Property Insurance Unit 1

Risk

The possibility that a loss will occur

Insurance

transfer of risk from a person or a business to an insurer

2 types of Risk

Speculative Risk: A type of risk that involves the chance of loss or gain, such as investments or gambling. Not insurable

Pure Risk: Involve the chance of loss only, with no opportunity for gain, such as property damage or liability.

Exposure

The potential for accidents and other losses. The higher the exposure to risk, the higher the premium. Risks for which the insurance company would be liable

Peril

the cause of a loss. House burns down = peril is the fire

Loss

1. The unintended, unforseen damage to property 2. Injury 3. Amount paid

2 types of Loss

Direct Loss: physical loss to property with no intervening cause. Examples of direct loss include lightning striking a house or a car hitting a tree

Indirect Loss: a consequential loss as the result from a direct loss. Examples include loss of rental income due to a house fire, which causes a loss of profits for a landlord. Always consequential of the direct loss

Hazard

anything that increases the chance that a loss will occur. They do not cause losses, but they do make them more likely. 

3 types of Hazards

Physical: physically identifiable factors that increase the chance of a loss. Examples: car tires with little or no tread. Putting a wet floor sign out after mopping

Moral: arise from an individual’s character. losses are more likely to occur to individuals who lack morals. Example: Dishonesty is a moral hazard because it may increase the chance that an individual lies on an insurance application or fakes a loss

Morale: a state of mind or careless attitude. Unconscious change in a person’s actions or behaviors. Example: carelessly leaving the windows/doors unlocked when not at home or leaving the car running while running into a store

Methods of Handling Risk - STARR

Sharing: Risk sharing where 2 or more individuals/businesses agree to pay a portion of any loss incurred by any member of the group. Risk is shared.

Transfer: Risk transfer like with insurance. The insurer agrees to pay if an insured customer has a loss & the insured no longer bears the risk. The customer has a cost in the form of a premium payment

Avoidance: Risk avoidance means eliminating a particular risk by not engaging in a certain activity. Example: An individual who does not drive avoids the risk of injury or collision & being held liable 

Retention: Risk retention means the individual or business will pay for the loss if it occurs, or a portion of the loss via a deductible. If you don’t have insurance to pay for the damages, you have retained that risk

Reduction: Risk reduction refers to lessening the chance that a loss will occur, or lessening the extent of a loss if it occurs. Example: buildings installing a sprinkler system

Contract (Policy)

an agreement between the insured (1st party) & insurer (2nd party)

The Law of Large Numbers

principle that makes insurance possible. The larger the group, the more accurately losses can be predicted. This prediction allows them to charge each insured a premium, that, if pooled together, will cover all claims and operating costs

Elements of Insurable Risk - CANHAM

Calculable: Premiums must be calculable based upon prior loss statistics for that particular risk in order to predict future losses

Affordable: The premium for transferring the risk should be affordable for the average consumer

Non-catastrophic: The risk must be non-catastrophic for the insurance company. National or area disasters, such as floods, riots, wars and earthquakes will often have coverage limitations in insurance policies. These events cause widespread simultaneous losses to many insured properties. The peril of war is excluded from most policies.

Homogenous: the risk must be similar in nature so the same factors affect the chance of loss. Example: If the actuary was going to predict the likelihood that a wood frame house would suffer a fire in CA, the actuary would not include brick houses in the sample

Accidental: The loss must have been caused due to chance. Intentional losses caused by the insured are not covered by insurance

Measurable: A definite (time & place) and measurable loss means that proof of loss must be established with numbers and dollar amounts, not just casual references.

Adverse Selection

Tendency for higher risk individuals to get and keep insurance as compared to individuals that represent an average level of risk. To insurers, this is a bad thing because it causes more losses than predicted. To avoid this, insurers make an extensive evaluation of information related to a particular risk - a process called Underwriting. Risks that have a greater than average chance of loss. High risk = higher rate to insure or refusal to insure

Reinsurance

insurance for insurers. To reduce the total amount of loss it is liable for, one insurer may pay the other insurer a premium to assume a portion of the risk. The company reducing its risk: the ceding insurer. The company assuming the risk: the Reinsurer

2 ways the reinsurance process works

1. Facultative reinsurance: The reinsurer considers each risk before allowing the transfer from the ceding company.

2. Treaty reinsurance: the reinsurer accepts all risks of a certain type from the ceding company

Types of Insurers

1. Stock Insurers: owned by stockholders, divided is not guaranteed, dividend is paid to stockholder, dividend is taxable to stockholder, issue “non-participating” policies (dividends never go to policyholders)

2. Mutual Insurers: owned by policy holders, dividend is not guaranteed, divided is paid to policy holders, dividend is not taxable and is considered refund of overpaid premium, issue “participating” policies

3. Fraternal Benefit Societies: provide insurance and other benefits to their members, must be a member to get the benefits, policies are called certificates and the members who have the insurance are certificate holders, certificate holders may be assessed additional charges if premiums are not sufficient in a given period, policies are referred to as open contracts

4. Reciprocal Insurers: unincorporated, members are assessed an equal amount to pay the claim if a loss occurs to any member of the group, managed by an attorney-in-fact

5. Lloyd’s Associations: insurance provided by individual underwriters, not companies, insure unusual risks - example: hole in one contest, athlete’s arm, celebrity’s hair

6. Risk Retention Groups: Liability insurance company created for policy holders from the same industry. Example: a car dealer’s risk retention group in which only car dealers can be policyholders

7. Risk Purchasing Groups: A group of businesses from the same industry that join together to buy liability insurance from an insurance company. Not insurers themselves and not regulated as such, they only purchase insurance on behalf of their members.

8. Self Insurers: a business that pays its own claims, reserves funds to cover losses, retains risk rather than transfers

Private vs Government Insurers

Government:

Federal - war risk insurance, nuclear energy insurance, flood insurance, crop insurance

State - unemployment insurance, works compensation

Domestic vs Foreign vs Alien Insurers

Domestic: the state in which the insurer was formed (chartered, incorporated, headquartered) the insurer is domestic

Foreign: In another state or US territory, the insurer is foreign. Ex: headquartered in Texas would be a foreign company to residents in Oklahoma 

Alien: An insurer formed under the laws of any other country other than the USA and it’s territories 

Authorized vs Unauthorized Insurers

Authorized (or admitted): states usually require companies to have a license sell insurance. the license is called a certificate of authority. 

Unauthorized (or non-admitted or non approved): Some states allow companies to sell insurance to certain types of risks (called surplus lines) without having a license. 

Surplus Lines

Insurance sold by unauthorized insurers - if on the state’s approved list of surplus insurers. Can only be sold to certain high risk insured. Cannot be sold solely for a cheaper rate than licensed/admitted insurers 

Financial Strength Rating

A report card of the company

Insurance agent vs insurance broker

agent: represents the insurer

broker: represents the insured

types of agents

Independent insurance agent: individuals that sell insurance products of several companies and are independent contractors, not employees of the insurer(s). They own the renewal policies they sell.

captive agents: individuals that represent only one company. Independent contractors, not employees of the insurer. The insurance company owns the renewals of the policies sold on their behalf

general agents or managing general agents: individuals that hire, train, and supervise other agents within a specific geographical area. Earn overriding commissions (overrides) on the business produced by the agents they manage

direct writing companies: Companies whose products are sold by employees. the producer may be compensated by a salary, commission or both. The insurance company owns the renewals of the policies sold on their behalf. Direct response advertising.

direct response marketing

no producer or agent. Policies are sold directly to the public by the insurer. Conducted through the mail, advertisements in newspapers and magazines, on tv, radio or the internet

Agent vs Principal

agent: the person authorized to act on behalf of the other

principal: the person on whose behalf the agents acts

example: in insurance, the insurer is the principal and the sales rep or producer is the agent.

law of agency

contracts made by the agent are considered to be contracts of the principal. the knowledge of the agent is assumed to be the knowledge of the principal. Therefore, the principal is liable for the statements and actions of her agents

Express, Implied & Apparent Authority

Express: authorities written in agent’s contract. example: if the producer is given authority to write a $500,000 policy, he cannot write a $1,000,000 policy. 

Implied: not written in agent contract but tasks agent must perform; implied that agent has this authority. For example: it may not say in writing that the agent can get business cards with the insurer’s logo on them, but the authority is implied by allowing the agent to act on the insurer’s behalf 

Apparent: Tasks the agent does that a reasonable person would assume as authority, based on the agent’s actions & statements. Example: if an agent sends an email stating that the insured’s policy covers flooding but in reality, it does not, the company may be required to pay the claim because of the actions of the agent.

Fudiciary

A person in a position of financial trust. Promptly sends premiums to insurer. Has knowledge of products. Complies with laws and regulations. Does not commingle funds

Comingling

The illegal act of mixing personal funds with the insured’s or insurer’s funds

Suitability Considerations

an agent must use this to make purchase recommendations that are appropriate or suitable, in light of a client’s particular needs, objectives and circumstances. Can only be made if an agent obtains information about an applicant’s needs, objectives, and circumstances