the reinsurance pool. In the past, the reinsurance facilities have experienced substantial underwriting losses.

Specialty automobile insurers. Specialty automobile insurers are companies that specialize in insuring motorists with poor driving records. These companies typically insure drivers who have been cancelled or refused insurance, teenage drivers and drunk drivers. The premiums are substantially higher than premiums paid in the normal or standard markets.


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Cost of Automobile Insurance There are a number of major factors for determining the rates of private passenger automobile premiums. Territory Each state is divided into rating territories: a large city, a suburban, or a rural area. Largely, the territory where the automobile is principally used and garaged determines the base rate. Age, Sex Most states permit age and sex to be used as factors in determining premiums. Age is an important rating since young drivers account for a disproportionate number of accidents. Young male drivers who own or are the principal operators of automobiles normally pay the highest rates, since this group has the highest accident rate and the most costly accidents. Use of The Automobile Insurers classify automobiles on the basis of the purpose for which the car is driven. Pleasure use; not used in business or driven to work less

than a specified distance, for example, less than three miles one way.

Driven to work; not used in business but driven less than a specified number of miles to work each day.

Business use; customarily used in business or professional pursuits.

Farm use; garaged on a farm or ranch, and not used in any other business or driven to school or other work.

A car classified for farm use has the lowest rating factor, using a car for business purposes requires a higher rating factor. Driver Education This discount is based on the premise that driver education courses for teenage drivers can reduce accidents and hold down insurance costs. Good Student Discount This discount is available from a limited number of companies and is based on the premise that good students are better drivers. To qualify the driver must be a full time high school or college student and be at least sixteen years of age. A school official must sign a form certifying that the student has met the scholastic requirements. Number and Type of Automobiles The multi-car discount is based on the assumption that two cars owned by the same person will not be driven as frequently as only one car owned by the same person. The year, make and model of the cars also affect the cost of insurance on the car. Individual Driving Record Some companies offer safe driver plans where the premiums paid are based on the individual driving record of the insured and operators who live with the insured. In states that have an accident point system, the actual premium paid may be based on the total number of accumulated points assessed against the insured’s driving record. Purchase Higher Deductibles If the insured purchases a higher deductible on collision and comprehensive insurance, the premium can be reduced by as much as twenty percent. Improved Driving Record A clean driving record covering the previous three years can substantially reduce the premiums of a high-risk driver. A conviction for drunk driving can be extremely costly when purchasing automobile insurance. Conclusion Approximately $100 Billion a year in damage is estimated to be caused by automobile accidents. This damage includes destroyed property, medical and funeral expenses, and the lost income of people involved in accidents.

Since auto insurance is the first experience for most people with respect to the insurance industry, it is especially important for the agent to provide these purchasers the extra attention and care they need and desire in order to create a lifetime relationship with the purchaser.

CHAPTER 2 – HOMEOWNERS AND PERSONAL PROPERTY INSURANCE Introduction While many people first interact with an insurance agent with respect to automobile insurance, some individuals’ first experience with an insurance agent occurs when obtaining a homeowners or renters insurance policy. For some customers, the insurance professional will need to advise regarding the benefits of other property insurance products covering various types of personal property. In this chapter, we explore homeowners insurance and many types of personal property insurance. We begin with some background regarding the history of property and liability insurance, the two major components of homeowners and personal property coverage. The History of Property Insurance The first fire insurance company in the United States was established in 1734 and was called the Friendly Society for the Mutual Insurance of Houses Against Fire. By 1740 this firm was out of business as a result of a fire in Charles Town, South Carolina that wiped out most of the town. Originally insurance policies were written to cover a single peril. After the disastrous fire of 1740 several other fire companies were formed. These insurers used a risk classification method basing rates on the construction materials used in the building of the dwelling. Thus a building constructed of brick would have a more favorable risk rating than one made of wood. The early fire policies differed from company to company and from state to state. They were full of conditions and exclusions and often difficult for the average person to understand. The definition of terms varied from company to company and in general lacked uniformity. If an insured needed additional coverage such as for wind damage or other peril, the additional coverage was written as a separate policy. Often times these additional perils were not even covered by the same company. Many consumer complaints and court decisions eventually led to the first uniform property insurance policy called the 165 Line New York Standard Fire Policy of 1943. This was the only insurance policy first standardized by law. This policy became the basis for all property insurance coverage and is still used as a basic form in some states. Because the standard fire policy covers only the perils of fire, lightning, and removal of covered property from endangered premises, it is never used alone and endorsements are added to cover additional perils. This extended coverage (EC) includes: Windstorm. Hail. Explosion. Riot. Aircraft. Vehicle Damage. Smoke.

When these endorsements are added a vandalism and malicious mischief endorsement may also be added. Although the standard fire policy offered basic protection, many insurers argued that a policy which offers broader coverage would be to the benefit of both the insured and the insurer. A policy that covered both property and liability in one policy would do much more to serve the needs of all parties. Insurance companies felt that they would benefit from such a policy in at least three ways:


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Decreased adverse selection against the company. Reduction in overall administrative and underwriting

costs. Increased policy retention.

In the late 1940’s insurers were permitted by insurance regulators to combine property and casualty perils into one policy. Many formats and combinations of coverage sprung out from this deregulation. In 1976 the Insurance Service Office (ISO) developed a homeowners program that incorporated the pertinent provisions of the 165-line policy as part of what became known as the “Homeowners 76.” The “Homeowner 76” simplified the language of the fire contract. The changes made the policy easier to read and created a homeowners policy with five sections: Definitions. Coverage. Perils Insured Against. Exclusions. Conditions.

This original policy was revised in 1982, 1984, and 1991 to arrive at the present format of the policy. Some states have approved a variation of the 1991 format, which was introduced in 1994. A further adaptation was unveiled in 2000, and many states have adopted this most recent variation of the homeowners policy. Under the ISO Homeowners Program the basic policy covers: A dwelling that is owner occupied. A dwelling where no more than two families and not more

than two roomers or boarders per family occupy the dwelling.

The owner-occupant has purchased the full homeowners package.

The dwelling is used only for residential purposes. A homeowners policy cannot be written on a property to

which farm forms or rates apply. The policy cannot be written on a mobile home.

Additional policies have been developed as part of the ISO Homeowners Program in order to provide additional coverages for various circumstances. We will discuss these policies and coverages later in these materials. Negligence Distinguished from actual property loss, liability losses are losses incurred by individuals as a result of their actions toward other people or their property. When an individual is required to make financial restitution to another person for loss to them or their property a liability loss has occurred. In the civil legal system, when an individual violates the rights of another that individual has committed what is known as a tort. A tort can either be intentional or unintentional. Liability insurance provides coverage for unintentional torts. Negligence is a key factor in determining liability. In order for a person to be liable to another, that individual must have been negligent. Negligence is defined as the lack of reasonable care that is required to protect others from the unreasonable chance of harm. Four factors must be present in order to establish negligence: There must be a legal duty owed.

Legal duty owed is that obligation that we all have toward another to reasonably protect their rights and property. Within that duty there are several levels of accountability depending on the relationship and conditions. A person invited to our home is owed the highest degree of care. An individual performing a service in our home is owed a lower degree of care. And a trespasser is owed the lowest degree of care.

A breach of that legal duty must occur.

Breach of legal duty occurs when it is established that standard care was not taken, and that lack of precaution caused harm to another individual or their property.

There must be “proximate cause.” The proximate cause is the action that occurred and directly resulted in harm or damage. The action must be continuous and unbroken. If the action is interrupted by an intervening action, then this new action becomes the proximate cause.

There must be damages. The last element in establishing negligence is damage. If no harm came to an individual or their property then there was no negligence and therefore no claim.

When an individual either contributes or assumes some of the potential for harm, the ability to collect damages either is decreased or removed entirely. Assumption of risk is a factor that enters the picture when an individual attends a concert or a sporting event and is injured. By that individual’s presence at that event, that individual has assumed some of the risk involved in attending such an event. When both parties contribute to the negligence, this is known as “contributory negligence” or “comparative negligence.” The degree of which each contributed is taken into account in arriving at a payment, or perhaps a non-payment, of damages. The last factor that comes into play in determining liability for negligence is a statute of limitations. A statute of limitation requires that a suit must be filed within a specified period of time in order to be valid under the law. If the suit has not been filed within the required period of time, then a party cannot be held accountable for negligence which occurred prior to that time period. The Language of Liability Insurance The following terms are commonly used when discussing liability and liability insurance: Absolute Liability is a liability imposed by law on those

participating in activities that are considered hazardous. Negligence is not a requirement for payment of damages in the event of absolute liability.

Damages are a monetary compensation awarded by a court to an injured party.

Declarations are that section of an insurance contract that shows who is insured, what property or risk is covered, when and where the coverage is effective and how much coverage applies to loss.

Deductible is the dollar amount the insured must pay on each loss to which the deductible applies.

Defense Costs are the legal expenses that must be paid by the insurer to defend suits brought against the insured.

Degree of Care is the extent of legal duty owed by one person to another.

Indemnity is the principle of insurance that provides that when a loss occurs, the insured should be restored to the proximate financial condition he or she occupied before the loss occurred.

Occurrence is a loss that occurs over a specific time and place or over a period of time.

Post-judgment interest is interest accruing on a judgment after an award has been made, but before payment is made by the insurance company.

Pre-judgment interest is interest awarded to compensate a third party for interest he or she might have earned if compensation had been received at the time of injury or damage, rather than at the time of judgment.

Proximate Cause is an action that, in a natural and continuous sequence, produces a loss.

Punitive Damages are damages intended to punish the defendant in an effort to discourage others from behaving in the same manner.


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Service Bureau is an organization that gathers, pools, and analyses statistics from its member insurance companies to establish loss costs used in determining insurance rates.

Supplementary Payments Coverage is a coverage that provides extra coverage over and above the insured’s limit of liability. Commonly included are defense costs, first aid expenses, bond premiums, and post-judgment interest.

Third Party is the individual receiving the award in a liability case.

Tort is a civil wrong for which monetary damages are paid.

Vicarious Liability is liability that a person or business incurs because of the actions of others for whom they are responsible. For example, vicarious liability may cause a loss to be incurred as a result of the actions of family members or employees of the insured.

Summary Concepts of both property insurance and liability insurance combine to form the backbone of Homeowners and Personal Property Insurance. The homeowner seeks protection from both loss of property and possible liability to third parties. With this background regarding property insurance and liability insurance, we now begin to examine Homeowners Insurance in more detail. Homeowners Insurance – Introduction Coverage and Limits of Liability The front page or the “Declaration Page” of the homeowners insurance policy shows exactly what is covered and for how much. The front page contains the following information: Name of the Insurance Company and address. Name and address of the insured and address of the

insured property. The agent’s and agency name and address. Policy number. Policy period showing the effective date, expiration date,

and time. The coverage and premium breakdown: Property Coverage – Section I: Dwelling Limits of Coverage Detached Structures Limits of Coverage Personal Property Limits of Coverage Loss of Use Limits of Coverage Section I Deductible Amount of Deductible

Liability Coverage – Section II Personal Liability,

Each occurrence Limits of Coverage Medical Payments to others,

Each person Limits of Coverage Policy forms and endorsements and charges. Rating information. Mortgagee’s name and address. Signature of insurance company officer.

Types of Homeowners Policy Forms and Their Coverages There are several standard policies available and they contain a standardized numbering system throughout the United States, as follows: HO-1: Basic Form for Homeowners. HO-2: Basic Form for Homeowners with similar coverage

available for mobile home owners. HO-3: Special Form for Homeowners. HO-4: Renters’ or Tenants’ Insurance. HO-5: Comprehensive Form for Homeowners.

HO-6: Condominium Unit owners insurance. (There is no HO-7 Form) HO-8: Market Value or Older Home Form for

Homeowners. The “HO” stands for Homeowners and the number following that designates the specific policy package. HO-1 and HO-2 Policy These two forms are referred to as “Named Peril Policies” and in these two forms the same perils are applied to the dwelling and personal property coverage. HO-1 covers the insured against the following losses: Fire and lightning. Removing damaged property. Explosion. Hail or windstorm. Smoke damage. Riots and civil commotion. Damage to dwelling caused by vehicles or aircraft. Theft. Breakage of glass. Malicious mischief or vandalism.

HO-1 is becoming less and less popular due to the fact that each of the above losses is usually limited by a paragraph of numerous exclusions. Although the cost of HO-1 is low, the old adage still applies: “You get what you pay for.” HO-2 covers the following losses: Fire and lightning. Removing damaged property. Explosion. Hail and windstorm. Riot/civil commotion. Damage to dwelling caused by vehicles or aircraft. Damage from smoke that is sudden or accidental. Falling objects. Weight of ice, sleet or snow. Theft. Breakage of glass. Collapse of building. Accidental ruptures of hot water heater or steam heater. Accidental overflow of water from a plumbing appliance. Freezing of heating, air conditioning or plumbing

appliances. Accidental injury from electrical currents artificially

generated. The HO-2 form gives a more “Broad form” of coverage than HO-1 and the exclusions are not as intensive as those in HO-1. HO-3 Policy HO-3 covers against each of the perils shown for the HO-1 and HO-2 policies above and any other peril that is not specifically excluded from coverage. As a result of the extensive perils, the HO-3 policy is the one most commonly used by homeowners. The extensive coverage is referred to as “all risk coverage” to the dwelling. The all-risk coverage significantly sets the HO-3 policy apart from the HO-1 and HO-2. The following are examples of exclusions from coverage: Flood. Surface water. Waves and tidal waves from other bodies of water. Back-up water and sewage or drains. Water below the surface of the ground that flows, seeps

or leaks through side walls, driveways, basements, walls, foundations, through doors, windows or floors.

Earth movement, volcanic eruption, earthquake, landslide, mudflow, earth sinking, shifting or rising.


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Damage to air conditioning, heating and plumbing systems caused by leaking or as a result of freezing if failure to heat or shut off water.

Wear and tear. Deterioration. Marring or scratching. Mechanical breakdown, inherent vice or latent defect. Rust. Wet or dry rot. Mold. Act of war. Smog. Contamination. Acts of Government. Nuclear reactions. Smoke from industrial operations or agricultural

smudging. Shrinkage, cracking, settling, bolting, expansions of walls,

floors, roofs, ceilings, foundations, patios, pavement. Domestic animals, insects, rodents, vermin, and birds. Continuous leakage from within a plumbing system or

seepage. Theft to a dwelling under construction including materials

and supplies. Vandalism and glass breakage. Wind, ice, hail, snow or sleet damage to outdoor

television antennas or outdoor radio antennas including towers, masts and wiring.

HO-5 Policy The HO-5 is very similar to the HO-3 policy in that again, the dwelling is covered on an all risk basis. Personal property, however, also is covered on an all risk basis under the HO-5 policy. This constitutes the major difference between the HO-3 and the HO-5. The HO-5 policy is the most comprehensive standard homeowners’ policy available. However, the coverage in this policy is quite expensive for the homeowner. This policy is rarely used today because agents prefer to attach endorsements to the HO-3 policy in order to create a custom policy serving the customer’s needs. HO-4 and HO-6 Policies The HO-4 is a tenant’s policy designed for people who rent houses or apartments, and it also applies to owners of cooperative apartments. The HO-6 is a condominium owner’s policy. Both are very similar. Both cover personal property and improvements to the residence made by the insured. Improvements can be cosmetic such as additions, paneling or shelves. The HO-4 affords coverage of up to 10% of the policy amount for improvements. Therefore if personal property is insured for $50,000 dollars, $5,000 would cover improvements. The HO-6 affords a straight $1,000 for improvements. Neither the HO-4 nor the HO-6 provides any coverage for building structures. In the case of condominiums, an owner’s association insures the structure and public areas, so the condominium owner need only insure the contents and limited improvements. Both the HO-4 and the HO-6 forms are named peril forms, which means the property is insured for damage resulting from certain perils. HO-4 and HO-6 policies cover personal property against the following named perils: Fire and lightning. Removal. Windstorm or hail. Explosion. Riot or civil commotion. Aircraft. Vehicle. Smoke.

Vandalism or malicious mischief. Theft. Falling objects. Weight of ice, snow, or sleet. Collapse of building. Damage from hot water heating systems. Damage from appliances or plumbing. Damage from freezing of plumbing appliances. Damage from electrical currents artificially generated.

Payment under both HO-4 and HO-6 is based on the actual cash value of the property, rather than the replacement cost. HO-8 Policy The HO-8 Policy offers coverage for the same named perils as the HO-1 Policy, but this policy does not insure the replacement cost of the dwelling. Instead, the HO-8 Policy only provides payment in the amount of the actual cash value of the dwelling. The HO-8 Policy also provides payments in the amount of repairs to the existing dwelling, as long as those repairs do not exceed the value of the dwelling. Homeowners Insurance – Property Coverage – Section I The Property Coverage section of each form of Homeowners Policy covers five basic areas: The dwelling. Detached structures located on the property. Personal property. Loss of the use of the structure. Additional coverage.

The Dwelling The dwelling consists of the home itself (the actual living structure) and includes attached structures, such as a garage. In the policy declaration page this coverage will be shown as: Section I, Coverage A. The major portion of coverage in a homeowners policy is designed to pay the cost of rebuilding the structure. A common misunderstanding in this area of coverage is that the homeowner does not actually insure the dwelling for its value on the open market. This is because the land on which the house is built has a value, and the value of that land is not to be included in the coverage amount. Only the cost of the structure is included in the insurance amount. A helpful way to determine the cost of the structure is to contact a Builder’s Association to find out what the cost per square foot is in the area of the dwelling’s location. By taking the total square footage of the house and multiplying it by the local per-square-foot building cost, an individual can obtain a pretty good idea of the cost required to replace the structure. Many homeowners follow a standard rule of thumb by insuring the structure for at least 80% of the actual cost to rebuild the structure. If the property is secured by a loan, the lender typically requires that the structure be insured for 100% of the actual cost to rebuild the structure. Detached Structures Located on the Property These consist of structures that are on the same parcel of land, but are not attached directly to the home itself. This could be a shed for tools, a greenhouse in the yard, or some other structure that would be defined as a non-attached covered structure. Protection for these unattached structures is provided under Section I, Coverage B. Personal Property A very important coverage under any residential insurance policy is the personal property coverage. The contents of a home such as furniture, stereos, televisions, appliances, clothing, and the like are considered personal property. These items are covered under Section I, Coverage C. Personal property will be covered as long as the insured owns the property notwithstanding where the insured uses the property. The loss to property does not have to occur at the covered dwelling. Should the insured have personal


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property of others that is located at the home, this too is covered under the policy. In other words, personal property owned by a tenant in a rented house would not be covered by the homeowners policy, but personal property brought by a guest visiting the insured would be covered. It is important to know that personal property coverage is not unlimited. In fact, unless endorsements are purchased for specific coverage, the personal property protection can be rather limited. For example, there is a limit of coverage for loss of personal property. Without further endorsements, this amount is typically 50% of the total amount that the home is insured for under Coverage A. So, if a home is insured for $100,000, the loss for personal property limits would be $50,000. In addition, there are specific limits of liability that apply to the following personal property items: Money, bank notes, bullion, gold other than gold-ware,

silver other than silverware, platinum, coins, and medals. Maximum liability $200. Additional dollar coverage will cause additional premiums.

Securities, accounts, deeds, evidence of debt, letters of credit, notes other than bank notes, manuscripts, passports, tickets, and stamps. Maximum liability, $1,000. Additional dollar coverage will cause additional premiums.

Watercraft, their trailers, furnishings, equipment and outboard motors. Maximum liability, $1,000. Since coverage is so low in this area, most homeowners choose to purchase separate boat insurance.

Trailers not used with watercraft. Maximum liability, $1,000.

Grave markers. Maximum liability, $1,000. This is not a frequent issue for homeowners.

Theft of jewelry, watches, furs, precious and semi-precious stones. Maximum liability, $1,000. Many people get caught short with this coverage and need to buy endorsements to protect items worth more than $1,000.

Loss of firearms by theft. Maximum liability, $2,000. Theft of silverware, silver-plated ware, gold-ware, gold-

plated ware, and pewter-ware. Maximum liability, $2,500. Included here are flatware, hollowware, tea sets and trays, and trophies made of these metals.

Property on the residence premises used for business purposes. Maximum liability, $2,500. Should an insured have an office in the home or work out of the home and have computers, desks, and other equipment, additional protection is required since the homeowners policy severely limits coverage for these business items.

Personal property away from the residence used for business purposes. Maximum liability, $250.

The homeowners policy sets forth specific exclusions to coverage. Articles which are expressly excluded from the homeowners policy must be separately described and insured by endorsement in order to achieve coverage. If the insured elects to specifically cover these items by endorsement, the coverage will be determined by the language of that endorsement and will not be protected by Coverage C. Animals, birds, or fish. Although they may be invaluable

to the insured, nothing will be paid for their loss under the homeowners policy.

Motor Vehicles and all other motorized land conveyances. Normally these items are protected under an automobile insurance policy. However, there are two exceptions to this exclusion: The vehicle is not subject to motor vehicle registration

and is used to service an insured’s residence. or, The vehicle is designed to assist the handicapped.

Aircraft and their parts. The insured will need to purchase separate aircraft insurance.

Property of roomers, boarders, and other tenants except property of roomers related to the insured. These items are covered under renter’s insurance, rather than the homeowners policy.

Property in an apartment regularly rented or held for rental to others by an insured. Again, these items are covered under renter’s insurance.

Property rented or held for rental to others off the residential premises. Again, renter’s insurance is required to obtain coverage over these items.

Books of account and drawings. Included here are records of bookkeeping that are on paper, electronic data, computer software, and other paper containing business data.

Credit cards. The basic homeowners policy does not protect the insured against the loss of credit cards or credit fraud. However, coverage can be obtained under the additional coverage section of a policy.

The following thefts are also excluded under Coverage C: Anything stolen by the insured. Anything stolen from a part of the residence rented to

another person. Theft to a building that is under construction. Items stolen from a secondary residence unless the

insured is living there when the theft occurs. Theft of watercraft, outboard motors, trailers, or campers

which occurs away from the residence premises. Loss of the Use of the Structure A homeowners policy provides funds to compensate for the loss of the use of property in the event of damage by a peril covered under the policy. This coverage is provided under Section I, Coverage D. The insured can elect to receive compensation for loss of use in one of two ways: Payment for additional living expenses.

Additional living expenses usually require a higher monthly outlay than one would normally pay at home. If an individual’s home is destroyed by fire, it would be necessary to rent another residence while that home is being rebuilt. The policy will pay additional living expenses that are incurred in order to allow the household to “maintain its normal standard of living.”

Payment for the fair retail value of the uninhabitable property. The insured may receive a benefit that will pay the fair retail value for the residence less any expenses that do not continue while the home is not fit to live in.

Whichever benefit one chooses to receive, the benefit will only be paid for the shortest time required to replace or repair the damages to the property, or if the insured permanently relocates, the shortest time within which the individual can relocate. Note that if the property that became uninhabitable WAS NOT the insured’s principal place of residence, the insured will only be compensated for additional living expenses as the fair retail value option is not available to the insured. Additional Coverage As mentioned above, the HO-3 homeowners policy is the insurance policy most commonly purchased by homeowners. The following additional coverage can be obtained under the HO-3 homeowners policy: Property removed.

If for example, wind destroys the walls of a home and the insured wants to have this property removed, the cost to do so can be paid for under additional coverage. There is a 30-day limit for this coverage to apply.

Service charges of the fire department. The policy will pay up to $500 for the liability for any fire department charges incurred because the fire department was called upon to save or protect the property. In most cases, the city provides this service without charge and


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no payment is made by the homeowners policy, but this benefit is still made available as additional coverage.

Reasonable repairs. The policy covers reasonable costs incurred by the insured to make necessary repairs to prevent the property from further damage.

Debris removal. If it is necessary to remove debris that is created by a covered loss, the homeowners policy will pay for the removal. The amount available for debris removal is included in the total limit of liability. Should the removal expense exceed that amount, an additional 5% of the total limit of liability may be made available as additional coverage to complete the job.

Trees, shrubs, and plants. Should a covered loss (other than windstorm) damage or destroy trees, shrubs, or plants the policy will pay up to 5% of the limit of liability that applies to the dwelling with a maximum of $500 for any one tree, shrub, or plant. Commercial growing is not covered.

Forgery, counterfeit money, credit card and fund transfer card. The HO-3 policy will pay up to $500 for the following: Forgery or alteration of a check that causes a loss. Unauthorized use or theft of an ATM card that results in

a loss. Unauthorized use of credit cards issued in the name of

the insured. If the insured in good faith accepts counterfeit U.S. or

Canadian paper currency. Collapse.

Any collapse of a building or collapse of part of a building will be covered if the collapse causes the insured a direct physical loss and the collapse is caused by one of the following means: Hidden insect damage. The weight of the building’s equipment, contents,

people or animals. Rain collecting on the roof and causing damage or

collapse. Hidden decay. Defective material used in construction, renovation or

remodeling, provided the collapse occurs during the course of such work.

Note – Collapse does not include any damages that may be caused by bulging, expansion, settling, cracking or shrinking. Homeowners Insurance – Liability Coverage – Section II Coverage for liability under each form of homeowners policy is found under Section II, Coverage E – Personal Liability. This coverage provides that if a claim is made or a suit is brought against an insured for damages because of bodily injury or property damage caused by an occurrence to which the coverage applies, the insurance company will: Pay up to the limit of liability if the insured is legally liable;

and Provide defense by counsel even if the suit is groundless,

false or fraudulent. In addition to the coverage for damages described in Coverage E, Coverage F of the homeowners policy specifically covers the cost of medical payments for individuals who are injured while at the insured location, as long as the injured party is at the property with the permission of the insured. Medical expenses will be paid under the homeowners policy in the following cases: An injury which requires medical payments arises out of a

condition on the insured property or the ways immediately adjoining. For example, if a tree that is rooted in an

insured’s yard has a branch that hangs over to the neighbor’s yard and that branch falls and hits the neighbor on the neighbor’s property, the insured’s homeowners policy will cover the neighbor’s medical costs arising out of injury from the tree branch.

Bodily injury is caused as a result of activities by the insured. Should an insured be riding a horse on the insured property or hit a golf ball from the insured property, the insured’s homeowners policy will pay medical bills for a third party injured by that activity.

A residence employee causes bodily injury to a party in the course of the employee’s work at the property. Maids, butlers and domestic help would fall under this category of coverage.

Bodily injury caused by an animal owned or in the care of the insured. For example, dog bites are covered here.

Personal Liability Exclusions The liability portion of the homeowners’ policy will not cover the following: Bodily injury to the insured. If the insured is injured at

home due to his or her own negligence, the policy will not pay any amount to the insured.

Damages caused by failure to render professional services or by rendering professional services. If the insured is a carpenter and work performed by the insured is defective and causes damages, the homeowners policy will not pay for those damages.

Damages caused by motor vehicles. Motor vehicle insurance must be provided by a separate motor vehicle policy.

Damages caused by operation of an aircraft. Again, separate insurance must be carried here. On the other hand, injuries caused by model hobby planes will be covered.

Communicable diseases. The homeowners policy does not provide liability protection for the transmission of a disease.

War. Any damage that a war causes is specifically excluded from coverage under the homeowners policy.

Workers’ Compensation injuries. Should an individual covered by his or her employer’s workers compensation coverage become injured while working at a home covered by a homeowners policy, the homeowners policy will not pay for damages arising from injury to that individual.

Damages caused by watercraft. If while using the craft, damages result, they will not be paid by the homeowners policy, even if the craft is used on the insured property. Separate coverage must be obtained to insure these matters.

Non-insured locations. If the insured own other property that is not listed on the homeowners policy, the insured will not receive liability protection under the policy from any damages which occur at the other property.

Intentional acts of the insured. If the insured intends to harm another party, the homeowners policy will not provide liability protection for that action.

Business activities. Should there be any damage as a result of business pursuits by the insured, the homeowners policy will not cover any such occurrence.

Filing the Homeowners Insurance Claim In general, there are four factors necessary in order for a loss to be covered by homeowners insurance: Losses must be accidental.

Insurance policies insure against “risks.” If a loss is certain to occur, there is no risk involved. As a result, losses must be accidental. Losses resulting from deterioration are generally thought to be the result of a certainty; after all, everything wears out sooner or later. For this reason, losses caused by deterioration are not


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deemed accidental and are not covered by homeowners insurance.

Losses must be caused by extraneous factors. This means an external cause of damage must cause the loss. As an example, an extraneous factor would include wind damaging patio furnishings. Should a loss be caused by an inherent physical condition, rather than an extraneous factor the loss would not be covered under the homeowners insurance policy.

Losses were not caused by deliberate action on the part of the insured. Any deliberate action by the insured which causes a loss to any insured property or liability to any third party is not covered under the homeowners insurance policy. The insured cannot deliberately destroy property that is insured and expect the insurance carrier to pay for that damage. Similarly, the insured cannot expect the insurance company to cover liability for intentional injury to a third party.

Losses must involve covered, legal property. Illegal items and contraband are not covered by insurance. If an insured possesses an illegal whiskey still in his home and the still is damaged by a covered peril, that loss will not be covered under the policy.

If a loss meets each of the above criteria, the insured may be able to file a claim for loss under the homeowners policy. Note that one of the elements of a valid claim is that the insured must actually sustain a loss. When a claim needs to be filed, the following must be kept in mind: A policyholder normally has a strong and favorable

position where claims are concerned. As a rule, the courts usually resolve questions on claims

in favor of the policyholder (the insured). The overall effect of court decisions has been to broaden

the coverage of homeowners policies beyond the plain language of the policy.

Although companies differ in their approach to claims, most work to provide good service to their customers. However, the policyholder must carefully monitor the claim adjustment process in order to assure fair, proper treatment of claims.

In approximately 80% of all claims, less than 10% of the property insured is affected by loss. Therefore, it could be said that individuals are buying insurance to only cover 10% of the property in question and coverage will be adequate 80% of the time.

Replacement Cost Coverage All homeowners policies contain a replacement cost provision that requires the insured to purchase an amount equal to 80% of the replacement cost of the dwelling. This requirement simplifies the determination of insurance rates across properties and allows premiums to be based on a fixed cost per $100 worth of insurance. Calculating replacement cost for the purpose of buying insurance is somewhat different than estimating the cost of buying a new home. There are two reasons why one needs to accurately determine the replacement cost of a home. First, to be certain that the coverage is adequate and that it complies with the replacement cost requirement. Second, the insured wants to be secure in the fact that he is not being sold an excessive amount of insurance with the higher premiums that go along with that excessive amount. Note that replacement cost coverage applies only to buildings and not the personal property covered under the policy. The insurance company may attach a penalty to a replacement cost claim due to insufficient coverage, as the homeowners policy stipulates that payment is to be based on replacement cost less the appropriate penalty or the actual cash value of the repairs, whichever is greater. As a result, claim payment based on actual cash value of repairs may be

higher than the net claim payment (factoring in the penalty) for replacement value on a property which is not adequately insured. When claims are paid under the replacement cost coverage, the insurance company is permitted to determine its obligation three different ways and choose the method that works best for the company. These three choices are as follows: On policy limits. The most the company ever will pay is

the amount of insurance that applies to the property covered.

On the cost of replacement. This would be based on the cost of an equivalent building at the same location.

On the actual amount spent in completing repairs. Replacement cost can be defined as the cost to replace damaged property with property which is: Of like kind and quality. Similar in basic style. Similar in basic quality. Similar in basic function.

Remember that the policy provides coverage for replacement costs, not reproduction costs. Reproduction costs are defined as the costs for replacing property exactly as it was, down to the last detail. There is one interesting loophole in replacement cost coverage: The repair work need not be performed in order to replace the actual property at the original location. In some states, reconstructing property at any location, including a different city or state, will qualify for coverage under a replacement cost claim. Dwelling Claims When an insured has a claim for a damaged dwelling or other structure, the insured must realize that the claims process may be an involved and complicated process. There are four important steps to filing a claim on a dwelling. They are: Determining coverage.

The insured must first determine what is and is not covered by the homeowners policy. If there is a difference between the cost to repair and the amount of the claim, it could result in out of pocket expenses to the insured. In other words, if coverage is lacking in certain areas, it may be necessary for the insured to take measures throughout the adjustment process to cover shortages on his or her own.

Determining the scope of repairs. This is the insurance company’s description of work that will be included in repair estimates. It can also be referred to as the “scope of damage,” the “description of work,” or the “job description.” The claims representative will prepare most scope of repairs documentation. The insured must review with the claims representative all of the work to be considered in the scope of repairs. Often, there are contentious aspects in determining the scope of repairs. For example, the insurance company representative (also referred to as the “adjuster”) may feel that a bedroom was not damaged enough by smoke to warrant painting it; or the representative may believe that a soiled carpet can be cleaned rather than replaced. The adjuster works for the insurance company and may try to convince the insured to accept a scope of repairs that will ultimately lower the cost of the repair.

Determining the cost to repair. Once the scope of repairs is determined, it must be converted into an agreed “cost to repair.” The insurance company is in a strong position compared to the position of the insured when determining the cost of repair. This is particularly true because most insurance companies use a contractor estimate to establish a cost to repair. The insurance company controls the estimate process


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and may receive quotes from parties which typically provide low estimates. Notwithstanding the relative positions of strength in determining the cost to repair, the process should be handled fairly and adhere to common conventions used to determine the cost. For example, contractor profit and overhead allowances must be included in determining the cost to repair. The insurance company cannot omit this component of the repair cost. The policyholder must be diligent in negotiating the cost to repair in order to receive the most favorable possible outcome.

Determining the amount of the claim. This part of the claims process is relatively easy, as the appropriate deductibles are subtracted from the agreed cost to repair. Portions of the loss that are not covered by the homeowners policy will also be subtracted from the cost to repair to determine the final amount of the claim.

Once all figures are agreed upon, including the cost to repair, the actual cash value amount of claim, and any pending replacement cost claim, the insured and the insurance company will sign documentation agreeing to the numbers and providing for payment to the insured or direct payment to contractors. Personal Property Claims A personal property claim is very similar to a dwelling claim. The claims process follows four steps similar to those steps for processing a claim on a dwelling: Determine coverage.

The insured should determine what personal property is covered by reviewing the policy and carefully reviewing the exclusions in the policy that specifically refer to personal property.

Determine the scope of loss. The scope of the loss determines the actual property which will be included in the claim. The insured should always complete an inventory on his or her own, rather than simply leaving this task to the insurance company representative. If the insured can present an accurate and detailed claim of loss, the insurance company will be able to more quickly determine the scope of loss. The insured must provide adequate documentation regarding lost or damaged personal property in order to facilitate the claims process. The insured will benefit from prior records of personal property inventory. Individuals who have photographed or videotaped evidence of the existence of lost or stolen personal property will be in a good position to clearly establish the scope of loss. Often, it may be difficult to determine whether damaged items can be cleaned or need to be replaced. If the insurance company agrees to clean the item and the cleaning is unsuccessful, the property will be replaced.

Determine the replacement cost. Once the parties determine the scope of loss, they may determine the replacement cost of the property. This involves a substantial amount of work obtaining cost estimates for each item of personal property included within the scope of loss. The insured must monitor this process and provide price references as necessary to help determine the appropriate replacement cost.

Determine the amount of the claim. The final step is determining the actual cash value of the claim. If the insured will not actually replace the property, the insurance company may only be required to pay the actual cash value of the lost or damaged item rather than the full replacement cost. Obviously, the insurance company will not be anxious to pay out the full dollar amount of the replacement cost without assurance that the insured will actually replace the property. This is particularly true because the value of most personal

property significantly depreciates over time, and there may be a large dollar gap between the actual cash value and the replacement cost. As a result, the insured will likely have to show evidence of actual purchase of the replacement item in order to receive payment of the replacement cost as final settlement of the claim.

Other Homeowners Insurance Concepts An agent’s understanding of the following terms and concepts is essential to offering and describing homeowners insurance to customers. Subrogation Subrogation is the substitution of one party in place of another party in respect to a claim or a lawful right. When one party negligently damages another person’s property, the injured party has the right to recover any damages. When the insurance company pays the injured party for the loss, the company takes over the rights of recovery that previously belonged to the injured party. In other words, subrogation permits the insurance company to step into the shoes of its insured in order to seek reimbursement for amounts which it pays to the insured under the homeowners policy. Subrogation evolved in order to prevent injured parties from receiving a windfall by collecting from both the insurance company and the responsible party. If an insured suffers a loss, the insurance company must pay the claim on a timely basis. The insurance company cannot force the insured to seek recovery from the responsible party. Often, an insurance company will stand aside and allow a third party to compensate an insured, but this can only occur with the consent of the insured. After the claim is paid, the insurance company will try to obtain restitution for the damages from the party which caused the damage. Statements Under the homeowners policy, the insured is to provide certain claim statements. There are two kinds of statements which the insured may be asked to give in regards to a claim: An informal statement taken by the company

representative upon inspection of the loss. This kind of statement is either handwritten or recorded on tape. The statement is taken in order to record facts and document the insured’s story. The existence of a recorded statement lessens the probability of an insured changing the story over time.

A formal statement under oath. If requested by the company, a formal statement can be required under a homeowners policy. It is usually taken by an attorney and is, in effect, sworn testimony. If the insured lies in this statement, he would be guilty of perjury. If the insured refuses to give a formal statement under oath, the claim may be rendered void. The insurance company’s decision to request a formal statement usually indicates that the company believes something is suspicious about the claim.

Salvage The insurance company has the right to salvage property such as fixtures, appliances and any other part of a building as long as the insured has been paid for a total loss. Sometimes, the salvage goods will be sold back to the insured, however, the insured is under no obligation to accept this offer. For the most part, insurance companies will seek the services of a salvage company and do not care to directly involve themselves in this process. After the salvage company subtracts expenses and a percentage for profit, the balance goes to the insurance company as a return on the salvage operation. Non-Waiver Agreement By merely investigating the facts of a case, the insurance company can sometimes lose its rights to deny a claim as a result of the legal concept of “estoppel.” In the event a company leads a policy holder to believe that a claim will be paid or implies that it will be paid in some manner, estoppel may prohibit the insurance company from denying the claim.


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The insurance company may be prohibited from denying the claim even if subsequently uncovered facts clearly indicate that the claim should not be covered by the policy. To avoid the possibility of coverage by estoppel, many insurance companies investigating questionable claims require the insured to sign a non-waiver agreement that states that the insured understands that the company will not be required to pay the claim merely because the company explores the facts regarding the claim. Cancellation The company or the insured may cancel a homeowners policy. If the company cancels, the insured is entitled to the full amount of unused premiums on a pro rata basis. The insured need only notify the company in writing to cancel the policy. The insurance company must provide no less than five days notice before canceling a homeowners policy. This period of time is intended to provide a window for the homeowner to obtain a new policy. Homeowners Insurance – Concluding Thoughts For many of your prospects, purchasing homeowners or renters insurance may be their first experience purchasing insurance. As you offer homeowners and renters insurance policies to potential customers, it is important that you ask enough questions to obtain a full understanding of the insured’s needs. You should also be aware that a number of states require specific policy endorsements which are created specifically for the state. Personal Property Insurance – Introduction As described above, the basic homeowners policy usually contains various limitations and exclusions on coverage. Therefore persons who are owners of valuable personal property often need broader and more comprehensive coverage than is provided by the basic homeowners policy. This broader and more comprehensive coverage may be obtained through appropriate personal property insurance. Inland Marine Insurance The very first form of personal property insurance coverage was an Ocean Marine policy. The policy was written to provide financial protection for owners of ships in case their property or cargo was lost at sea. Ocean marine policies insured the cargo from port to port. Later on, a clause was added to also insure cargo while it was being transported on land. As an end result, policy coverage extended from the original point of departure until the final destination point to include both ocean and inland transportation of those goods. Eventually a separate policy was developed that dealt only with the insuring of the goods while being transported on land and the policy became known as an “inland” marine policy (in contrast to the “ocean” marine policy). Inland Marine policies eventually began to provide a broad coverage for other property of a “floating” or moveable nature. Inland marine policies were offered on an “all risk basis” rather than a “named peril” basis as offered in most existing casualty policies. Inland Marine Insurance – Definition Inland marine policies generally cover property that is transported from one place to another (excluding transfer over waterways). This property includes goods in transit and other property transported over roadways and bridges or under tunnels. Information transferred via television broadcasting towers or other communication transfer devices may also be covered by an inland marine policy. Inland Marine Floater Characteristics Various floater policies can also be used to cover personal effects and property. The floater policy will provide coverage to items that “float” or move along with the covered property while it is changing locations. An inland marine floater has four major characteristics. Tailored coverage.

A personal articles floater provides coverage for nine optional classes of personal property. We will list each of these classes later in these materials. This type of floater permits the insured to select coverage for the class or classes of property needed. It is also possible to write each of these types of coverage on separate floaters. For example, any of the following floaters are possible: Jewelry floater. Fur floater. Coin collection floater. Stamp floater. Camera floater.

Selection of policy limits. As we have discussed, the basic homeowners policy has limitations on coverage of certain types of valuable property. The insured must look to a floater policy in order to obtain higher limits of coverage. Also, as a rule, when a basic homeowners policy combines the value of certain types of personal property with the value of unscheduled personal property it is possible that the combined total may exceed the homeowners policy limits on personal property. Here again, the floater policy can provide higher limits.

Extensive coverage to perils covered. When a floater is written it usually provides coverage on a “risks of direct physical loss” basis. The floater covers all risks of direct physical loss to the property that is described except specifically excluded losses. The commonly excluded losses will be discussed later in these materials.

Worldwide coverage. The property described in most floaters will be covered anywhere in the world with the exception of fine arts, which are usually covered only in the United States and Canada.

Inland Marine Floater Provisions The following policy provisions appear in most Inland Marine Floater policies: Loss settlement.

The amount that will be paid for a covered loss will be the lowest of the following four amounts: The actual cash value of the property at the time of loss

or damage. The amount for which the insured could reasonably

expect to repair the property to its condition which existed prior to the loss.

The amount for which the insured could reasonably expect to replace the property with property substantially identical to the article lost or damaged. The insurance company can purchase much of the property insured in a floater at discounted prices. Therefore the insurance company may want to replace the lost or damaged item itself rather than provide cash reimbursement to the insured. Should the insured reject the replacement offer, the insurance company’s cash reimbursement will then be limited to the amount for which the insured could reasonably be expected to replace the item. This amount will equal the discounted price which the insurance company would have paid to replace the item, even if the insured does not have access to that same discount.

The amount of insurance stated in the policy. Loss to a pair, set, or parts.

In the event that there is loss or damage to a covered property in a pair or set, such as the loss of one earring, the amount to be paid is not based on a total loss. The insurance company may either repair or replace any part to restore the pair or set to its pre-loss value or pay the


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difference between the actual cash value of the pair or set before and after the loss.

Loss clause. The loss clause provides that the overall limit of the insurance policy will not be reduced in the event of payment of a claim, except that the overall limit of the policy will be reduced in the event of payment on account of a total loss of a scheduled item. If the amount of the insurance is reduced because of a total loss of a scheduled article, the insurance company will either refund the unearned premium or apply the unearned premium to the current premium due if the scheduled article is replaced with another item.

Claim against others. This policy provision is very similar in nature to the subrogation clause. If a loss occurs and the insurance company believes that the insured can recover the payment for that loss from the person or parties responsible, then the loss payment to the insured will be considered a loan that must be repaid out of any funds recovered from others. The insurance company will expect the insured to cooperate with any attempt the insurance company makes to recover from others responsible for that loss. Should the recovery attempt be unsuccessful the insured will not be required to pay the “loan” on the loss settlement.

Insurance not to benefit others. No organization or other person that may have custody of the insured property and which is paid for services can benefit from the insurance on the property. The purpose of this provision is to prevent a third party who caused the loss from denying liability for payment by stating that the property is insured. The statement that the insurance is not for the benefit of third parties helps to retain the insurance company’s right of subrogation and a cause of action against the negligent party.

Other Insurance. In the event that there is other insurance at the time of loss that applies to the property, that insurance is considered excess insurance over the primary insurance policy. The primary insurance policy will pay its benefit in full, and the insured may then turn to the second insurer.

Inland Marine Floater Exclusions As a general rule, inland marine floaters provide coverage to property on an “all-risks” basis. Physical loss to covered property is provided for all cases other than the following exclusions: Wear and tear. Deterioration. Inherent vice. Insects or vermin. Mechanical breakdown or failure. Electrical breakdown or failure. Repairing the property. Adjusting the property. Servicing the property. Maintaining the property.

In addition, inland marine floaters contain general exclusions for loss related to war, nuclear reaction, and radiation. Personal Articles Floater The Personal Articles Floater (often referred to as the PAF) is a particular type of insurance floater which provides coverage over nine optional classes of personal property. Coverage follows the property worldwide, except for fine arts. The nine classes of personal property that can be insured under a Personal Articles Floater are: Jewelry. Furs. Cameras. Musical instruments.

Silverware. Golfer’s equipment. Fine arts. Postage stamps. Rare coins/current coins.

Certain newly acquired items of property such as jewelry, furs, cameras, and musical instruments will be automatically covered for 30 days without specific itemization, provided that insurance was already written on that class of property. The amount of insurance on newly acquired property is limited to the lower of 25 percent of the amount of insurance for that class of property or $10,000.00. The property must be reported to the company within 30 days of purchase in order for the coverage to continue. The insured will be charged an additional premium for coverage from the date of acquisition. We will now examine each of the nine classes of personal property which may be covered under a Personal Articles Floater: Jewelry.

Coverage on personal jewels applies anywhere in the world. Each item of jewelry, including watches, necklaces, and rings, must be scheduled with a specific amount of insurance. Jewelry is very carefully underwritten by the insurance company as a result of the significant hazard of loss. As a rule, the insurance company will require either the original bill of sale or a signed appraisal before the jewelry is insured. The insured must also possess satisfactory financial resources to suggest that the jewelry was not stolen, and the insurance company will want to know that the insured is not in the habit of losing or misplacing articles.

Furs. The PAF can be used to insure: Personal furs. Items consisting principally of fur. Garments trimmed in fur. Fur rugs. Imitation fur. Again, each item must be separately listed with a specific amount of insurance shown for each item. As with jewelry, furs are very carefully underwritten.

Cameras. A PAF can also be used to insure each of the following items. Each of these items must be individually described and valued. Photographic equipment. Cameras. Projection machines. Portable sound equipment. Recording equipment. Motion picture cameras. Motion picture projectors. Films. Binoculars and telescopes. Exceptions to the rule requiring the scheduling of items would be miscellaneous smaller items, carrying cases and filters, provided that the total value of the non-scheduled (or “blanketed”) items is not more than 10% of the total amount of the insurance on cameras.

Musical Instruments. The following items can be covered under a PAF: Musical instruments. Instrument cases. Sound equipment. Amplifier equipment.


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Should a musical instrument be used and played for pay during the policy period it will not be covered unless an endorsement is added reflecting this business use. Business equipment will require a higher premium.

Silverware. Silverware and gold-ware may also be covered under a PAF. Silver pens, pencils and smoking implements may not be insured as silverware. These types of property instead may be insured as jewelry.

Golfer’s equipment. Golf equipment such as golf clubs and golf clothes will be covered. Other golf equipment may also be insured under a PAF. Clothing contained in a locker is also covered while the insured is playing golf. Golf balls are covered only in the event of fire and burglary if there are physical marks of forcible entry into the building, room or locker.

Fine Arts. Fine arts can include the following: Paintings. Antique furniture. Rare books. Rare glass. Bric-a-brac (knick-knacks). Manuscripts. Fine arts are insured on a valued basis and must therefore be on a schedule with the amount that was paid for that item. Damages are paid on an actual cash value basis up to the stated value. Newly acquired fine arts will be automatically insured for ninety days without scheduling. The insured is required to notify the insurance carrier within ninety days of acquisition and the additional premium due will accrue from date of acquisition. The limit on fine arts property is subjected to 25% of the total insurance. Fine arts are subject to three major exclusions: Damage caused by repairing, or retouching. Breakage of art glass windows, glassware, statuary,

marble, bric-a-brac, porcelains, and similar fragile articles. However, the exclusion does not apply if fire, lightning, explosion, aircraft, collision, windstorm, earthquake, flood, malicious damage or theft, and derailment or overturn of a conveyance causes the breakage.

Loss to property on exhibition at fairgrounds or at national or international expositions is excluded unless the premises are covered by the policy.

Stamp and coin collections. These collections are insured for loss anywhere in the world. The stamps and coins may be insured in one of two ways: scheduled basis or blanket basis. The scheduled basis is suggested if the items are

extremely valuable. In this way each item is specifically listed and insured.

Under the blanket basis the insurance applies to the entire collection since each item is not separately described. In the event of a loss to a scheduled item, the amount to be paid is the lowest of the following: Actual cash value. The amount for which the property would reasonably

be expected to be repaired. The amount for which the property would reasonably

be expected to be replaced. The amount of insurance.

In the event of a loss to an item covered on a blanket basis, the amount paid will be the cash market value at the time of loss. There is a $1,000 maximum on any

unscheduled coin collection. There is a $250 maximum limit on any of the following: Single stamp or single coin. Individual article. Single pair. Single block or single series. Single sheet or single cover. Single frame or single card. In addition, for any stamps or coins insured on a blanket basis, the company is not liable for a greater proportion of any particular loss than the proportion which the amount of insurance on blanket property bears to the actual cash market value of the property at the time of loss. For example, suppose that the insured owns an unscheduled coin collection which is insured on a blanket basis for $500. One coin worth $50 is stolen. At the time of theft, the entire collection has an actual current market value of $1,000. Since the proportion of insurance on the collection compared to actual cash value of the collection is 50%, the insured’s maximum recovery for the loss of the coin will be $25 (50% of the coin’s $50 cash value). Had the insured purchased $1,000 worth of insurance, the $50 loss would have been paid in full. For stamp and coin collections, damage from any of the following causes is excluded from coverage under the PAF: Fading. Creasing. Denting. Scratching. Tearing. Thinning. Transfer of colors. Inherent defects. Dampness. Extremes of temperature. Depreciation. Damage from being handled. Damage from being worked on. Mysterious disappearance, other than in the event

where the item is scheduled or specifically insured, or is mounted in a volume and the page to which it is attached is also lost.

Property lost in the custody of transportation companies.

Shipments by mail other than registered mail. Theft from any unattended motor vehicle.

Personal Property Floater This floater provides extensive coverage on personal property owned or used by the insured that is kept at the insured’s residence. This rider will also provide worldwide coverage when this property is temporarily away from the residence. The property is issued on a special all-risk basis. This means all direct losses are covered unless specifically excluded. Scheduled Personal Property Floater This floater is used to provide coverage for personal articles and valuable items that do not fall within the nine categories previously listed for the Personal Articles Floater. Examples of such items are: Dentures. Typewriters. Camping equipment. Wheelchairs. Stereo equipment.


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Grandfather clocks. This is not a complete list, as almost any kind of personal property may be insured under a scheduled personal property floater. This type of coverage is quite flexible and may be adapted to meet the needs of the individual insured. Insurance producers will often be asked what type of personal property should be scheduled on a personal property floater. As a general rule, valuable personal property should be scheduled and specifically insured under a floater policy. Diamond rings, fur coats and other jewelry of high value should be specifically scheduled. The following types of personal property should also be considered for scheduled coverage: Unique objects. Works of art. Rare antiques. Paintings. Stamp collection. Rare coin collection. Portable property. Cameras. Camera equipment. Musical instruments. Sports equipment. Fragile articles. Glassware. Statuary. Scientific instruments. Typewriters. Home computers. Business or professional equipment.

Since the basic homeowners policy provides coverage for personal or business property only to a maximum of $2,500 on the resident premises and $250 away from the resident premises, the insurance producer may recommend that the property be more adequately insured by scheduling the property with a stated amount of insurance shown for those items. Unscheduled Personal Property The Personal Property Floater also may be used to insure the following classes of unscheduled property: Silverware, gold-ware, pewter-ware. Clothing. Rugs and draperies. Musical instruments and electronic equipment. Paintings and other art objects. China and glassware. Major appliances. Guns and other sports equipment. Cameras and photographic equipment. Building additions and alterations. Bedding and linens. Furniture. All other personal property and professional books while

on the residence. Each of the above categories carries a maximum limit for recovery for the particular category. The floater also carries a maximum limit spreading across all of the categories which matches the total policy limit. Newly Acquired Property Any newly acquired property will automatically be covered under a Personal Property Floater for up to the lower of 10% of the total amount of insurance or $2,500. Insurance on newly acquired property may be applied to any of the enumerated categories. Newly acquired property at the principal residence of the insured will be covered for thirty days from the time the property is moved there. The

coverage on the newly acquired property is subject to the amount of the insurance for each enumerated category. Property Not Covered The personal property floater will not cover any of the following personal property: Animals, fish, birds. Boats, aircraft. Trailers, campers. Motorcycles, motorized bicycles. Motor vehicle equipment, motor vehicle furnishings. Property pertaining to a business, property pertaining to a

professional. Property pertaining to an occupation. Property usually kept somewhere other than the insured’s

residence throughout the year. Additionally the personal property floater places specific limits on certain property. For example: $100 limit on money. $100 limit on unscheduled coins. A $500 limit on unscheduled securities, notes, stamps,

passports, tickets, jewelry, watches, and furs. The personal property floater also excludes certain losses such as: Animals owned or kept by the insured. Mechanical or structural breakdown. Water damage. Any work on covered property except jewelry, watches, or

furs. Dampness/extreme changes of temperature except if

caused by snow, rain, hail or sleet. Bursting of pipes. Bursting of apparatus. Acts or decisions of any person, group, organization or

government body. Wear and tear. Deterioration. Inherent vice. Insects or vermin. Marring or scratching of property. Breakage of eyeglasses. Glassware. Fragile article. Lightning. Theft. Vandalism. Malicious mischief.

Personal Effects Floater The Personal Effects Floater (PEF) is designed for travelers who want coverage on their personal effects while traveling. The PEF will provide coverage on the personal property of tourists and travelers anywhere in the world. However, this will only be in effect while the covered property is away from the residence premises. This coverage will apply to: the insured, his or her spouse, and any unmarried children who permanently reside with the insured. Personal Effects Coverage Property normally worn or carried by an individual comes under the heading of personal effects. Coverage for personal effects will include: luggage, clothes, cameras, and sports equipment while the insured is traveling or on vacation. Property Excluded The following property is excluded under PEF coverage: Automobiles, motorcycles, bicycles or boats. Accounts, bills, currency, deeds, evidence of debts, or

letters of credit.


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Passports, documents, money, notes, securities or tickets.

Transportation. Household furniture. Household animals. Automobile equipment. Salesperson samples or merchandise for sale or

exposition. Physicians/surgeons’ equipment. Artificial teeth. Artificial limbs. Theatrical property.

All-Risks Coverage Personal effects will not be covered on an all-risks basis. Risks of direct physical loss to a property are covered except as follows: Damage to personal effects from: Wear and tear. Gradual deterioration. Inherent vices. Vermin. Insects. Damage while property is being worked on.

Breakage of articles of a brittle nature unless caused by: Fire. Theft. Accidents to a conveyance.

Other Exclusions In addition to the exclusions previously mentioned, the following exclusions also are present in the PEF: Personal effects are not covered while on the named

insured’s residence premises. Property in storage is not covered. Personal effects in the custody of students while in school

are not covered except for loss by fire. Limitations on Certain Personal Effects Jewelry, watches and furs are subject to a single article limit of 10% of the total amount of the insurance, with a maximum of $100. A careful review of the prospect’s assets and needs will help determine the necessity for any of these additional coverages. Personal Umbrella Liability Insurance A serious personal liability lawsuit can reach catastrophic levels for the party defending the lawsuit, as the judgment may potentially exceed the individual’s insurance policy liability limits. Once these liability limits are exhausted the insured is often forced to pay a substantial amount out of his pocket. Thus, individuals may require increased protection against catastrophic lawsuits. Individuals that usually need this protection include: Highly paid executives. Physicians. Surgeons. Dentists. Attorneys.

Do not be misled to assume that only those listed above need this protection. Considering the increased frequency of liability lawsuits and the complexities of modern living, most people may actually require this protection. Such additional insurance protection can be provided by a personal umbrella liability insurance policy. Nature of Personal Umbrella Insurance The umbrella package is designed to provide the insured with coverage in the event of: A catastrophic claim.

A lawsuit. A judgment.

The amount of umbrella coverage can range from $1,000,000 to $10,000,000. The contract usually covers the entire family worldwide. The umbrella typically covers liability losses associated with the: Home. Automobile. Boats. Recreational vehicles. Sports. Other personal activities.

While it is true that an umbrella policy is not a standard contract, umbrellas do have some common features such as: A self-insured retention which must be met with certain

losses covered by the umbrella policy but not covered by an underlying insurance policy.

The umbrella policy provides excess coverage over basic underlying policies, such as personal auto, and homeowners insurance.

Coverage is broad and includes coverage for some losses not covered by underlying contracts.

Excess Liability Insurance The umbrella policy pays only after the limits of the underlying policy are exhausted. Some umbrella policies require that the insured carry certain minimum amounts of liability on the basic underlying contracts. For example, on an automobile policy the minimum liability coverage required on the basic contract could be: $100,000 per person for bodily injury liability. $300,000 per occurrence of bodily injury liability. $25,000 for property damage liability. A combined single limit of $300,000.

On a homeowners policy the minimum required on the basic contract could be $100,000 of personal liability. If a watercraft is involved, liability exposure requirements may be $500,000 of single limit underlying coverage. Broad Coverage With respect to personal loss exposures, the personal umbrella policy provides broad coverage. The personal policy coverage also covers certain losses that the underlying contract may not cover after the insured meets certain self-insured retention requirements. These losses include: Personal injury. Libel claims. Slander. Defamation of character. False arrest. False imprisonment. Humiliation.

Here are five specific examples of claims that may be paid by umbrella insurance companies: The insured slandered two police officers. The insured borrowed a tractor and damaged it. After a

self-insured retention was met the umbrella covered the loss.

The mast on a rented boat broke during a race and seriously injured a crewmember. Primary coverage was not available to the insured.

The insured rents a car in England and is involved in a serious accident. The personal umbrella covered the loss since only limited underlying coverage was available.

The insured’s spouse rents a motorcycle and is involved in a serious accident. Since the underlying automobile/homeowner contracts do not cover the ensuing third-party claim, the umbrella pays the claim.


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Self-Insured Retention When an umbrella policy covers a loss which is not covered by the underlying insurance policy, a self-insured retention or deductible must be met. As a rule this deductible is at least $250 per occurrence and can be higher. Personal Umbrella Coverages Personal umbrella coverage may include coverage for each of the following: Personal injury liability.

The insured’s liability for personal injury is covered under the personal umbrella policy. Personal injury is defined to include: Bodily injury. Sickness. Disease. Disability. Shock. Mental anguish. Mental injury. This definition can also include: False arrest. False imprisonment. Wrongful entry. Wrongful eviction. Malicious prosecution. Humiliation. Libel. Slander. Defamation of character. Invasion of privacy. Assault and battery (not intentionally committed or

directed by a covered person). Property damage liability.

Property damage can be defined as physical injury to tangible property and includes loss of use of the injured property. The umbrella insurance company agrees to pay losses for which the insured is legally liable and which exceed the “retained limit.” The “retained limit” is either: The total of all applicable limits of all required

underlying contracts and any other insurance available to a covered person, or

The self-insured retention if the loss is not covered by the underlying insurance.

Defense costs. Typically, legal defense costs in addition to the policy limits are paid under the personal umbrella policy. Defense costs include: Payment of attorney’s fees. Premiums on appeal bonds. Court costs. Interest on the judgment. Legal costs. However, some personal umbrella policies will include the cost of defending the insured as part of the total loss. It is possible that in a catastrophic judgment the insured may have to absorb part of the loss. Still, most umbrella policies will provide and pay the legal defense costs of a covered loss if that loss is not covered by any underlying insurance.

Personal Umbrella Exclusions Like other types of personal property insurance, the personal umbrella provides specific exclusions to coverage. Here are some of the more common exclusions found in personal umbrella policies:

Worker’s compensation. Any obligation for which the insured is legally liable under workers compensation, disability benefits, or similar law is not covered by the umbrella.

Fellow employee. Some personal umbrella contracts exclude coverage for any insured (other than the named insured) who injures a fellow employee in the course of employment arising out of the use of any of the following: Automobile. Watercraft. Aircraft.

Care, custody or control. Damage to property owned by a covered person is excluded under all personal umbrella contracts. Most contracts also exclude damage to a non-owned aircraft and non-owned watercraft in the insured’s possession. However most umbrellas will cover damage to: Property rented to the insured. Property used by the insured. Property in the care of an insured. Note that the umbrella contract will not cover aircraft or watercraft which fall into one of the three above categories.

Nuclear energy. All personal umbrella policies contain a nuclear energy exclusion.

Intentional acts. Any act directed by or committed by a covered person with the intent to cause personal injury or property damage will not be covered by the umbrella contract.

Aircraft. Umbrella policies will not cover any liability arising out of ownership, maintenance, use or loading or unloading of an aircraft.

Watercraft. Larger watercraft are usually excluded from umbrella coverage, including: Inboard watercraft. Inboard/outboard watercraft exceeding 50 horsepower. Outboard motors of more than 25 horsepower. Sailing vessels of more than 26 feet long.

Professional liability. While many insurance companies do not offer this coverage and virtually all umbrella policies exclude professional liability, some companies will cover certain professional liability losses with an endorsement and by charging a higher premium.

Officers and directors. This exclusion does not apply to a non-profit corporation or organization. It does exclude coverage for an act or failure to act as an officer, trustee or director of a corporation or association.

Recreational vehicles. Liability arising as a result of ownership or maintenance of golf carts is excluded.

Watercraft Insurance The homeowners policy only provides limited coverage for watercraft owned by the homeowner. As a result, the homeowner must obtain separate coverage under a watercraft policy in order to fully protect watercraft from loss. Watercraft insurance can cover various watercraft which range in size, such as: Rowboats. Canoes. Outboard motorboats. Inboard motorboats.


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Dinghies. Sailboats. Speedboats. Houseboats. Yachts.

Hull and Trailer Loss Exposures Watercraft as well as their equipment, trailers and furnishings may be exposed to a wide variety of theft and physical damage loss. Examples of possible damage or loss include the following: Two speedboats collide. A sailboat is overturned in heavy winds. A boat sinks in a severe storm. A sandbar strands a houseboat. An outboard motor falls into a lake. A boat trailer is stolen. An explosion seriously damages a boat.

Homeowners Policy Physical Damage Coverage Watercraft and trailers are covered under Section One of a homeowners policy for physical damage and theft. However this coverage is very limited. The major limitations on coverage are as follows: Direct loss to: Watercraft. Trailers. Furnishings. Equipment. Outboard motors from windstorm or hail are covered

ONLY if the property is inside a fully enclosed building. Theft of: Watercraft. Trailers. Furnishings. Equipment. Outboard motors away from the resident premises are specifically excluded. Watercraft and other boating property are covered only for a limited number of named perils.

Coverage on each of: Watercraft. Trailers. Furnishings. Equipment. … is limited to a maximum of $1,000.

Personal Auto Policy Personal Damage Coverage An automobile policy is not designed nor does it cover any physical damage to boats. The boat trailer however can be insured for physical damage loss under a personal auto policy. The trailer must be described fully in the declarations of the auto policy. Liability Loss Exposure When an insured owns or operates watercraft, the insured may be exposed to a wide variety of liability loss exposure, such as: A water-skier is injured because of excessive speed. A boat runs into swimmers and seriously injures them. A boat collides with a dock causing property damage. Two boats collide injuring the occupants. A child falls overboard and drowns and was not provided

a life preserver by the boat operator. Homeowners Policy Liability Coverage Section II of a homeowners policy provides personal liability insurance and it covers certain watercraft loss exposures providing the boat is under a specified size and length. Personal liability insurance provides the insured with

protection against bodily injury or property liability that arises out of the use or operation of certain owned watercraft. The liability protection can also apply on an excess basis for certain covered non-owned watercraft. There are however several important categories of watercraft liability that the homeowners policy excludes from coverage. These include: Owned watercraft regardless of size with inboard or

inboard/outboard motor power. Rented watercraft with an inboard or inboard/outboard

motor power with more than 50 horsepower. An owned or rented sailing vessel that is more than 26

feet in length. Watercraft powered by one or more outboard motors with

more than 25 horsepower if the motors were owned by the insured at the inception of the policy and not declared or reported. However, watercraft powered by outboard motors with more than 25 horsepower are covered if the motors were acquired prior to the policy period and providing the insured declared them at the time of policy inception or declared them within forty-five days of acquisition.

The above exclusions do not apply when the craft is in storage. Outboard Motor and Boat Insurance This specific type of watercraft insurance is designed for those who own motorboats and for those who have adequate personal liability coverage under their homeowners policy or under a comprehensive personal liability policy but desire broader physical damage insurance on their boat. An Inland Marine Floater can also provide this protection. Although floaters are not standard they do contain some common features such as: Covered property.

The insured selects the property to be insured. The floater can be written to cover the following: Hull. Motor or motors. Boat equipment. Boat accessories. Boat carrier. Boat trailer. Covered property is written on an actual cash value basis and may contain a deductible of $25, $50, $100 or some greater amount.

Covered Perils. The floater can be written on named perils or risks of direct loss basis. Most floaters currently are written on the risks of direct loss basis. The coverage does not include the liability for bodily injury, loss of life, or illness of individuals.

It is assumed that the insured has proper liability insurance under a homeowners or liability policy to cover any third party bodily injury claims. The floater, however, may provide collision damage liability insurance that protects the insured from a claim for property damage from the owner of another boat if the insured’s boat happens to collide with another boat while it is afloat. Outboard Motor and Boat Insurance Exclusions Outboard motor and boat insurance contracts do have exclusions. Some of the common exclusions are as follows: Business pursuits. No coverage will be afforded if the boat is used as a

public conveyance for carrying passengers for compensation.

No coverage will be provided if the boat is rented to others.

Coverage is excluded for race boats or boats in speed contests.


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Repair or service. Coverage is excluded for loss or damage from: Refinishing. Renovating. Repair is not covered. The person who is repairing the

boat would be responsible for any damage. General risks of direct loss. Coverage will not be

provided for loss or damage from: Wear and tear. Gradual deterioration. Vermin. Marine life. Rust. Corrosion. Inherent vices. Latent defect. Mechanical breakdown. Freezing. Extremes of temperature.

Watercraft Package Policies Many insurance companies have developed special boat owners policies that combine liability coverage, physical damage coverage, and medical payments coverage. These boat owners policies contain certain common characteristics: Physical damage coverage.

Currently most boat owners policies are written on a direct and accidental loss basis. The insurance company agrees to pay for direct or accidental loss to covered property under the physical damage insuring agreement. All losses are covered except those specifically excluded. The physical damage covers the boat, equipment, accessories, motor, and trailer. In addition, if the boat collides with another boat, gets damage from heavy winds, or is stolen, the loss is covered.

Liability coverage. Liability insurance that covers the insured for bodily injury and property damage, liability from a neglect ownership or operation of the boat, is included in a boat owner’s policy. Should the insured accidentally damage another boat or injure swimmers, for example, protection is provided under the liability coverage.

Medical payments coverage. This is similar to the medical payments coverage found in an automobile insurance contract. Medical payments will be made for all medical expenses incurred within three years from the date of a watercraft accident that causes bodily injury to a covered person. Under medical payments coverage, a covered person is defined as the insured, a family member, or any person while occupying the covered watercraft. Under the medical payments coverage section, expenses will be paid for reasonable charges for the following: Medical. Surgical. X-ray. Dental. Ambulance. Hospital. Professional nursing. Prosthetic devices. Funeral services.

Other coverage. The following may also be found in a boat owners policy:

Cost of removing a wrecked vessel. Cost of removing a sunken vessel.

The following are commonly excluded from physical damage coverage under a boat owners policy: Wear and tear. Inherent vice. Latent defect. Mechanical breakdown. War. Nuclear hazard. Damage caused by repair (except fire). Damage caused by restoration process (except fire). Carrying persons for a fee. Carrying property for a fee. Renting covered property. Racing covered property (except sailboats). Speed testing covered property (except sailboats). Infidelity of persons to whom covered property is

entrusted. Portable electronic equipment. Photographic equipment. Water sport’s equipment. Fishing gear. Cameras. Fuel. Portable radios. Fishing equipment.

The following are commonly excluded from medical expense coverage under a boat owners policy: Intentional injury. Intentional damage. Renting the watercraft to others. Carrying persons for a fee. Carrying property for a fee. Using watercraft in a race (except sailboats). Using watercraft in a speed test (except sailboats). Losses covered under worker’s compensation. Losses by a nuclear energy liability policy. Contractual liability.

Personal Yacht Insurance This type of policy is for larger boats such as inboard motorboats and cabin cruisers. Personal Yacht insurance provides hull insurance, protection and indemnity insurance, optional coverage and warranties. Hull insurance.

This protection refers to physical damage on the boat. This coverage also applies to sails, tackle, machinery, furniture, and the boat itself. This insurance provides “all-risks” protection. For example if the boat is damaged by: heavy seas, collision, flood or sinking because of an insured peril, the loss is covered. A deductible of varying amounts will apply to all physical damage and losses.

Protection and indemnity insurance. This coverage provides the boat owner with coverage for bodily injury and property injury on an indemnity basis. If for example the boat were to smash into a marina and injures several persons the loss to the dock as well as any bodily injury would be covered under Protection and Indemnity Insurance.

Optional coverage. The boat owner may add several options to your personal yacht policy, such as, medical payments coverage, liability of the insured to maritime workers injured in the course of employment, boat trailer insurance, land transportation insurance and a water-skiing clause.


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Warranties. Several warranties and promises are provided with yacht insurance. If the insured violates a warranty, higher premiums may be required to be paid to the insurance company. The major warranties on yacht insurance are as follows: Seaworthiness warranty.

The insured warrants that the vehicle is in seaworthy condition.

Lay-up warranty. The insured warrants the vehicle will not be in operation during certain periods, such as winter months.

Navigational limits warranty. The vessel will be used only in territorial waters described in declarations.

Private pleasure warranty. The insured warrants the vessel will not be hired or chartered.

Uninsured Boaters Coverage As is the case with automobile insurance where an individual can purchase uninsured motorist protection, boat packages also include an option for uninsured boat coverage. The company agrees to pay damages that a covered person is legally entitled to recover from an insured boat owner or operator due to bodily injury sustained by a covered person in a boating accident. Uninsured Boaters Coverage – Exclusions The uninsured boater’s coverage has several exclusions. Bodily injury from the following are excluded: While occupying or struck by any watercraft owned by the

insured or family member that is not insured under the policy.

If the bodily injury claim is settled without the insurance company’s consent.

While operating a covered watercraft which is carrying persons or property for a fee.

While occupying a covered watercraft being rented to others.

Using a watercraft without a reasonable belief that the person is entitled to do so.

Occupying a watercraft without the reasonable belief that the person is entitled to do so.

In the event there should be a disagreement as to whether a covered person is legally entitled to recover damages from the uninsured boat owner or operator, or on the amount of damages, the coverage has an arbitration provision which states that each party selects an arbitrator. The two arbitrators then select a third arbitrator. Those arbitrators have thirty days to agree on the selection of the third arbitrator. If the two arbitrators take longer than thirty days to identify the third arbitrator, then a judge in a court of law will be permitted to appoint the third arbitrator. Specialized Coverages As your clients become involved in business transactions, their needs for insurance will increase and may include a need to protect goods in transport. Marine insurance is a broad term including ocean and inland marine insurance. The Nationwide Marine Insurance Definition, published by the National Association of Insurance Commissioners, includes imports, exports, domestic shipments, and means of communications, and personal and commercial property floaters as marine insurance. In this section, we will discuss various types of specialized Marine Insurance. Ocean Marine Specialized Coverage First we cover specialized coverage which applies to Ocean Marine policies. Bumbershoot liability.

Bumbershoot coverage is a particular form of umbrella liability designed for accounts where the principal exposure is marine and involves the operation of vessels and use of docks. The Bumbershoot covers: protection and indemnity; general coverage, collision, salvage charges, labor; all other legal and contractual liability including employers liability, liability under admiralty laws or the Longshoremen’s Act, automobile liability, and those hazards usually associated with general liability insurance. Insured’s net retention of at least $100,000 is usually required.

Charter boats. Standard protection and indemnity forms issued in conjunction with Hull insurance policies on vessels exclude coverage on the use of a boat for hire or charter. Under certain circumstances, a Protection and Indemnity form, broader in coverage than a standard general liability contract, is issued to an owner or operator of such a vessel used for carrying passengers for sightseeing, fishing, transportation, entertainment or marine observations on a fee basis. Coverage for liability also may be arranged on a liability form with rates set in the specialty market at a surcharged rate. Vessels under 40 feet in length are rated at 50% of those over 40 feet. Coverage usually is subject to a deductible. Liability exposure is of more concern to underwriters than loss or damage to the hull. Operation of a restaurant and serving of alcoholic beverages are also principal hazards on larger vessels.

Ship charterer legal liability. This insurance is designed to protect a vessel charterer against liability incurred for loss of, or damage to, the vessel. Liability is ordinarily limited to damage caused in loading or unloading or failure to provide a safe berth. Policies may be written on an open basis with a flat premium charged for each voyage, or each voyage may be written separately.

Ship repairer legal liability. This coverage protects an individual ship repairer, marina or boat yard operator for legal liability to the vessel’s owner for damage to the vessel being repaired. This “care, custody or control” coverage provides only property damage liability and may be extended to include insured’s legal liability for damage to other property caused by a collision (or otherwise), while the vessel is being repaired or tested.

Inland Marine Specialized Coverage When clients become involved in business they will develop very specialized needs. Specialized coverage may also be obtained under an Inland Marine policy. Different types of specialized coverage include: Builders’ risk.

Builders’ Risk policies cover buildings or structures during the construction, renovation or repair process. While coverage is often tailored to meet the needs of each customer, the vast majority of policies also cover building materials destined to become a permanent part of the building or structure. This property is covered while in transit, at temporary storage locations and while stored at the job site. Builders’ Risk policies are an important insurance product within the construction industry because the vast majority of banks require evidence of Builders’ Risk insurance prior to closing on a construction loan. In addition, two of the most frequently used construction contracts (the Association of General Contractors and the American Institute of Architects Contract for Construction) contain specific provisions outlining requirements for Builders’ Risk insurance.


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Even putting these requirements aside, few, if any, companies can afford to invest in construction without insurance protection. Any business entity with a financial interest in property under construction, renovation or repair needs Builders’ Risk insurance. Typical policyholders include: Real estate developers. Building owners. Home builders. General contractors. Municipalities. Colleges and universities.

Computerized business equipment. Computerized Business Equipment policies can cover all types of automated equipment capable of accepting and processing data. While we typically think of computers as the primary subject of this coverage, automated manufacturing equipment, computerized medical equipment, flight simulators and any number of other types of specialized equipment can be eligible for coverage. Coverage may also include the software and data used by this equipment as well as business income and extra expense exposures that may arise for a loss to such equipment or data. Coverage typically applies on-premises, while in transit and while temporarily away from covered locations. Laptops and portable computers are covered worldwide. Technology represents a significant investment to many businesses. Computerized Business Equipment coverage is important to any business entity that relies on technology in their daily operations. The greater the dependence on technology, the more important it becomes to purchase specialized coverage on such a critical aspect of operations.

Contractor’s equipment. Contractor’s Equipment Coverage can cover scheduled, leased and miscellaneous property of the contractor. In addition, this coverage may be extended to include any similar property of others for which the contractor may be liable. This coverage can be further extended to include: Additionally acquired equipment coverage extending up

to the policy limit for equipment which the insured buys, leases, rents or borrows for defined period of days.

Rental expense reimbursement coverage, which pays up to a defined limit for rental expenses in the event that covered equipment is damaged in a covered loss.

Installation floater coverage extends to property intended for installation while at a job site, at any other location, or in transit.

Valuable papers coverage provides insurance for items such as blueprints and other documents of value to the contractor.

Contractors Equipment is owned or leased to perform a specific function. Use of the equipment is directly related to generating revenue, fulfilling a contract or providing maintenance. Without working equipment or the means to replace equipment as soon as possible, a contractor’s obligations cannot be fulfilled. The Contractors Equipment policy helps owners expedite the repair or replacement of damaged or stolen equipment. In addition, because of the high cost of the equipment many banks and lending institutions require insurance on the equipment. Any business entity with a financial interest in construction or other heavy equipment needs Contractors Equipment insurance. Typical policyholders include:

Real estate developers. Building owners. Home builders. General contractors. Municipalities. Street and road contractors. Excavation contractors. Port facilities. Warehouse operators.

Fine arts. Corporations and commercial accounts may have valuable works of art not specially covered as Fine Arts under standard package policies and Marine coverage fits the bill. Fine Arts coverage extends to works of art at a permanent location, in transit and while loaned to others. Agreed Value Fine Arts coverage ensures that collections are treated properly with a form that addresses the specific collection needs, with availability of breakage coverage, special pairs and sets coverage, and flood and earthquake coverage. For significant corporate collections, or for artwork and collectibles in commercial settings, insurers offer comprehensive coverage for a broad spectrum of paintings, sculpture, prints and multiples, as well as more specialized collections of historical, cultural or technological significance.

Installation coverage. Installation policies insure building materials and components, machinery, and specialized equipment while being installed in a building or structure or erected or fabricated at a specific location. Typical types of property include heating, ventilating, air conditioning and electrical systems; and wallboard, tile, carpeting and other interior finish material. More specialized installations include wastewater treatment facilities and controls, pipelines, electrical, telephone and cable television lines; and radio and cellular telephone towers. Coverage is typically effective from the time the customer’s financial interest in the property begins until the interest ceases, including while the property is in transit, at temporary storage locations and while stored at the job site. The vast majority of Installation policies are written for subcontractors (trade subcontractors in particular). Any business entity having a financial interest in property being installed, erected or fabricated may have a need for Installation coverage. Typical policyholders include: Specialty contractors. Government authorities and municipalities. Utilities (water, gas, telephone, electrical). Manufacturers, wholesalers, and retailers of machinery,

equipment and materials, who also install what they sell.

Marine underwriting specialists have written all types of installation projects, including low hazard residential electrical systems and tenant finishes, helicopter assisted tower installations, and the delicate relocation of a lighthouse threatened by erosion. Standard programs offer coverage against risks of direct physical loss or damage (subject to certain policy exclusions), or coverage tailored to a specific, complex project.

Manufacturers coverage. A Manufacturers Output Policy includes coverage for the personal property of a business at specific, as well as unnamed, locations, including while in transit.


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Personal property coverage includes such items as machinery, equipment, furniture, fixtures and stock, improvements, and includes any other similar property of others for which an insured is liable. Coverage extensions include: Accounts Receivable and Valuable Papers coverage, and Fire Protection System Recharge Expense coverage.

Motor truck cargo legal liability. Motor truck cargo policies insure common and contract carriers for loss or damage to cargo in their care, custody or control. Coverage is provided on a legal liability basis as determined by the contract of carriage between the motor carrier and the shipper (pursuant to a bill of lading or other specially negotiated contract). Generally, a carrier is liable for the safe delivery of the property entrusted to it, not only while on the carrier’s vehicles, but also while temporarily at terminals awaiting shipment. An insurer’s Motor Truck Cargo Legal Liability policy is designed to cover that liability on behalf of the carrier.

Museum coverage. Some Marine policies offer coverage developed specifically to insure museum-quality objects. The policy insures museum owned property at scheduled locations, on exhibition or on loan to other organizations. The policies also offer coverage for property in transit and the property of others for which the policyholder is legally liable. Coverage is available for art, history, natural history, science and technology and sports museums. Some insurers also offer coverage for specialized institutions such as aviation and automobile museums. In the United States, there are more than 12,000 museums eligible for this coverage. The market is expected to expand as the number of specialty museums and local historical societies continues to grow. Many of these smaller museums have no coverage for their collections because they perceive that one-of-a-kind objects are invaluable and therefore uninsurable. Although an exact replacement is not available, insurance can offer curators the opportunity to supplement the remaining collection with artifacts of the same genre to keep and preserve the mission of the museum.

Scheduled property. Scheduled Property coverage is designed to cover property that is unique or unusual or which is not typically covered under any other marine or property coverage. Coverage is available to protect against risks of direct physical loss or damage (subject to certain inland marine exclusions). Any commercial property owner with property that travels from location to location or who needs coverage for other than real property or contents is a candidate for Scheduled Property coverage. Scheduled Property coverage is desirable for any business entity that wants insurance protection for unique property ranging from structures outdoors to movable property. Some of the unusual types of risks eligible for this coverage include: Circus rides. Locomotives and rail cars. Voting machines. Transit systems. Water storage tanks. Antique cars and race cars. Ski lifts. This type of coverage may be tailored to the specific property. Coverage applies to property wherever it is located - at a specific location, in transit or at a temporary

location. Valuation options of all types are available including agreed amount, actual cash value or replacement cost.

Transportation. Transportation insurance typically covers a shipper’s interest in property while in transit by public motor carrier, contract carrier, railroad, air carrier, or while on the shipper’s own vehicles. The coverage form is often extended to provide insurance for loss to property while it is being loaded and unloaded. A Transportation policy pays up to the limit of insurance, regardless of the extent of the carrier’s legal liability or the carrier’s ability to meet its financial obligations. In today’s fast paced world, insureds don’t necessarily have time to spend collecting reimbursement from a carrier in the event of a loss, so the transportation policy covers these losses up front. Some Transportation policies also pay for certain losses even when the carrier may not be liable, such as Acts of God (flood, earth movement, etc.). And if the insured cannot collect the invoice amount from a consignee because of loss or damage during a shipment, the policy will cover the insured’s interest in the lost or damaged property. Any business that deals in a moveable product needs coverage for incoming and outgoing shipments, whether the business is a manufacturer, a wholesaler, a retailer or a distributor.

Ocean Marine Insurance Ocean marine policies were the first form of insurance coverage. They were written to provide financial protection for the owners of ships and cargoes in the event their property was lost at sea. The cargo was insured from port to port. Ocean marine policies still offer this coverage today and include Ocean Cargo, Commercial Hull, Hull Builders Risk, Marina Operators, Boat Dealers, Ship Repairers, Stevedores, Wharfingers and Charterers. Marine policies can be written to cover the movement of any legal goods. The property insured is not itemized in the policy, which is written generally to cover “goods and merchandise.” Certain types of property are not included under the general category of “goods and merchandise” and need to be specifically covered. These excluded items include livestock, frozen foods, refrigerated meats, poultry, game, as well as bullion, securities and similar property. The marine policy may be written not only to cover the value of the shipped goods but also import duties and freight charges. Hazards Covered Perils of the sea.

Under this coverage fall all perils which are peculiar to transportation and which cannot be prevented by any reasonable efforts of humans. Perils of the sea must be fortuitous; in other words, due to an uncontrollable action of the sea, not within the control of any person.

Fire. Fire is not a peril of the sea, but the policy covers this risk. On the other hand, there is no coverage against fire which is due to the inherent combustibility of the goods being carried. Combustible cargoes sometimes are insured with special, additional coverage specified in a policy.

Barratry of the master. Violation of trust of the master is covered provided it is not done in concert with the ship owner. “Barratry” is a specific term used to describe this type of maritime treachery.

Assailing thieves. Although petty thievery is not covered by the policy, theft accompanied by violence is covered.


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Jettison. Cargo thrown overboard is covered if the property was thrown overboard in order to attempt to preserve the property from loss.

All other perils. The policy covers “all other perils which shall come to the hurt, detriment or damage” of the goods. The clause would appear to make the policy cover against all risks, which is definitely not correct. It means only perils of a character similar to those insured.

Explosion. Most marine policies specifically cover the risk of explosion, whether on land or sea.

Latent defects in machinery, hull, appurtenances. Most marine policies are extended to cover damage caused by bursting of boilers, breakage of shafts or through any latent defects in the machinery, hull or equipment, and through faults and errors in navigation or management of the vessel.

Other Types of Ocean Marine Coverage In addition to the specific perils listed above, Ocean Marine Policies may be modified to include each of the following types of coverage: Charterers legal liability.

When a shipper contracts with a ship owner to use the owner’s vessel, this arrangement is considered a charter. Depending on the type of charter, the charterer is held legally responsible for certain liabilities and properties of the vessel. Depending on the type of contract the charterer enters into, the charterer may become liable for certain exposures related to the operation of the vessel. There are three types of commonly used charters: Voyage charter.

A charterer who contracts the entire vessel for a single voyage or series of consecutive voyages is considered a Voyage Charterer. In a Voyage Charter, the shipper in most cases is liable for a safe berth, loading and the unloading. The ship owner retains the responsibility for navigation, operation of the vessel and all expenses.

Time charter. A charterer who contracts to hire the entire vessel for a specific period of time is called a Time Charterer. In a Time Charter, the shipper is responsible for paying for the ship’s fuel and for providing a safe berth at the port of delivery. The ship owner remains responsible for navigation and the expenses of operating the vessel.

Bareboat charter. A charterer who contracts to hire the entire vessel without a crew, stores or provisions is called a Bareboat Charterer. In a Bareboat Charter, the ship owner is liable for the full operation of the vessel.

Hull protection and indemnity coverage. Hull policies cover physical damage losses to the vessel arising out of numerous perils, while protection and indemnity policies cover the liability of the vessel owner for bodily injury (including death) or property damage arising out of specific types of accidents. Hull and Protection and Indemnity coverage is often tailored for each customer. Typically hull coverage is written together with the protection and indemnity coverage. Hull policies are a necessary part of the shipping industry. Without hull coverage, a prospective buyer of a vessel will be unable to obtain a loan to finance the purchase. Hull coverage will protect the interests of the bank and the vessel owner if a loss does occur. Protection and Indemnity policies are also necessary. Without protection and indemnity coverage, most vessels would not be permitted to sail. The majority of labor unions require that a fleet have coverage for the crewmembers in case they become ill, injured, or are

killed while employed by the vessel. Without evidence of adequate Protection and Indemnity insurance, the vessels would not be manned and cargo would not leave the ports. Any commercial ship owner and/or operator of an inland/ocean-going vessel needs Hull Protection and Indemnity insurance. Typical policyholders include: Container vessel owners. Bulk-carrying vessel owners. Tanker vessel owners. Barge owners. Ferry owners. Heavy lift vessel owners.

Marina operators legal liability. Marinas provide a number of services to the owners of private pleasure crafts including renting dock space, fueling, storage, launching and hauling. The marina must exercise the appropriate care to protect its customers’ pleasure craft, equipment on board and motors that are in the marina’s care, custody or control. If negligent in such duties, a marina may be held liable for any loss or damage to their customer’s property. Marina Operators Legal Liability covers the insured’s liability for loss of or damage to customers’ private pleasure watercraft, equipment on board and motors that are in the marina’s care, custody or control. Any individual or any entity with a financial interest in a marina or yacht club should obtain Marina Operators Legal Liability. Typical policyholders include yacht club owners and marina owners.

Ocean cargo. Ocean Cargo policies cover physical loss or damage to goods and merchandise that are shipped by various types of carriers; i.e., rail, air, water, and motor truck. Besides just covering goods while in transit overseas, the coverage form can be broadened to cover the goods while temporarily stored at international and domestic warehouses, while being shipped domestically or while at a domestic or foreign processor. Ocean Cargo coverage is tailored to meet the needs of each customer. Ocean Cargo policies are a necessary part of the shipping industry. Without Cargo coverage, international transactions would not take place. When a bank finances the purchase of goods, the buyer is required to provide evidence of adequate insurance prior to any advancement of money. Once proof of adequate insurance has been given to the bank, the shipment of the goods can commence. Ocean Cargo insurance typically protects the interests of the bank, the seller of the goods and the buyer of the goods. Any individual or any entity with a financial interest in goods or merchandise being shipped internationally should obtain Ocean Cargo insurance. Typical policyholders include: Multi-national companies. Wholesalers and distributors. Manufacturers and processors. Shipping companies. Importers and exporters.

Ship repairers legal liability. A shipyard performing repairs on a vessel has certain responsibilities to the vessel owner for the safety of their property. The shipyard must anticipate the hazards to which the property is subject and must exercise the appropriate care to protect this property. If negligent in such duties, the shipyard may be held liable for loss or damage to this property. When a shipyard is repairing a customer’s vessel, there is a bailment between the shipyard and vessel owner while the vessel is in the care, custody, or control of the shipyard. This bailment makes the shipyard liable for


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certain damages and the shipyard must exercise an ordinary degree of care to protect its customer’s property. The Ship Repairers Legal Liability coverage form provides liability coverage for this exposure. Ocean Marine Specialists must work with each customer to develop a coverage form that fits the specifications of the customer. The insurer’s ocean marine claim surveyors, adjusters, and settling agents must all work together providing the customer the best coverage available to meet the customer’s requirements.

Stevedore’s legal liability. When a vessel enters a port, its cargo needs to either be loaded or unloaded safely and expeditiously so the vessel can set sail again with limited delays. An independent contractor called a Stevedore is usually responsible for the loading and unloading operations at a port. The Stevedore can be legally liable for damage to vessels, cargo, and property located on the premises they are conducting their operations on. Coverage provides protection to the Stevedore for their ordinary liability to exercise an appropriate degree of care for vessels, cargo and property in their care, custody or control.

Terminal operator’s legal liability. A terminal operator can perform many functions including warehousing services such as “pick and pack” operations, labeling, inventory control and local trucking. In addition, the operator may provide a safe berth for vessels and have employees that load and unload vessels. One common exposure that exists in all of these operations is the terminal operator’s legal liability exposure while goods and property of others are in their care, custody or control. A terminal operator provides an extended range of services that can include operations provided by a Wharfinger, Stevedore and Warehouseman. When determining coverage needs, it is important to examine the services that the insured provides their customers.

Wharfingers legal liability. When a vessel enters a port it must have a safe berth before it can be loaded or unloaded. The Wharfinger (pronounced “war-fin-jer”) provides the vessel owner with a safe berth, watches over the vessel, and exercises the appropriate care to protect the vessel from loss or damage. The Wharfinger is held liable for the vessel while it is in their care, custody or control. They also have certain responsibilities for the safety of the vessel. This liability is the principal exposure covered by a Wharfingers policy.

Conclusion – Personal Property Insurance As an insurance agent, you can offer an incredible variety of services and products to customers seeking personal property insurance. You can inform the customer that protection need not be confined to the standard homeowners policy, as inland marine, ocean marine and umbrella coverage can be tailored to provide the specific protection which the customer requires. If the customer is involved with a business enterprise, you and the customer must consider additional forms of coverage. By understanding the various options available to the customer and the multiple types of personal property insurance coverage, you will be able to better service each of your customers and offer valuable counsel to existing and potential new clients.

CHAPTER 3 – UNDERWRITING PROPERTY AND CASUALTY INSURANCE Knowledge of the insurance products to be offered to customers is essential for any insurance producer. The insurance producer must also understand the underwriting process by which insurance companies determine whether to offer insurance to a particular individual. Your customer may ask you specific questions regarding the underwriting process, and your answers may help that customer decide that your products and services are worthy of his/her investment. In this chapter we examine the underwriting of property and casualty insurance. Many underwriting practices have been in place for hundreds of years; however, changes to these practices are inevitable. Traditional underwriting practices may continue to appear perfectly logical to an experienced underwriter, but newer laws and regulations are forcing changes to some of those practices as longtime underwriting practices must give way to new concepts. Major Underwriting Goals Underwriting of all types is designed to accomplish three major goals. Underwriting helps the company to achieve “underwriting

gains.” Underwriting positively contributes to society. Underwriting assists in maintaining a strong, solvent

industry which can serve the public in the future. Each of these goals must be recognized and understood before changes in practices can be successfully adapted to new regulations and pressures. Underwriting Gains The first goal of underwriting is to help to achieve underwriting gains. In stock insurance companies, these gains can be called “profits.” For mutual insurance companies, the gains result in increased dividends or surplus. In all cases, the goal is to be able to show a gain after paying claims and expenses. Underwriting contributes to these gains by selecting applicants who fit within the parameters of the rates which have been developed. Every rate structure contemplates a certain type or class of risk. Underwriting has the responsibility of accepting and retaining those properties and exposures which fit the expected pattern. Underwriting gains cannot be achieved by accepting applicants whose probability of loss is greater than that which is anticipated by the rates. Applying contract provisions which are contemplated by the rate structure, can make a further contribution. Coverage cannot be unduly broadened, exclusions cannot be removed and conditions cannot be waived without jeopardizing the expected underwriting gains. Rates, contracts and selection are closely related. Improper use of any of these factors can destroy all hope of underwriting gains. If any of the three is inadequate, one or both of the others must be adjusted accordingly, or underwriting losses will occur. Total responsibility does not fall on the underwriters. Those who promulgate rates and those who draft contracts carry a share of the burden. But in the final analysis, it is the underwriter who must select applicants who fit the rates and contract provisions which have been designed to produce underwriting gains. If artificial restraints are imposed on underwriting, either rate must be increased or contracts restricted; otherwise underwriting gains cannot be realized. Contribution to Society Insurance contributes a great deal to society. In fact, it is difficult to imagine how our civilization could exist without insurance. Society benefits from insurance by the reduction in uncertainty which insurance provides. With this lessening of uncertainty, people can buy and furnish houses, establish


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manufacturing and processing firms, stock warehouses and retail establishments, and conduct the distribution of goods. If this uncertainty was not reduced, people would not necessarily be willing to embark on these ventures. Perhaps more importantly, lending institutions would not be able to finance these enterprises, so anything beyond a cottage-type of business would be almost impossible. Most of the recent strides in industrial and technological fields would have been unthinkable, and most consumers would not have been able to accumulate the volume of goods which help mark the affluence of society. Insurance companies supply a good share of the funds which finance long-term investments. The insurance companies’ accumulation of capital, which is needed to guarantee the payment of future losses, can be used to promote expansion in home ownership as well as in business and industrial fields. Another major benefit of insurance is the promotion of competition which results from the stability and reduction of uncertainty which are present in our economy. Small firms can compete with large enterprises because they do not need to accumulate large sums of money to help survive disasters. The protection given through insurance permits every firm to survive both heavy losses to property and claims for liabilities. Thus funds can be used for growth, and society benefits from the resulting competition. Underwriters are the focal point through which most of the benefits of insurance are supplied to society, as the underwriters arrange to protect almost every conceivable type of loss in a manner which meets society’s needs. When new exposures to loss arise, underwriters develop methods of insuring those exposures. Two important aims of underwriters are to support activities which will benefit society, and to oppose changes which will tend to restrict these benefits. Underwriters must not only analyze the immediate results of changes but also their long-range effects. Every underwriting action and every underwriting rule or guide should be considered in light of the ultimate effect on society as a whole. Maintaining a Strong Insurance Industry The greatest contribution that underwriters can make to their companies and to society is to help maintain a strong and solvent insurance industry. Underwriting gains, as discussed earlier, are an essential element in maintaining this strength. Another factor is steady, solid growth; this requires an analysis of markets and a selection of applicants who represent a broad, desirable spread. Still another element is an ability to meet the needs of buyers of insurance, for only in this way can insurance companies survive. In all of these areas underwriting contributes best when it classifies and accepts applicants on the basis of reasonable criteria, equitably applied. A constant objective of underwriting must be to analyze selection standards, change the standards and classifications when conditions require and administer them fairly in daily activities. Society benefits directly from the existence of strong and stable insurance companies. Only this type of insurer can meet the needs of the public. The future demands of a changing society will place new burdens on the insurance industry. New energy requirements, advanced technologies, the challenges of space travel, the opportunities for increased leisure activities, the opening of markets in undeveloped lands and all of the other possibilities which will be presented by changing world will require even more insurance protection than is available today. A strong, solvent insurance industry is a necessity if artificial brakes are not to be applied to these many new possibilities for fortune and growth. Underwriters must develop appropriate analysis of characteristics of applicants in order to find meaningful factors upon which to base underwriting selection. This is

the challenge of the future for underwriters. Laws and regulations will impose new rules. But underwriting must survive if a strong insurance industry is to exist. This will require adaptation by underwriters, through the use of revised approaches which will achieve the established objectives. Individual and Class Underwriting Underwriters can react in many different ways to newly adopted rules and regulations. If the underwriter does not carefully consider the ultimate consequences of that reaction, the underwriter may react in ways which will damage the underwriter’s reputation. In the long run, the damage will be irrevocable and will affect the entire insurance industry. Underwriting Individuals The only really viable alternative is to underwrite by applying the underwriter’s intelligence and knowledge. This will include securing more facts, evaluating applicants as individuals, making objective analyses and taking prompt action in conformity with the laws and regulations. As a starting point, underwriters must know why certain underwriting rules or guides were used in the past. For example, an applicant’s occupation may frequently be used as one underwriting factor. The applicant’s occupation is not a factor because there is anything inherently wrong with people who are engaged in the particular occupation. They are not wicked, dishonest nor abhorrent. Rather, experience has likely shown that persons in that particular occupation tended to be unstable with respect to location, frequently moving from place to place. This instability can be a problem to insurers, so caution will historically have been used in determining whether to accept applicants who were engaged in that occupation. The occupation should not have been a firm rule but just a guide (although it is likely that some underwriters always used it as an unacceptable factor). Suppose that a new law or regulation provides that occupation will be prohibited as a factor in underwriting. The instability of the applicant may still be a problem to the insurer, so the application may still need to be rejected by the underwriter. The reason for the rejection will not be the occupation, but the instability of the applicant’s residency. This instability can be indicated by factors other than occupation and may only be discovered by more intensive investigation by the underwriter. Occupation cannot be used as a reason for underwriting action, but it can still point out the need for more facts which may make the application unacceptable. If unstable conditions are not found, and other negative factors are not present, the application should be accepted. The key to better underwriting will be to secure all relevant information about the applicant. No longer will it be enough to find out a few facts, such as occupation, and then take action. Instead, the underwriting process will have to focus on the residency of the applicant and the likelihood for frequent movement. Both objective and subjective information can be secured by the underwriter, depending upon the circumstances and the management of the insurer. Objective information.

The most reliable data is that received from objective outside sources. Motor vehicle reports and accident information from the file are the most common forms of objective data for vehicle insurance. The condition of the property, photographs, a doctor’s report of physical impairments and the length of driving experience are other examples for various lines.

Subjective information. Purely personal and private information may be used under some circumstances. Ordinarily, this is best if secured from the applicant, not from outside sources. The application, telephone verification and a renewal


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questionnaire are devices which are used to obtain facts from applicants and policyholders.

Some insurers have used psychologically oriented self-completion questionnaires as investigative tools for new applicants, particularly for personal automobile insurance. Some of these sources may arouse antagonism from applicants or producers, but they are illustrations of the sources that are available to the underwriter. Right to privacy laws and other restraints imposed by government can restrict the information available to the underwriter. Such laws certainly make the underwriter’s job more difficult and require more innovation to locate permissible data. Underwriting By Class As described above, the first step in underwriting requires that the underwriter secure as much relevant information about the individual as is necessary or available. The second step is analysis of that information. There are two different ways of analyzing an insurance application: by class and by individual risk. Traditionally, personal lines have been subject to class underwriting. This means that classes or groups are identified as being problems and are not written as a general rule. Underwriters recognize that some individuals in each class would be acceptable; however, it would be more expensive to find these individuals through the underwriting process, and there is usually not much information readily available upon which to make the decision. If an exception is made and a loss occurs, criticism may result. On the other hand, there will be no criticism if the applicant is rejected. Commercial lines more commonly use individual risk underwriting. More complex factors are present, and premiums are high enough to permit more investigation. In most companies, even under individual risk underwriting, certain groups are identified as presenting problems, and these groups may be placed on an unacceptable risk list. Still, exceptions are made for meritorious applicants based on individual characteristics. This pattern is common among larger commercial risks; smaller ones may be handled more on a strict class basis. This traditional difference between class and individual risk underwriting is disappearing in today’s social and regulatory climate. People no longer tolerate being handled as members of a class without regard to individual characteristics. Many newer laws and regulations are aimed at precisely this factor. Since some physically impaired people are good drivers, it is no longer permissible to reject them simply because other physically impaired people may be problem drivers. Rather, the rules prohibiting the use of certain characteristics require that each person be considered on the basis of individual factors alone. The analysis of applicants, under government regulations, must include a study of individual characteristics, not just the group to which the applicant belongs. This does not necessarily involve a great deal more time and expense. Rather, it takes only a little more effort to consider whether the applicant is different, in some relevant way, from the other risks of the same type. If so, the differences must be analyzed. This type of analysis is new for most underwriters, particularly those handling personal lines. Education, training and frequent audits will be needed to make underwriters more familiar with these processes of analysis. After obtaining and analyzing information, the third step in underwriting is to make a decision and take action. This can be a perilous part of the process, or it can be a golden opportunity to serve the public and the industry. The manner in which underwriting guides are written and the way that the reasons for adverse action are stated can be very important. This is the point at which the true intentions of the insurance companies are measured. Underwriters should avoid using words like “location,” “sex,” “age” and

“marital status” when rejecting or canceling insurance. These may be factors to be considered in the evaluation, but they cannot be used as the primary reason for rejection. Reasons must be given, and these reasons should be specific. Underwriters should stop using such general terms as “condition of the property.” The public insists upon knowing why adverse action is taken. The reasons must be clearly explained. Action must be taken promptly. Restrictions place a burden on underwriters to avoid procrastination. Many states prohibit cancellation of new policies after a “discovery period” – usually about 60 days. Non-renewals are often permitted only if notice is sent to the policyholder well in advance of the expiration date. These rules require prompt and firm action, preventing the delays which previously marked the decision-making process of some underwriters. In summary, underwriters must avoid the specific use of factors which are prohibited, although these factors may be used as indicators along the path. Applicants and policyholders must often be analyzed as individuals, not as members of a class or group. Actions must be taken promptly, and always in compliance with the laws. Rejection or cancellation may be taken only for relevant reasons, and never because of factors which are prohibited. The reasons must be explained in specific terms. The previously mentioned approaches are the general approaches which must be followed by underwriters under government restraints. As a first step, management of the company should outline general principles, indicating how underwriting is to be conducted. These principles, which should be stated in broad terms, will give the necessary guidance to underwriters. It is obvious that compliance with all laws and regulations should be the cornerstone of these principles. General statements are needed as to the degree of investigation to be followed, the method of communicating decisions, and the handling of complaints. Such a statement of principles will supplement the underwriters with knowledge of general approaches to be used and will provide a broad base of guidance for future underwriting. Specific Underwriting Factors and Practices Desk underwriters need specific instructions on practices to be followed when they encounter problematic applications. While general statements are helpful, they are inadequate for the day-to-day handling of individual risks. Statements of general principles must first be developed and adopted by insurance company management. Such statements are needed before desk underwriters can make decisions which follow the wishes of management. Without such statements, underwriters can be expected to continue the old practices which have led to an atmosphere of public criticism of underwriting and demands for change. In addition to the company’s statement of general principles, underwriters must learn the laws and regulations affecting the insurance being underwritten. Controls must be established to be certain that both new and existing laws and regulations are communicated to all underwriters. Next, supervisors must conduct enough audits to be certain that underwriters are following the statement of principles and all of the applicable laws and regulations. Much more than this is needed, however, if underwriting is to survive as it is known today. The spirit as well as the letter of laws and regulations must be followed. Most rules have loopholes if someone looks hard enough for them. If underwriters find loopholes in laws or regulations and underwrite on that basis, further restrictions will be adopted by government to close the loopholes. Complaints and criticisms must be heard and addressed by the insurance industry. When reasonable adaptations to underwriting practices can be made to meet those objections, this should be done. The difficult problem is to separate those comments which are reasonable and logical from those


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which are not. The application of these principles will not be easy. The reasons for each type of criticism must be understood in order to allow for proper changes to exiting standards. The following sections list factors used by insurance companies to determine underwriting decisions. These sections describe information regarding each factor and suggest certain recommendations for handling some of the complaints which have been lodged against the insurance industry’s underwriting practices related to these factors. Loss History The record of past losses remains as one of the best factors which underwriters can use in the selection process. It is factual, relevant and well accepted as a factor which reasonably separates one risk from another. At the same time, underwriters must realize that not all losses can be considered as factors. Some losses are perceived by the public as being of types which do not reflect adversely on the individual involved. If the loss was not recent, or if the applicant was not at fault, its importance is diminished or removed. Accident Record Automobile underwriters should continue to use accident records as one of the primary underwriting selection tools. When facts are available, most accidents are reliable indicators of desirability and are generally accepted as such. Modifications in some past rules or guides are needed, however. Underwriters must not consider those types of accidents which do not have a clear relationship to possible future accidents. Also, they must not use the types of accidents which are specifically prohibited by statute or regulation. Fault The question of fault is most important. Although statistical studies do not separate accidents by fault, and automobile insurance underwriters, for example, may feel that all accidents indicate a driving pattern, the public generally does not see the relevance of not-at-fault accidents in the underwriting process. Most underwriters, for some time, have given little weight to the most obvious of the not-at-fault accidents. They disregard those where an applicant was struck while legally parked or while stopped for a traffic signal. In the future, the definition of not-at-fault accidents will likely be expanded. An applicant who recovers in full from another party is of the firm opinion that no fault should be affixed to his or her behalf. Underwriters should take such factors into account and not consider those accidents where an applicant was not charged with fault. The determination of fault is not easy, particularly with accidents that occur before risk is insured. Sometimes the determination can be made only by securing a copy of a police report or by contacting the previous insurer. These sources may be expensive and may even be prohibited by law. This leaves the underwriter with no alternative but to accept the description of the accident as given by the applicant, subject to verification by an official motor vehicle accident report, as much as possible. Modern traffic conditions lead to many accidents where fault is difficult to ascertain. Events happen quickly and each party may feel that the other person was completely at fault. Applicants who feel that they were without fault in an accident will resent being underwritten on the basis of an at-fault accident. This resentment could be translated into legislation which would deny all accident information in the underwriting process. Underwriters will likely view the value of past accidents as predictors of the future as too great to jeopardize by making arbitrary decisions on some “close calls.” As a result, if fault does not appear to fall on the applicant, the underwriter will generally ignore that accident.

Number of Accidents Underwriters not only consider every accident, they sometimes decide that one accident in the experience is too many to permit acceptance. Companies attempting to set predetermined standards may state that an applicant is unacceptable if there have been any accidents during the past two or three years. This approach may be too severe for the future. The traffic congestion of today, especially in the larger cities, makes it extremely difficult to avoid an occasional small accident. A blind spot during a lane change, vision obscured by a wet window in the rain, a sudden change in a traffic signal, an unexpected stoppage of traffic – all can result in accidents. A driver who is usually very careful and who has been accident-free for years may incur one incident of this type. All that is required is a moment’s inattention or carelessness. It would not be reasonable to refuse insurance to an applicant who has incurred just one loss of this type. Two or more accidents might be; but only one accident, perhaps in many years, does not make a driver a poor risk in the minds of most people. The solution is to consider more carefully the type of loss rather than just the number. If that one loss occurred shortly after midnight on a Saturday night and was the result of apparent high speed and possible drinking, the underwriter would be justified in being concerned. On the other hand, if the loss happened at 5:15 on a Tuesday evening and was a small rear-end accident on a crowded expressway, it is difficult to maintain that this is a good indication of possible future accidents. Underwriters must stop playing a “numbers game” and start analyzing the losses. Two or three small accidents scattered over a three-year period may be less indicative of future loss involvement than one recent accident where the circumstances indicate that a driving problem exists. No known legislation has attempted to control the number or type of accidents which can be considered in underwriting. This situation does not mean that these factors can be disregarded. Abuse of the privilege of considering accidents in the selection process may lead to restrictions. Automobile underwriting today requires more than a simple statement on the maximum number of accidents permitted during a specified period. Underwriters must secure all pertinent information concerning details of accidents from whatever sources are reasonably available. They then must analyze the losses to see if an indication of a poor driving pattern exists. If it does, underwriting action can be taken with little fear of challenge. But if it does not, there may be severe criticism of action taken solely because the loss is on record. Continuing action of the latter type may lead to restrictive legislation or regulation. Commercial/Personal Risks When an individual drives a vehicle as part of his or her job, it raises an additional underwriting issue: Should accidents occurring as part of the job be included when underwriting a personal automobile policy? The analysis of individual losses, rather than merely counting the number, will take care of the problem of differentiating between commercial and personal risks in most cases. An applicant, who incurs accidents because of poor driving, whether in a truck or a car, should bear the responsibility under all types of vehicle insurance. If the underwriter looks at the facts surrounding each loss, most of the pressure to disregard accidents from another line of insurance will disappear. Naturally, where laws prohibit consideration of accidents from another line, such as “emergency vehicles,” there is no opportunity to use such losses in the selection of risks. Property Losses Consideration of the degree of fault or responsibility should be a part of the underwriting process on property as well as automobile claims. The type of loss and the circumstances surrounding the loss are clues to the degree to which the


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applicant could have prevented the loss. Although there is no known legislation on the use of property losses, underwriters should not take advantage of this situation. Reckless disregard of factors causing a loss could lead to restrictions, and these probably will be stricter than those which underwriters would impose on themselves. Thus, isolated losses from factors beyond the control of the applicant should be disregarded or used with care. If conditions have changed, this fact should be part of the analysis. Intelligent underwriting requires nothing less. At the same time, a pattern of losses may reveal conditions which are likely to lead to future losses. Repeated windstorm or hail losses may indicate that the location of property is in a “pocket” where such losses are common. Repeated crime losses may show that the neighborhood is conducive to those types of losses and that the pattern can be expected to continue. Normal underwriting practices should continue, but these must be tempered with careful consideration of the circumstances surrounding the loss, not just a tabulation of the number of losses. Liability Losses Both personal and commercial liability losses should be handled much the same as property losses. Laws have not yet been enacted to regulate the use of these losses, but unreasonable application of underwriting rules could lead to controls. The facts surrounding losses should be analyzed carefully. If there is no pattern, and the loss was beyond the control of a reasonable person, the underwriter should not make the decision on that loss alone. On the other hand, a pattern of loss, or failure to take normal precaution against injury, is valid underwriting criteria. Recommendations for Improvement Property and liability losses often are the result of unsafe conditions. Rather than refuse insurance because of these conditions, or raise the premium, it would be better for underwriters to recommend improvements which would reduce future losses. This approach recognizes a responsibility on the part of underwriters to furnish insurance whenever possible and also to reduce losses and injuries. Underwriters who analyze losses often are able to see conditions which should be corrected. If these are not obvious, engineers or inspectors can be used to identify unsafe practices, and their reports can be part of the analysis of the cause of the loss. In addition, such reports can be the basis of recommendations for improvement. The underwriter, wishing to serve the public and avoid undue regulation, must do more than accept or reject applications. An effort must be made to write insurance, tailoring the contract and the rate to the risk. An important part of this approach is to discover areas where conditions can be improved and to recommend action to the applicant. Additional expense will be incurred by this approach; however, more business will be written and fewer losses may be incurred. More importantly, this approach will help to fulfill the duty of supplying coverage in the most economical fashion to every deserving risk. Universal use of this approach will go a long way toward limiting future adverse legislation and regulation. Traffic Violations Underwriters can continue to use traffic violations in selection and rating. This use is subject to specific state laws or regulations which limit the use of certain types of violations by underwriters. Where possible, however, underwriters should use judgment in their consideration of violations. The emphasis should be on those convictions which appear to have some element of future accident predictability. Equipment violations should be given little weight; on the other hand, they may indicate a careless attitude, an “I-don’t-care” approach to automobile safety. Where this appears to

be the case, further investigation is needed to determine the facts. In other cases, equipment violations should be ignored. Each case must be separately evaluated by the underwriter. Non-Verifiable Record The term “non-verifiable” driving record relates to the practice of refusing to insure newly licensed drivers because they do not have any past driving record, good or bad. Rules determining the definition of a “verifiable” record must be applied in a reasonable, nondiscriminatory fashion. The time period must not be excessive; three years is a maximum period in most cases. If used the rule must apply to all applicants and not be used as a screening device for youthful operators. For example, assume there is a middle-aged couple with a clean accident and conviction record but with only one of them who drives. If the non-driving spouse then gets another car and starts to drive, the non-verifiable rule must be applied, exactly as it would be if the new driver were a youth just starting to drive. Sources of Information In determining the record of traffic violations, it is crucial that underwriters use all reliable sources of information. Motor vehicle reports (MVRs) are the best source of information. They must be secured where it is important to see the traffic record. Arrangements should be made to secure MVRs as quickly and inexpensively as possible. Arrangements can often be made to secure MVR information directly from the computers of the state motor vehicle departments, either directly by the insurer or through a service organization. Prompt information is of great value in effective selection of applicants. Some traffic violation information, like some accident data, is not always available through an MVR. For example, some traffic courts have adopted the procedure of sending violators to a traffic school. Upon completion of the course, the record of the violation is destroyed. No entry is ever made on the MVR. This procedure may be effective from the standpoint of law enforcement officials, but it destroys the concept of underwriting on the basis of past driving performance. Underwriters must establish techniques for securing information on all traffic violations as much as possible. Proper questioning on the application is one source. Effective investigation technique is another. Driving Record The most significant factor which can be used in underwriting and rating of motor vehicle insurance is the driving record. Traffic violations are the major component of driving records, although accidents are usually included. Almost everyone who agrees that some type of selection and rating differences are justified will concur that the driving record is most critical. A risk should not be accepted if a driver’s license is suspended or revoked. To supply insurance to such persons is to encourage them to drive in violation of law. When investigation reveals that the license of a driver is not valid, the application should be rejected. The only exception is a case where it is represented that the person without a license will not drive. If this is verified, the factor can be disregarded. After the license is reinstated, the underwriter should analyze the reason for suspension or revocation and not reject the applicant only because of the previous action by licensing authorities. Condition of Property Underwriters have more opportunity to practice individual risk selection on the basis of property condition than on most other factors. By avoiding arbitrary rules and looking at specific risk characteristics, underwriters can improve their selection practices and still avoid the objections of regulators. Both automobile and property lines are subject to underwriting on the basis of property condition.


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Condition of automobile. Good underwriting requires consideration of the automobile’s condition. It is important that judgment be applied uniformly and that only relevant conditions be taken into account. Mechanical deficiencies should be handled carefully. If critical functions are involved, such as brakes or lights, the risk should not be accepted. Public safety, as well as insurance principles, requires that automobiles with serious deficiencies such as the foregoing should not be encouraged to operate on the streets. The proper underwriting technique is not to merely reject insurance. Such action may cause the owner to drive without insurance or to seek another insurer which may not discover the problem. Rather, the underwriter should point out the deficiency, suggest that it be corrected and offer to write the insurance when correction is made. In this manner, the financial exposures of the public and the owner will be protected, and the insurer will write another policy. Before this corrective action can be taken, the condition must be identified. If the facts are reported on the application, the underwriter can act immediately. If not, the condition can be determined only by an inspection on a new submission if it is economically feasible to do so. On existing policies, a claims report may indicate the existence of problems. In either case, it is important that the underwriter secure the facts. Then the alternatives can be considered and one of these should certainly be to recommend correction of the mechanical deficiency as a condition to writing or continuing insurance. Unrepaired damage can be handled in the same way. Minor damage can be ignored, except perhaps to note its existence so that it is not included again under the settlement of a later loss. More serious damage can be dangerous to pedestrians or occupants. Again, the best procedure is not to reject coverage automatically, but to be certain that the facts are correct and to then recommend correction. If repairs are made, the risk will be satisfactory from that standpoint, and a policy might be saved. Underwriters should not conclude that, as a class, people who do not correct mechanical defects or repair body damage are undesirable. There may be many reasons why improvements have not been made. If the specific condition of an individual automobile is poor, insurance should not be written. But if the correction is made, this factor should be disregarded. Underwriting consideration should be given to the actual condition of the vehicle, not the underwriter’s opinion as to why the deficiency was not corrected until an underwriter made a demand. Altered cars, or those decorated, do not necessarily indicate an undesirable risk. Some operators of these vehicles are inclined to speed and take chances in close situations, but others are good, safe drivers. The fact that a person likes a showy car does not mean that person also drives in a careless fashion. This is a factor which should be checked carefully but then underwritten on the facts of each individual case. When underwriters of automobile insurance are considering a vehicle’s condition, two rules must be followed. The first is to get the facts, to find out what is actually the case on a specific risk rather than to make assumptions based on experience with the class. The second rule is to apply judgment to each risk based on its individual characteristics, and not because it is a member of a group of risks. As with the driving record, the condition of a specific risk being considered is a critical factor. This applies to the mechanical condition, any un-repaired damage and any showy alterations.

Condition of buildings.

The condition of buildings must be carefully underwritten. Deficiencies which present an abnormal degree of risk must be corrected before insurance can be written. On the other hand, underwriters must guard against taking action solely on the basis of outward appearances.

Uncut grass and peeling paint may be indicative of a careless attitude which may also be reflected in frayed wiring and overloaded circuits. These conditions may also indicate a temporary illness of the applicant or a temporary financial reversal, neither, of which has adverse implications from an underwriting standpoint. The underwriter would be justified to refuse writing insurance where the condition of property is so poor that the chance of loss is materially increased; however, the underwriter would not be justified to reject a risk because the condition of the building does not measure up to the standard of neatness which an underwriter feels is desirable. Neither the property application itself nor a related line such as automobile should be rejected merely because the housekeeping is poor by an underwriter’s standards, provided the condition does not really increase the chance of a loss. Furthermore, outright rejection is undesirable in cases where the condition of property is so poor that insurance cannot be written. Rather, the underwriter should point out the types of improvements which could be made to achieve acceptability. Reasonable demands for improvements will benefit all parties and are perfectly legitimate. Again, however, the demands must be reasonable and not arbitrary. Underwriters must recognize that standards of neatness vary by individuals, and only those repairs which actually affect the exposure to losses must be demanded. When problem areas such as poor wiring and other so-called faults of management are identified, the property owner should be notified. This gives the owners an opportunity to correct the problem. Then, if correction is made, the coverage can be written. This approach accomplishes several things: more business is written, property owners are educated on proper methods of maintaining buildings and public relations are improved. This course of action is much better than merely rejecting the risk, if the condition is one which can be improved. The facts must be obtained before such decisions can be made. Sometimes the answers on the application are sufficient, particularly if a photograph of property is also available. Other times, an inspection is needed. The producer, a field underwriter or special agent, or an inspection company can perform these inspections. Regardless of the method used, it is essential that the underwriter have the facts available before taking action on the condition of the property. As a matter of procedure, the facts should be obtained, usually by physical inspection, before rejecting a risk because of poor condition, whether this involves actual unsafe conditions or poor maintenance of the building. Age of Buildings The age of a building on its own is not a reliable indication of its desirability as an insurance risk. After a few years, deterioration sets in, but repairs or renovation can offset this. Age may be a preliminary indication that there may be problems with the property. An older home, perhaps one over 25 years of age, certainly should be checked carefully. There may be problems in wiring, overloading of circuits or in the heating system. On the other hand, each of these potential problems can be corrected. A house can be rewired, new circuits can be added and a new heating system can be installed. With such improvements, a 40-year-old house may be safer than one which is 25 years old. Only proper inspection can determine if these improvements have been made. The acceptability of a property risk should not be based on its age alone. If it is older, but the critical parts have been modernized and the building has been maintained properly, the age should not be a factor.


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Two areas may be affected by the age of a building. One is the rate and the other is the type of coverage being offered. Rates can vary by the degree of exposure to loss. A 40-year-old house which has not been modernized is ordinarily more susceptible to fire losses than a five-year-old house, and the rates can vary. Value of Buildings It is imperative that underwriters determine the approximate value of buildings before writing property insurance. Securing the proper insurance-to-value ratio is the key to the profitable writing of property insurance. By encouraging property owners to insure property for close to its full insurable value, the insurance company increases the overall amount of insurance purchased across its portfolio. As a result, the insurance company is able to offer a lower premium rate to consumers while maintaining higher overall profitability by expanding its customer portfolio. A coinsurance clause helps to discourage the customer from under-insuring property. The coinsurance clause provides that the insurance company pay a reduced benefit on a claim if the amount of insurance carried by the insured is less than a required amount stated in the policy. This amount may be 100% of the replacement value of the property or some lesser percentage. Under many homeowners policies, insurance companies require that the property is insured for no less than 80% of the replacement cost. As a result, underwriters will not write a policy for less than 80% of the replacement cost. This may present a problem for low-income applicants who cannot afford the premium on 80% of the replacement cost of the property. This underwriting guideline has come under criticism from parties who believe that the insurance company is arbitrarily denying coverage to low income consumers. As a result of the impact on profits, underwriters do not want to write a policy for less than 80% of replacement cost. At the same time, there is strong pressure to offer homeowners coverage to all people who desire that coverage, as the practice is viewed as unfair discrimination toward low income consumers. As an answer to this criticism, the insurance industry has worked to develop a homeowners policy that does not contain the replacement cost provision; instead, structures can be insured for actual cash value. An actual cash value homeowners insurance policy includes basic coverage of fire, extended coverage, vandalism and malicious mischief, burglary or crime coverage, and liability coverage. The policy provides replacement cost coverage on partial losses up to the actual cash value of the covered property. Even under an actual cash value policy, there still may be a conflict between the insurer and the consumer regarding the minimum amounts of insurance which must be written. Reasonable minimum amounts must be agreed upon because minimum amounts of premium are needed to cover expenses, and there is a point below which property is simply uninsurable other than in a specialty market. A strong tendency exists for underwriters to keep pushing the minimum amount of insurance upward. As building costs increase, the cut-off point for desirability rises; values rise with building costs. Some people feel that special handling should be taken with owners of small or low-valued homes so as to be accommodated in the regular market. Underwriters should resist the tendency to set ever-increasing minimum values and should try to offer insurance to most risks. Rates and minimum premiums may need to be raised if the statistics justify this action, but acceptability should not be affected. The value of a building, above a reasonable minimum, should not be a factor in underwriting. The risk should be eligible, and acceptability should be based on other factors. Just as the underwriter tries to avoid under-insurance, they must also avoid over-insurance in order to reduce or eliminate the temptation for arson. This can be

accomplished only by an inspection of every structure on which there is any suspicion that the amount of insurance requested is in excess of the value. Occupancy of Buildings Underwriters are justified in considering the occupancy of buildings in determining whether to write a policy, provided the considerations are based on fact and are not arbitrary. Dwelling risks with commercial types of occupancies present different characteristics than those with only residential occupants. Some of these business pursuits may have little impact on desirability, but others can substantially increase the chance of loss. Underwriters who have identified the differences and who feel that some exposures are greater than appropriate can consider these occupancies as unacceptable. Little criticism can be expected by the underwriter if the rules are based on objective factors. However, a preferable course of action would be to accept the risk and charge a higher premium if this can be accomplished. Tenant-occupied dwellings may well require different rates than owner-occupied dwellings. As for acceptability, there may be reasons for refusing to write a policy on tenant-occupied property; for example, if theft losses on such occupancies are higher than justified by the rates typically used to handle the exposure. The problem with underwriting rules regarding types of occupancy is that they may appear to actually be based on other factors, such as the location of the neighborhood in which the property is located. Still, rules regarding type of occupancy generally are satisfactory if based on actual experience and if applied uniformly to all such risks. Vacancy can be a problem in both personal and commercial risks. Extended vacancy of a building can lead to deterioration, vandalism and a temptation for arson. Underwriters are justified in rejecting applications for insurance where extended vacancy exists at a property. This action is even permitted by state regulatory plans where very few underwriting criteria are allowed in order to protect high-risk insurance consumers and high-risk properties. However, this rule must be tempered with reason, and no declination is justified if the vacancy is for a limited time only between changes of occupants. Commercial risks must be written on the basis of occupancy. Nevertheless, this should just be the starting point. Almost all occupancies can be improved by the use of protective measures. The blanket listing of occupancies as being unacceptable, without consideration of the individual risk characteristics, can only lead to criticism and more regulation. It would be much better for underwriters to try to find a means of accepting every applicant rather than to exclude some risks by type of occupancy alone. This approach means that more inspections will be needed along with a careful preparation of recommendations and verification that they have been completed. If reasonable and necessary improvements are not made, the underwriter will not be forced to accept the risk. But if substantial compliance with recommendations is verified, the risk should be accepted. Rates may need to vary by occupancy, but the insurance should be made available. The use of protective devices can be encouraged by underwriters. Underwriters should require alarms, dead bolts, barred windows or other devices where these devices will improve borderline risks. Underwriters should consider the actual occupancy of each applicant and the problems associated with that commercial occupancy. Inspections may be required to secure all of the necessary information, although detailed information may already be available from local insurance services offices which hire inspectors and engineers for that purpose. Recommendations for improvements should be made, but only where needed and never on an indiscriminate basis. The conditions and hazards of each risk should be analyzed,


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and the insurance should be written if a means could be found to do so. Only in this way will underwriters discharge their duties to both the public and to their companies. Neighborhood Insurance practices based on risk location must change. If revisions are not made voluntarily, they will be mandated by government decree. Both risk selection and rating will be affected. The unethical practice of underwriting discrimination based upon risk location is referred to as “redlining.” More specifically, redlining has been referred to as a practice which results in significant fair or unfair geographic discrimination in terms of rates, extent of coverage or availability of coverage. Whatever reasons underwriters use to explain subjective selection based on geographic location, the public and the regulators simply will not tolerate the practice. Selection must be based on the characteristics of the risk itself, not the neighborhood. This approach must also extend to the evaluation of producers to be employed by insurance companies. A company should not refuse to appoint a producer because of the latter’s office location or the location of his or her customers. Existing producers should not be terminated or restricted because of location either. Age of Insured Underwriters have long felt that since accident frequency of youthful drivers, as a class, is considerably above the average, special attention should be given to all members of that class. Young people have been driving only a relatively short time; too brief a period to have established their own patterns. Individuals may have good driving records, but this may stem from their limited access to an automobile and to careful driving because they know they are being watched. The only safe approach is to limit acceptability of the class members and to charge higher rates to all of them until they have reached enough maturity to establish their own driving patterns. Elderly drivers have been viewed in much the same fashion as youthful operators. They are mature and have demonstrated their method of driving, but some loss of ability is common as a person ages. Again, the uncertainty concerning the class is present. Knowing that some persons lose some of their driving ability above age 68 or 70, underwriters tend to reject all such applicants. In some instances this practice has continued even while actuaries have determined that elderly drivers are better than the average driver, and reduced rates have replaced the former surcharges. Individuals in both of the aforementioned groups argue that they should be evaluated on their own performance. They resent being grouped with other drivers of similar ages, some of who have poor driving records. Sex Underwriters have been having difficulty in adjusting to the concept of ignoring sex in both selection and rating. Statistics have seemed to support different rates and selection patterns by sex, particularly in youths. Even though some later statistics appear to erase many of the differences, these statistics are not yet concrete enough to convince underwriters to change voluntarily. Where statistics are credible and irrefutable, insurers may be able to use different classifications for a time, although this may disappear in the near future. Where data is not so certain, underwriters should probably drop all consideration of these factors; any continuation under these circumstances will only lead to further laws and regulations with respect to underwriting. Marital Status Marital status virtually has been eliminated as an underwriting factor. This factor is expressly prohibited in many states. In addition, single, separated, widowed and divorced persons represent such a large share of the market

that the industry has determined that any underwriting rejections based solely on marital statuses would cause considerable harm to the insurance policy sales. Occupation The occupation of the applicant is not considered to be a valid selection factor. Its use is prohibited in some states. In other states, the trend is the same, and most observers agree that a reasonable approach to underwriting requires that occupation not be used as a selection device. This is not to say that occupation must be completely ignored. It might be a clue to other factors which should lead to rejection of the application. The occupation may indicate a risk which needs to be investigated in certain respects in order to determine acceptability. The characteristics of the individual applicant should be the guide, not the occupational group in which the applicant falls. If some occupations are marked by certain undesirable traits in many cases, the individuals who bear those traits may need to be rejected. On the other hand, those who do not show those traits should not be rejected simply because they work in that occupation. Specific examples, using traditional groups, illustrate the practices which should be used. Travel.

There is no doubt, that some people who travel extensively are more exposed to theft and loss than normal. This increased exposure can be caused by the merchandise carried, the type of transportation used, the geographic area traveled, the type of living quarters used while traveling and the attitude of the applicant toward protecting property. If an applicant has a history of losses because of these characteristics, the application may need to be rejected, or limited in perils or by deductibles, because of those losses. In such cases, the underwriting action is taken because of loss history, not the occupation itself. An applicant who travels in the course of work but who has not had any such losses is apparently not subject to these adverse traits exhibited by others. A good loss history can be due to many factors. If such is the case, an individual should not be rejected on the basis of the occupational hazards. Each individual applicant should be underwritten on other aspects of loss exposures, not just the fact that travel is an inherent part of the occupation.

Transients. Exactly the same type of approach should be used during the underwriting of applicants whose occupations are historically considered to be held by transients. Many of these people are in the restaurant, hotel and other such service based industries and may drift from job to job, but many others are just as steady as office workers. Most of the potential underwriting problems of people in these occupations can be specifically identified. Excessive usages of alcohol or drugs, high incomes that attract lawsuits and poor premium payment records are major concerns. Each of these may be justification for taking underwriting action. When a person in one of these transient-type occupations is found to present a specific problem, action should be taken on that basis. On the other hand, if an individual applicant does not present these problems, action should not be taken solely because of occupation. The emphasis should be on the individual characteristics of the applicant, not on the general characteristics of the group in that occupation.

Other factors. The same type of handling is desirable on applicants in other occupations. Military, students, ministers and other groups which concern some underwriters, can include both acceptable and unacceptable risks. The underwriter should get the facts about the specific qualities of each


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applicant and make a decision on that basis, not on the occupation itself.

Illegal activities are the exception. No government agency would require the writing of insurance on known illegal activities. Where the facts show that the applicant is engaged in such activities as smuggling or maintaining a house of ill repute, rejection is the only reasonable course of action. Stability An applicant’s “stability” is not a reliable underwriting factor without further clarification of the term. Factors which indicate stability or instability must be used carefully, as some may be prohibited by law or common practice as underwriting factors. Some of these are discussed in other sections, such as marital status and occupation. Other factors which are sometimes applied are the period of time on the job or in the area, the number of jobs or addresses during recent years (such as five years) and transient types of living quarters (hotels or motels, for example). Underwriters can use such factors if they can prove that the chance of loss is increased in such cases. Some companies may have statistics on policyholders with hotel or post office box addresses. With adequate proof of an impact on losses, such rules can be used. Without statistical proof, underwriters should not use these stability factors as primary selection rules. However, information on these items can be gathered because they might point to other types of problems. Tenants may offer particular problems. The loss ratio on tenants’ homeowner policies may be worse than for policies which insure the dwelling as well as contents and personal liability. If certain groups of tenants can be identified as being worse than the average, such as those who have lived in four or more locations during the past five years, this could be used as a selection factor. In the absence of such specific statistics, rate adjustments are a more logical solution than merely assuming that all tenants are unstable. Commercial underwriters could justify the use of a years-in-business rule for acceptability, based on statistics showing failures and bankruptcies. Such an arbitrary rule, particularly if it is longer than one year, will restrict sales and may be considered unreasonable. It would be preferable to use this as a guide, but to look at the work history and experience of the applicant in making the final decision. Social Maladjustment The involvement of applicants with such social agencies as welfare and public health clinics may be statistically proven to increase loss frequencies. However, this factor should never be used as a sole reason for taking underwriting action. As with other factors, this type of involvement may indicate other problems. When such is the case, action may be required because of these other factors. Underwriters should disregard any apparent social maladjustment in applicants, especially if this is indicated by contacts with social agencies, unless other adverse factors are present. Attitude Underwriters are interested in every factor that may affect the chances of loss involving applicants and policyholders. Thus, underwriters could be expected to use study results which show that certain “attitudinal characteristics” have been present in a large number of fatal accidents. The use of these characteristics has not been prohibited. At the same time, underwriters should be aware that abuses of a factor such as this could lead to restrictions. Underwriters wanting to use the attitude of the applicant as a selection tool will have difficulty in securing accurate information. An investigation report is virtually the only source which can be used to underwrite prospective new clients. With these reports, there is always the danger of a personality clash between the investigator and the applicant or a set of circumstances which the investigator might read incorrectly.

A neighbor may bear a grudge toward a person and will accuse that person of belligerence or argumentativeness. Caution must be exercised in using information secured from a single source when it involves a factor of this type. Information on existing policyholders may be secured from claims reports. This may be the best source to learn about attitude because it is at the time of a loss that verbal accusations, negativism, belligerence and similar traits are most likely to be revealed. The potential problem of a personality clash is present here too, so care must be taken in using this information. When adverse attitudes have been verified, underwriters may take action on that basis. They must realize that such a decision is subject to challenge and perhaps reversal by a regulator. On a case-by-case basis though, this factor may be very relevant and defensible. Too much use of this factor can lead to problems. Taking action on borderline cases, or without proper verification, could cause regulations to be imposed. Therefore, this characteristic should be employed only in serious cases, and then only with other types of problems which indicate the desirability of underwriting actions. Criminal Record Underwriters who become aware of an applicant’s criminal record must give serious consideration to this factor. Certain types of past criminal activity, combined with the temptations and opportunities of many lines of insurance, could substantially increase the chances of loss. On the other hand, other types of past criminal activity may have no relationship to the exposures of a particular line of insurance. Where this is the case, no underwriting action is justified. The individual circumstances of each case are extremely important. The date of the crime may govern; a conviction for car theft by a youth may not be relevant to the exposures when that person has grown to middle age. The type of crime may be important; assault and battery may be no problem for fire insurance but critical to automobile insurance. A record of petty theft or shoplifting may not concern an automobile underwriter but may be very important to a commercial underwriter. In every case, the underwriter must secure all of the relevant factors when a criminal record is discovered. This factor may justify a rejection. Many cases, however, will not be affected by this factor, and no action is warranted. Where circumstances do not call for underwriting attention, a setting aside of this information will both help sales and assist in keeping outside restrictions to a minimum. Mental Incompetence Underwriters cannot ignore evidence of mental incompetence of applicants. This condition can be very serious, particularly while driving a car. The pressures of driving, or even of living under many conditions, are great enough for normal people without adding the extra factor of mental instability. This condition is difficult to measure. There are many degrees of incompetence. Some people can respond to treatment, resulting in complete recovery. A blanket approach is not valid. The facts of each case must be obtained. When they indicate a non-harmful degree of incompetence, or a full recovery, the factor may be ignored. When the facts indicate potential problems, careful consideration must be given. All of the available facts about each such case must be analyzed. The decision must be based on these facts, whether to accept or reject. When care is taken, and the decision is based on a careful weighing of the facts, underwriters can expect support for their actions, rather than criticism. Physical Impairments Studies have shown that physically handicapped drivers are generally no worse than average drivers. In many cases, they are better.


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In the face of these indications, underwriters must abandon their long-held impression that driving problems are expected when insuring applicants with physical impairments. Where laws prohibit the use of these factors in the selection of risks, naturally these laws must be followed. In other states, judgment must be used, but with consideration of each individual case, not a blanket refusal to write such applicants. The only line of property/liability insurance in which the physical condition of the applicant has been used by underwriters is automobile insurance, both personal and commercial. The problem, then, is to determine those characteristics which actually affect driving ability. Different types of disabilities can offer different types of concerns for underwriters. Orthopedics.

The orthopedic group includes those physically handicapped persons who do not have use of one or more extremities because of loss, paralysis or serious deformity. The underwriter may need to secure and verify additional information about these disabled drivers.

Medical. Physical impairments which might be called “medical” or “seizures” include heart ailments, diabetes, and epilepsy. Although studies have not been detailed on each of these, indications are that these persons generally have better driving records than the average. This means that underwriters are not justified in automatically rejecting applicants having these conditions. At the same time, underwriting is concerned with individual applicants, and some persons having these impairments may be subject to driving problems. Doctor statements can be particularly helpful to the underwriter in these cases.

Hearing impairments. There are many types and degrees of hearing impairments. Most people with hearing impairments can hear traffic noises, often with the use of hearing aids, even though many of them cannot distinguish words. It is this ability to hear traffic sources that is crucial to automobile underwriters. Studies conducted in some states have indicated that people with impaired hearing are better drivers than the average. Other studies have arrived at the opposite conclusion. There is only one-way to for the underwriter to reconcile these conflicting reports; underwrite on an individual basis. Undoubtedly, some hearing impaired people are excellent drivers while others have poor driving records. This is the same as for any other group. A blanket rule for all members of a group simply does not fit.

Impaired sight. Different degrees of impaired sight also are found in the population. Many drivers wear glasses and most of these drivers enjoy adequate correction to permit normal living.

Fire insurance, health insurance and other lines probably should not apply underwriting selection because of total or partial blindness, unless actual experience indicated that such action is justified. Some states have adopted laws or regulations which refer to the “physically handicapped” or the “partially sighted.” These terms would apply to impaired sight unless specifically excluded. Where these controls are in effect, underwriters must not use these factors in the selection process, of course. In other states, each individual applicant should be considered on the merits of the case. Serious impairment of sight could be justification for refusing to write automobile insurance, but it seldom would be justified on other lines. If the impairments are not serious, the applicant should be accepted. Alcohol and Drugs Underwriters are justified in being concerned about the use of alcohol and drugs by drivers. Studies have indicated that usage is increasing and is a contributing factor in accidents.

Alcohol is estimated to be involved in roughly one-half of all highway fatalities, according to various surveys conducted by the National Safety Council and others. Drugs are being identified as a factor in an ever-increasing number of accidents. The picture is not yet clear as to the volume of cases involving only drugs or those involving both alcohol and drugs. Foreign Born The national origin or ancestry of an applicant should not be a cause for rejection. Both laws and the present climate prohibit taking underwriting action because of this factor. Most applications for insurance no longer request information on national origin or ancestry. Seldom do they request answers concerning the ability of the applicant to read, speak or understand English. In spite of suspected underwriting problems because of these deficiencies, the information simply is not available on most new submissions. However, these facts will come to the attention of underwriters in some cases. Producers concerned about a language deficiency might add comments to applications. Often, a claim will reveal the problem, and the adjuster may point this out to the underwriter. Where language or comprehension difficulty is discovered, the underwriter should not take action solely on that fact. This is prohibited in many states and would be criticized in others. At the same time, this information does not need to be ignored. Further investigation might be conducted to determine if there are other potential problems. Some persons with language difficulties may be found to have poor driving records, whether related to this factor or not. Other problems may also be found and the combination of borderline items may be enough to justify declination or cancellation. Underwriting action should never be taken solely because of the national origin or ancestry of an individual. This factor can be used as one item in the total picture, and may point to other deficiencies which would require action. Related Business Underwriters should no longer require the purchase of other policies with the same company before a requested coverage is written. The economies in investigation and underwriting expenses, and the desire for a more profitable coverage to offset an unprofitable one, simply cannot be justified. Each line should be priced so that it can stand on its own. Current underwriting standards discourage requiring an applicant to purchase additional policies as a condition to approval. Regulators agree that potential insureds have a right to purchase the coverage’s they desire, from the companies they desire, without any requirements of related business by the insurer. The requirement may be aimed only at efficiency, but it comes across poorly to applicants. Prior Insurance Underwriters are taught to secure as much information as possible in order to select applicants intelligently. One item of information which was used regularly was the name of the prior insurer, if any. This practice could continue if its only purpose was to verify the accident record from the prior insurer. While some insinuations have been made about “exchanges of privileged information” and some underwriters feel that the Fair Credit Reporting Act (including related state laws) may prohibit this practice, this is probably a valid source of reliable information. Unfortunately, it is difficult for underwriters to ignore other facts which reach them. If the prior insurer is a substandard writer, an underwriter may find it difficult to overlook this. If no insurance is reported to have been carried, it is a natural tendency to wonder if something is being hidden. This related use of the information that arouses suspicions among regulators.


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Underwriters have only two possible paths of action in such cases. Use the name of the prior insurer only as a means of securing facts about the losses which have occurred and disregard all other possible uses of the information. Underwriters should not even request data about the prior insurer. Prior Cancellation In the previous section, it was indicated that underwriters might want to continue to secure specific information concerning a prior insurer. Regardless of most information, it is obvious that no action should be taken solely because of a previous rejection or cancellation. Severe criticism will result from underwriting decisions based solely on the actions of others. Underwriting rules are presumed to be different by company. One of the quickest ways to arouse antagonism is to reject or cancel coverage solely because another underwriter took similar action. This does not mean, however, that an underwriter should ignore the actions of prior insurers. In fact, this may be the most valuable item of information which is secured by finding out about the previous insurer. This factor is one of the best examples of how “balanced underwriting” can be practiced. The secret is how underwriters use the information that a prior insurer had obtained to reject or cancel the coverage. The wrong course is to automatically reject the applicant. Not only will this bring down the wrath of regulators, it may also cause the rejection of some business which would be perfectly acceptable since insurers aim at different sectors of the market. The right course is to use the fact of a prior cancellation as another warning flag. A smart underwriter will immediately start to secure more information about the applicant. Such investigation may reveal a poor driving record or other such factors which would be adequate cause for rejection. This last factor to be discussed, the rejection or cancellation by a prior insurer, is a good illustration of how underwriters can continue to select risks under the watchful eye of govern-mental regulators. Factors which have caused concern to underwriters in the past, need not be ignored. However, they should not lead to a blind reaction based on past practices. Rather, these factors can point out the need for the securing of more facts before accepting an applicant. Then, based on complete information, a decision can be made which complies with the laws and regulations and still senses the needs of the company and the public. Conclusion As an insurance producer, you are likely to be asked significant questions by your customers regarding the underwriting process and the likelihood of your customer obtaining a policy. The preceding description of the multitude of issues involving property and casualty underwriting should help you identify many of the concerns which can be expected from customers. Underwriting will continue to evolve in a manner which balances fairness with the profit-taking nature of the business of insurance.

CHAPTER 4 – LIFE INSURANCE Having already examined automobile insurance, homeowners insurance and personal property insurance and the underwriting issues associated with those property and casualty policies, we now turn to a discussion of life insurance. Many individuals will turn to his insurance producer for advice regarding the sensitive subject matter of life insurance. While customers may be hesitant to discuss the purchase of an insurance policy which contemplates their demise, life insurance is one of the most important products which an individual must consider obtaining in order to provide financial security to loved ones. The Life Insurance Policy Life insurance is a contract between an individual and an insurance company. In this contract, the insurance company agrees to pay a stated amount of money to a beneficiary, under certain conditions, in exchange for a sum of money called the premium. It is important that you understand that a life insurance policy, like any other insurance policy, is in fact a legal contract. In other words, it is an agreement between the parties that the insurance company shall perform in exchange for the premium that is paid to the company. Uses of Life Insurance Life insurance is primarily used to function in personal and family situations. As a rule a person’s death creates an immediate need for money. The following is a list of some of the needs that might be created from a person’s death. Expenses created by final illness. Burial and funeral expenses. Debts that are due at time of death. Costs to administer the estate. Federal and state death taxes. Inheritance taxes.

Money may also be needed to provide for the following: Payoff mortgages or purchase a new home. Provide an education for children. Meet unexpected financial needs.

Life insurance can also provide benefits for business situations. Here are a few examples: Loss caused by death of a key employee. Collateral for loans. Buy-out of the business interest of a deceased owner. Fringe benefits for employees.

Life Insurance as a Property Very few people consider the fact that life insurance is a property. Where else could an individual make a premium payment of $100, and create an immediate estate or property valued at $250,000? Of course, that is possible with life insurance. Here are some advantages of life insurance as property: As an asset it is very secure. There is no managerial care required for the property. It can be purchased in any desired amount. It provides a reasonable rate of return. Proceeds are payable immediately upon death of the

insured. The insured chooses the method of payment for

premiums. The Life Insurance Application Three Parties to an Application A life insurance application contains three parties: The Proposed Insured. This is the person whose life is

being insured by the life insurance policy.


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The Applicant. This is the person that is making application to the insurance company for the life insurance and may or may not be the proposed insured.

The Policyowner. This is the person that usually pays the premiums and the person who retains all rights to any values or options contained in the policy.

The great majority of policies are issued on the application of the person to be insured who is also the owner of the policy. In the typical situation, the policyowner, the applicant, and the insured will be the same person. There are, however, many policies issued where someone other than the insured applies for and owns the policy. The situation in which someone other than the insured is the policyowner is referred to as “Third party ownership.” This type of arrangement is often found in family situations where, for example, a wife will insure her husband, or vice versa, or a parent will insure children. Third-party ownership is also often found in business situations, where a business insures the life of a key employee, for example. Another common third-party ownership arrangement is where a creditor owns a policy on the life of a debtor. Insurable Interest For a life insurance policy to be issued, an “insurable interest” between the insured and the policyowner must be present. In this regard, it is necessary to examine insurable interest from two standpoints. First, we’ll look at the situation in which a person applies for insurance on the life of another. Then, we’ll look at insurable interest when a person applies for insurance on his or her own life. We will examine the conditions that must be present to satisfy the insurable interest requirements in each of these situations. Again, to purchase life insurance on the life of another, an insurable interest in the life of the proposed insured must exist. The policyowner must benefit, either emotionally or financially, by the insured continuing to live. Generally, for an insurable interest to exist, the potential emotional loss must arise from love and affection which grows from a close blood relationship, or marriage. And, of course, where one’s own life is concerned, each person has an unlimited insurable interest in his or her own life. Suppose that a life insurance policy could be sold when no insurable interest requirements existed. If a person could apply for insurance on the life of another without this interest, then the policyowner would stand to gain, and suffer no emotional loss, by the insured’s death. As such, a life insurance policy would constitute a mere wager which would be clearly against public policy, and therefore illegal. An insurable interest may arise out of a close blood relationship, but being the relative of a potential policyowner does not automatically establish an insurable interest. For example, under most circumstances, a person would probably find it difficult to establish an insurable interest in an aunt, uncle, or cousin unless the policyowner could show that a significant financial or emotional loss would result upon the death of the relative. There is another important aspect of insurable interest; the relationship between a policyowner and a creditor. This relationship brings about another type of insurable interest. A creditor can establish an insurable interest with a debtor. For instance, assume a bank loans $5,000 to an individual. Obviously, the bank will suffer financially if the debtor dies before the loan is repaid. This fact establishes the insurable interest between the bank and the debtor. For this reason, the bank can purchase life insurance on the life of the debtor and receive the death benefit of the life insurance policy, but only in an amount which reflects the balance of the unpaid loan, should the debtor die prior to repaying the loan. Insurance purchased by a creditor on the life of a debtor must be in an amount that approximates the size of the debt. So, if a debtor owes a creditor $1,000, the creditor could not purchase a $10,000 life insurance policy on the life of the debtor.

For this reason, most credit life insurance purchased on the life of a debtor has a reducing death benefit, which keeps pace with the diminishing loan balance. Therefore, if a debtor owes $5,000 to be repaid over a period of five years, the death benefit might begin at $5,000 to match the original amount of the loan. However, this policy would eventually reduce to $0 at the end of five years when the loan has been repaid. The Application Form In order for a person to purchase life insurance they must make a request to the insurance company of their choice. The form on which this request is made is the application. Most companies now require that the proposed insured be physically present in front of the agent while the questions on the application are answered. The application is crucial in that it provides the data that the underwriters and insurance company will use to determine whether to issue a policy. The application is a life insurance company document containing questions and information, which the company uses in evaluating the insurance risk and in properly preparing the policy if one, is issued. The agent completes the application by asking the applicant the questions. The information requested on the application generally includes items such as the applicant’s full name and address, age, sex, marital status, occupation, medical and family histories, present physical condition, and a description of the type and the amount of insurance applied for. It also includes the name of the person who is the beneficiary of the insurance along with data on other insurance owned and applied for, as well as whether or not the applicant was ever refused life insurance. In view of the importance of the application, it is essential that the application be completed fully and accurately. If the application is incomplete, the underwriting process and policy issue will be delayed until the necessary information is obtained. The company depends upon accurate information to make a proper evaluation of the proposed insured. When the proposed insured signs the application, it constitutes a formal request to the company that a policy be issued on the proposed insured’s life. In addition, the signature on the application indicates that the information is true and correct to the best of the knowledge of the proposed insured. Minor Applications In most states a person is not considered an adult until the person is 18 years of age. As a rule, minors are not permitted to enter into contracts. However, life insurance is the exception in that a person is a minor only until age 15. In the event that the proposed insured is younger than age 15, one of the following persons must sign the application on behalf of that child: The mother or father. A court appointed guardian of the minor. The child’s grandparent.

Correcting Applications Should it be necessary to correct a mistake regarding information given on the application, the proposed insured must initial any and all changes on that application. Mistakes on the application can be costly especially when the company is usually paying an outside reporting service to conduct an inspection. Any changes that are made on a completed application must have the approval of the proposed insured. The normal procedure is to return the incorrect application to the agent who in turn will take it to the insured to have the corrections initialed. Incorrect or Incomplete Applications Should an application contain incorrect or incomplete information it should not be taken lightly. In the event that the company has already made a decision on a risk based on these inaccuracies, it could result in a serious loss.


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If the error is discovered after the issuance of a policy, the company can cancel or rescind the entire contract from the date of issue. Of course, this must take place before the incontestability clause of the contract takes effect. The incontestability clause provides a date after which the insurance company cannot contest the information in the application. Representations and Warranties All statements on applications are regarded as representations. When a person makes a statement that person believes to be true, the person is in effect making a representation of the truth. While it is possible that a representation may be found to be untrue, a person who makes a representation believes it to be true. A warranty on the other hand is a statement made with such absolute certainty that it is guaranteed to be true. No statement on an application is considered a warranty. A false representation can be defined as a misrepresentation. Fraud There are three elements necessary to constitute a fraud. They are: A person makes an intentional misrepresentation of what

is known to be a material fact. The person has intent to gain advantage from the

misrepresentation. A person relies upon that misrepresentation and suffers a

loss. Concealment Concealment is closely akin to misrepresentation when it comes to information included on a policy application. While misrepresentation as stated earlier is something known to be untrue, concealment is withholding of facts that the applicant should have given to the insurance carrier at the time of application. Conditional Receipt It is best to always collect the first full premium from the applicant at the time of application. The receipt that is located at the bottom of the application is called a conditional receipt. The word “conditional” is very important because the agent is not guaranteeing that the policy will be issued. Issuance of the policy is subject to the full approval of the insurance carrier. The conditional receipt serves two functions: It acknowledges the first full premium. It states in very clear terms that the policy acceptance is

subject to the approval of the carrier. In the event the proposed insured dies before the policy is issued, the premium will be returned to the beneficiary. Policy Effective Date / Backdating Full protection takes effect as of the policy effective date. The policy effective date is the date on which the contestable period begins. The policy effective date also is the date on which the suicide clause in the life insurance policy begins to run. The suicide clause provides that a beneficiary will not be paid a benefit under the life insurance policy if the insured commits suicide within a certain period of time following the policy effective date. Policies can be backdated a certain number of months. As a rule, the maximum is to backdate six months. Most companies allow backdating for sales reasons. For example: Often, backdating can save an age by one year for the

proposed insured and this can result in a lower premium for the proposed insured.

Backdating is useful to assist the policyowner in coordinating dates to fit their income pattern. Perhaps the backdating may change the policy premium due date to closely match payday.

Occasionally some policy forms have minimum and maximum age limits and backdating may help to put the

applicant’s age within the window of acceptable age limits.

How Much Life Insurance Do I Need? As an insurance agent, you will undoubtedly be asked the question: “How much life insurance do I need?” This is an important question to answer because the majority of families in America are inadequately insured. As a general rule it is said that a person should carry life insurance equal to five or six times their annual earnings. Types of Life Insurance There are many types of life insurance available. We will discuss the following: Term insurance. Whole life insurance. Universal life insurance. Variable life insurance. Adjustable life insurance. Modified life insurance. Family life insurance.

Term Insurance This is the most basic type of life insurance. Some of its characteristics are as follows: Term Insurance provides only temporary protection from

one to twenty years or until the insured reaches a specified age. Should the insured be alive at the end of the term period the protection expires.

Term Insurance has no cash value or savings element. It is strictly pure protection.

Term Insurance can be renewable and/or convertible. Renewable means that you can continue the coverage for additional periods without proof of insurability. As a rule, the premium increases each time the policy is renewed based on the age of the insured at the time of renewal. Convertible means that the term policy can be exchanged for some type of cash value insurance without proof of insurability.

The premium for a term insurance policy is based on a person’s age, health, whether or not he or she smokes and the amount of coverage. Term insurance premium prices are easier to understand than other life insurance policies. One simply pays a specified price for each $1,000 of death benefits.

Term Insurance comes in a variety of policies. These include: Yearly renewable term.

This type of policy is issued for a one-year period and the policyowner has the right to renew coverage for successive one-year periods. If term insurance is not renewable, the company selling the policy can require a medical examination when each period begins.

Five, ten, fifteen or twenty year term. Although a one-year term is the least expensive, term insurance can be purchased for a specific period such as five, ten, fifteen or twenty years, and in some instances even longer periods. The premium remains level during the policy term, and the premium will increase if the policy is renewed at the end of the term.

Term to age sixty-five or seventy. In this instance the term insurance is provided to a stated age. The premium remains level during the policy term and the insurance expires when the stated age is attained. As a general rule, the insured has the right to convert this term insurance to a cash value policy; however the policy must be converted sometime prior to the expiration date.

Decreasing term. With a decreasing term policy, although the premiums remain level during the policy term, the face amount of insurance gradually decreases over time. For example a $100,000 policy issued for a decreasing term of 30 years


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could decline to $50,000 by the end of the twentieth year and zero by the end of the thirtieth year.

Re-entry term. With this policy the premiums are based on a low-rate schedule. Under the terms of this policy, however, the insured must repeatedly demonstrate evidence of insurability, usually every one to five years.

Whole Life Insurance Whole life insurance is so named because it lasts for the insured’s whole life. The premium stays the same forever. Critics of whole life state that the policyholder overpays for that protection during the younger years of the insured, which would negate the savings during later years. Whole life insurance contains the basic elements of term insurance, with an investment element added. The insured pays a premium amount greater than the premium which would be paid for term insurance, and that portion of the payment is invested for accumulation over the life of the insurance policy. The growth on that investment is not taxable to the insured. This favorable treatment of return on investment is unique to life insurance and offers a substantial wealth accumulation vehicle. Traditional whole life is different from term insurance because it offers both protection and cash value. With a whole life policy, the cash value builds slowly. Life insurance companies stress it as a positive for its value as a savings account. Cash value is money that would be paid to a policyholder when the policy is surrendered. This is sometimes called the surrender value of the policy. With whole life, part of the premium buys the insurance, and part goes toward the cash value. This interest is tax-deferred and remains tax free if a person never utilizes the cash value before his or her death. Some examples of whole life insurance include: Ordinary life insurance.

Ordinary life insurance is a form of whole life insurance. Lifetime protection is provided until age 100 and the premiums remain level. In the event the insured is still alive at age 100, the full-face amount will be paid without death having to occur.

Limited payment life insurance. This is another form of whole life insurance. Although the premiums are level, they are only paid for a certain number of years. After that payment period the policy becomes fully paid up. Limited-payment policies can be issued for ten, twenty or thirty years. A policy that is paid up at age sixty-five or seventy is also available. The premiums for limited-payment policies are higher than an ordinary life insurance policy but the cash value is also higher.

Endowment insurance. This is the third basic type of whole life insurance. An endowment pays policy proceeds to the named beneficiary if the insured dies within a certain period. If the insured survives to the end of the stated period, the policy proceeds are paid to the policy owner.

Universal Life Insurance This variation upon whole life insurance became extraordinarily popular after its introduction. Universal life policies are sold as investments that combine insurance protection with savings. Actually, a universal life policy can be defined as a flexible premium deposit fund that is combined with monthly renewable term insurance. Here’s how it works: FIRST – An initial specific premium is paid. Then expenses are deducted from the gross premium and the balance is credited to the policy’s initial cash value. SECOND – A monthly mortality charge is deducted from the cash value to pay for the pure insurance protection.

FINALLY – The remaining cash value is then credited with interest at a specified rate. Universal Life has the following basic characteristics: Protection, savings, and expense components are

separated. There is a stated investment return. The plan offers considerable flexibility to the insured by

permitting the insured to increase or decrease the premium and the corresponding death benefit during the life of the policy.

Cash withdrawals are permitted. In some states, universal life is referred to as “flexible-premium adjustable life.” This describes many of its benefits. Universal life can be a useful tool to meet changing needs. It can also be useful if one’s income fluctuates from year to year. A person can vary his or her premium if he or she has a year with lower income. When someone varies his or her premium, the death benefit will fluctuate along with it. Universal life offers tax advantages to the insured because the investment value grows without current taxation. The tax on the interest is deferred while the policy is in force and until the funds are withdrawn. Variable Life Insurance With a variable life insurance policy, the face amount of insurance varies according to the investment experience of a separate account that is maintained by the insurer. This is the perfect solution to the problem of inflation quickly eroding the real purchasing power of life insurance. Under the variable life insurance policy the premiums are invested in equities or other investments. Should the investment experience be favorable, the face amount of insurance is increased. However, should the experience be unfavorable, the amount of insurance is reduced. In no event, however, can the amount of insurance be reduced below the original face amount. The variable life insurance policy was designed to maintain the real purchasing power of the death benefit. Variable life is not just another name for whole life. Variable life combines many features of traditional whole life with the new element of investment choice. That element is for the insurance purchaser who can live with elements of risk. Along with the freedom of choosing one’s own investments comes the inevitable risk. Variable life insurance can offer higher investment yields than a traditional whole life policy, but one must assume a greater degree of risk. Variable life might be justified if the minimum death benefit guaranteed by the policy satisfies a person’s needs, and he or she can afford to play with the policy in the hopes of achieving a better-than-average return for his or her family. Adjustable Life Insurance This variation on the whole life policy permits changes to be made in the following areas: Amount of life insurance. Period of protection. Amount of premium. Duration of premium-paying period.

This type of insurance is frequently called “Life Cycle” insurance because policy changes may be made to conform to different periods in the insured’s life. Within certain limits, the policyowner can make the following adjustments as the situation warrants: Reduce or increase the amount of insurance. Shorten or lengthen the period of protection. Increase or decrease the premiums paid. Lengthen or shorten the period for paying of premiums.

A cost of living provision can also be attached to the adjustable life policy and this will in fact maintain the real purchasing power of the insurance.


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Modified Life Insurance This is a type of life insurance policy in which the premiums are reduced for an initial period of three to five years and then the premiums increase thereafter: The initial or reduced premium as paid in the beginning is slightly higher than term insurance rates but substantially lower than the premium paid for an ordinary life policy issued at the same age. There are different types of modified life insurance: Under one type the term insurance is used for the first

three to five years and then automatically converts into an ordinary life policy at a premium that will be higher than what would have been paid for a regular ordinary life policy issued at the same age.

Under another type, the approach is to redistribute the premiums by charging lower premiums during the early years of the policy but higher premiums thereafter.

Modified life insurance can be attractive to individuals who expect their incomes to increase in the future. Family Life Insurance This is a variation upon the whole life policy designed to insure all family members in one policy. This policy is sold in units that state the amount and types of life insurance on the family members. One unit for example may consist of the following: $5,000 of ordinary life on the head of the family. $2,000 of term to sixty-five on the spouse. $1,000 of term Insurance on each child up to stated age.

As a rule, term insurance under the family life policy can be converted to some form of permanent insurance. Typically the children’s protection can be converted up to five times the face amount without proof of insurability. There is no additional premium if another child is born, and newborn children are usually automatically covered after a fifteen-day waiting period. This type of policy is no longer very common. Types of Insurance Companies Having examined types of life insurance policies, we now examine the structure of the life insurance companies offering those policies. Life insurance companies can be organized in several ways; however, most are organized either as stock companies or as mutual companies. Stock Life Insurance Company A stock life insurance company gets its name from its basic ownership characteristic. The stockholders, people who have bought stock in the company, own a stock company. The stockholders may or may not also be policyowners. The sole function of the stockholders is to elect a board of directors who in turn will guide the operation of the company. If the company is successful financially, the stockholders will receive dividends, which are paid for each share of stock owned. A stock life insurance company is in business to make a profit for the stockholders. Mutual Insurance Company A mutual insurance company is also a corporation, and it also derives its name from its basic ownership characteristic. Unlike a stock company, which is owned by its stockholders, a mutual company has no stockholders. Control in a mutual company rests with the policyowners who “mutually” own the company. The policyowners elect a board of directors, and any “profits” are returned as dividends to the policyowners in the form of reduced costs for insurance. It should be mentioned here that dividends from a mutual company are not profits in the mercantile or commercial sense but rather the return of an “overcharge” of premium. For example, a mutual life insurance company might sell life insurance at one specific age for $20 per $1,000 of face amount. Once a dividend has been declared, each policyowner might then receive credit on the premium statement in the amount of $2 per $1,000. Thus, the ultimate cost for the insurance is $18 per $1,000 of face amount.

While not true in every case, mutual insurance companies usually issue “participating” life insurance policies. The term “participating” means that if the company realizes a savings in death claims due to a lower mortality rate, or an increase in the interest earned, or if it realizes some efficiency in its operation which reduces expenses, these savings or “profits” are passed along to the policyowner in the form of policy dividends. Thus, the policyowner in a mutual life insurance company “participates” in any savings or “profits” enjoyed by the company. Insurance agents should not imply to clients that a stock company is better from an organizational standpoint than a mutual company, or vice versa, or that participating policies are better than nonparticipating ones. Both types of companies and both policies are acceptable. Before any life insurance company can sell insurance in any state, it must be licensed to sell insurance or, as it is called, “admitted” to that state. An insurer that is admitted to a state is authorized to do business in that state. If an insurer is not admitted to a state, it is unauthorized to do business in that state. Fraternal Benefit Society Another type of insurer with which you should be familiar is the fraternal benefit society, also known as a “fraternal.” A fraternal insurer is a social and benevolent organization, which provides, among other services, life insurance benefits for members. Each state defines and provides for the regulation of fraternal benefit societies in its insurance laws. But, although the exact definition of a fraternal may differ from state to state, an organization usually must have certain characteristics to qualify as a fraternal benefit society. First, the organization generally must exist only for the benefit of its members and of their beneficiaries and be non-profit. Second, it must be organized without capital stock. A third characteristic is that the society usually must be organized on a lodge system. This means that the organization must have local lodges or chapters, which hold regular meetings to carry on the activities of the society. Finally, the organization must have a representative form of government. There must be a governing body chosen by the members directly or by delegates, in accordance with the organization’s bylaws or constitution. Government Insurance Programs Government Insurance Programs have been established for a variety of reasons throughout history. Social insurance programs have been created to allow the government to make compulsory a program lacking equity in order to cover fundamental risks and to redistribute income. Government insurance programs have been created when private insurers would have been subjected to adverse selection or were incapable of meeting society’s needs. By its administration of various Federal insurance programs, the U.S. government has become the largest insurer in the world. These various programs include Social Security, Medicare, and the railroad retirement, disability, and unemployment programs. Reciprocals Reciprocals are groups of individuals (called “subscribers”) who are insured under an arrangement where each subscriber is both an insured and an insurer. In other words, the other members of the group insure each subscriber. However, the liability of each subscriber is limited. The administrator of the reciprocal is the “attorney-in-fact.” He or she is granted this power by the subscribers through a broad power of attorney and receives a percentage of the gross premiums paid by the subscribers. Other than this payment to the attorney-in-fact and administrative expenses, the cost to the reciprocal is limited to the amount of the losses that occur. Any unused premiums are returned to the subscribers.


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Lloyd’s of London Lloyd’s of London is a name familiar to many in the insurance industry. However, perhaps the most interesting fact about Lloyd’s of London is that it is not an insurer nor does it issue policies. Rather, Lloyd’s of London is an association of members who write insurance for their own accounts. The New York Stock Exchange bears the same relationship to stock purchases as Lloyd’s bears to the purchase of insurance. Like the New York Stock Exchange, Lloyd’s provides quarters for its members as well as procedures for business transactions. Though neither organization engages in trade, each provide facilities and rules that govern how its members will pursue trade. In addition, Lloyd’s maintains worldwide underwriting information and a complete record of losses. It also aids in loss settlements and supervises salvage and repairs throughout the world. At Lloyd’s, an insurance transaction begins when a proposal is placed before the underwriting members, or their agents, by a licensed broker. The broker prepares the policy and submits it to the Policy Signing Office where the policy is examined. If the policy conforms to agreed-upon rules, it is submitted to the underwriters. Those underwriters who wish to participate in the policy affix their signatures or “underwrite” the risk. American Lloyd’s associations operate under the same principles and methods as Lloyd’s of London. Insurer’s Financial Status Changing economic conditions and highly publicized failures of financial institutions (from savings and loan companies to insurance companies) have focused much attention on the financial status of private insurers. Independent rating services provide ratings consumers can use to measure the status of an insurance company and compare it to others. The two most popular rating services are A.M. Best Company and Standard and Poors. The A.M. Best Company looks at profitability, leverage, and liquidity and assigns ratings from A++ (Superior) to C (Fair) and below. Standard and Poor’s focuses on the claims paying ability of an insurer and offers ratings from AAA (Superior) to D (Insurers placed under an order of liquidation). In most cases, insurance companies pay a fee to be rated by a rating service. Other rating services include Moody’s Investors Service (measuring financial strength), and Duff and Phelps (measuring claims paying ability and managerial soundness). In addition to private rating services the National Association of Insurance Commissioners measures company performance and prepares analytical reports as part of the Insurance Regulatory Information System (IRIS). Agents have access to IRIS ratios, which serve as indicators of a company’s financial condition in various areas. Life Insurance – Policy Provisions It may surprise people that many insurance agents have never read the required policy provisions that are contained in every policy that they sell. It is important that you realize that policy provisions are in fact contractual provisions and govern what the policyowner can and cannot do with the policy you have sold them. Here is an overview of the list of provisions and then we will discuss them individually. Ownership clause. Entire contract clause. Incontestable clause. Suicide clause. Grace period. Reinstatement clause. Misstatement of age. Beneficiary designation. Change of plan provision.

Ownership Clause The owner of a life insurance policy can be the applicant, the insured, or the beneficiary. In most cases, the applicant and insured are the same person. Under the ownership clause, the policyowner possesses all contractual rights in the policy while the insured is still alive. These rights include the selection of a settlement option, naming and changing the beneficiary designation, election of dividend options, and other rights. These contractual rights typically can be exercised without the beneficiary’s consent. In addition, the ownership clause provides for a change in ownership. The policyowner can designate a new owner by filling out an appropriate form with the company. The insurer may require that the life insurance policy be endorsed to show the name of the new owner. Entire Contract Clause The entire contract clause states that the life insurance policy and attached application constitute the complete contract between the insurer and policyowner. No statement can be used by the insurer to void the policy unless the statement is a material misrepresentation and is part of the application. In addition, any officer of the company cannot change the terms of the policy unless the policyowner agrees to the change. Incontestable Clause Under the incontestable clause, the company cannot contest the policy after the policy has been in force two years during the insured’s lifetime. The insurance company has two years to discover any irregularities in the contract, such as a material misrepresentation or concealment. If the insured dies after that time, the death claim must be paid. For example, if John conceals a cancer operation when the application is filled out and dies after expiration of the incontestable period, the death claim will be paid. The purpose of the incontestable clause is to protect the beneficiary if the insurance company tries to deny payment of the death claim years after the policy is issued. Since the insured is dead, allegations by the insurer concerning statements made in connection with the application cannot be easily refuted. After the incontestable period has expired, with few exceptions, the company must pay the death claim. Suicide Clause A typical suicide clause states that the face amount of the policy will not be paid if the insured commits suicide within two years after the policy is issued. The only payment is a refund of the premiums. The purpose of the suicide clause is to reduce adverse selection against the insurer by providing the insurer some protection against an individual who purchases a life insurance policy with the intention of committing suicide. Grace Period A grace period is another important contractual provision. A typical grace period gives the policyowner thirty-one days to pay an overdue premium. The life insurance remains in force during the grace period. If death occurs during the grace period, the overdue premium usually is deducted from the policy proceeds. Reinstatement Clause If the premium is not paid during the grace period, a life insurance policy may lapse for nonpayment of premiums. The reinstatement clause allows the policyowner the right to reinstatement of a lapsed policy under certain conditions: The insured must provide evidence of insurability, a

condition that insurers often waive for lapses of less than two months.

All overdue premiums plus interest must be paid. A policy loan must be repaid or reinstated. The policy must not have been surrendered for its cash

value. The lapsed policy must be reinstated within five years.


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If the policyowner wishes to continue the same type of life insurance coverage, it usually is more economical to reinstate a policy than to buy a new one. This is because a new policy is likely to have a higher premium, since it will be issued when the insured is older than at the time of issuance of the first policy. Misstatement of Age The insured’s age may be misstated in the application. Under the misstatement clause, the amount paid is the amount of life insurance that the premium would have purchased at the insured’s correct age. For example, assume that Mary’s correct age is thirty but is incorrectly recorded in the application as age twenty-nine. Assume that the premium for an ordinary life application at age twenty-nine is $14 per $1,000 and $15 per $1,000 at age thirty. If Jane has $15,000 of ordinary life insurance and dies only 14/15ths of the proceeds will be paid, or $14,000. Beneficiary Designation The beneficiary is the person or party named in the policy to receive the policy proceeds. There are numerous beneficiary designations in life insurance. They include the following: The primary beneficiary is the first party who is entitled to

receive the proceeds at the insured’s death. The contingent beneficiary is the beneficiary entitled to

the policy proceeds if the primary beneficiary is not alive. A revocable beneficiary designation means that the

policyowner has the right to change the beneficiary designation without the beneficiary’s consent.

An irrevocable beneficiary designation means that the policyowner cannot change the beneficiary without the irrevocable beneficiary’s consent.

A specific beneficiary designation means that the beneficiary is named and can be identified. For example, Martha Smith may be specifically named to receive the policy proceeds if her husband should die.

A class beneficiary designation means that a specific individual is not named but is a member of a group to whom the proceeds are paid. One example of a class beneficiary designation would be “children of the insured.”

Change of Plan Provision The change of plan provision allows the policyowner to exchange the present policy for a different one. If the change is to a higher premium plan, such as exchanging an ordinary life policy for an endowment at age sixty-five, the policyowner must pay the difference in cash values between the two contracts plus interest at a stipulated rate. Since the net amount at risk is reduced, evidence of insurability is not required. Some insurers also allow the policyowner to change to a lower premium policy, such as exchanging an endowment contract for an ordinary life contract. The insurer refunds the difference in cash values to the policyowner. However, evidence of insurability is required since the net amount at risk is increased. Exclusions and Restrictions Life insurance policies contain very few exclusions and restrictions. The more common ones are as follows: Certain activities which are considered dangerous such

as flying, hang-gliding, auto racing or skydiving may either be excluded or covered if an additional premium has been paid.

The suicide clause described above, which excludes payment of the face amount in the event of suicide within two years of the issue date.

An aviation exclusion may be present in the policy and would exclude death coverage from an aviation accident other than as a passenger on a regularly scheduled airline.

The war exclusion is designed to control adverse selection during times of war and may be inserted to exclude payment if death occurs as a result of war.

Premiums There are two basic ways to purchase a life insurance policy. The first is by paying the entire cost in one lump-sum

payment. This is the “single premium” method. The second method of purchasing a policy is by the

payment of periodic premiums. Rather than making a single payment for the insurance, the policyholder makes annual, semi-annual, or more frequent payments.

A single premium policy is seldom purchased because of the large lump-sum payment that is generally required. The typical policyholder finds the periodic payments much easier to make. A second reason why single premium policies are seldom purchased concerns the cost of the policy if the insured dies in the early years of the contract. In this situation, the amount paid for the insurance under the periodic method will be less than the single premium amount. Parts of the Premium There are three basic factors which affect the premium charged for a life insurance policy. The first factor is mortality. Mortality refers to how many

people within a given age group will die each year. The second factor is interest. Interest refers to the

earnings the company receives on the premium dollars it invests.

The third factor is expenses. Expenses are all of the costs the company incurs in selling, issuing, and servicing its policies.

We said earlier that as one grows older, the cost of insurance increases. The reason for this is that as one grows older, the chance of death increases. Insurance companies use mortality tables and other statistics to determine the number of insureds within each age group, who will die each year. What would happen if more people died in a year than the company had predicted? The company will pay out more for death claims than was anticipated. Another factor which influences the cost of insurance is the interest income that the company earns from its investments. Insurance companies receive millions of dollars each month in premium dollars. And, while each company has death claims and other expenses, the costs for these claims and expenses should be less than the total premiums received. By law, a life insurance company is permitted to invest this extra money to obtain additional revenue in the form of interest. Most life insurance companies invest in stocks, bonds, construction projects, and in a variety of other ventures designed to provide a return on their investment. The principal, as well as the interest earned, on these investments establishes a fund to pay all death claims as they occur and also helps to offset the cost of insurance. Naturally, the insurance company is not permitted to keep all the money it receives. Expenses, of course, have to be paid. In addition to death claims, expenses include such items as: Agent’s commissions. Salaries. Advertising. Physical examinations. Legal costs. Policy issue costs.

Here is a very simple formula which indicates how these factors affect premium costs: Death claims + Other expenses - Investment interest earned = Premium to be charged. Keep in mind that no company determines the premium to be charged by the simple method we have described above. This simplified approach merely describes the important relationship between these factors.


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Net and Gross Premium The premium that a company charges for a life insurance policy is called the “gross” premium. When a company is calculating the premium for a policy, it begins by determining the “net” premium. Once the net premium has been computed, the company then adds the expense factor, or “loading,” to this net premium to arrive at the gross premium. Mortality An insurance company obviously cannot know when a particular insured will die. However, by using the mathematical concept of probability, the company can predict with a great deal of accuracy the number of insureds who will die each year. This prediction of future mortality is made on the basis of past mortality experience and assumes that future experience will parallel past experience. But, if past mortality is to be a reliable basis for prediction, accurate data must be kept on a large group of representative individuals for a sufficiently long period of time. Information on past mortality is analyzed and arranged in a table called the “mortality table” which shows probable death or mortality rate at a specific age. Beginning with a given number of individuals at a given age, the mortality table shows the number of people out of the group who probably will die at each age and the number who will survive. Remember that even if the mortality rates and the mortality table are accurate, a company which wants a reliable estimate of future mortality must apply the rates to a large enough group of individuals for the “law of averages” to operate. Level Premiums and Reserves Since few policies are purchased by the single premium method, once the net single premium is computed, the company then converts that premium into a “net level premium”. Let’s now turn to the concept of level premiums. The early renewable term premium, also called “natural or step-rate” premium, increases each year as the insured ages and the risks of mortality increase. The premium rises rather gradually during the younger ages, but increases sharply for the older ages. As a result, the premiums can become prohibitively expensive for most insureds at the older ages. To overcome the problem of annually increasing premiums, companies develop the level premium plan. With this plan, the premium remains the same during the premium payment period rather than increasing as the probability of death increases. This level premium is higher than the natural or yearly renewable term premium in the early years of the policy, but it is lower than the natural premium in the later years. Under the natural premium plan, the net premium charged policyowners each year is just sufficient to pay the expected claims for the year. This is not true for the level premium plan. The net level premium payments made in the early years of the contract are greater than the amount needed to pay the policy claims during those years. By investing the excess part of the premium in the early years, the company accumulates funds to cover the deficiency which occurs in the latter years. These funds which the company holds to meet future policy obligations constitute the policy reserve or simply the “reserve.” The reserve is the amount that, together with future premiums and interest earnings, will be sufficient for the company to pay all future policy claims, based on the company’s mortality and interest assumptions. Thus, the reserve is a liability - future obligation to the company. Because a company’s ability to fulfill its contract obligations depends upon sufficient policy reserves, each state requires a company to maintain certain minimum reserves. State laws specify the mortality table and the assumed rate of interest to be used in calculation of the legal minimum reserves.

Because of these state regulations, reserves are often called “legal reserves.” Insurance Age Premium charged for life insurance depends upon the insured’s age. This is true because the mortality factor is one of the three basic elements of the premium and the mortality factor varies with an insured’s age. However, the age used to determine the premium is the insured’s insurance age. The insured’s insurance age may, or may not, be the same as his or her actual or chronological age. A company may use one of two methods of determining an insurance age: In the first method, an insured’s insurance age is his or her age at the insured’s nearest birthday. If the insured turned age 30 less than 6 months ago, the insured’s age would be 30. However, if the insured’s 30th birthday was more than 6 months ago, the insurance age would be 31 since the next birthday would be nearer than the last. Although the nearest birthday is the more commonly used method, some companies may use the insured’s last birthday to determine the insurance age. The insurance age under this method is the same as the insured’s actual age, regardless of the number of months since his or her last birthday. Payment of Premiums The policyholder of a life insurance contract has a choice regarding how to pay premiums. Premiums generally can be paid annually, semiannually, quarterly, monthly or through monthly bank drafts. The company usually offers a discount for paying the premiums annually. The most popular method of payment is monthly bank draft. Settlement Options When benefits are paid following the death of the insured the payments of benefits is referred to as “settlement of the policy.” The following is an overview of the settlement options and then we will review them one at a time. They are: Lump sum settlement. Proceeds and interest. Fixed years installments. Life income. Joint life income. Fixed amount installments. Other mutually agreed methods.

Lump Sum Settlement This is when the beneficiary receives the policy proceeds in a single payment following the death of the insured. Proceeds and Interest Under this option the insurance company will hold the policy proceeds and make interest payments to the beneficiary. The minimum interest rate is spelled out in the policy and the company may pay a higher rate at its discretion. The beneficiary still has the right to withdraw all or part of the proceeds of the policy at any time. Fixed Years Installments With this option the insurance company pays the proceeds in equal monthly payments. The recipient of the proceeds chooses the number of years for which payments will be made. The amount received monthly depends on three factors: Policy proceeds. Number of years for which payments are to be made. Interest rate paid by the insurance company.

Again, under this settlement option the beneficiary still has the right to withdraw all or part of the proceeds at any time.


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Life Income Under this settlement option the beneficiary will receive equal monthly payments for the life of the beneficiary. The amount of monthly payments depends on four factors: Policy proceeds. Beneficiary’s sex. Beneficiary’s age at time payments begin. Period certain for which payments are guaranteed.

When payments are guaranteed for a period certain, such as ten years, payments will be made for the specified number of years regardless or whether the beneficiary lives to the end of that period. Should the beneficiary die during the period certain payments will continue to the beneficiary’s designated successor.

For example: A beneficiary is going to receive $500.00 a month for 10 years certain. This means that should the beneficiary live the entire ten years he will receive $500.00 a month. After ten years there are no more benefits paid. However, if the beneficiary dies in the sixth year the remaining four years of $500.00 per month will go to his designated successor. Joint Life Income When this option is chosen, equal monthly payments will be made so long as either payee is alive. This option may be used when an insured contributes to the support of his or her parents. In the event of the insured’s death, the parents, as beneficiaries, would receive monthly income for the rest of their lives. The amount of the monthly benefits would depend on two factors: The policy proceeds. Parents’ ages at time they begin to receive benefits.

However, under this option the beneficiaries typically do not have the right to discontinue the monthly payments and receive the balance in a lump-sum settlement. Fixed Amount Installments Using this settlement option, the insurance company makes equal payments per month, or at longer intervals, in an amount chosen by the policyowner or beneficiary. All proceeds held by the insurance company will earn interest. If the monthly payment is greater than the monthly interest earned, the balance of the proceeds held by the insurance company decreases each month until the total proceeds and interest due are paid out. Under this option the beneficiary may withdraw the unpaid balance at any time. If the beneficiary dies before the installment payments are completed, the unpaid balance is paid to the beneficiary’s estate. Other Mutually Agreed Method On occasion a life insurance company may allow the policyowner to designate other payment methods. An example of this may be that the proceeds and interest are to be paid to the insured’s spouse for the spouse’s lifetime and, upon the spouse’s death, a lump-sum settlement is to be made to the insured’s children. Non-Forfeiture Options Life insurance policies contain non-forfeiture options. They are designed to give the insured ways in which he or she may gain continued value from a policy in the event the insured is unable to continue premium payments. The five non-forfeiture options are as follows: Cash surrender value. Reduced paid-up insurance. Extended term insurance. Automatic loan provision. Dividend accumulations to avoid lapse.

We will now discuss each of these non-forfeiture options.

Cash Surrender Value If the policyowner is unable to continue paying premiums, he or she may surrender the policy and request that the company pays the cash surrender value of the policy, if any. As a rule most policies have no cash value whatsoever for the first two to three years. The cash surrender value usually consists of the following: The policy cash value. Cash value of paid-up additions. Dividends.

The cash surrender value can be reduced by: Any policy loans that are outstanding. Accrued loan interest on outstanding policy loans.

It is important to know that all coverage ceases when the policy is cash surrendered. Payment is usually made in one lump sum and in some cases in accordance with one of the other policy settlement options already discussed. Reduced Paid-Up Insurance Under this option the policyowner may request that the cash value of the policy be used to keep a reduced amount of paid-up insurance in force under the same policy. Usually the policy has a table contained in it that shows the amount of reduced insurance in any given year which the cash value would purchase in that year. Although the policy has had its face reduced, the policy will continue to earn cash value and pay dividends if applicable. Extended Term Insurance This option allows the same face amount of the policy to remain in effect for a specified number of years and days. Again, as with reduced paid-up insurance the policy will contain a table showing how long in years and days the original face amount will remain in force during any given surrender year. The length of time in years and days is calculated by taking the policy’s cash surrender value, the insured’s age and sex at the time premiums were discontinued, and using that cash surrender value to purchase term insurance for a specified amount of years and days. Under this option the policy does not continue to earn cash value or pay dividends. Automatic Premium Provision It is possible for the insured to authorize the insurance company to make an automatic loan from the policy’s cash value to pay any premium not paid by the grace period. Dividend Accumulations to Avoid Lapse When the policy pays a dividend, the dividend accumulations may be applied to any premium not paid by the end of the grace period. In the event the amount of accumulated dividends is not enough to pay the entire premium coverage will then be extended in proportion with the amount of premium paid by the accumulated dividends. As a result of this a new grace period will start at the end of extension coverage. Dividend Options If a life insurance contract is a participating policy that means that the policyowner is entitled to an annual dividend paid by the insurance company. Participating policies afford the policyowner the opportunity to participate in the earnings of the insurance company through these dividend payments. The following are ways in which a policyowner may use his or her dividends: Cash payment. Reduction of premium. Accumulation of interest. Paid-up additions. One-year term.


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Cash Payment Under this dividend option the insurance company sends the insured a check equal to the amount of the declared dividend payment. Reduction of Premium The premium due on the policy for the upcoming year will be reduced by the amount of the current years declared dividend and the balance becomes the new premium due for the upcoming year. Accumulation of Interest The dividend may be held by the insurance company to accumulate interest paid at the rate that is specified in the contract. The insured has the right to withdraw the accumulated dividends at any time. Should the accumulated interest and dividend be on deposit with the company at the time of the insured’s death, the accumulated interest and dividend will be paid along with the policy proceeds. Paid-Up Additions This option enables the insured to receive additional amounts of life insurance by using the dividend to purchase paid-up additions. The additional insurance will be the same kind and subject to the same provisions as the original policy. Again, on the insured’s death, paid-up additions of insurance will be paid along with the policy proceeds. One-Year Term Some policies permit dividends to purchase additional one-year term coverage. The amount of the one-year term coverage would be added to the face amount of the base policy in the event of the insured’s death. Life Insurance Policy Riders Most insurance agents are familiar with the term “endorsement.” However in life and health insurance the word “rider” is used in lieu of the word “endorsement.” The effect is the same in that riders modify the coverage of the basic policy the same as an endorsement would. The most commonly used riders in life insurance policies are: Waiver of premium. Accidental death and dismemberment. Guaranteed purchase option.

Waiver of Premium This rider protects the insured in the event he or she becomes totally disabled. The waiting period is usually six months, and if the insured continues to be disabled after the six-month waiting period, the premium payments on the policy will be waived by the insurance company. Many policies will also refund the premium that was paid by the insured during the six-month waiting period. The cost for this coverage is a bargain to the insured, and no policy should be sold without this rider. Accidental Death and Dismemberment The amount paid in the event of accidental death of the insured is usually twice the policy’s regular face amount. This benefit is often referred to as “double indemnity.” As a rule the accidental death rider is very carefully worded to define exactly under what circumstances this benefit will be paid. The most liberal of the definitions is “accidental bodily injury.” The less favorable wording would be that death must occur “by accidental means.” For example, with the language “by accidental means,” if an insured died from a broken neck after intentionally diving into the shallow end of a swimming pool the policy would not pay the accidental death benefit because the action of diving into this pool wasn’t accidental. However, if the insured accidentally fell into the pool and drowned the benefit would be paid.

On the other hand, under the “accidental bodily injury” definition, even the intentional diving into the pool would have been paid because the broken neck was an accidental injury notwithstanding the intentional dive into the shallow water. Normally the death caused by the accident must consummate itself within ninety to one hundred eighty days of the incident in order for the double indemnity benefit to be paid under the rider. While the accidental death benefit is paid to the beneficiary after the death of the insured, the dismemberment portion of the rider provides that the dismemberment benefit will be paid directly to the insured, rather than the beneficiary. Dismemberment benefits typically are paid for: Loss of sight. Loss of hand or hands. Loss of foot or feet.

Regarding the loss of hand or foot, the loss typically must involve “complete severance through or above the wrist or ankle joint.” Loss caused by amputation is excluded unless medically necessary and as the result of an accidental injury. Guaranteed Purchase Option This rider is used most frequently with whole life insurance rather than term insurance. Under this option the company guarantees the insured that he or she may purchase additional amounts of coverage without evidence of insurability. These additional purchases are usually made at specific time intervals or upon events that change the insured’s family status. For example, some policies permit additional purchases of life insurance under the following circumstances: Every fourth policy anniversary year. The insured purchases a new home. The insured gets married. The birth of a new child.

The premium charge for the additional coverage is typically based on the type of insurance purchased and the insured’s age at the time of exercising the option. Life Insurance Underwriting The ultimate purpose of life insurance underwriting is to develop a profitable book of business for the insurance company. In order to accomplish this goal the life insurance underwriter attempts to provide coverage for a diversified group of insureds whose expected death rate is the same or lower than what is expected of the population as a whole. Underwriting Factors for Individual Coverage Life insurance is priced on a class basis. Perspective clients of the insurance company are classed on the basis of a number of factors that help to predict expected mortality rates. The principal rating factors are: Age.

Mortality rates are measured in terms of deaths per one thousand persons, and this of course increases with age. Thus the older you are the more life insurance costs because you are closer to death than a younger person.

Sex. On average, women in the United States live approximately seven years longer than men. Therefore cost for life insurance on a woman is lower than on a man of the same age. For example a thirty-year old male may pay the same premium as that of a thirty-three-year old female.

Health. The health of an individual as well as the health history of that individual’s family helps the underwriter to determine if the applicant presents an average or better than average risk to the insurance company.


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In evaluating an insured’s health the company will consider whether the applicant or family members have had any of the following illnesses: Cancer. Heart disease. Hypertension. Diabetes. As a general rule, persons whose health history include the above diseases will likely have a higher than normal mortality rate. Most insurance companies are now offering discounted rates to non-smokers due to the link between smoking and lung and heart disease.

Occupation and avocation. Since certain occupations and avocations pose hazards, such as flying and scuba-diving, applicants who engage in these hobbies are likely to have a higher than normal mortality rate.

Personal habits. If a life policy is for a large amount of coverage the insurance company will more than likely investigate the personal circumstances of the insured’s life. For example areas such as alcohol or drug use, poor driving record or financial problems may be taken into consideration.

Foreign travel or recent immigration. People who travel or reside outside the United States may be exposed to diseases not commonly found in this country.

Additionally, mortality rates vary from country to country. Therefore if a person is applying for life insurance shortly before leaving the country, special medical tests or a postponement of coverage may take place. Underwriting Actions Based on the information that the underwriter receives from the applicant, one of three actions may be taken. They are as follows: Rate the applicant standard and charge the normal

premium. Rate the applicant substandard and charge a higher

premium. Decline the coverage.

In addition to the above three actions many insurance companies recognize preferred risks and they will actually reduce premiums for those preferred risks. Delivering the Policy Policy Effective Date The effective date of a life insurance policy is very important since this is the date on which coverage actually begins for the insured. As discussed earlier in these materials, the policy effective date will also have significance with regard to the incontestable and suicide clauses. To determine the effective date of the policy, we must examine the principle of contract law known as “offer and acceptance.” If a proposed insured signs the application and submits it with the first premium to the company, an offer to buy insurance has been made by the proposed insured. If the insurance company issues the policy, as applied for, then offer and acceptance occurs. That is, the proposed insured has made an offer to purchase a life insurance contract, and the insurance company has accepted that offer. So far, we have assumed that the premium was submitted with the application. However, there are two other possibilities to consider regarding the effective date of the policy. The first occurs when an application is submitted without the premium. In this case, the applicant has made no offer. The applicant has only extended an invitation to the company to make an offer.

The insurance company makes the offer when it issues a policy as applied for and delivers it to the applicant. Further, the offer is accepted when the applicant pays the premium, assuming any other conditions have been fulfilled. The date of payment of the premium becomes the effective date of the policy. In situations where the initial premium does not accompany the completed application, most companies state in the application that the proposed insured must be in good health at the time of policy delivery before coverage becomes effective. So, before accepting the initial premium and leaving the policy with the insured, the agent must obtain a signed statement of the prospective insured’s continued good health. This statement and the initial premium are then transmitted to the company. The final possibility occurs when the premium is submitted with the application but no receipt is given. If this is the case, then the policy’s effective date is generally the date that the policy is issued and delivered. Delivery Delivery of the policy constitutes the company’s acceptance of the applicant’s offer – the application and initial premium. A policy is considered delivered when one of the following three events occurs: The policy is actually handed over in person. The policy is mailed to the policyholder. The policy is mailed to the agent for unconditional

delivery to the policyholder. Delivery, then, does not usually have to be accomplished by the manual transfer of the policy to the policyholder. Delivery accomplished by means other than a manual transfer is called “constructive delivery.” If a policy is not, or cannot, be delivered, then the policy is not in effect, as policy delivery has not been accomplished. Two other situations should be noted: When the applicant wants to examine the policy for a time

before paying the initial premium, and the policy is left with the applicant for inspection, he or she should sign a receipt for the policy, referred to as an “inspection receipt.” This acknowledges that the policy is in the insured’s possession for inspection purposes only and that the initial premium has not been paid and that the insurance is not in effect.

An applicant may ask the company to give the policy for which they are applying a date earlier than the application date. The reason for this “backdating” is usually to obtain a lower premium. Premium paid for life insurance depends, among other factors, on the insured’s age. So, in order to obtain a lower insurance age, and, as a result a lower premium, backdating is used.

Agents Responsibilities Regarding Delivery The agent should deliver the policy to the client as soon as possible after the policy is issued. This is especially important when no premium was submitted with the application, because the coverage will not become effective until the policy is delivered and the first premium paid during the continued good health of the proposed insured. The agent also has a responsibility to explain the policy’s provisions, riders, and exclusions at the time of delivery of the policy. Income Tax Benefits of Life Insurance By building income tax benefits into life insurance, public policy encourages individuals to purchase life insurance and obtain income security in the event of death. Specific income tax benefits of life insurance include the following: Death benefits are income tax-free.

The primary advantage of life insurance is that the policyowner contributes a sum as a premium amount, and when he or she dies the whole death benefit amount is passed on to the insured’s beneficiaries tax-free. This


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is good for the beneficiaries as well as society since these beneficiaries do not become financially dependent upon society as a result of the death of the insured. The death benefits of life insurance policies have been exempted from income taxation in order to promote this societal benefit.

Current earnings and gains not currently taxed. The second advantage of life insurance is that during the insured’s lifetime, and while the policy is in force, all interest earned, dividends earned and/or capital gains realized on the policy investments are not subject to current income tax. The taxation is deferred until the gains are taken from the policy by the policyowner. All investment life insurance policies enjoy tax-deferral on this buildup and a possibility of total tax-exemption on investment returns within the contract, which occurs when the proceeds are disbursed as death benefits. In other words, if the policyowner never takes the gains from the policy, there will never be tax on the policy’s investment gains and the death benefit will be paid to the beneficiaries tax-free.

Policy tax basis includes amounts paid for life insurance and expenses. The third income tax benefit of life insurance containing investment capital is that the amount of money which the insured recovers tax-free when surrendering a life insurance policy includes all the life insurance costs that the policy has charged during the time the policy has been in force. These costs are paid on a pretax basis even when a policy is surrendered.

Tax-free use of untaxed earnings and gains. The fourth income tax benefit of life insurance depends on whether or not the insured incurs taxation as a result of using the monies accumulated within the life insurance policy while it is still in force. The insured could use these monies by withdrawing them, borrowing them from the insurance company or pledging the policy as collateral for a loan. The tax code permits tax-free use of these funds up to certain prescribed levels. Any insured should always obtain competent tax advice before accessing insurance policy funds in order to confirm that the use will be permitted free from tax.

Annuities Before concluding our discussion of life insurance, we will turn to another product frequently sold by life insurance companies: Annuities. An annuity is an investment contract between an individual and the insurance company. The individual receives a return on his or her investment that supplements the individual’s contribution. At some point in time, the individual can choose to “annuitize” the investment to provide income for a specified period of time in the person’s lifetime. The earnings on an annuity can grow without being diminished by taxes. These earnings are not taxable until the individual withdraws them, and they are spread out over a number of years. When an individual begins receiving income from an annuity, only part of the income is taxable because the individual receives both interest and a partial return of the invested principal. To make the best use of the positive tax advantages of an annuity, individuals also must be aware of potential tax problems. The IRS imposes a penalty on withdrawals unless an individual is over age 59 1/2 when withdrawing money from the annuity or cashing it in. There is a 10 percent penalty on any earnings withdrawn, along with the tax owed on the withdrawal. These charges are in addition to any insurance company fees that might be imposed upon the withdrawal. Customers should be advised to approach the purchase of an annuity with the expectation that they will not draw on it until they are older than age 59 1/2. To fully exploit the tax

advantages, the individual should plan on holding the annuity for many years so that the earnings can grow without current taxation. No matter what the tax advantages of an annuity are, the individual still must pay close attention to the rate of return on the investment. Types of Annuities There are many different types of annuities offered by life insurance companies, including the following: Qualified annuities.

Qualified annuities are purchased with funds generated from qualified retirement plans. Contributions to qualified plans generally are not subject to current taxation when they are contributed to the plan. Examples of qualified retirement plans include Individual Retirement Accounts (IRAs), IRAs that qualify for an income tax deduction are qualified plans as are Simplified Employee Pension Plans (SEPs), 401(k) plans, profit-sharing plans and pension plans. These qualified plans are unique because in addition to enjoying the deferral on the earnings within the plan which is enjoyed with all annuities, an individual and his or her employer may also make capital investments into these plans without having to pay taxes on the amount of investment in the year of contribution. These qualified plans are usually among the best investment opportunities available.

Finite term annuities. The finite term annuity is sometimes called a certificate of annuity because of its resemblance to a certificate of deposit (CD). An individual may purchase a finite term annuity with a variety of maturity dates and may choose when to pay taxes. The minimum investment is usually $5,000 or $10,000. The yield is usually slightly less than a bank CD. When the maturity date arrives, the individual may withdraw the money and pay taxes on the gain. If the individual does not need the money and does not want to pay the taxes at that point in time, he or she can roll the money over into a new finite term annuity. This annuity investment is an advantage for someone who is over 59 1/2. It is not ideal for someone younger than that, due to the 10 percent early-withdrawal penalty, along with the tax on the gain. There is also a question of safety. It’s not quite as safe as a bank CD, although choosing an A+ or A rated insurance company can bridge the safety gap.

Fixed annuities. One key appeal of annuities is that they offer the prospect of a guaranteed annual income after retirement, no matter how long one lives. Fixed-rate annuities guarantee a particular interest rate for a specified period of time; for example, ten years. After that period of time, only a minimum yield is guaranteed. Annuities are often called “life insurance in reverse.” While life insurance creates an estate immediately upon the insured’s death, an annuity protects against “living too long.” While many people agree that a long life is a blessing, they also acknowledge that they do not wish to outlast the savings they have accumulated upon retirement. This concern underlies one of the basic attractions of annuities. By assuring continued payments for an unlimited number of years, annuities guarantee that the insured will not deplete his or her source of income. The payments one makes for an annuity are referred to as premiums. Premiums, like money placed in a deposit account, earn interest, and these amounts increase in value while the insurance company invests them. The annuity contract also specifies the interest rate that the insurance company will pay on the accumulated fund. A specific interest rate may be guaranteed for one or two years and sometimes as long as five or ten years. After the guaranteed-rate period expires, the contract may call for the rate to be reviewed at specified intervals, such as


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quarterly or annually. At that time, the insurance company adjusts the rate in accordance with changes in the general interest rates. Many insurance companies use the rate paid on Treasury bills as an index for setting the rate paid on annuities. Sometimes indexes such as consumer prices or cost-of-living calculations are used. Most insurance companies also guarantee that the interest rate paid on annuities will never be lower than a particular rate specified in the contract. When an insurance company receives premiums on a fixed annuity, it invests them along with other funds it holds. However, not all dollars a contract owner pays are invested, since some are used for sales commissions and fees. These charges may vary between companies and contracts. Some companies charge only surrender fees. However, should the insured die before the cash value stated in the contract equals the amount of premiums paid in, most contracts provide for a payment to the beneficiary of at least the amounts paid in, regardless of sales charges.

Immediate annuities. An immediate annuity provides for payments to commence shortly after the purchase date according to the preference of monthly, quarterly, semiannual or annually under the annuity contract.

Deferred annuities. With a deferred annuity, the contract is arranged for a specific date for annuity payment to begin, also referred to as the maturity date. The time prior to maturity is referred to as the accumulation period. The time following the maturity date during which payments are made to the annuitant (purchaser) is called the liquidation or distribution period. Accordingly, the annuitant will receive payments according to the contract schedule.

Premium Options Premiums for annuities are usually paid for in one of the following methods: Lump sum premiums.

In this method, the customer pays a single, lump sum premium when the contract is signed initially. Lump sum premiums can be paid for either immediate or deferred annuities.

Scheduled premiums. This method pertains to deferred annuities only. The customer pays premiums on a regular set schedule whether it be annually, semiannually, quarterly or monthly until the date on which benefit payments begin.

Flexible premiums. This method again pertains to deferred annuities only. Flexibility is permitted in the timing and amount of premium payments. This flexible premium annuity may be preferred by annuitants who want a program in which they can vary the amounts they save each year.

Settlement Options Settlement options refer to the various ways funds will be distributed from an annuity. Terms are agreed upon by the annuitant and the insurance company determining when the owner wishes to begin receiving income from the annuity. Single lump sum.

This settlement may be made in a single lump sum. The lump sum includes both the amount the owner paid in premiums, and the interest those funds have earned.

Interest only payments. The annuitant may wish to receive interest only payments until a later date on which another settlement option may take effect.

Designated dollar amount. The annuitant may elect to have the settlement paid in a specified number or dollar amount payment over a number of years.

Life income option. The life income option is the most common payment associated with annuities. With the life option, the annuitant receives payments until he or she dies. Payments may or may not continue after the annuitant’s death. Three life income options are straight life, period certain and refund. Straight life.

A straight life annuity contract provides for guaranteed periodic payments that terminate upon the death of the annuitant. No remaining balance is paid to a beneficiary or to the annuitant’s estate after the annuitant dies.

Period certain and refund options. Some individuals do not want to use the duration of their lives as the factor that determines whether they will profit, break even, or perhaps even lose money on their investments. Therefore, straight life annuities do not interest them. Period certain and refund options guarantee a minimum amount that the insurance company will pay on an annuity. Both of these options can be regarded as types of death benefits, since they provide for payment to be made to designated beneficiaries upon the annuitant’s death.

Number of Annuitants An annuity contract may be written to provide for one or more annuitants. If there is only one annuitant named in the contract, the insurance company agrees to provide that person with income beginning on a specific date and to continue for an agreed-upon period, which is normally the duration of the individual’s life. Some contracts cover more than one person. A popular contract of this type is the joint and survivor annuity. With this arrangement, two people are insured, most commonly the husband and wife. Beginning on the date in the contract, payments are made to the annuitants. The payments are guaranteed to continue to the surviving spouse upon the other spouse’s death. Depending on the contract terms, the continuing payments will either be in the same amount as when both the annuitants were alive or to be reduced. Two types of joint and survivor annuities are most commonly used. With a joint and two-thirds survivor option, the surviving spouse receives two-thirds of the income paid to the original annuitant. With a joint and one-half option, the surviving spouse receives half of the income. Surrender Terms Another set of annuity contract terms which is important to an investor are the surrender charges. The word surrender describes the termination of an insurance contract, such as an annuity, by the owner. When an individual surrenders a contract, he or she turns in to the insurance company the documents stating the contract terms. In return, the company gives the owner a sum of money which is known as the surrender value. The surrender value is the cash sum that the insurance company agrees to pay the owner in the event the owner surrenders the policy prior to maturity. The surrender value of a policy increases in proportion to the number of premiums paid, but it does not always equal the amount that the contract owner has paid. The surrender value may be lower than the total premium amount, because under some circumstances insurance companies will impose surrender charges. Although these surrender charges vary among insurance companies, most annuities stipulate a period of about seven years during which some penalty is imposed. Surrender charges are one reason that consumers should not attempt to use annuities as short-term, liquid investments in the same way they might deposit accounts. Some annuity contracts do offer loan privileges where the policy owner may borrow against the contract instead of accepting a distribution of cash. However, this may not be helpful, since the loans carry interest charges that vary according to company


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regulations. Besides this negative, a policy loan is also considered taxable income. Determining the Mathematics of Fixed Annuities The cost of an annuity’s benefit is included in the premium paid for the annuity. Insurance companies use demographic projections as well as complex mathematical calculations to develop and price the annuity products they sell. A company must use projections on average life expectancies when it prices its products, because the number of years people will live directly relates to the amount that the company pays out on its annuities. In turn, statistical projections on the average number of people who will die at different ages influence the amount a policy owner must pay for an annuity. One important mathematical device insurance companies use for pricing annuities is a mortality table. A mortality table is a mathematical tool used to calculate the frequency of deaths that will occur between successive birthdays. The numbers in a mortality table are calculated through the use of mathematical equations that express the probability or likelihood of the occurrence of a specific event. Mortality tables are developed by actuaries. Actuaries are insurance specialists who are experts in mathematics. Actuaries calculate risks, premiums, reserves, and other mathematical factors for insurance companies. The numbers in a mortality table allow an insurance company to project its likely future obligations to annuitants. Similarly, the company uses the mortality table to project how many dollars will be released to it by annuitants who die. This information, together with statistics the company gathers on the interest it can earn on its holdings, is then used to calculate the premiums to be charged for annuities as well as their other products. Investor Considerations – Fixed Annuities The promise of a guaranteed lifetime income during retirement may be attractive to many investors. However, a guaranteed income is only one factor that should be considered when considering annuities. Among the other issues that should be examined carefully are risk, liquidity, earnings, and taxes. Risk.

Annuities are relatively safe investments. While they are not covered by federal deposit insurance, the principal and interest an individual invests in a fixed annuity contract are provided by the rigid state and federal regulations that govern insurance companies’ operations. However, these regulations do not protect an investor from all potential problems. If the insurance company that sold an annuity to an individual experiences severe business problems and becomes insolvent, other insurance companies doing business in the same state will be required to help meet that company’s remaining obligations. However, the annuitant may face extra paperwork and delays in attempting to obtain funds. Additionally, it is a good idea to research the soundness of the insurance company before purchasing an annuity from it.

Liquidity. Annuities are relatively liquid investments because they provide ways for individuals to surrender their contracts and withdraw their funds during the accumulation period. They are not completely liquid, however, since investors may not receive the full amount that they have paid in premiums if they decide to withdraw from their annuities. The amount that an individual would lose depends on the surrender fees and penalties assessed by the insurance company. These charges are described in the annuity contract.

Earnings. Interest earnings on annuities have attracted many current investors. Guarantee periods vary with different insurance companies. Some will pay an initial rate for

one or two years followed by subsequent annual guarantees. Others will peg their rates to formulas based on Treasury bill or consumer price indexes. A desirable feature that a careful buyer will seek in an annuity is the bailout provision. With this provision, the contract owner may bail out without paying any surrender charge if the rate falls below a certain designated percentage from the original rate, even if the initial guarantee period has expired. For example, assume the initial guaranteed rate is 8 percent for a period of one year. The contract promises a 1 1/2 percent bailout provision. The contract also says that a surrender charge is made upon a premature withdrawal anytime within seven years from the purchase date. After the initial one-year period of the contract, the company announces the next year’s interest rate will be 6 1/2 percent. Since this rate dropped 1 1/2 percent from the initial rate, the customer is entitled to avoid any surrender charges if the contract is cashed in.

Income Tax. One of the main appeals of deferred annuities is the income tax advantage that is offered investors. Investors pay no taxes on the earnings during the accumulation period; taxes are deferred until the liquidation period. Once payouts to the annuitant begin, only a portion of each payment is taxed as income. The remaining portion, which is not subject to income taxes, is considered as a return of the money that the investor paid into the annuity during the accumulation period.

The portion of an annuitant’s income that is subject to taxes is determined through a calculation required by the U.S. Department of the Treasury. This complex calculation is based on the projection of the amount the annuitant will receive in annuity income if he or she lives to life expectancy. This total income is referred to as the expected return. Once an expected return is determined, the next step is to calculate the percentage of the amount that was invested in the contract. Once the percentage is calculated, it is used each year to determine how much of the annual annuity income should be considered return of capital and how much should be regarded as taxable income. There are certain income tax penalties related to annuities. In particular, there is a 10 percent penalty which applies to lump sum withdrawals from annuities before age 59 1/2. This penalty applies whether the amount is taken as a loan or an outright withdrawal. (There is an exemption to this 10 percent penalty if the amount of withdrawals before age 59 1/2 is part of a series of approximately equal periodic payments over a lifetime. Also, exempt are such payments in the event of death or disability.) An important exception exists in the case of business-owned annuities. If a business entity, such as a corporation, partnership, or trust, owns an annuity on an employee’s life, any interest earnings or annual gains in the contract are subject to current income taxes. Annuities that are part of qualified plans, such as pensions and similar employee benefit programs, are exempt from the ruling. Immediate annuities are also exempt. (In addition to employer pension plans, the exclusion of taxable earnings on annuities applies to IRAs and other tax-sheltered annuities sponsored by certain nonprofit corporate employers.) Variable Annuities Like the fixed annuity, the variable annuity is a contract between an individual and a life insurance company. With both types, the owner contributes premiums that, along with their earnings, are accumulated within the policy contract. At an agreed-upon time, the insurance company begins making payments to the annuitant. Payments are made over the individual’s lifetime or for some other stipulated period. The basic difference between fixed annuities and variable annuities is the way in which accumulated funds are invested and the resulting payout. With fixed annuities, the


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accumulated funds are combined with the insurance company’s general investments. These investments help form the basis for the guaranteed cash values of life insurance and conventional annuity contracts. In general, insurance companies invest funds for their fixed products in long-term bonds and other non-speculative issues. The premium payments made on a variable annuity are not combined with the insurance company’s general investments. They are placed in stocks, government securities and other types of fluctuating investments. These investments have a better growth potential than those that underlie investments, but also are subject to a greater degree of risk. The investments make up a portfolio that is managed in much the same way as a typical mutual fund. When the annuitant is ready to receive payment, he or she can choose the best payout option. For many years, marketers of annuity products as well as savings institutions emphasized the advantages of conservative and secure investments. During the 1930s, when the U.S. economy was experiencing only moderate inflation rates, many people purchased annuities for retirement in the belief that they insured a comfortable, guaranteed income for life. A successful insurance company advertisement of the late 1930s enthusiastically proclaimed, “Retire for life on 300 dollars a month!” Then rising inflation rates began to affect the average person’s standard of living. Beginning in the 1960s, people became aware that they had to plan for more retirement dollars just to keep pace with anticipated increases in living costs. Savers sought financial instruments that could more readily keep up with inflation. Individuals of even average means were turning to the stock market for an increasing portion of their investments. Like savings institutions, insurance companies looked for ways to improve their traditional products. In an attempt to combine traditional annuity guarantees with the growth potential of a securities investment, the variable annuity was developed. Variable annuities generally are divided into two basic types. The difference between them lies in who has control over investing the money deposited into the annuity. With the first type, the company-managed variable annuity, the insurance company determines how the annuity funds are invested. With the second type, which could be referred to as a self-directed variable annuity, the annuity owner has substantial control over the investment of funds. Company-managed variable annuity.

The original variable annuities which were introduced in the 1950s were company-managed types. In this type of annuity, premiums paid in by contract owners are pooled and placed in a separate account designated by the insurance company. This method serves to distinguish these investments from the company’s other invested funds. (One advantage of a variable annuity is if the insurance company runs into financial problems, the funds in the separate account are beyond the reach of the company’s creditors. This is also true for the portfolios in self-directed plans.) The account is organized like a mutual fund in that it is made up of various investments – usually stocks, bonds and government securities. The insurance companies’ investment managers buy and sell these investments on a continuing basis. Like mutual fund managers, the insurance company tries to invest the money wisely and profitably so that it will generate a competitive return for its investors. In addition, the insurance company must meet both state and federal regulations regarding investment practices for these products. (Variable annuities are subject to regulation by the Securities and Exchange Commission, Internal Revenue Service, and state regulatory bodies.) One of the better known company-managed annuities is the College Retirement and Equities Fund, or CREF. Designed by the Teachers Annuity and Insurance

Association, it was the first variable annuity, appearing on the market in 1952. Because of CREF’s relatively long history, it has been the subject of many detailed studies.

Self-directed variable annuity. With the self-directed annuity, the contract owner can choose from several investments, each with different objectives. The selection of investments may be made during both the accumulation and distribution periods. In effect, the contract owner may construct a personal investment portfolio within the annuity. The owner selects investments based on his or her investment objectives in much the same way that a mutual fund investor does.

The annuity application form lists the selection of investments that the insurance company offers. For an example of a hypothetical self-directed variable annuity, consider there are five selections available. These include four mutual funds with differing objectives, plus a fixed account. The fixed account offers guaranteed safety of principal and specifies a fixed interest rate. (Interest rates on the fixed account may be guaranteed for periods ranging from one calendar quarter to one or two years or even longer.) Customers choose from among these options according to their investment objectives. On the annuity application the customer indicates, usually in percentage units, how each premium is to be allocated among the selected accounts. Most contracts allow an unlimited number of percentage combinations. The applicant can even allocate the entire premium to a single investment choice. One distinguishing characteristic of self-directed annuities is the owner’s ability to change the composition of the annuity portfolio. Three major factors that affect how individuals invest their assets are their investment objectives and philosophies, their financial standing and economic conditions. Since each of these factors may change over time, it is advantageous to the investor to be able to change the way in which his or her money is invested. As an individual progresses through life his or her investment philosophy and objectives often change. Many people who previously might have been inclined to take investment risks may become more cautious as they grow older. For the owner of a variable annuity, a change to more conservative investments may mean moving money from stock funds to funds composed of government securities or even a fixed fund. The typical self-directed variable annuity offers the contract owner the opportunity to redirect the investment of funds as his or her investment objectives change. Changes in one’s financial standing may also alter an individual’s willingness to accept risks. For example, some individuals may invest in more aggressive and risky funds only after they have accumulated what they consider an adequate nest egg. Similarly, some individuals move their variable annuity funds into conservative options if they experience losses in their other investments. Economic conditions and forecasts may also lead an individual to take advantage of a variable annuity’s flexibility. When stock prices are expected to fall, some individuals direct their money out of stock funds and into other types of funds. When yields on other investments are falling, investors often move their money into bond funds because these generally are considered good investments during such period. Thus, variable annuities allow the investor to react in the face of changing market conditions. Choosing an Annuity Type Determining which type of variable annuity is suitable for an investor depends mainly on two factors. One is the potential purchaser’s investment sophistication. The other is the extent to which the person wishes to become involved in investment decisions. The first consideration applies to the inexperienced

investor with limited knowledge of the stock market. In


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this case, a company-managed variable annuity is probably the better choice, since the insurance company will make all the investment choices and manage the portfolio.

The second factor concerns whether the contract owner wishes to continually monitor changing economic conditions and be responsible for changing the direction of investments in the annuity portfolio. With the self-directed type of variable annuity, the investor decides on the mix of investments in the portfolio. It is the contract owner’s responsibility to periodically review these investments to see whether their performances are still in tune with his or her investment objectives and adjust the portfolio accordingly. The self-directed plan is probably more suited to an investor who is accustomed to making these types of decisions.

The investor should also be aware of the various charges that the insurance company’s fund managers impose. Each annuity contract has its own schedule of fees and other charges, and the investor should carefully assess these before making a purchase. One charge that is commonly imposed is a surrender charge. This is similar to the surrender charge for fixed annuities. Typically, the surrender charge limits the amount of money that may be withdrawn during the early years of the contract. Some policies have a declining charge. For example, the charge might be 6 percent for the policy’s total value in the first year and decrease by a percentage point each year thereafter. Thus, no surrender charge would be imposed on withdrawals made after the sixth year. For funds invested in company managed accounts, companies usually impose management charges. Funds held in a fixed account usually escape the investment management fees. The insurance company typically justifies these fees by providing for a guaranteed death benefit and covering the administrative expenses involved in providing a life income. Accumulation Units During the years in which premiums are paid into the annuity contract, the annuity owner acquires accumulation units. Accumulation units have a designated initial price at the time of the annuity purchase but fluctuate in value thereafter. In the case of company-managed products, the changing values will correspond to the performance of the pool of investments. This is similar to the way mutual fund values are expressed. With a mutual fund share, each accumulation unit of a variable annuity has a designated value on a given day. In the case of self-directed annuities, the values of the fund or combination of funds the policy owner has chosen are totaled. The value of each accumulation unit is then calculated from this total. Under both company-managed and self-directed plans, each premium payment purchases a certain number of accumulation units. The number of units varies according to the unit’s current market values. The number of units continues to increase, as additional purchases are made, although each unit’s value will vary over the life of the contract according to its worth in the marketplace. This, too, is similar to the manner in which mutual fund share values are calculated. Annuity Units In order for the insurance company to begin paying out income from the annuity, accumulation units are converted into annuity units. An annuity unit is a measure of value that an insurance company uses when it calculates the amount of income to be paid to an annuitant. At retirement, the annuitant is credited with a designated number of annuity units. The exact number of annuity units to be credited depends on four basic factors. The first factor is the annuitant’s age. The insurance

company calculates from its mortality tables all charges in

order to provide a designated amount of lifetime income at a specified age.

The second factor is the number of guaranteed payments. If the annuitant chooses a period certain life income option, the extra charge for that benefit will be reflected in the calculation of the annuity unit.

The third factor is the interest rate that the insurance company projects. If the company predicts a fairly high interest rate, the annuity unit will have a greater value than it would with a lower rate. Interest rates typically are projected annually to determine the projected investment return.

Finally, there are administrative expenses to be incorporated into the unit cost calculation.

The calculated number of annuity units remains constant over the payment period. The annuitant has the option of choosing a fixed or a variable payment, or, as is often the case, a combination of both. With the variable payment, the annuity unit’s value may fluctuate just as it does during the accumulation period. The value will continue to vary according to the performance of the underlying investment portfolio and the general administrative costs that the company incurs. Obviously, the amount of periodic income also will fluctuate. There are two important reasons for the continued fluctuation in variable annuities after the retirement income period begins: The first is that the portfolio’s value constantly changes to

reflect current market conditions. The second is that the investments funding the annuity

contract also change continually, just as they do during the accumulation period. The various stocks, bonds and other financial instruments that make up the portfolio continue to change based on the decisions of the fund managers who supervise this process. In a self-directed plan, the contract owner may frequently change the contents of the portfolio.

Risk Considerations for Variable Annuities The variable annuity, with its combination of traditional guarantees and investment flexibility, offers great promise as a financial planning tool. It has the potential to be more responsive to economic trends than the conventional savings account or even the traditional fixed annuity. However, the savings customer who has basically considered only fixed investments should be aware of the special risk concerns connected with the purchase of a variable annuity. There are two important points to keep in mind regarding the risks of variable annuities. One concerns the insurance company that issues the annuity and the second concerns the investment’s fluctuating nature. Regarding the first point, it is essential to note that, while both fixed and variable annuities may be marketed by savings institutions, neither product is covered by the federal insuring agencies. The investment is backed only by the guarantee made by the insurance company that sells the annuity contract. The second area of risk is the fluctuating nature of the variable annuity. Investors should recognize that whenever they place money in variable annuities, the dollar value of their investments is subject to both upward and downward changes. An investor should assess his or her tolerance for risk when selecting a variable annuity and composing the annuity portfolio. Particular caution is needed during the retirement period when the contract owner may be contemplating changing investment strategies. Many owners like a more conservative investment position at the time when they were making deposits and accumulating funds. While it is possible to increase income payments by making the right investment choices, it is also possible to make the wrong decisions. Unlike during the accumulation period, when there is sufficient time to make up for a temporary loss, once


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retirement begins, it is difficult to recoup any losses resulting from investment mistakes. Life Insurance Terms and Definitions Having reviewed the background, provisions, underwriting and tax benefits of life insurance policies and annuities, we now provide an alphabetic listing of many of the important terms and definitions which you will encounter with respect to life insurance. Many of these terms have been used during our discussion of life insurance, while some of these are additional terms which may be helpful to supplement your understanding of life insurance. AGE CHANGE – The point in the 12 months between natural birthdays at which the individual is considered to be of the next higher age for the purpose of insurance rates. Most life insurers consider that point as halfway between birthdays. Health insurers frequently use the age at last birthday until the next birthday is actually reached. AGE LIMITS – The ages below or above which an insurer will not issue a given policy. AGENT – An individual appointed by an insurer to solicit, negotiate, effect or countersign insurance contracts on its behalf. ALIEN COMPANY OR INSURER – An insurer organized and domiciled in a country other than the United States. APPLICANT – The party submitting an application to an insurer for an insurance policy. ATTAINED AGE – The age an insured has reached on a given date. BENEFICIARY – A person, who may become eligible to receive, or is receiving, benefits under an insurance plan, other than as an insured. BENEFICIARY CHANGE – A change in the policy which alters the previous beneficiary designation. Must be made by formal application to the insurer. Compare to Beneficiary, Irrevocable. CANCELLATION – Termination of the insurance contract by voluntary act of the insurer or insured, effected in accordance with provisions in the contract or by mutual agreement. CARRIER – The insurance company that “carries” the insurance. Generally, the term “insurer” is preferred. CASH SURRENDER VALUE – In life insurance, the value in a policy that is the legal property of the policyowner, and which the policyowner may receive if the policy is surrendered for cash. Synonymous with cash value. CLAIM – The demand of an insured or his or her representative or beneficiary for benefits as provided by an insurance policy. COMMISSION – The portion of the premium stipulated in the agency contract to be retained by the agent as compensation for sales, service, and distribution of insurance policies. CONCEALMENT – The withholding, by an applicant for insurance, of facts that materially affect an insurance risk or loss. CONDITIONAL RECEIPT – Provides that if the premium accompanies the application, the coverage is in force from the date of the application (whether the policy has yet been issued or not) provided the insurer would have issued the coverage on the basis of facts as revealed by the application and other usual sources of underwriting information. CONTINGENT BENEFICIARY – Person or persons named to receive benefits if the primary beneficiary is not alive at the time the insured dies. DEATH BENEFIT – The policy proceeds to be paid upon the death of the insured. DEATH CLAIM – A formal request for payment of policy benefits occasioned by the death of the insured. Should be made through the agent, but may be made directly to the home office. Requires a copy of the death certificate as proof of death and is made by the beneficiary. DECLARATION PAGE – The portion of an insurance policy containing the information regarding the risk.

DECREASING TERM INSURANCE – Term insurance for which the initial amount gradually decreases until the expiration date of the policy, at which time it reaches zero. DOMESTIC COMPANY – An insurer formed under the laws of the state in which the insurance is written. DOUBLE INDEMNITY – Payment of twice the basic benefit in event of loss resulting from specified causes or under specified circumstances. EFFECTIVE DATE – The date on which an insurance policy goes into effect. ENDORSEMENT – Technically, a change made directly on the policy form by writing, printing, stamping or typewriting and approved by an executive officer of the insurer. In general use, also may refer to a change made by means of a form attached to the policy. ESTATE – Assets of an individual comprising total worth. EXCLUSIONS – Stated exceptions to prior provisions in a policy. Common exclusions in health policies include pre-existing conditions, suicide, self-inflicted injuries, and many others. In life policies, common exclusions are death through flying in a private airplane, riot, or act of war. EXPIRATION – The date upon which a policy’s coverage ceases. FACE AMOUNT – The amount indicated on the face of a life policy that will be paid at death or when the policy matures. FAMILY PLAN POLICY – An all-family plan, usually with permanent insurance on the father’s life, with mother and children automatically covered for a lesser amount. FOREIGN COMPANY – An insurer organized under the laws of a state other than the one where the insurance is written. FRAUD – An intentional misrepresentation made by a person with the intent to gain an advantage and relied upon by a second party which suffers a loss as a result. GRACE PERIOD – A period of time after the premium due date during which a policy remains in force without penalty even though the premium due has not been paid. This period is commonly 30 or 31 days in life insurance policies. HOME OFFICE – The place where an insurance company maintains its chief executives and general supervisory departments. INSURABILITY – The condition of the proposed insured as to age, occupation, physical condition, medical history, moral fitness, financial condition and other factors that makes the individual an acceptable risk to an insurance company. INSURABLE INTEREST – In life and health insurance, the interest of one party in the possible death or disability of an insured that would result in a significant emotional or financial loss. Such an interest must exist in order for the party to purchase insurance on the life or health of another. INSURANCE DEPARTMENT – A governmental bureau in each state or territory charged with administration of the insurance laws, including licensing, examination, and regulation of agents and insurers. In some jurisdictions, the department is a division of some other state department or bureau. INSURED – The party to an insurance contract to whom, or on behalf of whom, the insurer agrees to indemnify for losses, provide benefits, or render service. INSURER – The party to an insurance contract that undertakes to indemnify for losses provides other pecuniary benefits, or renders service. Also called insurance company and sometimes-insurance carrier. IRREVOCABLE BENEFICIARY – A named beneficiary whose status as beneficiary cannot be changed without his or her permission. LAPSED POLICY – A policy for which the policyholder has failed to make the premium payment during the grace period, causing the coverage to be terminated. LIFE EXPECTANCY – Average number of years of life remaining for persons at any given age.


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LIFE INSURANCE – Insurance that pays a specified amount upon the death of the insured to the insured’s estate or to a beneficiary. LOAN VALUE – The amount of cash value in a policy which may be borrowed by the insured. MISREPRESENTATION – Falsely representing the terms, benefits, or privileges of a policy on the part of an insurer or its agent. Falsely representing the health or other condition of the proposed insured on the part of an applicant. MORTALITY RATE – The average number of people in a particular class who die each year. NON-FORFEITURE OPTION – A legal provision whereby the life insurance policyowner may take the accumulated values in a policy as (1) paid-up insurance for a lesser amount (2) extended term insurance; or (3) lump-sum payment of cash value, less any unpaid premiums, or outstanding loans. NON-PARTICIPATING POLICY – A policy that does not provide for the policyowner to share in dividends. Also called a nonpar policy. NON-RESIDENT AGENT – An agent licensed in a state in which he or she is not a resident. PAID-UP INSURANCE – A non-forfeiture option in life insurance policies under which insurance exists and no further premium payments are required. PARTICIPATING POLICY – A policy in which the policyowner receives a share of policy dividends. Also called par policy. PERMANENT INSURANCE – Life insurance with some type of cash value accumulation. POLICY LOAN – A loan to the policyholder from the insurer using the insurance cash value as collateral. PRE-AUTHORIZED CHECK PLAN – An arrangement under which the policyowner authorizes the insurer to draft his or her bank accounts for the (usually monthly) premium. PRIMARY BENEFICIARY – The beneficiary named first to receive proceeds or benefits of a policy that provides death benefits. PROOF OF DEATH – A usual requirement before paying a death claim is that a formal proof of death form of some type be submitted to the insurer.

REINSTATEMENT – Putting a lapsed policy back in force, sometimes requiring the payment of back premiums and evidence of insurability. Provision is usually made for a method of reinstating the policy to its original amount. RIDER – An amendment attached to a policy that modifies the conditions of the policy by expanding or decreasing its benefits or excluding certain conditions from coverage. SETTLEMENT OPTION – A method of receiving life insurance proceeds other than a lump sum. STANDARD RISK – A risk that meets the same conditions of health, physical condition and morals as the risks on which the rate is based without extra rating or special restrictions. SUICIDE CLAUSE – In a life insurance policy, states that if the insured commits suicide within a specified period of time, the policy will be voided. Paid premiums are usually refunded. The time limit is generally one or two years. TERM INSURANCE – Life insurance that normally does not have cash accumulations and is issued to remain in force for a specified period of time, following which it is subject to renewal or termination. WAIVER OF PREMIUM PROVISION – When included, provides that premiums are waived and the policy remains in force if the insured becomes totally and permanently disabled. WHOLE LIFE – Permanent life insurance on which premiums are paid for the entire life of the insured. Conclusion Any insurance agent selling life insurance policies to customers must maintain solid knowledge of the types of life insurance policies and the provisions of each policy in order to answer any questions and offer competent service to customers. By demonstrating command of the subject matter, the insurance agent will benefit from additional referrals and recommendations from satisfied, happy clients. The customer may also inquire regarding the life insurance company’s annuities, and working knowledge of these products should accompany the agent’s understanding of life insurance.


Final Exam

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1. A ________ is a legal wrong. a. contract b. tort c. liability d. standard of care

2. Only certain types of vehicles are eligible for coverage under the Personal Auto Policy. a. True b. False

3. Part A of the Personal Auto Policy provides liability coverage for ________ different categories of parties. a. two b. three c. four d. five

4. Intentionally causing bodily harm or property damage is a covered liability in a Personal Auto Policy. a. True b. False

5. There is NO liability coverage on a vehicle while it is being used ________. a. in traffic b. for personal use c. by a family member d. to carry persons or property for a fee

6. A ________ can be added to a Personal Auto Policy to provide liability coverage for motorcycles. a. miscellaneous vehicle endorsement b. caveat c. trailer clause d. compulsory adjustment

7. Under a Personal Auto Policy, the company will pay all reasonable medical and funeral expenses incurred within ________ years from the date of the accident. a. two b. three c. four d. five

8. Uninsured Motorist Coverage under the Personal Auto Policy includes coverage for injury from hit-and-run drivers. a. True b. False

9. The amount paid under uninsured motorists coverage may be reduced by any benefits payable under ________. a. workers compensation law b. policy limits c. premiums d. gasoline expenses

10. Although a loss of tapes or records is not covered by a standard Personal Auto Policy, coverage may be added by an endorsement. a. True b. False


Final Exam

62

11. If the vehicle is declared a total loss, the amount paid is the ________. a. initial purchase price b. actual cash value c. amount requested by the insured d. amount of premiums paid

12. Part ________ of the Personal Auto Policy describes the duties and obligations of the insured in the event of an accident or loss. a. B b. C c. D d. E

13. A clean driving record covering the previous ________ years can substantially reduce the premiums of a high-risk driver. a. two b. three c. four d. five

14. ________ is a key factor in determining liability. a. Premium amount b. Age c. Income d. Negligence

15. Forms HO-1 and HO-2 are referred to as “Named Peril Policies.” a. True b. False

16. The HO-5 policy is very similar to the ________ policy. a. HO-1 b. HO-2 c. HO-3 d. HO-8

17. The HO-6 policy is a ________ policy. a. renter’s b. condominium owner’s c. all-risk d. premium free

18. The dwelling consists of the home itself and includes ________. a. attached structures b. personal property c. automobiles d. animals

19. Subrogation prevents injured parties from receiving payment from both the insurer and the responsible party. a. True b. False

20. If the insurer requests a formal statement from the insured after a claim is filed under a homeowners policy, the insured is under no obligation to comply. a. True b. False


Final Exam

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21. ________ policies generally cover property that is transported from one place to another. a. Homeowners b. Inland marine c. Crime insurance d. Personal auto

22. Each of the following are major characteristics of an inland marine floater policy EXCEPT: a. tailored coverage. b. selection of policy limits. c. limited coverage to perils covered. d. worldwide coverage.

23. Property described in floaters will be covered anywhere in the world, EXCEPT FOR: a. jewelry. b. furs. c. cameras. d. fine arts.

24. Generally, floaters provide coverage on an “all-risks” basis. a. True b. False

25. Stamps and coins may be insured in one of two ways: scheduled basis or ________. a. blanket basis b. article basis c. premium basis d. homeowner basis

26. Almost any kind of personal property can be insured under a scheduled Personal Property Floater. a. True b. False

27. The umbrella policy pays only after the limits of the underlying policy are ________. a. established b. broken c. modified d. exhausted

28. Specialized coverage may be obtained under an Inland Marine Policy for clients involved in business. a. True b. False

29. One important aim of underwriters is to support activities which will benefit: a. premium reduction. b. bankruptcy attorneys. c. society. d. courts.

30. ________ cannot be used as a reason for underwriting action. a. Accident fault b. Occupation c. Property condition d. Number of accidents


Final Exam

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31. ________ can restrict the information available to the underwriter. a. Right to privacy laws b. Insurance policies c. Standard practice d. Objective sources

32. The most significant factor which can be used in underwriting and rating of motor vehicle insurance is ________. a. driver occupation b. family size c. automobile size d. driving record

33. An underwriter would be justified in refusing to write insurance for a building that did not meet his personal standards of neatness. a. True b. False

34. Securing the proper ________ is the key to profitable writing of property insurance. a. office b. stockholders c. insurance-to-value ratio d. premium reduction

35. Underwriters are ________ rejecting applications for insurance where extended vacancy exists at a property. a. justified in b. prohibited from c. to be fined for d. to be imprisoned for

36. The only line of property/liability insurance in which the physical condition of the applicant has been used by underwriters is ________. a. crime insurance b. homeowners insurance c. inland marine insurance d. automobile insurance

37. No action should be taken solely because of a ________. a. misrepresentation b. fraudulent act c. history of drug abuse d. previous rejection or cancellation

38. Decisions to accept an applicant should be based on complete information and compliance with laws and regulations. a. True b. False

39. Life insurance can provide benefits for business situations. a. True b. False

40. For a life insurance policy to be issued, ________ between the insured and the policy owner must be present. a. an insurable interest b. an application c. an adult guardian d. a contract


Final Exam

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41. In most states, a person is not considered an adult until the person is ________ years of age. a. 13 b. 18 c. 21 d. 25

42. Under certain conditions, convertible term life insurance can be exchanged for a cash value policy. a. True b. False

43. ________ insurance contains the basic elements of term insurance, with an investment element added. a. Whole life b. Traditional c. Premium d. Batch

44. ________ offers tax advantages to the insured because the investment value grows without current taxation. a. Health insurance b. Key man coverage c. Term life d. Universal life

45. ________ life insurance permits changes to be made during the policy’s lifetime. a. Term b. Adjustable c. Universal d. Whole

46. A stock life insurance company is in business to make a profit for the ________. a. insureds b. stockholders c. policyowners d. government

47. Control in a mutual insurance company rests with the ________. a. insureds b. stockholders c. policyowners d. government

48. Each of the following are factors that affect the premium charged for a life insurance policy, EXCEPT: a. mortality. b. interest. c. expenses. d. exclusions.

49. It is unlawful for a life insurance company to invest any extra revenue to gain additional funds. a. True b. False

50. One of the principal rating factors for underwriting life insurance is age. a. True b. False

MANAGING COMMERCIAL RISKS

AND ETHICAL PRACTICE

Continuing Education for Illinois Insurance Professionals

MANAGING COMMERCIAL RISKS AND ETHICAL PRACTICE COPYRIGHT © 2005 – 2013 by Real Estate Institute All rights reserved. No part of this book may be reproduced, stored in any retrieval system or transcribed in any form or by any means (electronic, mechanical, photocopy, recording or otherwise) without the prior written permission of Real Estate Institute.

A considerable amount of care has been taken to provide accurate and timely information. However, any ideas, suggestions, opinions, or general knowledge presented in this text are those of the authors and other contributors, and are subject to local, state and federal laws and regulations, court cases, and any revisions of the same. The reader is encouraged to consult legal counsel concerning any points of law. This book should not be used as an alternative to competent legal counsel.

Printed in the United States of America. P8

All inquires should be addressed to: Real Estate Institute 6203 W. Howard Street Niles, IL 60714 (800) 289-4310 www.InstituteOnline.com

MANAGING COMMERCIAL RISKS AND ETHICAL PRACTICE

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INTRODUCTION ............................................................... 71 CHAPTER 1 – COMMERCIAL INSURANCE ..................... 71 Introduction to Commercial Insurance ............................... 71 History of the Commercial Package Policy Concept .......... 71 Structure and Terminology of Commercial Insurance Policies .............................................................................. 71

Structure of the Policy ............................................... 71 The Named Insured................................................... 71 Named Peril Form vs. All-Risk Form ......................... 72 Actual Cash Value vs. Replacement Cost ................. 72

Assessing Insurance Risks and Needs .............................. 72 The Special Multi-Peril Policy (SMP) ................................. 72

Advantages of the SMP Approach ............................ 72 Businesses That Qualify For an SMP ....................... 73 Businesses That Do Not Qualify For an SMP ........... 73 Defining the Two Types of Property .......................... 74 SMP (Section I) Property Coverage .......................... 74 The Standard (Named Peril) Form of Property Coverage ................................................................... 74 The All-Risk Form of Property Coverage ................... 74 Additional Optional Coverages .................................. 74 SMP (Section II) General Liability Coverage ............. 77 General Liability Coverage ........................................ 77 General and Special Liability Exclusions ................... 77 SMP (Section III) Crime Coverage ............................ 77 SMP (Section IV) Boiler and Machinery Coverage .... 78 Additional Coverages ................................................ 78 Impact and Future of the SMP Program .................... 79

The Business Owners Policy Plan (BOP) .......................... 79 History of the Policy................................................... 79 Determining the Premium .......................................... 79 Qualifications for Eligibility ......................................... 79 Businesses That Might Qualify For A BOP ................ 80 Businesses That Do Not Qualify For A BOP ............. 80 Exclusions, General Conditions and Provisions Specific to the BOP ................................................... 80 Available BOP Policies .............................................. 81 Standard (Named Peril) Form BOP ........................... 81 BOP (Section I) Property Coverage .......................... 81 Building Coverage (Section A) .................................. 82 Business Personal Property Coverage (Section B) ... 82 Loss of Income Coverage (Section C)....................... 83 Available Optional Coverages ................................... 83 The Special (All Risk) Policy ..................................... 84 Property Coverage (Section I, Sections A, B and C) . 84 Money and Securities Coverage (Section D) ............ 85 Additional Optional Coverages .................................. 85 Liability Coverage Under the Standard and Special BOPS (Section II in Both Forms) ............................... 85 Business Liability (Section E) .................................... 85 Limits of Liability ........................................................ 86 Supplementary Payments ......................................... 86 Medical Payments (Section F) .................................. 86

Conclusion ......................................................................... 86 CHAPTER 2 – CRIME INSURANCE ................................. 86 Introduction ........................................................................ 86 Policies Including Crime Coverage .................................... 86

Homeowners Insurance ............................................ 86 Tenants (Renters) Insurance ..................................... 87 Automobile Insurance................................................ 87 Property Insurance .................................................... 88 Business Interruption Insurance ................................ 89

Theft Coverages ................................................................ 90 Theft .......................................................................... 90 Robbery ..................................................................... 90 Larceny ..................................................................... 90 Burglary ..................................................................... 90 Safes ......................................................................... 91

Disappearance Coverage .......................................... 91 Extortion .................................................................... 91 Forgery ...................................................................... 91 Dishonesty and Fraud Insurance ............................... 92 Fidelity Bonds ............................................................ 92 Rules of Bailment ...................................................... 93 Redlining ................................................................... 93 Preventive Measures ................................................. 94

Conclusion ......................................................................... 94 CHAPTER 3 – WORKERS’ COMPENSATION AND UNEMPLOYMENT INSURANCE ....................................... 94 Introduction ........................................................................ 94 Development of State Workers’ Compensation Laws ........ 94

Common Law of Industrial Accidents ........................ 94 The Enactment of Employer Liability Laws ................ 94 Emergence of Workers’ Compensation Legislation ... 95

Objectives of Workers’ Compensation Laws ...................... 95 Broad Coverage ........................................................ 95 Substantial Protection Against Loss of Income.......... 95 Sufficient Medical Care and Rehabilitation Services . 95 Encouragement of Safety .......................................... 95 An Effective Delivery System for Benefits and Services .............................................................. 95

Disability Insurance Programs ............................................ 96 Temporary Partial Disability ....................................... 96 Temporary Total Disability ......................................... 96 Permanent Partial Disability ...................................... 96 Permanent Total Disability ......................................... 96

Workers’ Compensation Laws ............................................ 96 State Workers’ Compensation Laws .......................... 96

Temporary Disability Laws ................................................. 97 Workers’ Compensation – State Requirements and Concepts ............................................................................ 97 Workers’ Compensation Financing .................................... 98 Workers’ Compensation Claims Administration ................. 99 Workers’ Compensation Pricing ......................................... 99

Prior Approval Rating ................................................ 99 Competitive Rating .................................................... 99

Impact of Workers’ Compensation ..................................... 99 Unemployment Insurance .................................................. 99

Federal Unemployment Insurance Programs ............ 99 Conclusion ....................................................................... 100 CHAPTER 4 – DISABILITY INSURANCE AND LONG TERM CARE INSURANCE .......................... 100 Understanding the Importance of Disability Income ......... 100 Disability Insurance Concepts .......................................... 100

Policy Elimination Period ......................................... 100 Benefit Period .......................................................... 100 Renewal .................................................................. 100 Total Disability ......................................................... 101 Occupations ............................................................ 101 Income Requirement ............................................... 101 Definition of “Disabled” ............................................ 101 Waiver of Premium .................................................. 101 Exclusions ............................................................... 101 Grace Period ........................................................... 101 Contestability ........................................................... 102

Disability Policy Options ................................................... 102 Customizing the Policy ............................................ 102

Policies for Business ........................................................ 102 Business Overhead Policy ....................................... 102 Disability Insurance for a Key Employee ................. 103

Tax Effects of Disability Insurance ................................... 103 Disability Underwriting ...................................................... 103

Correlating the Data ................................................ 103 Medical Underwriting ............................................... 103 Importance of Medical Examinations ....................... 103 Underwriting Substandard Policies .......................... 104

Disability Claims ............................................................... 104


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Payment of Claims................................................... 104 Long Term Care Insurance ............................................... 104

The Producer’s Role ................................................ 104 History ..................................................................... 104 What Is Long Term Care ......................................... 104 Benefits Provided By LTC ........................................ 104 Optional Benefits ..................................................... 104 How Long Will Benefits Be Paid? ............................ 105 Pre-Existing Conditions and Other Exclusions ........ 105 Long Term Care Provisions in Other Policies .......... 105

Underwriting Long Term Care .......................................... 105 Sources of Information ............................................. 105 Substandard Underwriting ....................................... 105 Policy Provisions...................................................... 105 Required Policy Provisions ...................................... 105 Optional Policy Provisions ....................................... 106

Conclusion ........................................................................ 106 CHAPTER 5 – REGULATION OF INSURANCE .............. 107 State vs. Federal Regulation ............................................ 107 National Association of Insurance Commissioners ........... 107 Gramm-Leach-Bliley Act................................................... 108

Creating Uniformity in the Regulation of Insurance Producers ................................................ 108 Reciprocity and Uniformity Requirements ................ 110 The Producer Licensing Model Act .......................... 110 Protecting Privacy .................................................... 110 Financial Privacy Rule ............................................. 111 Safeguards Rule ...................................................... 111 Implementing Safeguards ........................................ 112 Permitted Disclosure of Nonpublic Personal Information ................................................ 114 Other GLBA Provisions ............................................ 114 GLBA – Summary .................................................... 114

Legal Cases and Implications ........................................... 114 Paul v. Virginia ......................................................... 114 Munn v. Illinois ......................................................... 115 The 20th Century ..................................................... 115 The South-Eastern Underwriters Association .......... 115 Public Law 15 .......................................................... 115 The U.S. v. Insurance Board of Cleveland ............... 116

Purposes of Regulation .................................................... 116 Major Categories of Regulation ........................................ 117

The Financial Strength of the Insurer....................... 117 Regulation of Products ............................................ 117 Regulation of Sales and Sales Activities .................. 117

Government and Self-Regulation ..................................... 117 Legislative Regulation .............................................. 117 Judicial Regulation................................................... 117 Executive Regulation ............................................... 118 Self-Regulation ........................................................ 118

Specific Types of Regulation ............................................ 118 Regulation of Insurer Expenses ............................... 118 Regulation of Admitted Assets ................................. 118 Regulating Rates ..................................................... 118 Regulating Automobile Insurance Rates .................. 118 Regulating Property and Liability Insurance Rates .. 119 Regulating Life and Health Insurance Rates ........... 119 Regulating Reserves ............................................... 119

Regulation of Dividends ........................................... 119 Regulation of Capital Stock/Surplus Accounts ......... 119 Regulation of Business Capacity ............................. 119 Regulation of Investments ....................................... 119 Requirements for Organizing and Licensing Insurers .................................................... 120 Liquidation of Insurers .............................................. 120 Regulation of Products ............................................. 120

Taxes ................................................................................ 120 Applicable Rates and Rules ..................................... 120

Pricing of Insurance Rates ................................................ 120 Rate Regulation Objectives...................................... 121 The State Insurance Commissioner’s Role .............. 121

Conclusion ........................................................................ 121 CHAPTER 6 – ETHICS .................................................... 122 Standards and Practices ................................................... 122

Perceptions of Ethics ............................................... 122 Ethics for the Agent .................................................. 123 Ethics for Insurance Brokers .................................... 123 Characteristics of a Professional .............................. 123 Responsibilities to the General Public ...................... 123 The Agent as a Fiduciary ......................................... 123

The Concept of Agency .................................................... 124 Authority ................................................................... 124 Captive Agent vs. Independent Agent ...................... 124 Responsibilities to Consumers and Clients .............. 125 Risk Management .................................................... 125

State and Federal Regulations ......................................... 125 Organizational Codes of Ethics ........................................ 126

Independent Insurance Agents and Brokers of America .................................................. 126 American Institute for Chartered Property and Casualty Underwriters (CPCU) ................................ 127 National Association of Life Underwriters (NALU) .... 128 National Association of Fraternal Insurance Counselors (NAFIC) ................................ 128 Million Dollar Round Table (MDRT) ......................... 128 American College ..................................................... 129 Summary – Organizational Codes of Ethics ............ 129

Areas of Unethical Activity ................................................ 129 Unlicensed Practice ................................................. 129 Illegal Rebating ........................................................ 129 Baiting and Switching ............................................... 130 Redlining .................................................................. 130 Commingling Of Premiums ...................................... 130 Altering Applications ................................................ 130 Ledger Selling .......................................................... 130 Misleading Illustrations ............................................. 130 Conflicts of Interest .................................................. 130

Agent Accountability ......................................................... 130 Agent Accountability to Principals as Clients ........... 131 Rating Services ........................................................ 131 On-Going Service .................................................... 132 Agents’ Accountability to the Companies They Represent ................................................................ 132

Conclusion ........................................................................ 132 Final Exam ....................................................................... 135

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INTRODUCTION Insurance professionals can impact customers’ lives in many different ways. Whether providing a renters policy for a young adult moving into his or her first apartment, providing long term care insurance for a senior citizen, or explaining the risks involved in starting a new business, insurance producers walk side by side with their customers through life’s various stages. In these materials we examine some of the insurance policies and services which your clients should be made familiar with when they enter the workforce, start a professional career, or organize a business venture of their own. In this course we will discuss commercial coverage, issues raised by the high incidence rate and need for crime insurance, and workers’ compensation issues affecting both employers and employees. We will also cover disability and long term care, which are risks that also should be addressed as your clients age and take on more responsibilities for themselves and their families. A discussion of the insurance producer’s role in the life of his or her client could not be complete without a review of the regulations that govern the insurance industry and the ethics that must guide all insurance professionals in day to day practice. By understanding the various insurance products and the regulatory and ethical framework guiding the insurance industry, you will develop a better capacity for advising your insurance prospects and customers regarding their options for optimal insurance protection.

CHAPTER 1 – COMMERCIAL INSURANCE Introduction to Commercial Insurance Commercial insurance is not unlike personal insurance in the types of coverage offered and in the different variations of the basic plan. For example, commercial insurance offers protection for property loss and liability. Also, as with personal insurance, a business owner can purchase additional coverage to supplement the coverage of his or her basic policy. However, despite any similarities that these two types of insurance share, business owners must carry commercial insurance, or insurance that is designed for businesses, since they may be exposed to considerably more loss than the personal insurance policyholder because of employees, inventory, and the constant stream of people entering the establishment. The term multiple-line, or multiple-peril, is used to describe an insurance policy that combines different lines of insurance in a single package. Those who purchase this type of insurance are actually buying several polices for one premium. Property and liability is commonly sold as a multiple-peril policy. This type of policy is more comprehensive than a single-line policy, which offers only one type of insurance. For example, a single-line policy might offer coverage for liability or property, but it does not offer coverage for both liability and property. Finally, because this package insurance policy exists as a single entity, it may not be subdivided into several separate policies. If a person does not wish to purchase the entire package, he may consider opting for a single-line policy although he will lose the discounted price and convenience of the package policy. In this chapter we will explore two types of commercial multi-peril policies: the special multi-peril policy (SMP) and the business-owners policy (BOP). History of the Commercial Package Policy Concept Package policies have been an integral part of the insurance industry for decades. Even the simple fire and extended coverage policy, one of the first insurance policies ever available, is a package in that the extended coverage endorsement (additional insurance that an insured has the option of adding to his basic policy to broaden coverage) combines a number of separate perils (wind, hail, explosion, impact by vehicles or aircraft, and riot and civil commotion) into one package. Since then, many different packages of

insurance coverages have been introduced and implemented as important components of the insurance industry. The first real commercial multi-peril packages offering protection for both property and liability did not appear until the early 1960s. Part of the reason for the late arrival of these types of policies was governmental regulations of insurance and because insurance at that time, with the exception of homeowners policies, had changed very little. For instance, for quite some time, many states were forced to comply with laws that required insurance agents to be licensed in the single-line form of insurance since most insurance companies were required to offer only single-line insurance. In other words, companies who specialized in property insurance were not allowed to sell liability coverage; therefore, insurance companies only hired agents who were licensed to sell property insurance. The same was true for other single-line policies such as liability, marine and aircraft policies. These regulations were slowly relaxed during the 1950s because by that time it was evident that many buyers of the homeowners package policy welcomed the “new” package policy. Naturally, business owners, many of whom were also homeowners, complained that they, too, could benefit from the reduced cost and the convenience of the package policy. Up to that time business owners were only able to purchase single-line policies, just as homeowners had done until the 1950s. Furthermore, because of the increased risks of store or company ownership, business owners had to purchase a much larger number of separate policies than a homeowner had ever had to buy. In the 1960s, one decade after homeowners insurance had been available, some insurers, together with agents and brokers, focused on the desires of potential commercial policyholders and created the package concept for businesses. Only a few innovative, aggressive insurance companies had worked to develop these new packages. Therefore, when the business package policies were finally approved, these few companies, taking advantage of the principles of free enterprise, were the first to market them, thereby jumping ahead of their competitors, and attracting more business. Structure and Terminology of Commercial Insurance Policies As with any type of insurance policy, an understanding of the basic terminology that one will encounter in the policy is crucial to understanding the policy itself and its coverages. Structure of the Policy Commercial policies contain at least two sections, property, and liability. These are referred to, respectively, as Section I and Section II. Depending on the type of policy, some insurance contracts contain other sections (such as theft and burglary) that are a part of the basic policy. These sections may describe a particular type of optional coverage or endorsement, or additional coverages that the purchaser may consider adding to extend the basic coverage of his policy. Regardless of how many sections the policy might contain, each section describes in detail the specific types of protection that the policy covers and the specific types of damages that are excluded, or not covered, under the policy. The Named Insured The “named insured,” usually stated as item one on the policy’s declarations page, is the person(s) or organization that is protected by the policy’s coverage as long as the named insured is acting either in the business’s interest or according to his role in that business. Many times, the word “insured” is quite broad, but the term can apply to any of the following: A sole proprietor and his spouse. A partnership or joint venture. An organization or any executive officer. A member of the board of trustees, directors or governors. Any stockholder; any employee of the named insured. Any person or organization who acts as the real estate

manager for the named insured.

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Named Peril Form vs. All-Risk Form Under the standard form policy, businesses are protected against the usual named perils, but there are special form policies that protect against multiple risks, and this type of protection is called all-risk coverage. Named peril insurance means that the insurance policy specifically names those perils from which the business owner is protected. All-risk insurance policies state that the business is protected against all risks except those that are specifically excluded, such as earthquake coverage. The named peril form states specifically which perils are covered, and if a policyholder feels that additional coverage is necessary, he can usually add these by endorsement or by optional coverage to broaden the coverage of his policy. The all-risk form works differently. This type of policy covers all situations except for those that are specifically excluded under the policy. As with the named peril form, additional policies, endorsements, or optional coverage may be added to the all-risk form so that insureds may more fully cover their exposures to risk. Actual Cash Value vs. Replacement Cost Replacement cost means that damaged or destroyed property is covered for the amount that it actually costs to replace or to restore the item to its original condition rather than its actual cash value (ACV), which is its current market or depreciated value. For instance, if a policy states that property is covered according to its replacement cost and if a business has a computer that originally cost $2,000, the insurance company will replace the damaged or destroyed computer with a new, similar computer even if that computer in today’s market is now worth $3,000. The insurance company does not consider that perhaps the damaged or destroyed computer is really only worth $1,500 (the original cost of the computer less its depreciation) as it would if the policy stated that damaged or destroyed property would be replaced or covered according to its present market value, or its ACV. Using the same example, when calculating an insurance company’s obligation to cover part of a loss according to the ACV method for calculation, the insurance company would pay the insured business owner $1,500, the original cost of the computer less its depreciation. Whether the policy provides for replacement cost or ACV, the business owner is responsible for paying the deductible. Assessing Insurance Risks and Needs Agents must help business owners to carefully assess their insurance needs from two standpoints. First, a business owner must examine his business’s exposure to loss or risks (pertaining to both property and liability) from which he wishes to be protected. If the basic policy does not include coverage for the type of risk to which a business is exposed, business owners can usually add the necessary coverage for the risk by purchasing an endorsement or optional coverage for added protection. Secondly, business owners should also consider the limits of liability that the policy contains. Like increased protection for exposure to risk, most liability limits can be raised by endorsement or optional coverage. Considering exposure to risk is essential since many types of exposures such as fire can severely impair the business’s normal activities or may even cause business operations to cease altogether. All risks, even those which seem unlikely, must be anticipated. Business owners must carefully weigh the advantages of lower annual, monthly, or quarterly, premiums against having high deductibles or low limits of protection. While it is less expensive to purchase an insurance policy that has a $1,000 deductible than one which has a $250 deductible, a business owner must decide whether the higher premium for the lower deductible makes good sense for the business. Companies that offer commercial insurance often have questionnaires that a potential policyholder must fill out. Using the information from the questionnaires the company’s agent can help the business owner pinpoint the insurance needs of the business and then suggest the best coverage to meet those needs.

The Special Multi-Peril Policy (SMP) As stated earlier, the evolution of commercial package policies and programs can be traced to the development and implementation of the homeowners’ package which protects an individual’s personal property and personal liability. When the first commercial policies, which were (and still are) called the special multi-peril policy (SMP), became available, small, medium and large businesses were rated in exactly the same way. The SMP was the sole commercial policy package on the market. Thus, a small business with only ten employees and a large company with hundreds of workers were rated in the same way and were insured under identical SMP forms. Although the SMP covered many perils, for some small and medium sized businesses, the coverage included protection against risks that these business owners would never require because these businesses, by their very size, are exposed to fewer risks than large companies. As a result, small and medium sized business owners paid for coverage they did not need and paid the same premiums that large companies paid. The SMP was a convenient, discounted policy since it combined several single-line forms of insurance. Unfortunately small and medium sized business owners wasted money because they were paying for coverage that they would likely never use. Once rating changed to recognize the relative levels of risk for differently sized business, the SMP became the most popular policy for small and medium sized businesses. While many small and medium sized businesses find the coverages of the SMP to be the best policy for insuring their businesses, many large businesses also find the SMP to be a viable way for insuring itself against property or liability. Although some of these large companies are not eligible for the SMP program, many large businesses do indeed qualify for the program. However, some large companies, which are otherwise eligible, have insurance requirements beyond the scope of the SMP program. This is, of course, to be expected if these companies are exposed to risks that the SMP does not include as part of its protection. Or, interested business owners who operate large companies may discover that even though they are interested in the plan, they are not able to purchase the additional required coverage through endorsements or optional coverages. Advantages of the SMP Approach When deciding whether to go with a single-line or a multiple-line type of coverage, the commercial policyholder will discover that when his insurance needs are combined as a multiple-line package, he will benefit from lower costs, from more complete coverage in a single policy contract, and from flexibility of choice when selecting optional coverages. Reduction in Cost Reduction in cost, the first advantage, is probably the most important and most attractive feature of the SMP program. The reduction in premium costs can be ascribed to the following elements: the selection process, the handling of just one policy, careful examination of class characteristics and through the reduction of risks. Reducing costs through the selection process.

Eligible policyholders are screened during the underwriting selection. For example, businesses involved in industries experiencing a higher degree of risk will probably be eliminated immediately. Insurance companies who screen applicants so that their underwriters eliminate poor risks and select only the better risks usually will benefit from cost reductions ranging from 15 to 30 percent. These are up-front reductions in initial premiums. Because SMPs are written by both dividend and non-dividend paying insurance companies, policyholders with some dividend companies may gain additional savings through receiving earned dividends. Another factor in cost reductions is that the insurance company’s selection process tends to ensure that a particular group of policyholders will statistically show a better than average loss ratio, meaning that SMP

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policyholders have less exposure to risk and, therefore, file less claims.

Reduced paperwork and lower losses. Cost reduction is also attributable to two additional factors. First, both the insurance company and the insurance agent or broker benefit from savings in processing reductions since they will manage only one policy instead of perhaps two to ten policies as they would have to do with single-line policies. Second, another cost reduction occurs because, overall, the losses suffered by the SMP class are less costly and fewer in number than the losses suffered by other classes with similar coverage that is written under a series of separate policies. These savings, both the cost of handling one policy rather than several and the decreased chances of the SMP class suffering a loss, are passed on to the policyholder, usually in the form of reduced premiums.

Reducing costs by cutting risks. The selection process, as described above, is repeated at renewal time. At that time, the loss experience (claims filed and losses suffered) and inspection reports of the condition of each business owner’s property and equipment (among other areas of examination) are taken into account when deciding whether each business still qualifies for the SMP program and its discounted premium. Obviously, it is necessary for an SMP policyholder to maintain his premises in excellent condition and to demonstrate that he is receptive, concerned, alert to loss prevention recommendations, and willing to implement suggested improvements in an effort to reduce exposure to loss. He must exhibit these desired characteristics if he wishes to continue benefiting from the reductions in insurance costs that an SMP provides. To illustrate this point, suppose that a business owner is advised by the insurance company’s representative to buy and to install a better locking mechanism for the cabinet where he stores the guns that he sells. The representative may even urge the policyholder to purchase one of several products that the insurance company has already deemed to be the best, or the most effective, locking mechanisms available in the current marketplace. The policyholder should comply with the representative’s suggested improvement since the representative will probably note in the policyholder’s file that the recommendation was made on a particular date. Sometimes, the representative, because he considers the risk of damage or loss to be significant, may even mandate that the locking mechanism must be installed by a specific time on a named day. This does not mean that the insurance company will constantly be making suggestions for improvement to the business owner’s property or that the insurance company will infringe upon the business owner’s right to conduct business as he sees fit. Rather, it is one of the insurance company’s methods for reducing exposure to risk, thereby lowering premiums and reducing the chances of a loss occurring. In that way, the class’s loss experience is reduced, or at the very least not increased, because businesses are willing to implement the insurance companies’ recommendations for risk reduction. Finally, not complying with such suggestions could mean that the business might lose its SMP coverage since the insurance company may determine that the business owner is, in effect, increasing the chances of risk and loss for his class.

Single Policy Contract A second main advantage of the SMP policy is that this policy covers most of the business operation’s exposure. One policy means only one expiration date to worry about, one premium payment (or one planned series if a payment plan is used), one insurance policy file, and, consequently, low probability that the business owner will have periods of time where coverage lapses. Also, one policy combining several

coverages gives the policyholder’s account a higher profile with the insurance company’s underwriter. Theoretically, a well-written SMP, together with a workers’ compensation policy and an appropriate automobile for business usage policy, encompasses in one document all of the insurance needs (other than employee benefits) for most small to medium sized business enterprises. However, an SMP is not a package which automatically provides business owners with all of their necessary coverages. Selecting a policy requires thoughtful decisions, review, and updating as the business owner’s situation changes. An effective insurance agent can greatly assist the business owner through this process. Flexibility of Choice Flexibility of choice, the third advantage, makes it necessary for the policyholder and his agent or broker to carefully review his business needs to ensure that selected coverages respond adequately to his needs. For example, in the mandatory property section, an insured must decide whether the desired coverage is going to be all-risk, named peril, or just fire and extended coverage. If the insured chooses the latter coverage, then he must determine whether there is a need for protection against sprinkler leakage or some other water or earthquake protection by way of either an endorsement or as an optional coverage. Finally, business owners who choose either the named peril or the all-risk form must review available optional coverages or endorsements before deciding whether these extra coverages are necessary. Businesses That Qualify For an SMP Today’s SMP policy program consists of eight different classification groups, each group offering its own package discount. The group in which a business is placed affects the premium that the business owner will pay. For the most part, the same policy forms are employed for each of the eight groups. The eight groups are: Apartment houses. Contractors. Motel-hotel operations. Industrial and processing plants. Institutions. Mercantile operations. Offices. Service firms.

The package discounts that apply to each group vary by group and by state. Discounts are periodically recalculated to reflect the loss experience of the group or of the class as a whole. For example, it is possible for a group to have a package factor of 1.00 (no discount) or, if the loss experience of the group is low, a factor of perhaps .65 (a discount of 35 percent). Businesses That Do Not Qualify For an SMP Eligibility rules for the SMP program now permit an expansive class of insureds to qualify for the program. Only a few classes are excluded from purchasing an SMP. These include: Boarding or rooming houses and other residential

properties that consist of fewer than three apartment units. Farms and farming operations (this is because a separate

commercial package policy exists for farmers). Automobile filling or service stations; automobile repairing

or rebuilding operations; automobile, motor home and motorcycle dealers; and parking lots or garages unless they are incidental to the otherwise eligible class.

Grain elevators, grain tanks and grain warehouses. Properties or businesses which can be categorized in one

of five ways: Highly protected risks. Petroleum properties. Petrochemical plants. Electric generating stations.

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Natural gas. Of course, this list does not indicate that these categories of business are ineligible for any type of commercial insurance; it only defines those establishments that are ineligible for participation in the SMP program. Other policies that more adequately and comprehensively address the coverage needs of these types of businesses have been created specifically for that purpose and are available at most insurance companies that offer business owners’ insurance. Defining the Two Types of Property There are two broad categories of property which must be considered: Real and personal business property. The agent must recognize the differences in these types and be able to clearly explain them to the business owner as this is essential for understanding property coverage. Real Property Coverage “Buildings” as defined in the SMP coverage forms include more than just buildings. The definition includes each of the following: Buildings. Structures. Additions. Fixtures. Permanent equipment and machinery used for

maintenance and/or service of the building. Materials and supplies intended for use in construction. Alterations or repairs. Yard fixtures. Fire extinguishing apparatus. Appliances used for refrigeration, ventilating or cooking. Dishwashing and laundering equipment. Floor coverings.

All of these property types must be located on the insured’s premises if the business owner is to benefit from the policy’s protection. Basic exclusions from building equipment are swimming pools, fences, piers, docks, wharves, walks, cost of excavation, building foundations and underground pipes. These types of properties, like other exclusions, may be protected against loss by purchasing a separate policy (depending on the type of property that it is), an endorsement, or optional coverage, depending on the type of property. Business Personal Property Coverage Coverage is available through the SMP for business personal property which is usual to the insured’s occupancy or to business operations. Included also are tenant improvements in buildings that are not owned by the insured, and limited extension to the personal property of others that is in the care, custody, or control of the insured at the time of the loss. In most situations personal property coverage is limited to property that is located on the insured premises. SMP (Section I) Property Coverage The type of personal property covered under Section I consists of, but is not limited to, stocks (inventories) of merchandise and of raw materials, supplies and fittings, and furniture, fixtures, equipment, and machinery. Basic exclusions are animals and pets; watercraft; automobiles, vehicles or trailers licensed for highway use; aircraft; personal property while waterborne; household and individual personal property; and accounts, bills, currency, deeds, evidence of debt, money and securities. Valuable papers, money, and securities coverage is available under Section III or by means of various crime endorsements. Each of the above exclusions may be included if the business owner opts to purchase a separate policy (if required), an endorsement or optional coverage. There are two types of SMP forms from which a business owner might choose. A business owner might choose the standard, or named peril approach, or he may opt for the all-risk approach. Each of these forms covers different perils, so a business owner must carefully weigh whether the additional cost of the all-risk form better suits his insurance needs than

the less expensive, but also less comprehensive, named peril form. The Standard (Named Peril) Form of Property Coverage Coverage for both buildings and personal property is provided by combining several different peril forms. The basic forms are the general building form and the general personal property form. Under these two forms, insurance coverage is on a named peril basis. These perils include fire, lightning, windstorm, hail, explosion and smoke; aircraft or vehicle damage; riot, riot attending a strike, or civil commotion; and vandalism or malicious mischief. Coverage is limited by exclusions of electrical injury, interruption of power, earth movement, flood, or any enforcement of ordinance or law regarding the use, the construction, or the repair of a building. At the insured’s or insurance company’s request, vandalism and malicious mischief, which is usually covered, may be excluded, which deletes this peril from the general form. The All-Risk Form of Property Coverage As an alternative to the named peril approach, an insured may consider coverage on an all-risks basis. The special building form and special personal property forms provide these types of coverages at an additional cost. Although the all-risk form offers a wide variety of coverage, certain exclusions will always be included as part of the policy. The exclusions are losses that are caused by the following: Enforcement of local or state ordinances regulating

construction. Electrical injury to electrical appliances caused by an

artificially generated current. Flood, earthquake, sewer backup, or water below the

surface of the ground. Wear and tear, gradual deterioration, rust, corrosion, mold,

wet or dry rot, or inherent or latent defect. Smog. Smoke, vapor, or gas from agricultural or industrial

operations. Mechanical breakdown, including rupture or bursting

caused by centrifugal force. Settling, cracking, shrinkage, bulging, or expansion of

pavements, foundations, walls, floors or ceilings. Animals, birds, vermin, or other insects. Explosion of steam boilers, steam pipes, or engines. Vandalism and malicious mischief to any building that is

vacant or that is unoccupied for more than 30 days. Continuous or repeated seepage or leakage from water or

steam from plumbing, heating and air conditioning or other equipment.

Theft of any property that is not an integral part of a building at the time of the loss.

Unexplained or mysterious disappearance of property. Loss that is caused directly or indirectly by an interruption

of power. Additional Optional Coverages An insured may purchase added endorsements or optional coverages so that he may more adequately meet his insurance needs. Because the policyholder is adding coverage to his basic policy, the business owner must pay an additional cost for each of these endorsements or optional coverages. An insured’s endorsements are usually found on the declarations page of his policy, so when the purchaser receives his policy, he must make sure that all the additional coverages he purchased are specifically listed on the declarations page so that he does not misunderstand his policy’s coverage.

Accounts Receivable, Valuable Papers, and Records Endorsements These endorsements provide coverage on an all-risk basis and are examined on an individual basis. The accounts receivable endorsement provides coverage for all money that customers owe a business, and these figures include interest and

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collection expenses in case the insured is unable to make collection because of a direct loss or because of damage to the accounts receivable records. Depending on the needs of the insured, both reporting and non-reporting forms, which are discussed below, are obtainable. The valuable paper and records endorsement provides business owners with insurance coverage for valuable papers and records while these are on the insured premises. Included are documents and records, books, maps, films, drawings, abstracts, deeds, mortgages, and manuscripts. However, money and securities are excluded. The perils insured against are protected on an all-risk basis from direct physical loss. A separate limit of liability is allowed for specific articles, and a blanket limit is available to provide coverages for all items which are not specified. There also exists a limited extension provision for coverage of such property while away from the insured premises (usually 10 percent of the combined limits not to exceed $5,000). Broad Form Storekeepers Endorsement Designed to provide limited fidelity and burglary coverage for small mercantile stores, this endorsement is applicable to business owners who employ less than five employees. Business Interruption Insurance Business interruption insurance includes a broad category of specific losses of use or time element insurance coverage. These are designed to indemnify, or to compensate financially, the insured for a loss of earnings (as the policy defines loss of earnings), tuition fees, rents, or the extra expenses involved in continuing operations in case an insured’s premises are damaged by an insured peril. Under the SMP program, several business interruption forms are available so that business owners may better select the necessary business interruption endorsement that their businesses require. For example, coverage may be added to business interruption insurance by adding to the policy a gross earnings endorsement, which covers gross earnings less non-continuing expenses, for the actual loss sustained by the insured from the interruption of business. As with all gross earnings forms, included as part of the policy’s coverage is a coinsurance (sometimes called a contribution) clause in the amount of 50, 60, 70, or 80 percent of the business’s annual gross earnings. Failure of any kind to maintain an adequate amount of insurance in respect to the selected coinsurance percentage will result in a claim payment penalty for a sustained loss. Coverage for ordinary payroll expense either may be excluded or limited to a period of 90 consecutive days following damage to the insured premises. If not specifically included in the policy as a coverage the business owner’s employees will not be paid unless he can prove that paying the payroll is essential to continuing or to speeding the resumption of business operations. Business interruption coverage also may be written on an earnings endorsement, which protects the business owner against actual losses suffered (gross earnings less non-continuing expenses) with no coinsurance requirement. However, recovery is restricted to a percentage of the limit of liability that is applicable on a monthly basis. The business owner may select 16.67 percent, 25 percent, or 33.33 percent depending on how long he estimates that it would take to repair or to restore the premises to its original condition. Coverage under this endorsement ensures that the insured is protected against perils that might damage or destroy the building and/or its contents.

Builders’ Risk Endorsement Another endorsement, the SMP builders’ risk endorsement, consists of two forms which can be applied either to the named peril or to the all-risk policy. For named peril policyholders, the appropriate form is called the completed value form, and for business owners who carry an all-risk policy, the SMP special builders’ risk completed value form is available. The builders’ risk endorsement is designed to provide property insurance coverages for builders’ risk exposures while they are constructing a new building or an insignificant addition. All but insignificant additions or new buildings must be specifically added by endorsement. Church Theft Endorsement This endorsement is designed to provide coverage for a church against theft or attempted theft of money, securities, or any other property while at the church, in a bank or night depository, or in the care or custody of an authorized person. The form is subject to definitions and exclusions which should be reviewed. Coverages can be provided at an agreed value for specified articles and/or at a specified limit for all other property. Combined Business Interruption and Extra Expense Endorsement The combined business interruption and extra expense endorsement provides coverage for both business interruption and for extra expense losses with a single, specified limit of liability which is explicitly stated in the endorsement. An insured may select from specified percentage options such as those found in the business interruption’s gross earnings endorsement. Usually, these percentages are based on the amount of time that a business owner estimates would be necessary for restoration. Condominium Operations Endorsement The condominium operations endorsement has been developed through the use of several special arrangement forms which are intended to meet the needs of certain insureds. The SMP condominium operations endorsement (an additional policy provisions endorsement) is available to provide named peril or all-risk property coverage for condominium operations. These forms follow the named peril and the all-risk forms discussed earlier with special terms and conditions that have been included to meet the needs of the condominium association that oversees the maintenance and general upkeep of its premises. Earthquake Extension Endorsement An earthquake extension endorsement can be added to afford coverage that is intended to meet the needs of certain insureds both under the named peril and the all-risk forms. This coverage is applicable only to the insured premises. Extra Expense Endorsement Some companies might find it advantageous to purchase insurance protection for extra expenses incurred so that they can continue their operations should their insured premises be damaged or destroyed. The extra expense endorsement available under the SMP program provides this type of coverage. This coverage should be considered either in lieu of or in addition to business interruption insurance for those businesses where a shutdown is unacceptable and would cause a complete cessation of business activities. In such situations, the insured will incur expenses for leasing temporary facilities and for resources that will be necessary and that enable the insured to continue servicing customers. Coverage is limited on a monthly basis (not more than 40 percent of the endorsement’s limit for any one month

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or less) and generally follows the perils insured in Section I. Remember that the expense portion of business interruption policies only covers extra expenses incurred to the extent that they reduce the loss of net profit. Accordingly, some types of businesses might need this endorsement in addition to the business interruption endorsement. Inland Marine Coverage Endorsements There are several optional inland marine coverage endorsements which can be added to Section I. These provide coverage for both personal property and for the property of others that is in the care, custody, or control of the insured. Coverage is provided on an all-risk basis and is limited by specific exclusions, terms, and conditions. These endorsements closely follow the usual inland marine property floater contracts. The specific endorsements available are the radium floater, the fine arts floater, the musical instruments floater, the neon sign endorsement, the glass coverage endorsement, and the physicians and surgeons equipment endorsement. Liability for Guests’ Property Endorsement Although this endorsement contains specific exclusions and limitations, the liability for guests’ property endorsement provides coverage for an innkeeper’s liability for loss or damage to property of guests while this property is within the insured premises or while in the possession of the insured’s care, custody, or control. Loss of Rents Endorsement This endorsement provides coverage for loss that an insured might sustain if tenants are unable to rent his insured property because of damage or destruction to the premises by an insured peril. Coverage is usually bound by the enacting of a predetermined contribution clause which essentially functions as a coinsurance clause. Also, the insurance company is not liable for a greater proportion of any loss than the stated limit of liability; this amount is produced by multiplying the rental values from the previous 12 months by the pre-determined coinsurance clause. Mercantile Open Stock Burglary Endorsement Because a business’s personal property may be exposed to loss that is caused by burglary, robbery or theft, there are several extension endorsements that can be added to Section I of the SMP policy to protect against loss by crime. These endorsements are available under Section I, or in some cases, under Section III, which deals exclusively with crime coverages and which will be discussed in greater detail later. Coverages under this endorsement closely parallel those that a person would find in a separate, or single-line, policy. Also, the mercantile open stock burglary endorsement may be combined with the general personal property form so that coverage is provided for the business owner’s merchandise, furniture, fixtures, and equipment that exists at the insured property. This property is protected against loss caused by burglary or robbery while the premises are not open for business. If personal property is covered by the all-risk form, this endorsement is not needed because that type of policy includes this coverage as part of its basic protection. Mercantile Open Stock Burglary and Theft Endorsement This endorsement provides coverage for loss or damage to merchandise, furniture, fixtures, and equipment that are located at the insured property in two situations. The first is for burglary or robbery of a watchman while the premises are closed for

business, and the second is for protection against theft or attempted theft regardless of whether or not the premises are open for business. As stated in the previous endorsement, this endorsement is not needed if the insured purchases an all-risk form since the all-risk form already protects the insured from this type of loss. Mercantile Robbery and Safe Burglary Endorsement This endorsement provides coverage for loss of money, securities and other property both inside and outside the insured premises; it includes as part of its coverage the burglary of a safe. Optional Perils Coverage Endorsement An optional perils coverage endorsement is available on the named perils form for both buildings and personal property protection. Additional perils covered by this form are breakage of glass (which is part of the building and subject to limitations); falling objects (loss or damage to personal property in the open is not included); weight of ice, snow or sleet; water damage and loss caused by collapse of the building structure itself. Coverage is also included for accidental discharge of water or steam from plumbing, heating or an air conditioning system, but discharge from automatic sprinkler systems is excluded from coverage. Replacement Cost Coverage Endorsement No matter which of the two forms (the named peril or the all-risk) that a business owner chooses, one important consideration is the method for establishing the value of insured property at the time of a loss. Unless specifically endorsed or stated in the coverage form, all property will be valued according to its ACV (actual cash value) rather than on its replacement cost. Also, the precise definition of ACV depends upon the type of property under consideration. There are variations in the application of ACV depending on whether the properties being valued are real or personal property used in the operation of the business or, finished goods or products held for sale by the business. This basis of adjustment may be modified, however, by the attachment of the replacement cost coverage endorsement. Under this endorsement, insured property involved in a loss will be adjusted on the basis of the amount necessary to repair or to replace the damaged property, and reimbursement is restricted only to the policy’s limit of liability without regard to the actual age of the property at the time of the loss. Business owners should be aware that this endorsement does not delete or replace any coinsurance requirement and that it is not extended to certain types of property such as stock, property of others, valuable papers, records, or fine arts. The business owner must first pay the deductible, no matter which method for establishing value the policy uses. Reporting Forms Endorsement Another available provision under both forms is the addition of a reporting form endorsement which converts basic property coverage forms to a reporting basis. Two separate forms comprise the reporting endorsement: The specific rate form and the average rate reporting endorsements form. This endorsement is convenient for business owners whose personal property values fluctuate and for business owners who have difficulty in determining the correct amounts of insurance to purchase. Business owners who opt for this endorsement are allowed to identify their business cycles, which generally range from peak to slow seasons. By using a reporting form, a business owner can establish a limit of insurance that sufficiently covers

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the maximum values of the insured property at a given time. The insured reports the actual value of the business at stated periods and a premium is charged on the average value at risk during the entire year rather than paying high premiums year round because of the increased risks which only exist during particular months of the year. For example, a Christmas ornament business’s busiest season of course is around the Christmas holidays, when it, therefore, has an increased exposure to risk. Exposure to risk is significantly less during the summer since this type of store is not busy then. To calculate the premium, the insurance company calculates the business’s average risk during the year by averaging its busy times with its slow periods rather than requiring the business to pay a premium that is based solely on the increased business activity during the Christmas season. As a result, the insured knows that the business has the benefit of adequate coverage during both peak and slower periods. Furthermore, the business owner will pay a fair premium that is based on the actual value of the annual average of risk exposure rather than paying a much higher premium that is based on higher risk exposure during only specific months of the year. Sprinkler Leakage Endorsement The sprinkler leakage endorsement provides protection for insured property against named perils that cause damage to the business owner’s property from leakage or discharge of water (or other substance) from an automatic fire protection system. It also includes coverage for loss or damage resulting from the collapse of a tank which is part of the sprinkler system. This endorsement contains specified limits of liability, coinsurance percentages, conditions, and exclusions and must be separately requested and priced when developing the SMP contract. Tuition Fees Endorsement The tuition fees endorsement provides coverage for lost tuition fees that an educational institution might suffer if the school’s physical facilities are damaged and unusable because of loss by an insured peril. The basis of recovery is the amount of the actual loss sustained from the date of loss to the opening of the school year that begins after the premises’ restoration is complete. Coverage is available on an 80 percent or on a 100 percent coinsurance basis.

SMP (Section II) General Liability Coverage The SMP, in Section II, describes general liability insurance and is a mandatory coverage, just as property coverage is in Section I. Typically, coverage is written on a comprehensive general liability (CGL) basis for any occurrence which is attributable to either of two causes: one is the liability brought on by the ownership, maintenance or use of the insured premises and the second is for the liability created by business operations that are necessary or incidental to the named insured’s commercial activities. Furthermore, the SMP’s liability coverage extends to the business’s products and completed operations unless the insurance policy specifically states that these are excluded for some reason. Coverage is on a combined single limit basis although the insured may purchase separate limits for bodily injury and property damage if he feels that this better suits the particular needs of the business. Agents and business owners should confer with the insurance companies’ underwriters so that they will be well informed about their liability coverage and whether they carry the standard or the all-risk package in Section II of their policy. The agent should be aware if the insurance company has created its own form which details what is protected on the premises or in the business operations. The insured should be made aware of any other optional coverages or

endorsements that are obtainable so they might broaden the scope of the policy’s basic coverage. In the personal injury section of coverage, the following coverages are included: an employer’s non-owned automobile, an automobile fleet (the agent should know what number of cars determines a fleet), professional liability, comprehensive medical payments, contractual liability, independent contractors, and elevator collision. Of course, policies differ from company to company, so not all of these will be found in every policy’s liability section. General Liability Coverage General liability covers exposures such as lawsuits occurring because of slips or falls on the insured premises, injuries which occur because of operating equipment, and certain liabilities which are assumed already to be under contract or agreement. As stated above, this coverage also extends to protect a business owner against liability that is caused from the use or consumption of products that the business produces or sells. However, if the underwriters feel that the product’s liability exposure is too severe to be covered under the CGL section, they will exclude the product(s) from the SMP and will require that the business owner purchase a separate products liability policy. General and Special Liability Exclusions The SMP does not cover claims for injury to employees because this must be covered under a separate workers’ compensation policy. Remember that workers’ compensation is not included in the SMP policy. This is a separate policy, not available under endorsement or optional coverage, which business owners must purchase in addition to their SMP policy. This is true also for employee benefit programs and for liability that occurs as a result of operating automobiles or trucks. These coverages, like workers’ compensation, are not available by endorsement or optional coverage and must be insured under an employee benefits program or under an automobile for business usage liability policy. Several special exposures such as liability for errors or omissions by professionals are not protected under Section II of the SMP. Section II of an SMP does not cover professional errors in professions such as architecture, engineering, the medical or legal field, or accounting. Instead, a separate professional liability policy is necessary if a business owner wants to protect himself against exposure to these risks. To avoid any future problems and to protect against common and special liabilities, the agent assisting the business owner to set up the policy should become completely familiar with the property and operations of the business. SMP (Section III) Crime Coverage Crime coverage, available under Section III, is entirely an optional coverage (unlike the mandatory property and liability coverages in Sections I and II of the SMP. Its purpose is to provide coverage for money and securities, negotiable instruments, and employee dishonesty. Protection against loss by crime is intended to closely parallel the single-line coverages which are available under separate policies. As mentioned in the property section, both property forms, the named peril and the all-risk, exclude crime coverage since it is covered under Section III. Furthermore, the SMP offers only limited coverage for these exposures under the various crime endorsements at an additional cost. Some businesses, however, might decide not to include this section as part of their SMP policy because they might need broader coverage than what is available, they may desire higher limits than what this section offers, or they simply may not even be eligible for coverage under the limited endorsements that they could add because the underwriters have decided that risk of loss is too great for their business. On the other hand, the SMP package discount may make it sensible for some business owners to include the crime coverage in this section. There are three basic coverages under this section: the comprehensive crime coverage endorsement, the blanket crime coverage endorsement, and the public employers blanket endorsement. A blanket form is a form of contract between an insured and an insurance company which provides coverage for similar

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types of property at different locations or for different types of property located at the same location. Also, the public employers blanket endorsement provides coverage for all employees or for a class of employees without their being specifically named. The main difference between the comprehensive crime and the blanket crime endorsement is that under the blanket form, all insurance agreements, which are broadly defined as the promises made by the insurance company to the insured, are mandatorily protected from loss. Under the comprehensive crime endorsement, the insured may select specific coverage agreements and varying limits of liability and coverage for employee dishonesty on a blanket position basis. The blanket position coverage for employee dishonesty under this endorsement also allows the stated limit of liability to be applied to each employee rather than to the employees as a group. Therefore, for example, if three employees acted together to steal $30,000, a $10,000 blanket position coverage would cover the loss in full since each of the employees is considered to be a separate entity. In contrast, the blanket limit of liability applies on a per occurrence basis for any one loss, regardless of the number of employees involved. In the previous example, a $30,000 commercial blanket bond would be required to cover the loss in full. In addition to providing coverage for loss by extortion, unless it has been specifically excluded, the following are coverages that are available under the comprehensive crime endorsement, which consists of five kinds of protection against loss caused by criminal acts. These five categories can be selected separately. In fact, business owners may opt for only some of these because certain coverages are more comprehensive than others. The five categories are: Employee dishonesty. Commercial blanket. This agreement provides coverage

for loss of money, securities, and other property because of any dishonest or fraudulent acts by the insured’s employee(s). The stated limit is the amount that can be applied to each occurrence, regardless of the number of employees which may be involved. The limit would typically apply to each occurrence, not to each employee.

Blanket position. Coverage under this agreement is similar to that provided under commercial blanket coverage; however, the limit of liability is applied per employee rather than per occurrence basis. All employees of the insured are covered and are considered to be a separate entity.

Money and securities loss inside the premises. This provides coverage up to the specified limit for loss of money and securities by destruction, disappearance, or wrongful abstraction inside the insured premises or at any banking premises.

Money and securities loss outside the premises. Coverage under this agreement is the same as that available under the prior coverage, except that it covers money and securities that are outside the premises that are being transported by a messenger, that are in the home of a messenger, or that are in an armored car.

Money orders and counterfeit paper currency coverage. This agreement provides coverage for the insured against loss due to the acceptance, in good faith, of any counterfeit money or money orders while in the course of business.

Depositor’s forgery coverage. Coverage under this agreement is provided for the insured or for a bank, when a savings or checking account is maintained, for loss that occurs as a result of forgery of checks, drafts or other negotiable instruments.

Coverage under these agreements is not always inclusive. Business owners must carefully review these forms for the endorsement’s specific limitations and exclusions. In addition, the consideration of deductibles should not be overlooked.

SMP (Section IV) Boiler and Machinery Coverage Boiler and machinery coverage, Section IV of the SMP, is optional and, if selected, is eligible for the SMP package discount. Usually coverage is provided or recommended on the basis of a survey that is completed by the insurance company and is based on a business owner’s responses. The specific limits, locations, and terms are outlined on a separate declarations endorsement. When setting up a policy, the agent should always have the business owner describe the business operations in detail because the owner may not realize that normal business operations may require his purchasing insurance which protects boilers, refrigeration equipment, electrical apparatus and other kinds of machinery. By disclosing information about the way his company operates, the owner avoids future disaster that might have been protected against had he carried the proper insurance coverage. Some insurance companies will not insure this type of coverage but, will obtain a cooperative arrangement through another insurance company who specializes in this area of insurance. The company that specializes in boiler and machinery insurance will provide the underwriting, pricing and loss control services. In fact, even though the insurance is provided through another company, this endorsement may be added to the business owner’s policy and the owner will receive a package discount. Finally, coverage is written on an ACV basis unless the business owner prefers protecting equipment on a repair and replacement cost basis, which must be added by endorsement. Boilers

The SMP boiler and machinery coverage endorsement includes coverage for all boilers, unfired pressure vessels and piping that are either in use or that are connected and ready for use. Because almost all fire and extended coverage policies exclude damage that results from explosion of boilers or other pressure vessels, this coverage is needed if insured property contains any heating boiler, process boiler, or any steam generator that operates under pressure. Another important consideration when deciding whether or not to add this endorsement is that the liability coverage in Section II specifically excludes liability which occurs as a result of these kinds of explosions. The addition of this protection also includes the insured’s liability for damage to the property of others and any associated defense costs if a lawsuit should be brought against the company or the business owner.

Machinery Machinery coverage insures against damage and costs that result from the breakdown of machinery while it is on the premises. The equipment to be insured must be scheduled, or itemized, on the policy. Business owners, in an effort to protect their business operations, usually insure only those machines that are abnormally expensive, time consuming to repair or are critical to their business operations. The coverage extends to damage to surrounding property, which is excluded in basic fire and extended coverage policies. It is wise to ask if the insurance company has a good boiler and machinery inspection service, for these inspections can be as important as the coverages themselves. Coverage on other types of machinery is usually available through an additional object groups endorsement. Equipment under this endorsement must be scheduled on the policy.

Additional Coverages Business interruption coverage may be available under Section IV on a daily or a weekly indemnity basis. Extra expense coverage also may be purchased for the period a business owner estimates it would take for him to continue his operations elsewhere while his usual premises are being restored to their original state. In addition, coverage may be

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available for prevention of occupancy and consequential damage that might occur by a company who leases its premises or which occurs if a business must continue its operations at a different location while the premises are being restored to their original state. Impact and Future of the SMP Program The impact of the SMP program has been significant. This is evidenced by the notable increase in premium dollars that insurance companies have written for their policyholders. Also, one must remember that two other successful policies, the Business Owners Policy and Farmers’ Insurance, originated from the SMP. It is unlikely there will be significant change to coverage or eligibility in the SMP program. However, periodic minor changes and updates will be made to its current form. Eligibility is now quite broad, the coverage options are stabilized, and cost savings have been established. The only likely adjustments in the foreseeable future might be slight modifications made to package discounts for individual business groups. The Business Owners Policy Plan (BOP) The business owners policy plan, or BOP, is written in a way that is easy to understand and is a simple policy structure offering broad coverage at a competitive price. Attractive features of the BOP include coverages for: Replacement cost without coinsurance. Loss of income. The property of others in the insured’s care, custody, and

control. Transit. Peak season. Broad business liability. Employees as additional insureds.

History of the Policy In an effort to meet the insurance needs of small and medium sized business owners, one independent insurer in 1974 filed a simplified version of the SMP. This simplified, new approach, with its simple rating structure, fixed coverages, and fixed limits of liability, was called the business owners policy, or BOP. In fact, eventually two forms of the BOP, the named peril and the all-risk, were created to satisfy the needs of these types of businesses. Although a business must meet certain eligibility requirements to purchase a BOP, its simplified rating approach, and coverage format quickly enabled the BOP to become an important policy in meeting the insurance needs and coverages for eligible business operations. Determining the Premium Several factors are considered when an insurance company determines the premiums its policyholders will pay. One factor is the insurance company’s rating procedure, and another factor is based on the information an agent gathers about a business’s background and its operations during a site visit. Lastly, some policyholders may be issued credits or debits that are applied to premiums, which lower the total premium that they must pay. The Rating Procedure A definitely attractive feature of the BOP is its simple rating procedure. The package premium is developed from the amounts of insurance that are placed on the building (if the business owner actually has ownership of the premises) and the business’s personal property. If any optional coverages or endorsements are necessary to extend or to broaden the policy’s coverage, the business owner can add these for a separately determined additional charge. The rates for the special BOP are higher than those for the standard BOP since it is an all-risk policy which offers more comprehensive coverage. Inspection of the Site to Determine Insurance Needs The underwriting and rating of a business heavily relies on the information the insurance representative collects in order to best determine what types of coverage and the limits of coverage a business must have to protect itself against loss.

The insurance company’s representative usually conducts at least one fact-finding visit to the business to analyze the conditions of the premises, its equipment, and its operations. When the representative conducts the inspection, the business owner should be prepared to relay all necessary information about the business so the basic application is complete and so the business owner’s BOP premium can be determined. Each of the following is among the information which the business owner may be asked to disclose: Background information about the business. The name of the business and its owners. The type of business to be insured. The square footage of the building. The percentage of the building occupied by the business. The grade of fire protection at the site where the business

operates. The building and contents replacement cost values. The value of outside signs (if any). The amount of external glass. The preferred BOP form (named peril or all-risk). The policy’s effective date (if purchased). Information regarding the handling and storage of money. Any burglar alarms that might have been installed. The quality of protective devices such as door locks. Any other measures the business owner might have taken

to reduce exposure to loss. Lower Premium Debits and Credits One final point which should be noted about BOP premiums is the possibility for premium credits or debits which are based on certain underwriting factors, including the following: Business’s management.

The business must be willing to cooperate in matters of safeguarding and proper managing of the property that is to be covered by the policy.

Location. Location refers to the accessibility and the environment of the premises.

Building features. Building features include the air-conditioning or any unusual structural features.

Premises and equipment. Insurance companies might issue credits if a business’s premises and equipment are in excellent condition, are well cared for, and are the appropriate type that is necessary for operating the business.

Employees. Business owners may also be questioned about the selection, training, supervision, and experience of their employees.

Type of protection that is desired. Business owners will be asked what other, if any, types of insurance protection they already have or if there is any coverage they would like to add that is not specifically mentioned in the BOP policy.

Finally, special credits and debits may be applied to accounts which carry a premium of $500 or more. These credits and debits are intended for use when the special characteristics of the business in question do not seem to be fully covered or recognized in the basic BOP rate structure. The maximum premium deviation for all credits and debits combined generally is limited to 15 percent. Qualifications for Eligibility The type of business a person owns determines whether or not that person is eligible to purchase this type of business insurance. Major insurance firms usually allow apartment and office complexes, motels, religious institutions, and certain mercantile businesses to purchase this policy. However, not all businesses qualify for a BOP. Generally, to qualify for the BOP program, insurance companies consider a number of factors. Most, but not all,

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insurance companies take into consideration the following: the building’s square footage, the amount of liability that will be needed to protect the business against loss, the type of business, and the extent of its off-premises servicing and processing activities. Also, the Insurance Services Office (ISO) has developed its own set of eligibility standards, which some insurance companies use as their standard. For example, to qualify, an apartment building may not be more than six stories tall, must consist of no more than 60 dwelling units, and may not contain more than 7,500 square feet of mercantile space. An office building may not exceed three stories, must encompass no more than 100,000 square feet, and is limited to 7,500 square feet of mercantile space. Retail stores, which include all buildings at the same location, may not have more than 7,500 square feet for the total area. Basement areas that are closed off from the public are not included in calculating the total area in any of these situations. Businesses That Might Qualify For A BOP Some types of businesses that might qualify for a BOP are hobby stores, barber/beauty shops, bookstores, churches, direct sales shops, dry cleaners, fabric shops, ice cream shops, opticians, and photo studios. Parking lots and garages that provide parking spaces may qualify only if they are an incidental part of an otherwise eligible business. Businesses That Do Not Qualify For A BOP Contractors are usually ineligible for this coverage, but if a hardware store sells merchandise such as materials for building a deck and then installs that merchandise, the hardware store may still qualify for eligibility since the contracting part of the business does not detract from what is considered to be the “essential nature” of the hardware store. In other words, the installation of materials comprises only a small percentage of the business’s revenue. Other types of small businesses, no matter how small or even if they qualify under most of the eligibility criteria, usually have specialized insurance needs such as high levels of liability in areas for which the BOP does not provide protection. For instance, companies whose operations are centered on cars, motor homes, motorcycles, or mobile homes are ineligible for purchasing a BOP. Bars, grills, and restaurants are also ineligible for BOP coverage as are condominiums since the ISO has developed separate coverage plans for these types of property. Buildings which have at least part of them dedicated to manufacturing or processing are not eligible for coverage because the coverage these types of businesses require is beyond the scope of this policy. In fact, even if a business’s operations are spread over several locations, if one of those has manufacturing or processing, the whole company is barred from purchasing a BOP. Places of amusement: fairs, carnivals, amusement parks, theaters, and bowling alleys are ineligible because their purposes are not primarily involved with the buying and selling of merchandise, which is an eligibility requirement. Finally, wholesalers are ineligible because these businesses are usually large-scale operations, and financial institutions of any sort may not purchase a BOP because their exposure to crime surpasses that of any small to medium sized business. Exclusions, General Conditions and Provisions Specific to the BOP The BOP program does not rely on the same wording or format of its forerunner, the standard fire policy. However, the essence of those provisions is contained in both BOP policy forms. The conditions and other provisions a policyholder will find in this section of the BOP policy are basically classified into two categories: one is general exclusions and the second is general conditions and provisions that are applicable to Section I (property) or to Section II (liability). Some of the more important provisions and conditions are discussed in the following text.

General Exclusions of War Risks, Governmental Action, and Nuclear Catastrophes The vast majority of insurance policies exclude coverage for losses that are caused by war risks, governmental action, and nuclear catastrophes. This section of the BOP, as with most other insurance policies, is intended to exclude losses caused by hostile or warlike action in time of peace or war, insurrection, rebellion, revolution, civil war, usurped power, risk of contraband, illegal transport or trade, nuclear radiation, and radioactive contamination. These exclusions incorporate acts of terrorism. General Conditions and Provisions This section of the BOP policy describes numerous general provisions that are usually, with perhaps slight variances in language, found in most insurance policies. Several of these provisions have been reworded to simplify the language, but the meaning and substance of these provisions remains unchanged. These provisions deal with: “Concealment or fraud,” which voids the policy

immediately upon discovery of the wrongdoing. “Subrogation,” a term that describes the process by which

an injured party pays the deductible and receives payment for the balance from the party’s own insurance company. The insurance company in turn seeks reimbursement, plus its insured’s deductible, from the insurance company of the person who caused the damage.

“Waiver or change of provisions,” which can only be accomplished if the waiver or if the alteration of the provisions is added to the policy by written endorsement.

“Liberalization,” which states the policy’s coverages might at any time in the future be extended or broadened to benefit this particular policy as if the policy had been altered by written endorsement.

“Replacement of forms and endorsements,” which states the insurer may convert old contract forms to new contract forms at the policy’s anniversary date even if the old contract forms stated that the policy was a continuous policy (one without a specific termination date).

“Inspection and audit,” which gives the insurer the right, but not the obligation, to inspect the insured business.

“Assignment,” which means the insured cannot sign over his interest in the BOP to another party without the written consent of the insurance company. If, however, the named insured should die within the policy period, the coverage provided by the policy applies: To the named insured’s legal representative whose job it

is to act in the interest of the named insured, but this is only effective until the legal representative’s duties are completed at which time the policy immediately ceases to be applicable to him.

To the person who has temporary custody of the named insured’s property until a legal representative has been appointed and qualified to act in the insured’s interest.

“Premium,” which states the premium for a BOP policy is to be computed according to the insurer’s rules, rates, and minimum premiums that are in place at the time. Furthermore, the policy may be continued by payment of successive one-year premiums even if the insured pays his premiums on a payment plan.

Provisions Specific to the BOP Some of the other general conditions found in the BOP are not the same as similar provisions that exist in other types of insurance contracts. The cancellation provision.

The cancellation provision of the BOP enables the named insured to cancel the policy at some future date if the cancellation date is submitted in writing before the effective date of cancellation. Similarly, the insurance company may cancel the policy by giving written notice of the date of cancellation to the insured and to the

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mortgagee at least 20 days in advance of the policy’s termination. The time allowed for cancellation under the BOP policy is much longer than the allowed time period for other policies. For instance, the standard fire policy stipulates only five days’ advance notice is required for either the insured or the insurance company to cancel the policy, and the SMP requires 10 days’ advance notice prior to the date of the policy’s cancellation. The BOP’s longer time period allows the insured, whether he or the insurance company terminates the policy, ample time to find adequate coverage elsewhere without any lapses in coverage.

Calculating the return premium. When a policy is cancelled, the insured is entitled to a return premium, which is the part of the premium already paid. The return premium that the insured receives depends on which party, the insured or the insurance company, cancels the policy. The method for calculating the return premium is the same whether the insured has already paid the premium in full or the premium is paid through a payment plan. On the one hand, if the insurer cancels the policy, the insured’s return premium is computed on a pro rata, or prorated, basis. To determine this figure, first the total premium is divided by the number of days in the policy period. This number reflects how much the insured is paying per day for this policy. The daily cost is then multiplied by the number of days that remain in the policy period. The product of these two numbers is the return premium that the insured will receive. On the other hand, if the insured should cancel the policy, he must pay the insurance company 90 percent of the premium that he has not yet used. This, too, is calculated on a pro rata basis. To calculate the insured’s return premium, the total premium is divided by the number of days in the policy period, and this number is then multiplied by the number of days left in the policy period. The insured is responsible for paying 90 percent of this figure, and the insurance company will return the remaining 10 percent to the policyholder as return premium.

Policy Period, Policy Territory, and Time of Inception Provisions Two other provisions found in the general conditions section of the BOP define the policy period, the policy territory, and the time of inception. The policy period provision of the BOP states the beginning and ending dates of the policy. The usual time of inception for a BOP is 12:00 noon, but if the BOP is replacing a policy that expires at 12:01 a.m., the BOP inception will be at 12:01 a.m. so that the insured can avoid any lapse of coverage. The policy territory includes the 50 states of the United States, the District of Columbia, and Puerto Rico. Other Insurance Provision The other insurance provision notifies the policyholder that his property and that the property of others which is in his care, custody or control is considered to be excess coverage, meaning that the insured’s other policy must first cover any loss and that the BOP will only cover amounts that exceed the limits of the other policy. In other words, the BOP does not work in conjunction with the other policy; it only covers the amount that remains after the other policy has been exhausted. Unlike property coverage, the BOP’s general liability coverage is meant to be used as primary, not as excess, coverage, and any excess beyond the limits of what the BOP policy will pay may be applied to umbrella coverage since this is how umbrella coverage is intended to be used. Duplication of Coverage Provision The final provision states that in the event there is a loss covered by more than one part of the policy, endorsement, or optional coverage, the insurer’s limit of liability is the amount of the loss. This provision is included to enforce the fundamental principle of indemnity.

Available BOP Policies There are two types of BOP coverage, the standard (or named peril) form, and the special (or all-risk) form. The policies offer similar coverage for property coverage for buildings, business personal property, loss of income, and other optional property coverages as well as comprehensive business liability coverage. Another similarity is that both BOP forms provide coverage without coinsurance penalties. As stated earlier, coinsurance means that the business owner shares the risk of any loss with the insurance company, and the policyholder is always responsible for paying his deductible before the insurance company will pay its percentage of the specified ratio in the policy. Furthermore, both policies cover buildings and most business property on a replacement cost basis. However, unlike business property, ACV is an option for buildings. Owners of older buildings for whom replacement cost coverage may be difficult or too expensive to obtain might consider the ACV option. Likewise, a business owner may consider rejecting the ACV option because the building was recently constructed, and little difference exists between its replacement cost and its ACV. What makes the forms different are the perils that each covers and the options that each offers. For instance, the standard form offers only optional coverage for burglary and robbery, and the special form offers optional coverage for money and securities. Standard (Named Peril) Form BOP The premium for the standard BOP is less than the premium for the special, or all-risk, form simply because of the differences in approach of named peril and all-risk coverage. However, many businesses find the standard form’s smaller premium attractive. They may also discover that the type of coverage the standard form offers is satisfactory for their insurance needs and thus may opt for the named peril rather than the all-risk form. Deductibles in the Standard Form BOP Of course, deductibles vary from company to company and certainly from state to state. Generally, however, under most standard BOP forms, direct property losses are subject to a $100 deductible per occurrence. This deductible applies separately to each location with an overall aggregate, or total, of $1,000 per occurrence for all locations. If the loss results from robbery or burglary or from employee dishonesty, a higher deductible of $250 applies to these two optional coverages if the business owner had added these policy endorsements prior to the loss. However, loss of income claims are handled differently; no deductible applies to this type of loss. BOP (Section I) Property Coverage The property section, found in Section I of the standard BOP policy, insures against direct losses suffered from the following: fire, lightning, extended coverage perils (windstorm, hail, explosion, smoke, aircraft, vehicles, riot, riot attending a strike, or civil disturbance), vandalism or malicious mischief, and sprinkler leakage. If the property is in transit to another location, in addition to the coverages mentioned above, it is protected against collision, derailment, or overturn of the transporting conveyance, stranding or sinking of vessels, and collapse of bridges, culverts, docks or wharves. Finally, while many of these named perils are not subject to any limitations, the BOP does limit two classes of property, and the policy also contains several general exclusions. General Property Limitations Under the Standard Form BOP The standard BOP also limits the coverage of two classes of property. These two classes are: Valuable papers and records, meaning books of account,

manuscripts, abstracts, drawings, card index systems, and other records (excluding film, tape, disc, drum, cells, and other magnetic recording or storage media for electronic data processing), which are covered for an amount not to

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exceed the cost of blank books, cards, or other blank material plus the cost of labor incurred by the insured for transcribing or for copying such records.

Film, tape, disc, drum, cell, and other magnetic recording or storing media for electronic data processing which are covered for an amount not to exceed the cost of such media in an unexposed or blank form.

While the standard form of the BOP includes this coverage without a specific dollar limitation, it does not cover the costs of research, which will probably be necessary for the reproduction or restoration of the lost, destroyed, or damaged records. General Property Exclusions Under the Standard Form BOP Although the BOP policy covers many types of losses, none of the following are covered: Exterior signs. Growing crops and lawns. Aircraft, cars, motor trucks and other vehicles that are

registered as motor vehicles. Watercraft (including motors, equipment, and accessories)

while afloat. Bullion (gold or silver), money, or securities. Losses that occur either directly or indirectly when

authorities enforce any ordinance or law that regulates the construction, repair, or demolition of buildings or structures.

Losses that result from power, heating or cooling failure unless the failure is the product of physical damage to the power, heating or cooling equipment which must be located on the premises that are named in the policy.

Losses caused by perils not otherwise excluded (such as damage resulting from an earthquake).

Losses resulting from riot, riot attending a strike, civil commotion, or vandalism or malicious mischief.

Electrical injury or disturbance of electrical appliances, devices, fixtures or wiring that is caused from electrical currents artificially generated unless a fire breaks out as a result of that damage.

According to most standard BOP forms, any losses that result, contribute to, or are aggravated by one of the following are covered: Earth movement, including but not limited to, earthquake,

landslide, mudflow, earth sinking, earth rising or shifting. Flood, surface water, waves, tidal water, tidal waves,

overflow of streams or other bodies of water, or spray from any of the foregoing, all whether driven by wind or not.

Water which backs up through sewers or drains. Water below the surface of the ground including that which

exerts pressure on or flows, seeps or leaks through sidewalks, driveways, foundations, walls, basement or other floors, or through doors, windows, or any other openings in such sidewalks, driveways, foundations, walls or floors.

Delay or loss of market, unless fire or explosion as insured against ensues, and then the insurance company will only pay for damages suffered by the resulting fire or explosion.

In addition to limiting classes of property and to excluding some perils, Section I of the policy usually breaks down into three subsections: buildings (Section A), personal business property (Section B), and loss of income (Section C). Building Coverage (Section A) The building coverages offered by the BOP are usually found in Section A of Section I in the policy’s declarations. There are four types of building coverage that this section of the policy discusses; buildings and fixtures, personal property, landscaping and debris removal, and quarterly automatic insurance rates.

Buildings and Fixtures The standard policy includes protection for the insured premises at the replacement cost, not ACV. This coverage also extends to garages, storage buildings and appurtenant structures, which are other types of buildings that might exist on the premises. Additionally, covered under this section are permanent fixtures, machinery, and equipment that the business must use to continue its normal business operations. Personal Property Personal property of the insured used for maintaining and for servicing the building is covered. This might include, but is not limited to, fire extinguishing equipment, floor coverings, and appliances such as those that are used for refrigeration, ventilation, cooking, dishwashing or laundering. Outdoor furniture and yard fixtures are considered to be part of the building, so they are covered as well. If an insured is a landlord and furnishes apartments or leased rooms with his own personal property, then this property is also covered. On the other hand, the tenants, if they wish to insure their own personal property, must purchase tenants (or renters) insurance since the landlord’s insurance coverage does not extend to their property. Landscaping and Debris Removal Trees, shrubs, and plants at the insured premises that are not worth more than $250 are protected against loss. However, the total liability for the company may not exceed more than a total of $1,000 for any loss to landscaping. The $250 limit that is mentioned above includes the cost of debris removal. However, if an insured would like to have additional removal coverage, it could purchase additional coverage that extends beyond the standard policy’s coverage. Sometimes this coverage can be written with no dollar limit on the total damage. Quarterly Automatic Insurance Rates Lastly, quarterly automatic insurance rate increases are included in this section of the BOP policy. The exact percentage that the policy may be increased in any one policy term is always included in the policy’s declarations. So if an owner at any time is concerned about how much his premium might increase in the coming year, he only needs to consult his policy to easily find this information. Business Personal Property Coverage (Section B) Before attempting to establish limits of liability in Section B, the business owner must first understand the definition of personal property coverage. Once he understands this, he can easily identify the policy’s coverages as they apply to property that is in transit, additional areas of coverage that may be available, and seasonal automatic increases that may benefit the policy. Defining Business Personal Property Restricted to a specific limit of liability, business personal property coverage is different from the personal property coverage that is included under Section A. Business personal property is property that is essential to running a business. For example, depending on the type of business, this may or may not include office equipment or other machinery that is needed for the business to function properly. Unlike other insurance policies, the definition of business personal property extends to similar property the insured has in his care, custody, or control. Property that is in the business owner’s care, custody, or control may be either solely or partially owned by another person. Whether it is the insured’s property or someone else’s, to qualify for protection against loss to business personal property, the property must be usual to the occupancy of the insured and on the insured’s premises at the time of the loss. Although the BOP specifically grants this type of coverage, the amount covered does not increase to reflect that the insured possesses the property of others. To illustrate, if a business owner has an additional $10,000 worth of merchandise on the premises that he has been asked to repair, the coverage that the business owner carries for his own business personal property does not increase by the additional $10,000 that is now in his care, custody, or control.

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Lastly, this part of the policy provides for replacement cost coverage for the insured’s business personal property, and the definition of this term applies to similar property the insured has in his care, custody or control but that belongs in whole or in part to others. Business Personal Property That Is In Transit or Being Moved To qualify for protection against loss, this property must be usual to the occupancy of the insured and on the premises that are named in the policy. However, business personal property or any similar property that is in the insured’s care is covered while in transit or otherwise temporarily away from the premises which are described in the declarations. Furthermore, business personal property at newly acquired locations is also covered for up to 30 days for amounts not to exceed a specified amount, usually set at $10,000. Additional Areas of Coverage The allowable amount also includes the value of labor, materials, and services that are furnished or performed. Also, tenant improvements, sometimes called betterments, are also covered if the business owner wants to use fixtures, alterations, installations, or additions that are found in a part of the building that is occupied, but not owned, by the insured. To qualify for coverage, the business owner must be paying rent for this area, and the insured must not be legally required to remove those improvements. Seasonal Automatic Increases Another distinct advantage is that the BOP offers a seasonal automatic increases provision. This provision increases the declared amounts of insurance by an extra 25 percent to provide for seasonal fluctuations in business activity. In fact, the insured does not have to specify in advance which months he expects this peak activity. So, a business person need not predict or even indicate that the Christmas season is busiest. Most policies state “this increase shall not apply unless the limit of liability shown in the declarations is 100 percent or more of the insured’s average monthly values for the 12 months immediately preceding the date of loss, or in the event the insured has been in business for less than 12 months.” Loss of Income Coverage (Section C) Loss of income coverage is found in Section C of most BOP policies. Different from most other types of coverage, business owners are not required to pay a deductible, are not bound by a coinsurance clause, and are not bound by a specified dollar limitation. A business person who loses his whole business due to a fire would be able to collect the amount which would otherwise have been earned from the business. Although this coverage does not state a maximum specified dollar limitation, this coverage may not exceed the reduction in gross earnings less charges and expenses which do not occur during the interruption of business or during the reduction in rents, less charges and expenses which also do not necessarily continue during the period of disuse. For instance, if the business person’s business was destroyed by a fire, he no longer would have to pay utility bills. These normal expenses would be deducted from normal gross earnings since he does not pay those bills either during the restoration or during the relocation of facilities. Coverage is on an actual loss-sustained basis. Loss of income coverage is limited to the period that it would take to repair, to rebuild, or to replace the damaged property, but, no matter what the circumstances are, this period may not exceed 12 months. Also, insurance companies expect the insured to minimize any income losses by resuming full or partial operations either at the premises named in the policy, if possible, or elsewhere, if practical. The insured is further required to resume business activities as soon as possible and to use all reasonable means not to delay reopening. Obviously, insurance companies are not willing to subsidize a closed business while it should be open for normal business operations. The BOP also states that the insurer will not be liable for any increase of loss caused by the interference of strikers or by

cancellation of any lease or contract unless that loss results directly from the interruption of business. Available Optional Coverages In addition to the standard coverages, business owners may want to purchase the following coverages to supplement the standard form’s BOP coverages. The costs of these additional coverages are added to the basic premium, and these supplementary coverages must be stated on the declarations page. Depending on the insurance company’s policies regarding premium payment, sometimes the business owner pays a separate premium for these types of coverages, and sometimes the cost of the additional insurance is added to the standard form’s premium so that the business owner only makes one payment rather than two or more. Accounts Receivable Coverage When accounts receivable coverage is available, it is normally subject to a separate deductible provision and to a separate limit of liability. This form of coverage pays all sums that are owed to a business by its customers if those sums become uncollectible because of loss or damage to the firm’s accounts receivable records. Boiler and Machinery Coverage When this coverage is selected, business owners are purchasing coverage against loss to objects such as boilers, pressure vessels, and air-conditioning equipment (as defined in the policy) when this damage is attributable to an accident (as accident is defined in the policy). Coverage extends to all objects that are owned, leased, or operated under the control of the insured. This optional BOP coverage gives insurance companies the right (but not the obligation) to inspect insured equipment and to suspend coverage (which may only be done in writing) if dangerous conditions are discovered during that inspection. If suspended, premium credit will be granted on a pro rata basis. Burglary and Robbery Coverage When burglary and robbery coverage is selected as an optional coverage, a business owner is protecting his company against losses of business personal property (excluding money and securities) on the insured premises for an amount not to exceed 25 percent of the liability in Section B. This coverage protects businesses against losses from money and securities that are in a bank or savings institution for an amount not to exceed $5,000. Finally, money and securities either that are traveling to or from the insured premises, bank, or savings institution or that are contained within the living quarters of the custodian of such funds is covered for an amount not to exceed $2,000. As with other types of coverage, certain types of property are subject to limited burglary and robbery protection. For instance, fur and fur garments are covered as long as the loss does not exceed an aggregate of $1,000 for any one occurrence. Also, jewelry, watches, watch movements, jewels, pearls, precious and other semi-precious stones, gold, silver, platinum, and other precious alloys or metals are covered but are subject to a limit of $1,000 for any one occurrence. However, this limitation does not apply to jewelry or to watches that are valued at $25 or less per item. Insurance companies frequently require that certain types of businesses have an acceptable burglary alarm system in order to obtain this optional coverage for protection against burglary and robbery. Earthquake Coverage Earthquake coverage may be added to most BOPs by endorsement. Some insurers, however, limit the availability of this extension of coverage to the special (or all-risk) policy, which is discussed at length below. When added to a BOP, the earthquake endorsement provides coverage for the business’s building(s), for business personal property, and for loss of income. The limits of liability are the same as those for any other peril that might cause a covered property loss, but the deductible, usually calculated at two percent (2%), is a percentage of the applicable limits of liability.

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Employee Dishonesty Coverage When employee dishonesty coverage is included in the policy the declarations page also states the BOP’s limit of liability for employee dishonesty losses. Employee dishonesty coverage contains several conditions, and the agent should always review these conditions with the business owner. For instance, one important condition excludes coverage for any losses that result from dishonest or fraudulent acts by the business owner or by any partner, officer, director, or trustee. Another condition freezes the amount for which the owner may be reimbursed to the amount that is discovered missing at the time of its discovery. In other words, once a loss has been discovered, the BOP will pay for losses only up to that date, but not for any further loss that is caused by the known culprit. Some BOPs even stipulate that the culprit, when proven guilty, must be fired. Some insurance companies warn the business owner that he now runs the risk of losing this protection should any future losses result from the acts of any employee. Exterior Grade Floor Glass Coverage This BOP coverage is one of the broadest, most comprehensive glass coverages available under any policy. This optional coverage provides replacement cost coverage for all exterior grade floor and basement glass, including the glass’s lettering or ornamentation and its encasing frames. This damage must be to the property of the business owner or to others who have placed their property in the care, custody, or control of the business owner. Glass is protected against damages that result from direct physical loss unless the loss is the result of wear and tear, latent defect, corrosion, or rust. This coverage also includes reimbursement for the expenses of boarding up damaged openings, of installing temporary plates, and of removing or replacing obstructions when necessary. The usual perils and exclusions (except for the war risk, governmental action, or nuclear exclusions) do not apply. Exterior Signs Coverage The declarations page, as in the above coverage, states the amount of insurance that applies when this optional coverage is in effect. This coverage insures all exterior signs located on the business owner’s premises whether he owns these signs or whether they belong to others who have placed their property in the business owner’s care, custody, or control. The usual perils and exclusions (except for the war risks, governmental action, and the nuclear catastrophe exclusions) provided by the standard BOP do not apply to this coverage. Although this coverage utilizes all-risk protection against loss, it does exclude normal wear and tear, latent defect, rust or corrosion, and mechanical breakdown. The Special (All Risk) Policy The special BOP is similar to the standard form; however, the few differences that exist between these two forms are significant. For instance, although both policies describe coverage for buildings, business personal property and loss of income (Sections A, B and C, respectively) in precisely the same way, the special BOP makes coverages available on an all-risk basis, while the standard BOP is a named peril policy. Furthermore, the special BOP has more subsections than the standard form. For example, the special form also automatically includes money and securities coverage (Section D) in its basic policy, which as discussed above, is available only in the standard BOP as an optional coverage. Finally, primarily because of the difference between the all-risk and named peril approach to coverage, differences between the special and the standard forms are substantial in regard to excluded property and to property that is subject to limitations. Property Coverage (Section I, Sections A, B and C) As mentioned above, Section I and its subsections (A, B, and C) in both the standard and the special forms define building(s), business personal property, and loss of income in exactly the same way. However, the special BOP covers these categories of property against all risks of direct physical

loss rather than on a named peril basis and is bound only to specific exclusions that are included in the policy. General Property Limitations under the Special Form Like the standard form, the special BOP has two sets of limitations. In fact, the first of these is very similar to the standard BOP; this limits the coverage for valuable papers and records, including film, tape and other forms of electronic data storage media, to the cost of blank cards or other media form. In the case of a manual records system, the coverage also recognizes the cost of labor needed to transcribe or to copy such records, but not to reproduce the electronic data processing types of storage media. The second set of limitations is exclusive to the special version of the BOP. Coverage for the following areas of property is limited when a loss results from a peril that is not specifically excluded from coverage; however, these limitations do not apply to losses caused by fire, lightning, any of the extended coverage perils or sprinkler leakage. The limitations are: Glass constituting a part of the building is not covered

against loss for more than $50 per plate, pane, multiple plate insulating unit, radiant heating panel, jalousie, louver, or shutter, nor for more than $250 in any one occurrence.

Glass, glassware, statuary, marbles, bric-a-brac, porcelains, and other articles of a fragile or brittle nature are not covered against loss by breakage. This limitation does not apply to bottles or similar containers of property for sale or sold but not delivered or to the lenses of photographic or scientific instruments.

Fur and fur garments are covered for amounts not exceeding loss in the aggregate of $1,000 for any one occurrence.

Jewelry and watches, watch movements, jewels, pearls, precious and semi-precious stones, bullion, gold, silver, platinum, and other precious alloys or metals are covered for amounts not exceeding loss in the aggregate of $1,000 in any one occurrence. This limitation does not apply to jewelry valued at $25 or less per item.

General Property Exclusions Under the Special Form The same categories of property are specifically excluded under the special BOP as under the standard policy: exterior signs unless insured under optional coverage, growing crops and lawns, and aircraft, cars, motor trucks, and other vehicles subject to motor vehicle law, registration, or watercraft (including motors, equipment and accessories) while afloat. Another exclusion under the standard BOP (bullion, money, and securities) is specifically covered under the special BOP, coverage D, as discussed earlier. Business owners will also find that the special BOP form contains the list of perils that are not protected against loss or damage. Usually stated in the following way, losses not protected by the special policy are those which are: Occasioned directly or indirectly by enforcement of any

ordinance or law regulating the construction, repair or demolition of buildings or structures.

Caused by or resulting from power, heating, or cooling failure or due to change in temperature or humidity unless the change results from physical damage to the building or to the equipment contained therein caused by a peril not otherwise excluded. Also the insurance company will not cover for any such loss resulting from riot, riot attending strike, civil commotion, vandalism or malicious mischief.

Caused by any electrical injury or disturbance of electrical appliances, devices, fixtures or wiring caused by electrical currents artificially generated, unless an insured fire ensues, in which case the insurance company will be liable for losses that are caused by the resulting fire.

Caused by pilferage, appropriation or concealment of any property covered or any fraudulent, dishonest or criminal act done by or at the instigation of the insured, partner, or joint venturer, including any officer, director, trustee, employee or agent thereof, or any person to whom the property covered may be entrusted.

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Caused by leakage or overflow from plumbing, heating, air conditioning, or other equipment or appliances (except fire protective systems) caused by or resulting from freezing while the described building is vacant or unoccupied unless the insured has exercised due diligence with respect to maintaining heat in the buildings or unless such equipment and appliances have been drained and the water supply shut off during such vacancy or occupancy.

Caused by any of the following: Wear and tear, marring or scratching. Deterioration, inherent vice or latent defect. Mechanical breakdown of machines, including rupture or

bursting caused by centrifugal force. Faulty design, materials or workmanship. Rust, mold, wet or dry rot, contamination. Dampness or dryness of atmosphere, changes in or

extremes of temperature. Smog, smoke from agricultural smudging, or industrial

operations. Birds, vermin, rodents, insects and animals unless loss

by fire, smoke (except smoke from agricultural or industrial operations), explosion, collapse of a building, glass breakage, or water not otherwise excluded ensues, then this policy will cover only the resulting losses. If loss by water not otherwise excluded ensues, the policy will also cover the cost of tearing out and of replacing any part of the building covered required to effect repairs to the plumbing, heating or air-conditioning system or domestic appliance, but excluding loss to the system or appliance from which the water escapes.

Due to any and all settling, shrinking, cracking, bulging or expansion of driveways, sidewalks, swimming pools, pavements, foundations, walls, floors, roofs or ceilings.

Caused by explosion of steam boilers, steam pipes, steam turbines or steam engines (except direct loss resulting from the explosion of accumulated gases or unconsumed fuel within the firebox, or combustion chamber of any fired vessel or within the flues or passages which conduct the gases of combustion there from) if owned by, leased by, or operated under the control of the insured, or for any ensuing loss except by fire or explosion not otherwise excluded, and then the insurance company is liable for only any ensuing losses.

Found in steam boilers, steam pipes, steam turbines or steam engines that are caused by any condition or occurrence within such boilers, pipes, turbines or engines (except for direct loss resulting from the explosion of accumulated gases or unconsumed fuel within the firebox or combustion chamber of any fired vessel or within the flues or passages which conducted the gases).

Found in hot water boilers or other equipment for heating water that is caused by any condition or occurrence within such boilers or equipment other than an explosion.

Caused by rain, snow, ice or sleet to any property that is out in the open.

Caused by, resulting from, contributed to, or aggravated by any of the following: Earth movement, including but not limited to earthquake,

landslide, mudflow, earth sinking, earth rising or shifting. Flood, surface water, waves, tidal water, tidal waves,

overflow of streams or other bodies of water, or spray from any of the foregoing, all whether driven by wind or not.

Water which backs up through sewers or drains. Water below the surface of the ground including that

which exerts pressure on or flows, seeps or leaks through sidewalks, driveways, foundations, walls, basement or other floors, or through doors, windows or any other openings in such sidewalks, driveways, foundations, walls or floors.

Due to voluntary parting with title or possession of any property by the insured or others if induced to do so by any fraudulent scheme or false pretense.

Due to unexplained or mysterious disappearance of property or shortage of property disclosed on taking inventory.

Due to delay or loss of market. Due to property sold by the insured under conditional sale,

trust agreement, installment payment, or other deferred payment plan, after delivery to customers.

The special BOP automatically includes coverage for theft losses with a $250 deductible. This deductible is consistent with the $250 deductible applicable to related optional coverages such as the employee dishonesty and the burglary and robbery coverages under the standard BOP. Money and Securities Coverage (Section D) Coverage D, Section I provides protection against on- and off-premises insurance coverage for money and securities that are used in the insured’s business. The amount of insurance that applies to this category of coverage is selected by the insured and is listed in the appropriate space on the declarations page. Additional Optional Coverages The automatic inclusion of theft, money, and securities coverage under the special BOP eliminates the need for the burglary and robbery coverage option that is available under the standard BOP. However, in all other ways, the special BOP offers the same optional coverages as does the standard BOP. Among these are employee dishonesty, exterior signs, exterior glass, and boiler and machinery coverage. Some insurance companies also offer accounts receivable and earthquake coverage with their special BOP while others do not. Liability Coverage Under the Standard and Special BOPS (Section II in Both Forms) The liability coverage provided by the standard BOP is exactly the same as that provided by the special BOP. While some insurers may permit higher limits of liability under the special BOP, no difference exists in the types of liability covered, nor in the definitions and other provisions discussed in Section II, the liability portion of the policy for both the standard and the special forms. The liability is, in fact, quite broad. The only decision that business owners must make is whether to select the $300,000 or the $1 million limit of liability made available through either form of BOP policy. Business Liability (Section E) Section E of the BOP states that it “will pay on behalf of the insured all sums which the insured shall become legally obligated to pay as damages because of bodily injury, property damage, or personal injury caused by any occurrence to which this insurance applies.” The BOP liability insuring agreement thus provides comprehensive general liability insurance on a per occurrence basis. This includes the usual liability coverage for a business’s “premises and operations.” Coverage for “completed operations” and “products” liability are also specifically included as is coverage for personal injury liability. The latter protects business owners against alleged false arrest, libel or slander, and wrongful entry or eviction or other invasion of privacy. A special fire legal liability provision provides up to $50,000 of coverage per occurrence for all damages resulting from fire or explosion, which damage structures rented to or occupied by the named insured. The liability coverages are written out in detail in the policy. In addition to the coverages listed above, the business liabilities exclusions section in the BOP covers other forms of liability. These may include employers’ non-owned automobile liability, blanket contractual liability, and host liquor law liability. Most insurers also provide druggists professional liability coverage when the insured operates a retail drugstore. This coverage protects the named insured, including partners, and executive officers, and the individual pharmacists who work for the insured. This coverage extends to all claims that arise

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out of goods or products prepared, sold, handled or distributed by the drugstore. Another extension of coverage nearly always found in the BOP is broad form property damage coverage. This coverage is especially valuable to those businesses that service or install items away from their business location. In essence, this coverage relaxes the usual care, custody and control exclusion to specifically cover damage to property that is caused by the negligent installation or replacement of an equipment or system part. The cost of the negligently installed item is excluded from coverage. Limits of Liability As noted, business owners may select liability insurance limits of either $300,000 or $1 million. These limits of liability are on a per occurrence basis and are not reduced by any supplementary payments, which are discussed below. However, the selected per occurrence limit is also limited to a specific total for all occurrences during the policy period that result from completed operations and/or products liability hazards. Fire and legal liability claims are further limited to no more than $50,000 per occurrence. As with other forms of liability insurance, insurance companies are required to defend any claim or suit against insured business owners by claimants who seek damages that are covered by the BOP even if the suit is false, fraudulent, or groundless. However, the BOP also gives the insurance company the right to investigate and to settle claims as it (the insurer) sees fit. Furthermore, when the BOP’s limits of liability have been exhausted by payment of a judgment or by a settlement, the insurance company is released from any further obligation to defend the insured or to make payments on the insured’s behalf. Supplementary Payments Similar to other insurance policies, the BOP agrees to make certain supplementary payments, which, if made, do not count toward the policy’s limit of liability. These types of payments include: All expenses incurred by the company. All cost incurred by the insured in any suit defended by the

company and all interest on the entire amount of any judgment which accrues after entry of the judgment and before the company has paid or deposited in court that part of the judgment which does not exceed the limits of the company’s liability.

Premiums on appeal bonds in any such suit. Premiums on bonds to release attachments in any such

suit for an amount not in excess of the applicable limit of liability of the policy.

Expenses incurred by the insured for first aid to others at the time of an accident for bodily injury to which the policy applies.

Reasonable expenses incurred by the insured at the company’s request in assisting the company in the investigation or defense of any claim or suit, including actual loss of earnings not to exceed $50 a day.

Medical Payments (Section F) The BOP automatically includes medical payments coverage (Section F) in the amounts of $1,000 per person and $10,000 for all persons requiring medical attention as a result of a single accident. This coverage is provided on a per-accident (as opposed to a per occurrence) basis. Conclusion Whether the Special Multi-Peril Policy (SMP) or the Business Owners Policy (BOP), it is essential that a business owner purchase commercial multi-peril insurance which offers protection for property loss and liability and any additional coverage that may be needed to supplement the coverage of his or her personally owned policies. By understanding your client’s business and the specific benefits of the different types of commercial property policies, you can offer sophisticated service which will lead your clients to appropriate insurance protection.

CHAPTER 2 – CRIME INSURANCE Introduction Whether your client is a homeowner or business owner, often a sensitive and scary subject for the client is the thought of being the victim of a crime. The producer’s knowledge and guidance regarding coverage will go a long way to putting clients at ease and helping them to acquire the necessary coverage for each particular situation. Policies Including Crime Coverage A number of insurance policies include coverage against losses incurred due to criminal activity. We will first review the ways in which the following policies protect against loss from crime: Homeowners Insurance. Tenants (Renters) Insurance. Automobile Insurance. Property Insurance. Business Interruption Insurance.

Homeowners Insurance There are many types of crime coverage policies. One of the most common forms of crime insurance is found in homeowners insurance. This type of insurance is, in reality, a package policy with a combination of coverages. This policy typically covers the home and its appurtenant structures from a variety of perils, such as fire, vandalism, burglary, robbery, theft and malicious mischief. The property of the insured is likewise covered from these perils. In addition, the policy provides coverage for the insured’s liability arising out of the covered premises and includes benefits to cover living expenses in the event the house becomes uninhabitable due to a covered peril. Typically, under a homeowners policy the insured premises are the residence premises described in the policy declarations. The intent of the policy is to cover losses on the described premises and not on other premises rented by the insured or on business premises. The homeowners policy covers the described dwelling building, including additions in contact therewith, occupied principally as a private residence. This includes insurance of all building equipment, fixtures and outdoor equipment pertaining to the service of the premises while located thereon or temporarily elsewhere. It also covers materials and supplies located on or adjacent to the premises which are intended for use in construction, alteration or repair of such dwelling. This policy also covers structures other than the described dwelling building, including additions in contact therewith, appertaining to the premises. This coverage also includes materials and supplies located on the premises or adjacent thereto intended for use in construction, alteration or repair of such structure. This coverage excludes structures used in whole or part for business purposes and structures rented or leased in whole or part. Generally, property structures are listed and scheduled on the policy, and coverage is clearly determined by inspection of the policy’s declaration sheet. In addition, the policy covers unscheduled personal property usual or incidental to the occupancy of the premises as a dwelling. The property must be owned or used by an insured while on the described premises, and at the option of the named insured, owned by others while on the portion of the premises occupied exclusively by the insured. Phrases such as “household goods,” “household furniture” and the like, cover a variety of articles, as long as the articles in question are chiefly associated with the household in their general nature and use. On the other hand, coverage is normally denied where it appears that the articles in question are not ordinarily associated with the household. Objects purchased or brought on the premises after the inception of the policy are generally held to be within the coverage of the policy terms. Floater policies and endorsements provide coverage for specific goods or classes of property which are easily

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moveable. Such floaters are governed by all connotations and provisions of the policy to which they are endorsed. Homeowners policies may typically cover certain types of personal property on a worldwide basis, as in the nature of floaters. Floater policies are also used to cover mobile equipment, such as cranes and similar construction machinery, and may provide at-risk coverage to both the lessor and the lessee of the equipment. However, floater policies may exclude coverage for equipment held in permanent storage. Blanket coverages may be used to cover all items described in the policy, or the term may be used to describe a specific type of policy, such as a blanket crime policy, which covers a wide range of perils. Reporting form policies are designed to provide more flexible policy limits than a standard policy. This is particularly helpful for insureds who have fluctuating inventories. They only pay premiums on the amount of coverage for the particular monthly period determined by a monthly inventory report, which the insured sends to the insurer. This policy will generally limit coverage to the amount declared in the last report filed prior to the loss. Such a provision will still be operative despite the failure of the insured to file a report for the previous months in a timely manner. In such a situation, the insurer may look to the last report filed by the insured. Policies often require that the insured take necessary steps to protect the insured property after a loss occurs. Similarly, the policy may be issued on the basis of assurances that the insured will install or maintain protective safeguards which lessen the risk of loss. Such provisions are valid and enforceable and may require the insured to use due diligence to exercise all necessary precautions, or to use reasonable care. For example, where a burglar renders a burglar alarm inoperative, coverage will exist for the loss. The insured may be required to maintain records to show that the system was repaired. This type of policy may exclude loss where the insured fails to exercise reasonable means to preserve the insured property after the loss. The insured’s failure to preserve and protect the insured property is generally a question of fact for a jury. However, where the insurer has the option to repair or replace the damaged property, the insured may be relieved of his duty to protect the property. Tenants (Renters) Insurance The tenant, or lessee, of any property has an insurable interest in the improvements and betterments that he makes to the leased premises, at least for the duration of the lease. In addition, the tenant has an insurable interest in buildings erected by him on the leased premises, even though he may be prevented from removing such buildings if they become the property of the lessor at the expiration of the lease. A tenant may elect to purchase “tenants,” or “renters,” personal property coverage, similar to homeowners insurance coverage, only without the coverage of the structure. The renter may insure his personal property, which is incidental to the occupancy of the premises. This will include coverage in the event of loss from crime. The insured may elect to cover “household goods” and “household furniture” as long as these articles are associated with the household in their general use. Coverage is not afforded where the articles are not ordinarily associated with the household. Typically, this type of policy affords coverage to the personal property of others while on the portion of the premises occupied exclusively by the insured. Automobile Insurance Automobile theft insurance policies generally state that they provide insurance against loss resulting from “theft, larceny, robbery or pilferage.” In addition, insurance against loss from theft is frequently provided in the comprehensive coverage provisions of liability and collision policies. Whether a covered loss has occurred will turn most often upon one or both of two factors: first, the nature of the taking, and second, the identity of the taker.

Courts have held that in determining the losses that fall within the coverage under a policy insuring an automobile against theft, the provisions of the policy are to be construed according to the natural import of the language used. Any ambiguities in such language are to be resolved in favor of the insured. Since automobile theft policies commonly protect the insured against robbery, pilferage, theft and larceny, these coverage terms require some discussion. Robbery, the courts have recognized, is a form of larceny.

To recover insurance benefits for an alleged robbery of a car, all of the elements of the criminal offense of robbery must be shown.

Pilferage is synonymous with petty, or petite, larceny. Because of the nature of the crime of petty larceny and the restrictions with regard to value in connection with this crime, the theft of an automobile would rarely be within the scope of that term.

It is generally recognized that the theft is roughly, though not exactly, equivalent to a taking that would amount to the crime of larceny. To recover for an alleged theft, the insured has the burden of proving much the same facts that would be required in a criminal prosecution for larceny. Thus, the policyowner must show a felonious intent upon the part of the taker of the car.

The majority of courts have held that felonious intent to commit larceny is an intent to permanently deprive the insured of the insured’s car. As a result, courts have generally held that there is no theft or larceny if the alleged thief intended to return the car after using it temporarily. However, the mere fact that the taker of a car testifies that he intended to return the car will not constitute sufficient proof that the taker did not commit larceny.

An insurer’s liability is not limited under an automobile theft policy to payment of the value of the automobile which is stolen and then recovered. It extends also to damages or losses sustained by the vehicle after it is stolen and before it is returned to the owner. Thus, if an automobile is stolen and wrecked by thieves, whether by collision or otherwise, and is rendered as having little or no value, there the insurance company will still be liable for the full amount of the loss under the theft coverage in the automobile policy. When an insured’s automobile is damaged as a result of a collision while in the custody of a police officer who is returning the vehicle from the place where it was discovered after its theft, the insurance company is generally liable for the amount of the damage incurred, even if the policy excludes loss by collision. Theft provisions of automobile insurance generally refer to the theft of the vehicle itself, and not to personal property contained in or on such vehicles. Coverage of personal property generally is obtained in policies other than the automobile insurance policy, such as the homeowners policy, including floaters or endorsements thereto. Personal property also may be protected under the theft provisions of business or commercial policies; however, the theft provisions of commercial policies frequently exclude coverage in situations where property is stolen from an unattended vehicle other than by forcible entry into a locked, enclosed body or compartment, as evidenced by physical signs of such forcible entry. Commercial policies may expressly extend to the transportation of personal property or property in the custody of an employee, such as a salesperson. Often they apply only while the property is actually under the protective custody of the insured’s chauffeur or driver. Some policies apply only to the theft of the entire cargo and do not extend to pilferage. In some instances the theft provisions of an automobile policy may also extend to the theft of property contained in the insured vehicle. Where the policy does extend to the theft of property contained in a vehicle but is unclear as to whether it applies all theft of personal property or only to theft when the vehicle itself is stolen, ambiguities will be construed in favor of the insured. As a result, coverage will typically apply where

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personal property is stolen from the vehicle, but the vehicle itself is not stolen. Frequently, some policies are issued to carriers, indemnifying them from losses of merchandise arising from theft. These policies may extend only to the theft of an entire shipping package. They may exclude pilferage and theft by employees of the carrier. They may also exclude theft from unmanned vehicles, unless the vehicle is enclosed and fully locked, and there is visible evidence of forcible or violent entry. Although automobile theft coverage customarily does not extend to the theft of personal property contained in an automobile, it often may cover “equipment” of the automobile. “Equipment” in this sense, means something designed for relatively permanent installation in the vehicle, and which cannot readily be utilized without being so installed. However, it is not limited to factory-installed equipment. Similar to other insurance policies covering loss from crime, there generally can be no recovery under an automobile policy for a loss from a taking of an automobile if there is not proof of the existence of a criminal or felonious intent on the part of the taker. Accordingly, there is no “theft” of an automobile when it is taken by someone incapable of criminal intent, or when it is taken by someone claiming ownership of the vehicle. Automobile theft insurance policies contain policy provisions expressly excepting particular losses from the coverage provided in the policy. A policy may specifically exempt theft from coverage when the automobile is used in an illegal activity. Theft of an automobile through acts of a member of the insured’s own household is often expressly excepted from coverage since individuals who live in the insured’s household most often have liberal authority to take possession of and operate motor vehicles of the insured, and they have unlimited opportunity for theft of such vehicles. This exception to coverage has also been designed to prevent fraud and collusion by and between the insured and the persons in his or her household. Various factors are considered in determining whether the taker of the automobile was a member of the insured’s household. The term “household” is interpreted as pertaining to or belonging to the house or family who resides in the household of the insured. For example, a nephew or an uncle may be a member of the insured’s household even though he may not physically reside in the insured’s home. Theft policies commonly contain provisions requiring the insured to lock the automobile when unattended or to maintain and use adequate locking devices. The insurer will not be liable for loss that occurs while the vehicle is left unlocked contrary to the policy provision. A stipulation to have and maintain a certain locking device and to “use all diligence and care in maintaining the efficiency of the locking device in locking the automobile when leaving it unattended” does not mean that the car can never be left unlocked. It does, however, require the exercise of due diligence and care that someone of ordinary prudence would exercise under the circumstances. Leaving a car unlocked and unattended in the street for at least five minutes would breach a warranty to use all due diligence by locking it when leaving it unattended. Similarly, the requirement that an automobile be left locked when unattended is not satisfied when the automobile is locked but the key is left in the automobile. Also, leaving an automobile unlocked after dark on a city street with the motor running and the door open, although only for a few minutes, breaches the covenant to use all diligence and care in keeping the car locked when unattended. As a final example, the duty of due diligence and care would be breached if the insured fails to have a locking device repaired for an extended period of time after the device becomes broken. Property Insurance A person who derives a benefit from the existence of particular property, or who would suffer from loss of that property, is said to hold an insurable interest in the property. A party may only obtain a benefit from a property insurance

policy if that party holds an insurable interest in the insured property. Generally, there are two classifications of property insurance. “Direct loss insurance” offers coverage to the insured in the event of loss from damages, destruction or theft to his property. “Liability insurance” protects the insured against damages for which the insured is legally liable. In addition to perils of fire, casualty, disaster and theft, property insurance policies, or extended coverage provisions thereof, commonly insure against “vandalism” or “malicious mischief.” In ordinary usage, the word “vandalism” has been broadened in its meaning to include the destruction of property. Generally the ransacking and destruction of an insured’s personal property has been held sufficient to warrant recovery under a property insurance policy for damages resulting from “vandalism.” The term “malicious mischief” has been defined as an act done willfully and intentionally. In applying this term to particular acts, “malicious mischief,” as used in property insurance policies, has been held to cover the systematic breaking of windows, doors and fixtures. Generally, it is unnecessary to distinguish between vandalism and malicious mischief for purposes of determining coverage under property insurance policies. Some examples that have been held as constituting vandalism and malicious mischief under property insurance policies, are: Damaging of washing machines in a coin-operated

laundry. Damaging of a roof by children throwing rocks. Removal of air-conditioning units from apartments. Placement of poison near feeding cattle. Shooting of a dog. Flooding of a building by trespassers.

Watchmen and Guards A property insurance policy may commonly require the presence of watchmen or armed guards. The insurer may require employment of guards to protect the insured building against burglary, robbery, theft or vandalism. Some insurance policies require constant watch, while others only require guards during specific times. Often, there are questions involving who the watchmen are, and also there are questions regarding the degree of compliance with such provisions. There are questions of what constitutes a “continuous watch” or a “night watch.” The primary and controlling issue is determining whether a person is a watchman and whether he is employed and acts as such, as required by the terms of the contract of insurance. The compensation he is paid and whether or not he is called a “watchman” are not material. The purpose of a watchman provision in a policy of insurance is to protect the insurer from fraud and to protect the property from the peril against which it is insured, such as burglary, robbery, theft or fire. To be considered a watchman, it is necessary that the person have the duty of watching. The mere physical presence of a person on the premises, even though continuously, does not automatically constitute that person as a watchman if he has no duty to watch. For this reason, one who sleeps on the premises is not a watchman even though stationed at a property at night. In some policies, the obligation to maintain a watchman arises only when a plant located at the property is shut down or idle. Premises on which a large number of people are employed, but are not “open for business,” eliminate the necessity of a watchman. A temporary absence of a watchman is sometimes held immaterial on the theory that it occurred without the knowledge or consent of the insured and that the insured had otherwise fully complied with the agreement to keep a watchman on the premises whose competency and fidelity he had no reason to distrust. The fact that the watchman is negligent in the performance of his duty does not breach the obligation of the insured to maintain a watchman, at least where the insured has no

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reason to expect that the watchman would not perform his duties properly. Accordingly, a warranty that a watchman is kept on duty at night is not broken when, without the employer’s knowledge, the watchman goes to sleep during the time he should be on duty. On the other hand, a breach of the insured’s obligation to maintain continuous watch would exist if the insured makes arrangements only for a casual or intermittent watch of the insured property. In some instances, the policy provision requires the presence of an employee of the insured, or a “custodian,” in addition to the presence of a watchman. A watchman is not required to have only duties as a watchman, nor is it required that only one person be the watchman. Therefore, the insured complies with the requirement of maintaining a watchman where the duty of watching is placed successively on the various members of a hired crew. Even though a watchman is not required to be exclusively a watchman, the duty of watching must be a significant part of his duties. The watchman must exercise such care and skill in the performance of his duty as are usually exercised by “reasonable, prudent and careful persons in watching similar premises.” A watchman clause frequently may be eliminated by the payment of an additional premium sufficient to cover the risk. Business Interruption Insurance Business interruption insurance, sometimes called use and occupancy insurance, has become increasingly popular over the years. As the name implies, this type of insurance is designed to protect the insured from losses arising from the interruption of his or her business. If losses arise as a result of criminal activity, this type of coverage may benefit the insured. Business interruption insurance does not have a fixed or single meaning and cannot be defined with precision. However, it may generally be described as a form of insurance designed to indemnify the insured against losses arising from the inability to continue the normal operation and functions of the business, industry or other commercial establishment. The insurer is liable, within the policy limits, for the insured’s fixed charges and expenses necessarily continuing during the period of total or partial suspension of such business due to the loss, or loss of use of, or damage to all or part of the building, plant, machinery, equipment, or other physical assets thereof, as the result of a peril or hazard insured against. However, the insurer is liable only to the extent that these expenses would have been incurred if the contingency causing the suspension had not occurred. Particular matters or items which have been allowed as fixed charges or continuing expenses are: Taxes. Licenses. Rent. Insurance. Telephone. Lights. Heat. Power. Payroll taxes. Social security. Payments to employees who would have been retained. Association and club dues which the insured customarily

paid for certain officers. The expense of maintaining a branch in another city.

The following items or matters have been excluded from business interruption coverage as they have been held not to constitute fixed charges or continuing expenses: Depreciation on the destroyed property. Partners’ drawing accounts where the insured was

awarded a recovery for lost profits and such withdrawals were included in the net profit figure.

Labor costs which were paid as a part of the property loss under another insurance policy.

Business interruption insurance policies commonly provide that in the event of loss, the insurer would be liable for (in addition to lost profits, fixed charges and continuing expenses) expenses necessarily incurred to reduce the loss. It has sometimes been stipulated that the expenses are payable only if incurred at the written direction of the insurer. Such policies have usually provided that the insured is required to use due diligence in attempting to resume business operations. Courts reviewing cases involving business interruption insurance have determined that the purpose of the policy is to protect the prospective earnings of the insured business. In determining the nature and extent of the business covered by the policy, the intention is to insure against loss from the interruption of the insured’s business as a whole. The recoverable losses are not confined to a particular property described in the policy or to the exact operation or business in which the insured is engaged at the time the policy is written. Recovery has been allowed for lost profits from business activities which were commenced after the issuance of the policy and even for profits which would have been earned by a new plant structure which was not yet built, but would have been built during the suspension period. Recoveries have also been allowed where the business interruption resulted from the destruction of buildings not described in the policy but which were a part of the entire plant. Not surprisingly, business interruption insurance is also often termed “earnings insurance.” A business interruption insurance policy is generally in the form of a rider or endorsement on a policy insuring against loss or damage to physical assets as the direct result of the perils specified: often burglary, robbery, theft or fire. Policy provisions, terms and conditions, with respect to the perils insured against and notice and proofs of loss are usually those contained in the policy to which the rider or endorsement is attached. In the construction and interpretation of business interruption insurance, the rules applicable to all insurance policies generally apply. The interpretation must be reasonable, and the contract should be interpreted to give practical effect to the intentions of the parties. In addition, the language must be given the meaning which a person of ordinary intelligence would attribute to it. It should also be construed in favor of the insured if it is susceptible to ambiguous meanings. The loss should be determined in a practical way, having regard for the nature of the business and the methods employed in its operation. The extent and computation of any loss which may be recovered by the insured are handled like many other types of property insurance. The insured’s accounting practices and system are not controlling in determining the recoverable loss under business interruption insurance, but they are not irrelevant and should be given such weight as practical judgment dictates. Business interruption policies may be “valued.” In this type of arrangement the value of the loss is agreed upon in advance, and the amount to be paid by the insurer is fixed in the language of the policy. The determination of the amount of liability is a matter of mathematical computation. Where the property is valued and the parties have agreed upon the value of the insured’s loss in advance, the amount fixed by the policy is ordinarily controlling. In some states, laws called “valued policy statutes” provide that the amount of insurance written is to be taken as the true value of the insured property in the event of a total loss. In the case of “open policies,” the agreement of the insurer is to indemnify the insured for actual loss, up to the policy limit. The amount of any loss sustained is not agreed upon in advance. The coverage is determined by competent evidence showing the actual amount of loss. The question is one of fact, and the burden of proof of the actual loss sustained is left to the insured.

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Open policies have commonly provided for the recovery of the insured’s actual loss during the time of the business suspension. Coverage includes: Net profits that are not earned as a result of the loss. Fixed charges and expenses that continue during the

suspension period, up to the amount that they would have been incurred under normal business circumstances.

Expenses incurred to reduce the amount of the loss. Profits and business expenses covered by this type of insurance should be determined in a practical way, with due regard for the nature of the business and the methods employed in its operation. In such a determination, the insured’s books and accounting systems are used to help establish the amount of regular ongoing expenses. Other evidence can also be used to help determine the amount of expenses. Also in the determination of the loss, due consideration is given to the experience of the business of the insured before the event insured against and the probable experience thereafter. The indemnity has commonly been fixed on a daily basis of not exceeding 1/300 of the face amount of the policy or 1/365 in the case of a business which operates on Sundays and holidays. It is frequently provided that the insurer’s liability for a partial business suspension is limited to a proportion of the liability that would have been incurred by a total suspension of business. The insurer’s liability during a time of partial suspension of business should be limited to the actual loss sustained, not exceeding that proportion of the per diem liability that would have been incurred by a total suspension of business which the actual per diem loss sustained. There is no prescribed or accepted formula for the determination of the actual loss of net profits and business expenses covered by business interruption insurance, except the test of past experience and the probabilities of the future. All agree that the insured should not be deprived of indemnity merely because it is difficult to determine the loss with absolute precision. Business interruption insurance policies have frequently contained coinsurance clauses, and these have been held enforceable in the absence of statutory prohibition. These, however, are subject to strict construction and the requirement of strict proof. The period of time for which an insured can recover under a business interruption policy is primarily controlled and determined by the terms and conditions of the policy. While definite periods of time have sometimes been fixed during which the liability of the insurer would continue, the period for which an insured can recover under business interruption insurance is generally limited to the time required to rebuild, repair or replace the destroyed or damaged property with the exercise of due diligence and dispatch. Where the policy limits the liability to actual loss resulting from a business suspension due to a specified risk, the insurer is not liable unless it is shown that the risk insured against directly produced the loss for which a recovery is sought. It is well established that the loss of (or damage to) physical property is not covered by business interruption insurance policies. The insured must obtain that type of coverage separately under a commercial property policy. In addition, the insurer is not liable under business interruption insurance for interruption losses other than those directly caused by an insured risk. For example, an insurer is not liable for losses actually attributable to lack of demand for the insured’s product, increased production costs, unfavorable business conditions or similar business factors. Theft Coverages The language and provisions of insurance policies covering theft, robbery, larceny and burglary must be interpreted in a fair and reasonable manner in order to properly cover risk in the manner intended by the parties purchasing these policies. We will now examine some of these specific terms and provisions.

Theft The term “theft” is intended to be interpreted as broadly and as liberally as possible to protect the insured. Theft is defined to mean the taking of the property of another without authority. Theft includes any wrongful deprivation of property of another, including embezzlement or swindling. However, theft coverage under a homeowners policy is almost always limited to the property located on the insured premises. On the other hand, the policy may be expressly endorsed to include property which is away from the insured premises. Theft coverage for a dwelling may often exclude coverage unless the insured is residing therein. Theft policies frequently contain clauses excepting liability under other circumstances as well. For example, coverage for the loss of goods due to the dishonesty of employees of the insured generally is exempted from coverage and the insurer is relieved of liability for such acts. Robbery “Robbery” is a greater crime than theft. It is the unlawful taking of property, of any value, by means of force or violence or by putting a person in fear. Robbery policies frequently insure against loss by theft or larceny as well and may also cover losses from false pretenses. Robbery policies frequently contain provisions requiring the insured to take certain specified precautions to avoid or discourage the commission of robberies. Such conditions are particularly common in bank robbery policies. Prominent among such provisions are those extending coverage to robbery from safes or vaults while they are locked or if a certain number of custodians, employees or guards are present. Larceny “Larceny” is the wrongful or fraudulent taking and carrying away by any person of the personal property of another, from any place, with a fraudulent intent to deprive the owner of his property. Burglary “Burglary” at common law is the breaking and entering of the dwelling house of another, with the intent to commit felony therein. Burglary policies cover loss and damage to property occasioned by burglary or attempted burglary. There are provisions which are designed to either extend or to limit the coverage under policies covering burglary. These provisions may include the following: The policies may expressly restrict coverage to particular

times or places, such as times when the property is in the actual care or custody of the insured, in transit, in a specified building, in a safe or vault, or in the mail.

A burglary policy may require that the insured exercise due diligence in maintaining an alarm system. Failure to keep the insured property within a designated area or place for safekeeping also may preclude recovery.

Burglary policies commonly extend to losses sustained by the insured, members of the insured’s family and members of the insured’s household. Some insurance policies may restrict the benefit of the coverage to permanent members of the insured’s household.

In some burglary policies, exception is made for loss caused by riots or civil commotions.

Burglary policies often contain provisions restricting the insurance company’s liability to cases where there are some “visible marks” or “visible evidence” of the use of force or violence affecting a felonious entry. These provisions are inserted for the protection of the insurer to help avoid false claims.

Policies covering burglary from safes also commonly require visible marks upon the insured’s safe for payment of a claim. In some instances, the requirement of visible marks or visible evidence has also been imposed in policies pertaining to the theft of property from an insured’s automobile. In order to satisfy the policy requirement, the determination of what constitutes visible marks or visible evidence, and where the marks or

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evidence must be located is largely dependent upon the particular facts at hand. For example, a burglary policy requires that there must be visible marks of force or violence “at the place of entry” onto the premises. This requirement has been held to have been complied with if the visible marks are on one of the outer doors of the insured’s premises. However, if the only visible marks are those on the inside doors, recovery has been denied. The term, “visible marks at the place of entry,” means that there must be marks from which it can be properly inferred that there exists intent to commit a felonious act.

Some insurers have added a force or violence provision to their policies. This provision adds a further requirement that the forcible entry must be evidenced by “physical damage to the premises.” A burglary policy may require an entry with force and violence greater than that employed in any breaking in order “to effect entry.” The fact that a thief obtains property through intimidation satisfies the criminal law requirement of a taking by force.

Many policies specifically exclude loss of property by “mysterious disappearance.” Such a position would relieve the insurer of liability where the property was misplaced or lost by the insured and not the result of the felonious act of another.

Generally, there are provisions requiring the insured to deliver any recovered or damaged property to the insurer. If the insurer has paid the insured the indemnity provided in the policy, and the property later is recovered, the insurer may be entitled to possession of the recovered property.

Coverage specifically exists if the insured is forced at gunpoint to cash checks or withdraw money for payment to a thief.

A policy may cover the theft of “securities” and may define what is meant by that term. Blank checks, “all negotiable or nonnegotiable instruments, or contracts representing either money or property” are considered securities.

The word “merchandise” is used in policies insuring proprietors against interior robbery of “money, merchandise and securities.” Merchandise is defined as being customarily sold within the proprietorship. In addition, these policies indemnify the insured for all damages, within the policy limits, for loss of money by robbery from messengers, loss of money when a custodian is kidnapped, loss of money by safe burglary (provided the safe doors are locked), and loss of money by burglary from within any night depository in a bank.

Safes Bank robbery policies commonly provide that coverage is only extended to robbery from safes or vaults while they are locked. Similarly, a commercial burglary insurance policy may limit coverage to property within a safe, vault or other designated container or place of security. A policy of burglary insurance covering the burglary of the contents of a safe while it is duly closed and locked does not cover a loss where only a compartment was feloniously broken into while the outer door of the safe was unlocked and open. The loss of money from an open safe is not covered by a burglary insurance policy covering loss from a locked safe opened by force or forcible entry. However, the taking of money by robbers from a safe which has been unlocked in preparation for the transferring of money is an insured risk. Disappearance Coverage Early burglary and theft insurance policies occasionally contained provisions which stated that the disappearance of an insured object would not be considered as evidence of a theft or burglary. The insurance companies varied widely in their requirements for proof of theft. Generally, these provisions were interpreted in favor of the insured, allowing the proof of loss by the use of circumstantial evidence. A mysterious disappearance of an object was an event from which theft might be deduced. Courts readily

accepted that the proof of the disappearance of insured property under mysterious circumstances was adequate to support recovery under a policy in which the insurer agreed to pay for the loss by theft. In order to bring about a greater uniformity in adjusting practice and also to eliminate a source of policyholder dissatisfaction, the “mysterious disappearance” contingency clause was later introduced into the standard form theft policy. Today many policies actually include the term “mysterious disappearance” within the definition of theft. Others simply provide affirmative coverage for loss by theft, attempted theft or by mysterious disappearance. The general rule is that the proof of mysterious disappearance alone suffices to enable the insured to recover, even without showing the probability of theft. Mysterious disappearance embraces any disappearance or loss under any unknown, puzzling or baffling circumstances. Recovery is typically allowed when the article disappears from the place the insured left it. Generally, proof of the disappearance alone establishes the insured’s right to recover without showing a probability of theft Recovery is ordinarily disallowed where the insured has no recollection of when he or she last had possession of the article. Policies may allow for a presumption of theft; however, it is still necessary for a loss to be established. Thus, the words “mysterious disappearance” do not transform the policy into an “all loss” policy, or one which covers lost or mislaid articles. Extortion Extortion is defined as the act or practice of obtaining money from a person by force or by illegal power. Extortion is a type of criminal activity which falls within general theft insurance coverage, even where the policy does not specifically mention extortion. Consequently, insurers find it worthwhile to draft theft insurance policies to expressly exclude coverage of extortion payments or to attempt to obtain increases in insurance premiums for the coverage of extortion payments. Generally, in cases involving kidnapping and the taking of hostages in a plane hijacking, the insured may recover against the insurer under a theft policy for ransom paid in response to such extortion activities. There is no obstacle to the insured’s recovery where the policy states that the losses must occur while the property is on the premises of the insured. As long as the policy covers the sort of risk posed by threats of extortion, the insured cannot be denied coverage on the grounds that the ransom payoff occurred off the premises of the insured. Forgery “Forgery,” under an insurance policy, is roughly equivalent to an act which the criminal law would consider to be a crime of forgery. This crime is defined as the act of falsely or fraudulently making or altering a document. However, some policies contain their own definitions of that term. In these cases, the policy definition prevails over the criminal law definition. Recovery is allowed under the policy where the evidence establishes a loss occasioned by forgery. Recovery is denied where the loss does not involve a forgery, such as where the false instruments actually are executed by the parties purporting to have made them. Like other forms of insurance contracts, any ambiguities are resolved in favor of the insured. There is a fund given appropriations from the United States Treasury that makes money available to the Treasurer of the United States for making settlement with the payees of certain checks drawn on the Treasury of the United States which have been lost or stolen, and negotiated and paid by the treasurer on forged endorsements. To receive a replacement check, the claimant must show that: The check was stolen or lost without fault on the part of

the claimant. The check was thereafter negotiated and paid on a forged

endorsement of the claimant’s. The claimant did not participate either directly or indirectly

in the proceeds of such negotiations.

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Reclamation from the forger subsequent to the forgery has been or may be unsuccessful.

Dishonesty and Fraud Insurance Insurance against fraud is often found in the coverage of fidelity insurance, or a fidelity bond. The party issuing the bond is called the “insurer” or “surety,” and these terms are often used synonymously. This type of insurance covers losses caused by “fraud or dishonesty” to an employer through acts of an employee. The bond covering these losses is ordinarily held to extend beyond acts which are criminal. The terms “fraud” and “dishonesty” are generally words which are given a broad meaning, and they are always construed most strongly against the insurer. These terms include any act showing a want of integrity or breach of trust, or an abstraction of funds, together with deceit or concealment. “Abstraction of funds” and “wrongful abstraction” are terms defined as the unauthorized and illegal taking or withdrawing of funds or property from the possession and control of the employer, and the appropriation of such funds or property to the benefit of the taker, or to the benefit of another, without the employer’s knowledge and consent. “Willful misapplication” means a willful, unauthorized, and illegal application of funds or property of the employer to the use and benefit of the bonded employee, or to the use and benefit of another with the employee’s knowledge and consent with intent to injure or defraud the employer. “Funds” do not necessarily mean actual cash. Funds is a much more comprehensive term and may include other assets or property. Mere negligence, a mistake or an error in judgment does not constitute fraud or dishonesty. However, by their express terms, some fidelity bonds cover losses resulting from the negligence of the bonded person. A fraudulent or dishonest act is often defined as one of “wrongful purpose and connotes immoral inclination.” To constitute fraud or dishonesty, it is not necessary that the bonded person intend to benefit personally from his wrongful act or conduct. The breach of trust can be performed for the profit of, or in connection with, another person. A breach of the bond occurs when an employee fails to account for money which he is engaged in collecting and receiving for his employer, or where he fraudulently misappropriates, or assists in misappropriating, funds or property belonging to his employer. On the other hand, there is no breach of the terms of the bond if an employee becomes indebted to his employer through a mistake or carelessness with no intent to defraud, even though his act results in a loss to his employer. The following section characterizes the more detailed aspects of fidelity bonds. Fidelity Bonds A fidelity bond, or fidelity insurance, is a contract whereby, for a consideration, one agrees to indemnify another against a loss arising from the want of honesty, integrity or fidelity of an employee or other person holding a position of trust. While the contract may resemble suretyship, it is generally held that guaranteeing the fidelity of employees or other persons holding positions of trust is, in effect, a form of insurance. Such a contract is subject to the rules applicable to insurance contracts generally. The party that insures the fidelity of another is called the “insurer” or “surety.” For any party that insures the fidelity of an employee, that party’s liability is primary and direct. A fidelity bond must be issued for a lawful purpose; a contract guaranteeing the fidelity of one’s employees in an illegal pursuit is unenforceable. A fidelity bond issued to a foreign corporation which has no right to do business in a state is, likewise, invalid. Fidelity bonds take the nature of insurance contracts and are generally subject to the same rules of construction applicable to insurance policies. For example, ambiguities shall favor the insured. The parties to a fidelity bond or policy have the right to write their own contract under whatever terms they require. Further, a fidelity bond is not binding on the insurer when not signed by the employee.

A surety on a fidelity bond is liable for losses only when they are caused by the derelictions occurring within the period of time covered by the bond. The bond may validly limit the liability of the surety to losses occurring within a specified term or period of time. This practice thereby excludes liability for acts occurring prior to the effective date of the bond and acts occurring after the expiration of the bond. Often fidelity bonds are issued to insure the integrity and honesty of officers and employees who are reelected or reappointed to their offices or employments. Where the officer or employee holds a continuous office subject to the pleasure of his superiors, it is held that the continuity of the office has not changed by an annual reappointment, so the party is covered by the bond during the entire time that the party holds the office. A different rule is applied where the contract of the parties evidences that the fidelity bond is limited to a particular term or time during which the bonded person holds the covered position. The period covered by a fidelity bond and the renewals thereof depends upon the intention of the parties ascertained from the terms. The renewal of a fidelity bond constitutes a separate and distinct contract for the period of time covered. Some fidelity bonds contain provisions specifying the grounds for the termination of the bond. A clause may authorize the surety or the employer to terminate the bond by giving the other party a notice within a specified advance time. A clause may provide that the bond shall terminate upon the discovery by the employer of any act of infidelity or default on the part of the employee. However, even the strongest suspicion does not amount to knowledge or discovery of dishonesty and nothing short of the discovery of dishonesty, fraud or the positive breach of the imperative conditions will terminate the bond. A fidelity bond insuring an employer against the dishonesty and/or fraud of a particular employee terminates upon the death of the employer, even though the employer’s business is continued by his executors. In order to hold a surety or insurer liable under a fidelity bond, the loss insured against must be caused by the person whose fidelity is insured and while that person is acting in the particular capacity or position for which his or her fidelity is insured. Fidelity bonds frequently insure an employer against losses caused by the wrongful acts or conduct of “employees.” The existence of an employer-employee relationship has been sustained where the insured has control over the activities of the alleged employee. If a person performs the duties of an employee, that person is held to be an employee within the terms of a fidelity bond regardless of whether that person is called an employee, agent, broker, salesman, etc. Whether the parties have properly used the generic term “employee” is immaterial. Ordinarily, the term “employees” applies only to those persons who are regularly and permanently employed by the insured employer. It does not cover an employee of another company, for example, who at its direction merely reported to the insured temporarily for work, and then reported back to his or her own employer. Generally, where a person occupies a dual position as employee of two or more entities, it is necessary to determine in which capacity he acted when he caused the loss by his misconduct or infidelity. If the loss occurs through acts performed under both employments, the sureties on the fidelity bonds to the different employers are jointly liable. A corporate director is not an employee under a fidelity bond defining the term “employees” as “officers, clerks and other persons in the insured’s direct employ.” However, the director is not necessarily excluded from the class of “employees” and can be covered by special wording of the policy. In order for a surety or insurer to be liable under a fidelity bond, the loss suffered by the insured employer must have been caused by acts or defaults contemplated by the bond. The particular type of misconduct covered by the fidelity bond

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must be expressly specified, and the bond does not provide coverage for other kinds of misconduct that are not specified. Ordinarily, a fidelity bond does not cover acts or defaults committed outside the scope of employment. Also, there is no coverage where an employee causes the employer loss in connection with a business other than the one which is designated in the fidelity bond. However, the fact that the wrongful act was committed by the employee after working hours does not preclude coverage for the resulting loss. Some fidelity bonds limit their coverage to acts or defaults committed at a particular place or location. However, the fact that an employee works at a place other than that described in the terms of the bond does not preclude recovery where the contract permits “interchanges or substitutions among any of the employees.” Often fidelity bonds are conditioned upon a faithful discharge of duties covering losses resulting from negligence of the bonded employee. Even though a fidelity bond does not use the term “negligence,” but does insure the faithful discharge of an employee’s duties, it is held that if the employee, knowing the risk involved, fails to use such diligence in protecting the property entrusted to his care as should be used by an ordinarily prudent person, the surety may be held liable from the resulting loss. However, fidelity bonds conditioned upon a faithful discharge of duties do not provide coverage where the loss results from the incompetence of the employee. Fidelity bonds cover losses caused by purposeful acts or conduct on the part of the bonded person amounting to fraud, dishonesty, larceny, embezzlement, wrongful abstraction, misappropriation and the like. However, there is no recovery for these or similar acts when there is only a mistake, carelessness, or error of judgment on the part of the bonded person. The general principles of concealment, representations and warranties which apply to insurance contracts generally are applicable to fidelity bonds. For example, it would be fraudulent for an employer, without making full disclosure, to apply for and accept a fidelity bond upon an employee whom he knows or believes to be untrustworthy or guilty of conduct which makes him unfit for a position of trust. Further, as a general rule, a surety or insurer on a fidelity bond is released from liability where the employer, in obtaining the bond, knowingly misstated facts or deliberately concealed them. A fidelity bond may validly impose upon the insured employer the requirement of taking steps to bring about the prosecution and conviction of the defaulting employee and may make performance of such obligation a condition to recovery. Such a provision, however, requires only that the employer make reasonable efforts to bring about the prosecution and conviction of the defaulting employee. If he has made such reasonable efforts he is entitled to recover on the bond, although no indictment is actually returned against the employee. An insured employer under a fidelity bond cannot recover from the surety if he releases the defaulting employee from liability. For example, if upon discovery of default, the employer and employee, without the consent of the surety, enter into a new contract having resolved their differences, the surety is released from liability. Even in the absence of an express provision in the fidelity bond, an employer who retains in his employment an employee who has been guilty of conduct that breaches the bond and conceals this fact from the surety cannot hold the surety liable for subsequent defaults of the employee. Unless specifically stated otherwise within the terms of the bond, a material change in the nature of the duties of the person whose fidelity is guaranteed acts to release the surety from liability for acts committed after the change in the person’s duties. However, this is distinguished from the mere addition of further duties to the person’s usual tasks. If a crime is committed after the termination of a bonded person’s employment, the surety is not liable, even if the conspiracy was formulated during his or her employment. Unless otherwise stated under the terms of the fidelity bond, the employer is required to provide notice of loss when he has

actual knowledge of the loss or dishonest act. This is distinguished from the time the employer may merely suspect wrongdoing. The employer is required to be diligent in making discovery or obtaining knowledge regarding suspected wrongdoing. The liability of the surety is generally reduced in the event the insured employer recovers any part of the loss. Rules of Bailment A “bailment” is defined as the delivery of personal property by one person to another for a specific purpose with a contract, expressed or implied, that this trust shall be faithfully executed. The property is returned or duly accounted for by the bailee when the special purpose of the bailment is answered or is kept until the bailor reclaims it. The word “bailment” is derived from the French “bailer,” meaning “to deliver.” “Bailee” is the term applied to the person who receives possession or custody of the property, thereby constituting bailment. “Bailor” is the term given to the person from whom the property is received. The only property that can be the subject of a bailment is personal property, including money and personal belongings. Some examples of particular classifications for transactions to which the law of bailments applies follow: “Depositum” is a deposit of goods to be kept for the bailor

by a person usually called a depositary. Custody, as opposed to service, is the chief purpose here. The depositary only holds the goods for safekeeping without any personal benefit.

“Mandatum” is a delivery of goods to someone who is to carry or do something to them, without compensation.

“Commodatum” is a lending or hiring of personal property to another with the property to be used by the bailee for his own pleasure or in his own business.

“Pignori acceptum” or “vadium” is the pawn or delivery of goods as security for a debt, where the title actually passes until the bailor reclaims it.

“Locatum” is the delivery of goods, always with reward, such as the bailee who gains temporary use of the goods.

The Consumer Leasing Act regulates contracts in the form of leases or bailments for the use of personal property for periods exceeding four months. Here a consumer lease is defined as a contract in the form of bailment for a period exceeding four months and not exceeding $25,000, primarily for personal, family or household purposes. Bailments for agricultural, business, commercial or governmental purposes are specifically excluded. Each lessor is required to give the lessee, before consummation of the lease, a dated written statement with all pertinent information concerning the terms, including such things as the identification of the property, amount of money to be paid or to become payable, express warranties and guaranties, insurance requirements, security interests, and liabilities on the expiration of such. Penalties or other charges for delinquency, default or early termination may be specified in the lease. Redlining Case law has defined “redlining” as discrimination based on the characteristics of the neighborhood surrounding the dwelling. It is the denial of home mortgage loans or insurance coverage in these areas based on geography rather than risk. Redlining evolved when financial institutions and insurance companies literally drew red lines around entire neighborhoods, usually poor and minority communities, deemed off-limits for loans and homeowners insurance. Redlining is now illegal. Crime is often higher in urban areas, making them riskier to insure. Insurance carriers often cite loss costs being demonstrably higher for these areas, accounting for more stringent underwriting rules and higher premiums. Over the years, civil rights groups have filed complaints accusing major insurance carriers of redlining, stating that the concept of “risk” is often used as an excuse for prejudice. Lobbyists for the poor have long claimed that this practice denies their clients fair access to the financial system.

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One solution to the problem of redlining was introduced when the Federal Crime Insurance Program was established by Congress in 1970 and began operation in August 1971. The Federal Crime Insurance program is a national insurance program administered by the Federal Insurance Administrator. The program’s purpose is to make available crime insurance policies in high crime areas where an availability problem exists. These policies provide coverage for individual and business losses due to burglary and robbery and are made available when private insurance is not. Preventive Measures Most insurance companies offer reductions in premiums to those who take preventative measures in keeping their homes, businesses, automobiles and personal property secure. Keeping property secure causes a likeliness of avoidance of crime. It is well documented that education and preventative efforts can contribute toward substantial decreases in crime. To commit a crime, a criminal needs two things: an opportunity and a victim. Some efforts for which insurance companies reward prevention with decreased premiums are keeping the home secure with deadbolt locks, window locking devices, special outdoor lighting and monitored alarms. Automobile theft can be discouraged with the use of car alarms or supplemental security devices. Insurance companies often offer premium reductions for these devices. With regard to businesses or commercial properties, efforts such as security gates, deadbolt locks, and guards or guard services are often given premium reductions. Neighborhood watch programs have proven to be effective crime deterrents. They offer a constructive way to channel anger over crime. Police departments and citizens’ organizations suggest that promoting social interaction and fighting isolation may be the most effective weapon against crime. Conclusion Some producers may be reluctant to discuss crime with customers because it may seem like they are trying to scare people into purchasing insurance products. Although insurance producers should not unduly frighten prospects, it is important that the industry make customers aware of the dangers of crime that exist and the coverage available to protect against losses from these dangers.

CHAPTER 3 – WORKERS’ COMPENSATION AND UNEMPLOYMENT INSURANCE Introduction Workers’ compensation laws provide cash benefits, medical care, and rehabilitation services to workers who are disabled from work-related accidents or occupational disease, and death benefits to the survivors of workers killed on the job. Workers’ compensation laws exist in all states, the District of Columbia, American Samoa, Guam, Puerto Rico, and the U.S. Virgin Islands. Two federal workers’ compensation laws also are in operation. The various workers’ compensation laws differ widely with respect to coverage, adequacy of benefits, rehabilitation services, administration, and other provisions. In this text, we analyze the various state workers’ compensation laws, considering in particular the following areas: Development of state workers’ compensation laws. Objectives and theory underlying the laws. Provisions and concepts in workers’ compensation laws.

Development of State Workers’ Compensation Laws Workers’ compensation was the first form of social insurance to develop in the United States. Its development can be conveniently analyzed in three stages: The common law of industrial accidents. The enactment of employer liability laws. The emergence of workers’ compensation legislation.

These concepts are discussed below. Common Law of Industrial Accidents The common law of industrial accidents was the first stage in the development of workers’ compensation in the United States; its application dates back to 1837. Under the common law, workers injured on the job had to sue their employers and prove negligence before they could collect damages. The employer was permitted to use three common law defenses to block the worker’s suit: Under the contributory negligence defense, injured

workers could not collect damages if they contributed in any way to their injuries.

Under the fellow servant defense, an injured worker could not collect if the injury resulted from the negligence of a fellow worker.

Under the assumption of risk defense, the injured worker could not collect if he or she had advance knowledge of the dangers inherent in a particular occupation.

As a result of these harsh defenses, relatively few disabled workers collected damages for their injuries. Lawsuits were expensive, and the damage awards were small. Furthermore, legal fees had to be paid out of these small awards, and there was considerable uncertainty regarding the outcome of the lawsuit. The disabled worker had two major problems to solve: the loss of income from the disabling accident and the payment of medical expenses. Under the common law, these problems were largely unsolved, resulting in great economic insecurity and financial hardship to the disabled workers. The Enactment of Employer Liability Laws Because of the deficiencies in the common law, most states enacted employer liability laws between 1885 and 1910. These laws lessened the severity of the common law defenses and improved the legal position of the injured workers. For example: Three states substituted the less severe doctrine of

comparative negligence for contributory negligence. The fellow servant rule and assumption of negative risk

doctrine were modified. Employers and employees were denied the right to sign

contracts that would relieve employers of legal liability for industrial accidents.

Surviving dependents were allowed to sue in death cases.

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Despite some improvements, however, the fundamental problems experienced by disabled workers still remained. The injured employee still had to sue the employer and prove negligence, and there were still long delays in securing court action. Lawsuits remained costly and the legal outcome was uncertain. Also, the worker still had problems of maintenance of income during disability and payment of medical expenses. Emergence of Workers’ Compensation Legislation The Industrial Revolution, which changed the United States from an agricultural to an industrial economy, caused a great increase in the number of workers who were killed or disabled in job-related accidents. Because of limitations on both the common law and the employer liability statutes, the states began to consider workers’ compensation legislation as a solution to the growing problem of work-related accidents. Workers’ compensation was slower to develop in the United States than it was abroad. Workers’ compensation laws existed in parts of Europe in the 1880s, and by 1903, most European countries had enacted some type of workers’ compensation legislation. In 1902, Maryland passed a law, but it was limited in application and was subsequently declared unconstitutional. The stimulus for enactment of state workers’ compensation laws started in 1908, when the federal government passed a law covering certain federal employees, and by 1911, ten states had passed workers’ compensation laws. By 1920, all but six states had enacted such laws. Workers’ compensation programs exist in all states today. Workers’ compensation is based on the fundamental principle of liability without fault. The employer is held absolutely liable for the occupational injuries suffered by the workers, regardless of who is at fault. The injured worker is compensated for his or her injuries according to a schedule of benefits established by law and does not have to sue the employer to collect benefits. The laws provide for the prompt payment of benefits to injured workers, regardless of fault, with a minimum of legal formality. Objectives of Workers’ Compensation Laws There are five basic objectives in workers’ compensation laws: Broad coverage of employees for occupational injury and

disease. Substantial protection against loss of income. Sufficient medical care and rehabilitation services. Encouragement of safety. An effective delivery system for benefits and services.

We now discuss each of these objectives. Broad Coverage Broad coverage means that the laws should cover most employees for all work-related injuries and occupational diseases. Reasons why certain groups should be excluded have been presented, but the arguments have not withstood careful analysis. Arguments have been presented citing that some firms should be excluded because they are small, have poor safety records, or are reluctant to bear the cost of workers’ compensation benefits. States have extended their workers’ compensation laws to cover most firms without undue financial distress. If the cost of covering certain excluded groups is high, then the disabled workers and society in general are bearing the costs of occupational injuries to these groups in the form of poverty or welfare programs. For these reasons the states have concluded costs should be charged to the firms and not to society. Broad coverage through workers’ compensation benefits society as a whole by preventing workers from becoming dependents of the states. Substantial Protection Against Loss of Income The second basic objective of workers’ compensation laws is that the benefits should replace a substantial proportion of the disabled worker’s lost earnings. The measure of a worker’s economic loss is the lifetime reduction in remuneration because of occupational injury or disease. Gross remuneration consists of basic wages and salaries, irregular wage payments, pay for leave time, and employer

contributions for fringe benefits and Social Security benefits. The measure of loss is the difference in net remuneration before and after the work-related disability. This net remuneration reflects taxes, job-related expenses, fringe benefits that lapse and uncompensated expenses that result from the disability. The view that workers’ compensation should restore a large proportion of the disabled worker’s lost remuneration can be justified by two major considerations. First, workers’ compensation is social insurance, not

public assistance. Public assistance programs provide benefits based on a person’s demonstrated need. Workers’ compensation benefits, however, should be closely related to the worker’s loss of present and future income and so should be considerably higher than a subsistence level of income.

Second, in exchange for the workers’ compensation benefits, disabled workers renounce their right to seek redress for economic damages and pain and suffering under the common law. Other social insurance programs, including Social Security and unemployment insurance, do not require the surrender of a valuable legal right in exchange for benefits.

Under workers’ compensation, both minimum and maximum weekly cash payments must be established. A minimum benefit is one necessary to keep the disabled worker off welfare. A maximum amount is set because highly paid workers are in a position to provide for their own disability income insurance if the workers’ compensation benefits are inadequate and is also necessary so as not to encourage abuse by creating an incentive not to work. Sufficient Medical Care and Rehabilitation Services Workers’ compensation also has the objective of providing sufficient medical care and rehabilitation services to injured workers. The laws require the employer to pay medical, hospital and surgical expenses, and other medical bills relating to the disability. Vocational counseling, guidance, retraining and other rehabilitation services are also provided to restore the injured worker to gainful employment. Disabled workers who can be returned to productive jobs can experience a feeling of well-being and worth as a result, and adequate and prompt rehabilitation services can reduce workers’ compensation costs. Encouragement of Safety Workers’ compensation programs also encourage safety and the development of sound safety programs. Experience rating is used to encourage firms to be safety-conscious and to make a determined effort to reduce industrial accidents, since firms with superior accident records pay relatively lower workers’ compensation premiums. For safety-conscious firms, the end result is often an improvement in the competitive position. For instance, firms and industries with superior safety records generally are not penalized for others’ lack of safety standards and initiatives. The laws allocate the costs of industrial accidents and occupational disease among those firms and industries responsible for them, so a firm or industry with a poor safety record may have to increase its prices, thereby losing some customers to other firms with lower rates of injury and disease. An individual firm with a poor safety record will generally have higher costs and lower profits, which weaken its competitive position. An Effective Delivery System for Benefits and Services Finally, the workers’ compensation programs have the objective of providing an effective delivery system, by which the benefits and services are provided comprehensively and efficiently. Comprehensive performance means that workers’ compensation personnel should exist in sufficient numbers and quality to carry out the objectives of the program. High-quality performance is expected of employers, physicians, state courts and workers’ compensation insurers and agencies.

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Efficient performance means that the services necessary to restore an injured worker are provided promptly, simply and economically. Disability Insurance Programs Workers’ compensation statutes ordinarily provide four classifications of disability. These classifications are determined by the severity or extent of the disability, with the disability characterized as either partial or total. Additionally, disabilities are affected by their duration and are characterized as either permanent or temporary. The four common disability classifications are: Temporary partial. Temporary total. Permanent partial. Permanent total.

These classifications, in conjunction with the employee’s average wages and appropriate statutory formulas, provide the basis for disability benefit computation. Temporary Partial Disability A temporary partial disability is present when an employee who has been injured on the job is no longer able to perform that job, but for the period of disability is able to engage in some kind of gainful employment. Temporary partial disability compensation is designed to pay an injured worker for lost wages. This classification promotes the prompt return of an injured employee to the work force. Examples of this type of injury include sprains, minor fractures, contusions, and lacerations. The critical factor in determining the temporary partial classification may be the impairment of the employee’s earning capacity. Temporary Total Disability The condition of temporary total disability exists when an employee is unable to work at all for a temporary, but undetermined, amount of time. One may be totally disabled, even though not completely helpless or wholly disabled. Examples of injuries that can result in temporary total disability are serious illnesses, heat exhaustion, and disabling back injuries. Temporary total disability is designed to provide compensation to an injured worker for the economic losses incurred during a recuperative period. Permanent Partial Disability A permanent partial disability may be found when a permanent and irreparable injury has occurred to an employee; in other words, one that probably will continue for an indefinite period with no present indication of recovery. For example, one who loses a foot on the job will experience a period of temporary total disability during hospitalization and recuperation. At the point in time when maximum medical improvement has been attained, the disability should be classified as permanent partial. The employee is now able to perform some gainful work. The purpose of permanent partial disability is to provide compensation for the employee’s reduced earning capacity. There are two types of permanent partial disabilities: Scheduled and nonscheduled. Scheduled Injuries – are listed in the law and include the

loss of an eye, arm, leg, hand, finger or other member of the body. In most states, the amount paid for a scheduled injury is determined by multiplying a certain number of weeks (based on the bodily member involved) by the weekly disability income benefit. In most states, the amount paid for a scheduled injury is in addition to the benefits paid during the healing period or while the worker is totally disabled. In most states, if a scheduled injury produces additional disability to other parts of the body, the employee will be able to recover an amount in excess of that provided in the schedule; for example, the loss of a foot could produce traumatic neurosis.

Nonscheduled Injuries – are disabilities of a more general nature and involve the loss of earning power to the body as a whole, such as a back or head injury that makes working difficult. The benefit paid for a nonscheduled

injury is generally based on a wage-loss replacement percentage. The percentage is applied to the difference in earnings before and after the injury, multiplied by a certain number of weeks. In some states, nonscheduled permanent partial disability benefits are based on a percentage of a total disability case.

Permanent Total Disability The condition of permanent total disability exists when an employment-related injury renders an employee permanently and indefinitely unable to perform any gainful work. An employee need not be entirely helpless or completely incapacitated in a medical sense. The so-called “odd-lot” doctrine permits the finding of a permanent total disability for workers who are not completely incapacitated but are handicapped to such an extent that they cannot become regularly employed in a capacity in which they are skilled; the worker is said to have been left in the position of an “odd-lot” in the labor market. One may receive a permanent total disability on the basis of a scheduled loss; for example, loss of sight in both eyes can be a scheduled loss that requires compensation as a permanent total disability. It is difficult to generalize about permanent total disabilities, but the following factors are generally relevant to such determinations: age, experience, skills and training, education, nature and extent of injury, employment history, and nature of employment at the time of injury. Workers’ Compensation Laws The United States Constitution prohibits states from enacting laws that impair contract obligations. As a result of this general prohibition and the parallel provisions sometimes found within state constitutions, some workers’ compensation acts were held at one time to violate these provisions. The general view is that even if a workers’ compensation act impairs an existing contract obligation between an employer and employee, the impairment may nevertheless be valid because a proper exercise of the state’s police power has occurred. The health, safety, and welfare of the people are of overriding importance. Many of the original workers’ compensation acts were said to be elective in order to avoid the constitutional difficulties imposed by the impairment of contract clause. The majority of states have enacted constitutional amendments that eliminate the constitutional difficulties originally imposed in this area. Virtually all states today have compulsory coverage. This has generally been accomplished by state constitutional amendments authorizing workers’ compensation statutes. These state amendments grant the necessary legal power for the enactment of workers’ compensation laws. The grants include the power to enact all reasonable and proper provisions necessary to carry out the law and to fulfill the objectives of the constitutional provisions. Needless to say, the legislation cannot exceed whatever limitations exist in the constitutional provision. Regardless of whether a workers’ compensation act is compulsory or elective, it generally affords the exclusive remedy for employees or dependents against employers for personal injuries, diseases, or deaths arising out of and in the course of employment. The exclusivity provision of workers’ compensation acts is the keystone of all such legislation. The employee or dependents recover without regard to fault, and the employer is spared the possibility of large tort verdicts. State Workers’ Compensation Laws A limited number of states have elective laws, whereby the employer can either elect or reject the state plan. Under elective plans, if the employer rejects the act and the injured worker sues for damages based on the employer’s negligence, the employer is deprived of the three common law defenses of contributory negligence, fellow servant rule, and assumption of risk. Although most firms elect workers’ compensation coverage, some do not, so some disabled employees are unable to collect benefits unless they sue for damages. Elective laws also permit firms’ employees to reject coverage, but they seldom do. Under most elective laws, it is presumed that both

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the employer and the employees elect coverage, unless a specific notice of rejection is filed prior to a loss. Employers can comply with the law in one of three ways: Purchasing a private workers’ compensation policy. Most firms purchase a workers’ compensation policy from

a private insurer. The policy guarantees payment of the benefits that the employer is legally obligated to pay to the disabled workers.

Obtaining protection from a monopoly or competitive state fund. In some jurisdictions, employers generally must insure in a monopoly state fund. Monopoly state funds have been established for the following reasons: Workers’ compensation is social insurance, and private

companies should not profit from the business. Monopoly state funds should have reduced expenses

because of economies of scale and no sales effort. Monopoly state funds are intended to have greater

concern for the welfare of injured workers. Other states permit employers to purchase insurance from either private insurers or competitive state funds. Competitive state funds are established for the following reasons: The fund provides a useful standard for measuring the

performance of private insurers. The states want to make certain that all employers can

obtain the necessary protection. A competitive fund operates more efficiently if it faces

competition from private insurers. Employers who do not meet the insurance requirements are subject to fines, imprisonment or both. Also, some states prohibit the employer from doing business in the state until the insurance requirements are fulfilled.

Self-insuring. Self-insurance programs are common and permitted in most states. Employers who meet certain requirements may pay their workers’ compensation liabilities directly, rather than by purchasing insurance. As insurance premiums rise, this has become an attractive option for employers with the size and expertise to administer such a program. Self-insurance programs exist in all but a very limited number of jurisdictions.

Temporary Disability Laws A number of states have laws providing temporary disability benefits. These laws provide benefits for workers who are temporarily disabled by injuries or illness not related to their employment. Benefits may be paid by a state fund, a private insurance company or directly by a self-insured employer. Temporary disability benefits cover persons who are unable to work because of illness or injury, but who do not qualify for benefits under workers’ compensation or unemployment compensation laws. Workers’ compensation laws cover only injuries or illnesses that are work-related; unemployment laws require that beneficiaries be able and available to work. While temporary disability laws often share definitions and exclusions with the state unemployment law, temporary disability benefits are often specifically extended to workers not covered under the unemployment laws. Employers who operate in states having these laws are required to perform certain duties in connection with the laws. Temporary disability benefits may be financed by employee contributions withheld by the employers, employer contributions or a combination. Even in the states where the plans are financed solely by employee contributions, employers are responsible for withholding the contributions, paying them to the state government, and filing reports in connection with the withholding. Employers who fail to comply with these requirements are subject to penalties. The state disability benefits laws vary considerably, but most permit employers to substitute an approved plan for the state plan. As stated earlier in the discussion of the development of worker’s compensation, the common law remedies and the

statutory actions provided by the various employers’ liability acts form the underlying layer of law upon which a remedy can be based when the applicable workers’ compensation act fails to provide coverage. Thus, common law and statutory actions remain important. These laws and actions are also extremely important when there is third-party involvement and recovery is sought against them. Third parties are not covered by the act and are not allowed to limit their liability in the same manner as an employer. Workers’ Compensation – State Requirements and Concepts Workers’ compensation is a system of state laws, rather than an umbrella federal law. Therefore, requirements vary widely from state to state. It is necessary to know the following terms to be able to discuss application of policy. Employee coverage and exemptions.

Coverage by the workers’ compensation law is determined by the number of employees. Special rules apply regarding which employees are counted, and there are special rules applying to specific occupations, such as construction.

Minors. Minors are covered by the law in every state. Minors employed illegally, however, may be entitled to double or even triple compensation. Because benefit amounts are set based on the employee’s average weekly wage, and minors are generally low-paid, the illegally employed minor’s potential future earnings (what the worker might have earned as an adult, if not injured) may be considered in setting benefits in some states.

Exempt employees. These are employees who are specifically exempt from the law. In some cases, there may be limits on the hours worked or wages paid in order for the exemption to be effective.

Exempt injuries. Exempt injuries include only those incurred in activities or through actions on the workers’ part for which no compensation is payable. Many states provide for reduced benefits in certain circumstances, as when the employee is injured as a result of intoxication or failure to obey safety rules.

Employer coverage. Generally, any employer in the state, regardless of safety history, can secure insurance from the state fund.

State funds. State funds are essentially state-run insurers. Some state-fund states prohibit private insurance.

Private insurance. Most states permit private insurance. However, some state-fund states prohibit it.

Self insurance. As stated earlier, self insurance is also permitted in most states.

Insurance options. Insurance options are gaining in popularity. Included under this heading are programs ranging from those permitting employers to use PPOs or other managed care programs to provide medical benefits while controlling costs, and to programs allowing employers to replace their traditional workers’ compensation insurance with some combination of life, disability, accident, health or other insurance.

Deductibles. Deductibles have become an increasingly popular cost-savings option.

Waiting period. This is the period of time after an accident, during which benefits, other than medical treatment, will not be paid. Generally, the waiting period will be excused after the injury has lasted a certain amount of time. For example,

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benefits may not be paid for the first three days of disability unless the disability lasts 14 days or more.

Stress or mental disability. Injuries of this type are usually mentioned in some state laws. Many of these laws provide fairly stringent limits on benefits for such injuries.

First choice of physician. The first choice of physician may be given to the employee or to the employer. A number of states allow a second choice, if the employee or employer is dissatisfied with the first choice.

Fee limits. A number of states are imposing fee limits. These may take the form of actual schedules of approved fees for specified procedures or may be more general, limiting fees to “prevailing rates in the community” or to “usual and customary costs.”

Benefit amounts. Under the workers’ compensation laws of the various states, benefit amounts set the wage replacement/indemnity benefits payable to injured workers and dependents of deceased workers.

Total disability. These are the total benefits payable to workers unable to work as the result of an occupational injury or, in most states, disease. Permanent total disabilities are those which render the employee unable to engage in remunerative employment. In some states, certain injuries (loss of eye(s) or limb(s)) are considered permanently, totally disabling even if the worker is able to perform some services after recovery. Temporary total disability benefits are paid during a period of recuperation, where the employee has expectations of regaining sufficient health to return to work.

Partial disability. These benefits are paid to workers whose ability to earn has been impaired by an injury. However, some injuries are considered inherently disabling, and permanent partial disability benefits may be paid, regardless of earnings loss. Often, these benefits are expressed in terms of benefits to be paid for a specific number of weeks for a specific injury. For example, loss of a thumb may be compensated for 300 weeks, loss of one phalange of a finger compensated at the same rate for 100 weeks, etc. Injuries not specified in the law may be compensated in terms of the entire benefit for a part of the maximum number of weeks proportional to the degree of disability. Temporary partial disability is the least clearly-defined of the injury categories. Often, however, it is used as a stop-gap, being paid to individuals between the time of the injury and the time of maximum medical improvement, when, if the worker remains unable to perform the pre-injury job, wage loss or permanent partial disability benefits begin.

Survivor’s benefits. When an employee is killed on the job or dies as a result of an occupational injury or disease, persons dependent on that employee are entitled to compensation. A surviving spouse and minor children are compensated automatically in virtually all states. Most states also have provisions for other persons who may have been dependent on the worker, such as parents, grandparents, siblings, etc. Burial expenses are also payable in all states.

Payment of claims. Medical coverage is usually provided in full, without any dollar or limits on the amount paid. Medical costs now account for 40 percent of workers’ compensation benefits. Disability income benefits are payable after the disabled worker satisfies a waiting period that usually ranges from three to seven days. If the worker is still disabled after a certain number of days or weeks, most states pay benefits retroactively to the date of the injury.

The weekly benefit amount is based on a percentage of the worker’s average weekly wage and the degree of disability. Most states have minimum and maximum dollar limits on the weekly benefits. In addition, in most jurisdictions, the maximum weekly benefit is automatically adjusted each year based on changes in the state’s average weekly wage. In 40 states, the maximum weekly cash benefit for temporary total disability cases now equals or exceeds 66 2/3 percent of the statewide average weekly wages; of these states, 29 now pay a maximum weekly benefit of 100 percent or more of the statewide weekly wage.

Death benefits. Death benefits are also payable if the worker is killed on the job. Two types of benefits are paid. First, a burial allowance is paid. Second, cash income payments can be paid to eligible surviving dependents. A weekly benefit based on a proportion of the deceased worker’s wages (typically 66 2/3 percent) is usually paid to a surviving spouse for life or until he or she remarries. Upon remarriage, the widower/widow usually receives a lump-sum benefit, such as one or two years of payments. Benefits also can be paid to the children until age 16, 18, or later if the children are incapacitated. Many states, however, have amount or time limits on the maximum that can be paid.

Rehabilitation services. Rehabilitation services are also available in all states to disabled workers to restore them to productive employment. In addition to weekly disability benefits, workers who are being rehabilitated are compensated for board, lodging, travel, books and equipment. Training allowances are also paid in some states.

Second injury funds. All states have second injury funds. The purpose is to encourage employers to hire handicapped workers. If a second-injury fund did not exist, employers would be reluctant to hire handicapped workers because of the higher benefits that might have to be paid if a second injury occurs. For instance, assume that a worker with a pre-existing injury is injured in a work-related accident. The second injury, when combined with the first injury, produces a disability greater than that caused by the second injury alone. Thus, the amount of workers’ compensation benefits that must be paid is higher than if only the second injury had occurred. The employer pays only for the disability caused by the second injury, and the second-injury fund pays for the remainder of the benefit award.

Workers’ Compensation Financing Workers’ compensation benefits are financed by employer premiums or self-insurance payments, based on the theory that the costs of job-related accidents or disease are part of the cost of production. However, a few states also have provisions for nominal contributions by covered employees for hospital and medical benefits. The actual workers’ compensation premium paid by employers is based on numerous factors, including the size of payroll, industry, occupation of covered employees and industrial operations performed. Smaller firms are class-rated. Class rating means all employers in the same class pay the same workers’ compensation rate. Larger firms, whose annual workers’ compensation premiums are at least $750, are subject to experience rating. Experience rating means the class-rated premium is adjusted upward or downward depending on the employers’ loss of experience and the statistical reliability of that experience. The purpose of experience rating is to encourage loss prevention by providing employers with a financial incentive to reduce job-related accidents or disease. Finally, the costs incurred by the states in administering the workers’ compensation laws and supervising insurance carriers, self-insurers and the state funds are financed by legislative appropriations or by special assessments on insurance carriers and self-insurers.

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Workers’ Compensation Claims Administration Most states use a workers’ compensation board or commission to administer workers’ compensation claims. The law is administered either by an independent workers’ compensation agency or by the same agency that administers the state’s labor law. A few states use the courts to administer the claims. The court must either approve the settlement or, if the parties disagree, resolve the dispute. To receive workers’ compensation benefits, the injured worker must file a claim for benefits with the appropriate workers’ compensation agency and give proper notice to the employer or insurer. Three principal methods are used to settle non-contested claims: Agreement. Most states use the agreement method, by

which the injured worker and employer or insurer agree upon a settlement before the claim is paid.

Direct settlement. Some states use the direct-settlement system, by which the employer or insurer pays benefits immediately to the injured worker upon notice of disability.

Hearing. Under the hearing method, an industrial commission or board hears the case and must approve it before the claim is paid.

Workers’ Compensation Pricing Most states base their workers’ compensation benefits on their statewide average weekly wage, which most commonly is calculated annually. However, states vary in the way they set benefits. Some states set maximum benefits by statute, and those benefits remain in effect until changed by the legislature. In most states at the present time, workers’ compensation insurers use the rates developed by the National Council on Compensation Insurance. Prior Approval Rating Prior approval rating means that workers’ compensation rates are determined for the various occupations and classes by the National Council on Compensation Insurance. These rates must be approved by state regulatory officials, and workers’ compensation insurers must use these rates, subject to any rate deviations allowed under state law. It is argued that approved rating has worked well over time since rates are established for numerous occupations and trades that are ranked according to their risk or hazard level. The rates are based on a broad range of national loss data. Competitive Rating In contrast, competitive rating or open competition means that workers’ compensation insurers are free to develop their own rates based on the competitive market system. A company would be free to establish and charge a particular rate without first obtaining approval of state regulatory officials. Supporters of the present system of approved rating argue that adoption of a competitive rating will result in several adverse effects. They include the following: Safety may be undermined. Emphasis on low workers’

compensation rates may force insurance companies to drop the additional expense of providing loss-control services and rehabilitation programs to firms. Since safety services may decrease, future workers’ compensation claims could increase.

Small policy owners will be adversely affected. Critics also argue that under competitive rating, workers’ compensation insurers would rate small firms on the basis of individual loss experience. Thus, smaller firms with a high loss potential would pay much higher premiums for their workers’ compensation coverage than they are now paying.

Small insurers would be adversely affected. Under competitive rating, individual insurance companies must have their own staff of experts to estimate the costs of any benefit changes in the state. Many insurers would have to hire additional persons with the necessary actuarial and underwriting expertise. Many smaller insurers would be confronted with a substantial increase in expenses and may lack the financial resources to develop their own

rates. It is argued that, ultimately, many smaller companies would not be able to compete and would withdraw from the workers’ compensation market. This would leave only a small number of large companies to write the coverage.

On the other hand, supporters of competitive rating point out certain advantages that will result from a competitive rating system. They include the following: Price competition will lower rates. It is argued that under

approved rating there is little incentive to reduce rates, even when loss experience is favorable. However, under competitive pricing, it is argued that there would be greater price competition, which would tend to lower rates.

Government involvement would be reduced. Since rates would not have to be approved by state regulatory officials, government involvement in the insurance industry would be reduced. This is consistent with the present national trend of reducing the role of government in the economy.

Product innovation would increase. Eliminating the present system of administered pricing would stimulate the development of new programs and products in workers’ compensation insurance. Thus, policy owners would have a greater opportunity to select their own combination of product, price, and service. In addition, insurers would be able to respond quickly to changing loss and loss experience.

These competing arguments will determine future trends toward price approval or competitive rating. Impact of Workers’ Compensation It is important to be aware of how social insurance programs like workers’ compensation supplement the private insurance coverage provided by the insurance industry. Unemployment insurance is another form of social insurance that an informed agent should understand as a result of its impact on the client’s overall risk management program. Unemployment Insurance In 1935, an unemployment insurance system was established in order to provide economic security for workers during periods of temporary unemployment. The original system was created by Title IX of the Social Security Act of 1935. In 1939, the tax provisions of Title IX became the Federal Unemployment Tax Act, under the Internal Revenue Code. Today, the Social Security Act, the Federal Unemployment Tax Act, and numerous amendments to these acts provide the statutory basis for federal unemployment compensation programs in the United States. The unemployment insurance program relies on cooperative federal and state programs. Federal laws provide general guidelines, standards, and requirements, with administration left to the states under their particular unemployment legislation. The unemployment compensation system is generally funded by unemployment insurance taxes or contributions imposed upon employers. The federal taxes are generally applied to the costs of administration, while the state taxes provide trust funds for the payment of benefits. Federal taxes are paid into a Federal Unemployment Trust Fund, from which administrative costs and the federal share of extended benefits are paid. The fund is also used to establish a Federal Unemployment Account from which the states can borrow if their state trust funds become depleted. Unemployment taxes should not be confused with the separate Social Security taxes imposed by the federal government, or with the separate disability benefits taxes imposed by some states. Unemployment benefits are taxable as ordinary income. Federal Unemployment Insurance Programs The principal vehicle for providing weekly unemployment benefits is referred to as the regular state program. Subject to federal guidelines, the states determine all of the following: Qualifying requirements. Amounts of benefits. Duration.

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Grounds for disqualification. State unemployment laws vary, and qualification requires a demonstration of employment by an employer subject to the unemployment tax of a particular jurisdiction, and employment during a base period, usually a recent 12 month period. Generally, one must have been employed in more than one quarter. Payments usually take the form of weekly benefits calculated on the basis of a particular jurisdictions formula. Commonly, an employee’s average weekly wage provides the basis for the weekly benefit amount, and this average amount is determined by dividing one’s high quarter wages by the 13 weeks in a quarter; one-half of the result is the weekly benefit amount paid to the worker. There is usually a one week waiting period prior to the initial payment of benefits. The duration of unemployment varies with the particular jurisdiction. The vast majority of jurisdictions determine duration on the basis of the length of employment or the amount earned. Usually, the longer the length or the greater the amount, the more weeks of benefits one can receive. Workers can be denied unemployment compensation if certain grounds for disqualification exist. Policy dictates payment only to those employees who have lost their jobs through no fault on their part. In all jurisdictions, an employee is disqualified from benefits if the worker voluntarily quits employment without good cause or is discharged for employment-related misconduct. Additionally, disqualification can occur at any time if a claimant or benefit recipient refuses to accept suitable employment without good cause. In order for benefits to continue, a claimant must: Register for employment with the jurisdiction’s

employment service. Be able to work. Be available for work. Seek work on one’s own.

Claims examiners make initial findings of fact that lead to a grant or a denial of unemployment compensation benefits. The appellate rights of a dissatisfied claimant are generally guaranteed by Title III, Section 303(a) of the Social Security Act, which requires administration by the states in a manner reasonably calculated to insure full payment of unemployment benefits when due and an opportunity for a fair hearing before an impartial tribunal for all individuals whose claims for unemployment are denied. An employer’s unemployment experience rating affects the amounts that an employer is required to contribute. Certain amendments have provided extended, supplemental, or special unemployment benefits, thus increasing unemployment compensation for many unemployed persons in the United States. Conclusion Workers’ compensation and unemployment insurance are both very important to the individual receiving benefits and society; however, there are many instances in which the needs caused by an illness or disability cannot be fully met by these programs. Private sector insurance does have programs to meet these needs in disability and long term care insurance. We will explore these policies in our next section.

CHAPTER 4 – DISABILITY INSURANCE AND LONG TERM CARE INSURANCE Understanding the Importance of Disability Income Disability income insurance is one of the most undersold and overlooked markets in the insurance business. In the United States we tend to have a very optimistic outlook. Most of your clients probably give little consideration to what they would do if they became disabled and unable to work for more than a month. The fact is that if we look at the reason many individuals and families fall upon extreme hardship we find that inability to work due to prolonged illness or disability is a common factor. Disability income insurance may seem expensive to your clients, but its importance is significant. If disability insurance can be afforded, it can help protect against a risk that could be devastating to your clients and their families. Disability Insurance Concepts Policy Elimination Period The policy elimination period is the amount of time the insured will wait before the company begins paying benefits after occurrence of a disability. Therefore an important factor to consider when choosing the elimination period is how long the insured would be able to continue his or her present standard of living in the event of a total disability. Most policies offer a choice of elimination periods ranging from thirty days to a full year. These periods are typically 60, 90, 180, or 365 days. Obviously the policy elimination period has a great deal to do with the premium the insured will pay. The longer the insured is willing to wait, the less the policy will cost. The shorter the policy elimination period the higher the cost will be. You need to consider the following factors in helping your client choose the policy elimination period: How much liquidity of assets or savings does the client

have? Does the prospective insured: Have a short-term disability policy at work? Have sick days, accumulated holidays, or bonus days at

work that may be used? Have vacation time coming? Have a spouse earning an income that can be depended

upon? Have sources of unearned income from rentals,

investments, dividends, interest and the like? Very carefully make a list of the prospect’s fixed expenses and know exactly how long the above factors can provide an income. With this knowledge you can intelligently assist the prospect in determining the proper policy elimination period. Benefit Period Another factor that affects the cost of a disability income policy is its benefit period. The benefit period is the period of time that benefits will be paid for total disability. Typical benefit periods are one year, two years, five years, age 65, or the insured’s lifetime. Insurance company statistics indicate the average disability lasts 9 to 18 months. However, depending on the occupation and the classification of the occupation, the benefit period is a major consideration. Renewal There are two types of renewal provisions in disability plans. Non-cancelable.

If premiums are paid on time to a pre-determined date, usually age 65, the company cannot: Cancel the policy. Change any provisions. Add any riders that restrict coverage. Add any changes to the policy. Raise the premiums.

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This type is the most favorable to the insured and therefore the applications that underwriters look at most carefully.

Guaranteed Renewable. Guaranteed renewable policies only provide the first four guaranties listed above for the non-cancelable policy. This means that the company can raise the premium under certain circumstances. An individual insured cannot be singled out for a premium increase. The company must raise the premium for all policies that are either in a particular class or type of policy.

Total Disability The policy’s definition of “total disability” determines whether the insured will receive payment when a claim is filed. Total disability is defined by two requirements: The insured cannot or is unable to work at one or more of

the important duties of his or her regular job. The insured is under the care of a qualified and licensed

physician. Claims will be paid only if the insured satisfies both of these requirements. Occupations One of the most important considerations in issuing a disability policy is the insured’s occupation. Obviously, because of the inherent risks factors the more hazardous the job, the higher the premium. Therefore, when insurance company underwriters determine the risk classification for a specific occupation, the underwriters take a close look at the following issues: Does the job require a lot of travel? What kinds of materials, machines, or tools are used at

the job? What types of products or services are offered? Is the insured involved directly in the work or is the job

managerial? Is the job seasonal in nature? Is the occupation prone to layoffs or having hours

shortened? Each of these factors helps determine the level of hazards associated with the occupation, and the appropriate occupational classification can be determined for that occupation. Disability policies typically use either a class grouping or an alphabetical grouping for occupations. These classifications are usually set as “AAAA” through “B” with “B” carrying the highest risk of loss to the insurance company. Class One (or AAAA).

Occupations commonly found here are the ones with favorable claims experience such as CPAs, lawyers, dentists, and doctors.

Class Two (or AAA). Occupations in this group are typically managerial, technical, professional, and executive types whose duties are generally restricted to the office.

Class Three (or AA). Occupations here are comprised of supervisors of performing employees but not those that participate in the actual operations. Merchants, salespeople, and store managers are a few examples.

Class Four (or A). Here you will find skilled labor types of occupations such as home construction and small construction.

Class Five (or B). These are the most hazardous of the occupational classifications and the most difficult to insure. Motorcycle police officers, bricklayers, or welders are prime examples. The premium charged for the disability policy will be the highest for the Class Five (or B) grouping.

Income Requirement This area is one that is very strictly underwritten as insurance companies do not want to permit the insured to earn more income while disabled than he or she would earn while working. Obviously, this situation would cultivate false claims and lingering disabilities. Therefore, companies place a limit on the percentage of monthly benefits to monthly-earned income. Typically, companies will issue a monthly benefit equal to between 40% and 70% of the insured’s earned income. For example, if earned income is $3,000 per month, a company will allow a monthly benefit of between $1,200 (40% of $3,000) and $2,100 (70% of $3,000). Underwriters look at “earned income,” which is the income an insured earns for work performed. Companies also look at “unearned income” such as rental income, royalties, investments, or dividends. Since this is income that would normally continue even if the insured were disabled it is generally not considered in the percentage formula and in some cases, it may even reduce the amount the company is willing to issue as a benefit. Definition of “Disabled” Various definitions are used to describe “disabled” as it applies to the payment of benefits under disability insurance policies. The particular definition will be an important factor in the decision regarding to which policy is the best choice for each client. The common definitions for “disabled” are the inability to work in The insured’s regular occupation; or Any occupation for which the insured is reasonably suited

based on his or her training or experience. “Insured’s regular occupation” – This definition is the best of the choices for the insured, since it will consider the insured disabled and qualified to receive benefits even if the insured could perform work other than exactly the work he or she has been performing. “Any occupation for which the insured is reasonably suited” – This is the less favorable definition for the insured, as this type of policy would only pay benefits when the insured could not work in any occupation for which the insured is reasonably suited based on his or her training or experience. Some policies offer a combination approach to the definition of “disabled.” This approach is the second best choice for the insured, as the insured would not be considered disabled in the same way for the full benefit period. For example if the benefit period were 5 years, the policy may cover 3 of those years under the regular occupation definition and then switch to the reasonably suited definition for the remainder of the benefit period. Some policies also provide partial disability benefits if the insured has lost a portion of his or her income due to disability. Waiver of Premium A “waiver of premium” provision is included in most disability contracts. It states that if the insured is disabled more than 6 months (some may state 90 days) the premiums are waived until the insured goes back to work and is no longer disabled, or until the benefit period expires. Some policies also refund the premiums paid during the 6 month (or 90 day) period while waiting for the waiver provision to start. Exclusions There are three specific exclusions that commonly appear in most disability policies: Self inflicted injury. Pregnancy. War.

Grace Period The grace period is defined as the period of time beyond the due date that the insured may pay the premium without the policy lapsing. The grace period is 31 days in most disability policies. During the grace period, the policy stays in force so long as the insured pays the premium that is due before the end of the 31st day.

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Contestability Disability policies contain a period of contestability that is usually two years. It should be noted that some policies exclude periods of disability during the two years. During the period of contestability the insurance company is given time to determine if any misstatements were made so that it can have the option of either rewriting the policy, or canceling it. After two years, there is nothing that can be done if misstatements are discovered. Disability Policy Options Customizing the Policy Flexibility is one of disability income’s strong suits in that companies offer a number of options to customize the disability policy. The following are common options that are available to customize the policy: Cost of living.

This is an excellent option considering the steady trend of inflation. This option permits the insured to increase the monthly income benefit based upon certain factors. The increase may be tied to the Consumer Price Index or it can be guaranteed up to specific limits, as cost of living provisions contain a cap on the maximum increase. Others have no cap and allow the insured to continue increasing coverage until age 65.

Future increase of monthly benefit. This option allows the insured to increase the monthly benefit without evidence of insurability on specific future dates. Examples of times in which the insured may increase the monthly benefit include: Every fourth policy year anniversary up to a specific

number or amount. The birth of a child. Marriage. Purchasing a new home. Typically, the policy states that when any of the above events take place, the insured may increase the monthly benefit by a specific amount up to a final monthly maximum.

Hospital confinement. This option permits the insured to purchase a specific daily benefit in addition to the regular monthly disability income benefit. This option requires being admitted to the hospital on an in-patient basis, and during that time, the policy pays a specified daily benefit for each day of hospital confinement.

Life extension. This option is available when the basic policy has a benefit period limited to age 65. It extends the benefit period for total disability to the lifetime of the insured in one or more of the following ways: Lifetime benefits are paid if total disability begins before

a specific age; usually age 50, 55, or 60. Lifetime benefits are paid if total disability begins before

a specific age, but at a reduced percentage of the policy’s monthly income benefits. For example, if an insured is 60 years of age and becomes totally disabled, the full monthly benefit will be paid until 65, then at age 65, the lifetime extension is reduced to 50%.

Lifetime benefits are paid if an accident causes total disability before age 65. This covers accidents but does not include illness, in which case benefits would cease at age 65 with no lifetime extension.

Lifetime benefits are paid if total disability occurs before age 65 and there are absolutely no other restrictions as to accident or sickness, age of onset of disability prior to age 65, or reduction in benefit. Obviously, this is the best of the four choices and also the most expensive.

Social Security rider. Here a benefit is paid if Social Security does not pay benefits. This can be a valuable rider for the additional

premium because Social Security disability income can be difficult to obtain. Basically this rider stipulates that the insured will receive an additional monthly benefit above and beyond the basic monthly benefit if Social Security benefits are denied. If however, Social Security does approve benefits, then the insurance company will not pay this additional monthly benefit. Another way in which this option may work is that the basic monthly benefit will be reduced by any amount Social Security pays the insured.

Cash back option. Many people feel that this option is expensive and impractical. One of the major complaints is that money under this option does not earn any interest. An insurance company charges an additional premium, which can be very substantial for the cash back option. The two most common cash back options are: At age 65 the company will return to the insured all

premiums paid less any benefits received. In the event benefits received exceed the premiums paid to age 65, there is no return of premium. Some companies will permit the insured to drop the cash back option, and reduce the premium accordingly, should the insured ever reach the point that benefits paid exceed the premiums. However, most companies continue charging the additional premiums for the cash back option even when benefits paid exceed premiums paid.

The company will review the policy every ten years (rather than waiting to age 65) and return 80% of all premiums paid, less any benefits received.

As mentioned above these options are very expensive and not frequently added to policies.

Policies for Business Business Overhead Policy When the insured owns a business, one of the major problems which could hurt the business would be the unavailability of the owner to run the business. Many businesses are uniquely dependent upon the owner’s knowledge, skilled profession, or contacts with customers or suppliers. Obviously, the owner’s absence could pose significant problems in these areas. This is especially true when the owner is the key employee or major factor in the success of the business. A business overhead policy functions as a type of “business disability” policy which can help the business meet necessary expenses until the owner is able to return to work. The purpose of the policy is to cover essential expenses which must be paid to operate the business: Elimination periods.

Common elimination periods for business overhead policies are: 30 days. 60 days. 90 days. The most commonly purchased policy contains the 30 day elimination period, particularly for businesses in which the owners do not have sufficient funds to cover business expenses for a long period of time.

Benefit period. Common benefit periods for business overhead policies are: 12 months. 15 months. 18 months. 24 months. Benefit periods generally do not exceed 24 months because if the business owner does not return from a total disability after 24 months, the owner is less likely to return at all.

Monthly benefit. Considerations affecting the amount of the monthly benefit to be paid under the business overhead policy include:

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The type of business. Owner’s occupation. Insured’s portion of the work. Employee’s portion of the work. Amount of loss of income. The company’s current expenses.

Covered expenses. There are many expenses in running a business and not all can be covered with a business overhead expense policy. The following are some of the more common of the covered expenses: Rent. Utilities such as water, heat, and electricity. Telephone. Telephone answering service. Employee’s salaries. Employee fringe benefits. Payroll taxes. Professional or association dues. Accounting fees. Premiums for business insurance. Postage. Stationary and supplies. Furniture and equipment depreciation. Janitorial service and maintenance. Laundry.

Expenses not covered. It is very important that the policy owner understands what is not covered so that there are no misunderstandings or disputes at the time of a claim. Common exclusions are: Purchases of equipment or furniture. Salaries, draws, commissions, fees, or any other monies

due the owner. (The owner covers these expenses with a personal disability income plan.)

Payments made towards debts. Disability Insurance for a Key Employee Often an employee of a company is a key ingredient to its success. Should he or she become sick or hurt, the financial consequences to the company could be severe. A disability insurance plan for this key employee may provide significant protection against this possibility. The company purchases the disability policy and the company becomes its beneficiary. Should the key employee become disabled, the company is then reimbursed for the expected income loss to the company caused by the employee’s absence. As a general rule, the benefit period runs for 6, 12, or 18 months. Tax Effects of Disability Insurance Disability insurance policies may offer certain tax benefits to the insured. Here we examine tax treatment for some of the policies which we have discussed. Personal disability income plans.

Premiums paid for personal disability income plans are not tax deductible. The good news for the insured is that regardless of how much the insured business owner receives while totally disabled under a personal disability plan; all income is received 100% tax-free. A business owner for example, could insure him or herself under a “tax-favored sick-pay plan” and have it construed to be personally purchased. Here again the benefits are completely tax free because the business owner is not considered an employee and the premiums are not tax deductible.

Sick-pay plan for key employees. The premiums are tax deductible for the business owner as a necessary business expense for disability purchased on key employees.

Taxes on overhead expense policies.

Since the business owns the policy and the premiums are deducted as a business expense, the income from the policy is taxable when paid to a disabled owner.

Disability Underwriting Many companies place a lot of responsibility on the good judgment of the agent in the field when it comes to insuring a disability risk. As an agent in the field, you have the upper hand in that you are not merely dealing with the information contained on the application, but are in fact, seeing and talking to the potential insured. For this reason the agent is sometimes referred to as the field underwriter. Underwriters use the following details to determine the risk factors in writing a disability policy: Date of birth. Occupational rating. Address. Gender. Earned income. Net worth. Expenses. Unearned income. Benefits applied for. Current coverage. Medical history. Family history. Present physical condition. Hobbies. Moral character.

Correlating the Data Underwriters gather all of the evidence concerning an individual and try to determine whether to issue that individual a disability income plan. Disability underwriting and life underwriting have many different concerns. There are many conditions a potential insured can have that are not life threatening but are certainly possible disability income claims. For example, a bad knee or back or shoulder injury, while not life threatening, certainly can become the subject of a future disability claim. Medical Underwriting Medical underwriting for the disability policy is accomplished in two ways: First, in the field with the agent and, second, with questions on the application. The following areas are studied very carefully during the medical underwriting process: Parts of the body that have been affected. Symptoms. Date of onset. Severity of symptoms. Frequency of symptoms or illness. Duration of symptoms or illness. Cause of symptoms or illness. Time off work. Diagnostics. Kind of treatments taken. Names of all medical practitioners consulted.

Importance of Medical Examinations The companies print and publish what are referred to as “non-medical limits” for examinations. In other words, there are certain thresholds at which a medical exam is required. The following factors are taken into consideration and the company determines whether or not to require a physical exam or other test. Occupational classification. Age of applicant. Amount of benefit applied for. Benefit period applied for.

If the applicant has a non-hazardous occupational class, is over age 60, and requests a long benefit period, he or she will

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probably exceed the non-medical limit. Conversely, the applicant could have a hazardous occupation with a short benefit period and not be required to take an exam. Underwriting Substandard Policies Not every applicant can be given a standard policy. There are many factors that cause an applicant to be considered substandard. Some reasons an applicant may be considered substandard are: Current status of health. Age. Occupational rating. Pre-existing conditions. Sports or hobbies.

Rather than completely deny coverage, some companies are willing to make adjustments and issue a substandard policy. This can be done in a number of ways: Shorten the benefit period. Lengthen the elimination period. Issue a rider that excludes or limits coverage in certain

areas. Charge an extra premium above the standard premium. Issue an exclusion rider for a specific condition.

Disability Claims Any time that an insurance company sells disability income insurance, it recognizes that part of the premium dollars taken in are going to be paid out in claims. Most companies make every effort to pay claims fairly and promptly. However, they also know that it is the company’s obligation to be certain that unjust claims are not paid. Obviously, the claim form is very important. As an agent, your role is to bring the form to the insured and assist them in completing it. Caution is given here in that you should only assist the insured and you should never complete the form yourself. The claim form will give the company the information necessary to process the claim. The quicker the claim process begins, the quicker the claim can be paid for your client. Payment of Claims Some confusion may exist as to when one can apply for claim benefits if the disability income policy contains a 30 day waiting period. The insured is eligible for benefits on the 31st day. However the agent must realize that his client may not see the first check for over 60 days. Companies pay claims only as earned. In other words, they will not accept estimates that a client may be off work for six months and therefore send a check for six months in the future. As a rule, if an insured is in fact not going to return to work for a period of six or eight months, according to the physician’s estimates, the insured must submit an up to date claim form every 30 days. One of the primary requirements of the insurance company for continuation of disability benefits is that the insured be currently under the care of a qualified licensed physician. The company also reserves the right to request periodic physical examinations of the insured to ascertain whether or not the condition that has caused total disability still applies. In most cases, the company pays for the physical examination and in almost all cases, the company, not the insured, picks the doctor to perform that examination. Long Term Care Insurance The Producer’s Role Most clients would rather not think about the possibility of themselves being subject to an injury or illness that would impact them for an extended period of time. This reluctance to think about these possibilities makes it that much more important for you, the insurance producer, to discuss these uncomfortable topics with clients so they can begin to appreciate the protection that can be available through disability and/or long term care insurance.

History Long term care is not a new concept or idea. Long term care insurance (LTC) first appeared on the scene in the early 1980’s, but was very primitive in nature and had numerous stipulations, requirements, and exclusions that made it undesirable. Insurance companies were reluctant to enter this market simply because there was not previous claims experience that they could follow. Actuarial science could not be applied because there were no records of who went into long term care facilities, their ages, what caused their need or how long they remained in care. Needless to say, this posed major obstacles in the pricing of the long term care policies. Over the years long term care insurance has become more popular. This is true because the need is increasing, more people are becoming aware of the need, and the policies have improved. Baby boomers and their children are seeing their parents and grandparents live longer and require the kind of financial assistance provided by LTC. LTC policies can cover the cost of certain types of care at home as well as care provided in a professional facility. Long term care policies have also become more standardized. The National Association of Insurance Commissioners (NAIC) has helped move LTC from a fringe product to the mainstream. The NAIC has created model polices that have been adopted by many states. While some states have adopted the model in its entirety, others have made use of its principles or used portions of its language. Once a number of states began to insist on the use of these policies, a standard developed that most insurance companies have applied to all of their LTC policies. What Is Long Term Care LTC insurance provides coverage for the care that becomes necessary when an individual cannot perform the “activities of daily living” (ADLs) for themselves. The ADLs include: Bathing and personal hygiene. Continence. Dressing. Eating. Toileting. Transferring or mobility.

Benefits Provided By LTC To provide assistance with the ADLs, the four most common long-term care benefits required and provided by LTC are: Skilled nursing care.

Skilled nursing care is the most expensive type of care. It requires a prescription from a qualified licensed physician. The care must be continuous on a 24 hour a day basis and the insured individual is to be cared for by a Registered Nurse.

Intermediate care. Although a doctor’s prescription is not necessary for this level of care, it does require medical care under the supervision of medical personnel it must be administered by a Registered Nurse, Licensed Practical Nurse, or a Physical Therapist.

Custodial care. Custodial care assists the patient in meeting ADLs shown above. This type of care can be provided by someone without a medical or professional nursing degree.

Home health care. Under this care, the patient is not confined to a nursing home and is usually able to care for him or herself. Usually a non-medical type person assists in shopping, meal preparation, and some physical therapy.

Optional Benefits The more common optional benefits are: Hospice.

Hospice provides the terminally ill with comfort in their last days and does not prolong treatment or employ life saving devices. Often a hospital bed is set up in the patient’s

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home to keep them in familiar surroundings with family members during their last days. Depending on the severity of pain or medical needs, home visits are made by Registered Nurses as well as Social Workers.

Adult day care. Adult day care is usually given at a center that caters to those that are mentally or physically impaired. A typical day at the center provides social activity, medical care, meals, and transportation to and from home.

Inflation protection. Long term care is not immune to inflation. Inflation protection is an important option available with most LTC policies. Inflation protection provides for automatic increases in the daily benefit provided by the policy. Most times this policy provision offers a 5 percent increase in the daily benefit each year. One of the differences to be aware of is that while some inflation clauses apply through the entire life of the policy, others limit this benefit to the first ten or twenty years of coverage.

Waiver of premium. While optional, most companies include waiver of premium as a standard provision. Typically, once the insured has been receiving benefits for more than 90 days, the policy premiums will be paid by the company.

How Long Will Benefits Be Paid? Insurance companies offer long term care benefit periods from one year to the remainder of the insured’s life. Benefits can also be scheduled to begin at different intervals of time after the care becomes necessary. The decision regarding an insured’s choice of benefit period can be complex. The cost of LTC must be balanced against the risk after taking a number of factors into consideration. The age and current financial condition of the insured will of course be major considerations. Other insurance that will cover the expense of long term care can considerably change the needs of your prospect. If the prospect has disability coverage that lasts for five years and provides similar care to LTC coverage you would want your client to avoid duplication. The availability of Medicaid should also be a consideration. There may also be income tax considerations since portions of some LTC premiums may be tax deductible. Pre-Existing Conditions and Other Exclusions Most policies make provisions for pre-existing conditions. Most pre-existing conditions are measured by excluding any condition for which the insured was treated or given medical advice. It is common for pre-existing conditions to include the period of six months prior to, and in some instances six months following the effective date of the policy. An agent must be aware and make prospects aware of the exclusions that long-term care policies contain. The time of a claim is not the time when the insured wants to first learn of these coverage exclusions. In the early long term care policies, companies would exclude Alzheimer’s disease by saying that “the policy excludes diseases of an organic nature,” which was a way of excluding Alzheimer’s disease without mentioning the disease by name. This has since been rectified because Alzheimer’s disease and other organic diseases are now covered in most policies. There are some of the other common exclusions: Care given in a veteran’s hospital. Losses that workers’ compensation provides for. Mental psychoneurotic, or personality disorders that are

not the result of organic or physical disease. War. Self inflicted injuries that are intentional.

Long Term Care Provisions in Other Policies Some insurance companies now make it possible to purchase a life insurance policy or a disability income policy and add long term care as a rider. The rider is very much like the standard long-term care policy in that it affords the insured the same elimination periods, benefits periods and levels of care. A living benefit long term care rider permits terminally ill patients to use life insurance proceeds in advance to cover

expenses connected with their illness. In some instances this option will make 70% to 80% of the death benefit available to the insured to cover the cost of nursing home care. Another option in this category is agreeing to and receiving a discounted amount of the death benefit that the patients are entitled to because they are terminally ill. Underwriting Long Term Care Sources of Information The underwriting process employs four important sources of information. The application.

The application provides the company with the primary basis upon which they will make the decision to issue a contract. Questions need to be answered in full with honesty and integrity.

The agent. Years ago, you were permitted to take applications by mail or phone so long as they were signed by the applicant. Today, however, companies want to know that the agent actually sees the applicant and assists in the field underwriting. You will be able to make observations unavailable to the home office underwriter.

Verification reports. The verification reports provide investigative information to verify statements made by the applicant. These reports also sometimes produce additional information or problems that may not have been listed on the application. Today it has also become common for insurers to check the applicant’s credit report. Many insurers believe an applicant’s credit history can let them know a great deal about the applicant. In fact the major credit bureaus have developed credit scoring models specifically for insurance purposes.

Medical records and history. Often companies employ the Medical Information Bureau and obtain information from attending physician’s reports when verifying medical records and history. Obviously, this information is extremely important in the underwriting process.

Substandard Underwriting Not all applications are approved as submitted or issued standard. Often, the applicant is required to pay more than the standard premium in order for the company to absorb certain extraordinary hazards or risks. Factors that directly affect whether the policy will be issued standard or substandard are: Pre-existing conditions. Age. Occupation (if applicable). Moral issues affecting the customer’s record.

Policy Provisions The National Association of Insurance Commissioners developed model standardized provisions to be used by states adopting their Uniform Policy. These provisions are divided among two categories. One group of “required provisions” that must appear in all policies, and another group of “optional provisions” that may be used at the discretion of insurance companies to better customize their policies. One rule that is strictly enforced is that no substitute language may be used in any provision unless the substitute language is in favor of the insured. Required Policy Provisions Entire contract.

A policy including all attached papers constitutes the entire contract. Riders, endorsements, and changes must be approved in writing and executed by an officer of the company. The agent does not have permission to change or waive any policy provision.

Time limit on certain defenses. This provision is more commonly referred to as the “period of incontestability.” The period of contestability is usually two years in length. Should an application contain any

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fraudulent statements, the policy’s period of contestability will be extended to the life of the contract. The only exception is a “guaranteed renewable policy.” Under a guaranteed renewable policy, once the period of contestability has expired the policy cannot be contested. This is true even if fraudulent statements were made on the application.

Reinstatement. A policy that has lapsed may be reinstated under certain conditions, provided that the proper procedure is followed. Some companies require an application for reinstatement, which may or may not be approved.

Claim forms. Companies are required to supply the insured with a claim form within 15 days after receiving a claim. If the company does not meet this requirement, the insured may submit proof of loss on any form.

Grace period. The grace period is the time the company gives the insured to make a delayed payment without penalty and with the policy remaining in force. Should payment not be made by the end of the grace period, the policy will lapse and terminate. A grace period of 31 days is fairly common.

Notice of claims. When a loss occurs the insured is required to notify the company within 20 days, or as soon thereafter as is reasonably possible that a claim will be made.

Time payment of claims. This provision stipulates that “the company must pay the claim immediately.” Usually payment of claim is made within 60 days.

Proof of loss. When a claim is made the insured is given 90 days in which to submit proof of loss. Should the insured be unable to meet this 90 day deadline, the claim will not be affected if it was not reasonably possible for the insured to meet the deadline.

Claim payment. Payment is paid to the insured or the insured’s hospital, physician, or other designated service provider. For loss of life, benefits are paid to the designated beneficiary. If no beneficiary has been named, payment will be made to the insured’s estate.

Autopsy or physical exam. The company can request, at its own expense, physical exams. So long as law does not forbid it, the company also has a right to request an autopsy on the body of the insured.

Change of beneficiary. The insured has a right to change the beneficiary at any time unless an irrevocable beneficiary has been designated.

Legal Action. Should the insured have a dispute with the company in regards to a claim, the insured must wait at least 60 days and no longer than 5 years to take legal action.

Optional Policy Provisions Misstatement of age.

If an applicant misstates his or her age at the time he or she is applying for coverage, any benefit due to the applicant will be adjusted to reflect what would have been purchased had the correct age been stated in the first place.

Unpaid premiums. Should a claim become due and payable while a premium remains unpaid, the premium due will be subtracted from the claim amount due and the difference will be sent to the insured or the insured’s beneficiary.

Insurance with other insurer. In order to avoid over insurance, if the company finds that there was other existing coverage for the same risk, the excess premiums will be refunded to the policy owner.

Cancellation. The company has the right to cancel the policy with 20 days written notice to the insured and the insured may cancel the policy following the expiration of the policy’s original term.

Change of occupation. After a policy has been issued, if the insured changes to a more hazardous occupation that would require an increase in premium and the insurance company is not notified and a loss occurs, the benefit paid will be reduced. Should the opposite occur, and a loss occurs, a refund will be made to the insured for the excess premium.

Other insurance in this insurer. To avoid over insurance and to limit a company’s risk, coverage written on one person is restricted to a maximum amount no matter how many separate policies the insured has. Premiums that have been applied to the excess coverage will be refunded to the insured or to the beneficiary.

Conformity with state statutes. Should any part of a policy conflict with state statutes in the state where the insured resides, the policy shall automatically amend itself to conform to statutory requirements.

Illegal occupation. Policy benefits are not payable if the insured has a loss while committing a felony or being connected with a felony or participation in any illegal occupation.

Intoxicants and narcotics. Should the insured be intoxicated or under the influence of narcotics, unless such drugs were administered on the advice of a physician, the company is not liable for any losses.

Conclusion As we mentioned earlier, disability and long term care insurance may seem expensive when purchased; however, if you ever get the opportunity to speak to someone who has had the unfortunate experience of needing these benefits you will never again neglect to talk to your clients about this coverage.

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CHAPTER 5 – REGULATION OF INSURANCE State vs. Federal Regulation The history of insurance regulation has its roots in 17th century England; however, the controversial and highly contested route of its development has resulted in a regulatory structure that is uniquely different than that found in other industries. There is no question, however, that the activities of American insurance companies are highly regulated, and few other businesses are guided by the strict controls and guidelines found in this industry. To illustrate, an insurance company cannot establish operations without specific and regulated levels of operating funds. Other businesses do not have these start-of-business requirements. Similarly, insurance products must be sold by only state approved licensees, while other businesses may market their goods and services through whatever means they elect. Only the insurance industry must have its rates approved by the state in which it is operating, while other businesses are free to set their own prices and rates. Finally, regulations require insurance companies to maintain certain levels of funding (reserves) for the protection of their consumers. Generally, in most other industries, the state regulatory focus becomes secondary to federal regulation as an industry matures, but the insurance industry in the United States has moved away from a centralized federal regulatory structure and the concentration of regulation has been passed to state governments. Although the states exerted little control over insurance businesses prior to the Civil War, several states established statutes requiring charters for the insurers selling products within their boundaries. These charters and their provisions restricted insurance company activities and offerings, specified reserves, and established parameters regarding investments. In some states, chartering bodies directed insurance companies to make their financial standings public, while others required insurers to publish annual reports. Companies in Massachusetts were mandated to make these reports public as early as 1818. Other states soon followed this lead, asking for annual reports from state-based insurance companies, and requiring insurers outside the state to make statements of their financial condition available. Other than these parameters, the insurance businesses of the time were allowed to operate as they chose. While these chartering mechanisms provided regulatory guidelines for the industry, little was done to enforce these guidelines. The states were adept at issuing charters and often appointed various departments to tax their earnings from premiums, but the administrators assigned to regulate insurance businesses in certain states were not always effective in policing the industry in regards to legislation. As a result, some companies made poor investment decisions and squandered their funds. Others simply went bankrupt. Still others used deceptive and unfair policy provisions. This roller coaster track record made it obvious that some type of regulation was necessary for the protection of the public. It also indicated a need for regulation to balance business activities and sustain the industry. In an effort to more efficiently empower state regulatory offices, New Hampshire was the first state to establish a three-seat insurance commission in 1851. The board was later reorganized to include a single commissioner in 1869. Other states followed, and today, state insurance commissions continue to exercise substantial influence within the insurance industry. In 1855, the state of Massachusetts established the first department of insurance and in 1858 appointed mathematics professor Elizur Wright as insurance commissioner. Wright would later be credited as the person who contributed most to the future of insurance supervision, due to his concept of regulation as a means to promote insurer solvency. Shortly after New Hampshire created the first insurance commission, the U.S. House of Representatives proposed a

bill to establish a national bureau of insurance as an adjunct of the Treasury Department. Two years later, the Senate proposed a similar bill. Both were defeated, however. The reason for the failure of the two bills, it was speculated, was because the country was not yet ready to embrace the idea of federal control of the insurance industry. In the early 1900s, the effectiveness of the regulation of the insurance industry was studied by two separate committees. The New York legislature appointed a committee (the Armstrong Committee) for the purpose of studying the life insurance industry in 1905. The committee reported finding several areas of abuse regarding financial reporting and other wrongdoings resulting from the lack of effective regulation. In 1910, the New York legislature appointed the Merritt Committee to investigate non-life insurance lines. This committee reported that price competition would result in rate wars that would be devastating to the industry. It noted that insurers that had only marginal operations would be forced to offer coverage at a slightly lower rate and that those insurers with stronger operations would respond to these decreases by lowering their rates. Eventually, this would create a problem for the margin insurers, which would result in bankruptcies. This study reported that cartel insurance pricing was acceptable for the public good as well as for the good of the industry. In most states, the insurance department is part of the executive branch of state government, and it is under the direction of the insurance commissioner. In a few instances, this is an elected position. However, in other states, the governor appoints the commissioner. The commissioner’s main duty is to administer the insurance laws of the state, with the assistance of staff members. In most states, the insurance department is represented by a force of anywhere from 50 to 100 persons. National Association of Insurance Commissioners Paramount to the success of the state departments of insurance is the National Association of Insurance Commissioners (NAIC), a nongovernmental body developed to coordinate the activities of the individual state insurance departments. Founded by George W. Miller, the second superintendent of insurance for the state of New York, the early goals of the NAIC were those of uniformity of examination practices, annual reporting statements, and laws. The first meeting of the body was in 1871 and included the insurance commissioners of each state. It became a voluntary organization, and through the guidance of the NAIC, the state departments began to avoid the confusion of uncoordinated operations. Today, the NAIC meets twice yearly, with regional meetings scheduled between meetings of the entire NAIC body. Various committees from the organization work throughout the year on specific topics. Many committees focus on standardization procedures and formats, but others have developed information included on policies and policy statements. As a body, the group is committed to the development of legislative recommendations. Once the need for a new law is identified, a specific committee studies the situation and makes a recommendation to the larger group. If the group can pass the measure, it is submitted to the legislatures of the states involved in the form of a model bill for discussion. Although some states eventually reject some of these legislative proposals, the process has resulted in a growing uniformity of the industry’s regulation throughout the country. The NAIC continues to study the problems and changes within the industry. Task force groups use advisory committees made up of insurers and the public-at-large to investigate issues and ideas to improve the industry as a whole. For example, one NAIC task force gave primary attention to the use of gender and marital status as classification factors used in automobile insurance ratings and comprehensive health insurance coverage. Another looked at the question of state versus federal insurance regulation and ways to detect insurer insolvency before it actually occurred. The NAIC’s statement of intent highlights that the NAIC is committed to modernize insurance regulations to meet the

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realities of an increasingly dynamic and internationally competitive financial service market. Ultimately, the NAIC is committed to work cooperatively with governors, state legislators, federal officials, consumers, companies, agents, and other interested parties in order to facilitate and enhance this new evolving marketplace. The Financial Services and Modernization Act of 1999, which is known as the Gramm-Leach-Bliley Act (GLBA), established a comprehensive framework to permit affiliations among banks, securities firms, and insurance companies. GLBA acknowledged that states should regulate the business of insurance. However, Congress also called for state reforms to allow insurance companies to compete more effectively in the newly integrated financial service marketplace and to respond with innovation and flexibility to increasingly demanding consumer needs. Working with governors and state legislators, the NAIC has undertaken a thorough review of respective state laws to determine needed regulatory or statutory changes to achieve functional regulation as outlined by GLBA. The NAIC is committed to uniformity in producer licensing and the creation of uniform licensing standards. As a necessary interim step, the NAIC has adopted the Producer Licensing Model Act for consideration by state legislatures. The model act provides specific multi-state reciprocity provisions to comply with the requirements of GLBA. Seeing reciprocity as only a short range solution, the NAIC has empowered the Insurance Regulatory Information Network to develop recommendations for a streamlined national producer licensing process that will reduce the cost and complexity of regulatory compliance related to the current multi-state process. According to the NAIC, the model act creates uniformity in agent licensing procedures, defines the exceptions to licensing; simplifies the licensing process; promotes the Insurance Regulatory Network and Producer Database; creates reciprocity while preserving states’ rights; eliminates the regulation of business relationships through key commission-sharing provisions; and eliminates retaliatory fees. The NAIC is in the process of refining their risk-based approach to examining the insurance operations of financial holding companies to place greater emphasis on a company’s unique risk exposures and how it manages those risks. The NAIC is committed to enhance communication and coordination among all functional regulators and is reviewing the role of NAIC resources in supporting such communication and coordination. The NAIC is committed to pursue development of a group wide approach to regulating insurer groups and enhancing coordination among states. Gramm-Leach-Bliley Act Historic legislation affecting the banking industry in the United States intended to keep banks out of businesses that would be risky and thereby put the depositors’ funds at risk. The National Banking Act of 1864 gave banks the power to carry out tasks directly necessary and incidental to banking business, however insurance was not considered incidental to the banking business and therefore a prohibited activity. The stock market crash of 1929 caused the public to lose confidence in the banking system. Congress passed the Glass-Steagall Act of 1933 in an attempt to restore confidence in banks. The Glass-Steagall Act prevented a commercial bank from affiliating with any entity that was principally engaged in the sale of securities. However, banks were still allowed to operate holding companies. Through these holding companies and their affiliates banks were able to avoid some of these restrictions and became involved in the securities and insurance businesses. Over the years decisions made by regulatory agencies that oversee banks (such as the Federal Reserve, the Office of the Controller of Currency, and the Office of Thrift Supervision) effectively allowed banks to enter into insurance and other financial businesses. Additional legislation in 1985 and 1986 continued to eliminate the barriers intended to keep banks out of the insurance

business. In 1985 the Controller of Currency declared insurance a general investment product, thereby allowing banks to become involved in the insurance business. Additionally, over the years if a bank was located in a town with a population of 5,000 people or less, the bank was allowed to sell insurance. In 1986 the Controller’s office expanded this loophole and permitted banks to sell insurance products in towns with populations over 5,000 so long as the transaction was conducted through a subsidiary of the bank or branch located in a town of under 5,000. The insurance industry challenged these decisions in court but the challenges were ineffective and banks were allowed to continue entering the insurance business. When BankAmerica acquired Charles Schwab and Company in 1981 and Citicorp and Travelers Group merged in 1988 it became obvious banks were in the securities and insurance businesses to stay. Congress now realized that there was a need for legislation that recognized this change and which would provide necessary safeguards to protect the public’s interests. Through the 1980s and 1990s Congress debated the deregulation of financial industries a number of times; however, each time there was an attempt to pass legislation removing the barriers or regulating the entry of banks into financial investment and insurance businesses, the legislation failed to pass. In 1999 Congress realized it was time to take action and passed the Financial Services and Modernization Act of 1999, also known as the Gramm-Leach-Bliley Act (GLBA), which was signed into law by President Clinton on November 12, 1999. GLBA impacts the insurance industry in two key ways. First, GLBA brings federal regulation to insurance sales primarily through the regulation of insurance producers. This is to be accomplished first and foremost by creating uniformity in the regulation of producers throughout the nation. The second major impact is the protection of personal financial information. In taking the steps to comply with GLBA most states found it necessary to update and amend existing legislation and pass some new laws. For example, Illinois amended both its license law and its administrative code provisions affecting insurance law. Creating Uniformity in the Regulation of Insurance Producers Subtitle B of Title III of the GLBA sets forth the national standards required for insurance producer licensing. To insure swift action by the states to comply with the new regulations, GLBA actually set forth an ultimatum. If the requirements were not met within a specified time frame the NAIC was to oversee the creation of a group named the National Association of Registered Agents and Brokers (NARAB). The purpose of the NARAB would be to provide a mechanism through which uniform licensing, appointment, continuing education, and other insurance producer sales qualification requirements and conditions would be adopted and applied on a multistate basis, while preserving the right of states to license, supervise, and discipline insurance producers and to prescribe and enforce laws and regulations with regard to insurance-related consumer protection and unfair trade practices. The legislators that put these rules together felt so strongly about the need for uniformity and reciprocity to truly meet the goals of GLBA that the law even goes on to create steps that would be taken toward creation of NARAB if the NAIC did not take action on these issues. The NAIC moved swiftly to take action and the creation of NARAB has not and will probably never be required. However, the text of this portion of GLBA appears here.

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GRAMM-LEACH-BLILEY ACT

Subtitle C—National Association of Registered Agents and Brokers

SEC. 321. STATE FLEXIBILITY IN MULTISTATE LICENSING REFORMS. (a) In General.--The provisions of this subtitle shall take

effect unless, not later than 3 years after the date of the enactment of this Act, at least a majority of the States (1) have enacted uniform laws and regulations

governing the licensure of individuals and entities authorized to sell and solicit the purchase of insurance within the State; or

(2) have enacted reciprocity laws and regulations governing the licensure of nonresident individuals and entities authorized to sell and solicit insurance within those States.

(b) Uniformity Required.--States shall be deemed to have established the uniformity necessary to satisfy subsection (a)(1) if the States (1) establish uniform criteria regarding the integrity,

personal qualifications, education, training, and experience of licensed insurance producers, including the qualification and training of sales personnel in ascertaining the appropriateness of a particular insurance product for a prospective customer;

(2) establish uniform continuing education requirements for licensed insurance producers;

(3) establish uniform ethics course requirements for licensed insurance producers in conjunction with the continuing education requirements under paragraph (2);

(4) establish uniform criteria to ensure that an insurance product, including any annuity contract, sold to a consumer is suitable and appropriate for the consumer based on financial information disclosed by the consumer; and

(5) do not impose any requirement upon any insurance producer to be licensed or otherwise qualified to do business as a nonresident that has the effect of limiting or conditioning that producer’s activities because of its residence or place of operations, except that countersignature requirements imposed on nonresident producers shall not be deemed to have the effect of limiting or conditioning a producer’s activities because of its residence or place of operations under this section.

(c) Reciprocity Required.--States shall be deemed to have established the reciprocity required to satisfy subsection (a) (2) if the following conditions are met: (1) Administrative licensing procedures.--At least a

majority of the States permit a producer that has a resident license for selling or soliciting the purchase of insurance in its home State to receive a license to sell or solicit the purchase of insurance in such majority of States as a nonresident to the same extent that such producer is permitted to sell or solicit the purchase of insurance in its State, if the producer’s home State also awards such licenses on such a reciprocal basis, without satisfying any additional requirements other than submitting (A) a request for licensure; (B) the application for licensure that the

producer submitted to its home State; (C) proof that the producer is licensed and in

good standing in its home State; and (D) the payment of any requisite fee to the

appropriate authority.

(2) Continuing education requirements.--A majority of the States accept an insurance producer’s satisfaction of its home State’s continuing education requirements for licensed insurance producers to satisfy the States’ own continuing education requirements if the producer’s home State also recognizes the satisfaction of continuing education requirements on such a reciprocal basis.

(3) No limiting nonresident requirements.--A majority of the States do not impose any requirement upon any insurance producer to be licensed or otherwise qualified to do business as a nonresident that has the effect of limiting or conditioning that producer’s activities because of its residence or place of operations, except that countersignature requirements imposed on nonresident producers shall not be deemed to have the effect of limiting or conditioning a producer’s activities because of its residence or place of operations under this section.

(4) Reciprocal reciprocity.--Each of the States that satisfies paragraphs (1), (2), and (3) grants reciprocity to residents of all of the other States that satisfy such paragraphs.

(d) Determination.- (1) NAIC determination.--At the end of the 3-year

period beginning on the date of the enactment of this Act, the National Association of Insurance Commissioners (hereafter in this subtitle referred to as the ‘‘NAIC’’) shall determine, in consultation with the insurance commissioners or chief insurance regulatory officials of the States, whether the uniformity or reciprocity required by subsections (b) and (c) has been achieved.

(2) Judicial review.--The appropriate United States district court shall have exclusive jurisdiction over any challenge to the NAIC’s determination under this section and such court shall apply the standards set forth in section 706 of title 5, United States Code, when reviewing any such challenge.

(e) Continued Application.--If, at any time, the uniformity or reciprocity required by subsections (b) and (c) no longer exists the provisions of this subtitle shall take effect 2 years after the date on which such uniformity or reciprocity ceases to exist, unless the uniformity or reciprocity required by those provisions is satisfied before the expiration of that 2-year period.

(f) Savings Provision.--No provision of this section shall be construed as requiring that any law, regulation, provision, or action of any State which purports to regulate insurance producers, including any such law, regulation, provision, or action which purports to regulate unfair trade practices or establish consumer protections, including countersignature laws, be altered or amended in order to satisfy the uniformity or reciprocity required by subsections (b) and (c), unless any such law, regulation, provision, or action is inconsistent with a specific requirement of any such subsection and then only to the extent of such inconsistency.

(g) Uniform Licensing.--Nothing in this section shall be construed to require any State to adopt new or additional licensing requirements to achieve the uniformity necessary to satisfy subsection

Sections 322 through 335 of GLBA go on to establish the alternative if the goals of section 321 are not met. The formation of the National Association of Registered Agents and Brokers would accomplish these goals.

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SEC. 322. NATIONAL ASSOCIATION OF REGISTERED AGENTS AND BROKERS.

(a) Establishment.--There is established the National Association of Registered Agents and Brokers (hereafter in this subtitle referred to as the ‘‘Association’’).

(b) Status.--The Association shall- (1) be a nonprofit corporation; (2) have succession until dissolved by an Act of

Congress; (3) not be an agent or instrumentality of the

United States Government; and (4) except as otherwise provided in this Act, be

subject to, and have all the powers conferred upon a nonprofit corporation by the District of Columbia Nonprofit Corporation Act (D.C. Code, sec. 29y-1001 et seq.).

SEC. 323. PURPOSE. The purpose of the Association shall be to provide a mechanism through which uniform licensing, appointment, continuing education, and other insurance producer sales qualification requirements and conditions can be adopted and applied on a multistate basis, while preserving the right of States to license, supervise, and discipline insurance producers and to prescribe and enforce laws and regulations with regard to insurance-related consumer protection and unfair trade practices. SEC. 324. RELATIONSHIP TO THE FEDERAL GOVERNMENT. The Association shall be subject to the supervision and oversight of the NAIC.

The NAIC created the NARAB Working Group to help states implement the requirements of Section 321 of Subtitle C and avoid the formation of NARAB as called for in Sections 322 through 335. William J. Kirven III, Co-Chair of the Working Group testified before a subcommittee of the United States House of Representatives stating “NAIC and State insurance regulators wholeheartedly support the licensing goals endorsed by Congress in NARAB. We (the insurance commissioners) do not, however, believe NARAB is necessary. Moreover, we believe the creation of NARAB as a separate organization would undermine the legal authority of State insurance departments to protect consumers throughout the United States. If NARAB were to prevent States from exercising their full range of powers to regulate insurance for the benefit of consumers, there would be nobody to perform this vital function.” Reciprocity and Uniformity Requirements Subtitle C of the GLBA provides the states with two approaches to avoid creation of NARAB. The first is for states to recognize and accept the licensing procedures of other states on a reciprocal basis so agents will not be required to meet different standards in each state. In order to achieve reciprocity under the NARAB provisions, a majority of states and United States territories must have laws and regulations that guarantee reciprocal treatment for non-resident agents doing business in more than one state. The required reciprocity will be reached if a majority of states and territories do all of the following: Permit a producer licensed to sell insurance in his or her

home state to sell in non-resident states after satisfying only minimum requirements such as submission of a licensing application and payment of all applicable fees.

Accept the satisfaction by a producer of his or her home state’s continuing education requirements.

Do not limit or condition producers’ activities because of residence or place of operations (except that counter-signature requirements are still permitted).

Grant reciprocity to all other states meeting reciprocity requirements.

Alternatively, the States can avoid the creation of NARAB by adopting uniform laws and regulations regarding non-resident agent licensing. Laws and regulations will be deemed to be uniform under the NARAB provisions if the states do each of the following: Establish uniform criteria for integrity, personal

qualifications, education, training, and experience of licensed insurance producers.

Establish uniform continuing education requirements. Establish uniform ethics course requirements. Establish uniform criteria regarding the suitability of

insurance products for specific customers. Do not limit or condition producers’ activities due to

residency or place of operations. The Producer Licensing Model Act Prior to passage of the GLBA, the NAIC was working on an improved Producer Licensing Model Act to promote uniformity and efficiency among the States. NAIC moved quickly to amend this model legislation to incorporate the NARAB reciprocity provisions required by the GLBA. The NAIC’s Producer Licensing Model Act has been used as the primary vehicle for the States to implement the GLBA requirements for licensing reciprocity. Adoption of the Model Act by a majority of states assured that the NAIC and the industry would be in compliance with the NARAB reciprocity requirements. The NAIC further asserts that adoption and implementation of the Model Act does much more than simply satisfy the minimum requirements of the GLBA. The Model Act creates a foundation for achieving the ultimate goal of uniformity among the States for agent licensing. As of August 2004, 49 states and Guam had passed the Producer Licensing Model Act (PLMA) or other licensing laws with the intent of satisfying the reciprocity licensing mandates of GLBA. 42 states have been certified by the NAIC as meeting the requirements for producer licensing reciprocity under GLBA. The NAIC states that the only significant barriers to national reciprocity are fingerprinting and surplus lines bond requirements for nonresident producers, as these represent core consumer-protection issues to the states that have them in place. However, the NAIC indicates that a state that is reciprocal is not precluded from extending reciprocity to states that maintain these consumer protection requirements, which may further expand the scope of reciprocity. 30 states plus the District of Columbia are processing non-resident applications electronically through the National Insurance Producer Registry (NIPR) gateway. The Uniform Non-Resident Application is now accepted in 49 states and the District of Columbia. The states under the guidance of NAIC have made great progress in implementing the requirements of GLBA and thereby have seemingly made the creation of the NARAB unnecessary. Illinois has been an active participant in the dialog and planning during this transitional period and has passed its own legislation to bring the state into compliance. Illinois adopted a new licensing act incorporating the necessary elements of the Producer Licensing Model Act on August 16, 2001. Protecting Privacy When GLBA expressly allowed financial institutions that had operated as separate companies to be combined or owned by the same entity (for example, banks owning or operating as insurance brokers), it opened new opportunities for the use of information gained from operations in one business area to be used by other segments of the business. To protect against the possibility of these intertwined business relationships intruding on individual privacy rights, GLBA includes provisions to protect consumers’ personal financial information held by financial institutions. There are three principal parts to the privacy requirements: The Financial Privacy Rule. The Safeguards Rule. The Pretexting provisions.

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The GLBA gives authority to eight federal agencies and the states to administer and enforce the Financial Privacy Rule and the Safeguards Rule. These two regulations apply to “financial institutions,” which include not only banks, securities firms, and insurance companies, but also companies providing many other types of financial products and services to consumers. Among these services are lending, brokering or servicing any type of consumer loan, transferring or safeguarding money, preparing individual tax returns, providing financial advice or credit counseling, providing residential real estate settlement services, collecting consumer debts, and an array of other activities. The previously unregulated non-traditional “financial institutions” are regulated by the Federal Trade Commission (FTC). The Financial Privacy Rule governs the collection and disclosure of customers’ personal financial information by financial institutions. It also applies to companies, whether or not they are financial institutions, who receive such information. The Safeguards Rule requires all financial institutions to design, implement, and maintain safeguards to protect customer information. The Safeguards Rule applies not only to financial institutions that collect information from their own customers, but also to financial institutions, such as credit reporting agencies that receive customer information from other financial institutions. The pretexting provisions of the GLBA protect consumers from individuals and companies that obtain their personal financial information under false pretenses, a practice known as “pretexting.” An example of pretexting would be a phone survey claiming to be gathering information to allow insurance companies the opportunity to create new policies that will be better for all insureds, when in truth the information will be used to better organize a presentation to sell insurance to the consumer being questioned, or in a worst scenario, to use the information to steal a person’s identity. Financial Privacy Rule Protecting the privacy of consumer information held by “financial institutions” is at the heart of the financial privacy provisions of the GLBA. The GLBA requires companies to give consumers privacy notices that explain the institutions’ information-sharing practices. In turn, consumers have the right to limit some, although not all, sharing of their information. The GLBA applies to “financial institutions” that offer financial products or services to individuals. This of course includes insurance businesses. The law requires that financial institutions protect information collected about individuals; it does not apply to information collected in business or commercial activities. A company’s obligations under the GLBA depend on whether the company has consumers or customers who obtain its services. A consumer is an individual who obtains or has obtained a

financial product or service from a financial institution for personal, family, or household reasons.

A customer is a consumer with a continuing relationship with a financial institution. Generally, if the relationship between the financial institution and the individual is significant and/or long-term, the individual is a customer of the institution.

For example, a person who purchases an insurance policy from an insurer is considered a customer of the company and the insurance producer that assisted in the purchase, while a person who makes application or discloses personal financial information during an interview is considered to have a consumer relationship with the company and producer. The difference between consumers and customers is important because only customers are entitled to automatically receive a financial institution’s privacy notice. Although there are some exceptions, consumers are entitled to receive a privacy notice from a financial institution only if the company shares the consumers’ information with companies not affiliated with it. Customers on the other hand,

must receive a notice every year for as long as the customer relationship lasts. The privacy notice must be delivered to individual customers or consumers by mail or in person; it may not be posted on a wall with the mere hope that the customer sees it. Reasonable methods to deliver a notice may depend on the institution’s business. For example, an insurance company taking applications at its website may post its privacy notice on its website and require online consumers to acknowledge receipt as a necessary part of an application. The privacy notice must be a clear, conspicuous, and accurate statement of the company’s privacy practices; it should include each of the following: Information the company collects about its consumers and

customers. The parties with whom it shares the information; and The manner in which it protects or safeguards the

information. The notice applies to the “nonpublic personal information” the company gathers and discloses about its consumers and customers. In practice, that may be most or all of the information a company has about consumers and its customers. For example, nonpublic personal information could be information that a consumer or customer puts on an application, information about the individual from another source, such as a credit bureau, or information about transactions between the individual and the company, such as an account balance. Indeed, even the fact that an individual is a consumer or customer of a particular financial institution is nonpublic personal information. But information that the company has reason to believe is lawfully public, such as mortgage loan information in a jurisdiction where that information is publicly recorded, is not restricted by the GLBA. Consumers and customers have the right to opt out of or say no to allowing their information to be shared with certain third parties. The privacy notice must explain how and offer a reasonable way for the party to opt out. For example, providing a toll-free telephone number or a detachable form with a pre-printed address is a reasonable way for consumers or customers to opt out; requiring someone to write a letter as the only way to opt out is not acceptable. The privacy notice also must explain that consumers have a right to say no to the sharing of certain information including credit report or credit application information, with a financial institution’s affiliates. An affiliate is an entity that does one of the following: Controls the company. Is controlled by the company. Is under common control with the company.

The GLBA does not give consumers the right to opt out when the financial institution shares other information with its affiliates, and the GLBA provides no opt-out right in several other situations. For example, an individual cannot opt out if: A financial institution shares information with outside

companies that provide essential services like data processing or servicing accounts.

The disclosure is legally required. A financial institution shares customer data with outside

service providers that market the financial company’s products or services.

Safeguards Rule The Safeguards Rule was adopted in May of 2000. These rules are written in an understandable and relatively brief format. Therefore we have included most of the actual rule below. We have removed some of the specific references to sections of law that will not affect your understanding of the rule, and we have also added some short clarifying remarks, although the rule is primarily self explanatory.

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STANDARDS FOR SAFEGUARDING CUSTOMER INFORMATION

1. Purpose and scope (a) Purpose. This part, which implements sections 501

and 505(b)(2) of the Gramm-Leach-Bliley Act, sets forth standards for developing, implementing, and maintaining reasonable administrative, technical, and physical safeguards to protect the security, confidentiality, and integrity of customer information.

(b) Scope. This part applies to the handling of customer information by all financial institutions over which the Federal Trade Commission (‘‘FTC’’ or ‘‘Commission’’) has jurisdiction. This part refers to such entities as ‘‘you.’’ This part applies to all customer information in your possession, regardless of whether such information pertains to individuals with whom you have a customer relationship, or pertains to the customers of other financial institutions that have provided such information to you.

2. Definitions (a) In general except as modified by this part or unless the

context otherwise requires, the terms used in this part have the same meaning as set forth in the Commission’s rule governing the Privacy of Consumer Financial Information.

(b) Customer information means any record containing nonpublic personal information … about a customer of a financial institution, whether in paper, electronic, or other form, that is handled or maintained by or on behalf of you or your affiliates.

(c) Information security program means the administrative, technical, or physical safeguards you use to access, collect, distribute, process, protect, store, use, transmit, dispose of, or otherwise handle customer information.

(d) Service provider means any person or entity that receives, maintains, processes, or otherwise is permitted access to customer information through its provision of services directly to a financial institution that is subject to this part.

3. Standards for safeguarding customer information (a) Information security program. You shall develop,

implement, and maintain a comprehensive information security program that is written in one or more readily accessible parts and contains administrative, technical, and physical safeguards that are appropriate to your size and complexity, the nature and scope of your activities, and the sensitivity of any customer information at issue. Such safeguards shall include the elements set forth in section 4 of this rule and shall be reasonably designed to achieve the objectives of this part, as set forth in paragraph (b) of this section.

(b) Objectives. The objectives of … the Act, and of this part, are to: (1) Insure the security and confidentiality of customer

information; (2) Protect against any anticipated threats or hazards

to the security or integrity of such information; and (3) Protect against unauthorized access to or use of

such information that could result in substantial harm or inconvenience to any customer.

4. Elements In order to develop, implement, and maintain your

information security program, you shall: (a) Designate an employee or employees to coordinate

your information security program. (b) Identify reasonably foreseeable internal and external

risks to the security, confidentiality, and integrity of customer information that could result in the unauthorized disclosure, misuse, alteration, destruction or other compromise of such information, and assess the sufficiency of any safeguards in place to control these risks. At a minimum, such a risk assessment

should include consideration of risks in each relevant area of your operations, including: (1) Employee training and management; (2) Information systems, including network and

software design, as well as information processing, storage, transmission and disposal; and

(3) Detecting, preventing and responding to attacks, intrusions, or other systems failures.

(c) Design and implement information safeguards to control the risks you identify through risk assessment, and regularly test or otherwise monitor the effectiveness of the safeguards’ key controls, systems, and procedures.

(d) Oversee service providers, by: (1) Taking reasonable steps to select and retain

service providers that are capable of maintaining appropriate safeguards for the customer information at issue; and

(2) Requiring your service providers by contract to implement and maintain such safeguards.

(e) Evaluate and adjust your information security program in light of the results of the testing and monitoring required by paragraph (c) of this section; any material changes to your operations or business arrangements; or any other circumstances that you know or have reason to know may have a material impact on your information security program.

5. Effective dates (a) Each financial institution subject to the Commission’s

jurisdiction must implement an information security program pursuant to this part no later than May 23, 2003.

(b) Two-year grandfathering of service contracts. Until May 24, 2004, a contract you have entered into with a nonaffiliated third party to perform services for you or functions on your behalf satisfies the provisions of 4(d), even if the contract does not include a requirement that the service provider maintain appropriate safeguards, as long as you entered into the contract not later than June 24, 2002.

These rules are issued by the FTC specifically for those businesses that are under its jurisdictions regarding oversight of the provisions of the GLBA. Although the insurance business is not under the control of the FTC there is a potential that businesses that fall under these rules could be involved in an insurance transaction. To recap, the GLBA includes as non-public personal financial information; names, addresses and phone numbers; bank and credit card account numbers; income and credit histories; and Social Security numbers. The Safeguards Rule applies to businesses, regardless of size, that are “significantly engaged” in providing financial products or services to consumers. In addition to developing their own safeguards, financial institutions are responsible for taking steps to ensure that their affiliates and service providers safeguard customer information in their care. This is why it is good business to check out the practices of firms you do business with to see that they are in compliance with these rules. Adequately securing customer information is not only the law, it makes good business sense. When you show customers that you care about the security of their personal information, you increase their level of confidence in your business. Poorly-managed customer data can lead to identity theft. Identity theft occurs when someone steals a consumer’s personal identifying information to open new charge accounts, order merchandise, or borrow money. Implementing Safeguards The Safeguards Rule requires financial institutions to develop a written information security plan that describes their program to protect customer information. The plan must be appropriate to the financial institution’s size and complexity, the nature and scope of its activities, and the sensitivity of the

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customer information it handles. As part of its plan, each financial institution must do each of the following: Designate one or more employees to coordinate the

safeguards. Identify and assess the risks to customer information in

each relevant area of the company’s operation and evaluate the effectiveness of the current safeguards for controlling these risks.

Design and implement a safeguards program, and regularly monitor and test it.

Select appropriate service providers and contract with them to implement safeguards.

Evaluate and adjust the program in light of relevant circumstances, including changes in the firm’s business arrangements or operations, or the results of testing and monitoring of safeguards.

These requirements are designed to be flexible. Each financial institution should implement safeguards appropriate to its own circumstances. For example, some financial institutions may choose to describe their safeguards programs in a single document, while others may memorialize their plans in several different documents, such as one to cover an information technology division and another to describe the training program for employees. Similarly, a company may decide to designate a single employee to coordinate safeguards or may spread this responsibility among several employees who will work together. An insurance producer should be aware of how and where they fit into the safeguards of the companies with which they work. In addition, a firm with a small staff may design and implement a more limited employee training program than a firm with a large number of employees. A financial institution that doesn’t receive or store any information online may take fewer steps to assess risks to its computers than a firm that routinely conducts business online. When a firm implements safeguards, the Safeguards Rule requires it to consider all areas of its operation, including three areas that are particularly important to information security: employee management and training; information systems; and managing system failures. Firms should consider implementing the following practices in these areas: Employee Management and Training The success or failure of an information security plan depends largely on the employees who implement it. A company may want to: Check references prior to hiring employees who will have

access to consumer or customer information. Ask every new employee to sign an agreement to follow

the organization’s confidentiality and security standards for handling non-public financial information.

Train employees to take basic steps to maintain the security, confidentiality and integrity of customer information, such as: Locking rooms and file cabinets where paper records are

kept. Using password-activated screensavers. Using strong passwords. Changing passwords periodically, and not posting

passwords near employees’ computers. Encrypting sensitive customer information when it is

transmitted electronically over networks or stored online. Referring calls or other requests for customer

information to designated individuals who have had safeguards training.

Recognizing any fraudulent attempt to obtain customer information and reporting it to appropriate law enforcement agencies.

Instruct and regularly remind all employees of your organization’s policy - and the legal requirement - to keep customer information secure and confidential and post reminders about their responsibility for security in areas where such information is stored.

Limit access to customer information to employees who have a business reason for seeing it. For example, grant access to customer information files to employees who respond to customer inquiries, but only to the extent they need it to do their job.

Impose disciplinary measures for any breaches. Information Systems Information systems include network and software design, and information processing, storage, transmission, retrieval, and disposal. Here are some suggestions from the FTC on how to maintain security throughout the life cycle of customer information - that is, from data entry to data disposal: Store records in a secure area. Make sure only

authorized employees have access to the area. For example: Store paper records in a room, cabinet, or other

container that is locked when unattended. Ensure that storage areas are protected against

destruction or potential damage from physical hazards, like fire or floods.

Store electronic customer information on a secure server that is accessible only with a password - or has other security protections - and is kept in a physically-secure area.

Don’t store sensitive customer data on a machine with an Internet connection.

Maintain secure backup media and keep archived data secure, for example, by storing off-line or in a physically-secure area.

Provide for secure data transmission (with clear instructions and simple security tools) when you collect or transmit customer information. Specifically: If you collect credit card information or other sensitive

financial data, use a Secure Sockets Layer (SSL) or other secure connection so that the information is encrypted in transit.

If you collect information directly from consumers, make secure transmission automatic. Caution consumers against transmitting sensitive data, like account numbers, via electronic mail.

If you must transmit sensitive data by electronic mail, ensure that such messages are password protected so that only authorized employees have access.

Dispose of customer information in a secure manner. For example: Hire or designate a records retention manager to

supervise the disposal of records containing nonpublic personal information.

Shred or recycle customer information recorded on paper and store it in a secure area until a recycling service picks it up.

Erase all data when disposing of computers, diskettes, magnetic tapes, hard drives or any other electronic media that contain customer information.

Effectively destroy the hardware. Promptly dispose of outdated customer information.

Managing System Failures Effective security management includes the prevention, detection, and response to attacks, intrusions or other system failures. Consider the following suggestions: Maintain up-to-date and appropriate programs and

controls by: Following a written contingency plan to address any

breaches of your physical, administrative or technical safeguards;

Checking with software vendors regularly to obtain and install patches that resolve software vulnerabilities;

Using anti-virus software that updates automatically; Maintaining up-to-date firewalls, particularly if you use

broadband Internet access or allow employees to

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connect to your network from home or other off-site locations; and

Providing central management of security tools for your employees and passing along updates about any security risks or breaches.

Take steps to preserve the security, confidentiality, and integrity of customer information in the event of a computer or other technological failure. For example, back up all customer data regularly.

Maintain systems and procedures to ensure that access to nonpublic consumer information is granted only to legitimate and valid users. For example, use tools like passwords combined with personal identifiers to authenticate the identity of customers and others seeking to do business with the financial institution electronically.

Notify customers promptly if their nonpublic personal information is subject to loss, damage, or unauthorized access.

Permitted Disclosure of Nonpublic Personal Information The GLBA puts some limits on how anyone that receives nonpublic personal information from a financial institution can use or re-disclose the information. Take the case of an insurance company that discloses customer information to a service provider responsible for mailing premium notices, where the consumer has no right to opt out. The service provider may use the information for the limited purpose of mailing the notices. It may not sell the information to other organizations or use it for marketing. However, it’s a different scenario when a company receives nonpublic personal information from a financial institution that provided an opt-out notice when the consumer didn’t opt out. In this case, the recipient steps into the shoes of the disclosing financial institution, and may use the information for its own purposes or re-disclose it to a third party, consistent with the financial institution’s privacy notice. That is, if the privacy notice of the financial institution allows for disclosure to other unaffiliated financial institutions – like insurance providers – the recipient may re-disclose the information to an unaffiliated insurance provider. Other GLBA Provisions Other important provisions of the GLBA also impact how a company conducts business. For example, financial institutions are prohibited from disclosing their customers’ account numbers to non-affiliated companies when it comes to telemarketing, direct mail marketing or other marketing through e-mail, even if the individuals have not opted out of sharing the information for marketing purposes. As we mentioned above, another provision prohibits “pretexting.” Pretexting is the practice of obtaining customer information from financial institutions under false pretenses. The FTC has brought several cases against information brokers who engage in pretexting. Under the GLBA it is illegal for anyone to: Use false, fictitious, or fraudulent statements or

documents to get customer information from a financial institution or directly from a customer of a financial institution.

Use forged, counterfeit, lost, or stolen documents to get customer information from a financial institution or directly from a customer of a financial institution.

Ask another person to get someone else’s customer information using false, fictitious, or fraudulent statements or using false, fictitious, or fraudulent documents or forged, counterfeit, lost, or stolen documents.

Pretexting can lead to “identity theft.” Identity theft occurs when someone hijacks personal identifying information to open new charge accounts, order merchandise, or borrow money. Consumers targeted by identity thieves usually don’t know they’ve been victimized until the hijackers fail to pay the bills or repay the loans, and collection agencies begin dunning the consumers for payment of accounts they didn’t even know they had.

According to the FTC, the most common forms of identity theft are: Credit card fraud - a credit card account is opened in a

consumer’s name or an existing credit card account is “taken over.”

Communications services fraud - the identity thief opens telephone, cellular, or other utility service in the consumer’s name.

Bank fraud - a checking or savings account is opened in the consumer’s name, and/or fraudulent checks are written.

Fraudulent loans - the identity thief gets a loan, such as a car loan, in the consumer’s name.

GLBA – Summary The insurance industry will continue to feel the impact of the GLBA as the most important federal law affecting the insurance industry in recent years; the GLBA has already provided significant benefits with respect to multi-state coordination and reciprocity. The financial privacy and safeguards rules have also been widely implemented and provide significant additional information to the consumer which was not available just a few years ago. Legal Cases and Implications Regulation of the insurance industry is ultimately triggered by the fact that the insurance industry is “affected with a public interest.” This concept was initially developed by the British jurist Lord Matthew Hale in 1676. The U.S. Supreme Court used Hale’s concept as a basis for writing its own decisions and determined that the insurance industry was deemed “affected with a public interest” because of its role in many other business and industry activities. Paul v. Virginia The case of Paul v. Virginia in 1869 determined the legal basis for state regulation of the insurance industry. Samuel Paul was a Virginia insurance agent for several New York fire insurance companies. In Virginia at that time, insurance agents representing out-of-state companies were required to provide certain information to the state controller’s office. Paul had not met these requirements. The result of his noncompliance was a $50 fine. When Paul appealed the fine, he argued that the insurance business was commerce, and in his case, interstate commerce. The U.S. Constitution, by his interpretation, controlled interstate commerce, and according to Paul, Virginia’s requirement’s of the insurance industry were highly unconstitutional. The Supreme Court rejected Paul’s argument, ruling that selling insurance policies was not commerce. The court said these were personal contracts and did not fall into the same category as merchandise being shipped from one state to another. In their ruling on Paul v. Virginia, the Supreme Court upheld the Virginia laws and ruled that insurance companies were not to be regulated by the federal government, but by the states. Paul ultimately lost his fight and had to pay the $50 fine. This case is important to our discussion because it determined that it was the right of the government to regulate insurance companies, a ruling that was held intact for the next 75 years. In part, the ruling stated: “Issuing a policy of insurance is not a transaction of commerce. The policies are simple contracts of indemnity against loss by fire, entered into between the corporations and the insured, for a consideration paid by the latter. These contracts are not articles of commerce in any proper meaning of the word. “They are not subjects of trade or barter offered in the market as something having an existence and value independent of the parties to them. They are not commodities to be shipped or forwarded from one state to another and then put up for sale. They are like other personal contracts between parties that are completed by their signature and the transfer of consideration. Such contracts are not interstate transactions, though the parties may be domiciled in different states. The policies do not take effect and are not executed contracts until delivered by the agent in Virginia. They are, then, local

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transactions, and are governed by the local law. They do not constitute a part of the commerce between the states any more than a contract for the purchase and sale of goods in Virginia by a citizen of New York whilst in Virginia would constitute a portion of such commerce.” Munn v. Illinois In 1877, in the case of Munn v. Illinois, the Supreme Court further determined that insurance companies were businesses affected by the public interest. In its ruling, the Court recognized the states’ rights to regulate “properties” affected with the public interest, but protected these “properties” or businesses by further stating that the courts, not the legislature, would be responsible for determining “reasonableness.” Munn v. Illinois became a landmark ruling because it specified that property was “clothed with a public interest when used in a manner to make it of public consequence and affects the community at large.” However, no specific consequences were delineated in the ruling, and in its final form, the public interest concept became a dynamic one that would vary with court opinions through the years. The 20th Century In the early 1900s, it was proposed that certain aspects of the insurance industry be placed under federal regulation. However, the judiciary committee advised the U.S. Congress to refrain from passing such legislation, basing their arguments on the fact that Paul v. Virginia and other cases had determined that the federal government had no documented authority over the industry. It was not until 1944 that the Supreme Court reversed its Paul v. Virginia decision and ruled in the South-Eastern Underwriters Association case that the insurance industry was indeed commerce. In 1945, however, the U.S. Congress passed the McCarran-Ferguson Act. This act stated that the states should continue to regulate the insurance industry because it was in the public interest, and further specified that federal antitrust laws only apply to the insurance industry in instances where state regulation is not effective. If the state regulatory body is strong and adequately regulates the industry in that state, federal antitrust laws would not be applicable. The McCarran-Ferguson Act was accompanied by a report from the House Judiciary Committee, which stated: “Nothing in this bill is to be so construed as indicating it to be the intent or desire of Congress to require or encourage the several states to enact legislation that would make it compulsory for any insurance company to become a member of rating bureaus or change uniform rates. It is the opinion of the Congress that competitive rates on a sound financial basis are in the public interest.” The South-Eastern Underwriters Association In 1944, the Supreme Court ruled on a case involving the South-Eastern Underwriters Association (SEUA) and, in a surprise move, reversed the Paul v. Virginia decision. The SEUA was a rating bureau with approximately 200 members (representing about 90 percent of the fire insurance lines) and was located in Atlanta, Georgia. The SEUA had been charged with violating the Sherman Antitrust Act because it was believed that it was monopolizing the fire insurance business. The indictments brought against the SEUA included those for restricting interstate commerce by fixing noncompetitive rates on fire and other related insurance lines and monopolizing commerce in insurance. The SEUA also had charges against it for fixing commissions, compelling consumers to buy only from SEUA members, and using boycotts. Attorneys for the SEUA argued that, based on Paul v. Virginia insurance was not commerce and therefore not governed by the Sherman Antitrust Act. The court determined that insurance was indeed commerce and subject to control by the federal government. This ruling, in turn, subjected the insurance industry to the terms of the Sherman Antitrust Act, and the court determined that cooperative pricing by the 200 rating bureau members was illegal. It is important to note that the Supreme Court received criticism for deciding a question about the U.S. Constitution

without a majority vote by the nine justices; however, with a vote of 4-3, the decision stood. The insurance industry was now officially subject to federal regulation. The opinion itself concluded: “Our basic responsibility in interpreting the Commerce Clause is to make certain that the power to govern intercourse among the states remains where the Constitution placed it. That power, as held by this Court from the beginning, is vested in the Congress, available to be exercised for the national welfare as Congress shall deem necessary. No commercial enterprise of any kind that conducts its activities across state lines has been held to be wholly beyond the regulatory power of Congress under the Commerce Clause. We cannot make exception of the business of insurance.” The confusion caused by the SEUA decision led to the belief that there was a penalty in disobeying state laws that require rate-making organizations, but going along with them would cause one to be in violation of the Sherman Antitrust Act. Nothing could be further from the truth, however. In fact, only state laws that did not run counter to federal legislation applied because the rest were nullified by the ruling of the SEUA. One fact was made clear: the states’ rights to regulate insurance were never challenged by the SEUA ruling. In his written opinion, Justice Black pointed out: “Another reason advanced to support the result of the cases that follow Paul v. Virginia has been that, if any aspects of the business of insurance be treated as interstate commerce, ‘then all control over it is taken from the states and the legislative regulations that this Court has heretofore sustained must now be declared invalid.’ Accepted without qualification, that broad statement is inconsistent with many decisions of this Court. It is settled that, for constitutional purposes, certain activities of a business may be intrastate and therefore subject to state control, while other activities of the same business may be interstate and therefore subject to federal regulation. And there is a wide range of business and other activities that, though subject to federal regulation, are so intimately related to local welfare that, in the absence of Congressional action, they may be regulated or taxed by the states.” Public Law 15 The states’ authority to regulate the insurance industry was clarified through the SEUA decision, but while the opposing sides awaited the Court’s opinion, Congress introduced the Bailey-Van Nuys bill to establish their intentions for the states to continue to regulate insurance, making the industry exempt from the Sherman and Clayton Antitrust Laws. The members of the rating bureaus supported the bill because they did not want the antitrust laws to apply to their activities. Members of the NAIC and the “independents” (nonmembers of the rating bureaus) wanted to do away with the monopolistic activities they perceived in the industry, so they were against the bill. The bill did not make it past the Senate and ultimately failed, but later, other proposals followed that were eventually the McCarran-Ferguson Act, or “Public Law 15.” This law stated that the states’ regulation of the industry was, indeed, in the public interest, and for this reason, the industry was exempted from the provisions of the antitrust laws until July, 1948 – the date fair trade and antitrust laws were applicable to those parts of the industry not regulated by the states. However, according to Section 3(b) of Public Law 15, “... nothing in this act should render the Sherman Act inapplicable to any agreement to boycott, coerce or intimidate, or act of boycott, intimidation, or coercion.” The report accompanying the act stated: “Nothing in this bill is to be so construed as indicating it to be the intent or desire of Congress to require or encourage the several states to enact legislation that would make it compulsory for any insurance company to become a member of the rating bureaus or charge uniform rates. It is the opinion of Congress that competitive rates on a sound financial basis are in the public interest.” Some interpreted this law to mean that only insurance companies volunteering to become part of a rating bureau in a state-regulated environment were sanctioned. However, the

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Allstate, et al. v. Lanier, et al. case ruled that the law requiring that all automobile insurance companies in the state of North Carolina become members of the North Carolina Rating Office was not in conflict with the McCarran-Ferguson Act. In this ruling, the U.S. District Court stated that the state was so “authorized” and could go into further depths of regulation if the legislature decided to do so. Therefore, the states were given the right to limit competition if they chose to do so. The Supreme Court declined to review the case. The U.S. v. Insurance Board of Cleveland Before the SEUA case, certain rules were locally enforced which would be illegal under the Sherman Act. These rules, which were introduced by stock agents’ associations included boycott, coercion, and intimidation. Both insurers and agents were affected by these rules that effectually curbed competition. Among other limitations, insurance companies were allowed to have a certain number of agents in an area. Further, they were limited to reinsuring member insurers. Members were also not allowed to represent non-stock insurance companies, insurance companies that wrote policies directly (bypassing agents), companies selling established below-bureau rates and companies whose agents were not members of the association. Although the National Association of Insurance Agents decided to refrain from reinforcing these rules, certain local associations continued to use the rules, causing challenges from the Justice Department. Such was the rationale behind The U.S. v. Insurance Board of Cleveland and a similar case pitting the Justice Department against the New Orleans Insurance Exchange. The two boards said that the tenets of the McCarran Act had nullified the antitrust laws, but the court rebutted that nothing in the McCarran Act had suggested that the Sherman Act was not applicable, particularly in instances of boycott, coercion, or intimidation for the purposes of limiting competition. Purposes of Regulation In the objective examination of insurance regulation, the primary purpose is the protection of the consumer public. In all areas of the insurance industry, public confidence in the established system is required to maintain success. If the public should lack confidence in the industry because of experiences with fraudulent and incompetent insurers, the system would eventually fail. This lack of confidence would occur if the insurer became unable to provide the coverage promised. In cases of insolvency, the consumer would not only forfeit the price of the policy, but also the expected reimbursement for loss of property, disabilities, medical expenses or the support of dependents. To establish and maintain consumer confidence, certain regulatory goals have been developed to combat negative and unscrupulous business activities within the industry in order to: Prevent insurer insolvency. Prevent fraud. Assure reasonable pricing. Increase the availability of insurance.

Each of these goals is explained in more detail below. Insurer insolvency.

One of the primary goals of insurance regulation is to prevent insurance companies from going into bankruptcy. To this end, controls have been established through government regulations unique to the insurance industry. These controls require insurance companies to maintain certain levels of operating capital, as well as specified reserves and surplus levels to underwrite “the future services” agreed upon in the policies issued by that company. The government requires insurance companies to meet these levels because of the far-reaching effects of an insurance company going bankrupt. When any other business fails, investors in that business lose their money and people lose their jobs, but the bottom line of a business failure is something called competition – a major aspect of our free enterprise system. Sometimes a business goes bankrupt because it is not offering the

goods and services at a reasonable price to the consumer. When a business folds, the competition absorbs its customers and may adjust goods and prices to remain within the good graces of the consumer public. In this scenario, both the competitor and the consumer benefit. When an insurance company fails, there are no similar beneficiaries. The other major aspect to be considered in understanding regulations for the prevention of bankruptcy of insurance companies is that insurance premiums are based on the insurer’s estimate of the cost of future services. If the estimated costs of these services or losses are lower than the actual costs, the result is that rates are set too low and policies are under-priced. Several decades ago, the industry underestimated the necessity of raising rates in liability claims for property and casualty policies. A few years later, this area of the industry experienced significant losses because of the under-pricing. Because the industry must estimate future trends and activities, there is always the possibility that rates may be inadequate to cover losses. This fact, when coupled with the far-reaching impact of insurance company failure, forms the logic of regulation as a necessary means to protect the industry from insolvency.

Prevention of fraud. The prevention of fraud is also a primary goal of government regulation because it protects the consumer against being misled or misinformed by an insurer. As has often been pointed out by the industry, as well as public advocates, insurance policies are highly complex, technical documents that few laypeople actually understand. Without regulation, the possibility would exist that, at some time, an unscrupulous insurer could include certain phraseology that would mislead the insured and save the insurer from paying a particular claim. The second aspect of regulation for the purpose of preventing fraud concerns an insurance company’s continuing solvency. Attempting to strengthen its consumer base, a struggling company will advertise itself as a strong and reliable firm, with well-invested funds. To provide the consumer with some protection against fraudulent claims of this type, states monitor a firm’s operations to assure that no false claims may be made.

Reasonable pricing. A third goal of regulation is to protect the insurance consumer against excessive rates. Like regulations to protect the consumer from fraud, this type of regulation is also unique to the insurance industry. If an insurer decides to increase rates, it must first file its intentions to raise rates with the state commissioner. If there are objections, no rate increases may occur. Since the insurance industry’s pricing is based on past experience and certain statistics, the assumption is that the future will be much like the past. Rates, therefore, are based on the past experiences of many insurers. These collective rates, of course, would be more reliable than the rates based on the past experiences of a single insurer. In view of this assumption, the insurance industry is not required to comply with the anti-price fixing aspects of antitrust laws but, instead, may establish its prices based on its collective experience. With rates established through regulation, the resulting competition works to maintain reasonable pricing within each state’s industry.

Insurance availability. Making insurance available to all who need coverage is the final goal of regulation. This pledge to the consumer public is the basis for the establishment of automobile insurance pools in states to make liability insurance available to those drivers considered to be high-risk and not otherwise able to obtain insurance from standard insurers. Insurance is also made available to a broad-based market through federal programs reinsuring those companies that

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offer property and crime insurance in high-risk situations. And because increasing liability claims have raised the cost of professional malpractice insurance, government regulations have also been put into place to continue making this insurance available to all who require it. As years go by more insurance is becoming necessary for individuals and families. There is an ongoing debate as to whether insurance companies should be regulated to the point that they have no choice as to whom they insure. Some argue that the government should underwrite protection, such as Medicare, particularly for those deemed to be too great a risk for a private insurance company to insure. The opposing view believes that insurance companies should be forced to make coverage available to all who require it. The debate continues.

Major Categories of Regulation From its beginnings, the insurance industry has had ample time and opportunity to diversify itself regarding products, services, and methods of marketing. Today, it provides various services to its patrons, delivering these in a variety of formats that respond to the various and emerging needs of the public it serves. All, however, are strictly regulated, and, within the industry today, the complexities of its business are divided into three major areas of regulation: Financial strength of the insurer. Products. Sales and sales practices.

The Financial Strength of the Insurer In order to protect the solvency of the insurer, numerous regulations are required to control aspects of the business, such as rates, expenses, investments, surplus, dividends, organization, annual reports and liquidation of insurers. Specific levels of capital and surplus are required before insurers can open their doors for business. Once these requirements have been met, regulators have ongoing expectations of the insurer to maintain an adequate cushion of operating capital and surplus to respond to any unexpected declines in investments or burden of claims. All insurers are regulated to prohibit investments that are highly speculative or that fall in the high-risk category. This type of regulation limits the percentage of any insurer’s assets that may be committed to investments in stock or real estate. This, in turn, may also limit the company’s ability to build capital at a rapid rate. A company’s reserves are also regulated and must always be adequate to meet obligations that may arise in the future. Each state has its own formula for calculating reserves to cover each type of policy. Financial regulatory laws affect not only the reserves and assets of the insurance companies across the country, but also the basic organization of the companies, their investments, valuation of assets and rate setting mechanisms. Regulation of Products Over the years, the insurance industry has become so complex that policies are often the subject of court interpretation. Because of these complexities, it is difficult for the average policyholder to understand even a basic policy, which allows for unscrupulous agents to write policies that may not be in the best interest of the insured. In some cases, even honest insurers may inadvertently include exclusions and special provisions that may be misleading or unfavorable to the policyholder. Because of this situation, and because it is generally felt that most insurance policies are difficult to understand, there has been a movement in place for several years to simplify policy formats. One rate advisory bureau filed a homeowners policy reducing the narrative by about 40 percent and increasing the size of the type used in the policy by 25 percent. More white space was also allowed between the lines. More readable policy guidelines have also been instituted for automobile, business, personal, life, and health insurance policies. Certain state insurance commissions have also instituted guidelines regarding insurance policy forms. In doing so, they are attempting to protect both the policyholder, as well as

reputable insurers, against policies that are ambiguous, deceptive, or so difficult to understand they could be misleading. Certain formats of life and health insurance policies are prohibited from use, and commissions reserve the right to disapprove policies that contain unjust, inequitable, deceptive, or misrepresentative provisions. Regulation of Sales and Sales Activities The purpose of this type of regulation is, at first glance, to protect the consumer from unreliable services and disreputable agents. However, the regulation also serves to provide a balance of fair competition within the environment. In this area of regulation, the states regulate how insurers obtain new policyholders, the ethical standards within the industry and the standards required of insurance sales professionals. Most of the states statutes regulate not only the qualifications for those that sell insurance but also prohibit misrepresentation of the facts about a policy and its coverage. Some statutes also cover the parameters of the relationship between the insured and the insurer. In the insurance industry, the term “twisting” refers to the misrepresentation of the facts by an agent in order to manipulate the policyholder into substituting one contract for another. Twisting also includes failure to include all the facts when policies are represented. Because of regulations against twisting, agents are discouraged from making recommendations that may include dropping one policy in favor of another. Some regulations provide that any insurer of a policy that could be replaced would have the ability to evaluate and rebut any comparative information received by the policyholder. Rebating is another regulated sales activity. Rebating occurs when an agent refunds part of the premium to the policyholder. This practice is intended to skirt around the rate requirements established by a state. In most states, anti-rebating regulations have been established for the purpose of protecting the public interest. Rebating is difficult to prove and, therefore, few cases of rebating are ever heard in court. Government and Self-Regulation Historically, self-regulation was the first type of formalized insurance regulation and continues to be the most powerful form of industry regulation in both the United States and Great Britain. This form of regulation has maintained its power because of the fear of more public reaction against individual insurers. Therefore, it has been advantageous for industry professionals to seek and obtain additional self-regulatory powers that support the public interest. Under the current system, the insurance industry is also subject to three distinct types of regulation executed by the three branches of the democratic form of government – legislative, judicial, and executive. These three methods of regulation, plus the self-regulatory structures, oversee specific areas of operations within the industry and distribute regulatory powers between state and federal regulatory agencies. The following paragraphs will examine and explain the distinctions of each of the four categories. Legislative Regulation State legislatures create insurance codes which govern the insurance industry within that state. Insurance codes address the licensing of insurance companies and producers in order to regulate the conduct of the companies and their agents and employees. The laws also focus upon the specific products permitted to be sold within a state. Each state may implement different variations upon the common themes which mold the regulation of the insurance industry. Judicial Regulation Through their interpretation of legislation and other questions, the judicial branch of each state plays a major role in the legislation of the insurance industry. Although their involvement is often indirect in its nature, the courts are also employed to settle disputes between parties involved in insurance contracts. The written ruling of the court for each case, therefore, becomes a part of the body of regulation affecting insurance.

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Executive Regulation As the insurance industry became more diversified and complex, it became obvious, that the industry’s regulation should be supervised by knowledgeable and experienced individuals. No longer could lawmakers be charged with regulating this rapidly-growing business alone. To fill the administrative needs, each state has established an insurance department headed by a commissioner. Commissioners help to create and enforce rules, called administrative law, to assure the successful operation of the industry within their state. The duties of state insurance commissioners are broad and varied, but each state insurance department has certain basic duties. These include licensing of insurance companies and agents working within the state, monitoring the activities of licensed agents, and screening these activities regarding good business practices. In some cases, the commission is required to mete out certain penalties for unscrupulous behavior, such as the revocation of licensure or the closing of businesses who fail to meet regulatory requirements regarding reserves, capital, and surplus. Since 1818, when the Massachusetts insurance department required filing of the first annual financial reports, state commissions have required the filing of annual statements; furthermore, they act as a depository for securities in states with laws governing securities and require an evaluation of corporate assets on a regular basis. The commissions also regulate trade practices and oversee and approve policy contracts. In its role as a regulatory body, the commission may also monitor rates to assure against discrimination. Self-Regulation Once regulations were in place from governmental sources, the instrument of self-regulation reemerged from a growing consciousness or awareness by special groups of the disadvantages of intrusive outside interpretation and regulation. In view of this, the insurance industry has continued to be a self-regulated industry to a certain degree. Through associations of insurers and agents, these self-regulatory groups have exerted some degree of control through strict codes of ethical conduct and other cooperative agreements. These groups continue to function, generally out of the fear that more public regulation would impair the industry and its purposes. Specific Types of Regulation We now examine specific types of regulation which states may enforce in order to permit the prosperity of the insurance industry and protection of consumers. Regulation of Insurer Expenses The regulation of insurer expenses is a typical area of financial regulation. With the SEUA decision, organizations control commission rates, and if rate wars occur, it is within the jurisdiction of the state insurance commissioner to regulate the situation. Life insurance expenses are regulated in several states, with the New York law being the most complex. This law places caps on expenses and the cost of acquisitions, and affects approximately 70 percent of the life insurance sold in the United States. The New York law features: Restricted commission and fees on individual policies. Controls on awards or prizes for volume business. Complex limits on field expenses. Maximum caps placed on renewal commissions and

service fees. Training allowances for new agents that are commission-

approved. Regulation of Admitted Assets The solvency of an insurance company is measured by the amount by which admitted assets surpass the company’s liabilities. This measurement is taken by state regulators. Valuations for the company are highly regulated, a feature unique to the insurance industry compared to most corporations.

In most situations, “admitted assets” are those assets held by the company that include legal portfolio investments. Admitted assets always include office buildings and real estate (some states also allow computer equipment), but do not include operational assets for the firm. Assets such as automobiles, supplies, furniture and other capital expenditures, or secured or unsecured loans and advances to agents are not included in calculating admitted assets. It is often easier to value some admitted assets than others. For example, cash and bank accounts are valued at face amount, but there are other criteria for most other holdings. Examples of these criteria include: Real estate – valued at book value or market value. Mortgage and collateral loan – valued at amount of

outstanding debt. Bonds – amortized value if they are secured by earning

power. Bonds in default – market value as instructed by the

Committee on Valuation of Securities of the NAIC. Stocks – values prepared by the Committee on Valuation

of Securities of the NAIC and equal actual market value as of December 31 of that year.

Open accounts and premiums to be collected – valued at book value less an estimate of bad debts.

With these guidelines, it is not the insurer who is able to pay claims within a reasonable period that is deemed solvent, but rather the insurer whose admitted assets are equal or exceed their liabilities. Regulating Rates While the rates on individual life policies, most health policies, and ocean marine insurance are not regulated, there is a minimum rate level set for group life by several state insurance departments. Property and liability rates are controlled by model rating laws. These regulations are based on historical records of prospective loss and expense, as well as the occurrence of catastrophic events and hazards within a certain area. When there is regulation of this sort, an insurance company must file premium rates, rating plans, coverage, and rules for approval by the commissioner or a special committee. In this filing, the company must also provide support of any calculations with documentation. Some insurers will go through a licensed rating organization rather than filing directly with the state commissioner; however, the commissioner can also disapprove any filing, as long as he or she specifies reasons why the filing was disapproved. Each state commission must also approve a rating organization, and each rating organization must allow any qualified insurance company to take advantage of its services, without any discrimination toward the company. There are technical requirements built into methods of recording and reporting loss and expense experience, exchange of rating plan data, and consultation with other states, and the state commissioner usually taps a rating organization to collect this data. Unless a company files an application for deviation, each subscriber must follow the rating organization’s rates and policies; but, the commissioner may also disapprove these applications for deviation if there is a hint of inadequate, excessive, or discriminatory rates. Regulating Automobile Insurance Rates Observers of the insurance industry have often pointed out that the regulation of automobile insurance rates has taken on a political aspect, because state department commissioners are more focused on whether the standard is excessive as opposed to the standard being adequate. It was the suggestion of one such observer that the political careers of the regulators in one state were obviously more important than the financial solvency of insurers in that state. The problem arises when the public pressure for lower auto insurance rates takes precedence over the required financial strength of the insurance companies, and therefore, some

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states continue to walk a tightrope between these two priorities. Notably, in one state, when a commissioner voted to increase automobile insurance rates, that person was quickly fired by the incumbent governor who was running for another term. Regulating Property and Liability Insurance Rates In the area of property-liability insurance, many states no longer favor direct regulation of these rates. This is because there is an abundance of data and research behind the rates of this coverage, and because of strong competition, there is no danger either of excessive or inadequate rating. Because some insurance companies could charge inadequate rates in an effort to become more competitive, the state commissions are now sophisticated enough to detect those companies who could be bordering on insolvency. Because of these and other situations that are unique to property-liability rating, numerous proposals have been set forth to remove regulators from the pricing of this coverage. These proposals have resulted in two types of rating laws: File-and-use rating laws. No-file rating laws.

With file-and-use rating laws, a company could request a rate change with the documentation to support it, and then use the new rate until it is disapproved by the state commission. Under the no-file laws, the insurer can request a new rate without statistical documentation and then use that rate before notifying the commissioner. In most states, there is a specified period in which the commission is notified regarding the no-file rates. Regulating Life and Health Insurance Rates Valuation rules applying to the insurer’s reserve liability operate in lieu of regulation of life insurance rates, and the reserve requirements are not related directly to the premium structure of life insurers. An inadequate structure will cause inadequate assets to offset the required reserves. In this branch of insurance coverage, discriminatory prices are prohibited, just as they are in property-liability insurance, yet unit prices may vary with the policy size and the insurability of the policyholder. In other branches of the industry, competition has been an effective tool for regulation; however, in the life and health insurance branches, competition is not regarded as a useful regulatory tool because purchasers have no basis for comparison of rates and no tools to technically analyze these comparisons. Because of past abuses among life and health insurers, these rates are monitored by most state insurance departments. All states require that insurance companies file annual reports of loss ratios on health insurance because the public interest requires tracking of these statistics; however, the state insurance departments are not well-enough staffed to consistently check insurance company rates against the benefits offered. Regulating Reserves This, too, is a controversial area of regulation and is probably discussed more than most of the other financial regulation categories. Those companies that write property and liability insurance should maintain both loss reserves and unearned premium reserves. The loss reserve is the liability for claims and settlement costs the insurer estimates. The unearned premium reserves are those which at the time of valuation represent all policies outstanding and their gross premiums. Medical malpractice, automobile, and workers’ compensation loss reserves use the formula or loss ratio method for computing the minimum reserve, based on the previous three years and the expected loss ratio, which is 60 percent for medical malpractice and auto, and 65 percent for workers’ compensation. The sticky point which most concerns regulators about loss reserves is that most insurance companies estimate loss reserves lower than practicable, and, in turn, this may lead to insolvency when the insurer is pressed for payment. Conversely, when insurers set reserves too high, they also increase their rates to excessive proportions. Because most

state insurance departments do not have the trained personnel to “police” these areas of a firm’s operations some insolvencies have occurred as insurers have been able to hide the exact circumstances for setting their reserve percentages. Life insurers have one principal reserve known as the policy reserve. This reserve is calculated to meet all policy obligations, as well as premiums and assumed interest. The valuation on this reserve may be different from premiums charged by an insurer because it does not include an allowance or expenses and in fact may be calculated based on a different set of interest and mortality assumptions. The Modified Reserve Standard is used by some life insurers because the bulk of the expense a company incurs is during the first year the policy is in effect. These expenses include premium taxes, general expenses on the part of the insurer and mortality costs. This leaves little of the premium left for the insurer, and is definitely not enough to cover the reserve for the end of the first year. Regulation of Dividends The payment of dividends to policyholders is usually a matter of judgment on the part of the insurer. Still, some state insurance departments attempt to control this decision by limiting the surplus amount accumulated by the insurer; for example, not to exceed 10 percent of the policy reserve. By this type of limitation, the insurance departments effectively prevent the accumulation of a large surplus while dividends are lower or not paid at all. This type of regulation, according to insurance commissioners, also curbs inefficient use of a large store of assets. Regulation of Capital Stock/Surplus Accounts The surplus of an insurance company will be made up of surplus that is paid-in and surplus that is earned. A capital stock insurer also has capital that is paid-in. The capital-stock account of an insurance company is the dollar value that has been given to shares owned by stockholders. In most states, these shares are issued at a premium, or, in other words, the stock has a value that is less than the money paid by the stockholders. This creates the paid-in surplus. Mutual insurance companies are required to have a paid-in fund minimum, but because there is no capital stock in a mutual insurance company, the fund is entirely made up of paid-in surplus. Regulation of Business Capacity If an insurance company writes new business at a fast pace, there is the possibility that this increase in business could exhaust the insurer’s surplus and lead to insolvency. At the end of World War II, for example, several insurance companies actually “sold out” their products because they wrote as much business as they could without bringing their surplus accounts down to below acceptable levels. Because they could not raise enough capital in a short period of time, the companies had to quit issuing new policies. Some insurers decided to become selective in who they insured, favoring the more profitable companies. The less profitable businesses were left without insurance. This “capacity problem” is particularly important in discussions of property-liability insurance. Currently, the state insurance departments guard against this problem by using a rule of thumb that net premiums should not exceed twice the policy owners’ surplus. In some circles, a ratio of 3-to-1 is used, and some states even allow ratios as high as 4-to-1. The branch of the insurance industry that does not seem destined for “capacity problems” is life insurance. The need for a large surplus is not as immediate in life insurance, and many states limit the accumulation of surplus by those companies who sell participating policies. Regulation of Investments With the exception of property-liability insurers, who experience a majority of problems in the area of underwriting, most other branches experience most of their financial problems as the result of problems with their investments.

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Because of this fact, most states regulate investment of the assets of insurance companies. These restrictions may be either quantitative or qualitative, dealing with the types of investment media, the amount of security required, the percentage of admitted assets to be invested, and the percentage of admitted assets dedicated to a single area of investment, among others. Requirements for Organizing and Licensing Insurers Each state has insurance codes that guide the development of new companies in the insurance business. These codes are in place to protect the public from being misled, from being the victims of unscrupulous business people and from people who want to profit from the sale of the insurance company’s stock. State insurance commissions have the right to regulate the types of insurance to be offered by new insurance companies, as well as the types of coverage available from this insurance. The states issue a license to write insurance for domestic, foreign, and alien insurers, and then establish strict guidelines by which all insurers must do business in that state. The licenses issued to domestic insurance companies are usually permanent, but foreign and alien licenses are subject to renewal each year. The state insurance commissions believe that their licensing requirements are effective in controlling the activities of all insurance companies, assuming that they are complying with minimum statutory standards of financial solvency, and eliminating fraud or dishonesty among the insurers. There are two laws that currently deal with unauthorized insurers (those who are unlicensed in a certain state or mail-order insurers). One of these is the Unauthorized Insurer Service of Process Act. In this act, the commissioner serves as the agent for foreign companies for service of process (the summons that brings a defendant to court for legal jurisdiction). The second act is the Uniform Reciprocal Licensing Act. Under the Uniform Reciprocal Licensing Act a domestic insurance company’s license may be taken away if it operates in another state that has a reciprocal licensing act without obtaining a license. A state may also control unauthorized insurers by limiting their business to that of licensed surplus lines or licensed brokers. Liquidation of Insurers When an insurance company becomes technically insolvent, the state commission of insurance takes over the company for liquidation, rehabilitation, or conservation. The commissioner may take over operations at any time if the company is not being operated in the best interests of those holding policies with that company. An insurance company suspected of nearing insolvency has a right to a hearing by the commission, but when an order to liquidate is issued, the assets of the company become vested in the commission. At that point, if the need for a takeover is not sufficiently supported, the assets are returned to the company’s management. The Uniform Insurers Liquidation Act provides a uniform procedure in liquidation cases where insurers have done business in more than one state. This gives equal rights to each adopting state in the handling of claims and the final distribution of the insolvent company’s remaining assets. Regulation of Products To maintain a certain amount of control over the policies offered by various insurers, each state commission must approve policy forms. This makes it difficult for companies to either mislead or deceive the consumer with statements that contain highly technical terminology or ambiguous descriptions of coverage. For certain types of insurance coverage, including fire and workers’ compensation, a standard form is required. Other coverages, such as life and health, forbid the use of gimmickry in their forms and verbiage. The commissioner, upon reviewing a new policy format, may overrule any type of wording in provisions that may be deceptive or misrepresent the “real” coverage. The unfortunate aspect of this particular type of regulation is that most state insurance departments have neither the funds nor

the trained personnel to review every form that is used for insuring individuals in that state. Taxes Like any other industry, insurance companies in America pay local, state, and federal taxes and fees. The bulk of these taxes are levied by the state; however, some communities and municipalities collect taxes as well. These mandatory payments include income taxes, property taxes, license and filing fees for annual financial statements, and fees for taking the insurance licensing exam. Companies also pay taxes on franchises (if they apply), premium taxes (although some states tax insurance companies as an alternative to premium taxes), and special taxes on workers’ compensation and various other types of insurance. Applicable Rates and Rules While state taxation varies according to state requirements, federal income taxes are levied according to formulas found in the Internal Revenue Code, and taxation on real estate and property are the same as for any other taxpayer. In some states, taxes levied on fire insurance premiums go to support local fire departments. Likewise, the taxes on workers’ compensation insurance are used to establish the system, security funds, and funds to underwrite programs for employing handicapped individuals. One of the most unique and most controversial of taxes paid by insurance companies is the premium tax. At one time, the proceeds from this form of taxation were used to pay the costs of regulation; however, state insurance companies today receive only a small portion of the premium tax, with the greater part of the proceeds used to fund other services provided by the state. This particular tax has brought an outcry from the insurance industry, with objections centering around the seeming inequity in taxing one industry without taxing others. The bottom line of the premium tax is that it is ultimately paid by insurance subscribers, and no state has reported any problems in collecting the premium tax. The truth of the matter is that the premium tax is a bone of contention within the industry. First of all, the states vary taxation rates between 1.7 percent and 4 percent, with 2 percent being the most widely used. In some states, U.S. companies are taxed at a lower rate than foreign companies, a situation that the NAIC has worked to eliminate. To strike some type of balance, a large majority of the states charge what is called a retaliatory tax, which equalizes the domestic tax rate for companies operating outside the state. In some states, too, the premium tax varies according to the line of insurance, based on whether or not the insurance company may have some of its assets invested in that state. The states also vary their formulas for calculating the premium tax. In some cases, the insurance company is allowed to deduct its policy dividends from its tax base, but few states allow this deduction. Today, some states are considering an income tax in place of a premium tax (or, in some instances, in addition to the premium tax). The difficulty in determining a company’s income is most often cited as a reason for not going forward with this idea. It is also important to know that formulas to measure income presently differ among the states. Pricing of Insurance Rates Although most insurance rates are derived by extremely complicated formulas, a simplified explanation is that insurance rates are a determination of a policyholder’s percentage of responsibility for loss expenses. The premium to insure a home or automobile is the rate per unit of coverage multiplied by the number of units purchased. Here are some examples: A customer wants to purchase a homeowners policy. A unit would be 100 square feet within the building. Depending on the particular circumstances, the unit may be $100 or $1,000 of coverage purchased. Once the cost per unit is established, the insurer must look into the future to determine the percentage chance that the homeowner will suffer a loss, based on past experience and the rate of probability that a homeowner will file a claim. This historical experience plus the influence of new trends and

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developments, such as improved building materials, are also taken into consideration to determine the final rate to be paid. Historically, insurers calculated each policy on a separate basis. But, as business increased, this system proved to be too cumbersome, and insurance companies also found some glaring deficiencies in their existing methods. Rate setting (sometimes referred to as rate making) soon became a group effort in order to make rates both profitable for the companies and fair to the policy buyers. These rates were published, and if variances were appropriate, the established rates became the basing point for these variations. The various lines of insurance began setting their own rates, and today, the industry trends suggest that independent rate making is the rule for all types of insurance coverage. Rate Regulation Objectives When a rate filing is submitted to the state insurance department by an insurance company, the data submitted is evaluated by the department, with three objectives in mind: To prohibit excessive rates for coverage. To maintain the financial solvency of the company. To avoid unfair discriminatory rates.

The strictness and meticulousness with which new rates are evaluated depends upon the state. In some states, for example, property and casualty rates require explicit approval by the insurance commission, prior to the use of new rates. In other states, the “open competition” condition exists, and it is assumed that the competition will regulate costs much more effectively than the insurance commission. In the “open competition” states, the commissioner of insurance may curtail the use of certain rates, particularly those violating rating standards, but rates do not have to be filed and approved, as is the practice in the more rigidly controlled states. It is worth noting here that anyone having a grievance against an insurance agent or insurance company is invited to file a complaint and is entitled to a hearing. However, the burden of proof that rate filings actually comply with the law is on the shoulders of the insurance company or the rating bureau. Life insurance rates are not regulated in the same manner that other rates are regulated. The control of these rates is indirect, or, in other words, based on supervision of mortality tables, dividends and interest rates used to compute the reserves of life insurers. When these controls are combined, the result is an indirect regulation of life insurance rates that are inadequate, excessive, or discriminatory. Within the regulation of life insurance, there is one central controversy involving “cost disclosure.” Since life insurance rates do not reflect the true costs of the policy to the company, it is entirely possible that a policy having a low premium may be very costly to the issuing insurer, or the opposite may be true – a policy with a high premium may require very little from the insurer, cost-wise. To provide consumers with a better understanding of life insurance rates, and to give them a better tool with which to compare the costs of various policies and coverages, the industry has turned to the interest-adjusted method for computing policy costs. Indeed, the NAIC has recommended that the states require life insurance companies to provide detailed information to consumers about the costs of a policy. Some states have agreed to this suggestion. Others vehemently oppose this concept. Ultimately, some consumers have agreed, saying that the interest-adjusted computation is just as difficult to understand as other methods, and that they will rely on their agents for guidance in purchasing adequate coverage for their individual needs. The State Insurance Commissioner’s Role In terms of regulating rates, the state insurance commissioner decides whether or not to approve a rate. In some states, the commissioner is assisted by appointive rating organizations to collect and maintain data regarding rates. The commissioner also has access to rating laws that involve the technical requirements of methods for recording and reporting losses and expenses over certain periods, as well as exchange of

rating plan data and the experience and advice of other states. Rates for life insurance lines are regulated individually by guidelines applicable to the insurer’s reserves and the liability of these reserves. However, the reserve requirements do not relate to the premium charged. As an example, if the insurance company charges a premium on a life insurance policy that is inadequate to cover its exposure, the company’s assets will soon be smaller than the liability of the coverage it will have to eventually pay. The thinking among insurance industry leadership and regulators alike has been that competition would ward off excessive rates, but because the consumer public has neither the technical knowledge nor general understanding of the industry, it is questionable that competition actually serves as an effective regulator of life insurance. To serve as a guide for charging rates, the industry has developed price indexes based on formulas developed within the industry. The indexes are used by a large number of companies. The states have also entered into the educational area of the industry by publishing buyers’ guides showing the prices of a number of life insurance lines. In the case of health insurance lines, there are several states that require these lines to file a schedule of their rates with the insurance commissioner. Other states allow the commissioner the ability to disapprove health insurance forms, particularly if benefits and premiums are not proportionally balanced. Some states require that insurers file a listing of expected losses associated with the claims filed on health insurance. In addition, all states require that insurance companies file reports of their loss ratios. While the public interest automatically requires close scrutiny of each case in point, the states cannot provide enough professionals to review or supervise every health insurance policy. In fact, so many different health insurance policies now exist that it is impossible to check their rates against benefits. This makes the agent’s role extremely important since the public is generally unable to fully understand the many variables between policies. Conclusion Although it may seem that most regulation applies to the insurance companies rather than the individual producer, it is the producer that the client sees and therefore the person most responsible for the image the public will have of our industry. Rules and regulations can only go so far to create the proper business environment. Ethical standards are also a necessary element in guiding a producer’s conduct. The next section of study will focus on ethics and ethical behavior for insurance producers.

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CHAPTER 6 – ETHICS No matter what line of business, the subject of ethics is of crucial importance in the workplace for both management and agents or employees. A survey of a cross section of 650 adults revealed that rank-in-file workers hold the same opinions on what is right or wrong as the executives polled. The survey demonstrates that both labor and management believe that ethically conducting business is the right thing to do. Both senior management and workers closely agree that unethical behavior, even if not illegal, is grounds for termination. What is legal is not always ethical and what is unethical is not always a violation of state or federal laws. Behaviors considered serious ethics violations by management include: Supervisor access to employee health records. Using resumes to discriminate. Personal credit checks on employees. Making misleading promises to employees or contractors.

Behaviors considered serious ethics violations by employees included: Using email to harass co-workers. Use of drugs at work. Use of alcohol at work. Circulating pornography by email. Falsifying experience on a resume. Revealing confidential information. Making misleading statements or promises to customers

and clients. Because insurance companies and their agents are in a position of trust, ethical behavior is paramount to perpetuating the industry and the livelihood of each agent. Both the insurer and the agent have an obligation to each other to be truthful and honest with each other through their agency relationship. This agency relationship continues and a level of honesty and proper representation is required with the insured. State laws further enforce this requirement of honesty and proper representation through state departments of insurance. Over the years the insurance industry has earned the trust of the consumer and perhaps more information and public exposure of the history of the industry would serve well to strengthen the public’s perception of the industry. During the great depression and the years that followed, although many individuals lost savings as banks and savings and loans closed their doors, the insurance industry remained solvent and in many cases became a source of funds for individuals. Through the built-up assets of life insurance policies, individuals were able to borrow money to carry them through these very difficult times. Because the industry is made up in a great percentage by independent agents, workplace ethics is critical to creating sound ethical behavior by agents as they deal with customers and clients. These behaviors must come from within the agent and must be reflexive in nature in order to avoid a dereliction of this responsibility when faced with everyday work demands. Having to meet either employer work quotas, personally set quotas, or to satisfy a personal need to be the “best” must never stand in the way of meeting the client’s needs and the need to paint an impeccable image of the insurance profession. Although individuals in every profession are there to serve their own needs of supporting themselves or their families, insurance agents are in a position of trust and their needs of self preservation must be put aside and the interest of the client must always be put first. Ethical conduct can easily be violated; for example, by selling someone more insurance than they need in order to earn more commission or perhaps by selling someone a higher commissioned product, even though another policy would better serve the individual’s needs. Although not necessarily

illegal, both of these actions would be unethical, not consistent with meeting the client’s needs, and certainly risk creating mistrust of the insurance professional and the industry. Because insurance is a product that requires a skilled individual to interpret its benefits, an agent’s knowledge and recommendations are held to a high level of accountability. The average consumer does not possess the ability to interpret the information in a policy accurately or realize the additional options that may be in order to properly meet his or her needs. An agent can look at a situation as a one time sale and try to maximize his or her gain from that transaction without regard for the client’s needs or look at it from the point of view that it is the beginning of a long lasting professional relationship. This latter point of view will earn the agent many more transactions, future referrals and commissions. This can only be accomplished through proper professional conduct and ethical behavior. No matter what type of insurance you sell, the ethics you employ in your sales approach reflects not only on you but also the companies you represent and the entire industry. Although some ethical issues are limited to personal issues of conduct or personal levels of integrity, other issues become violations of state laws. In selling insurance it is critical that the highest standard of ethics be adhered to from making a product recommendation to assisting the settlement of a claim. It is imperative that you recognize and make the consumer aware of the risk factors involved in the choices they make. In this chapter we will be reviewing the ethical issues that face all agents in the process of earning a living and serving the consumer’s needs. At the core of ethical behavior are honesty, responsibility, care, integrity, and trustworthiness. Codes of ethics developed by various professional associations serve as guides for the insurance professional who is committed to his or her responsibilities to both the insurance companies and consumers. Standards and Practices Perceptions of Ethics Ethics is the discipline that deals with what is good and bad or right and wrong or with moral duty and obligation. Society, through laws and accepted behavior patterns, imposes guidelines on how to deal with other people. From the practical side, most insurance agents have been tempted from time to time to either “stretch the truth” or perhaps “color” their presentation in order to obtain the sale. Although this may appear to have no short-range harm, this coloration, or untruth could affect the client’s future benefit. This consideration is critical in ethical behavior because it can result in future liability and/or lost clients for both the producer and the company. A strong sense of honesty and personal integrity will enable an individual to stay on the straight and narrow and avoid deceptive practices that could harm either the customer or the insurance company. Overstating a product can be injurious to the insured and a deceptive statement on the application could result in a higher risk for the insurer. Society often measures success by financial gain and many businesses, including the insurance industry, motivate their employees or independent contractors by the same theory. When achieving success and financial gain becomes primary over the customer’s, client’s or employer’s needs, ethical issues may begin to arise. Ethics and the law are not always synonymous. What is legal is not always ethical. In many cases professional organizations preceded laws and their code of ethics served as guides to establishing some of the laws to which we adhere. However, not all ethical standards were codified into law. Thus it is possible to operate within the law and yet be unethical. Selling someone a casualty policy they do not need might be legal, but not necessarily ethical. Often times, things that are unethical but legal today may become illegal tomorrow due to public pressure to bring about

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reform. For this reason, ethical behavior should supersede the lack of a law which prohibits certain activities which are obviously unethical. Ethics for the Agent An insurance agent is anyone who solicits insurance or who aids in the placing of risks, delivery of policies or collection of premiums on behalf of an insurance company. In most states agents are considered representatives of the insurance company and not of the insured. An agent is regarded as a fiduciary, a position of special trust in handling the affairs or funds of another. There are four areas of ethical responsibility for an insurance agent: Responsibilities to the agent’s insurer.

These responsibilities are covered under the concept of agency. The agent owes his or her insurer the duties of good faith, honesty, and loyalty. The agent’s day-to-day activities are a direct reflection on the insurer’s “image” within the community. Under the ethical responsibilities owed to the insurer the agent has an obligation to reveal all material facts concerning the insured or any other matter relating to the agency relationship.

Responsibilities to policy owners. Responsibilities to the policy owners require the agent to meet the needs of the insured, provide quality service, and maintain loyalty, confidentiality, timely submission of applications and prompt policy delivery.

Responsibilities to the public. The responsibilities the agent has to the public require the agent to maintain the highest level of professional conduct and integrity in all public contact in order to maintain a strong, positive image of the industry.

Responsibilities to the state. State responsibilities held by the agent require the agent to adhere to the ethical standards mandated by his or her state.

Ethics for Insurance Brokers A broker’s primary responsibility is to his or her client, meaning that, the broker is charged with the responsibility of finding the appropriate insurance coverage and markets to meet a client’s needs. By this definition a broker legally represents the insured. Many brokers provide sources of specialized insurance products and with this provide their clients with their expertise and knowledge of such products. It is critical that insurance brokers realize that their fiduciary responsibility to the insured dictates that they work in the best interest of the insured. Their ethical standards should reflect this obligation and put the client’s needs ahead of any financial gain they might realize by selling one product over another. An individual who is strictly a broker does not have binding power and coverage is not effective until the insurance company receives the application and accepts the risk. Dual agency exists when a broker is both a broker and an agent in which case the broker is functioning both on behalf of the insured and the insurer. Most states do not issue separate broker and agent licenses, but simply issue an insurance producer license. Brokers are held to the same standards of care as agents in terms of their responsibilities to the general public and the state. Brokers’ primary responsibilities are to their clients by finding the appropriate insurance coverage to meet their clients’ needs. Characteristics of a Professional The word “profession” has come to mean any calling requiring academic training and specialized knowledge. Insurance agents are considered professionals because their business meets the following six commonly accepted characteristics of a profession: Commitment to high ethical standards. Concern for the welfare of others. Mandatory licensing and training. Formal participation in an association or society.

Acting with integrity and objectivity. Public acknowledgement as a profession.

Commitment to high professional standards often comes in conjunction with membership to professional associations that demand these high standards from their membership. Concern for the welfare of others is a personal ethics issue that often is learned during one’s upbringing and later required as part of one’s profession. The fiduciary responsibility entrusted to every insurance producer demands that the welfare of the client is put ahead of his or her own need. Mandatory licensing is required by virtually all states and continuing education has become a core requirement to update the producer on changes occurring within the law and the industry. Membership in formal associations further enhances professionalism and ethical behavior by providing a forum for additional exchange of information and knowledge. Responsibilities to the General Public Because unethical behavior by agents and brokers can affect the whole industry, the integrity and professionalism of their conduct is of utmost concern to all. The public’s perception of the insurance industry is determined by the behavior of both insurance agents and brokers, and their commitment to professionalism is the key to the public’s trust of the industry. Insurance is something that is used by many; yet, many are unaware of how insurance works and benefits them. The ethical agent has a duty to provide the consumer with fair and honest information of the policies and services he or she has to offer. The Agent as a Fiduciary Fiduciary responsibility in many professions is harnessed under a concept called agency. Many times both insurance agents and brokers and real estate agents and brokers do not realize that even though they are involved in the sale of a product, they are not merely sales representatives working to fulfill their own needs, but are fiduciaries of their principals. This high level of performance makes them ethically and legally accountable to their principals and legally accountable to the state and federal licensing bodies. An individual whose position and responsibilities involve a high degree of trust and confidence is known as a fiduciary. An insurance producer has a fiduciary relationship with his or her client. Insurance producers can represent either the insurance company or the insured. When the producer represents the insurance company it is the company that we call the principal and the producer is called the agent. Alternatively when it is the prospect or insured the producer represents, then it is the insured that becomes the principal and the producer is called the broker. In any fiduciary relationship the agent owes the client the duties of: Care. Obedience. Honesty. Disclosure. Confidentiality.

In most instances the nature of the insurance business puts a producer in the position of owing some of these duties to each party. When representing the insurance company as an agent, a producer must consider each of the following: Loyalty to insurer. A producer must at all times act in the

insurer’s best interest, not his or her interests of personal gain.

Skill and performance. An agent has the duty to carry out his or her actions with care and skill.

Full disclosure. An agent is obligated to fully disclose all information he or she obtains that may affect the insurer and the ability to do business. Full disclosure is critical during the application and claims handling processes.

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Follow up. An agent has the obligation to act promptly in all matters regarding the insurer’s business, including the duties to forward completed applications as quickly as possible.

Handling of premiums. By law, payment to an agent is payment to the insurer. The agent has a fiduciary duty to turn over all funds given to him or her as specified by agreement.

Avoiding conflicts of interest. An insurance agent cannot serve two principals at the same time. An agent has the ethical duty to make full disclosure to an insurer in regard to any other related service for which he or she receives compensation.

Responsible solicitation. An agent has the duty to solicit only business that appears to be good and profitable to his employer.

Competitive integrity. An agent cannot misrepresent or in any way defame a competitive agent or insurer. An agent must compete only on the basis of products and services that he or she can provide.

When a producer acts as a broker representing the insured these obligations change to serve the insured while still requiring certain obligations to the insurer with regard to field underwriting and accounting for funds collected on the company’s behalf. We will explore these issues further in the following sections of these materials. The Concept of Agency Agency is a legal term used to describe the relationship between two parties, in which the principal authorizes the agent to perform certain legally binding acts on the principal’s behalf. When a producer represents the insurance company he or she is considered to be an agent of the company. The main components of an agency relationship are: An agent is an agent of the principal (the insurance

company), not the third party with whom the agent deals (the insured).

An agent has the power to bind the principal to a legal contract and its terms.

The acts of the agent, within the scope of authority, are deemed to be the acts of the principal.

Since the acts of the agent are legally the acts of the principal, it is critical that the agent does not misrepresent the principal in any manner or fashion, and that the third party understands that the agent is working to serve the best interests of his or her principal. While serving the principal, the agent also has a responsibility to the third party to be honest and forthright in presenting products for discussion. Because agency can be created in several ways, it is important that an agent does not create an agency relationship that becomes a conflict of interest without proper disclosures. The methods through which an agency can be created are: Appointment or explicit contract.

Appointment is an agreement between the principal (insurer) and the agent that specifically outlines the duties the agent may perform on behalf of the principal.

Estoppel. Estoppel is the concept wherein the insurer allows someone (an agent) to act in a way that would cause an innocent third party to believe that the individual was an agent of the insurer. Under those circumstances that agent actually becomes an agent of the insurer and the insurer is held accountable for his or her actions. In order for estoppel to occur, three elements must exist: The principal must act in some way that gives the

appearance that an agency relationship exists. An innocent third party must be misled. An innocent third party must be harmed or rely on the

agent to his or her detriment.

Ratification. Agency by ratification is the last method in which an agency relationship can exist. In this format agency is initially created by misrepresenting that an agency relationship exists, but later on, the “authority” is legitimized by the principal through ratification (acceptance of the representation) by its actions.

Authority Before an individual can act as an agent he or she must have the power and authority to take action. There are three types of agency authority: Express authority is the authority the principal intentionally

and expressly gives the agent. In the case of express authority the limits to an insurance agent’s authority are usually defined in his or her agency agreement and the agent must work within those parameters.

Implied authority is the authority that the principal intends for the agent to have, but does not expressly give. Implied authority permits an agent to perform incidental actions that go along with the authority vested by virtue of the express authority.

Apparent authority arises when a principal permits an agent to perform acts neither expressly nor implicitly authorized. Apparent authority is created when a third party relies on the acts of an agent, which have not been authorized, but through negligence are permitted by the principal. Apparent authority holds the principal responsible for the agent’s acts.

The ethical significance of these limits to an insurance agent’s authority is that an insurance producer must serve the needs of the insurer, live up to the contract and operate within the scope of his or her authority. By entering into this contractual relationship with the insurer, the producer becomes a fiduciary of the insurer. Captive Agent vs. Independent Agent Captive Agents Captive agents have different ethical responsibilities than independent agents. Captive agents are agents for the insurer and by virtue of an exclusive contract owe all of their allegiances exclusively to the individual insurer or group of insurers. All accounts belong to the insurer. Should an agent terminate his contractual employment agreement with the insurer, such accounts would remain under the control and ownership of the insurer. A captive agent owes all of his allegiances to the insurer and must notify the insurer of any other sources of contractual or employment revenue the agent may have. Such sources would be reviewed for potential conflicts of interest to the insurer. The legal and ethical responsibility lies entirely with loyalty to the insurer and any attempt to sell a competitor’s product would be a violation of that ethical responsibility and possibly the law. Independent Agents Independent agents typically represent a number of companies and are compensated on a commission basis. The relationship with the insurance consumer belongs to the agent and is controlled by the agent upon an agent’s termination of a business relationship with an insurer. An independent agent can switch a client to another insurer with the client’s permission, as long as the switch does not harm the client. Ethical issues arise when the agent does not “shop” the policy for the client in order to obtain the best price or terms for the client. Because an independent agent is “quota” and “commission” driven much temptation may confront him on an everyday basis. Although the independent agent represents the insurer, every attempt must be made to serve the client in an ethical manner.

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The agent must comply with the guidelines of dual agency to avoid possible conflict. The rules of dual agency typically require that an independent agent represent the client during the process by helping the client select the insurance plan best suited to the client’s needs, and represent the insurer in the application process, underwriting, record-keeping, and claims settlement processes. Legally, a broker acts as an agent and representative of the applicant. However, when an insurer gives a policy for delivery to an insured, the broker becomes the agent for the insurer. Should payment of a premium be involved, payment to the broker is considered payment to the insurer. Although, the broker technically represents the client, the ethical and fiduciary standards that apply to an agent also apply to a broker. Employing sound ethical principles permits producers to serve both the insurer and client without creating a conflict of interest. Responsibilities to Consumers and Clients Producers fulfill their ethical responsibilities to their insurers by providing the appropriate products to meet their consumers’ needs and by providing quality service. Making sure that the consumer understands both the products and underwriting process is a critical responsibility of the producer. Agents in the property and casualty field are usually designated as either limited agents or general agents. A general agent can usually bind for the companies they represent, whereas a limited agent has reduced authority and usually cannot bind policies. Selling to the needs of the client is critical in maintaining integrity and ethical behavior. The insurance agent can serve the needs of the prospect by providing the prospect with the types of policies that best fit his or her needs, in amounts the insured can afford. In order to accomplish these goals, the agent should: Obtain the required knowledge and skills to accomplish

the needed objectives. Constantly update this knowledge and skill through

continuing education. Educate the prospect or policy owner about the products

and plans being recommended by the producer. In servicing the prospect, the producer should make the prospect aware of possible shortcomings of the basic policy and of the possible need for additional insurance. Additionally, the producer should be committed to not only selling the product, but to quality service before, during and after the sale. This means: Educating the prospect about insurance products and the

underwriting process. Treating all information obtained with confidentiality. Disclosing all necessary information so that both the

insurer and the prospect can make an informed decision. Keeping the prospect informed throughout the application

process. Showing loyalty to prospects, the insured, and the insurer.

It is the producer’s duty to: Confirm that the application is completed both accurately

and completely. Properly explain why required information is necessary. Explain how the information will be evaluated by the

underwriter. Inform the prospect that failure to disclose information

could result in denial of claims or policy cancellation. Explain that a binder provides temporary protection while

the policy is being underwritten and is not a guarantee that the policy will be issued.

The agent or broker is responsible for service before and after the sale, which includes: Maintaining complete and accurate records of all business

transactions. Knowledge of new coverage and products.

Keeping aware of availability and changes in products offered in the marketplace.

Assistance with claims processing. Reviewing clients’ existing policies. Making suggestions for updating coverage on existing

policies. Ethically an agent or broker must respect the confidential information provided by the client and must assist the client in the following areas: Selecting the most appropriate policy. Understanding the features of the policy. Evaluating the costs and features of similar plans.

Risk Management Ethical standards must be used in evaluating risk management. Risk management is the process of decision making that protects assets and income against accidental or unintended loss by identifying, measuring, controlling and treating the elements that contribute to the risk. Two basic risk management rules for insurers are: The size of the potential loss must be within the scope of

the resources available to the insurer. The possible benefit must exceed the costs of the

potential loss. The broker acting as agent for the insured should do all of the following: Identify and measure the loss exposures and hazard. Determine the amount of money available to pay for the

potential loss. Identify various risk management techniques to deal with

potential losses. Risk management techniques include: Avoidance. Averting a loss by refusing to take part in

something that could cause a loss. Transfer. Shifting risk to another entity through a contract

or hold-harmless agreement. Loss control. Reducing the frequency or probability of loss

through loss prevention or lowering the severity of loss through loss reduction.

Retention. Holding part of the risk through deductibles or all of the risk through self-insurance.

Insurance. Transferring risk to an insurance company. State and Federal Regulations Each state regulates the ethical conduct of insurance producers by creating rules, regulations, and legislation to protect the consumer. In 1945 the U.S. Congress enacted Public Law 15, better known as the McCarran-Ferguson Act, which clarified the roles of state and federal government in the regulation of the insurance industry. This law gave the federal government the authority to regulate insurance in the area of fair labor practices and antitrust. The states were left with the power of all other regulatory matters. States through an Insurance Commissioner or Director oversee the marketing activities of agents and regulate the insurance industry. The state departments of insurance also issue rules and regulations, license insurers and producers, suggest laws to legislators, conduct examinations of insurers’ financial operations, approve policy forms and oversee marketing practices. States also prohibit unfair claims methods and practices such as: Misrepresenting policy provisions to claimants or insureds. Failing to deliver a determination on a claim within a

reasonable time. Failing to settle claims promptly and fairly. Attempting to settle a claim for less than could be

reasonably expected. Engaging in activities that result in a disproportionate

number of complaints.

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Failing to provide necessary claims forms. Compelling policyholders to go to court to recover

amounts due them by attempting to make unreasonable settlement claims.

Engaging in underwriting or rating that is based on race, religion, and national origin or redlined areas.

In most states the punishment for unethical practices ranges from fines to license suspension and revocation. Once a license is revoked, normally a minimum one-year waiting period is required for re-application and in most states a bond will also be required. People who set high personal and professional goals of honesty, integrity, loyalty, fairness, and truthfulness should never have to deal with or encounter the penalties set by state governing bodies. Organizational Codes of Ethics In order for agents and brokers to provide accurate and knowledgeable information to the consumer, many industry organizations exist that produce and provide guidelines and information to their members. Codes of ethics may be employed by members of the industry to guide corporations, agents, and brokers. These codes emphasize a high level of professional competence and service to the general public. Insurance producers continuously face complex issues dealing with skill, competence, and levels of knowledge required of professionals. Ethical standards outlined by various groups and insurance associations set the standard for ethical behavior within the industry. In many cases these organizations were in place before state licensing bodies and actually set the pace for legislation that now governs the industry in many states. Organizations that have such ethical standards in place include: Independent Insurance Agents and Brokers of America. American Institute for Chartered Property and Casualty

Underwriters (CPCU). The National Association of Life Underwriters (NALU). National Association of Fraternal Insurance Counselors

(NAFIC). Million Dollar Round Table (MDRT). The American College.

We now examine these organizations and examples of their codes of ethics. Independent Insurance Agents and Brokers of America The Independent Insurance Agents and Brokers of America is the nation’s oldest and largest independent agent association. It is a highly regarded consumer advocacy organization and a powerful force within the insurance industry. The Independent Insurance Agents and Brokers of America makes its presence known both with the media and on Capitol Hill. The association was founded in 1896 by a small group of local fire agents and now has grown to represent over 300,000 agents and their employees. As it now confronts its second century of existence, the Independent Insurance Agents and Brokers of America has expanded its activities to address the many challenges and opportunities that agents face today. Through its federation of state associations, as well as its headquarters and Capitol Hill offices, the association provides advocacy, business tools and media visibility to its members. The Independent Insurance Agents and Brokers of America represents more than half of all the independent insurance agencies in the country. Its members range from small rural agencies selling personal lines to large commercial brokers handling major national accounts. Independent Insurance Agents and Brokers of America strive to serve the public by promises to: Serve the public through the honorable occupation of

insurance. Provide the full measure of service required of an

independent agent.

Recommend the best coverage to meet the needs of the client.

Provide the public with a better understanding of insurance.

Work with national, state, and local authorities to heighten safety and reduce loss in a community.

Recognize civic, charitable, and philanthropic movements which contribute to the public good of the community.

Independent Insurance Agents and Brokers of America strive to serve the companies they serve by: Respecting the authority vested in them by the companies

they serve. Using care in the selection of risks submitted. Expecting the same from the companies served as is

rendered to them. To fellow members, Independent Insurance Agents and Brokers of America pledge: Friendly relations with other agencies, fair and honorable

competition. Strict observance of insurance laws. Betterment of the insurance business. Encourage others to subscribe to the same high

standards. Independent Insurance Agents of America believe in the insurance business and its future, and that the independent insurance agent is the instrument through which insurance reaches its maximum benefit to society and attains its most effective distribution. The code of ethics provides: I will do my part to uphold and build the Independent Agency System, which has developed insurance to its present fundamental place in the economic fabric of our nation. To my fellow members of the Independent Insurance Agents of America, I pledge myself always to support right principles and oppose bad practices in the business. I believe that these three have their distinct rights in our business: first, the public, second, the Insurance Companies, and third the Independent Insurance Agents, and that the rights of the public are paramount. To the public: I regard the insurance business as an honorable occupation and believe that it affords me a distinct opportunity to serve society. I will strive to render the full measure of service that would be expected from an Independent Insurance Agent. I will analyze the insurance needs of my clients, and to the best of my ability, recommend the coverage to suit those needs. I will endeavor to provide the public with a better understanding of insurance. I will work with the national, state, and local authorities to heighten safety and reduce loss in my community. I will take an active part in the recognized civic, charitable, and philanthropic movements, which contribute to the public good of my community. To the companies: I will respect the authority vested in me to act on their behalf. I will use care in the selection of risk, and do my utmost to merit the confidence of my companies by providing them with the fullest creditable information for effective underwriting, nor will I withhold information that may be detrimental to my companies’ sound risk taking. I will expect my companies to give to me the same fair treatment that I give to them. To fellow members: I pledge myself to maintain friendly relations with other agencies in my community. I will compete with them on an honorable and fair basis; make no false statements, or any misrepresentation or emission of facts. I will adhere to a strict observance of all insurance laws relative to the conduct of my business.

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I will work with my fellow Independent Insurance Agents for the betterment of the insurance business. Realizing that only by unselfish service can the insurance industry have the public confidence it merits, I will at all times seek to elevate the standards of my occupation by governing all my business and community relations in accordance with the provisions of this Code and by inspiring others to do likewise. American Institute for Chartered Property and Casualty Underwriters (CPCU) The American Institute for Chartered Property and Casualty Underwriters is an independent, nonprofit organization offering educational programs and professional certifications to people in all segments of the property and liability insurance business. To help them provide professional service to the public, the organization responds to the educational needs of people in insurance and risk management. The American Institute for Chartered Property and Casualty Underwriters offers an online counseling system to help individuals inventory their personal background and interests and makes suggestions for appropriate programs of study. The American Institute for Chartered Property and Casualty Underwriters makes available online classes for the busy insurance professional who cannot find time for traditional classes. The American Institute for Chartered Property and Casualty Underwriters, through its Canons and Rules endeavors to maintain a high degree of professionalism and ethical conduct for its membership through the following commitments: At all times place the public interest over their own and

should encourage non member agents to do the same. Maintain and improve their knowledge, skills, and

competence. Obey all laws and regulations and avoid conduct that

would cause unjust harm to others. Be diligent in performing their occupational duties. Assist in maintaining and raising professional standards. Strive to maintain dignified and honorable relationships

with others. Strive in assisting to improve the public understanding of

insurance and risk management. Honor the integrity and respect the limitations placed upon

the designation. Always assist in maintaining the integrity of the Code of

Professional Ethics. Code of Professional Ethics Canons and Rules Canon 1 CPCU’s Should Endeavor at All Times to Place the Public Interest above Their Own. Rules of Professional Conduct R1.1 A CPCU has a duty to understand and abide by all

Rules of Conduct, which are prescribed in the Code of Professional Ethics of the American Institute.

R 1.2 A CPCU shall not advocate, sanction, participate in, cause to be accomplished, otherwise carry out through another, or condone any act which the CPCU is prohibited from performing by the Rules of this Code.

Canon 2 CPCU’s Should Seek Continually to Maintain and Improve Their Professional Knowledge, Skills, and Competence. Rules of Professional Conduct R2.1 A CPCU shall keep informed on those technical

matters that are essential to the maintenance of the CPCU’s professional competence in insurance, risk management, or related fields.

Canon 3 CPCU’s Should Obey All Laws and Regulations, and Should Avoid Any Conduct or Activity Which Would Cause Unjust Harm to Others. Rules of Professional Conduct

R3.1 In the conduct of business or professional activities, a CPCU shall not engage in any act or omission of a dishonest, deceitful, or fraudulent nature.

R3.2 A CPCU shall not allow the pursuit of financial gain or other personal benefit to interfere with the exercise of sound professional judgment and skills.

R3.3 A CPCU will be subject to disciplinary action for the violation of any law or regulation, to the extent that such violation suggests the likelihood of professional misconduct in the future.

Canon 4 CPCU’s Should Be Diligent in the Performance of Their Occupational Duties and Should Continually Strive to Improve the Functioning of the Insurance Mechanism. Rules of Professional Conduct R4.1 A CPCU shall competently and consistently

discharge his or her occupational duties. R4.2 A CPCU shall support efforts to effect such

improvements in claims settlement, contract design, investment, marketing, pricing, reinsurance, safety engineering, underwriting, and other insurance operations as they will both inure to the benefit of the public and improve the overall efficiency with which the insurance mechanism functions.

Canon 5 CPCU’s Should Assist in Maintaining and Raising Professional Standards in the Insurance Business. Rules of Professional Conduct R5.1 A CPCU shall support personnel policies and

practices which will attract qualified individuals to the insurance business, provide them with ample and equal opportunities for advancement, and encourage them to aspire to the highest levels of professional competence and achievement.

R5.2 A CPCU shall encourage and assist qualified individuals who wish to pursue CPCU or other studies, which will enhance their professional competence.

R5.3 A CPCU shall support the development, improvement, and enforcement of such laws, regulations, and codes as will foster competence and ethical conduct on the part of all insurance practitioners and inure to the benefit of the public.

R5.4 A CPCU shall not withhold information or assistance officially requested by appropriate regulatory authorities that are investigating or prosecuting any alleged violation of the laws or regulations governing the qualifications or conduct of insurance practitioners.

Canon 6 CPCU’s Should Strive to Establish and Maintain Dignified and Honorable Relationships with Those Whom They Serve, with Fellow Insurance Practitioners, and with Members of Other Professions. Rules of Professional Conduct R6.1 A CPCU shall keep informed on the legal limitations

imposed upon the scope of his or her professional activities.

R6.2 A CPCU shall not disclose to another person any confidential information entrusted to, or obtained by, the CPCU in the course of the CPCU’s business or professional activities, unless a disclosure of such information is required by law or is made to a person who necessarily must have the information in order to discharge legitimate occupational or professional duties.

R6.3 In rendering or proposing to render professional services for others, a CPCU shall not knowingly misrepresent or conceal any limitations on the CPCU’s ability to provide the quantity or quality of professional services required by the circumstances.

Canon 7 CPCU’s Should Assist in Improving the Public Understanding of Insurance and Risk Management.

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Rules of Professional Conduct R7.1 A CPCU shall support efforts to provide members of

the public with objective information concerning their risk management and insurance needs, and the products, services, and techniques which are available to meet their needs.

R7.2 A CPCU shall not misrepresent the benefits, costs, or limitations of any risk management technique or any product or service of an insurer.

Canon 8 CPCU’s Should Honor the Integrity and Respect the Limitations Placed upon the Use of the CPCU Designation. Rules of Professional Conduct R8.1 A CPCU shall use the CPCU designation and the

CPCU key only in accordance with the relevant guidelines promulgated by the American Institute.

R8.2 A CPCU shall not attribute to the mere possession of the designation depth or scope of knowledge, skills, and professional capabilities greater than those demonstrated by successful completion of the CPCU program.

R8.3 A CPCU shall not make unfair comparisons between a person who holds the CPCU designation and one who does not.

R8.4 A CPCU shall not write, speak, or act in such a way as to lead another reasonably to believe the CPCU is officially representing the American Institute, unless the CPCU has been duly authorized to do so by the American Institute.

Canon 9 CPCU’s Should Assist in Maintaining the Integrity of the Code of Professional Ethics. Rules of Professional Conduct R9.1 A CPCU shall not initiate or support the CPCU

candidacy of any individual known by the CPCU to engage in business practices which violate the ethical standards prescribed by this Code.

R9.2 A CPCU possessing unprivileged information concerning an alleged violation of this Code shall, upon request, reveal such information to the tribunal or other authority empowered by the American Institute to investigate or act upon the alleged violation.

R9.3 A CPCU shall report promptly to the American Institute any information concerning the use of the CPCU designation by an unauthorized person.

National Association of Life Underwriters (NALU) The National Association of Life Underwriters believes that all members have a combination of professional duty to the client and company and to maintain a balance between them. As a result of this belief the National Association of Life Underwriters subscribes to the following code of ethics: Preamble: Those engaged in life underwriting occupy the unique position of liaison between the purchasers and the suppliers of life and health insurance and closely related financial products. Inherent in this role is the combination of professional duty to the client and to the company, as well. Ethical balance is required to avoid any conflict between these obligations. Therefore, I believe it to be my responsibility: To hold my profession in high esteem and strive to

enhance its prestige. To fulfill the needs of my clients to the best of my ability. To maintain my clients’ confidences. To render exemplary service to my clients and their

beneficiaries. To adhere to professional standards of conduct in helping

my clients to protect insurable obligations and attain their financial security objectives.

To present accurately and honestly all facts essential to my clients’ decisions.

To perfect my skills and increase my knowledge through continuing education.

To conduct my business in such a way that my example might help raise the professional standards of life underwriting.

To keep informed with respect to applicable laws and regulations and to observe them in the practice of my profession.

To cooperate with others whose services are constructively related to meeting the needs of my clients.

National Association of Fraternal Insurance Counselors (NAFIC) The National Association of Fraternal Insurance Counselors requires that its sales personnel adhere to a position of utmost professional standards to their clients and at the same time maintain a position of trust and loyalty to their society. The highest ethical standard is required of all its members through the following code of ethics. Preamble: As a fraternal life underwriter, I will maintain the utmost professional standards toward my members and at the same time maintain a position of trust and loyalty to my Society. I believe it to be my responsibility: To conduct my fraternal business according to high

standards of honesty and fairness and to render that service to my members which, in the same circumstances, I would apply to or demand for myself. I will develop my ability and improve my knowledge through regular continuing education.

To provide competent and member-focused sales and service based on my members’ concerns, needs, and input. I will present accurately and completely the facts essential to my members’ decisions and always place their best interest and welfare above any personal considerations. I will submit complete and accurate applications for membership and insurance on only those persons whom I believe to have the proper requirements that conform with my Society’s underwriting rules.

To engage in active and fair competition. I will refuse any person or persons any part of my commissions or earnings as an inducement to purchase an insurance or annuity product. I will follow applicable regulations as well as guidelines developed by my Society whenever a sale involves replacement of insurance.

To only use advertising and sales materials approved by my Society and the applicable regulatory authorities.

To respect my members’ confidences and hold in trust personal information.

To fairly and expeditiously handle member complaints or disputes.

To cooperate in a system of supervision and review that is designed to achieve compliance with this Code of Ethics and Principles of Ethical Conduct.

As a Fraternal Insurance Counselor, I pledge myself to uphold and maintain these principles and responsibilities. Million Dollar Round Table (MDRT) Founded in 1927, the Million Dollar Round Table provides its members with resources to improve their technical knowledge, sales, and client service while maintaining a culture of high ethical standards. The Million Dollar Round Table’s mission statement is “to be a valued, member-driven international network of leading insurance and investment financial services professionals/advisors who serve their clients by exemplary performance and the highest standards of ethics, knowledge, service, and productivity.” Members of the Million Dollar Round Table subscribe to the following code of ethics. Members of the Million Dollar Round Table should be ever mindful that complete compliance with and observance of the Code of Ethics of the Million Dollar Round Table shall serve to promote the highest quality standards of membership. These standards will be beneficial to the public and the insurance and financial services profession.

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Therefore, members shall: Always place the best interests of their clients above their

own direct or indirect interests. Maintain the highest standards of professional

competence and give the best possible advice to clients by seeking to maintain and improve professional knowledge, skills, and competence.

Hold in the strictest confidence and consider as privileged, all business and personal information pertaining to their clients’ affairs.

Make full and adequate disclosure of all facts necessary to enable their clients to make informed decisions.

Maintain personal conduct which will reflect favorably on the insurance and financial services profession and the Million Dollar Round Table.

Determine that any replacement of an insurance or financial product must be beneficial for the client.

Abide by and conform to all provisions of the laws and regulations in the jurisdictions in which they do business.

American College The American College makes it clear that since it’s founding in 1927, it has deemed ethics to be a defining cornerstone of what it means to be a professional in the financial services industry. To this end, the College engages in a number of activities that foster an awareness of ethical business practices. The College offers seminars, publishes articles, and offers college level courses for insurance professionals leading to a number of possible designations. Two of the most widely recognized designations offered by the College are Chartered Life Underwriter (CLU) and Chartered Financial Consultants (ChFC). The American College subscribes to and promotes the following pledge and code of ethics. The Professional Pledge: In all my professional relationships, I pledge myself to the following rule of ethical conduct: I shall, in light of all conditions surrounding those I serve, which I shall make every conscientious effort to ascertain and understand, render that service which, in the same circumstances, I would apply to myself. The Canons: Conduct yourself at all times with honor and dignity. Avoid practices that would bring dishonor upon your

profession or The American College. Publicize your achievements in ways that enhance the

integrity of your profession. Continue your studies throughout your working life so as

to maintain a high level of professional competence. Do your utmost to attain a distinguished record of

professional service. Support the established institutions and organizations

concerned with the integrity of your profession. Participate in building your profession by encouraging and

providing appropriate assistance to qualified persons pursuing professional studies.

Comply with all laws and regulations, particularly as they relate to professional and business activities.

Summary – Organizational Codes of Ethics Each of the above examples demonstrate the application of ethical considerations to everyday practice in the insurance industry. The overriding theme of putting others before one’s self should always be remembered by insurance professionals. Areas of Unethical Activity Although not all unethical activities are illegal, all illegal activities are unethical. Crossing the line of illegal activities is one that is approached with much caution, but crossing the line of ethics often times is gray and individuals attempt to justify their actions in the name of supporting their families,

meeting their personal goals, or meeting their company’s quotas. Unethical activities are not only of concern for those that commit them, but should also be of concern to fellow workers, managers, and employers. Agent’s behaviors are a reflection on the entire industry and whether agents are members of organizations that promote ethics and high standards for the industry, or not, members of such organizations, every agent, manager, or employer should serve as a watch dog to preserve the integrity of the profession. Trust is a primary factor that consumers consider in purchasing their insurance products. Which agent they use or what product they purchase is greatly affected by their perception of the agent or company. Unlicensed Practice The sale of insurance is regulated by both the state and federal government and requires a license in most jurisdictions. Licensing is left to state authorities with the exception of variable products. Variable products are considered securities and agents must meet certain federally regulated rules and regulations. Producers must be licensed in their home states, as well as any other state in which they sell insurance. Continuing education is required to renew licenses and in most jurisdictions. Meeting the continuing education requirement of an agent’s home state often time satisfies the requirements for renewal in the additional states he or she may hold a license. Agents in most states must be licensed for each specific line of insurance that they market. Selling insurance without a license is illegal and failure to complete the continuing education requirement and renew a license in a timely fashion also leads to an unlicensed practice during the time of non-renewal. Selling a line of insurance for which an agent is not licensed is illegal and unethical and could result in harm to the unsuspecting prospect. It is critical that managers and employers are aware of licensing laws and continuing education requirements and make sure that their agents and contractors are properly licensed. With the advent of continuing education many companies employ a continuing education coordinator to insure the uninterrupted licensing of their agents. Illegal Rebating Rebating is the process of refunding some of the agent’s commission to the insured. Rebating is illegal in the majority of states and strictly regulated where permitted. Rebating raises the legal and ethical issue of discrimination. Because the larger the policy the larger the commission, the discrimination issue arises when rebates are made on larger commissioned items verses lower commissioned items. Some companies have established a policy of not permitting rebates even though they are legal in their state. Where permitted, the following offer examples of rebating regulations: The rebate must be available to all insureds in the same

actuarial class. The rebate must be in accordance with a rebating

schedule filed by the agent with the insurer issuing the policy to which the rebate applies.

The rebating schedule must be uniformly applied so that all insureds who purchase the same policy through the agent for the same amount of insurance receive the same percentage rebate.

Rebates must not be given to an insured with respect to a policy purchased from an insurer that prohibits its agents from rebating.

The rebate schedule must be prominently displayed in public view in the agent’s place of business and a copy made available to insureds on request at no charge.

The age, sex, place of residence, race, nationality, ethnic origin, marital status, or occupation of the insured or

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location of the risk is not utilized in determining the percentage of the rebate or whether a rebate is available.

The agent must maintain a copy of all rebate schedules for the five most recent years and their effective dates.

No rebate shall be withheld or limited in amount based on factors that are unfairly discriminatory.

No rebate will be given that is not reflected on the rebate schedule.

No rebate shall be refused or granted based on the purchase or failure of the insured or applicant to purchase collateral business.

Baiting and Switching This is a process wherein a price or product is advertised that cannot be delivered, but is used to lure clients in the door and then later switch them to an available product or higher price. One example more specific to the insurance industry is when customers are lured in by the insurer quoting or advertising a lower rate and then upon delivery of the policy saying that a rate change has occurred which requires an increase of the premium. Another example would be quoting a rate on a policy with fewer endorsements than the customer requires and then adding the endorsements at an additional premium. Both practices are unethical, illegal, and a detriment to the insurance profession. These tactics undermine trust of the industry and create a deception that makes it more difficult for abiding agents to gain public trust. Redlining Ethical standards and law forbid the practice of redlining. Redlining is the process of excluding certain geographic areas from insurance coverage strictly on the basis of location. The federal Fair Housing Act forbids this practice in any form, including the sale of homeowners insurance. Commingling Of Premiums State laws require agents to deposit in separate accounts any funds belonging to others. Premiums, when not directly delivered to the insurer, must be deposited in a separate trust account by the agent, for the benefit of the parties, until delivery is required. Records must be adequately maintained in order to segregate one transaction from another and funds must never be deposited in an agent’s personal account. Violation of this procedure constitutes a serious breach of fiduciary obligations. Altering Applications Altering information on an application is a serious breach of fiduciary duty. Sometimes agents are tempted to alter information in order to allow the policy to be underwritten, or perhaps in order to put the applicant in a different premium class. The agent must remember that he has a legal and ethical obligation to both the insured and the insurer and this breach can result in harm to one, the other, or both. Ledger Selling Ledger selling is the practice of making sales based primarily on the figures shown in policy illustrations. In life insurance contracts the death benefits are the primary purpose of the contract and the life benefits are a “bonus” item. When insurance is sold to emphasize the life benefits portion of the contract, illustrations are used to give examples of the potential return. An unethical agent will emphasize the illustrations with such emphasis as to create a picture of such “guaranteed return” when in actuality they are illustrations. It is critical that agents do not overstep their ethical bounds and point out that they are merely illustrations to depict examples, and that, the actual returns can be significantly different. Because the following elements are part of assumptions and illustrations used, to ethically stay on track it is recommended that agents properly explain and have a clear understanding of the following: Dividend distribution of the divisible surpluses. Interest rate changes and the indexes to which they are

pegged. Methods of crediting returns.

Current experience parameters used. Mortality charges. Expense charges.

Misleading Illustrations Insurance companies will often include illustrations that show the amount that the benefits of a policy will total if a specific set of circumstances occur. In some cases these examples may be misleading. The National Association of Insurance Commissioners (NAIC) model regulation on illustrations sets standards for using illustrations and requires certain disclosures. It applies to all individual and group life insurance plans except variable life, individual and group annuities, credit life insurance policies with no illustrated death benefits over $10,000. Under the regulation, insurers must decide whether or not they wish to use illustrations to market a given policy. If so, any illustration must be provided no later than the policy delivery. If not delivered by policy delivery date, the use of illustrations is prohibited. All illustrations must: Identify the insurer, the producer, the insured, the

underwriting classification, type of policy, initial death benefit, and any option selected for applying non-guaranteed elements such as dividends.

Be complete, accurate, clearly labeled, and presented in a truthful manner.

Use an “illustrated scale” for non-guaranteed elements that is not more favorable than either of the following: The currently payable scale. “Disciplined current” scale certified by an actuary as

being reasonably based on actual recent historical experience.

Include both a narrative explanation and a numeric summary that shows values at policy years 5, 10, 20 and at age 70 on three different bases; Policy guarantees The illustrated scale. Midway between the guarantees and the illustrated

scale. Insurers must keep a copy of an illustration for an issued

policy for three years after the policy is terminated. Conflicts of Interest Conflicts of interest arise in many different shapes and forms. Some conflicts are inherent with a profession, some arise without malicious intention, and still others are malicious and perpetrated. Conflict of interest situations always are reason for concern, special handling, or potential for civil and criminal liability. A conflict of interest occurs when an individual representing another individual as a fiduciary encounters a competing interest between the other individual and themselves in a specific situation. In the case of an insurance agent the inherent conflict arises between his or her need for a commission and the client’s need for insurance. The fact that an agent makes more money on a larger policy or a product paying more commission than another cannot be a consideration in making a recommendation to a client. Because the agent has specialized knowledge that exceeds the client’s knowledge, and because the client relies on that knowledge to make a decision, the agent must make a decision to serve the needs of the client first and the agents needs second. To do anything less than this would cause a conflict of interest situation and a breach of ethical standards. Additionally, with the factor that an agent is licensed, the agent is put in a position of trust and to violate this trust would be cause for punitive action. Agent Accountability The law holds an agent accountable to clients for ethical practice in the areas of: Needs selling to the interest of the client.

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Competence in advising the client. Confidentiality to information provided. Disclosure of all pertinent information to the client. Service to the client on an on going basis.

We now examine each of these requirements. Agent Accountability to Principals as Clients Needs Selling Needs selling involves the agent taking due care to carefully analyze the client’s situation in order to make the proper recommendations for insurance products. This process often involves obtaining confidential information, which must be used for the client’s best interest. Violating this trust is a serious ethical and legal violation. An agent must never be tempted by the need for money and thus sell a higher commissioned product when it is not suited to the best need of the client. Competence Competence is another element of accountability for an insurance agent. As a professional, consumers look to insurance agents as having the skill and knowledge to give them proper information so that they can make an informed decision. Since this decision is based upon information provided by the insurance agent, the theory of reliance comes into place. In other words, the “client” has relied on the information and therefore any decision made as a result of relying on such misinformation creates a liability for the agent. Representing to have competence that one does not possess is a breach of ethical standards and may also be a violation of the law. Joining professional organizations that make education a part of the requirement of membership and that sponsor and promote on going education is a step in the right direction for the prudent agent. Continuing education, as mandated by most states, becomes another critical element in the journey to skill and competence. Insurance agents are not merely “salespeople”; they are skilled professionals that help individuals plan the road maps of life in the area of financial protection for the clients they serve and their families. Insurance is a product not only to avoid catastrophe during life but also to protect loved ones after ones death. An insurance agent has both an ethical and legal obligation to be informed enough to serve his or her clients in a competent manner on which they can rely. Confidentiality In working with clients, confidentiality becomes another critical element. To properly serve a client’s needs an agent must delve into personal areas in order to properly counsel the client. The confidential information must be retained only to the extent required to serve the client. The information should only be used to properly counsel the client and for underwriting purposes. Disclosure Disclosure is another aspect of the agent’s role. An agent must be sure to provide clients with all the pertinent facts regarding the product being presented. Disclosure not only encompasses the delivery of all the pertinent facts, but also, makes omission of information an ethical violation of ethics and law. Agents must also be sure to disclose any conflicts of interest and obtain the client’s permission to proceed under that understanding. The life insurance field has an even greater need for proper disclosure due to the sensitive nature of some of the life-based financial products. Strict adherence to disclosure requirements by agents and companies may help to deter further governmentally required disclosures and regulations in the field of life insurance products. Standardized disclosures created through membership organizations will help the consumer better understand and compare like products. Proper and standardized disclosures help alleviate agent liability by having an outlined schedule of disclosure items and facts, thus leaving less chance of forgetting something of importance.

Failure to disclose, whether intentional or unintentional, still creates a reliance situation for the client and the possibility of a decision that is not accurate and possibly injures the client. Rating Services Because an agent has an ethical obligation to disclose all, when disclosing a company’s rating it is imperative the agent disclose not only the most favorable rating, but if aware, he or she must supply the ratings of all five rating firms to the prospect. Together with this type of disclosure it is important that the client understand that each of the rating firms have different methods of arriving at their conclusion and how this can affect the client’s analysis of the situation. Additionally these ratings are not uniform from one company to another and although, AAA is first and A+ is fifth at Standard & Poor’s, an A+ rating is first at Weiss Research. Because of this lack of uniformity, it is important that an agent disclose what the ratings mean as defined by each rating company. Failure to disclose this information could cause a client to make a wrong decision based on the incomplete information provided by the agent. This failure on the part of the agent is certainly unethical and possibly fraudulent. The five rating companies are: A.M. Best Company. Weiss Research. Standard & Poor’s. Moody’s Investors Service. Duff & Phelps.

Not all rating companies rate one hundred percent of the insurance companies. Some rating companies only rate a percentage of the insurance companies. This information is also important for a client in order to make an informed decision. Agents must not only disclose all the facts to their clients, but also have an ethical obligation to make sure the client understands all of the facts. In recent times Risk Based Capital Ratios (RBC) have been developed as a regulatory tool to monitor if a company has a sufficient amount of capital, regardless of a company’s line of business, to satisfy the state’s insurance regulatory department. When a company’s RBC ratio goes below a certain level, the state insurance director begins to take a specified course of action. In states where this is in use using RBC ratios for marketing purposes is unethical and a violation of the law. Some state laws are very specific, and may state: “The making, publishing, disseminating, circulating, or placing before the public, or causing, directly or indirectly, to be made, published, disseminated, circulated, or placed before the public, in a newspaper, magazine, or other publication, or in the form of a notice, circular, or pamphlet, letter, or poster, or over radio or television station, or in any other way, an advertisement, announcement, or statement, containing, an assertion, representation, or statement with regard to the RBC levels of an insurer, or of any component derived in the calculation, by any insurer, agent, broker, or other person engaged in any manner in the insurance business would be misleading and is therefore prohibited.” The prohibition does not apply to third parties, such as a newspaper. Another area requiring disclosure driven by ethical responsibilities is commissions. In the real estate and mortgage brokering businesses, as well as other fields where agents serve clients under a trust relationship, disclosure of commission has become mandatory in many states. It is felt that since there is an inherent conflict between the commissions earned and the products recommended, that disclosure at the very least is an ethical issue. Some insurance brokers have taken the position of disclosure, as an ethical obligation, regardless of state mandates.

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On-Going Service The final responsibility agents have to their clients is on-going service. Service before, during and after the sale is both an ethical and business requirement for an agent. Service before the sale begins with the needs analysis, the outlining of the policies that best meet the client’s financial needs within his or her affordability range and thorough disclosures of what the policies have to offer. The agent must also disclose any potential conflict of interest or dual agency relationship. Service during the sale should encompass an accurate application, quick submission of the application, proper deposit and or delivery of trust funds (premiums), keeping the client informed during the process and timely delivery of the policy. Service after the sale should include a periodic review of the client’s financial position and a needs analysis of potential insurance that would benefit either the client or his or her family. Clients should be kept informed of changes in laws that might necessitate modifications of existing policies, or company rating changes that might adversely affect a client. With respect to claims, clients should receive service in the area claims with both honesty and ethical considerations. Servicing the client after the sale also includes an agent’s need to be constantly informed through continuing education and other seminars and industry related presentations. Agents’ Accountability to the Companies They Represent As agents for companies and employers, the insurance professional has certain obligations to fulfill as a fiduciary. Like the client principal to agent relationship, the insurer principal to agent relationship carries with it certain responsibilities. These responsibilities include: Acting in a fiduciary capacity. Handling of premiums. Field underwriting. Care in avoiding liability. Exclusivity, if required. Avoiding conflict of interest.

We now examine each of these responsibilities. Acting as a Fiduciary In a principal-agent relationship the agent acts as a legal representative of the principal and binds the principal as if his own actions were the actions of the principal. The agent has a legal and fiduciary obligation to deal with matters in a manner that does not jeopardize the principal. A fiduciary is a position of trust and must be handled with honesty and integrity. Repeating our common theme, the agent must never put his or her need ahead of the principal’s needs. Handling of Premiums When an agent is acting as a representative of the insurer, delivering premiums to the agent is the same as delivering them to the company. The agent has a fiduciary duty to turn over all funds given to him or her as specified in the agency agreement. Premiums collected from the insured parties are usually held in premium fund trust accounts for no more than 90 days or another date specified in the agent’s contract with the insurer. Funds held by agents are required to be held in these special trust accounts by most states. In submitting funds from these accounts to the insurer it is most commonly permitted for agents or brokers to retain their portion of commissions earned prior to submitting the premiums to the insurer. Field Underwriting An agent is obligated to fully disclose all information he or she has that may affect the insurer and the decision to accept the risk or rate of premium charged. Full disclosure is critical during the application process and at the time of a claim if a claim should arise. It is the agent’s obligation to the insurer to make sure that all questions on the application are answered truthfully and nothing is omitted or distorted. To induce the insurer to enter into a risk that is not sound is both unethical

and in conflict with the agent’s fiduciary obligation to the insurer. Care in Avoiding Liability An agent has the duty to carry out his or her actions with care and skill because an agent represents the company to the public and must act in a manner that does not bring bad light on the image of the company. It is important that the agent represent the principal with the highest possible competence. If an agent should encounter a consumer demand that he or she is not skilled to handle, he or she should refer the client to another competent source to handle the matter. It is only in this fashion that an agent can avoid creating liability to the principal due to incompetence. Exclusivity if Required An agent must at all times act in the principal’s best interest, not for his or her own personal gain. Unless authorized to do so, an agent cannot represent more than the interest of one principal. Often independent agents and brokers represent the interest of more than one insurer. This is proper and ethical as long as there is full knowledge and consent of all the parties. An agent must stay within the confines and conditions of his or her agency contract with the principal. An agent cannot receive personal financial gain other than that specified in his or her agency agreement. Avoiding Conflict of Interest An insurance agent cannot serve two principals at the same time. An agent has the ethical duty to make full disclosure to an insurer in regard to any other related service he or she provides and for which compensation is received. An agent must act in all transactions as to avoid any potential conflict of interest between him or herself, the insured or the insurer. An agent has an obligation to the insurer to represent the product in a skillful and honest manner. Should there be any misrepresentation wherein the insured makes a decision based on misrepresentation, intentional or otherwise, the agent would be liable for losses to the insurer, the insured, or both. Replacing an existing policy for another can create a scenario for potential conflict of interest if the replacement is not to the benefit of the principals involved in the transaction. If the agent replaces a policy simply to make a commission this is a breach of the fiduciary obligation to the principal whether it is the insured or the insurer. Collecting fees and commissions could result in both an unethical and illegal act on the part of the agent. When an agent acts as a consultant, for a fee, to the insured and acts as an agent, for commission or salary, for the insurer, an inherent conflict exists that could lead to administrative sanctions by the State’s Director of Insurance. Because of this inherent conflict, in many states agents are prohibited from charging fees and collecting commissions in the same transaction. Some states permit the collecting of both a fee and commission in the same transaction, provided specific requirements are met. These requirements usually include: Full disclosure to all parties. Agent must put all self interest aside. Agent must act in an advisory capacity to the insured. Agent must provide a service beyond just a simple

recommendation to buy a policy. Conclusion We have just learned that ethical behavior is of utmost importance in the work place for both management and producers in the field. Producers must be committed to selling the product that best fits the consumers need along with quality service during and after the sale. In addition to obligations to the consumer, the producer and other representatives of the company have the continuing obligation to be truthful and honest in their relationship with each other.


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1. The first real commercial multi-peril packages offering protection for both property and liability did not appear until the early ________. a. 1700s b. 1800s c. 1960s d. 2000s

2. Each section of a commercial policy describes in detail the specific types of protection that the policy covers and the specific types of damages that are excluded. a. True b. False

3. ________ means that damaged or destroyed property is covered for the amount that it actually costs to replace or to restore the item to its original condition. a. Depreciation b. Actual cash value c. Replacement cost d. Market value

4. ________ is probably the most important and most attractive feature of the Special Multi-peril Policy (SMP) program. a. Increased paperwork b. Reduction in cost c. Homeowners coverage d. Tax deferral

5. Today’s SMP policy program consists of ________ different classification groups. a. two b. four c. six d. eight

6. Automobile filling or service stations are qualified for the SMP program. a. True b. False

7. The all-risk form of property coverage excludes losses caused by: a. fire. b. lightning. c. windstorm. d. animals.

8. General liability coverage covers exposures such as lawsuits occurring because of ________. a. slips or falls on the insured premises b. on-the-job employee injuries c. professional errors and omissions d. operation of automobiles

9. The business owners policy plan (BOP) is written in a way that is difficult to understand and is a policy structure offering limited coverage at a high price. a. True b. False

10. BOP premium debits and credits are based on all of the following underwriting factors EXCEPT: a. location b. building features c. employees d. marital status of owners


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11. Which of the following businesses might qualify for a BOP? a. Motorcycle dealership b. Hobby store c. Restaurant d. Amusement park

12. The special BOP makes coverages available ________, while the standard BOP is a named peril policy. a. without charge b. with only two exclusions c. on an all-risk basis d. without underwriting

13. The BOP liability insuring agreement provides comprehensive general liability insurance on a ________ basis. a. per capita b. per stirpes c. per occurrence d. biannual

14. Floater policies and endorsements provide coverage for specific goods or classes of property which are easily moveable. a. True b. False

15. Equipment of the automobile means something designed for permanent installation in the vehicle. a. True b. False

16. One purpose of a watchman provision in a policy of insurance is to protect the insurer from fraud. a. True b. False

17. Theft is defined as the taking of the property of another: a. without a lease. b. with deception. c. without authority. d. with force.

18. Extortion is a type of criminal activity which is not covered in a general theft insurance policy. a. True b. False

19. There are ________ federal workers’ compensation laws in operation. a. 2 b. 4 c. 6 d. 8

20. Workers’ compensation was the first form of ________ to develop in the United States. a. social insurance b. federal statutory law c. state statutory law d. cash reimbursement


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21. Under a disability income insurance policy, the benefit period is the period of time that benefits will be paid for total disability. Which one of the following is a common benefit period? a. Three months. b. Two years. c. Up to age 35. d. Up to age 40.

22. “Non-cancelable” and “guaranteed renewable” mean the same thing in disability plans. a. True b. False

23. The more hazardous the job, the ________ the premium for disability insurance. a. higher b. lower c. more adjustable d. more fixed

24. Typically, insurance companies will issue a monthly disability benefit equal to ________ of the insured’s earned income. a. 100% b. between 80% and 90% c. between 40% and 70% d. between 10% and 20%

25. Unearned income may reduce the amount of disability insurance a company is willing to provide. a. True b. False

26. A business overhead policy can help the business meet necessary expenses until the owner is able to return to work. a. True b. False

27. A business overhead policy covers which of the following expenses? a. Purchases of equipment. b. Salary of the owner. c. Payments toward debts. d. Rent.

28. The agent’s role is to bring the disability claim form to the insured and ________. a. complete it for the insured b. assist the insured in completing it c. leave the form with the insured d. wait 90 days to complete the form

29. Long term care insurance provides coverage for the care that becomes necessary when an individual cannot perform ________ for themselves. a. activities of daily living b. extraordinary feats c. military maneuvers d. medical procedures

30. ________ provides for automatic increases in the daily benefit provided by a long term care policy. a. Premium escalation b. Lock-in procedures c. Premium waiver d. Inflation protection


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31. Portions of some long term care premiums may be tax deductible. a. True b. False

32. The following are principal parts of the privacy requirements of the Gramm-Leach-Bliley Act, EXCEPT: a. The Financial Privacy Rule. b. The Regulation of Sales. c. The Safeguards Rule. d. The Pretexting provisions.

33. The difference between consumers and customers is not important because both are entitled to the same Gramm-Leach-Bliley Act privacy notice at all times. a. True b. False

34. The privacy notice required by the Gramm-Leach-Bliley Act should include each of the following, EXCEPT: a. Information the company collects about its consumers and customers. b. The parties with whom the company shares the information. c. The manner in which the company protects or safeguards the information. d. The consumer’s obligations required to receive privacy benefits.

35. ________ requires financial institutions to develop a written information security plan that describes their program to protect customer information. a. The Safeguards Rule b. The Pretexting provision c. Reciprocity d. The Producer Licensing Model Act

36. To prevent insurance companies from going into bankruptcy, controls have been established through government regulations that are unique to the insurance industry. a. True b. False

37. In order to prevent insurer insolvency, controls require insurance companies to maintain certain levels of ________. a. operating capital b. customer contact c. employee retention d. free enterprise

38. All insurers are regulated to prohibit investments that are ________. a. highly speculative b. low risk c. in any type of real estate d. in any type of stock

39. ________ determines the formula for calculating reserves to cover each type of policy. a. The federal government b. The National Board of Consumers c. Each state d. Every insurance company

40. Twisting can help the agent determine the insured’s correct level of risk tolerance. a. True b. False


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41. ________ occurs when an agent refunds part of the premium to the policyholder. a. Rebating b. Twisting c. Legislative regulation d. Speculative investment

42. All of the following are forms of government regulation of the insurance industry, EXCEPT: a. Legislative regulation. b. Judicial regulation. c. Consumer group regulation. d. Executive regulation.

43. An example of executive regulation, the basic duties of state insurance departments include: a. licensing of insurance companies and agents working within the state. b. creating insurance codes. c. settling disputes between parties to insurance contracts. d. self-regulation.

44. The solvency of an insurance company is measured by the amount by which admitted assets surpass the company’s liabilities. a. True b. False

45. ________ are those reserves which at the time of valuation represent all policies outstanding and their gross premiums. a. Unearned premium reserves b. Loss reserves c. Military reserves d. Executive reserves

46. An individual whose position and responsibilities involve a high degree of trust and confidence is known as a ________. a. professional b. captive agent c. fiduciary d. consumer

47. When a producer represents the insurance company he or she is considered to be ________ of the company. a. an agent b. independent c. captive d. risk averse

48. The acts of the agent, within the scope of authority, are deemed to be the acts of the ________. a. consumer b. client c. producer d. principal

49. A binder provides temporary protection while the policy is being underwritten and is a guarantee that the policy will be issued. a. True b. False

50. Once a license is revoked, normally a minimum ________ waiting period is required for re-application. a. 30 day b. 6 month c. 1 Year d. 5 year

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6. 7. 8. 9.

10.

1. 2. 3. 4. 5.

16. 17. 18. 19. 20.

11. 12. 13. 14. 15.

46. 47. 48. 49. 50.

41. 42. 43. 44. 45.

26. 27. 28. 29. 30.

21. 22. 23. 24. 25.

36. 37. 38. 39. 40.

31. 32. 33. 34. 35.

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A B C D A B C D A B C D A B C D A B C D A B C D A B C D A B C D A B C D A B C D





6. 7. 8. 9.

10.

1. 2. 3. 4. 5.

16. 17. 18. 19. 20.

11. 12. 13. 14. 15.

46. 47. 48. 49. 50.

41. 42. 43. 44. 45.

26. 27. 28. 29. 30.

21. 22. 23. 24. 25.

36. 37. 38. 39. 40.

31. 32. 33. 34. 35.

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