Pearson Vue - Other Insurance Concepts
CHAPTER SUMMARY - BASIC PRINCIPLES OF LIFE AND HEALTH INSURANCE
The Concept of Insurance
Insurance is a legal contract that transfers an uncertain risk from one party to another. The insured transfers the possibility of suffering a large financial loss to an insurer in return for paying a relatively small, contractually defined premium.
An insurance policy restores an insured to the financial position she experienced before an insured loss. Insurance companies indemnify their insureds when covered losses occur.
Types of Insurance Companies
Stock Companies – Nonparticipating
Stockholders own a stock company.
Stockholders share in company profits, and, if these insurers declare stock dividends, they’re taxable.
Stock insurers issue nonparticipating insurance policies because policy owners are not stockholders and, therefore, are not owners.
Mutual Companies – Participating
The policy holders own mutual insurance companies.
Mutual insurance companies sell “participating policies” because policy owners receive a share of surplus revenue in the form of policy dividends.
The revenue paid out in the form of policy dividends is referred to as the divisible surplus.
In the aggregate, policy dividends represent a refund of excess premium or that portion of premium remaining after a company has set aside the necessary reserves.
Assessment Mutual Insurers
To pay for claims, assessment mutual insurance companies assess premiums at the time members experience losses.
Pure assessment mutual companies charge no premium in advance.
Advance premium assessment insurers levy assessments if the premium is insufficient.
Fraternal Benefit Societies
Fraternal societies are not-for-profit organizations that are noted for their social, charitable, and benevolent activities.
Fraternal membership is based on a common bond, and these organizations may form around a common religion, nationality, ethnicity, charitable cause, or other affiliation.
The three defining characteristics of a fraternal organization are as follows:
It’s non-profit.
It has a lodge system, including ritualistic work and a representative form of government.
It was not formed simply to provide insurance
Reciprocal Insurers
Each policy owner individually assumes a share of another’s risk, which makes reciprocal insurance contracts a form of risk sharing rather than risk transfer.
Policy holders receive policy dividends, and they own a share of the company surplus, which they can receive upon terminating their membership.
An attorney-in-fact is appointed to handle transactions for the reciprocal insurer.
Risk Retention Groups (RRGs)
A risk retention group (RRG) is a specialized insurance company that provides liability insurance for individuals and entities with a common bond.
Risk retention groups retain risks (risk retention) and process claims.
Risk Purchasing Groups (RPGs)
A risk purchasing group (RPG) buys coverage for its members, which must have a common bond.
The risk purchasing group becomes a master policy holder, and its members receive certificates of insurance.
Reinsurers
Reinsurers provide insurance for other insurance companies.
The reinsurer assumes risk from a ceding insurer, which is also referred to as the primary insurer.
Primary insurance companies purchase reinsurance when they underwrite large risks that could result in claims exceeding the primary carrier’s risk retention limit. The risk retention limit is the maximum amount of exposure that the insurer can carry when insuring a single risk.
Treaty reinsurance exists when a reinsurer enters into a contract with a primary insurance company to automatically assume its excess exposure for risks that meet contractually defined criteria. This agreement is also referred to as automatic reinsurance.
When a primary insurer seeks reinsurance for a specific exposure without an ongoing agreement, it’s referred to as facultative reinsurance.
A captive insurer is established to cover the loss exposure of the parent organization that owns it.
Surplus Lines Insurance Carriers are unauthorized insurers that provide coverage when authorized insurers reject buyers or authorized insurers don’t offer the type of insurance being sought.
Lloyd’s of London is a syndicate of individuals that individually underwrite special (unique) risks.
Self-Insurers establish a self-funded plan to cover potential losses and often cap potential losses with a stop-loss insurance policy. “Self-insurance” does NOT EQUAL “no insurance.”
Insurers Classified by Authorization
An authorized or admitted insurer describes an insurer that has been issued a certificate of authority from a state's insurance department authorizing the insurer to transact insurance in that state. Insurers must receive a certificate of authority from each state they wish to transact insurance.
An unauthorized (non-admitted) insurance company is prohibited from conducting insurance operations in that particular state.
Insurer Classified According To Domicile
A domestic insurer is organized and incorporated in the state in which it’s writing business.
A foreign insurer is organized under the laws of a different state.
An alien insurer is organized under the laws of a different nation.
Departments within an Insurance Company
The marketing or sales division prospects for new business.
The sales department meets with clients face-to-face and completes applications.
The underwriting department reviews applications, selects risks to insure, and assigns risk classifications.
The claims department administers claims.
The actuarial department calculates policy parameters, such as risks and costs relative to promised benefits.
Key People Within an Insurance Company
Producers
The term “Producer” describes an individual or organization that is licensed by a state to solicit, sell, or transact insurance in that state.
Licensed producers have a fiduciary responsibility to the companies they represent and the consumers they serve.
The terms “agent” and “broker” are used throughout the insurance industry to describe the legal relationship between a producer, an insurer, and a consumer.
Agents, represent one or more insurers under the terms of an appointment contract, which gives them limited authority to make binding commitments on the insurer’s behalf.
Brokers, represent themselves and the insured. The state licenses brokers, but they are not appointed by the insurer whose product is being considered by a consumer. Brokers cannot bind the insurer.
Underwriters
Underwriters identify, examine, assess, and classify loss exposures.
Underwriters approve or decline applications and determine the cost of insurance.
Actuaries calculate policy rates, reserves, and dividends.
Adjusters investigate and settle claims.
How Insurance is Sold
Most insurance purchased in the United States is sold through licensed insurance producers. Typically, these producers are agents who are appointed to represent one or more insurance companies.
Agents represent the insurer during a sales transaction and can bind insurance. In other words, they can commit the insurers that they represent to cover a risk exposure—at least temporarily.
Career Agency System
Major insurers (including direct writers) often establish career agencies, which recruit and train new agents. The agency is often a branch of a significant stock or mutual insurance company.
Some career agencies are contracted to represent an insurer in a specific geographical area or market.
A general agent typically runs a career agency.
The managerial system features career agencies that are run by a salaried branch manager.
Personal Producing General Agency System
The personal producing general agency (PPGA) system is affiliated with one or more insurers, but a PPGA doesn’t recruit, train, or supervise career agents. Instead, a PPGA focuses on sales in its assigned market or territory.
PPGAs generally maintain their own offices and staff. The staff consists of employees of the PPGA rather than of the appointing insurer.
Independent Agency System
Independent agents represent any number of insurance companies through contractual agreements.
Other Methods of Selling Insurance
Insurance companies also sell coverage using mass marketing methods that expose their products to large groups of consumers, with occasional follow-up by agents.
Insurance companies that use these methods deal directly with consumers.
Direct sellers use vending machines, advertisements, or salaried producers.
Evolution of Industry Oversight
Federal Court Cases and Legislation Affecting Insurance Industry Regulation
Paul v. Virginia (1868): The United States Supreme Court ruled that insurance is not interstate commerce, thereby upholding the states’ right to regulate it.
The United States v. Southeastern Underwriters Association (SEU) (1944): The United States Supreme Court reversed Paul v. Virginia and ruled that insurance is a form of interstate commerce and is subject to federal regulation.
The McCarran-Ferguson Act(1945): Congress responded to the SEU decision by delegating the regulation of insurance to the states while requiring compliance with federal antitrust standards – either directly or through comparable state laws. McCarran-Ferguson (also referred to a Public Law 15) also levied a maximum penalty of up to one year in jail and a fine of $10,000 for violators.
The Fair Credit Reporting Act (1970): This Act was established to protect privacy by requiring the fair and accurate reporting of consumer information.
Amendments to USC 1033 and 1034 regarding Fraud and False Statements (1994): This section of the United States Code (USC) prohibits felons (those guilty of crimes involving dishonesty or breach of trust) from participating in the insurance industry without a “Letter of Written Consent” from their state insurance regulator. Any person who engages in intentionally unfair or deceptive insurance practices is subject to a fine of up to $50,000, 15 years in prison, and license revocation.
The Financial Services Modernization Act (1999): This Act allowed banks to sell insurance and prompted states to create regulations for insurance companies to protect the privacy of consumer personal information.
The USA PATRIOT Act (2001): This Act focuses on the funding sources for terrorists and international money laundering in general.
The Do Not Call Implementation Act (2003) implemented the Do Not Call Registry, which allows consumers to opt-out of receiving calls from telemarketers, except for those on behalf of charities, political organizations, and surveys.
2003-CAN-SPAM Act: This Act outlines the right for consumers to request a business to stop sending emails, the requirements for businesses to honor such requests, and the penalties incurred for those who violate the Act. The Act does not apply to transactional and relationship messages.
National Association of Insurance Commissioners (NAIC)
The National Association of Insurance Commissioners (NAIC) is an industry association of state insurance regulators focused on establishing model acts and regulations that provide a common framework for state officials to address industry-wide issues. These regulatory models help streamline the legislative and administrative processes while encouraging uniform standards.
The NAIC lists four objectives: (1) To encourage regulatory uniformity among the states. (2) To promote efficient regulatory administration. (3) To protect policy owners and consumer interests. (4) To preserve state regulation of the insurance industry.
The NAIC’s Model Advertising Code labels certain words and phrases as inherently misleading and bans their use.
NAIC Unfair Trade Practices Act (Model) Act gives a state insurance department the power to:
Investigate insurance companies and producers.
Issue cease and desist orders.
Impose penalties.
Seek a court injunction to restrain unfair activities.
The National Conference of Insurance Legislators (NCOIL) is an association of state legislators that serves on insurance and financial institutions committees to educate policymakers and preserve state regulation. NCOIL also writes model laws.
The National Association of Insurance and Financial Advisors (NAIFA) and The National Association of Health Underwriters (NAHU) created a Code of Ethics for agents.
Agent Marketing and Sales Practices standards include:
Selling to needs: Learning and addressing client needs
Suitability: Recommending products that address client needs and match client capabilities
Full and accurate disclosure of product information
Documentation of each client meeting and transaction
Client service after the sale
Rating Services describe companies that determine an insurer’s financial strength. These services publicize the financial health of insurers after analyzing company reserves and liquidity.
CHAPTER SUMMARY: THE NATURE OF INSURANCE
The Nature of Insurance
An insurance policy is the transfer of risk from one party to another in exchange for a fee (premium) using a legal contract.
Insurance companies take one person’s risk of loss and spread it among all parties who are participating in the insurer’s risk pool, as evidenced by the payment of premiums.
The “Principle of Indemnification” is financial. Any insurance contract that’s based on this principle intends to restore insureds to their original financial position after they suffer losses.
The same principle stipulates that insureds will not profit or gain from their loss. In other words, they will not receive more than they lost.
The amount needed to restore the insured’s financial status can be referred to as an indemnity. The act of restoring is considered indemnifying.
The ‘law of large numbers’ states that the greater the number of homogenous loss exposures, the more accurate the prediction of the aggregate risk within an insurance pool.
Adverse selection is the tendency for higher-than-average risks to seek out insurance more frequently than lower risks.
Perils, Loss, and Hazards
A peril is the immediate and specific cause of a loss.
Insurance policies that cover Specified or Named Perils will individually list the perils that they cover. If the peril that causes a loss is not listed, then the loss is not covered.
Insurance policies that use a Special or Open Peril definition of covered perils will cover losses that result from any cause (peril) which is not explicitly excluded in the policy.
A loss is an unintended (by the insured) loss of financial or monetary value.
The event that causes a loss is referred to as an Occurrence. An occurrence takes place at a specific time or place or develops over time before it makes itself known.
An accident is a type of occurrence but is unexpected and unintended. An accident happens at a specific time and place and causes a measurable loss.
Other occurrences such as illnesses, repetitive motion injuries, or exposure to toxins may cause an identifiable loss, but it’s not possible to determine the exact moment that the loss occurred.
A direct loss occurs when people are harmed, or a covered peril damages property.
An Indirect Loss or “Consequential Loss” results from a direct loss, such as the loss of revenue when a business shuts down to rebuild after a fire. Disability insurance also covers a consequential loss—the loss of income when a person cannot work because of an illness or injury (direct loss).
Loss exposure is the risk of a possible loss. Basically, any situation that presents the possibility of a loss. In some cases, the term is used to refer to a loss exposure unit.
Homogeneous exposure units are individual entities that are exposed to the same group of perils. Their similarities allow them to be grouped together so that the same actuarial assumptions can be applied when pricing coverage.
A hazard is a physical condition, a way of acting, or a way of thinking that increases the likelihood that a loss will occur.
Physical hazards are physical or tangible conditions that make a loss more likely to occur, such as the increased risk of disability if a person has chronic back problems.
Moral hazards make the loss more likely to occur due to the dishonest character of the insured or harmful acts that are done intentionally. Cigarette smoking is an example of a legal action that’s considered a moral hazard. Falsifying the circumstances of an automobile insurance claim to avoid paying a deductible or being held liable is both illegal and evidence of a moral hazard.
Morale hazards arise from a state of mind that’s indifferent to the possibility of loss because of the existence of insurance.
Risk
Risk is the uncertainty regarding the occurrence of a loss.
Speculative risks are not insurable as they result in financial gains as well as losses.
Pure risks are insurable because there’s only the potential for loss.
In general, insurable risk must include all of the following elements:
An insurable loss must be due to chance (accidental), which means the cause must be outside an insured’s control.
An insurable loss must be definite and measurable, which means the time, place, and amount are known.
An insurable loss must be predictable (calculable). There must be a sufficient number of homogeneous loss exposures.
An insurable loss cannot be catastrophic. If the potential loss is too large or unpredictable, an insurer cannot financially survive after paying a claim.
An insured consumer must have a substantial loss exposure to make the option of buying insurance economically reasonable.
The premium cost must be affordable.
The following are the three basic risk classifications:
Standard risks have an average potential for loss.
Substandard risks have a higher-than-average potential for loss.
Preferred risks have a lower-than-average potential for loss.
Risk managers analyze existing loss exposures and create programs that manage the risk using one or more of the following risk management tools:
Risk avoidance eliminates situations that expose a person to risk.
Risk reduction accepts the existence of a risk but takes actions to reduce the likelihood or severity of a loss.
Loss prevention is a form of risk reduction. The insured takes actions that eliminate damage or loss.
Risk retention occurs when a person accepts a degree of risk and creates a reserve to pay for it if needed.
Risk transfer is the practice of transferring risk from one party to another and is the basis of insurance.
Risk-sharing spreads risk among multiple parties that each assumes a portion of the covered losses.
Risk pooling spreads risk by distributing the anticipated cost of future losses among many individuals.
Risk pooling transfers the risk of loss from an individual to a group.
Reinsurance is a form of risk transfer between insurance companies.
The ceding primary insurer transfers excess risk (risk in excess of its retention limit for a single exposure) to a reinsurance carrier that assumes the risk after receiving a premium from the primary carrier.
CHAPTER SUMMARY: DISABILITY INCOME INSURANCE
Basic Concepts of Disability Insurance
▪ Disability income insurance protects an individual insured’s earned income if he’s injured and cannot work.
▪ Disability insurance helps assure the continuation of a business if a principal owner becomes disabled.
▪ Disability insurance indemnifies businesses against the loss of key employees.
▪ Disability policies provide benefits if an insured experiences a disabling condition that’s caused by an accident or an illness.
▪ The purpose of a short-term disability policy is to quickly replace a percentage of the insured’s income while he recovers from a temporary injury or illness that prevents him from working but is less serious in nature.
▪ Long-term disability (LTD) plans provide longer benefit periods and are typically reserved for an injury or illness that’s more serious in nature.
Qualifying for Benefits
Disability Defined
▪ Disability income policies primarily define “disability” as the inability to perform tasks or earn an income.
▪ Being under the care of a physician is a requirement to qualify for total disability benefits.
▪ Disability insurance policies define the term “disability” as a loss of income, the inability to work, or both.
▪ To be disabled is to be unable to “perform the material and substantial duties” of one or more occupations.
‒ Material duties are the actual tasks or activities that a person performs while she does her job.
‒ Substantial duties refer to essential capabilities.
▪ The “any occupation” definition of disability means that an insured cannot perform “the material and substantial duties” of:
‒ Her own occupation, or
‒ Any occupation for which she’s reasonably suited by education, training, or experience.”
▪ The “own occupation” definition of disability means that the insured cannot do “the material and substantial duties of her own occupation.”
▪ The loss of earnings test determines whether income has been lost.
‒ A minimum loss of 20% of income is needed to qualify for benefits.
‒ Policies that use the loss of income definition are referred to as “income replacement contracts.”
At-Work Benefits
▪ Partial disability is a person’s inability to perform one or more key duties of his own occupation or the inability to work at his job full-time.
‒ The traditional partial disability benefit is 50% of the total disability benefit for a maximum of six months.
▪ Residual disability is a proportional disability benefit that’s based on loss of income.
▪ Recurrent disability is when the insured returns to work after a disability but then suffers a relapse.
‒ The relapse is considered part of the original disability if it occurs within six months.
‒ There’s no new elimination period.
‒ There’s no new benefit period.
▪ Presumptive disability identifies conditions that automatically qualify an insured for the total benefit.
‒ Double dismemberments
‒ Total and permanent loss of sight
‒ Total and permanent loss of hearing
‒ Total and permanent loss of speech
Other Definitions of Disability
▪ When disabling events occur in tandem, it’s considered a concurrent disability.
▪ Most policies cover disability claims that result at some point after the occurrence that caused them.
▪ Delayed disability is the amount of time allowed for a delay between the cause and the resulting disability.
▪ Confined disability requires the insured to be hospitalized, but non-confined disability does NOT.
▪ If a policy doesn’t cover work-related injuries, it’s referred to as non-occupational coverage.
▪ If the policy covers work-related disabilities and losses that are suffered away from work, it provides occupational coverage.
▪ Credit disability guarantees loan payments if a debtor is disabled.
▪ The two types of disability benefits that are found in life insurance are the waiver of premium rider and the disability income rider.
Government (Social) Disability Insurance
Social Security Disability Income
▪ Payroll taxes fund Social Security disability benefits.
▪ Only fully insured individuals are eligible for Social Security Disability.
▪ There’s a five-month waiting period before an individual qualifies for Social Security benefits.
▪ The Social Security Disability Income (SSDI) benefit equals 100% of the worker’s primary insurance amount (PIA).
▪ Social Security defines “disability” as the inability to perform any substantial gainful work, which means:
‒ A person is unable to do work because of her medical condition, and
‒ A person’s disability is expected to last for at least one year or result in her death.
Workers’ Compensation
▪ Workers’ Compensation is a form of liability insurance that guarantees benefits for workers who are harmed by work-related accidents or occupational diseases.
Individual Disability Income Insurance
Basic Structure
▪ Individual disability income insurance is an occupational contract. Insurers underwrite the risk based on the applicant’s occupation as well as his personal characteristics.
▪ The benefit period is the maximum length of time that disability income benefits will be paid for a single claim.
‒ Short-term disability policies have a benefit period of up to two years, while long-term policies pay benefits for two or more years per claim.
▪ The elimination period is the time immediately following the start of a disability when benefits are not payable.
‒ The elimination period is a time-based deductible.
‒ When calculating a disability claim, the elimination period must be taken into account.
▪ The probationary period defines the number of days that must elapse once a new policy is in force before claims due to illness are covered.
‒ The probationary period effectively excludes those illnesses that were contracted before coverage began but only became symptomatic after the policy was in force.
▪ Disability income insurers limit coverage to a percentage of the insured’s income.
▪ The percent-of-earnings approach defines the benefit as a fixed percentage of the insured’s pre-disability earnings.
‒ If the insured’s income increases, the benefit also increases to maintain the percentage.
▪ The flat amount method defines benefits as a specific dollar amount.
‒ It remains fixed despite changes in income.
▪ Premium rates are based on the monthly benefit amount, the waiting period, the benefit period, the insured’s occupation, and the general level of insurability.
‒ Individual disability policies are sold with a level premium.
‒ Group or association-sponsored plans often have increasing premiums and five-year premium age bands.
Underwriting Considerations
▪ Morbidity measures the likelihood that an individual will suffer a disability.
▪ Personal underwriting criteria includes an insured’s:
‒ Age
‒ Sex (gender)
‒ Occupation
▪ Individuals with certain professions (e.g., physicians, attorneys, etc.) engage in less hazardous work.
▪ Other white-collar and gray-collar occupations are somewhat riskier.
▪ Many blue-collar occupations have the highest morbidity rates. Insurers often restrict policy terms and limit the benefit periods to either two or five years.
Standard Provisions and Benefits
▪ The change of occupation provision allows the insurance company to automatically change the premium or benefit if the insured files a claim and has not informed the insurer of a change in occupational risk.
▪ The relation of earnings to insurance limits the total amount of benefits that are paid to the amount of pre-disability income.
▪ Insurers use impairment riders to permanently exclude certain losses if the risk is too high or too uncertain.
▪ The rehabilitation benefit provision calls on the insurer to pay the approved cost of a rehabilitation program as long as the insured remains disabled and active in the program.
▪ The non-disabling injury benefit pays up to a specified amount if the insured suffers an injury and no other claim is filed.
▪ The general exclusions in a disability income policy reflect the general exclusions that are common to all health insurance policies which don’t relate to pre-existing conditions.
Renewal Provision
▪ Disability insurance policies are either non-cancelable (and guaranteed renewable) or guaranteed renewable. Insurance carriers cannot cancel these contracts before the end of the policy’s terminal date unless it’s due to the failure to pay the premium.
▪ If a policy is non-cancelable, the insurer guarantees that neither the premium rate nor the policy’s terms will change as long as the policy is in force.
▪ If the policy is guaranteed renewable, the insurance carrier has the right to raise rates on a class basis.
▪ Disability income policies typically require the insured to be actively working for a stated number of hours per week if coverage extends past the age of 65.
Individual Disability Income Policy Riders
▪ Accidental Death and Dismemberment (AD&D) rider
‒ The death benefit is referred to as the principal sum.
‒ The dismemberment benefit is referred to as the capital sum.
‒ The principal sum is the rider’s face amount, while the capital sum is typically 50% of the principal sum.
▪ Some disability policies allow the insured to take an optional lump-sum payment that’s referred to as an elective indemnity option rather than periodic income.
▪ The hospital confinement rider pays an additional sum on top of the regular monthly disability benefit based on the number of days the insured is confined to a hospital.
▪ The return of premium rider refunds premiums if the insured doesn’t have a claim.
▪ A cash surrender value rider is also available from some insurers.
▪ The lifetime extension rider extends the benefit period beyond the age of 65.
▪ The Social Security rider coordinates a portion of individual disability policy benefits with Social Security Disability Insurance (SSDI) and other forms of social insurance.
‒ The policy holder accepts coordination of benefits on some of the policy’s benefits in exchange for a lower premium.
▪ The additional monthly benefit (AMB) rider is a short-term benefit that addresses the insured’s needs during the initial six to 12 months of disability.
▪ The future increase option (FIO) helps an insured’s coverage keep pace with his income by allowing him to buy additional insurance at various specified future dates without evidence of insurability if his income increases.
▪ The cost-of-living adjustment (COLA) rider indexes the disability benefits that are paid for an active claim to changes in the Consumer Price Index (CPI).
Group Disability Income Insurance Plans
▪ The group must be a natural group.
▪ Insurers base premiums on the group’s aggregate level of risk.
▪ Insurance carriers require a minimum level of participation to avoid adverse selection.
Group versus Individual Disability Insurance
▪ Group policies often don’t have probationary period provisions but require new participants to fulfill a minimum required length of service before becoming eligible for coverage.
▪ Group insurance policies have an elimination period that’s often designed to integrate with sick-day allowances and long-term disability benefits.
‒ Up to 10 days for short-term disability plans, and
‒ 180-days for the long-term disability benefit
▪ Group insurance benefit periods mirror those for individual insurance policies.
▪ Group policies define disability benefits as a percentage of an insured’s wages which keeps pace with any changes. Employers that pay for employee benefits often pay for a disability benefit that’s equal to 50% or 60% of their workers’ weekly or monthly wage. They often allow employees to purchase coverage for up to 70% of their income.
Coordination of Benefits
▪ Group disability plans coordinate benefits with other groups and social insurance programs (e.g., Social Security).
▪ Group plans are secondary to Workers’ Compensation for work-related claims.
▪ Some group disability plans limit coverage to non-occupational disabilities.
Qualifying for Benefits and Benefit Periods
▪ Group insurance plans often provide both total disability and partial disability benefits.
▪ Like individual plans, group disability can include short-term plans or long-term plans.
Group Short-Term Disability Income Plans
▪ Group short-term disability plans have short maximum benefit periods of 13 weeks (where allowed by law) or 26 weeks.
▪ Benefits are typically paid weekly and range from 50% to 100% of the individual’s income.
▪ The definition of disability is the insured’s “own occupation.”
Group Long-Term Disability Income Plans
▪ Group long-term disability benefit periods often extend to the insured’s retirement age.
▪ Benefit amounts are typically limited to between 50% and 70% of the participant’s income.
▪ Long-term plans often use an “own occupation” definition of total disability for the first two years of disability and then switch to an “any occupation” definition.
Business Uses for Disability Insurance
▪ Insurers use disability insurance to facilitate business continuation in the event of a disabling sickness or injury.
Business Overhead Expense Insurance
▪ Business overhead expense (BOE) insurance covers business expenses and payroll costs if the owner becomes disabled, but it doesn’t cover the disabled owner’s income.
▪ Business overhead expense policies pay a maximum monthly reimbursement for covered expenses rather than a fixed indemnity.
Disability Buy-Out Policies (Buy-Sell Plans)
▪ Disability buy-out policies fund disability buy-sell agreements in much the same way as life insurance policies do.
▪ In the cross-purchase plan, partners insure each other.
▪ In an entity buy-sell plan, the company buys a policy that covers each owner. The company is the beneficiary of each policy and uses the funds to buy out the disabled partner or shareholder.
▪ Disability buy-out policies contain a provision that allows the insurer to pay a lump-sum benefit.
▪ They also have lengthy elimination periods, some of which may be up to two years.
Key Person (Employee) Disability Insurance
▪ Key person disability insurance indemnifies the business for a key person’s lost services.
▪ A key person could be a partner, stockholder, or key employee.
▪ The business is the owner and premium payor of the policy.
Taxation of Disability Insurance Policies
▪ The IRS generally taxes money only once – either when the premiums are paid in, or the benefits are taken out.
▪ Social Security benefits are partially taxed after a person’s total income reaches $25,000 for individuals and $32,000 for married couples filing jointly.
▪ Workers’ Compensation benefits are generally not subject to income tax.
▪ Individual Disability Income Insurance
‒ Premiums are not tax-deductible (i.e., they’re taxable).
‒ Benefits are not subject to income tax.
▪ Group Disability Income Insurance
‒ Employer-paid premiums are a tax-deductible business expense.
‒ If the employer pays a participating worker’s disability insurance premium, the benefits are taxable.
‒ If an employee pays group premiums on a pre-tax basis, any benefits are taxable.
‒ If an employee pays group disability premiums with after-tax dollars, the benefits are not taxable.
‒ If the employee-paid portion of the premium is paid pre-tax, then the entire benefit is taxable.
‒ If employees pay their portion of the premium with after-tax dollars, the benefit will be partially taxable and partially tax-free.
▪ Business Overhead Expense (BOE) Insurance
‒ A BOE policy premium is a tax-deductible business expense.
‒ The benefit is counted as part of taxable revenue because it offsets tax-deductible business expenses such as rent, utilities, and payroll.
▪ The taxation of disability buy-out policies works like a standard individual policy. Because the policy holder (the company) pays a premium with after-tax dollars, the policy benefit is income tax-free.
▪ The taxation of the key-employee policy mirrors the taxation of the individual disability policy.
CHAPTER SUMMARY: INSURANCE PLANS FOR SENIORS AND SPECIAL NEEDS
Medicare
The federal government administers Medicare through the Center for Medicare and Medicaid Services (CMS).
Medicare is considered a part of OASDHI.
Medicare provides hospital and medical expense insurance primarily to those who are the age of 65 and older.
Any person who’s eligible for Social Security retirement benefits is automatically eligible for Medicare.
Original Medicare versus Medicare Advantage
There are two ways to access Medicare—Original Medicare and Medicare Advantage.
Original Medicare (Part A and Part B) is administered by the federal government.
Individuals who choose Original Medicare also must purchase a Medicare Part D Prescription Plan.
Individuals who choose Original Medicare generally need a Medicare Supplement (Medigap) policy to cover co-insurance, co-pays, and deductibles.
Medicare Advantage (Part C) is an “all in one” private alternative to Original Medicare and a Medicare Supplement.
These plans are often HMOs or PPOs.
Some plans include Medicare Part D prescription drug coverage.
Original Medicare
Enrollment in Medicare Part A and Part B is automatic for Social Security recipients at age 65, though one can decline Part B.
Anyone still working must enroll themselves.
Enrollment
When an individual turns the age of 65, the initial Medicare enrollment period:
Begins three months before the start of his birth month
Ends at the end of the third month following the month he turns age 65
If an individual fails to enroll in Part B during the initial enrollment period, he may enroll during the annual open enrollment period, which is January 1 through March 31.
Coverage begins the following July 1.
Late enrollees may pay a higher premium.
Premiums
There’s no Medicare Part A premium for any person who’s covered by Social Security and is “fully insured.”
Any person who elects Medicare Part B pays a monthly premium that’s automatically deducted from her Social Security check.
Participating Providers and Medicare Assignment
▪ Participating providers accept assignments and agree to accept the approved Medicare fee for their services.
▪ Non-participating providers don’t accept assignment and collect their fees directly from the insured, but they may charge up to 15% more than the Medicare-approved amount.
Medicare and Group Insurance
Employer Group Medical – COBRA Groups
An employer-sponsored group health plan that covers a person who’s the age of 65 or older is her primary insurer if the employer is a qualified COBRA group, while Medicare is secondary.
The employee will be eligible for a “special enrollment period” when she retires.
Individual and Retiree Insurance and Medicare
Individual health insurance policies and retiree health insurance benefits are secondary payors after Medicare.
Medicare Part A – Hospital Insurance
Medicare Part A provides inpatient hospital care, skilled nursing care, home health care, and hospice care.
The primary source of financing for Part A is federal payroll and self-employment taxes.
Inpatient Hospital Care
Inpatient hospital benefits cover the expense of a semi-private room, nursing, drugs, tests, operating rooms, and other medical services and supplies.
Benefit periods begin when a person is admitted to a hospital and end 60 days after a person is discharged.
Hospital Benefits: Medicare Part A covers up to 90 days of inpatient hospital care per benefit period and an additional 60 Lifetime Reserve Days.
Cost-Sharing
Per benefit period deductible.
No co-insurance for the first 60 inpatient days.
Daily co-insurance amount for days 61 through 90.
Co-insurance amount of twice the co-insurance for days 61 through 90 for lifetime reserve.
Skilled Nursing Care Benefits
Medicare provides a short-term recovery benefit of up to 100 days in a skilled nursing facility.
Beneficiaries qualify for this benefit following a recent hospital stay of at least three inpatient days.
Coverage ends sooner if the maximum level of recovery is achieved.
Medicare doesn’t cover custodial care.
Cost Sharing
There’s no cost-sharing for the first 20 days of residential care.
Starting on day 21, there’s a daily co-insurance amount.
All coverage ends after a maximum of 100 days.
Other Part A Benefits
Inpatient Psychiatric Care: Up to 190 days (lifetime) of inpatient care at a psychiatric facility
Home Health Care Benefits: Medicare Part A covers home health care costs.
Hospice Care:
Medicare offers hospice benefits to individuals with a life expectancy of six months or less.
Medicare provides two 90-day benefit periods.
A person may receive additional care in 60-day increments.
Exclusions (Medicare Part A)
A private duty nurse or attendant in private rooms
The first three pints of blood
Personal conveniences (telephones, TV rentals, etc.)
The cost of non-employee surgeons and anesthesiologists
Medicare Part B – Supplemental Medical Insurance
Part B covers doctors’ services, outpatient medical services, labs, x-rays, supplies, durable medical equipment, and other services.
Part B also pays for the cost of non-employee surgeons and anesthesiologists who are performing inpatient surgery.
Medicare Part B covers doctors’ services and exams that are performed anywhere in the United States.
Cost Sharing
All beneficiaries pay an annual deductible ($203 in 2021).
Beneficiaries pay 20% co-insurance on covered charges.
Medicare Part B – Exclusions
The services of a private duty nurse or attendant
Intermediate or custodial care
The cost of skilled nursing care over 100 days
Vision and hearing care
Dental care
Outpatient prescription drugs and immunizations
Cosmetic surgery
Routine physical examinations and foot care
Physician costs exceeding Medicare’s approved amount
Medicare Part C – Medicare Advantage (Formerly Medicare + Choice)
Medicare Part C (Medicare Advantage) is a private alternative to the Original Medicare.
The government pays private companies 95% of the government’s average cost for each insured who chooses an Advantage plan.
Advantage plans provide major medical insurance that replaces Original Medicare and eliminates the need for Medigap.
Qualifying for Medicare Part C
An individual must enroll in Parts A and B to be eligible for Medicare Advantage.
Part C enrollees continue to pay the Part B premium.
Part C enrollees also pay a premium to their chosen insurer.
Evidence of insurability is not required during the six months following an individual’s 65th birthday.
An individual may only participate in one Medicare Advantage plan at a time.
Part C participants may use HSAs to pay medical expenses.
Health Maintenance Organizations (HMOs)
Medicare Advantage HMOs are similar to other HMOs.
They provide coverage through a defined network.
A primary care physician manages care and refers patients to network specialists.
Out-of-network care is restricted to emergency services only.
Preferred Provider Organizations (PPO)
Medicare Advantage PPOs are similar to other PPOs.
They cover discounted services through a defined network.
They also provide some coverage for out-of-network services.
Private Fee for Service (PFFS) Plan
An individual may see any participating Medicare provider.
The insurance plan, rather than Medicare, decides how much the insurer and insurer will pay, respectively.
PFFS plans may include extra benefits.
Medicare Part D – Prescription Drug Plans
Part D prescription drug plans (PDPs) cover outpatient medication costs.
Private companies offer and administer these PDPs.
The initial enrollment period is the same as that which is used for Part B.
In subsequent years, the annual open enrollment period is October 15 through December 7.
Any person who enrolls late is subject to a premium penalty.
Each plan covers the cost of the prescription medications that are listed in its formulary.
Part D PDPs typically have a gap in coverage between the two layers of coverage—basic and catastrophic. This is referred to as the “donut hole.”
Medicare Supplements (Medigap)
Medigap or Medicare Supplement policies are sold by private insurers and other health care providers.
These policies help fill in any gaps in coverage under Original Medicare by paying Medicare’s cost-sharing amounts, which include deductibles and co-insurance.
The National Association of Insurance Commissioners (NAIC) established regulated coverage forms. Currently, there are 10 different plans available for purchase out of 14 options labeled Plan A through Plan L. Only contracts that conform to one of these forms can be referred to as a Medicare Supplement policy.
Original Medicare limits the coverage Medigap policies can offer.
Medicare Supplement benefits cannot duplicate Medicare.
Medigap plans cannot add additional benefits (e.g., dental).
Benefit terms cannot be more restrictive than those that are set by Medicare.
A person can only have one Medicare Supplement.
Medigap benefits change annually and reflect changes in Medicare.
Insurers must provide insureds with at least 30 days’ notice.
Medicare Select is a Medicare Supplement that’s available in most states, and it offers the standard coverages through a closed-end HMO in return for a lower premium.
Medigap Enrollment
The best time for a person to buy a Medicare Supplement policy is during her open enrollment period.
Medigap is a guaranteed issue contract during open enrollment.
Standardized Plans
The NAIC has standardized policies to help consumers understand them, compare them, and make informed buying decisions.
All Medigap contract policies must include the core benefits.
Plan A is the most basic Medigap policy, which only offers the core benefits.
Core Benefits
Part A Benefits
100% of the daily hospital co-insurance for days 61 through 90 of inpatient care during a standard benefit period
100% of the daily hospital co-insurance for the insured’s lifetime reserve days
365 additional lifetime reserve days
100% of hospice care co-insurance or co-payments
Part B Medical Benefit: Payment of the 20% co-insurance for approved charges after meeting the annual deductible
Parts A and B Benefits: Medigap plans pay for the first three pints of blood
Additional Benefits
Plans B through L provides additional benefits such as the payment of deductibles, excess charges, skilling nursing home cost-sharing amounts, and foreign travel emergencies.
In some states, Plans F and G offer a high-deductible option.
Contract Requirements
The NAIC Model Act, which governs Medigap policies, sets forth a variety of contract requirements:
Medigap policies must have a 30-day free-look period.
Medicare Supplements must be guaranteed renewable.
Medigap policy terms cannot be more restrictive than Medicare.
Pre-existing conditions cannot be excluded.
The maximum pre-existing condition waiting period is six months.
Policy benefits and other terms automatically change to mirror changes in Medicare and the law.
Soliciting duplicate coverage is prohibited by law.
Medigap policies must have a six-month open enrollment period which starts when an insured enrolls in Medicare Part B. Insurers cannot charge higher rates because of underwriting considerations during this time.
No new probationary period may apply to a replacement policy.
The model law states that insurers must achieve a minimum 65% loss ratio for individual policies and 75% for group plans.
Advertising and Marketing Standards
State insurance departments must approve Medigap policy forms before they’re marketed in most states.
Insurers must submit Medigap policy advertisements to the state insurance department at least 30 days before being used.
Insurers must provide applicants with a copy of the Medigap Buyer’s Guide at the time of application.
Agents must provide a “Notice of Replacement” when replacing an existing Medigap plan.
Prohibited Practices
Duplication of Coverage – The sale of multiple Medigap policies to one person is illegal.
High-Pressure Tactics – This refers to any sales approach that uses explicit or implicit threats, excessive pressure, or creates a climate of fear.
Cold Lead Advertising – This is an advertising or marketing practice that fails to disclose that an agent may be calling.
Twisting – This is the illegal use of misrepresentation or deception to induce the sale of a policy.
Producer Compensation
First-year commissions cannot exceed 200% of the second-year commissions.
The amount paid in year two must continue for five years.
Long-Term Care Insurance (LTCI)
Long-term care insurance (LTCI) pays for a broad range of services for individuals who need assistance with the activities of daily living (ADLs) for an extended period due to either cognitive impairment or a physical loss of function. These contracts cover at least 12 consecutive months of care in a setting other than a hospital.
Today there are three types of contracts that provide LTCI—life insurance riders, hybrid contracts, and stand-alone LTCI policies.
There are three distinct levels of nursing care—skilled nursing care, intermittent care, and custodial care. Individuals receive this care in nursing homes, assisted living facilities, adult daycare centers, and their own homes.
Skilled Nursing Care
Skilled nursing care is daily nursing and rehabilitative care available 24 hours a day.
Physician-ordered care performed by (or under the supervision of) skilled medical personnel.
Intermediate Care
Intermediate care is intermittent nursing and rehabilitative care.
It’s based on a physician’s orders and provided by skilled medical personnel.
Custodial Care
It’s non-medical assistance with personal needs such as bathing, walking, eating, dressing, or taking medication (the ADLs).
Medically unskilled persons can provide this care.
This care must still be approved and ordered by a physician.
The Delivery of Long-Term Care Services
Formal care is paid care, while informal is unpaid care.
Insurance policies only pay for formal care but may provide a training allowance for informal caregivers.
Nursing homes provide skilled nursing care for persons with medical issues and a significant loss of functions.
Assisted living facilities are residential communities that offer intermittent nursing services and personal services such as housekeeping, onsite meal facilities, and social activities.
Home health care is primarily skilled care that’s delivered by visiting nurses and other medical professionals (e.g., physical therapists).
Home careis personal care that’s delivered by home health aides who help clients perform the activities of daily living.
Home care may include hands-on help and stand-by assistance, both of which fall in the category of substantial assistance.
Adult daycareis designed for seniors who live at home but whose family members cannot stay with them during the day because of work or other commitments.
The level of care provided at adult daycare centers is similar to home health care.
Continuing care communities allow elderly individuals to access progressively more intensive levels of care without leaving the community that has become their home.
Respite care gives informal caregivers a short period of relief or time off. It may be provided at the individual’s home or in a facility.
Long-Term Care Insurance – NAIC Model Minimum Standards
The NAIC model proposes the following standards:
Long-term care insurance provides benefits for at least 12 months of ongoing care.
Long-term care insurance pays benefits based on the loss of function or cognitive impairment.
The policy must have a free-look period and must be guaranteed renewable or better.
The maximum pre-existing condition exclusion is six months.
The maximum pre-existing condition look-back period is six months.
The NAIC model includes the following prohibitions:
Policies cannot require a residential facility stay before receiving home care.
Policies cannot pay significantly greater benefits for skilled care than for other levels of care in a facility.
Policies cannot require prior hospitalization.
Policies cannot supplement Medicare.
Policies cannot require a particular medical condition or terminal diagnosis to qualify for benefits.
Insurers cannot include an impairment rider for specific conditions.
Insurers must give the consumer an outline of coverage.
Producers are principally responsible for determining suitability.
The NAIC definition doesn’t include life insurance contracts that pay a lump-sum accelerated death benefit.
Long-Term Care Riders in Life Insurance Contracts
Accelerated Death Benefit Riders
An accelerated death benefit pays part of a life insurance death benefit upon the diagnosis of a terminal illness.
Some riders pay a monthly benefit if the insured is confined to a nursing home for end-of-life care.
The NAIC does NOT include these riders in its model definition of long-term care insurance.
Long-Term Care Riders
Long-term care riders use part of a life insurance policy’s face amount to pay a monthly benefit for long-term care services.
Insureds qualify for benefits on the same basis as those covered by stand-alone long-term care insurance policies.
LTC Hybrid (Linked) Plans
Hybrid long-term care plans combine annuity (or life insurance) benefits with a traditional long-term care policy.
The long-term care benefits are guaranteed.
The potential long-term care benefit is greater than the underlying contract.
Qualifying for Long-Term Care
LTCI policies have two benefit triggers—a loss of the physical ability to perform at least two ADLs or cognitive impairment.
Loss of the Ability to Perform Two ADLs:
The six recognized ADLS are Bathing, Dressing, Toileting, Transferring, Continence, and Eating
Policies define a loss as the inability to perform two or more ADLs without substantial assistance, which the NAIC defines as either “Hands-on” (physical) assistance, or “Stand-by assistance”
Cognitive Impairment: The NAIC Model LTCI regulation defines a “cognitive impairment” as a deficiency in a person’s:
Short or long-term memory
Orientation as to person, place, and time
Deductive or abstract reasoning, or
Judgment as it relates to safety awareness
Long-Term Care Insurance – Benefit Periods
Policies often require a diagnosis that a person’s impairment is expected to last 90 days or more.
Elimination Period: LTCI policies generally include an elimination period.
Waiver of Premium: The waiver of premium provision suspends premium payments while the insured is receiving benefits.
LTCI policies define benefits as a maximum daily amount that’s payable for a specified duration.
The “pool of money” concept defines benefits as an amount of available dollars, not a number of days.
Daily Benefit Amounts
A higher LTCI daily limit results in a higher annual premium.
Home care limits are often between 50% and 80% of the benefit for care in a facility.
LTCI contracts pay daily benefits either as a fixed daily indemnity or a reimbursement for actual costs.
Long-Term Care Insurance – Optional Provisions
Return of Premium Option: The return of premium rider refunds the premiums paid under certain circumstances, such as when a policy lapses or the insured dies without using the policy’s benefits.
Guarantee of Insurability Option (Rider): The guaranteed insurability rider is inflation protection.
The insured can buy more coverage at future intervals based on an assumed rate of inflation.
Renewability Provisions: All long-term care policies must be issued as at least guaranteed renewable.
Non-Forfeiture Options: An insured receives non-forfeiture benefits if the policy lapses due to the non-payment of premium. Policy owners receive one of the following amounts depending on the policy:
A reduced paid-up policy
Access to the policy’s daily benefit for a shortened period, or
A specified dollar amount
Automatic Inflation Rider (AIR): The automatic inflation rider increases the initial daily LTCI benefit, most often by 5% compounded annually.
Policy Exclusions
Exclusions that are found in a long-term care policy include war, treatment for drug or alcohol abuse, intentionally self-inflicted injury, attempted suicide, nervous disorders, mental illnesses, institutional care received outside the U.S., or losses covered by Workers’ Compensation.
Application and Underwriting
Insurers must ensure that their agents:
Make fair and adequate policy comparisons
Avoid selling excessive insurance; and
Advise buyers that the policy may not cover all costs
Insurers must waive any pre-existing condition limitations on replacement policies.
Agents must provide disclosures at the time of sale. Although the disclosures vary by state, they typically include an Outline of Coverage, LTCI Shopper’s Guide, Personal Worksheet, and Rating Practices.
To prevent an unintentional lapse, applicants may designate a third party to receive any notice of a policy lapse due to non-payment.
Post-claims underwriting is the prohibited practice of approving all applicants and then underwriting risk exposures when a claim is filed (and then often denied).
Post-claims underwriting is an unfair trade practice.
Association and Group Long-Term Care Insurance
Association (Affinity Group) LTCI
An association markets the policy, addresses member questions, and provides objective information.
The association must disclose all compensation received for endorsing the program and the process for selecting it.
Employer Group Insurance
Employers often offer LTCI as a voluntary, employee-paid benefit.
Policies often have simplified underwriting and discounted premiums.
Plans allow access to a more extended family group.
Large employers may also offer the benefit as a true group LTCI plan with some guaranteed issue coverage for employees.
Tax Considerations
Individual long-term care policy premiums are not tax-deductible (i.e., they’re after-tax).
LTCI benefits that reimburse expenses are not taxable.
LTCI policies that pay a flat daily indemnity may pay the insured more than the insured spent. The insured may owe taxes on the excess unless the insured’s long-term care policy is tax-qualified.
Expenses that are paid for long-term care services, including premiums paid for qualified plans, are treated as any other medical expense. They’re deductible in excess of 7.5% of an individual’s adjusted gross income.
Qualified Long-Term Care Policies
The policy cannot pay expenses that are reimbursable under Medicare.
The benefit trigger must be either the loss of a person’s ability to perform two ADLs or severe cognitive impairment.
The policy is at least guaranteed renewable.
The policy doesn’t include a cash surrender value.
The policy only provides long-term care services.
The policy has a 30-day fee-look period.
The policy requires all claims to be based on a medical diagnosis of disability lasting at least 90 days.
Insureds who file claims must have a written plan of care.
Medicare, Medicaid, and LTCI
Medicare
Medicare is medical insurance for individuals who are the age of 65 and older, along with certain individuals who suffer a severe disability.
It provides treatment for acute and chronic illnesses.
Medicaid
Medicaid is a means-tested, public program established to provide medical and supportive services to individuals who are at or below the poverty line.
The federal government and the state share the funding.
Each state administers its own program.
Low-income individuals who are the age of 65 and older can qualify for both Medicare and Medicaid to cover their medical costs more fully.
Senior citizens who lack assets can be eligible for long-term services and supports (LTSS) that are paid by Medicaid.
If an insured transfers assets to family members, the medical assistance administrators will delay the insured’s access to public funding for long-term services and support.
The look-back period is five years.
Long-Term Care Insurance
Long-term care insurance (LTCI) policies are the private alternative to Medicaid.
The long-term care partnership programs in each state encourage individuals to purchase private policies.
Long-Term Care Partnership Programs
Partnership programs are federally supported and state-operated initiatives.
They allow individuals who purchase policies that meet the long-term care partnership standards to protect a portion of those assets that they would otherwise need to spend before qualifying for Medicaid.
Partnership policy requirements vary by state.
All partnership policies must be tax-qualified and must provide inflation protection.
All policies must also meet consumer disclosure requirements.