NC HEALTH INSURANCE CHAPTER 5

What is insurance and how does it work?

nsurance is a form of protection against losses people know or predict they are going to experience. It creates a situation where several people chip into a pool of money so that everyone draws from it. For example, everyone knows that there's a possibility they'll get sick and have medical bills, so most people pay premiums on health insurance. However, only a few of those people will actually have a loss that they need insurance to pay for, so the loss actually gets spread out over several people. Life insurance works differently - it helps create an immediate estate for the policyholder's survivors when they die.

What are the three main parts of an insurance application and what does each cover?

• Part 1 - General Information: Covers the applicant's name, age, address, gender, income, marital status, and occupation. This is where the applicant identifies what type of insurance coverage they're applying for and includes information about existing policies.

• Part 2 - Medical Information: Covers the applicant's health, including medical background, present health, recent medical visits, AND the health of applicant's relatives (including causes of death of deceased relatives). May require a medical examination.

• Part 3 - Agent's Report: Where the applicant shares personal analysis with the agent. This information is crucial for the underwriter and must be upfront and complete.

What is insurance and how does it work?

nsurance is a form of protection against losses people know or predict they are going to experience. It creates a situation where several people chip into a pool of money so that everyone draws from it. For example, everyone knows that there's a possibility they'll get sick and have medical bills, so most people pay premiums on health insurance. However, only a few of those people will actually have a loss that they need insurance to pay for, so the loss actually gets spread out over several people. Life insurance works differently - it helps create an immediate estate for the policyholder's survivors when they die.

What are the three main parts of an insurance application and what does each cover?

• Part 1 - General Information: Covers the applicant's name, age, address, gender, income, marital status, and occupation. This is where the applicant identifies what type of insurance coverage they're applying for and includes information about existing policies.

• Part 2 - Medical Information: Covers the applicant's health, including medical background, present health, recent medical visits, AND the health of applicant's relatives (including causes of death of deceased relatives). May require a medical examination.

• Part 3 - Agent's Report: Where the applicant shares personal analysis with the agent. This information is crucial for the underwriter and must be upfront and complete.

What's the difference between warranties and representations in insurance applications

• Warranties: ABSOLUTELY TRUE statements that the validity of the insurance policy depends on. If a warranty is breached, it can result in the policy being voided and premiums returned. Warranties are statements made by applicants that are unconditionally guaranteed to be true.

• Representations: Statements that are merely BELIEVED TO BE TRUE to the best of the applicant's knowledge. There's no guarantee of truthfulness. However, if an insured INTENTIONALLY answers dishonestly (misrepresentation), this could void the contract if it's material to the risk.

What happens when an agent collects the first premium, and what types of receipts are there?

When collecting the first premium, agents should issue a premium receipt. There are two main types:

• Conditional Receipt: Most common - makes coverage effective either on the date of application or the date of medical exam (if coverage isn't declined or issued with exclusions)

• Unconditional Receipt: Coverage becomes effective immediately when the premium is paid, regardless of underwriting outcome

The conditional receipt basically says you're covered as long as everything checks out and you're insurable.

What is a replacement policy and what must happen during the replacement process?

A replacement policy occurs when an existing life insurance or annuities policy is lapsed, forfeited, terminated, reissued with reduced cash value, converted to extended term insurance, amended with benefit reductions, pledged as collateral, or used in a financed purchase.

Key Requirements:

• Producer must submit a statement signed by the applicant stating whether the transaction involves replacement of existing insurance

• Producer must also submit a signed statement indicating whether they know replacement is involved

• Producer must present a "Notice Regarding Replacement" signed by both applicant and producer

• Applicant must receive copies of replacement policies and notices from companies being replaced

What is underwriting and how are applicants classified by risk?

Underwriting is a risk selection process where information on an applicant is analyzed and the company's exposure to risk is calculated. Underwriters select only insurable risks that meet the insurer's standards.

Risk Classifications:

• Standard Risks: People entitled to insurance protection without extra rating or restrictions - the average risk for their age and lifestyle

• Substandard/High Exposure Risks: Not acceptable at standard rates due to physical condition, personal/family history, occupation, or dangerous habits - issued with premium rate-ups

• Preferred Risks: Meet certain requirements for lower premiums than standard risk - superior physical condition, lifestyle, and habits

What is the Medical Information Bureau and how is it used in underwriting?

The MIB is owned by hundreds of insurance companies and serves as their members' central information file. It provides a way for companies to compare information applicants provide with information other companies may have.

Key Points:

• Used to help insurers verify information, not to "trap" applicants

• Prevents fraud and misrepresentation

• If coverage is declined due to MIB information, the consumer must be advised and given the reporting agency's name and address

• Consumers have the right to know what's in their report and can request a free copy once per year

• Subject to Fair Credit Reporting Act regulation

What is insurable interest and when must it exist?

Insurable interest must exist at the time the application for life insurance is made. This means the person seeking insurance must NOT love the person for whom they're seeking insurance purely for financial gain.

Key Principle: The loss that would occur if the insured person died must be greater than any financial gain from the death benefit.

Example: If someone starts a business with a partner and they take out life insurance on each other, but then dissolve the business 3 years later, the insurable interest may no longer exist. However, once a policy is issued, even if the insurable interest disappears later, the insurer must still pay the policy out.

What's the difference between pure and speculative risk, and which can be insured?

• Pure Risk: Has only one possible outcome - financial loss. Examples include risk of fire, illness, death, or injury. These risks are insurable because if one occurs, you could face financial loss and would not "profit."

• Speculative Risk: Has a possibility of gain or loss. Examples include lottery tickets, investing in stock market. These risks are NOT insurable because there's potential for either loss or gain, and you could profit from the outcome.

Insurance Rule: Only pure risks can be insured.

What is the law of large numbers and how does it apply to insurance?

The law of large numbers states that the larger the number of similar risks you have, the more accurate probability statistics become.

Insurance Application: If we have data that 3 out of 1,000 forty-year-old males will die before reaching age 41, and we have a group of 1,000 males aged 40, we'd expect about 3 to die based on mortality tables. However, if we have 100,000 males, we'd expect about 300 to die. The larger the group, the more accurate the prediction becomes.

Importance: This principle allows insurance companies to predict losses and set appropriate premiums.

What are the three types of hazards and how do they differ?

• Physical Hazards: Tangible characteristics that increase the chance of loss - things like age, sex, family medical history, or physical location of property

• Moral Hazards: Characteristics of the insured that increase chances of loss due to carelessness or lack of concern - examples include lack of proper care for property, smoking, being overweight, or poor exercise habits

• Morale Hazards: Mental hazards that arise from an individual's state of mind or attitude - create situations where someone might deliberately cause a loss for personal gain

What's the difference between Stock and Mutual insurance companies?

• Stock Companies: Owned by stockholders. Dividends represent the stockholders' share of profits and are taxable investment income. Profits go to stockholders, not policyholders.

• Mutual Companies: Owned by policyholders. Dividends are simply returning the part of the premium paid by the policyholder that was not needed to pay claims. These dividends are NOT taxable because they're considered a return of overpaid premium, not profit.

Key Difference: In mutual companies, policyholders ARE the owners and receive any excess profits as dividends.

What is Surplus Lines insurance and when is it used?

Surplus Lines insurance is used when a company hasn't filed all required paperwork with a state's insurance department, making them "non-admitted" or "non-authorized."

When It's Used: A company wishing to write only specialty lines of coverage (like health insurance for professional athletes) may choose to be "non-admitted," allowing them to write only for a special group of coverages known as Surplus Lines.

Key Point: This allows specialized insurance for unique or high-risk situations that standard admitted companies might not cover.

How does agency authority work and who is responsible for agent actions?

The agent is the agent of the insurance company, and legally represents the company. The agent's authority can be:

• Express Authority: Specifically given by the company in the agent's contract

• Implied Authority: Powers that naturally go with the position

• Apparent Authority: What a reasonable person would assume the agent can do

Key Point: When an agent acts within their authority (expressed, implied, or apparent), the company is legally bound by those actions. The customer deals with the company through the agent, so from the customer's perspective, they're dealing directly with the company.

What do "adhesion" and "consideration" mean in insurance contracts?

• Adhesion: Both parties in financial contracts must not have traits that allow one to take advantage of the other. When you buy insurance, you have no ability to alter or change the wording - if there's confusion about what's intended, the disagreement is settled in favor of the insured. The client is "stuck" with the company's wording.

• Consideration: The exchange between the insured and insurance company. Either the client pays premium each year and has no claims for the company to pay, OR the insured pays very little premium and then has a major claim. This represents the mutual exchange of value in the contract.

What is an Indemnity Health Plan?

A “fee-for-service” plan where the insured can choose any provider; the insurer reimburses a set percentage of “usual and customary” charges and the individual pays the remainder (coinsurance) after any deductible.

What is Coinsurance?

After meeting the deductible, the percentage split of covered costs between insurer and insured (e.g., insurer pays 80%, insured pays 20%).

What is an Out-of-Pocket Maximum?

The annual cap on the insured’s total cost-sharing (deductible + coinsurance + copays). Once reached, the insurer pays 100% of covered benefits for the rest of that year.

What are Usual, Customary, and Reasonable Charges?

The insurer’s benchmark fee range for a given service in a geographic area; insurer pays up to this amount, and insured pays any excess if provider charges more.

What is a Maximum Dollar Limit?

The total amount an insurer will pay for claims within a time period or lifetime (e.g., a lifetime cap of $1M). Plans with no/larger limits are generally preferred.

What is a Lifetime Limit?

• A cap on total benefits paid over an insured’s lifetime; modern regulations often prohibit low lifetime limits.

What is Capitation in an HMO?

A set dollar payment per member per period paid to PCPs for all covered services, encouraging cost control by fixed payment rather than fee-for-service.

What is a Point-of-Service (POS) Plan?

Hybrid of HMO & PPO: members choose at point of service whether to go in-network (with PCP/referral rules) or out-of-network (higher cost-sharing). Offers some flexibility.

What is an EPO (Exclusive Provider Organization)?

Similar to PPO but no coverage for out-of-network providers except emergencies; must use contracted providers to receive benefits.

Key Differences: HMO vs. PPO vs. POS vs. EPO.

• HMO: lowest flexibility, lowest cost, PCP/referral required, in-network only.

• PPO: more flexibility, higher cost, no referrals, in- & out-of-network with different cost-sharing.

• POS: blend; PCP/referral for in-network, option to go out-of-network at higher cost.

• EPO: in-network only (like HMO) but usually no PCP/referral requirement.

What to Check When Comparing Plans?

Benefits covered, exclusions/limitations, provider network size, referral rules, prior authorization requirements, cost-sharing (premiums, deductibles, coinsurance, copays), out-of-pocket max, stop-loss, and lifetime limits.

What Are Exclusions & Limitations?

Services not covered or covered only to a limited extent (e.g., experimental treatments, certain therapies). Must review to avoid surprise denials.

Which Services to Consider (Benefits Checklist)?

Inpatient hospital, outpatient surgery, emergency, physician visits, specialist care, skilled nursing, medical tests/X-rays, prescription drugs, mental health, substance abuse, home health, rehab, physical/speech therapy, maternity, chiropractic, alternative medicine, preventive care, well-baby.

How to Evaluate Provider Network?

Check if preferred doctors/hospitals are included; PCP availability; referral requirements; whether network meets geographic needs (near home, work, school, or for dependents elsewhere).

What is Guaranteed Issue (Small Group)?

Requirement that insurer must offer coverage regardless of health status to small employers (1–50 employees) under certain rules (Small Group Health Access).

COBRA Eligibility & Process.

Employer must notify within 60 days; coverage continuation runs 18–36 months depending on event; full premium plus 2% admin fee; specific events include termination, divorce, Medicare entitlement, dependent loss of status.

USERRA and COBRA Integration.

Military leave health coverage under USERRA may run concurrently with COBRA. Employers should coordinate notices; USERRA often more generous.

COBRA for Graduating Full-Time Students.

If student loses eligibility at graduation, they have a COBRA election period; insurer’s policy dates may affect timing; employer must issue proper notices and explain election rules.

COBRA and Dependents.

Dependents losing status may elect COBRA; they have similar rights as a “qualified beneficiary”; new dependents (e.g., birth) may need HIPAA compliance for coverage.

COBRA for Retirees.

Extended COBRA possible; must avoid discrimination (Section 105(h)); rates can differ for actives vs. retirees but watch nondiscrimination concerns and FAS liabilities.

Hospital Confinement Indemnity Insurance.

• Supplemental policy paying fixed amounts per day/week for hospital stays, not a substitute for major medical; often has elimination period before benefits begin.

Cash Management Metrics in Plan Administration.

• Premiums Receivable: days’ delay collecting premiums; rising days may signal cash issues.

• Claims Payable: days outstanding between service incurred and payment; too high may show aggressive management or trouble.

Where Do Premiums Go?

Split between medical costs (payments for services) and administrative costs (overhead, claims processing). Insurers monitor ratios to manage profitability.

Compensation Concepts in Health Plan (optional HR context).

Some insurers/health orgs use person-based pay linking compensation to competencies or skills; less central for clinical coverage but relevant for plan staffing.

What is HIPAA Portability?

Allows prior group coverage time to count toward waiting periods for pre-existing conditions under a new group plan, typically up to 12 months for new hires or 18 months for late entrants.

Who is an “Eligible Individual” under HIPAA for portability?

Someone whose most recent plan was group coverage, had ≥18 months creditable coverage with ≤63-day gaps, exhausted COBRA, and is not eligible for Medicare/Medicaid or other coverage.

What does a “Certificate of Previous Coverage” do?

Documents prior coverage duration and benefits, reducing or eliminating pre-existing condition waiting periods when moving to a new plan within 63 days.

If coverage gap ≤63 days after COBRA ends, is portability preserved?

Yes; gaps <63 days are not “significant,” so pre-existing limitations typically cannot be imposed.

Can insurers limit choices for HIPAA “eligible individuals”?

Yes; they must offer some policies but can restrict plan options or use high-risk pools in some states.

What is Guaranteed Issue in individual health insurance?

Requirement for insurers to issue coverage regardless of health status or pre-existing conditions if criteria are met (prior group membership, exhausted COBRA/similar, <63-day gap).

What are the three criteria for Guaranteed Issue?

Previously held group coverage; exhausted continuation coverage (e.g., COBRA); no break in coverage >63 days.

Does an employer paying an individual policy make it “employer-sponsored”?

ERISA rules may apply (summary plan descriptions, COBRA reporting), but tax treatment: employer can deduct premiums; employee may get tax-free benefit if plan qualifies.

If an employee buys an individual policy while employed and later leaves, do they retain COBRA rights?

No. COBRA continuation applies only to coverage in force at termination. If they opted out of group coverage, no group COBRA rights remain.

Are there nondiscrimination issues if a self-insured group pays individual policy premiums?

Generally individual policies exempt from group nondiscrimination rules; paying premiums is tax-deductible business expense but must watch ERISA/reporting.

What is Salary Continuation (“Qualified Sick Pay Plan”)?

Employer-funded plan to pay disabled employees a defined benefit (e.g., a weekly amount) instead of ad-hoc sick leave; must meet IRS/ERISA requirements to be deductible.

Key elements for a valid salary continuation plan?

Written plan document; defined participants; defined benefit amount and duration; reasonable benefit period; communication to employees.

What was the Levine case lesson?

Verbal/ad-hoc “sick pay” led to non-deductible dividends. Plans must be written, uniformly applied, reasonable duration, communicated formally.

Self-Insured vs. Insured Salary Continuation

Self-insured: employer bears risk, must handle design/admin, meets ERISA/IRC rules. Insured: buys disability insurance; simpler compliance, shifts risk.

What is a Section 105 Plan for disability benefits?

An employer group disability income plan qualifies under IRC Section 105 if it meets requirements (written, eligibility, benefit specs) to be deductible without insurance funding required.

Section 105 Plan Effective Date requirement?

Must be in effect before disability begins; cannot establish retroactively once disability occurs.

Section 105 Eligibility rules?

Can discriminate by employment class/salary/duration; qualification based on bona fide employment-related factors.

Does a salary continuation plan constitute an ERISA welfare benefit plan?

Yes, typically disability wage continuation is an ERISA welfare benefit; triggers ERISA requirements.

ERISA “In Writing” requirement?

Benefits, terms, eligibility must be documented in writing (plan document, corporate resolution, partnership agreement, etc.).

ERISA Communication & Reporting?

Must provide summary plan description (SPD) to participants; file reports (5500) if plan has ≥100 participants or is funded/trusted as required.

Who is the Plan Administrator under ERISA?

• Designated in plan document; if unspecified, employer defaults. Responsible for SPD, reporting, fiduciary duties.

ERISA Fiduciary Requirements?

Plan assets held in trust or via insurance satisfy funding; fiduciaries must act solely in participants’ interest, follow plan terms, and prudent practices.

Funding basis under ERISA?

Insured plans: premiums satisfy funding. Self-funded: assets/trust required; determines contributions, benefit payments, elimination periods.

Summary Plan Description (SPD) must include?

Plan name/ fiduciary, eligibility, enrollment, benefits (salary continuation), cost, termination, claims procedures, appeal, ERISA rights.

ERISA Form 5500 requirements?

Filed annually by plans with ≥100 participants at start of year, unless exempt (unfunded, fully insured small welfare plans). School districts often exempt if governmental.

Small Welfare Plan Exemption?

Plans covering <100 participants that are unfunded or fully insured may be exempt from Form 5500; self-insured plans generally do not qualify.

If plan drops below 100 participants mid-year, must you file 5500?

If >100 at beginning, must file for that year; no requirement to file again until start of a year with ≥100 participants.

Governmental/School District Plans and ERISA?

Governmental plans (e.g., public school districts) often ERISA-exempt; may not need Form 5500 unless certain IRC Section 125 plans apply.

What is a Cafeteria Plan (Section 125)?

A benefit structure allowing employees to choose among pre-tax benefit options (e.g., health insurance premiums, FSAs) financed by employer allocations or salary reductions.

Premium Conversion Plan?

Converts after-tax premium payments into pre-tax salary deductions for medical/dental premiums, reducing employee taxable income (FICA/FUTA) and employer payroll taxes.

Health Flexible Spending Account (FSA)?

Employee contributes pre-tax dollars to an account to reimburse eligible medical expenses (copays, deductibles). “Use-it-or-lose-it” by year-end unless grace or carryover rules apply.

Dependent Care FSA?

Pre-tax contributions to reimburse eligible dependent care expenses (babysitting, daycare, summer camps) enabling employee/spouse to work.

Plan Year and Enrollment?

Coverage period is typically 12 months; elections made at plan start, can change with qualifying life events (marriage, birth, divorce).

“Use-it-or-Lose-it” Rule?

Unused FSA funds at end of plan year are forfeited unless plan offers allowed carryover or grace period; employees should estimate expenses carefully.

Tax Impact for Employee?

Pre-tax contributions reduce taxable wages (income tax, FICA), increasing take-home pay. Salary reductions for benefits lower taxable income.

Tax Impact for Employer?

Employer contributions to cafeteria plan are tax-deductible and reduce payroll taxes (FICA/FUTA) on amounts employees contribute pre-tax.

Monitoring FSA Expenses?

Employers/agents often provide worksheets to estimate expenses; encourage employees to track actual spending to avoid forfeiture

Cafeteria Plan Compliance?

• Must meet IRC Section 125 rules, file necessary IRS forms; properly communicate options, plan documents, and follow nondiscrimination rules if applicable.

Interaction of Section 125 and ERISA?

Cafeteria plans are considered welfare plans under ERISA; must comply with ERISA’s SPD and reporting rules, though small fully insured plans may be exempt.

What workforce demographics influence cafeteria plan appeal?

More dual-income families, increased female full-time employment, and single parents benefit from flexible benefit choices.

Why might flexible benefits matter more than tax savings?

Employees appreciate selecting benefits that match needs, boosting morale and cost-awareness, which can control overall benefit spending.

Under IRC §125, who must participate in a cafeteria plan?

• Participants must be employees; the plan must offer two or more qualified benefits (cash or in-kind) for elections.

What are “qualified benefits” in a cafeteria plan?

Examples: group-term life insurance above statutory limit, medical/dental expense reimbursement, disability benefits, dependent care FSA, 401(k) (special rules), dependent group insurance, vacation.

What is the “use-it-or-lose-it” rule for FSAs?

Unused amounts at plan year-end are forfeited (unless plan permits limited carryover or grace period), so estimate expenses carefully.

What written documents must a cafeteria plan include?

Description of benefits; eligibility rules; election procedures; employer contribution details; plan year and forfeiture rules.

What discrimination tests apply to cafeteria plans?

Eligibility test, benefits test, and concentration test. The plan must not favor highly compensated individuals in eligibility or benefits.

Who is a “highly compensated individual” for cafeteria plan testing?

Officers; >5% owners/shareholders; or others meeting compensation thresholds; plus spouses/dependents of those.

What is the concentration test?

If key employees receive >25% of total benefits, the excess may become taxable to them; ensures non-discrimination in benefit value.

What reporting is required for cafeteria plans?

File IRS Form 5500 annually: total employees, eligible employees, participants, plan cost, and business type. Failure incurs penalties.

What is Short-Term Disability (STD) insurance?

Pays a percentage of salary (e.g., 50–66⅔%) for a limited period (e.g., 13, 26, or 52 weeks) when temporarily unable to work due to illness/injury.

What is the Maximum Benefit Period in STD?

• The longest duration STD benefits will pay (e.g., up to specified weeks) as long as the insured remains disabled.

What is the Maximum Monthly Benefit?

The highest dollar amount payable per month under the disability plan.

How is Benefit Percentage determined?

• Usually a set percent of the insured’s pre-disability income, up to a plan’s maximum benefit amount.

When do STD benefits typically begin?

From a few days to 1–2 weeks after disability onset, depending on policy and illness/injury severity.

Are Individual STD policies common?

Rare and often hard to find; group STD via employer is more typical.

What is Long-Term Disability (LTD) insurance?

Kicks in after STD expires; covers several years or to retirement (e.g., to age 65); premiums rise with longer benefit duration.

Who is an Active, Full-time Employee for group disability?

Must work regular hours for employer to be eligible; plan may specify a minimum number of continuous service days.

What is Business Overhead Expense insurance?

• Reimburses business expenses (rent, salaries) if a key person is disabled; not income replacement for the person.

Why is Rehabilitation important in disability insurance?

Supports clinical/vocational services to restore functionality, enabling return to productive work and reducing long-term claims.

Are disability income benefits taxable?

Employer-paid group disability premiums are taxable to the employee when benefits are tax-free; individual disability premiums paid individually are generally not deductible and benefits are tax-free.