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actual cash value

actual cash value is defined as replacement cost
less depreciation

Principle of Indemnity

In property insurance

Fair market value

is the price a willing buyer would pay a willing seller in a free market

Broad evidence rule

means that the determination of ACV should include all relevant factors an expert would use to determine the value of the property

A valued policy

pays the face amount of insurance if a total loss occurs

Some states have a valued policy law

that requires payment of the face amount of insurance to the insured if a total loss to real property occurs from a peril specified in the law

Replacement cost insurance

means there is no deduction for depreciation in determining the amount paid for a loss

Principle of Subrogation

Substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third party for a loss covered by insurance.

Principle of Utmost Good Faith

A higher degree of honesty is imposed on both parties to an insurance contract than is imposed on parties to other contracts

Representations

are statements made by the applicant for insurance

An innocent misrepresentation

of a material fact

A concealment

is intentional failure of the applicant for insurance to reveal a material fact to the insurer

A warranty

is a statement that becomes part of the insurance contract and is guaranteed by the maker to be true in all respects

Offer and acceptance

of the terms of the contract

Consideration

the value that each party gives to the other

Competent parties

with legal capacity to enter into a binding contract

Aleatory

values exchanged are not equal and relies on a specific event

Unilateral

only the insurer makes a legally enforceable promise

Conditional

policyowner must comply with all policy provisions to collect for a covered loss

Personal

A contract between insured and insurer (and no one else) and upholds standards of character and morality

A contract of adhesion

the insured must accept the entire contract with all of its terms and conditions

The principle of reasonable expectations

states that an insured is entitled to coverage under a policy that he or she reasonably expects it to provide

Insurers can place limitations on the power of agents by adding a nonwaiver clause

to the application or policy

Waiver

is defined as the voluntary relinquishment of a known legal right

Estoppel

occurs when a representation of fact made by one person to another person is reasonably relied on by that person to such an extent that it would be inequitable to allow the first person to deny the truth of the representation

Premature Death

The death of a family head with outstanding unfulfilled financial obligations can cause serious financial problems for the surviving family members

Costs of Premature Death

-The deceased's future earnings are lost forever
-Additional expenses are incurred

Declining Problems of Premature Death

-Life expectancy has increased significantly over the past century
--Thus

Various Family Types in Need of Life Insurance

-Single person
-Single-parent family
-Two income earners with children
-Traditional family
-Blended family
-Sandwiched family (Adults caring for both children and parents)

Human Life Value

the present value of the family's share of the deceased breadwinner's future earnings

To calculate:
-Estimate the individual's average annual earnings over his or her productive lifetime
-Deduct taxes

Needs Approach

The amount needed depends on the financial needs that must be met if the family head should die

Types of needs to consider:
-Estate Clearance Fund
-Readjustment Period
-Dependency Period
-Blackout Period
-Families should also consider special needs

Estate Clearance Fund

cash needed for burial expenses

Readjustment Period

1-2 year period in which the insured's family adjusts to its new living standard after the insured's death

Dependency Period

is the period until the youngest child reaches age 18

Blackout Period

refers to the period from the time that Social Security survivor benefits terminate to the time the benefits are resumed

Types of Life Insurance

Two general categories:
-Term Insurance
-Cash-value Life Insurance

Term Insurance

Provides temporary protection. Protection expires at the end of the policy period

Cash-value Life Insurance

has a savings component and builds cash values

Characteristics of Term Life Insurance

-Renewable
-Convertible

Renewable

Part of most term policies and lead to increased premiums each time.

Convertible

means the policy can be exchanged for a cash-value policy without evidence of insurability

Types of Term Life Insurance

-Yearly-Renewable Term Insurance
-Term to Age 65 Policy
-Decreasing Term Insurance
-Reentry Term Insurance Policy
-Return of Premiums Term

Yearly-Renewable Term Insurance

is issued for a one-year period
Term insurance can also be issued for 5 or more years

Term to Age 65 Policy

provides protection to age 65

Decreasing Term Insurance

the face value gradually declines each year

Reentry Term Insurance Policy

renewal premiums are based on select (lower) mortality rates if the insured can periodically demonstrate acceptable evidence of insurability (i.e.

Return of Premiums Term

the premiums are refunded if the policyowner outlives the term of the policy

Term Life Is Appropriate When

-The amount of income that can be spent on life insurance is limited
-The need for protection is temporary
-Renewability

Limitations of Term Life

-Term insurance premiums increase with age at an increasing rate and eventually reach prohibitive levels
-Term insurance is inappropriate if you wish to save money for a specific need

Whole Life Insurance

a cash value policy that provides lifetime protection. A stated amount is paid to a designated beneficiary when the insured dies

Types of Whole Life Insurance

-Ordinary Life
-Limited-Payment Life
-Variable Life
-Universal Life
-Variable Universal Life

Ordinary Life Insurance

a level-premium policy that provides lifetime protection

Characteristics of Ordinary Life Insurance

-Premiums are level throughout the premium paying period.
-The excess premiums paid during the early years are used to supplement the inadequate premiums paid during the later years of the policy. It is referred to as a legal reserve.
-The insurer's legal reserve is a liability that must be offset by sufficient financial assets.
-Cash Surrender Values

Cash Surrender Values

-A policyholder overpays for insurance protection during the early years

Limitations of Ordinary Life Insurance

-A term policy for the same premium would purchase substantially more protection

Limited-Payment Life Insurance

The insured has lifetime protection

Single-Premium Whole Life Policy

Type of Limited-Payment Life

Variable Life Insurance

fixed-premium policy in which the death benefit and cash values vary according to the investment experience of a separate account maintained by the insurer

Characteristics of Variable Life Insurance

-The premium is level
-The entire reserve is held in a separate account and is invested in common stocks or other investments
--If the investment experience is favorable

Universal Life Insurance

a flexible premium policy that provides lifetime protection

Characteristics of Universal Life Insurance

-After the first premium

Flexibility of Universal Life

-Cash withdrawals are permitted
-Policies receive favorable federal income tax treatment

Limitations of Universal Life

-Insurers advertise misleading rates of return
-Cash-value and premium-payment projections based on higher interest rates are misleading and invalid
-Insurers can increase the current mortality charge to recoup expenses
-A policy may lapse because some policyowners do not have a firm commitment to pay premiums

Variable Universal Life

an important variation of whole life insurance

Characteristics of Variable Universal Life

-Most are sold as investments
-Similar to universal life except that:
--The policy owner decides how the premiums are invested
--The policy does not guarantee a minimum interest rate or minimum cash value
-These policies have relatively high expense charges

Reasons for Insurance Regulation

• Maintain Insurer Solvency
• Compensate for Inadequate consumer knowledge
• Ensure reasonable rates
• Make Insurance available

Paul v. Virginia (1868)

• Affirmed the right of the states to regulate insurance.
• The court ruled that insurance was not interstate commerce.

U.S. v. South Eastern Underwriters Association (1944)

• The court ruled that insurance was interstate commerce when conducted across state lines and was thus subject to federal regulation.

McCarran-Ferguson Act (1945)

• States that continued the regulation and taxation of the insurance industry are in the states best interest
• Federal antitrust laws only apply to areas that the state doesn't already regulate insurance.

Financial Modernization Act (1999)

• Allowed banks

Three Principle Ways of Regulating Insurers

1. Legislation through both state and Federal Laws
2. Court Decisions interpreting policy decisions
3. State Insurance Departments

National Association of Insurance Commissioners (NAIC)

• Every state has an elected insurance commissioner who administers state insurance laws.
• They meet periodically to discuss laws and problems in the industry.

Licensing

• States are required for licensing their insurers

Domestic Insurer

• Chartered in that State

Foreign Insurer

• Out-of-State insurer

Alien Insurer

• Chartered in another country but licensed to operate in that state.

Solvency Regulation

Assets must be sufficient to offset liabilities.
States have regulations to calculate necessary reserves

Risk Based Capital

Method of measuring the minimum amount of assets in an insurance company in consideration of its size and risk profile.

Guaranty Funds

Funds set up by states to protect policyholders in the event that an insurance company defaults

Assessment Method

The major method used to raise money for unpaid claims.

Prior Approval Law

Must file with insurance commissioner and wait for his approval in determining insurance rates

Modified Prior Approval Law

If the rate change is based solely on loss experience

File and Use

Once the insurer files they can use those rates and the state has 30 days to object.

Use and File

The insurer can immediately implement the rates but they must be filed within 15-60 days of that.

Flex Rating

Insurers must get approval for rate changes that exceed a specified percentage

State Made Rates

A few states have where states have a certain rate applies to a certain insurance ie. Massachusetts and auto

Open Competition

No filing needed (minority of states)

Policy Forms

State insurance commissioners have the right to approve and disapprove new policy forms before they are sold to the public.

Twisting

this occurs when an agent convinces an insured to drop an existing insurance policy by misrepresenting the policy in hopes to obtain the insured's new business.

Rebating

The occurs when an agent agrees to return part of a commission to an insured in order to obtain their business.

MacCarran-Ferguson Act Repeal

• Greater efficiency
• Uniformity Laws
• More Competent Regulators.

State Regulatory Advantages

• Greater responsiveness to local needs
• Promotion of uniform laws by NAIC
• Greater opportunity for Innovation
• Unknown Consequences of Federal Regulation
• Decentralization of Political Power

Shortcomings of State Regulation

• Inadequate protection against insolvency
• Inadequate protection of consumers
• Improvements needed in handling complaints
• Inadequate market conduct examinations
• Insurance availability

Optional Federal Charter

• This would allow for life insurer's to choose between a federal and state charter.

Reasons for Insolvency

Inadequate Rates

Credit-Based Insurance Score

Proponents are arguing that there is a strong relation between credit score and future claims experience.
Critics argue that the use of credit score is going against minorities and other groups.

Risk management

A process that identifies loss exposures faced by an organization and selects the most appropriate techniques for treating such exposures

Loss exposure

Any situation or circumstance in which a loss is possible

Loss frequency

The probable number of losses that may occur during some given time period

Loss severity

The probable size of the losses that may occur