Risk Management and Insurance

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Treisch12e Chapter 1.ppt

Trieschmann, Hoyt & Sommer

Introduction to Risk
Chapter 1

Chapter Objectives

Explain three ways to categorize risk
List the components of an entity’s cost of risk
Give several examples of risks involving property, liability, life, health, loss of income, and financial losses
Distinguish between chance of loss and degree of risk
Give examples of three types of hazards
Identify the difference between hazards and perils
Explain the evolving concept of integrated risk management
Explain the four steps in the risk management process

Introduction

Risk is often used to mean uncertainty and creates both problems and opportunities for businesses and individuals in every walk of life
Risk regarding the possibility of loss can be especially problematic
If a loss is certain to occur
It may be planned for in advance and treated as a definite, known expense
When there is uncertainty about the occurrence of a loss
Risk becomes an important problem

The Burden of Risk

Some risks involve only the possibility of loss
Risks surrounding potential losses create significant economic burdens for businesses, government, and individuals
Billions of dollars are spent each year to finance potential losses
But when losses are not planned for in advance they may cost even more
Risk of loss may deprive society of services judged to be too risky
For instance, without malpractice insurance many physicians would refuse to practice medicine

The Burden of Risk

Businesses may try to either avoid risk of loss or to reduce its negative consequences
An entity’s cost of risk is the sum of
Expenses of strategies to finance potential losses
The cost of unreimbursed losses
Outlays to reduce risks
Opportunity cost of activities forgone due to risk considerations

FIGURE 1-1 Types of Risk

Pure vs Speculative Risk

Pure risk exists when there is uncertainty as to whether loss will occur
No possibility of gain is presented only the potential for loss
Example includes certain damage to property by fire or flood or the premature death caused by accident and illness.
Speculative risk exists when there is uncertainty about an event that can produce either a profit or a loss
Both pure and speculative risks may be present in some situations. It is important to recognize that many profit motivated, speculative risk decision made by individuals and firms can have an impact on pure risk exposures.

Static vs Dynamic Risk

Static risk, which can either be pure or speculative, stems from an unchanging society that is in stable equilibrium.
Examples of pure static risk include the uncertainties due to such random event as lightning, windstorm and deaths.
Dynamic risk are produced because of changes in society. Dynamic risk can also be pure or speculative.
Examples of source of dynamic risk include urban unrest, increasingly complex technology and changes to legislatures and courts

Subjective vs Objective Risk

Subjective risk refers to the mental state of an individual who experiences doubt or worry as to the outcome of a given event
It is essentially the psychological uncertainty that arises from an individual’s mental attitude or state of mind
Objective risk differs from subjective risk in the sense that it is more precisely observable and therefore measurable
It is the probable variation of actual from expected experience

Sources of Risk

Property risks
Risk that property may be damaged, destroyed or stolen
For example, lightning, tornadoes, hurricanes, explosions, riots, collisions, falling objects, floods, earthquakes, freezing, etc.
Liability risks
Legal judgments may result in payments made to compensate injured parties as well as to punish those responsible for the injuries
Even if the individual is absolved of liability the expenses involved in the defense may be substantial
All individuals who own or use real property are susceptible to liability losses if others are injured on their premises

Sources of Risk

Life and health and loss of income risks
The possibility of the untimely death of a star salesperson
The potential death of a parent with young children
Employees who become ill or injured in accidents
Financial risk
Include credit risk, foreign exchange risk, commodity risk, and interest rate risk
These risks must be identified and assessed in order for the firm to achieve its business goals

Measurement of Risk

Chance of loss
The long term chance of occurrence, or relative frequency of loss
Meaningful only when applied to the chance of loss occurring among a large number of possible of events
Expressed as the ratio of the number of losses that are likely to occur compared to the larger number of possible losses in a given group
Peril
Specific contingency that may cause a loss. For example, one of the perils that can cause loss to an automobile is collision.
Hazards
Conditions that exist which either increase the chance of a loss for a particular peril or tend to make the loss more severe once the peril has occurred.

Hazards

Physical hazard
A condition stemming from the material characteristics of an object
An icy street makes the occurrence of collision more likely to occur. The icy street is the hazard and the collision is the peril
Physical hazard include such phenomena as the existence of dry forest (a hazard affecting the peril of fire), earth fault (a hazard for earthquakes), and the existence of oily rags in a firms storage closet (a hazard for fire).
Moral hazard
Stems from an individual’s mental attitude
Associated with intentional actions designed either to cause a loss or to increase its severity
Also describes the change in attitude that can occur when insurance is available to pay for loss
Such as the tendency for individuals to consume more health care if the costs are covered by insurance.

Hazards

Morale hazard
The mental attitude of a careless or accident-prone person

Degree of Risk

Amount of objective risk present in a situation
Relative variation of actual from expected losses
Range of variability around the expected losses
Objective risk = probable variation of actual from expected losses ÷ expected losses

Degree of Risk

If a loss has already occurred the probable variation of actual from expected losses is zero
Therefore the degree of risk is zero
If it is impossible for loss to occur the probable variation is also zero
In measuring the degree of risk, results are meaningful only in terms of a group large enough to analyze statistically

Management of risk

Risk management
Process used to systematically manage risk exposures
Integrated risk management and enterprise risk management
Intent to manage all forms of risk, regardless of type
Many businesses have special departments charged with overseeing the firm’s risk management activities
The head of such a department often is called a risk manager
Some firms have formed risk management committees
Some firms have created the position of chief risk officer to coordinate the firm’s risk management activities

Risk Management Process

Identify risks
Evaluate risks
Select risk management techniques
Implement and review decisions

Treisch12e Chapter 10.ppt

Trieschmann, Hoyt & Sommer

Risk Management and Commercial Property–Part II

Chapter 10

Chapter Objectives

Identify the perils of transportation and the carrier’s liability on the land and on the sea
List the major types of property insurance available for ocean and inland marine loss exposures
Describe expressed and implied warranties as they’re used in ocean marine insurance
Explain how floater insurance policies help meet the insurance needs of businesses whose properties move from one location to another
Explain the need for and use of title insurance
Explain the difference between insurance and bonding
Identify the differences among burglary, robbery, and theft

Introduction

Various types of policies are used to insure personal property including
Transportation policies that include ships and their cargo
As well as personal property carried by trains and trucks
Such policies include coverages for items that may be transported by land, air, or sea
Floaters that concern property that will be or is capable of being moved from one place to another
Several miscellaneous coverages
Credit, title, and glass insurance

Transportation Insurance

One of the oldest and most vital forms of insurance
All types of trade depend heavily on the availability of insurance for successful and expedient handling
Insurance played a vital part in stimulating early commerce
In Roman times bottomry contracts and respondentia contracts covering the terms under which money was borrowed to finance ocean commerce
The lender of money took as security for loan either the ship itself (bottomry), or the cargo (respondentia)
However, if the ship or cargo was lost as a result of ocean perils, the loan was canceled
If the voyage was successful, the loan was repaid and substantial interest was charged
Mainly because the interest included an allowance for the possibility of loss of the security
Essentially an insurance premium

The Perils of Transportation

There is an inability to control adequately or completely the forces of nature
Or to prevent human failure as it affects the safe movement of goods
With ocean transportation, for instance
Storms can capsize even the largest ocean vessels
Hurricane winds often dump tons of sea water onto a vessel and damage cargo
Engine failure may drive ship aground
With ground transportation
Vehicles can overturn
Rough or careless handling can damage goods

The Liability of the Carrier

The question arises
“Is not the carrier of the goods responsible for their safe movement?”
To some extent, yes
The common law liability of the carrier differs depending on
The country in which the transportation conveyances are chartered
The applicable statutes
Custom
The type of shipping, etc.

The Carrier’s Liability in Ocean Transportation

The ship owner is responsible only for failure to exercise due diligence
The responsibility of the carrier is to
Make the ship seaworthy
Employ proper crew
To equip and supply the ship
Make all holds and other carrying compartments safe and fit for the goods stored there
Exercise due care in loading, handling, and stowing cargoes

The Carrier’s Liability in Ocean Transportation

The carrier is definitely not liable for certain things, including loss resulting from
Errors in navigation or management of the vessel
Strikes or lockouts
Acts of god
Acts of war or public enemies
Seizure of the goods under legal process
Quarantine
Inherent vice of the goods
Failure of the shipper to exercise due care in the handling or packing of the goods
Fire
Perils of the seas
Latent defects in the hull or machinery
Other losses where the carrier is not at fault

The Carrier’s Liability in Land Transportation

The common law liability of the land carrier is considerably greater than that of the ocean carrier
But it is still not absolute
In addition to being responsible for failure to exercise due diligence
The land carrier is responsible for all loss to the goods except for
Acts of god
Acts of public enemies or public authority
Acts or negligence of the shipper
Inherent vice or quality of the goods

The Carrier’s Liability in Land Transportation

Acts of god
Have been interpreted to mean perils such as the earthquakes, storms, and floods that could not have been reasonably guarded against
Fire is not an act of god
Public enemy
Action by forces at war with a domestic government
Not gangsters, mobs, or rioters
Acts of negligence of the shipper
Improper loading or packing and instances where the nature of the goods is concealed
Inherent nature of the goods
Losses due to decay, heat, rust, drying, or fermentation

Need for Transportation Insurance

Many types of transportation losses fall outside the responsibility of the common carrier
Common carriers have been slow to settle losses for which they’re legally liable
In land transportation, the shipper usually sends goods under what is known as a released bill of lading
The effect is to limit the dollar liability of the carrier for any loss to the goods
In return, the shipper obtains a lower freight rate

Ocean Transportation Insurance

Larger ships and more advanced instruments and navigation made long voyages possible
With these changes came the realization that insurance protection was almost a necessity
The major source of underwriting capacity was England
Probably because the country was among the first to develop a complex system of admiralty law
Table 10-1 shows that the U.S. market for ocean marine insurance increased almost 120 percent from 1980 to 2002

Table 10-1: United States Ocean Marine Insurance Premiums

Major Types of Coverage

Chief interests to be insured on ocean voyage
The vessel, or the hull
The cargo
The shipping revenue or the freight received by the ship owners
Legal liability for proved negligence

Major Types of Coverage

Hull policies
May cover the ship only during a given period of time
Commonly subject to geographical limits
May cover builders’ risk while the vessel is being constructed
Cargo policies
May be written to cover losses only during a specified voyage or on an open basis

Major Types of Coverage

Freight coverage
Is an insurable interest because in the event that freight charges are not paid
The carrier has lost income with which to reimburse expenses incurred in preparation for a voyage
Normally made a part of the regular hull or cargo coverage instead of being written as a separate contract
Legal liability for proved negligence
Running down clause (RDC)
Hull owner is protected against third-party liability claims that arise from collisions
RDC is intended to give protection in case the ship owner is held liable for negligent operation of the vessel that is the proximate cause of damage to certain property of others
Protection and indemnity clause is usually added to the hull policy
To provide liability coverage for personal injuries, loss of life, or damage to property other than vessels
Intended to provide liability insurance for all events not covered by the more limited RDC
Except liability assumed under contract

Perils Clause

In 1779, Lloyd’s of London developed a more-or-less standard ocean marine policy containing an insuring clause
Wording has been retained in almost its original form in policies issued today
Clause might be interpreted as an all-risk contract
Because it refers to certain named perils “and all other perils, losses, and misfortunes “
However, the courts have interpreted the quoted phrase to mean “all other like perils”
The insuring clause covers perils of the sea and not all perils
Perils on the sea are not insured unless they’re specifically mentioned
Most modern policies contain a free-of-capture-and-seizure clause
Excludes all loss arising out of war

General Average Clause

Refers to losses that must be partly borne by someone other than the owner of the goods that were damaged or lost
May be partial or total
Whereas particular average losses are always partial, by definition

Sue-and-Labor Clause

The insured is required to do everything possible to save and preserve the goods in case of loss
The insured who fails to do this has violated a policy condition
Loses the rights of recovery
The insured must incur reasonable expenses
Such as salvage, attorney, or storage fees
May be reimbursed by the insurer even if the expenses fail to recover the goods

Abandonment

Actual total loss
Occurs when the property is completely destroyed
Constructive total loss
Occurs when it would cost more to restore than it is worth
The damage must equal 50 percent or more of the ship’s value in an undamaged condition under U.S. law

Ocean Transportation Insurance

Warehouse-to-warehouse clause
Protection afforded under the insuring agreement extends from the time the goods leave the warehouse of the shipper
Until they reach the warehouse of the consignee
Coinsurance
Losses are settled as though each contract contained a 100 percent coinsurance clause

Warranties in Ocean Marine Insurance

Express warranties
Written into the contract and become a condition of the coverage relating to potential causes of an insured event
Implied warranties
Not written into the policy but become a part of it by custom

Express Warranties

FC&S warranty
Both parties agree that there should be no coverage in the case of loss from such perils as capture, seizure, confiscation, weapons of war, revolution, insurrection, civil war, or piracy
SR&CC warranty
Agreed that the insurer pay no loss due to strikes, lockouts, riots, or other labor disturbances
An endorsement is available to add coverage for these exposures
Delay warranty
Insurer excludes loss traceable to delay of the voyage for any reason
Unless such liability is assumed in writing
Trading warranty
Examples include those
Restricting the operation of the ship to a given area
Specifying that the insurance issued represents the true value of the ship or other interests
Restricting the time during which the ship may operate

Implied Warranties

Seaworthiness
If the ship leaves port without being in safe condition
The implied warranty as to seaworthiness has been breached
The entire coverage is immediately void
If the ship leaves port seaworthy but became unseaworthy later on
The warranty is not breached
Involves such factors as having a sound hull, engines in good running order, a qualified captain and crew, proper supplies for the voyage to be undertaken, and sufficient fuel

Implied Warranties

Deviation
Breached when a vessel, without good and sufficient reason, departs from the prescribed course of the voyage
But without the intention of abandoning the voyage originally contemplated
Liability of the insurer ceases the moment the ship departs from its course
Undue delay may constitute a deviation
Even if the ship later resumes course and then suffers a loss
No coverage is available unless later negotiations with the insurer have restored the insurance
Unavoidable necessity and aiding in saving human life may excuse a deviation that has not been authorized by contract

Implied Warranties

Legality
One that is never waived
If the voyage is illegal under the laws of the country under whose dominion the ship operates
The insurance is void

Land Transportation Insurance

With the growth of inland centers of commerce
Pressure grew for an extension of the ocean marine contract to cover the perils of land transportation
The warehouse-to-warehouse clause was developed to meet this need
The marine definition
Inland marine insurance is defined by criteria known as the nationwide marine definition of the National Association of Insurance Commissioners
Does not distinguish between inland or ocean marine insurance
Permits insurance on certain classes of goods and contains a section of prohibited risks
Mobility is the basis for differentiating between permitted risks and prohibited risks

Land Transportation Insurance

Inland transit policy
A basic contract covering domestic shipments that are shipped primarily by land transportation systems
Sometimes called the annual transit floater
Designed for manufacturers, retailers, wholesalers, and others who ship or receive a substantial volume of goods
Usually cover shipments by rail and railway express and by public truckers
Trip transit insurance
Covers on a named-perils basis and is written for a specific shipment of goods between named locations
Especially applicable for the individual or business firm that makes only an occasional shipment
It is used commonly to insure household furniture, merchandise, machinery, or livestock under trip transit insurance contracts

Floater Contracts

The practice of insuring property at a fixed location or while it is being transported by common carrier is well established
The need for coverage is universally recognized
Owners of such goods rely on fairly standard contracts to protect them
A more difficult insurance problem
The risk of loss associated with property that is either not at a fixed location or not being transported by a common carrier

Floater Contracts

Floater policy
Has never been satisfactorily defined
But is generally understood to be a contract of property insurance that satisfies these requirements
Under its terms, the property may be moved at any time
The property is subject to being moved
The property is not at some location where it is expected to remain permanently
The contract insures the goods while they’re being moved from one location to another

Bailed Property

A bailment exists when one has entrusted personal property to another
Such as in the case of laundries, repair establishments, and garages
Special forms of insurance are available to some bailees
To cover loss to bailed goods for which they might be liable
Homeowners forms also cover such losses
But only with respect to the bailor’s interest
Other bailees use floater policies to cover losses to bailed property

Business Floater Policies

Block policies
In insurance language the term block connotes the general idea of a contract that is somewhat broader than the traditional form of inland marine or fire insurance
A block policy covers en bloc, on an all-risk basis, the stock in trade or the equipment belonging to a business firm
No matter where the property is located

Business Floater Policies

Jewelers’ block policy
Written to insure all the stock in the trade of the typical jeweler on an all-risk basis
Items are covered whether they belong to the jeweler or to a customer
Items are covered if they belong to another firm and are in the store on consignment so that the jeweler is legally liable for their safety or has a financial interest in them
Covers not only property belonging to the jeweler as an owner but also property of the customer bailor
An example of a bailee liability insurance

Scheduled Property Floater Risks

Scheduled property floater
A general or skeleton form to which is attached an endorsement describing specific types of property and the conditions under which they are insured
Contractors’ equipment floater
Typical of most floaters on scheduled property
Contractors have a special need for protection against the many perils that can cause loss to movable equipment
Large sums are often invested in a single piece of equipment that is used under basically dangerous conditions
Insures such items as tractors, steam shovels, cement mixers, scaffolding, pumps, engines, generators, hoists, drilling machinery, hand tools, cable, winches, and wagons
Electronic data processing floater (EDP)
Can cover special perils not addressed in the BPP
As computer equipment becomes more portable this property is often utilized by firm’s employees away from the insured premises
Can provide coverage for data and media and for business income and extra expense associated with loss of use of EDP equipment
Valuation can also be on an upgraded value basis
Allows for replacement with the latest state-of-the-art equipment

Credit Insurance

The use of credit has created many complex problems
Including the risk that debts will not be paid off because of the occurrence of some peril that is often outside the control of the debtor

Types of Credit Insurance

Insurance of bonds
Issuing insurance against the default of credit instruments such as municipal bonds
To improve the instrument’s investment quality and reduce interest costs
Credit life and credit accident/sickness
Credit life insurance
Insurance against failure to pay a debt because of the death of the borrower
Domestic merchandise credit insurance
Insures against the insolvency of domestic debtors on credits arising out of the sale of merchandise on an unsecured basis
Government credit insurance
Deposit insurance program
FDIC insures accounts held in insured institutions up to a maximum of $100,000
Cash loan credit insurance
Government agencies sponsor programs to insure cash loans made by banks to individuals and certain business enterprises that cannot obtain credit from other sources

Title Insurance

A device by which the purchaser of real estate may be protected against losses in case it develops that the title obtained is not legitimate or can be made legitimate only after certain payments are made
Defects in titles may stem from sources such as
Forgery of titles, forgery of public records, invalid or undiscovered wills, defective probate procedures, faulty real estate transfers
A person may occupy real property for years only to find that the one who conveyed the title was not the rightful owner
If the title is defective, title insurance does not guarantee possession of the property

The Title Insurance Contract

No standard title insurance contract exists
But the general form of the insuring clause is fairly uniform
The insurer agrees to indemnify the owner against any loss suffered
“By reason of the marketability of the title of the insured to or in said premises or … from all loss and damage by reason of liens, encumbrances, defects, objections, estates, and interests, except those listed in schedule B”
Schedule B is a separate endorsement which lists all title defects or rights in the property found during the title search

The Title Insurance Contract

Defense
Under the typical policy, the insurer agrees to defend the insured in any legal proceedings brought against the insured concerning the title
Assuming that the action involves a source of loss not excluded under the contract
The insured is required to notify the insurer of any such proceedings and to cooperate in any legal action by the insurer
Premium
Paid only once, and it keeps the policy in force for the named insured for an indefinite period
If the property is transferred, a new premium must be paid for the protection of the new purchaser
The old policy is not assignable to the new buyer

Glass Coverage Form

Plate glass has assumed great significance in modern architecture
Not only as protection against the elements but also because of its advertising value
The BPP with the special causes of loss form does provide coverage for glass as does the BOP
However all three causes of loss forms in the BPP have limitations that may make separate glass coverage necessary

Glass Coverage Form

A comprehensive glass policy provides a place in the declarations for a detailed description of each plate of glass, the value of lettering and ornamentation, the position of the plate in the building, and its size
The insuring clause indicates that the insurer agrees to pay for
Damage to the glass and its lettering or ornamentation by breakage of the glass or by chemicals accidentally or maliciously applied
The repair or replacement of frames when necessary
The installation of temporary plates or the boarding up of windows when necessary
The removal or replacement of any obstructions made necessary in replacing the class
No dollar amount of liability is stated
It is the practice of insurers to replace the glass insured under the policy and to do so immediately after the loss
Insurance on the replacement glass continues as before without extra premiums

Crime

Crime against property in the United States is one of the most serious and most underinsured perils
It is estimated that less than 10% of loss to property from ordinary crime is insured
The problem has become so serious in recent years that the Federal Government has entered the field of burglary and robbery insurance

Crime Insurance and Bonds

Surety bonds and fidelity bonds
Provide guarantees against loss through the dishonesty or incapacity of individuals who are trusted with money or other property and who violate this trust
Theft insurance
Provides coverage against a loss through stealing by individuals who are not in a position of trust

Insurance vs Bonding

Bond
A legal instrument whereby one party (the surety) agrees to reimburse another party (the obligee)
Should this person suffer a loss because of some failure by the person bonded (the the principal or obligor)
If a contractor furnishes a bond to the owner of a building
The surety will reimburse the owner if the contractor fails to perform as agreed and thereby causes a loss to the owner

Insurance vs Bonding

A bond may appear to be a contract of insurance, but some important differences should be considered
In bonding, the surety sees as its basic function the lending of credit for a premium
It expects no losses and reserves the legal right to collect from the defaulting principal
The nature of the risk is different
Usually a bond guarantees the honesty of an individual and the capacity and ability of that individual to perform
In bonding, if the principal defaults and the surety makes good to the obligee
The surety enjoys the legal right to attempt to collect for its loss from the principal
The bonding contract involves three primary parties
Whereas the insurance contract normally involves only two
In insurance, the contract is usually cancelable by either party
In bonding, the surety is often liable on the bond to the beneficiary, regardless of breach of warranty or fraud on the part of the principal
Also, the bond often cannot be canceled until it has been determined that all the obligations of the principal have been fulfilled

Fidelity and Surety Bonds

Strictly speaking, all bonds are surety bonds
However it is convenient to classify them as fidelity bonds and surety bonds
Fidelity bonds
Indemnify an employer for any loss suffered at the hands of dishonest employees
Surety bonds
Sometimes known as financial guaranty bonds
Contracts among three parties
The principal (obligor), the person protected (obligee), and the insurer (surety)
The surety agrees to make good on any default on the part of the principal in the principal’s duty toward the obligee

Types of Fidelity Bonds

Bonds in which an individual is specifically bonded
Individual bond
Names a certain person for coverage
Schedule bonds
May list many employees by name and bond them for specific amounts
Bonds are known as name schedule bonds

Types of Fidelity Bonds

Blanket bonds
Have several advantages over individual or schedule bonds
Automatic coverage of a uniform amount is given on all employees
New employees are automatically covered without need of notifying the surety
If the loss occurs, it is not necessary to identify the employees who are involved in the conspiracy in order to collect
Because blanket bonds are subject to rate credits for large accounts
The cost may be no more than that of schedule bonds
Heavily favored among most business firms
Two major types of blanket bonds
Blanket position bond
Commercial blanket bond

Types of Surety Bonds

Construction bonds
Contract construction bond
Sometimes called a final or performance bond
Guarantees that the principals involved in construction activities will complete their work in accordance with the terms of the construction contract and will deliver the work to the owner free of any liens or other debts or encumbrances
Bid bond
Guarantees that if the bidder is awarded the contract at the bid price and under the terms outlined
The bidder will sign the contract and post a construction bond

Burglary, Robbery, and Theft Insurance

Burglary
Defined somewhat narrowly to mean the unlawful taking of property from within premises closed for business
Entrance to which has been obtained by force
Visible marks of the forcible entry must be present
Robbery
The unlawful taking of property from another person by force, by threat of force, or by violence
Personal contact is the key to understanding the basic characteristic of the robbery peril
Robbery means the forcible taking of property from a messenger or a custodian
Theft
Includes all crimes of stealing, robbery, or burglary
Forgery
Involves the passing of bad checks
Among the most common of types of dishonesty losses and are among the easiest to prevent

Business Coverages

A variety of coverages are available to insured against crime losses
Table 10-2 lists several of the crime coverages available in the CPP
A firm can pick and choose from these options based on the specific crime exposures it faces

Table 10-2: Basic Crime Coverages under the CPP

Federal Crime Insurance

The Federal Government began to offer crime insurance to the public in 1971 in certain states
Coverages are noncancelable and include burglary, robbery, and theft
To be eligible for federal crime insurance the insured must
Live in a state deemed eligible for the crime coverage
Meet certain protective device standards
Agree to permit inspections of the premises at reasonable times
Agreed to report to the insurer all crime losses, whether a claim is filed
Accept the form of coverage prescribed by the Federal Insurance Administration

Risk Management of the Crime Peril

Assumption
Many firms retain the crime risk, as many losses are small and expensive to insure
Insurance
Suffers from serious weaknesses as a way to handle crime risk
Adverse selection is present
Due to the tendency of those applicants who are most likely to suffer loss (such as pawnshops and jewelry and liquor stores) to apply for the most coverage
A moral hazard exists
Temptation of those who are insured to take advantage of opportunities to arrange a robbery or burglary with an accomplice in order to collect illegally from the insurance company
Often difficult to establish the amount of the loss when it occurs
Because of inadequate inventory control methods or lack of adequate records

Treisch12e Chapter 12.ppt

Trieschmann, Hoyt & Sommer

Workers’ Compensation and Alternative Risk Financing

Chapter 12

Chapter Objectives

State the different alternatives available to fund workers compensation losses and the relative importance of each alternative
Describe how workers’ compensation insurance developed and identify recent trends in the field
List coverages provided in a worker’s compensation policy
Calculate retrospective insurance premiums and understand how a retrospective insurance plan can be used as an alternative to self-insuring workers’ compensation
Determine the cash flow benefits of self-insuring workers’ compensation
Identify all the functions a self-insurer must perform
Understand captive insurance companies and how risk managers can use them

Workers’ Compensation Insurance

Covers the loss of income and the medical and rehabilitation expenses that result from work-related accidents and occupational disease
Single largest line of commercial insurance
Growth in workers’ compensation premiums was very high during the 1970s but it slowed during the 1980s
In the early 1990s this line suffered significant losses
However, by the mid 1990s high investment returns had returned this line to profitability
Intense price competition returned
Developed in the latter half of the 1800s in Europe and in the early 1900s in the United States
Because of hardships placed on workers by common law
A worker receives a guarantee of compensation
The employer is protected from employees seeking damages for work-related injuries

Major Reform

The National Commission on State Workmen’s Compensation laws was created to determine the extent to which state laws provided adequate, prompt, and equitable compensation to injured workers
Generally the studies raised doubts about the effectiveness of workers’ compensation as it operated in the United States at the time the studies were made
Since then state legislatures have passed numerous reforms to comply with the commission’s recommendations, including
Full coverage for medical care and rehabilitation
Adequate income replacement
Coverage of all workers
Cost-of-living adjustments
Improved data systems

Insurance Methods

Three methods by which an employer can provide employees with the coverage required by law
Purchase a worker’s compensation and employer’s liability policy from a private commercial insurer
Purchase insurance through a state fund or a federal agency set up for this purpose
Self-insure

Private Insurance

The standard workers’ compensation and employer’s liability policy has two major insuring agreements
Coverage A
To pay all claims required under the workers’ compensation law in the state where the injury occurred, including
Occupational disease benefits, penalties assessable to the employer under law, and other obligations
Coverage B
To defend all employees’ suits against the employer and pay any judgment resulting from the suits
Employee suits are surprisingly frequent because methods are constantly being found to bring an action against the employer in spite of the intention of the statutes to discourage such suits
The insured deals directly with the employee and is primarily responsible to the employee for benefits
Thus, even if the employer should go out of business, the injured employee’s security is not jeopardized

State Funds and Federal Agencies

In 20 states, an employer has the choice of using a private insurer or a state fund as the insurer of workers’ compensation
In five states, the employer does not have this choice
Must insure in an exclusive state fund or, in three of those states, may self-insure
In addition to state funds, federal agencies provide for workers’ compensation coverage

Self-Insurance

In most states, under specified conditions, an employer is permitted to self-insure the workers’ compensation coverage
Self-insurance is generally not permitted in Canada
Self-insurers are generally large concerns with adequate diversification of risks and financial resources that enable them to qualify under the law

Evaluation of Insurance Methods

Data from National Academy of Social Insurance show that
Private insurers incurred 55 percent
Self-insurers 23 percent
Federal and state funds 22 percent of the cost of workers’ compensation in 2001
Private insurers are preferred by most employers in states where they’re permitted to operate
Offer the employer an opportunity to insure in one contract all the liabilities likely for damages arising from work-connected injuries
Private insurers offer more certainty in handling out-of-state risks
While the expenses of state funds are somewhat lower than those of private insurers
The difference is not as great as rough comparisons often lead one to believe
Self-insurance has the handicap that it is necessary for the insured to enter the insurance business
Which is essentially unrelated to the insured’s main operations
Also, contributions to a self-insurance fund are often not tax deductible
Experience rating and retrospective rate plans enable large firm to use a private insurer’s facility in transferring as much or as little of the risk as is desired at a modest cost

Employment Covered

Compensation laws do not cover all workers
For example, domestic labor and farm labor are often excluded
Employers with only a few employees are excluded under compulsory laws
Only about 9 out of 10 workers are covered
Liability suits are necessary if an excluded worker is to recover anything
Even though a basic purpose of compensation legislation was to eliminate this condition as a prerequisite for employee recoveries
It is a small employer who is excluded from compensation laws and who is most likely to be the object of such suits
This often means that
A successful suit will bankrupt the employer
If the employer is more or less judgment-proof, the injured worker will recover nothing

Income Provisions

Compensation laws recognize four types of disability for which income benefits may be paid
Permanent and temporary total disability
Permanent and temporary partial disability
Generally limit payments by specifying the maximum duration of benefits and the maximum weekly and aggregate amounts payable

Income Provisions

For permanent total disability benefits, most states permit lifetime payments to the injured worker who is unable to perform the duties of any suitable occupation
In the remaining states, typical limitation is between 400 and 500 weeks of payments
There is often a limitation on the aggregate amount payable
A common limitation that income benefits cannot exceed about 2/3 of the worker’s average weekly wage or some dollar amount
Weekly benefits for temporary total disability are usually the same as for permanent total disability
Except that often there is a lower maximum aggregate limitation and a shorter time duration for such payments
Most workers’ compensation laws specify the lump sums may be paid to a worker as liquidating damages for a disability
Such as the loss of a leg or an eye
Loss is permanent but does not totally incapacitate the worker

Survivor Benefits

In the case of fatal injuries, the widow or widower and children of the worker are entitled to funeral and income benefits
Subject to various limitations
The maximum benefits to the widow or widower are generally less than they would have been to the disabled worker
But if the survivor has children, these benefits are comparable to what the worker would have received for permanent total disability
Highway crashes represent the single largest cause of workplace deaths
Accounting for ¼ of all fatalities in workers’ compensation

Medical Benefits

Most workers’ compensation laws provide relatively complete medical services to an injured worker
Including allowances for certain occupational diseases
In all jurisdictions unlimited medical care is provided for accidental work injuries
And broad coverage for occupational disease is provided

Rehabilitation Benefits

Provided by most states
Generally recognized that the quantity and quality of the services are subject to wide variation
Federal Vocational Rehabilitation Act includes federal funds to aid states in vocational rehabilitation of individuals who are injured in the workplace

Benefits

There is great variability between the states
Table 12-1 shows descriptive statistics for some states
A Federal Employees Compensation plan covers federal employees
It has the highest benefit of any plan

Table 12-1: State Workers’ Compensation Provisions

Experience Rating

Widely used in workers’ compensation insurance
General theory is that an employer has some control over the loss ratio and is entitled to a credit for good loss record
Or should pay a higher rate if the loss record is poorer than average
The details of the plan are very complex
General procedure is to determine, for each occupational class, some expected loss ratio against which the insured’s actual loss ratio is compared
Not all losses suffered by an insured are counted
The plan uses a stabilizing factor so that unusually large losses cannot operate to increase the small employer’s rate unreasonably
For the large employer, the employer’s loss experience becomes more important as its expected losses become greater
Experience rating in workers’ compensation gives employers an incentive to do whatever is within their control to prevent accidents

Retrospective Rating

Entirely voluntary agreement between the insured and the insurer
If the employer’s payroll is such that a standard of premium of $1,000 or more is incurred
Is considered that the firm is large enough to develop experience that is partially credible
Standard premium is defined as what the employer would have paid at manual rates after adjustment for experience rating
But before any adjustment for retrospective rating
In practice, an employer likely to use retrospective rating is generally considerably larger than this

Retrospective Rating

There are various plans of retrospective rating
The employer must choose one
Which plan should the employer choose?
Essentially, this question reduces to one of how much risk the employer is willing to assume
The basic retrospective rating formula is given by
R = [BP + (L)(LCF)]TM
R = retrospective premium payable for the year in question
BP = a basic premium designed to cover fixed costs of the insurer
L = losses actually suffered by the employer
LCF = loss conversion factor designed to cover the variable cost of the insurer
TM = tax multiplier designed to reflect the premium tax levied by the state of the insurer’s business
The basic premium declines as the size of the employer increases
Differs with the type of plan used
The formula is subject to the operation of certain minimums and maximums
Both of which decline as the size of the employer increases

Risk Management and Workers’ Compensation

Workers’ compensation is one of the most frequently self-insured coverages in the risk management area
Characterized by relatively high-frequency and low-severity losses
In recent years, the motivation to self-insure a portion or all of this exposure has increased
Due to rapidly rising premium levels
When premiums are high, the cash flow benefits of self-insurance are greater
Self-insurance becomes more attractive

Factors Favoring Self-Insurance

Lower administrative expenses
When a firm establishes a self-insured workers’ compensation program, it eliminates most of the premium paid to an insurer
Cash flow benefits
Probably greater than the cost saving aspects of self-insuring workers’ compensation
Under a traditional insured plan, the insured pays the premium
And at some later date the insurer pays all the claims
In the aggregate, this arrangement provides the insurance company with a large amount of money that can be invested in income-producing securities until the claims are paid
When a firm self-insurers, it holds the money until the claims are paid
As it takes several years to pay all the claims from a given year’s loss exposure
The self-insurer has the use of some of the funds for a fairly long time
There’s a perpetual sum available for investment in securities or in the self-insured’s own operations

Factors Favoring Self-Insurance

Claims-conscious management
Management often becomes more claims conscious when it is paying directly for workers’ compensation losses
When insurers are paying the claims, only an indirect effect is seen by operating managers
As a consequence, workers’ compensation losses often decline when a firm initiates a self-insurance program

Factors Against Self-Insurance

Size of firm
A company must be financially capable of retaining self-insured losses
It must have a large enough exposure so that it can predict much of its losses
Generally, a firm with an annual premium of less than $250,000 will not self-insure
Stability of workforce
Concerns how much turnover of the firm has and how rapidly it is expanding
Newly employed people, as well as younger employees, have higher accident rates than more mature workers
New plants tend to have higher accident rates than established ones

Factors Against Self-Insurance

Tax consequences
Under a self-insured program, one cannot take a tax deduction until the funds are actually paid
Availability of services
When a firm self-insures, it must provide or purchase services that were formally provided by the insurance company
These services include
Loss control activities, claims adjusting, data processing, and program administration
A firm can usually buy these services from companies that specialize in such activities

Excess Insurance

Most companies do not completely self-insure the workers’ compensation exposure
Because of the catastrophic nature of certain types of workers’ compensation losses
Such claims as long-term disability or death may add up to hundreds of thousands of dollars
To prevent such circumstances, self-insurers purchase excess insurance
Basic types of excess insurance
Specific
The self-insurer absorbs the first x dollars on any loss
Aggregate excess
The policy operates like an aggregate deductible
Typically, the aggregate limit is at least the level of what the workers’ compensation premiums would have been if insurance had been purchased

Potential Problems

Problems include, but are not limited to
Financial ability to retain losses
A large enough exposure base to be able to predict losses accurately
Actual management of the plan
Establishment of a loss prevention and protection program
Management of a risk management information system
Availability of excess-of-loss insurance
Top management commitment to the plan

Alternative Workers’ Compensation Risk Financing Strategies

Various financing plans for workers’ compensation programs often use a letter of credit issued by a financial institution on behalf of the insured
By using this approach, an insured obtains maximum cash flow and tax benefits
However, there are caveats that need to be considered
Each year a letter of credit must be issued
Letters of credit cost money and they’re more expensive than they used to be
The firm’s overall debt limit could be adversely affected
IRS is taking a tougher position on plans where the insured tries to take a tax deduction for the full premium but pays only a small part in cash

Alternative Workers’ Compensation Risk Financing Strategies

Alternative financing strategies include such programs as
Investment credit
Require one to pay the full premium in cash at the beginning of the year, but give the insured investment earnings from the premiums
Compensating balance
Reduce the firm’s obligations to banks that lend money to the insured

Captive Insurance Companies

General, auto, and product liability cases can give rise to large awards
For example, Domino’s Pizza, Inc., lost a lawsuit concerning an auto accident in which one of its delivery persons ran a red light and injured someone
Part of the evidence involved Domino’s promise to deliver pizza in 30 minutes and that drivers were not driving in a reasonable manner
The jury returned a verdict for $78 million
A captive insurance arrangement would have been useful in financing the loss

Special Tax Status of Insurance Companies

Insurance companies are the only type of company that can establish loss reserves and take a tax deduction for the loss’s accrual
Other corporations can take tax deductions for loss only after the loss has been paid
Insurance companies can pre-fund losses with pretax dollars
A manufacturer must use after-tax dollars
If a risk manager could create an insurance company or an organization that would pass the IRS definition of an insurance company
Pretax dollars could be used to fund self-insured losses of his or firm

Operation of a Captive

Captive insurer
A subsidiary formed by a company that is called a parent
It is a captive of the parent because the parent controls it
Captive insurance companies became very popular in the 1960s and 1970s
A firm paid a premium to the subsidiary and took the deduction
The captive recorded the premium as revenue and increased its loss reserve by almost an equal amount
So the captive did not show a profit
Resulted in a 100 percent tax deduction for the parent
The captive held the funds; it did not earn a profit, so did not pay any income taxes
IRS began to challenge this arrangement in the courts
Rule slowly involved that a parent could not take the deduction unless a subsidiary had a significant amount of non-related risks
The rule required a significant number of exposures that were not part of the parent organization

Onshore Versus Offshore Captives

Creating a captive insurance company in the United States is not a difficult task
But it is relatively expensive
Most states have minimum capital requirements that can run as high as several million dollars
An onshore captive is subject to the state laws in which it is incorporated
However offshore captives are not subject to such restrictive regulatory laws
Little upfront money is needed to start offshore captives
Offshore captives have very favorable income tax laws

Other Attributes of Captives

When a firm writes its insurance in a captive
It can write the policy exactly the way it wishes
Often the risk manager of the parent firm is the CEO of the captive
So the parent can make the insurance policy as liberal as it desires
For some firms that have sought to manage risk on a broader enterprise-wide basis
Captives have offered a useful tool for financing risks that have not traditionally been addressed in the insurance market
Such risks include reputation risk, branded risk, residual value risk on vehicle leases, and weather risk
In 2003 some firms begin to fund employee benefits through their captives

Other Attributes of Captives

Regulatory restraints on investments are less
Captive can invest its funds almost any way it wishes
Captive insurance companies can have direct contact with reinsurers
It is through reinsurance that captives can serve as a funding vehicle for self-insured plans and reduce the probability of catastrophic losses

Potential Problems of Captives

Demand time and energy of the risk manager
Require the firm to incorporate the captive either on- or offshore
Which takes time and money
The firm must have enough of a loss exposure to warrant these expenses
For this reason companies often group together to form association or industry captives
If a parent creates a single-owner captive the tax deductibility of payments will be problematic
IRS may require a substantial amount of unrelated business
One advantage of the association or industry captive is that it has diverse ownership and insures a significant amount of unrelated business

Potential Problems of Captives

Hard reinsurance markets may make it difficult for the captive to reinsure its business
Without reinsurance, the captive can be a very dangerous undertaking
Sometimes it is difficult for the risk manager to justify the continued use of a captive in extremely soft markets
The temptation may arise to shut down the captive because insurance is so cheap
However, it is important for the risk manager to have continuity in his or her own risk management program
Changing from insurance to a captive and then back again can break the continuity of the plan and cost more money
Financial officers often dislike captives because once money is placed or funds accumulate in a captive
It is difficult to obtain the money except for risk management purposes
Table 12-5 shows the most popular locations for captive insurance companies

Table 12-5: Most Popular Locations for Captive Insurance Companies, 2002

Treisch12e Chapter 13.ppt

Trieschmann, Hoyt & Sommer

Risk Management for Auto Owners—Part I

Chapter 13

Chapter Objectives

Define the key terms in the personal automobile policy
Identify the major parts of the personal automobile policy
State four major exclusions of the personal automobile policy
Distinguish between collision and loss other than collision
State limitations on the insurance company’s right to cancel an auto insurance policy
Describe the various approaches to dealing with the problem of uninsured drivers
Describe the key factors that determine variation in auto insurance premiums across individuals

The High Cost of Automobile Losses

Automobile losses represent exposures to risk that nearly all individuals and risk managers must consider
Of the $377 billion spent by individuals and business on property-casualty insurance premiums in 2002
About 43% was for auto insurance
The human toll of auto losses is very high
Over 40,000 Americans die every year in auto accidents
However substantial progress has been made over the years in improving the situation
Table 13-1 shows fatality rates for recent years
A disproportionate number of automobile accidents involve young drivers
Over the last several years falling accident rates indicate a significant improvement in driving records
May be explained by society’s greater emphasis on loss prevention and safer cars
And the reduction in the number of youthful drivers

Table 13-1: Death Rate per 10,000 Cars

Insurance Claims

Insurers have been faced with rising claims for most types of automobile insurance protection
Table 13-2 shows statistics illustrating the level to which claims have risen
Notice that the average property-related losses have risen steadily over the years
While average bodily injury losses have fluctuated
Average collision and property damage liability claims rose dramatically faster than inflation from 1992-2002
While average bodily injury liability losses fell slightly over the same time period

Table 13-2: Average Insurance Claims

Insurance Claims

The federal government has adopted some minimum vehicle safety and antipollution standards
Aimed at improving the environment in which automobiles operate
Table 13-3 lists some 2000-2002 passenger autos with respect to injury claims frequency
These frequencies do not reflect only the actual safety of the vehicles—they also reflect who is driving the vehicle
Table 13-4 shows the relative average collision loss payment per insured vehicle
This number varies widely across different vehicles

Table 13-3: Relative Injury Claims Frequency per Insured Vehicle …

Table 13-4: Relative Average Collision Loss Payments per Insured Vehicle …

The Need for Insurance

What should the average driver do to protect against the financial consequences of the high cost of automobile accidents and the substantial probability of being involved in one?
Risk managers of large corporations that own many automobiles often retain the risk of physical damage to the vehicles
However, for nearly all individuals, the answer has been insurance
Despite its high cost
In many states auto liability insurance is a legal requirement
Self-insurance is not usually an option as few individuals own more than two or three automobiles

Personal Automobile Policy (PAP)

Introduced in 1977 as part of the consumer movement designed to produce easier-to-read insurance policies
Replaced the more difficult to read Family Automobile Policy
Eligibility
A car must be owned or leased by an individual or jointly owned by a husband and wife
PAP is primarily designed for private passenger cars used for pleasure or business
But a pickup truck or van used in farming may be insured as may a pickup truck or van that is used to deliver or transport goods

Definitions

You and your are used to refer to the named insured and spouse, if a resident of the same household
We, us, and our refer to the insurance company
No fault means that the insured does not have to prove another person negligent before compensation can be received from an insurer

Definitions

The term covered auto includes these categories
Any vehicle shown on the declarations page of the policy
Any of the following types of vehicles that you acquire ownership of during the policy period
A private passenger auto
A pickup truck or van meeting certain requirements
Any trailer you own
Any auto or trailer you do not own
While used as a temporary substitute for any other vehicle described in this definition that is out of normal use because of its breakdown, repair, servicing, loss, or destruction

Definitions

With respect to replacement vehicles
One must only notify the insurer in order to obtain coverage for physical damage to the auto
Liability protection is automatically provided for the policy term
The insurer must be notified to obtain physical damage coverage because there is a high probability that a greater exposure exists
A trailer is defined as
A vehicle designed to be pulled by a private passenger-type auto, pickup or panel track, or van
It also includes a farm wagon or farm implement towed by one of these vehicles

Definitions

A family member is defined by the PAP as
A person related to you by blood, marriage, or adoption who is a resident of your household
Occupying is defined as
In, upon, getting in, on, out, or off
In the PAP, bodily injury means bodily harm, sickness, or disease, including any death that results
Business means trade, profession, or occupation
Property damage is defined as physical injury to, destruction of, or loss of use of tangible property

Personal Auto Policy Components

PAP has six major components
Liability
Medical payments
Uninsured motorist
Physical damage to your auto
The first four sections provide four different coverages
The definitions of terms may vary between sections
Duties after an accident or loss
General provisions
Insurance policies must be read very carefully in order to be properly understood

Liability

The insurer promises to pay bodily injury and property damage claims for which any insured becomes legally responsible due to an auto accident
The insurer will either settle or defend, at its own discretion, any covered claim or suit
The insurer agrees to pay for all defense costs, and these are paid in addition to the policy limits
There is no duty to defend the insured in situations where the coverage is excluded
Or after the limits of liability for direct damages have been reached
Many courts have held the insurance company’s duty to defend is greater than the duty to pay damages

Liability

The policy defines the insured as follows
For the ownership, maintenance, or use of any auto or trailer, you or any family member
Any person using your covered auto
For your covered auto, any person or organization
But only with respect to legal responsibility for acts or omissions of a person for whom coverage is afforded under liability coverage
Would apply when a fellow employee drives your car on company business
Your employer is covered under your policy if an accident occurs and your employer is sued
For any auto or trailer, other than your covered auto, any person or organization, but only with respect to legal responsibility for acts and omissions of you or any family member for whom coverage is afforded under liability coverage
This provision applies only if the person or organization does not own or hire the auto or trailer
Would apply when you drive a fellow employee’s car and have an accident
The employer is covered under your policy if a lawsuit results

Supplementary Benefits

In addition to the policy limits
Bail bonds up to $250 are covered for an accident resulting in bodily injury or property damage
A bail bond posted for a speeding violation or driving while intoxicated is not covered unless bodily injury or property damage occurs
Premiums on appeal bonds and bonds to release attachments are insured
Interest that accrues after a judgment and reasonable expenses incurred at the insurer’s request are also included
Up to $200 per day is available for loss of earnings resulting from attending trials or hearings at the insurer’s request

Limit of Liability

Defined using the “split limits” approach
The limit is described by three numbers
Such as $100,000/$300,000/$50,000
The first number is the maximum limit of liability for all damages arising out of bodily injury to any one person
The second number is the maximum limit for all damages for bodily injury resulting from any one accident
Regardless of the number of persons involved
The third number is the limit of liability for all property damage resulting from any one accident

Exclusions

No coverage exists for persons who intentionally cause a loss
Damage to property owned or being transported by an insured is excluded
As is property rented to, used by, or in the care of an insured
Except for damage to a residence or private garage
Vehicles operated as a public or livery conveyance are not covered
However share-the-expense car pools are not affected by this exclusion

Exclusions

If an employee of the insured is injured, the insured’s PAP does not provide liability coverage
Unless the injury is to a domestic employee for whom workers’ compensation is not required
No protection is given to someone in the automobile business unless the insured’s covered auto is being driven by
The insured
A family member
Any partner, agent, or employee of the insured or any family member

Exclusions

For those in any other type of business, liability coverage is provided for the business use of private passenger cars and pickup trucks and vans
No requirement is made in the PAP that the insured have permission to operate the vehicle involved in an accident
However, the policy excludes liability coverage for anyone using a vehicle without reasonable belief that he or she is entitled to do so
Another exclusion excludes coverage for injury or damage for which the insured has coverage under a nuclear energy liability policy

Exclusions

No coverage is provided for the use of any vehicle with fewer than four wheels
Thus, motorcycles are not covered
An auto (other than the covered auto) that is owned by you or furnished or made available for your regular use is excluded
Any vehicle, other than the covered vehicle, that is owned by, furnished to, or available for the regular use of any family member is excluded
An exception to this exclusion exists when such a vehicle is driven by the named insured or spouse
Liability coverage is excluded for any vehicle participating in an organized racing or speed contest while located inside a racing facility

Other Liability Conditions

Another provision in the PAP is out-of-state coverage
Including coverage in a Canadian province
If you have an accident in a state having higher required liability limits than your state
The policy will pay up to the higher limits
PAP liability coverage can be primary or excess
When your owned auto is involved your policy is primary
When your policy applies to a nonowned vehicle, it is excess
If two policies are applicable to the same owned auto
The PAP will pay its pro-rata share of the loss

Medical Payments

PAP will make medical payments on a no-fault basis for reasonable and necessary medical expenses caused by an auto accident and sustained by an insured
Such expenses must be incurred and paid within three years of the accident
If more treatment is needed but has not yet been paid, the policy will not cover it
For medical payments, insured means
You or any family member when occupying, or as a pedestrian when struck by, a motor vehicle designed for use mainly on public roads or by a trailer of any type
Any other person while occupying your covered auto

Exclusions

The medical payments coverage does not apply to any injuries sustained when riding a motorcycle
But if a motorcycle collides with you or your vehicle, you are insured
No protection is available while your vehicle is used to carry people or property for a fee
Share-the-expense carpools are exempted from this restriction
Any bodily injury received while occupying a vehicle located for use as a residence or premises is also excluded

Exclusions

No coverage is available for injuries occurring in the course of employment if workers’ compensation is supposed to provide benefits
No protection exists while occupying an owned auto (other than your covered auto) or one furnished or available for your regular use
No coverage exists while occupying a vehicle without a reasonable belief that you are entitled to do so
Injuries sustained by occupying a vehicle while it is being used for business is excluded unless the vehicle is
A private passenger auto
An owned pickup or panel truck or van
A trailer used with a vehicle described in the first two
Other exclusions are losses due to war, radiation, and racing

Other Conditions

The medical payments limits are on a per-person basis
PAP specifically states that the maximum amount receivable is the per-person limit stated on the declarations page
This limit is the maximum, regardless of the number of autos insured
The policy states that no one can collect under the medical payments portion of the policy as well as under the liability or uninsured motorists portion
PAP pays on a pro-rata basis in cases where other insurance applies on an equal basis
However, with respect to nonowned automobiles, it is always excess

Uninsured Motorist

Pays for your bodily injuries that result from an accident with another vehicle if the other driver is negligent and does not have any insurance
Or has insurance less than that required by law
Punitive damages are not covered
Insured persons include
The named insured and family members
Any person occupying your covered auto
Other persons who are entitled to recovery because of injury in the first two categories
Insureds purchase uninsured motorist insurance to protect themselves against other drivers who are uninsured
While many states require or strongly encourage liability insurance, many people do not purchase it
Table 13-5 gives the uninsured motorist rates for the nine highest-rate states

Table 13-5: State Uninsured Motorist Rates (in %)

Uninsured Motor Vehicles

A land motor vehicle or trailer of any type with the following specifications
One to which no bodily injury liability bond or policy applies at the time of the accident
One to which a bodily injury liability bond or policy applies at the time of the accident
But with a limit for liability less than the minimum limit specified by the financial responsibility law of the state in which your covered auto is principally garaged
One that is a hit-and-run vehicle whose operator or owner cannot be identified and that hits you or any family member, a vehicle occupied by you or any family member, or your covered auto
One to which a bodily injury liability bond or policy applies at the time of the accident
But that is covered by a bonding or insuring company that denies coverage or becomes insolvent

Uninsured Motor Vehicles

None of the following is considered an uninsured motor vehicle
One owned by, furnished to, or available for the regular use of you or any family member
One owned or operated by a self-insurer under any applicable motor vehicle law unless the self-insurer becomes insolvent
One owned by any government unit or agency
One operated on rails or crawler treads
One designed mainly for use off public roads while not on public roads
One located for use as a residence or premises

Exclusions

In addition to the exclusions under the definition of an uninsured motor vehicle
The uninsured motorist coverage has five exclusions for bodily injury
If the injury is sustained while occupying, or when struck by, a motor vehicle or trailer of any type owned by you or any family member that is not insured for this coverage
If the claim is settled by the insured or the insured’s legal representative without consent of the insurer
If the injury is sustained while occupying your covered auto when it is being used to carry people or property for a fee
If the injury is sustained while using a vehicle without reasonable belief that you are entitled to do so
If the coverage directly or indirectly benefits any insurer or self-insurer under any workers’ compensation, disability benefits, or similar law

Other Conditions

The maximum limit of liability is the amount shown on the declarations page
Split limits are used
The number of persons or vehicles insured does not affect this limit
No stacking is allowed
Coverage is excess on nonowned vehicles
When a dispute develops between the insured and the insurer on a claim
The policy gives either party the right to ask for binding arbitration

Physical Damage to Autos

The insurer provides protection for direct accidental loss to the covered auto or to a nonowned auto
A nonowned auto is defined as any private passenger auto, pickup truck, van, or trailer not owned or furnished for the regular use of you or any family member while in the custody of or being operated by you or any family member
As well as any auto or trailer while used as a temporary substitute for your covered auto while it is out of normal use
Coverage for a nonowned auto is equal to the broadest protection provided for any covered auto

Physical Damage to Autos

Coverage is separated into two sections
Collision
Defined as upset of your covered auto or nonowned auto or its impact with another vehicle or object
Definition is new to PAP
It clarifies what some persons thought was awkward in the old definition
Which used the word collide to define the term collision
Other than collision
Losses to an auto caused by missiles, falling objects, fire, theft or larceny, explosion, earthquake, windstorm, hail, water, flood, malicious mischief or vandalism, riot or civil commotion, contact with a bird or other animal, or breakage of glass

Physical Damage to Autos

If breakage of glass is caused by a collision
You may elect to have it considered a loss caused by collision
Without this alternative approach on glass
A deductible could be required for the collision loss and another deductible on other than collision for the glass
The advantage to the insured for not having the preceding perils considered collisions is
Coverage for other than collision usually has a lower deductible than collision coverage
Additionally, other-than-collision claims often will not raise an insured’s rates
Whereas collision claims usually will

Exclusions

The physical damage section excludes loss resulting from the operation of a vehicle used to carry persons or property for a fee
Damage resulting from war, radioactive contamination, and discharge of any nuclear weapon is excluded
Loss to equipment designed for the reproduction of sound
Unless the equipment is permanently installed in or designed to be solely powered by the electrical system of your covered auto
Loss to any of the following or their accessories
Citizens-band radio
Two-way mobile radio
Telephone
Scanning monitor receiver
Television monitor receivers
Video cassette recorders
Audio cassette recorders
Personal computers

Exclusions

Loss to tapes, records, discs or other media used with the equipment described previously
Loss to laser or radar detection equipment
Loss to a camper body, trailer, or motor home not shown in the declarations, as well as associated equipment
Loss to custom furnishings or equipment in or upon a pickup or van

Exclusions

No coverage is given for a nonowned or temporary substitute vehicle used by you or a family member without a reasonable belief that the person is entitled to do so
Rental car companies are not covered for coverage on a car you rent from them unless you can be held liable under the rental agreement or a state statute
Damage from wear and tear, freezing, mechanical or electrical breakdown or failures, and road damage to tires

Transportation and Towing

PAP will pay up to $20 a day for temporary transportation expenses incurred by you in the event of a covered loss to your auto
In the case of theft, you must wait 48 hours in order to recover
For an additional premium, towing and labor cost coverage may be added
The insurer’s limit of liability is generally about $50
All labor must be performed at the site of the disablement
Given the roadside assistance plans that accompany many car purchases
Most persons probably do not need this coverage
But because the premium is so low many purchase it

Other Provisions

The insurer limits its liabilities to the actual cash value of the loss
Or the amount necessary to repair or replace the property, whichever is less
Actual cash value includes an adjustment for depreciation and the physical condition of the auto
In the case of antique or customized automobiles
A stated-amount endorsement may be used
The insurer reserves the right to pay for the loss in money, repair, or replacement of the damaged or stolen property
If the car is stolen, the insurer will pay for the cost of returning the vehicle to the owner
If the cost of repair or replacement is greater than the value of the property
The insurer may declare the loss a total loss and pay the actual cash value of the vehicle

Other Provisions

New wording in the policy states that if the repair or replacement results in betterment of the property
The insurer will not pay for the amount of the betterment
The betterment provision and the used of “aftermarket” parts has caused significant concern to consumers and insurance companies
Insurers have argued that aftermarket parts are just as good as those made by the auto manufacturer
They cost less so everyone wins because of lower premiums to insureds and lower costs to insurers
Another provision states that the insurance shall not directly or indirectly benefit any carrier or bailee
Such persons include a railroad or shipping line that transports your vehicle as well as a parking lot operation
This allows the insurer to subrogate against the bailee when the bailee is negligent in damaging your auto
All coverage for nonowned autos is excess over any other collectible insurance

Duties after an Accident or Loss

The insured must promply notify the insurance company of how, when, and where the accident or loss occurred
Typically, reporting such information to your agent is considered reporting it to the company
Any person seeking coverage under the PAP must be willing to
Cooperate with the company in the investigation, settlement, or defense of any claim or suit
Promptly send the company copies of any notices or legal papers received in connection with the accident or loss
Submit, at the company’s expense and as often as reasonably required, to physical examinations by physicians selected by the company and to examination under oath
Authorize the company to obtain medical reports and other pertinent records
Submit a proof of loss when required by the company

Duties after an Accident or Loss

A person seeking uninsured motorist coverage must also be willing to
Notify the police promptly if a hit-and-run driver is involved
Send copies of the legal papers to the company if a suit is brought
When a claim is made under the coverage for damage to your auto, you must
Take reasonable steps after a loss, at company expense, to protect your covered auto and its equipment from further damage
Notify the police promptly if your covered auto is stolen
Permit the company to inspect and appraise the damaged property before its repair or disposal

Duties after an Accident or Loss

If you have an accident, the insurer will pay towing expenses
If the disabled vehicle was left at the scene of the accident
There is a chance that someone will strip it of its salable parts
Promptly notifying the police when theft occurs increases the probability of recovery
It also reduces the moral hazard of an insured’s selling or hiding the vehicle and reporting it as stolen to the insurer

General Provisions

The policy states that its territorial limits are the U.S. and Canada
Transportation of the auto between any of these points is also covered
Note that Mexico is not a covered territory
All policy modifications must be in writing
When a policy is changed to give greater coverage without additional charge
The insured’s policy is automatically modified
The insured cannot start legal proceedings until full compliance with all policy terms has been met
The policy cannot be assigned without the written permission of the insurer
Bankruptcy of the insured does not relieve the insurer of its obligation

Policy Cancellation Provisions

The PAP policy has a rather lengthy termination provision
The insured can cancel at any time by returning the policy or giving written notice of the time when the insured intends to cancel
Termination by the company is more complex
During the first 60 days of the policy the insurer may cancel for any reason
It may cancel for nonpayment of premium at any time

Policy Cancellation Provisions

The insurer has 60 days to investigate the insured and make its underwriting decision
During the first 60 days, the insurer must give ten days notice before canceling
After the policy has been in effect for 60 days the insurer can cancel only
For nonpayment of premium
If the insured or a resident of the household, or someone who regularly uses the auto, has his or her license suspended or revoked
If the policy was obtained through material misrepresentation
If your state requires longer notice than the PAP gives
Your state law will determine the notification period
The insurance company is obligated to give you a refund of the premium if one is due
However, it is not required to tender the refund when it cancels
You may have to ask for it

Endorsements to the PAP

The PAP may be endorsed to give physical damage coverage to owned trailers
Made on a schedule basis
When nonowned autos are furnished for your regular use
The extended nonowned liability endorsement is needed
In the case of a custom van
The insured needs to add a covered property endorsement
The underinsured motorists endorsement provides the insured protection when another person who is inadequately insured causes the insured to be injured
In some states underinsured motorist insurance is included in uninsured motorist coverage
These provisions apply only if the other driver is at fault

Motorcycles and Other Vehicles

Through the use of the “Miscellaneous Type of Vehicle Endorsement”
Under the PAP a person can insure motorcycles, motor homes, golf carts, or other similar types of vehicles
In addition, a private passenger auto owned jointly by two or more resident relatives other than a husband and wife may be insured
Coverages available include liability, medical payments, uninsured motorists, collision, and loss other than collision

Motorcycles and Other Vehicles

This endorsement creates three changes
Newly acquired miscellaneous vehicles are covered if they are like the insured vehicle
Temporary substitute autos of any kind are covered
Exclusion with respect to vehicles with fewer than four wheels is changed when a motorcycle is insured

Snowmobiles

May be insured by endorsement to the PAP
This approach has advantages over purchasing snowmobile insurance through the homeowners program
One can purchase uninsured motorist and physical damage insurance in addition to the liability insurance
Snowmobiles subject to motor vehicle registrations can be covered
The named insured and family members may be covered under medical payments

Auto Loan/Lease Coverage

Also known as “gap” insurance
Provides protection to the insured and/or the lending institution
For the difference between the actual cash value of a car and the outstanding debt or residual value on a lease
This endorsement may be of benefit to recent college graduates who have limited current resources

Automobile Insurance and the Law

What happens if you’re seriously injured in an auto accident caused by another driver
But the at-fault driver has no assets and no insurance?
In the U.S. and Canada, legislatures have passed some form of automobile insurance law designed to deal with the problem of the uncompensated victim of financially irresponsible automobile drivers
Laws have taken the following forms
Financial responsibility laws
Compulsory liability insurance laws
Unsatisfied judgment funds
Uninsured/under insured motorist coverage
No-fault laws

Financial Responsibility Laws

Represent a common approach to the general problem of the uncompensated victim of the financially irresponsible motorist
Most such laws have these basic requirements
Motorists without liability insurance who are involved in an automobile accident must obtain and maintain liability insurance or other proof of financial responsibility of a specified character for a given period, usually three years, as a condition of continued licensing of the operator and registration of the vehicle
Motorists without liability insurance who are involved in an automobile accident must pay for the damages they have caused
Or give evidence that they were not to blame as a condition for the continued operation of their vehicle

Financial Responsibility Laws

Financial responsibility laws have no penalty other than the suspension of driving privileges
They are not guarantees that the uncompensated victim will actually be paid
The effectiveness of the laws rests on the hope that most drivers will purchase insurance rather than face possible loss of their driving privileges

Financial Responsibility Laws

Financial responsibility laws have serious drawbacks including
No assurance is made that all drivers will have liability insurance
The penalty for not complying with the law is weak
No protection is given against hit-and-run drivers, people driving stolen cars, or motorists driving illegally

Compulsory Insurance Laws

Because of the inherent weaknesses of financial responsibility laws
Most states have implemented compulsory insurance laws
Require that auto liability insurance with at least specified minimum limits be purchased before a vehicle can be licensed or registered
Even in states with compulsory insurance laws
A large number of drivers are uninsured

Unsatisfied Judgment Fund

Set up by a state to pay automobile accident settlements that cannot be collected by other means
If the negligent motorist is insolvent, does not carry liability insurance, or has voided insurance through violation of a policy provision, or if the insurer is insolvent
The innocent victim may collect from the unsatisfied judgment funds after every other means of collection is exhausted

Uninsured/Underinsured Motorist Coverage

Usually applies only to bodily injury claims
If it is determined that an insured driver is injured by a driver who is uninsured
The injured driver can collect from his or her own insurance company any damages that the negligent uninsured motorist would be legally obligated to pay
Up to the insured’s own uninsured/underinsured motorist coverage limit
The insurer has the right to collect from the negligent uninsured motorist for any damages paid to the insured motorist
In the unlikely case that the uninsured driver has the assets to pay

Risk Management and Personal Automobile Rating

The average expenditure for auto insurance in the U.S. in 2001 was $718
Thus, insurance is a significant factor in the cost of owning or operating automobiles

Rating Factors

Two of the key determinants of auto insurance premiums are the age and sex of the driver
Youthful drivers, and especially youthful male drivers, tend to pay significantly more for auto insurance than older drivers
Generally, a person is considered a youthful driver until age 25 if female
And age 30 if male
Young drivers are involved in a disproportionate number of auto accidents

Rating Factors

The difference in premiums between males and females is driven by multiple factors
Males tend to drive more than females which leads to more accidents
Males are involved in more fatal accidents per mile driven than females
Marital status also affects insurance premiums
Young married drivers pay lower auto insurance premiums than young unmarried drivers

Rating Factors

Territory is also a major rating factor
In 2001 the lowest average expenditure on auto insurance was in South Dakota ($510)
While the highest was in New Jersey ($1,128)
Even within a state, premiums vary dramatically by territory
Premiums in urban areas tend to be higher due to higher accident rates in cities compared to rural areas

Rating Factors

The principal use of the car is also a rating factor
Rates vary depending on whether the auto is used to drive to and from work, and, if so, how far each day
Rates also vary depending on whether the auto is used generally for business or farm purposes

Rating Factors

Some factors affecting the cost of auto insurance are within the control of the individual
For instance, the type of auto driven can significantly influence insurance premiums
Sports cars are more costly to insure for liability than sedans, for example
Good students can obtain discounts on their auto insurance
Youthful drivers who complete a driver education course can obtain discounts
Insuring multiple vehicles under one policy can yield a multi-car discount
Purchasing auto and homeowners insurance from the same insurer can yield a multi-policy discount

Rating Factors

Probably the most important thing a person can do to control the cost of his or her auto insurance in the long run is to drive carefully
The insured’s driving record has a major influence on premiums
Auto accidents, speeding tickets and other moving violations, and convictions for driving while intoxicated all lead to higher premiums
Another rating factor used by some insurers is credit history
Statistics show that people with poor credit tend to have higher auto insurance claims

Deductibles for Damage to Your Auto

In the PAP, deductibles exist for collision and for loss other than collusion
Higher deductibles reduce premiums
Table 13-7 shows examples of credits for collision and comprehensive deductibles

Table 13-7: Examples of Credits for Collision and Comprehensive Deductibles

The Youthful Driver Dilemma

Insurance companies are more sensitive to claims in the automobile line than they are in most other lines
It may not take more than one claim to cause an insured’s cost to increase significantly
This statement is especially true with respect to male drivers under 25 and females under 21

The Youthful Driver Dilemma

Given the sensitivity, the smart move for many young drivers may be to not purchase collision coverage because
Any claim for which the insured is responsible, liability or collision, will cause rates to be increased
It usually takes at least three years of claim-free driving before rates will be lowered
It is often difficult to obtain coverage, even when paying higher rates
Given the above factors, the insured should not make any kind of collision claim
So it is not wise to purchase insurance that will not be used
This strategy works best when the car involved is worth only a few thousand dollars and there is no outstanding loan on the car

Selection of Liability Limits

When people are choosing their liability limits
If they have any meaningful amount of assets to protect, they should think big
Each year awards increase as both economic inflation and social inflation occur
On a relative basis, higher liability limits are not overly expensive
Table 13-8 shows a typical schedule

Table 13-8: Liability Rate Factor for Personal Auto Policy

Treisch12e Chapter 2 (1).ppt

Trieschmann, Hoyt & Sommer

Risk Identification and Evaluation

Chapter 2

Chapter Objectives

Explain several methods for identifying risks
Identify the important elements in risk evaluation
Explain three different measures of variation
Explain three different measures of central tendency
Discuss the concepts of a probability distribution and explain the importance to risk managers
Give examples of how risk managers might use the normal, binomial, and Poisson distributions
Explain how the concepts of risk mapping and value at risk are used in an enterprise-wide evaluation of risk
Explain the importance of the law of large numbers for risk management

Risk Identification

Loss exposure
Potential loss that may be associated with a specific type of risk
Can be categorized as to whether they result from
Property
Liability
Life
Health
Loss from income risks

Risk Identification

Loss exposure Checklists
Specifies numerous potential sources of loss from the destruction of assets and from legal liability
Some are designed for specific industries
Such as manufacturers, retailers, educational institutions, religious organizations
Others focus on a specific category of exposure
Such as real and personal property

Risk Identification

Financial statement analysis
All items on a firm’s balance sheet and income statement are analyzed in regard to risks that may be present
Flowcharts
Allows risk managers to pinpoint areas of potential losses
Only through careful inspection of the entire production process can the full range of loss exposures be identified

Figure 2-1: Flowchart for a Production Process

Risk Identification

Contract analysis
It is not unusual for contracts to state that some losses, if they occur, are to be borne by specific parties
May be found in construction contracts, sales contracts and lease agreements
Ideally the specification of who is to pay for various losses should be a conscious decision that is made as part of the overall contract negotiation process
Decision should reflect the comparative advantage of each party in managing and bearing the risk
On-site inspections
During these visits, it can be helpful to talk with department managers and other employees regarding their activities
Statistical analysis of past losses
Can use a risk management information system (software) to assist in performing this task
As these systems become more sophisticated and user friendly , it is anticipated that more businesses will be able to use statistical analysis in their risk management activities

Risk Evaluation

Once a risk is identified, the next step is to estimate both the frequency and severity of potential losses
Maximum probable loss
An estimate of the likely severity of losses that occur
Maximum possible loss
An estimate of the catastrophe potential associated with a particular exposure to risk
Most firms attempt to be precise in evaluating risks
Now common to use probability distributions and statistical techniques in estimating loss frequency and severity

Risk Mapping or Profiling

Involves arraying risks in a matrix
With one dimension being the frequency of events and the other dimension the severity
Each risk is marked to indicate whether it is covered by insurance or not

Statistical Concepts

Probability
Long term frequency of occurrence
The probability is 0 for an event that is certain not to occur
The probability is 1 for an event that is certain to occur
To calculate the probability of any event, the number of times a given event occurs is divided by all possible events of that type
Probability distribution
Mutually exclusive and collectively exhaustive list of all events that can result from a chance process
Contains the probability associated with each event

Statistical Concepts

Measures of central tendency or location
Measuring the center of a probability distribution
Mean
Sum of a set of n measurements divided by n

Statistical Concepts

Median
Midpoint in a range of measurements
Half of the items are larger and half are smaller
Not greatly affected by extreme values
Mode
Value of the variable that occurs most often in a frequency distribution

Measures of Variation or Dispersion

Standard deviation
Measures how all close a group of individual measurements is to its expected value or mean
First determine the mean or expected value
Then subtract the mean from each individual value and square the result
Add the squared differences together and divide the sum by the total number of measurements
Then take the square root of that value
Coefficient of variation
Standard deviation expressed as a percentage of the mean

Table 2-1: Calculating the Standard Deviation of Losses

Loss Distributions Used in Risk Management

To form an empirical probability distribution
Risk manager actually observes the events that occur
To create a theoretical probability distribution
Use a mathematical formula
Widely used theoretical distributions include binomial, normal, Poisson

The Binomial Distribution

Suppose the probability that an event will occur at any point in time is p
The probability q that an event will not occur can be stated as 1 – p
One can calculate how often an event will happen with the binomial formula
Indicates that the probability of r events in n possible times equals

The Normal Distribution

Central limit theorem
States that the expected results for a pool or portfolio of independent observations can be approximated by the normal distribution
Shown graphically in Figure 2.2
Perfectly bell-shaped
If risk managers know that their loss distributions are normal
They can assume that these relationships hold
They can predict the probability of a given loss level occurring or the probability of losses being within a certain range of the mean
Binomial distributions require variables to be discreet
Normal distributions can have continuous variables

Figure 2-2: Normal Probability Distribution of 500 Losses

The Poisson Distribution

Determine the probability of an event using the following formula
Mean of the distribution is also its variance
Standard deviation is equal to the square root of m

p = probability that an event n occurs
r = number of events for which the probability estimate is needed
m = mean = expected loss frequency
e = a constant, the base of the natural logarithms, equal to 2.71828

The Poisson Distribution

As the number of exposure units increases and the probability of loss decreases
The binomial distribution becomes more and more like the Poisson distribution
Most desirable when more than 50 independent exposure units exist and
The probability that any one item will suffer a loss is 0.1 or less

Integrated Risk Measures

Value at risk (VAR)
Constructs probability distributions of the risks alone and in various combinations
To obtain estimates of the risk of loss at various probability levels
Yields a numerical statement of the maximum expected loss in a specific time and at a given probability level
Provides the firm with an assessment of the overall impact of risk on the firm
Considers correlation between different categories of risk
Risk-adjusted return on capital
Attempts to allocate risk costs to the many different activities of the firm
Assesses how much capital would be required by the organization’s various activities to keep the probability of bankruptcy below a specified level

Accuracy of Predictions

A question of interest to risk managers
How many individual exposure units are necessary before a given degree of accuracy can be achieved in obtaining an actual loss frequency that is close to the expected loss frequency?
The number of losses for particular firm must be fairly large to accurately predict future losses

Law of Large Numbers

Degree of objective risk is meaningful only when the group is fairly large
States that as the number of exposure units increases
The more likely it becomes that actual loss experience will equal probable loss experience
Two most important applications
As the number of exposure units increases, the degree of risk decreases
Given a constant number of exposure units, as the chance of loss increases, the degree of risk decreases

Number of Exposure Units Required

Question arises as to how much error is introduced when a group is not sufficiently large
Required assumption
Each loss occurs independently of each other loss, and the probability of losses is constant from occurrence to occurrence
Formula is based on knowledge that the normal distribution is an approximation of the binomial distribution
Known percentages of losses will fall within 1, 2, 3, or more standard deviations of the mean

Number of Exposure Units Required

Where:
P = probability of loss
N = the number of exposure units sufficient for a given degree of accuracy
E = the degree of accuracy required, expressed as a ratio of actual loss to the total number in the sample
S = The number of standard deviations of the distribution.

Number of Exposure Units Required

Value of S indicates the level of confidence that can be stated for the results
If S is 1
It is known with 68 percent confidence that losses will be as predicted
If S is 2
It is known with 95 percent confidence
Fundamental truth about risk management
If the probability of loss is small a larger number of exposure units is needed for an acceptable degree of risk than is commonly recognized

Treisch12e Chapter 22.ppt

Trieschmann, Hoyt & Sommer

Risk Management and the Insurance Industry

Chapter 22

Chapter Objectives

Indicate the size of the insurance industry
Describe how the insurance business is divided between the private and public sectors
Explain why personal insurance has a larger premium volume than property insurance
Identify and explain the differences between stock companies, mutual companies, Lloyd’s associations, and reciprocal insurers
Indicate which types of insurance have the largest volume
Explain how insurance guaranty funds operate
Describe how insurance is distributed from insurers to consumers and list the differences between types of agents and brokers in insurance
Described the global nature of risk management and the insurance industry

The Field of Insurance

Insurance coverages can be divided into various opposing categories
Personal (life and health) vs property (buildings, homes, autos)
Government (flood insurance) vs private (product liability)
Involuntary (Social Security) vs voluntary (fire insurance)
The categories are not mutually exclusive and they overlap
Figure 22-1 depicts the major classifications of insurance and what they have in common with each other

Figure 22-1: Major Classifications of Insurance

Personal Coverages

Those related directly to the individual
The risk they cover is the possibility that some peril may interrupt the individual’s income, such as
Death, accidents and sickness, unemployment, and old age
Insurance is written on each
Private insurers are active in providing insurance for death, accidents and sickness, and old age
Governmental units are active in all categories

Property Coverages

Directed against perils that may destroy property
Property insurance is distinguished from personal insurance
Personal insurance covers perils that may prevent one from earning money with which to acquire property in the future
Whereas property insurance covers property that is already acquired
Property insurance as used here includes fire, marine, liability, casualty, and surety insurance
Sometimes referred to as general insurance, property/liability insurance, or property and casualty insurance

Private and Public Insurance

Private insurance consists of all types of coverage written by privately organized groups
Consists of associations of individuals, stockholders, policyholders, or some combination of these
Public insurance includes all types of coverage written by government bodies or operated by private agencies under government supervision

Voluntary and Involuntary Coverages

Most private insurance comes under the rubric of voluntary coverage
A major part of government insurance is involuntary coverage
It is required by law that insurance be purchased by certain groups and under certain conditions
Examples of required insurance include automobile liability insurance and workers’ compensation insurance

Voluntary and Involuntary coverages

Table 22-1 shows the importance of private passenger auto insurance
Table 22 -2 shows that PPA made up 33.1 percent of total premiums in 1980 although there has been a relative decline since 2000
Due to the dramatic increases in commercial lines insurance premiums during the hard insurance market

Table 22 -1: Net Premium Written by Line of Property Liability Insurance–2002

Table 22 -2: Private Passenger Auto as a Percentage of Total P-L Premium

Stock Companies

A corporation organized as a profit-making venture in the field of insurance
For companies organized in the United States
A minimum amount of capital and surplus is prescribed by state law to serve as a fund for the payment of losses and for the protection of policyholders’ funds paid in advance as premiums
Organized with authority to conduct certain types of insurance business
Some pay dividends to policyholders on certain types of insurance
Never issue what is called an assessible policy
The insured can not assess an additional premium if the company’s loss experience is excessive
The stockholders are expected to bear any losses
And they also reap any profits from the enterprise

Mutual Companies

Organized under the insurance code of each state as a nonprofit corporation owned by the policyholders
Has no stockholders
No profits are made
Because any excess income is returned to the policyholder-owners as dividends
Or is used to reduce premiums, or retained to finance future growth
The company is managed by a board of directors elected by policyholders
Many types of mutual organizations exist and operate under different laws and with different types of businesses

Class Mutuals

Operate in only a particular class of insurance
Such as farm and property, lumber mills, factories, or hardware risks
Farm mutuals
Specialize in farm property insurance
Insure a large portion of farm property in some states, primarily because of the specialized nature of the risks
Factory mutuals
Specialize in insuring factories
Place emphasis on loss control
Generally do not solicit small risks due to the relatively high cost of inspection, engineering services, surveys, and consultations that are provided by the organization in an attempt to prevent losses before they occur

General Writing Mutuals

One that accepts many types of insureds
Require an advanced premium calculated on roughly the same basis as that of a stock insurer
Operate in several states or even internationally
May or may not pay a refund of the portion of the premium of the dividend if experience warrants it
Many mutuals insist on relatively high underwriting standards
Taking only the best risks so that a dividend will more likely be paid
Some mutuals are both participating and deviating
They plan to cut the initial rate somewhat below stock company levels and to pay dividend if warranted

Fraternal Carriers

Designed as a nonprofit corporation, society, or voluntary association, without capital stock, organized and carried on solely for the benefit of its members and their beneficiaries
Have a lodge system with a ritualistic form of operation and a representative form of government that provides for the payment of benefits in accordance with definite provisions in the law
As charitable, benevolent associations, they usually are exempt from taxation

Reciprocals

Sometimes called an interinsurance exchange
Like a mutual in that both are formed for the purpose of making the insurance contract available to policyholders at cost
Basic differences exist between the legal control and capital requirements of reciprocals and mutuals
In a reciprocal, the owner-policyholders appoint an individual or a corporation known as an attorney-in-fact to operate that company, as opposed to the board of directors
A mutual is incorporated with a stated amount of capital and surplus
Whereas a reciprocal is unincorporated with no capital as such
Operate mainly in the field of automobile insurance

Lloyd’s Associations

An organization of individuals joined together to underwrite risks on a cooperative basis
Each member assumes risks personally and does not bind the organization for these obligations
Each investor is individually liable for losses on the risks assumed to the fullest extent of personal assets
Unless the liability is intentionally limited
Similar to reciprocals in that each underwriter is an insurer
However, a reciprocal is composed of individuals who are both insurers and insureds at the same time
Whereas a Lloyd’s association is a proprietary organization operated for profit

London Lloyd’s

Lloyd’s started in 1688 in London as an informal group of merchants taking marine risks
Their operations are now worldwide
Operate extensively in the United States largely in the surplus line market
Consist of risks that domestic insurers have rejected for one reason or another
In 2004 nearly 66 underwriting syndicates existed
Groups of names that combine their resources and employee manager
Who determines which risks to insure

Direct Distribution in Life Insurance

Life insurance is distributed in two main ways
Salaried group insurance representatives
Individual insurance agents who usually work on commission
Life insurance is also sold by direct contact with the consumers in advertising, mail order, or the internet
The insurer maintains a one-on-one relationship with the insured
Independent intermediaries usually are not involved

Group Insurance

Life insurers offer many of their products on a group basis
Under contracts covering groups of persons rather than individuals
Customers from group coverage are generally business firms
Persons employed to sell and service businesses usually receive a salary and bonus

Individual Agents

Policies sold to individuals are usually handled by persons known as agents, underwriters, or financial planners
The agent or underwriter contacts the ultimate consumer and reports directly to the insurer or intermediary who in turn reports to the insurer
The authority of the underwriter or agent is limited

Individual Agents

A general agent in life insurance is an individual employed to hire, train, and supervise agents at lower levels
Sometimes collects premiums and remits them to the insurer’s home office
Not an independent intermediary in the sense that a typical wholesaler is
General agent does not exercise final control over the issuance terms of the contract
The company normally is not bound by the general agent in putting a contract in force
The general agent exercises no control over the amount of premium, has no investment in inventory, does not own any business written, and has no legal right to exercise any control over policyholders once he or she leaves the employment of the company

Reasons for Direct Distribution in Life Insurance

The system of direct distribution has grown up in life insurance because of several basic factors
The insurer’s need to maintain close control over the policy product
The insurer’s need to exercise control over sales promotion and competition
The infrequent purchase of life insurance
The agent’s ability to make a better living through specialization

Treisch12e Chapter 23.ppt

Trieschmann, Hoyt & Sommer

Functions and Organization of Insurers

Chapter 23

Chapter Objectives

Explain why “production” in insurance is called “selling” elsewhere
Explain the meaning of underwriting
Show how insurance premiums are calculated and adjusted
Understand the concept of credibility as it relates to rate making
Differentiate between experience and retrospective rating
Know what fair claims settlement laws are
Understand the advantages and limitations of reinsurance

Functions of Insurers

The functions performed by any insurer necessarily depend on
The type of business it writes, the degree to which it has shifted certain duties to others, the financial resources available, the size of the insurer, the type of organization used, etc.
These functions, which are normally the responsibility of definite departments or divisions within the firm, are
Production
Underwriting
Rate making
Managing claims and losses
Investing and financing
Accounting and other recordkeeping
Providing miscellaneous other services
Such as legal advice, marketing research, engineering, and personnel management

Underwriting

Includes all the activities necessary to select risks offered to the insurer in such a manner that general company objectives are filled
In life insurance, underwriting is performed by home or regional office personnel
Who scrutinize applications for coverage and make decisions as to whether they will be accepted
And by agents, who produce the applications initially in the field

Underwriting

In the property-liability insurance area agents can make binding decisions in the field
But these decisions may be subject to postunderwriting at a higher level because the contracts are cancelable on due notice to the insured
In life insurance, agents seldom have authority to make binding underwriting decisions
In all fields of insurance, agency personnel usually do considerable screening of risks before submitting them to home office underwriters

The Objective of Underwriting

To see that the applicant accepted will not have a loss experience that is very different from that assumed when the rates were formulated
Certain standards of selection relating to physical and moral hazards are set up when rates are calculated
The underwriter must see that the standards are observed when a risk is accepted

Policy Writing

In property-liability insurance, the agent frequently issues the policy to the customer, filling out forms provided by the company
Or the form may be printed in the agent’s office on a printer controlled by the issuer’s computer
A check to determine accuracy of the rates charged, whether a prohibited risk has been taken, and other matters is done by the examining section of the home office
In life insurance, the policy usually is written in a special department
Whose main task is to issue written contracts in accordance with instructions from the underwriting department and to keep a register of them for future reference

Conflict Between Production and Underwriting

An apparent conflict of interest arises between the underwriting department and an agent
Because the underwriting department may have turned down business that previously has been sold by an agent
Neither the agent nor the underwriter will profit long by writing underwriting that is
Too strict
Will choke off acceptable business and may create unnecessary expenses in canceling business already bound by the agent
Too loose
Invites substantial losses such that the company may be forced to withdraw entirely from a given line

Rate Making

Extremely technical in most lines of insurance
Involves the selection of classes of exposure units on which to collect statistics regarding the probability and severity of loss
In life insurance, this task is relatively uncomplicated
Because the major task is to estimate mortality rates according to age and other factors such as sex, smoking, drinking habits, and occupation
In other fields, such as liability and workers’ compensation
Elaborate classifications are necessary
Rate making is usually supervised by specialists known as actuaries

Rate Making

Once the appropriate classes have been set up
The problem becomes one of developing reliable loss data for each class over a sufficiently long period of time
The next step is converting that data into a useful form for the purpose of developing a final premium
Requires incorporating estimates of the cost of doing business into the premium structure on an equitable basis

Makeup of the Premium

The insurance rate is the amount charged per unit of exposure
The premium is the product of the insurance rate and the number of exposure units
Thus, in term life insurance, if the annual rate is $1.50 per $1,000 of face amount of insurance
The premium for a $1 million policy is $1,500

Makeup of the Premium

The premium is designed to cover two major costs
The expected loss, or the pure premium
Determined by dividing the total expected loss by the number of exposures
The cost of doing business, or the loading
Such items as agents’ commissions, general company expenses, premiums, taxes and fees, and allowance for profit
The sum of the pure premium and loading is termed the gross premium
The loading is usually expressed as a percentage of the expected gross premium
The pure premium is the estimate of loss cost
The ratio of the loss cost to the gross premium is called the loss ratio

Makeup of the Premium

Two factors must be estimated and are subject to errors in forecasting
Frequency of occurrence
Severity of loss
Insureds do not know in advance exactly how often a loss will occur or what its size will be
The expected cost of a loss is a function of both frequency and severity of loss
Insurers handle forecasting errors and ratemaking by calculating estimates of both objective and subjective risk

Rate-Making Guidelines

All states establish certain criteria that insurers are expected to observe in calculating rates, including
The rate should be adequate to meet loss burdens, yet not be excessive
The rate should allocate cost burden among insureds on a fair basis
The rate should encourage loss control among insureds, if possible
While these criteria seem simple enough, applying them raises many difficult problems

Adequacy of the Rate

If a rate is to be adequate, but not excessive, how wide a margin should these limits impose?
From one standpoint, an underwriter may reason that to have an adequate premium
It is necessary to collect an amount sufficient for all possible contingencies
Whereas another underwriter may have a much different view of the size of these possible contingencies
This problem arises because the insurance rate must be set before all the costs are known

Adequacy of the Rate

In insurance a definite estimate must often be made in advance
With no possibility of later negotiation if the estimation of loss is incorrect
Frequently, these estimates are inaccurate because they are derived from past experience
The insurance contract may involve a substantial future period during which conditions change dramatically
The problem of preventing rates from becoming excessive has been the subject of much legislation
Yet unrestricted competition often leads to rates that are too low for the long-term solvency of insurance companies

Rate-Making Methods

The calculation of an insurance rate is in no sense absolute or completely scientific in nature
The scientific method in insurance makes its greatest contribution in narrowing the area within which executive judgment must operate

Manual or Class (Pure) Method

Sets rates that apply uniformly to each exposure unit falling within some predetermined class or group
These groups usually are set up so that loss data may be collected and organized in some logical fashion
Everyone falling within a given class is charged the same rate
The major areas of insurance that emphasize use of this method are
Life, workers’ compensation, liability, automobile, health, homeowners’, and surety
With life insurance, the central classifications are by age, sex, and smoking habits
With automobile insurance the loss data are broken down territorially by type of automobile, age of driver, gender of driver, and major use of automobile

Loss Ratio Method

It may be impractical to employ the manual rating method in developing a rate
Because of too many classifications and subclassifications
So many categories may be involved that losses on only a small number of exposures occur in a given time
This small number of losses may be deemed insufficient exposure on which to base decisions from a statistical point of view
The new rate is developed by comparing the actual loss ratio of the combined group with the expected loss ratio

Individual, or Merit Rating, Method

Recognizes the individual features of a specific risk and gives a rate that reflects the particular hazard
Some groups of insureds, and some individual insureds, have loss records that are sufficiently credible to warrant reductions or increases in their rates from that of the class to which they belong
One generally used device is to set up special rating classes for which discounts from the manual rates are made
Either beforehand in the form of a direct deviation or as a dividend payable at the end of the period

Individual, or Merit Rating, Method

Schedule rating is another widely used plan
The best example is in the field of commercial fire insurance
Each individual building is considered separately and a rate is established for it
The physical features of the structure are analyzed and rate credits are given for good features in the form of a listing, or schedule
The insured is rewarded in advance for features it is hoped will yield a lower loss cost for all similar structures as a group

Combination Method

In many lines of insurance, a combination of manual and merit rating is used in different degrees
The rate maker may develop an annual rate and then proceed to set up a system whereby individual members of a group may qualify for reductions from the manual rate
If certain requirements are met
They may be subjected to increased rates under certain other conditions

Credibility

Refers to the degree to which the rate maker can rely on the accuracy of loss experience observed in any given area
For example, assume that the rate maker is faced with the task of revising a rate for a certain type of policy issued by the company in a given geographical area
The loss ratio on these policies indicates that losses have been considerably higher than anticipated
Should future rates be based on the experience of these losses
Or is there a considerable likelihood that the previous year produced higher-than-average losses only by chance?
It is not fair for one group to subsidize another group if each group is large enough to develop a loss experience that is reasonably credible

Rate-Making Associations

Also called rating bureaus
The largest is Insurance Services Organization (ISO)
Most states specifically authorize such groups
This type of cooperation is essential
Many companies do not have a sufficiently large volume of business in certain lines to enable them to develop rates that are statistically sound
When the experience of many companies is pooled, a large enough body of data is available to permit a higher degree of credibility

Rate-Making Associations

Policy provisions must be quite uniform
Otherwise, the cooperating insurers will not experience uniform loss ratios
Rate making bodies have worked toward uniform policy provisions and standard policies
ISO develops statistical data for use by its member companies in the calculation of rates in various lines of property and liability research

Rate-Making Associations

ISO performs the following functions
Conducts actuarial research
Reports loss costs
Offers advice to others on rating problems
Develops standard policies
Files forms to state insurance departments
Offers management advice to its member companies
Other rating organizations are the National Council on Compensation Insurance and the Surety Association of America

Reinsurance

A method created to divide the task of handling risk among several insurers
Often accomplished through cooperative arrangements, called treaties
Specify the ways in which risks will be shared by members of the group
Also accomplished by using the services of specific companies and agents organized for that purpose
Table 23-5 shows the five largest reinsurers with respect to premiums written
May be defined as the shifting by a primary insurer (ceding company) of a part of the risk it assumes to another company (reinsurer)
That portion of the risk kept by the ceding company is called the line, or retention
That portion shifted to the reinsurer is called the cession
The process by which a reinsurer passes on risks to another reinsurer is known as retrocession

Facultative Reinsurance

Informal facultative reinsurance
Specific reinsurance on an optional basis
A primary insurer shops around for reinsurance
Attempting to negotiate specific coverage on a particular contract
Does not affect the insured in any way
Usually satisfactory when reinsurance is of an unusual nature or when it is negotiated only occasionally
Formal facultative contract
An agreement whereby the reinsurer is bound to take certain types of risks involved if offered by the ceding company
But the decision of whether to reinsure remains with the ceding company
Used when the ceding company is bound on certain types of risks by its agents before it has an opportunity to examine the applications

Automatic Treaty

Reinsurance may be provided whereby the ceding company is required to cede some certain amounts of business and the reinsurer is required to accept them
Two basic types of treaties have been recognized
Pro-rata treaties
Premiums and losses are shared in some proportion
Excess-of-loss treaties
Losses are paid by the reinsurer in excess of some predetermined deductible or retention
No directly proportional relationship exists between their original premium and the amount of loss assumed by the reinsurer

Treisch12e Chapter 24.ppt

Trieschmann, Hoyt & Sommer

Government Regulation of Risk Management and Insurance

Chapter 24

Chapter Objectives

Explain why insurance needs to be regulated
Identify what aspects of insurance are regulated
State the pros and cons of state versus federal regulation
Indicate how regulation affects insurance rates
Indicate the direction in which insurance regulation is headed

Why Insurance is Regulated

Certain characteristics of insurance set it apart from tangible goods industries and account for the special interest in government regulation
Insurance is a service that is paid for in advance
But its benefits are reaped in the future
Often the beneficiary is entirely different from the insured and is not present to protect his or her self-interest when the contract is made
Insurance is affected by a complex agreement that few lay people understand
The insurer could achieve a great and unfair advantage if disposed to do so
Insurance costs are unknown at the time the premium is established
There exists a temptation for unregulated insurers to charge too little or too much
Insurance is also regulated to control violations of the public trust

Future Performance

The management of other people’s money immediately becomes a candidate for regulation
Because of the temptations for the unscrupulous to use these funds for their own ends
Instead of for those to whom the funds belong
Particularly when it has grown to be one of the largest industries in the nation

Complexity

Even if the lay person understands the implications of every legal clause in a contract
The rights of that person are vitally affected by the operation of certain legal principles and industry customs to which no reference exists in the written contract
The legal battles that have been fought over the interpretation of the contractual wording of a policy
Offer testimony to the fact that misunderstandings arise over the meaning of provisions even after the best legal minds have attempted to make the intent of the insurer clear
An insurer would find no difficulty in framing a contract that looked appealing on the surface
But under which it would be possible for the insurer to avoid any payment at all

Unknown Future Costs

The price the insurer must charge for service must be set far in advance of the actual performance of the service
The cost of the service depends on many unknown factors
Such as random fluctuations in loss frequency and unexpected changes in the cost of repairing property
To increase business, an insurer may consciously underestimate future costs in order to justify a lower premium and attract customers
This may ultimately lead to the bankruptcy of the insurer
If the insurer refuses to accept business except at a very high premium
Those who pay may be overcharged and those who cannot pay will go without a vital service

Violations of Public Trust

These include
Failure by the insured to live up to the contract provisions
Formulation of contracts that are misleading and seem to offer benefits they do not cover
Refusal to pay legitimate claims
Improper investment of policyholders’ funds
False advertising
Abuses in insurance have been such that major investigations of the insurance business have taken place
However, it should be emphasized that most insurers operate their business in an ethical fashion

The Legal Background of Regulation

Insurance has traditionally been regulated by the states
Each state has an insurance department and an insurance commissioner or superintendent
Before 1850, insurance was operated as a private business
With no more regulation than any other business sector
As a result of the early abuses of insurance, the need for regulation became apparent

The Legal Background of Regulation

In 1868 an important U.S. Supreme Court decision, Paul v Virginia
Established the right of states to regulate insurance by holding that insurance was not commerce
But was in the nature of a personal contract between two parties
In 1871 an organization that was later named the National Association of Insurance Commissioners was formed
Through whose efforts a considerable measure of uniformity in regulation has been achieved
The South-Eastern Underwriters Association case overturned the Paul v. Virginia ruling
The court held that insurance was commerce and when conducted across state lines it was interstate commerce
This made insurance subject to federal regulation

The McCarran-Ferguson Act

The complete abandonment of state regulation of insurance in favor of federal regulation is not desired by either the insurance industry or state insurance commissioners
The National Association of Insurance Commissioners propose what later became known as the McCarran-Ferguson Act which made these declarations
It was the intent of Congress that state regulation of insurance should continue
No state law relating to insurance should be affected by any federal law unless such law is directed specifically at the business of insurance
The Sherman Act, the Clayton Act, the Robinson-Patman Act, and the Federal Trade Commission Act would be fully applicable to insurance
But only “to the extent that the individual states do not regulate insurance”
That part of the Sherman Act relating to boycotts, coercion, and intimidation would remain fully applicable to insurance

The McCarran-Ferguson Act

Except to the extent indicated by the provisions of the McCarran-Ferguson Act
The insurance business continues to be regulated by the states
The law does not exempt the insurance business from federal regulation and provides for limited applicability of certain federal laws to insurance

The McCarran-Ferguson Act

In summary
Both states and the federal government are currently exercising regulatory control over the insurance industry
States still have basic regulatory functions
While the federal government exercises regulation in specified areas only
The general trend seems to be for more federal control

Responsibilities of the Insurance Regulators

Can be classified into four primary categories
Licensing and enforcement of minimum standards of financial solvency
Regulation of rates and expenses
Agents’ activities
Control over contractual provisions in insurance policies and their effects on the consumer

Licensing and Financial Solvency

The insurance commissioner enforces the state’s laws regarding the
Admission of an insured to do business
Formation of new insurers
Liquidation of insurers who become insolvent
The commissioner must see that
Adequate reserves are maintained for each line insurance written
The investments of the insurer are sound and within the state requirements

Minimum Capital

Licenses are granted according to the type of insurance business to be conducted
Different capital standards are applied to each type
Minimum standards are set forth in each state and they vary considerably from state to state and by type of insurer
In the 1990s additional capital requirements were added beyond the flat dollar minimums
Called risk-based capital requirements
The minimum amount of capital an insurer must hold varies according to the insurer’s particular asset and liability portfolio
Those with riskier assets and those who write riskier lines of insurance are required to hold more capital

Investments

Insurers do not have complete freedom over how to invest policyholder funds
Excessively risky investments may result in an insurer being unable to meet its obligations
All states impose investment limitations on insurers
The idea behind these limitations is to require that funds paid in as an advance payment of premiums be invested relatively conservatively
The objective is to maintain safety and to give sufficient liquidity to enable insurers to pay all claims when due

Liquidation

The insurance commissioner is charged with the responsibility of liquidating an insolvent insurer
An equitable treatment of policyholders and other creditors is essential
Some types of insurers subject their policyholders to additional assessments in the event of financial inability to pay claims
The insurance commissioner must see that these obligations are paid

Security Deposits

Most states require that each insurer make a deposit of securities with the insurance commissioner
To guarantee that policyholders will be paid claims due them
These laws have been unpopular because
The size of the deposit is generally too small in proportion to the volume of business to be of any real protection to the insured

Regulation of Rates and Expenses

The state insurance department is responsible for regulating the rates and expenses of insurance companies
If inadequate rates are charged
Insolvency becomes a threat
If excessive or discriminatory rates are allowed
The insurance department must handle public complaints

Property-Liability Rates

In all states, rates must meet three basic requirements
The rate shall be reasonable
The rate shall be adequate to cover expected losses and expenses
The rate shall not be unfairly discriminatory among different insured groups
The typical rating law permits insurers to form rating bureaus
And to pool statistical information with these bureaus
In about 30 states, prior approval laws dictate that a rate must be filed with the insurance commissioner before it can be used
The commissioner must give permission to use the rate or not
The remaining states have open competition laws
Rating bureaus can publish advisory rates only

Life Insurance Rates

Are essentially unregulated by states
Except indirectly through regulation of expenses and reserves
Are affected by reserve and mortality assumptions
Life insurance reserves represent an insurer’s obligation to the policyholder for the savings element in the life insurance policy
In calculating the reserve, an insurer assumes that it will earn some interest rate and will experience a certain mortality rate
The higher the interest assumption and the lower the mortality rate assumption, the lower the reserve and the associated premium rate will be
States generally regulate the maximum interest assumption and the minimal mortality table
In order to be assured that the life insurer will not charge so little that it cannot meet its obligations to the policyholder

Life Insurance Rates

It is assumed that competition among insurers will operate to keep life insurance rates from becoming excessive
However, wide variations exist in life insurance premiums among insurers in the open market
An active movement exists to require life insurers to disclose more information about costs to the policyholder
So that a more intelligent buying decision can be made
It can be presumed that as additional cost information is made available
Open competition will become more efficient and will result in less variation in premiums
The internet may also contribute to reduced variation in premiums
A number of websites make it easy to compare prices of life insurance across a large number of insurers

Agents’ Activities

The agent has been a dominant figure in the insurance industry almost from the beginning
For most consumers the agent is the only contact with the insurer
It is vital that the agent be well trained and posses a requisite degree of business responsibility
Most states require any insurance representative to be licensed
And to pass an examination covering insurance and the details of the state’s insurance law

Agents’ Activities

Part of the reason for the failure of insurers to insist on higher standards is due to the fact that agents generally are paid on a commission basis
The insurer assumes that because nothing is paid out unless the agent produces business
The easiest way to obtain more businesses to hire more agents
In such an atmosphere, the insurer is not likely to insist that its agents be exceptionally well trained

Agents’ Activities

Most state laws prohibit such practices as
Twisting
Occurs when an agent persuades an insured to drop an existing insurance policy by misrepresenting the facts for the purpose of obtaining an insured’s new business
Rebating
Occurs when an agent agrees to return part of the commission to an insured as an inducement to secure business
Misrepresentation
An example would be making misleading statements about the cost of life insurance

Regulation of Contract Provisions

New policy forms must be approved in most states before they’re offered to the public
The purposes of such laws is to
Ensure that the rates being used meet state requirements as to adequacy, nonexcessiveness, and fairness
Protect the public against deceptive, misleading, or unfair provisions
Approve the language in policies that is intended to make them more readable and understandable by the consuming public
A recent trend has been the deregulation of commercial lines contracts and rates
The idea is that while individuals may need protection from certain unscrupulous insurers
Large businesses have the knowledge and resources to be able to take care of themselves
State regulators can then focus their efforts on personal lines, where consumer protection is likely to be more valuable

Treisch12e Chapter 3 (1).ppt

Trieschmann, Hoyt & Sommer

Property and Liabilities Loss Exposures

Chapter 3

Chapter Objectives

Identify the kinds of property subject to loss and the types of losses that may occur
Define the basic payments made under liability insurance contracts
Distinguish between criminal law and civil law
Understand what a tort is
Describe negligence and the characteristics of a negligent act
Explain some of the defenses against a claim of negligence
Discuss factors that are causing individuals and businesses to maintain higher standards of care
Identify the basic types of liability exposure and give an explanation of each

Property Loss Exposures

Real property
Land, all structures permanently attached to the land, and whatever is growing on the land
Examples include buildings, attachments to buildings, crops
Personal property
All property other than real property
Examples include cars, money, clothes, furniture, textbooks, airplanes, animals

Property Loss Exposures

Direct loss
Occurs when there is damage to property
Indirect loss
Occurs when a direct loss causes expenses to increase or revenues to decline
Many insurance contracts insure both direct and indirect losses in the same contract
When dealing with property insurance, there are usually only two parties to the contract
The insured and the insurer

Property Loss Exposures

Not all types of property are insurable
Coverage cannot be purchased for loss of goodwill or loss of a copyright
Raw land is difficult to insure
Sex and property loss exposures
For insurance purposes, animals are considered property
Firms must be able to manage loss to or from the animals and learn to manage the animals during the mating season

Liability Exposures

One of the most serious financial risks that risk managers must deal with
Loss through legal liability for harm caused to others
Insurance for liability losses is more complex than property insurance
Because people other than the insured and the insurer are involved
Liability is usually determined by proving negligence

Types of Liability Damages

Insurance contracts are designed to pay only for certain types of losses
Usually restricted to pay for
Bodily injury
Property damage
Personal Injury
Legal expenses

Types of Liability Damages

Bodily injury
Includes liability for losses a person may incur because his or her body or mind has been harmed
Includes payments for medical bills, loss of income, rehabilitation costs, loss of services, pain and suffering damages, punitive damages
Punitive damages are assessed when it is deemed that the defendant acted in a grossly negligent manner and deserve to have an example made of his or her behaviour so as to discourage others from acting that way.

Types of Liability Damages

Property damage
Loss may be due to a loss from actual damage to the property, as well as loss of use of the property
Personal injury
Result from libel, slander, invasion of privacy, false arrest, etc.
Typically, libel involves written, printed, or pictorial material that damages a person’s reputation by defaming or ridiculing the person.
Slander involves spoken words that are defamatory and/or injurious to a persons reputation.
Legal expenses
Individuals or organizations being sued must be prepared to retain a lawyer for their defense, as the defense process can be very costly.

Criminal and Civil Law

Criminal law
Directed toward wrongs against society
Examples include murder, robbery, rape, assault with a deadly weapon
Charges under criminal law are made by a government body or agent and the guilty party is subject to fine and/or imprisonment.
Civil law
Directed toward wrongs against individuals and organizations
Examples include breach of contract and negligent acts

Torts

Legal injury or wrong to another that arises that of actions other than breach of contract
Courts will provide a remedy by allowing recovery in an action for damages
Legal injury
Results when a person’s rights are wrongfully invaded
Right of personal privacy, right to enjoy one’s property and right to be free from personal injury

Basic Law of Negligence

The negligent act
Negligence is the failure to exercise the degree of care required by law
Conduct that a reasonably prudent individual would exercise to prevent harm
A negative act
Failure to do something
Negligence maybe the failure to act when there is a duty to act
A positive act
The doing of something. E.g. Driving your vehicle into the rear of another vehicle.

Basic Law of Negligence

A voluntary act
One that is done voluntarily
An involuntary act is excusable
A negligent act is not excused because there is no intention to harm
An imputed act
One is liable not only for one’s own actions but also for the negligent acts of service or agents acting in the course of their employment or agency
Employers may be sued because of negligence acts of their employees
Vicarious liability
Proximate cause of the loss
There must be an unbroken chain of events leading from the negligent act to the damage sustained

Defenses Against Negligence Claims

Contributory negligence
If both parties are to blame in a given accident
May not collect against the other, even if the defendant was 90 percent to blame and the plaintive only 10 percent to blame
Assumed risk
Defendant may raise the defense that the plaintiff has no cause for action because the plaintiff assumed the risk of harm from
The conduct of the defendant
The condition of the premises
The defendant’s product
Guest-host statutes
Relate to the standard of care by an automobile driver to a passenger
Standard of care owed an automobile driver to a passenger. The guest must prove that the driver was guilty of gross negligence or willful injury.