Module 5
Insurance
a. Insurance and Risk Management: An Introduction
In today’s world of the “strange but true,” you can obtain insurance for just about
anything. You might purchase a policy to protect yourself in the event that you are
abducted by aliens. Some insurance companies will offer you protection if you think you
have a risk of turning into a werewolf. If you are a fast runner, you might be able to get a
discount on a life insurance policy. Some people buy wedding disaster insurance just in
case something goes wrong on the big day. You may never need these types of insurance,
but you’ll certainly need insurance on your home, your vehicle, and your personal
property. The more you know about insurance, the better able you will be to make
decisions about buying it.
Insurance is protection against possible financial loss. Although many types of
insurance exist, they all have one thing in common: They give you the peace of mind that
comes from knowing that money will be available to meet the needs of your survivors,
pay medical expenses, protect your home and belongings, and cover personal or property
damage caused by you when driving.
Life insurance replaces income that would be lost if the policyholder died. Health
insurance helps meet medical expenses when the policyholder (or any family member
covered by the policy) becomes ill. Automobile insurance helps cover property and
personal damage caused by the policyholder’s car. Home insurance covers the
policyholder’s place of residence and its associated financial risks, such as damage to
personal property and injuries to others.
Insurance is based on the principle of pooling risks, in which thousands of
policyholders pay a small sum of money (premium) into a central pool. The pool is then
large enough to meet the expenses of the small number of people who actually suffer a
loss. An insurance company, or insurer, is a risk-sharing firm that agrees to assume
financial responsibility for losses that may result from an insured risk. A person joins the
risk-sharing group (the insurance company) by purchasing a policy (a contract). Under
the policy, the insurance company agrees to assume the risk for a fee (the premium) that
the person (the insured or the policyholder) pays periodically.
Insurance can provide protection against many risks of financial uncertainty and
unexpected losses. The financial consequences of failing to obtain the right amount and
type of insurance can be disastrous.
You face risks every day. You cross the street with some danger that you’ll be hit
by a car. You can’t own property without taking the chance that it will be lost, stolen,
damaged, or destroyed. Insurance companies offer financial protection against such
dangers and losses by promising to compensate the insured for a relatively large loss in
return for the payment of a much smaller but certain expense called the premium.
Risk, peril, and hazard are important terms in insurance. While in popular use
these terms tend to be interchangeable, each has a distinct, technical meaning in
insurance terminology. Basically, risk is uncertainty or lack of predictability. In this
instance, it refers to the uncertainty as to loss that a person or a property covered by
insurance faces. Insurance companies frequently refer to the insured person or property as
the risk.
The most common risks are classified as personal risks, property risks, and
liability risks. Personal risks are the uncertainties surrounding loss of income or life due
to premature death, illness, disability, old age, or unemployment. Property risks are the
uncertainties of direct or indirect losses to personal or real property due to fire,
windstorms, accidents, theft, and other hazards. Liability risks are possible losses due to
negligence resulting in bodily injury or property damage to others. Such harm or damage
could be caused by an automobile, professional misconduct, injury suffered on one’s
property, and so on.
Risk management is an organized strategy for protecting assets and people. It
helps reduce financial losses caused by destructive events. Risk management is a long-
range planning process. People’s risk management needs change at various points in their
lives. If you understand risks and how to manage them, you can provide better protection
for yourself and your family. In this way, you can reduce your financial losses and
thereby improve your chances for economic, social, physical, and emotional well-being.
Since you will probably be unable to afford to cover all risks, you need to understand
how to obtain the best protection you can afford.
Most people think of risk management as buying insurance. However, insurance
is not the only method of dealing with risk; in certain situations, other methods may be
less costly. Four risk management techniques are commonly used.
You can avoid the risk of being in an automobile accident by not driving or being
a passenger. McDonald’s can avoid the risk of product failure by not introducing new
products. Risk avoidance would be practiced in both instances, but at a very high cost.
You might have to give up your job, and McDonald’s might lose out to competitors that
introduce new products.
In some situations, however, risk avoidance is practical. At the personal level,
people avoid risks by not smoking or by not walking through highcrime neighborhoods.
At the business level, jewelry stores avoid losses through robbery by locking their
merchandise in vaults. Obviously, no person or business can avoid all risks.
While avoiding risks completely may not be possible, reducing risks may be a
cause of action. You can reduce the risk of injury in an auto accident by wearing a seat
belt. You can install smoke alarms and fire extinguishers to protect life and reduce
potential fire damage. You can reduce the risk of illness by eating a balanced diet and
exercising.
Risk assumption means taking on responsibility for the loss or injury that may
result from a risk. Generally, it makes sense to assume a risk when the potential loss is
small, when risk management has reduced the risk, when insurance coverage is
expensive, and when there is no other way to obtain protection. For instance, you might
decide not to purchase collision insurance on an older car. Then, if an accident occurs,
you will bear the costs of fixing the car.
Self-insurance is the process of establishing a monetary fund to cover the cost of a
loss. Self-insurance does not eliminate risks; it only provides means for covering losses.
Many people self-insure by default, not by choice, by not obtaining insurance.
The most common method of dealing with risk is to shift it. That simply means to
transfer it to an insurance company or some other organization. In exchange for the fee
you pay, the insurance company agrees to pay for your losses. Most insurance policies
include deductibles, which are a combination of risk assumption and risk shifting. A
deductible is the set amount that the policyholder must pay per loss on an insurance
policy. For example, if a falling tree damages your car, you may have to pay $200 toward
the repairs. Your insurance company will pay the remaining amount.
Because all people have their own needs and goals, many of which change over
the years, a personal insurance program should be tailored to those changes. In the early
years of marriage, when the family is growing, most families need certain kinds of
insurance protection. This protection may include property insurance on an apartment or
a house, life and disability insurance for wage earners and caretakers of dependents, and
adequate health insurance for all family members.
Later, when the family has a higher income and a different financial situation,
protection needs will change. There might be a long-range provision for the children’s
education, more life insurance to match higher income and living standards, and revised
health insurance protection. Still later, when the children have grown and are on their
own, retirement benefits will be a consideration, further changing the family’s personal
insurance program.
In managing risks, your goals are to minimize personal, property, and liability
risks. Your insurance goals should define what to do to cover the basic risks present in
your life situation. Covering the basic risks means providing a financial resource to cover
costs resulting from a loss. Suppose your goal is to buy a new car. You must plan to make
the purchase and to protect yourself against financial losses from accidents. Auto
insurance on the car lets you enjoy the car without worrying that an auto accident might
leave you worse off, financially and physically, than before.
Planning is a sign of maturity, a way of taking control of life instead of letting life
happen to you. What risks do you face? Which risks can you afford to take without
having to back away from your goals? What resources—public programs, personal
assets, family, church, or private risk-sharing plans—are available to you? To understand
and use the resources at your command, you need good information. In terms of
insurance, this means a clear picture of the available insurance, the reliability of different
insurers, and the comparative costs of the coverage needed.
As you carry out your plan, obtain financial and personal resources, budget them,
and use them to reach risk management goals. If, for example, you find the insurance
protection you have is not enough to cover your basic risks, you may purchase additional
coverage, change the kind of insurance coverage, restructure you budget to cover
additional insurance costs, and strengthen your savings or investment programs to reduce
long-term risk.
The best risk management plans have flexibility. Savings accounts or other cash,
for example, should be available as emergency funds for unexpected financial problems.
The best plans are also flexible enough to allow you to respond to changing life
situations. Your goal should be an insurance program that expands (or contracts) with
changing protection needs. To put your risk management plan to work, you must answer
these questions: What should be insured? For how much? What kind of insurance should
I buy? From whom? What amount can I afford?
Evaluate your insurance plan periodically, at least every two or three years or
whenever your family circumstances change. Among the questions you should ask
yourself are: Does it work? Does it adequately protect my plans and goals? An effective
risk manager consistently checks the outcomes of decisions and is alert to changes that
may reduce the effectiveness of the current risk management plan.
A young working couple may be entirely happy with their life and health
insurance coverage. When they add an infant to the family, a review of protection is
appropriate. Suddenly the risk of financial catastrophe to the family (should one or both
parents die or become disabled) is much greater.
The needs of a single person differ from those of a family, a single parent, a
couple, or a group of unrelated adults living in the same household. While these people
face similar risks, their financial responsibility to others differs greatly. In each case, the
vital question is: Have I provided the financial resources and risk management strategy
needed to take care of my basic responsibilities for my own well-being and the well-
being of others?
b. Property and Liability Insurance
Major disasters have caused catastrophic amounts of property loss in the United
States. In recent years, hurricanes, tornadoes, and floods in various areas have caused
billions of dollars of damage.
Since most people invest large amounts of money in their homes and motor
vehicles, protecting these assets from loss is a great concern. Each year, homeowners and
renters lose billions of dollars from more than 3 million burglaries, 500,000 fires, and
200,000 instances of damage from other hazards. The cost of injuries and property
damage caused by automobiles is also very great. Most people use insurance to reduce
their chances of economic loss from these risks.
The price you pay for home and automobile insurance may be viewed as an
investment in financial protection against these losses. Although the costs of home and
automobile insurance may seem high, the financial losses from which insurance protects
you are much higher. Property and liability insurance offer protection from financial
losses that may arise from a wide variety of situations.
Houses, automobiles, furniture, clothing, and other personal belongings are a
substantial financial commitment. Property owners face two basic types of risks. The first
is physical damage caused by hazards such as fire, wind, water, and smoke. These
hazards can cause destruction of your property or temporary loss of its use. For example,
if a windstorm causes a large tree branch to break your automobile windshield, you lose
the use of the vehicle while it is being repaired. The second type of risk property owners
face is loss of use due to robbery, burglary, vandalism, or arson.
In a wide variety of circumstances, a person may be judged legally responsible for
bodily injuries or property damages. For example, if a child walks across your property,
falls, and sustains severe injuries, the child’s family may be able to recover substantial
damages from you as a result of the injuries. If you accidentally damage a rare painting
while assisting a friend with home repairs, the friend may take legal action against you to
recover the cost of the painting.
Liability is legal responsibility for the financial cost of another person’s losses or
injuries. Your legal responsibility is commonly caused by negligence, failure to take
ordinary or reasonable care. Doing something in a careless manner, such as improperly
supervising children at a swimming pool or failing to remove items from a frequently
used staircase, may be ruled as negligence in a liability lawsuit.
Despite taking great care, a person may still be held liable in a situation. Strict
liability is present when a person is held responsible for intentional or unintentional
actions. Vicarious liability occurs when a person is held responsible for the actions of
another person. If the behavior of a child causes financial or physical harm to others, the
parent may be held responsible; if the activities of an employee cause damage, the
employer may be held responsible.
c. Home and Property Insurance
A homeowner’s policy provides coverages for the house and other structures,
additional living expenses, personal property, personal liability and related coverages,
and specialized coverages. The main component of homeowner’s insurance is protection
against financial loss due to damage or destruction to a house or other structures. Your
dwelling and attached structures are covered for fire and other hazards. Detached
structures on the property, such as a garage, toolshed, or gazebo, are also protected. The
coverage will usuall If damage from a fire or other event prevents the use of your home,
additional living expense coverage pays for the cost of living in a temporary location
while your home is being repaired. Some policies limit additional living expense
coverage to 10 to 20 percent of the home’s coverage and limit payments to a maximum of
six to nine months; other policies pay the full cost incurred for up to a year. y also include
trees, shrubs, and plants.
Your household belongings, such as furniture, appliances, and clothing, are
covered for damage or loss up to a portion of the insured value of the home, usually 55,
70, or 75 percent. For example, a home insured for $80,000 might have $56,000 (70
percent) of coverage for household belongings.
Personal property coverage commonly has limits for the theft of certain items,
such as $1,000 for jewelry, $2,000 for firearms, and $2,500 for silverware. Items with a
value exceeding these limits can be protected with a personal property floater, which
covers the damage or loss of a specific item of high value. A floater requires a detailed
description of the item and periodic appraisals to verify the current value. This coverage
protects the item regardless of location; thus, the item is insured while you are traveling
or transporting it.
Floaters to protect home computers and other electronic equipment are
recommended. This additional coverage can prevent financial loss due to damage or loss
of your computer. Contact your insurance agent to determine whether the equipment is
covered against damage from mischievous pets, spilled drinks, dropping, or power
surges.
Personal property coverage usually provides protection against the loss or damage
of articles taken with you when away from home. For example, possessions taken on
vacation or used while at school are usually covered up to a policy limit. Property that
you rent, such as some power tools or a rug shampoo machine, is insured while in your
possession.
In the event of damage or loss of property, you must be able to prove both
ownership and value. A household inventory is a list or other documentation of personal
belongings, with purchase dates and cost information. You can get a form for such an
inventory from an insurance agent or online. For items of special value, you should have
receipts, serial numbers, brand names, model names, and written appraisals of value.
A household inventory can be a list, photographs, or a video of your home and
contents. Photograph closets and storage areas open to see all items. Indicate the date and
the value of property. Regularly update your inventory, photos, and appraisal documents.
Keep information in a waterproof bag in a fireproof box with a copy in a safe-deposit
box. Online inventory tools and phone apps are also available.
Each day, you face the risk of financial loss due to injuries to others or damage to
property for which you are responsible. The following are examples of this risk. A
neighbor or guest falls on your property, resulting in permanent disability. A spark from
burning leaves on your property starts a fire that damages a neighbor’s roof. A member of
your family accidentally breaks an expensive glass statue while at another person’s
house.
In each of these situations, you could be held responsible for the costs incurred.
The personal liability component of a homeowner’s policy protects you from financial
losses resulting from legal action or claims against you or family members due to
damages to the property of others. This coverage includes the cost of legal defense. Not
all individuals who come to your property are covered by your liability insurance. While
a babysitter or others who assist you occasionally are probably covered, regular
employees, such as a housekeeper or a gardener, may require workers’ compensation
coverage.
Most homeowner’s policies provide a basic personal liability coverage of
$100,000, but additional amounts are frequently recommended. An umbrella policy, also
called a personal catastrophe policy, supplements your basic personal liability coverage.
This added protection covers you for personal injury claims such as libel, slander,
defamation of character, and invasion of property. An umbrella policy also increases
bodily injury and property damage coverages. Extended liability policies are sold in
amounts of $1 million or more and are useful for individuals with substantial net worth. If
you are a business owner, you may need other types of liability coverage.
Should you or a family member accidentally damage another person’s property,
the supplementary coverage of homeowner’s insurance will pay for these minor mishaps.
This protection is usually limited to $500 or $1,000. Again, payments are made
regardless of fault. Any property damage claims for greater amounts would require action
under the personal liability coverage.
Homeowner’s insurance usually does not cover losses from floods and
earthquakes. People living in areas with these two risks need special coverage. In various
communities, the National Flood Insurance Program makes flood insurance available.
This protection is separate from the homeowner’s policy. An insurance agent or the
Federal Emergency Management Agency of the Federal Insurance and Mitigation
Administration can give you additional information about this coverage. Fewer than half
of the people who live in flood-prone areas have this coverage. To learn more about flood
insurance, read the nearby Financial Literacy for My Life feature on flood facts.
d. Home Insurance Cost Factors
Studies reveal that as many as two-thirds of homes in the United States are not
insured or are underinsured. Financial losses caused by fire, theft, wind, and other risks
amount to billions of dollars each year. Since most homeowners have a mortgage on their
property, their lending institutions usually require insurance. When purchasing insurance,
you can get the best value by selecting the appropriate coverage amount and being aware
of factors that affect insurance costs.
Several factors affect the insurance coverage needed for your home and property.
Your insurance protection should be based on the amount needed to rebuild or repair your
house, not the amount you paid for it. As construction costs rise, you should increase the
amount of coverage. In recent years, most insurance policies have had a built-in inflation
clause that increases coverage as property values increase.
In the past, most homeowner’s policies contained a provision requiring that the
building be insured for at least 80 percent of the replacement value. Under this
coinsurance clause, the homeowner would have to pay for part of the losses if the
property was not insured for the specified percentage of the replacement value. Few
companies still use coinsurance; most require full coverage.
If you are financing a home, the lending institution will require you to have
property insurance in an amount that covers its financial investment. Remember, too, that
the amount of insurance on your home will determine the coverage on the contents.
Personal belongings are generally covered up to an amount ranging from 55 to 75 percent
of the insurance amount on the dwelling.
Insurance companies base claim settlements on one of two methods. Under the
actual cash value (ACV) method, the payment you receive is based on the current
replacement cost of a damaged or lost item less depreciation. This means you would get
$180 for a five-year-old television set that cost you $400 and had an estimated life of
eight years if the same set now costs $480. Your settlement amount is determined by
taking the current cost of $480 and subtracting five years of depreciation from it—$300
for five years at $60 a year.
Under the replacement value method for settling claims, you receive the full cost
of repairing or replacing a damaged or lost item; depreciation is not considered.
However, many companies limit the replacement cost to 400 percent of the item’s actual
cash value. Replacement value coverage costs about 10 to 20 percent more than ACV
coverage.
The main influences on the premium paid for home and property insurance are the
location of the home, the type of structure, the coverage amount and policy type,
discounts, and differences among insurance companies. The location of the residence
affects insurance rates. If more claims have been filed in an area, home insurance rates
for people living there will be higher. Weather events such as a hailstorm or a hurricane
also affect insurance costs.
The type of home and the construction materials influence the costs of insurance
coverage. A brick house, for example, would cost less to insure than a similar house
made of wood. However, earthquake coverage is more expensive for a brick home than
for a wood dwelling. Stronger, more wind-resistant home construction can reduce
insurance costs in Florida and provide greater protection against hurricane damage. Also,
the age and style of the house can create potential risks and increase insurance costs.
The policy you select and the financial limits of coverage affect the premium you
pay. It costs more to insure a $150,000 home than a $100,000 home. The comprehensive
form of homeowner’s policy costs more than a tenant’s policy. The deductible amount in
your policy also affects the cost of your insurance. If you increase the amount of your
deductible, your premium will be lower since the company will pay out less in claims.
The most common deductible amounts are $500 or $1,000 or higher, which can reduce
the premium 15 percent or more.
Most companies offer incentives that reduce home insurance costs. Your premium
may be lower if you have smoke detectors or a fire extinguisher. Deterrents to burglars,
such as dead bolt locks or an alarm system, can also save you money. Some companies
offer home insurance discounts to policyholders who are nonsmokers or may give a
discount for being “claim free” for a certain number of years.
Studies show that you can save more than 30 percent on homeowner’s insurance
by comparing companies. Contact both insurance agents who work for one company and
independent agents who represent several. The information you obtain will enable you to
compare rates. Home insurance rates may be compared using information from websites
such as www.netquote.com. Don’t select a company on the basis of price alone. Also
consider service and coverage. Not all companies settle claims in the same way. For
example, a number of homeowners had two sides of their houses dented by hail. Since
the type of siding used in these houses was no longer available, all of the siding had to be
replaced. Some insurance companies paid for complete replacement of the siding, while
others paid only for replacement of the damaged areas. State insurance commissions,
other government agencies, and consumer organizations can provide information about
the reputations of insurance companies. Consumer Reports (www.consumerreports.org)
regularly publishes a satisfaction index of property insurance companies.
e. Automobile Insurance Coverages
Each year, motor vehicle crashes cost over $150 billion in lost wages and medical
costs. The National Traffic Safety Administration estimates that alcohol use, texting, and
cell phone use are factors in more than half of all automobile accidents. Such accidents
result in thousands of highway deaths and injuries and over $30 billion in costs. These
automobile accidents create a risk that affects many people financially and emotionally.
Automobile insurance cannot eliminate the costs of automobile accidents; however, it
does reduce the financial impact.
A financial responsibility law is state legislation that requires drivers to prove
their ability to cover the cost of damage or injury caused by an automobile accident. All
states have such laws to protect the public from physical harm and property damage
losses caused by drivers. When injuries or significant property damage occur in an
accident, the drivers involved are required to file a report with the state and to show
financial responsibility. Nearly all states have compulsory automobile insurance laws. In
other states, most people meet the financial responsibility requirement by buying
insurance, since very few have the financial resources to meet this legal requirement on
their own.
Most money automobile insurance companies pay in claims goes for the cost of
injury lawsuits, medical expenses, and related legal costs. The main bodily injury
coverages are bodily injury liability, medical payments coverage, and uninsured motorist
protection. No-fault systems in a number of states have influenced the process of settling
bodily injury claims.
Automobile liability insurance coverage is usually expressed as a split limit, such
as 50/100/25 or 100/300/50. The first two numbers represent bodily injury liability
coverage. These amounts represent thousands of dollars of coverage. The first number is
the limit for claims that can be paid to one person; the second number is the limit for each
accident; the third number is discussed in the section on property damage coverages.
With 100/300 bodily injury coverage, for example, a driver would have a limit of
$100,000 for claims that could be paid to one person in an accident. In addition, there
would be a $300,000 limit for all bodily injury claims from a single accident.
While bodily injury liability pays for the costs of injuries to persons who were not
in your automobile, medical payments coverage covers the costs of health care for people
who were injured in your automobile, including yourself. This protection covers friends,
carpool members, and others who ride in your vehicle. Medical payments insurance also
provides medical benefits if you or a member of your family is struck by an automobile
or injured while riding in another person’s automobile.
If you are in an accident caused by a person without insurance, uninsured motorist
protection covers the cost of injuries to you and your family; in most states, however, it
does not cover property damage. This insurance also provides protection against financial
losses due to injuries caused by a hit-and-run driver or by a driver who has insufficient
coverage to cover the cost of your injuries. Underinsured motorist coverage provides
financial protection when another driver has insurance coverage below the amount to
cover the financial damages you have encountered.
Difficulties and high costs of settling claims for medical expenses and personal
injuries have resulted in the creation of the no-fault system, in which drivers involved in
accidents collect medical expenses, lost wages, and related injury costs from their own
insurance companies. The system is intended to provide fast, smooth methods of paying
for damages without taking the legal action frequently necessary to determine fault.
Massachusetts was the first state to implement no-fault insurance. In recent years,
nearly 30 states had some variation of the system. While nofault automobile insurance
was intended to reduce the time and cost associated with the settlement of automobile
injury cases, this has not always been the result. One reason for continued difficulties is
that no-fault systems vary from state to state. Some no-fault states set limits on medical
expenses, lost wages, and other claim settlements, while other states allow lawsuits under
certain conditions, such as permanent paralysis or death. Some states include property
damage in no-fault insurance. Drivers should investigate the coverages and implications
of no-fault insurance in their states.
When you damage the property of others, property damage liability protects you
against financial loss. This coverage applies mainly to other vehicles; however, it also
includes damage to street signs, lampposts, buildings, and other property. Property
damage liability protects you and others covered by your policy when driving another
person’s automobile with permission. The policy limit for property damage liability is
commonly stated with your bodily injury coverages. The last number in 50/100/25 and
100/300/50, for example, is for property damage liability ($25,000 and $50,000,
respectively).
When your automobile is involved in an accident, collision insurance pays for the
damage to the automobile regardless of fault. However, if another driver caused the
accident, your insurance company may attempt to recover the repair costs for your
vehicle through the other driver’s property damage liability. The insurance company’s
right to recover the amount it pays for the loss from the person responsible for the loss is
called subrogation.
The amount you can collect with collision insurance is limited to the actual cash
value of the automobile at the time of the accident. This amount is usually based on the
figures provided by some appraisal service such as the Official Used Car Guide of the
National Automobile Dealers Association (www.nada.org). If you have an automobile
with many add-on features or one that is several years old and has been restored, you
should obtain a documented statement of its condition and value before an accident
occurs.
Another protection for your automobile involves financial losses from damage
caused by a risk other than a collision. Comprehensive physical damage covers you for
risks such as fire, theft, glass breakage, falling objects, vandalism, wind, hail, flood,
tornado, lightning, earthquake, avalanche, or damage caused by hitting an animal. Certain
articles in your vehicle, such as some radios and stereo systems, may be excluded from
this insurance. These articles may be protected by the personal property coverage of your
home insurance. Like collision insurance, comprehensive coverage applies only to your
car, and claims are paid without considering fault. Both collision and comprehensive
coverage are commonly sold with a deductible to help reduce insurance costs.
Deductibles keep insurance premiums lower by reducing the number of small claims
companies pay. Going from full-coverage comprehensive insurance to a $100 deductible
may reduce the cost of that coverage by as much as 40 percent.
In addition to basic bodily injury and property damage coverages, other protection
is available. Wage loss insurance will reimburse you for any salary or income lost due to
injury in an automobile accident. Wage loss insurance is usually required in states with a
no-fault insurance system; in other states, it is available on an optional basis.
Towing and emergency road service coverage pays for the cost of breakdowns
and mechanical assistance. This coverage can be especially beneficial on long trips or
during inclement weather. Towing and road service coverage pays for the cost of getting
the vehicle to a service station or starting it when it breaks down on the highway, not for
the cost of repairs. If you belong to an automobile club, your membership may include
towing coverage. Purchasing duplicate coverage as part of your automobile insurance
could be a waste of money. Rental reimbursement coverage pays for a rental car if your
vehicle is stolen or is in the shop for repairs from an accident or for other covered
damages. The nearby Financial Literacy For My Life feature explains what to do if you
are in an accident caused by the other driver.
f. Automobile Insurance Costs
Most households spend more than $1,200 for auto insurance each year.
Automobile insurance premiums reflect the amounts insurance companies pay for injury
and property damage claims. Your automobile insurance is directly related to coverage
amounts and factors such as the vehicle, your place of residence, and your driving record.
“How much coverage do I need?” This question affects the amount you pay for
insurance. Our legal environment and increasing property values influence coverage
amounts. As discussed earlier, every state has laws that require or encourage automobile
liability insurance coverage. Since very few people can afford to pay an expensive court
settlement with personal assets, most drivers buy automobile liability insurance.
In the past, bodily injury liability coverage of 10/20 was considered adequate. In
fact, most states have only recently increased their minimum limits for financial
responsibility above 10/20. However, in recent injury cases, some people have been
awarded millions of dollars; thus, legal and insurance advisors now recommend 100/300.
As discussed earlier in this, an umbrella policy can provide additional liability coverage
of $1 million or more.
Just as medical expenses and legal settlements have increased, so has the cost of
vehicles. Therefore, a policy limit of more than $10,000 for property damage liability is
appropriate; $50,000 or $100,000 is usually suggested. Several factors influence the
premium you pay for automobile insurance. The main factors are vehicle type, rating
territory, and driver classification.
The year, make, and model of your motor vehicle strongly influence automobile
insurance costs. Expensive replacement parts and complicated repairs due to body style
contribute to higher rates. Also, certain makes and models are stolen more often than
others. In most states, your rating territory is the place of residence used to determine
your automobile insurance premium. Various geographic locations have different costs
due to differences in the number of claims made. For example, fewer accidents and less
vandalism occur in rural areas than in large cities. New York City, Los Angeles, and
Chicago have the highest incidence of automobile theft.
You are compared with other drivers to set your automobile insurance premium.
Driver classification is a category based on the driver’s age, sex, marital status, driving
record, and driving habits; drivers’ categories are used to determine automobile insurance
rates. In general, young drivers (under 25) and those over 70 have more frequent and
severe accidents. As a result, they pay higher premiums.
Accidents and traffic violations influence your driver classification. A poor
driving record increases your insurance costs. Finally, you pay less for insurance if you
do not drive to work than if you use your automobile for business. Belonging to a carpool
instead of driving to work alone can reduce insurance costs. Your credit history may also
be considered when applying for auto insurance. While some states limit the use of credit
scoring in auto insurance, the practice is common in other areas.
The number of claims you file with your insurance company also affects your
premiums. Expensive liability settlements or extensive property damage will increase
your rates. If you have many expensive claims or a poor driving record, your company
may cancel your policy, making it difficult for you to obtain coverage from another
company. To deal with this problem, every state has an assigned risk pool consisting of
people who are unable to obtain automobile insurance. Some of these people are assigned
to each insurance company operating in the state. They pay several times the normal rates
but do get coverage. Once a good driving record is established, the driver can reapply for
insurance with a lower premium. Review the nearby How To . . . Decide Whether to File
an Auto Insurance Claim feature to learn what factors might influence your decision
about whether to file a claim.
Rates and service vary among automobile insurance companies. Among
companies in the same area, premiums can vary as much as 100 percent. If you relocate,
don’t assume your present company will offer the best rates in your new living area.
Rates may be compared online at www.netquote.com.
Also consider the service the local insurance agent provides. Will this company
representative be available to answer questions, change coverages, and handle claims as
needed? You can check a company’s reputation for handling automobile insurance claims
and other matters with sources such as Consumer Reports or your state insurance
department. Several states publish information with sample auto insurance rates for
different companies to help consumers save money. The address and contact information
of your state insurance regulator may be found online.
The best way to keep your rates down is to establish and maintain a safe driving
record. Taking steps to avoid accidents and traffic violations will mean lower automobile
insurance premiums. In addition, most insurance companies offer various discounts.
Drivers under 25 can qualify for reduced rates by completing a driver training program or
maintaining good grades in school. When young drivers are away at school without a car,
families are likely to get reduced premiums since the student will not be using the vehicle
on a regular basis.
Installing security devices such as a fuel shutoff switch, a second ignition switch,
or an alarm system will decrease your chances of theft and lower your insurance costs.
Being a nonsmoker can qualify you for lower automobile insurance premiums. Discounts
are also offered for participating in a carpool and insuring two or more vehicles with the
same company. Ask your insurance agent about other methods for lowering your
automobile insurance rates.
Increasing the amount of deductibles will result in a lower premium. Also, some
people believe an old car is not worth the amount paid for collision and comprehensive
coverage and therefore dispense with them. However, before doing this, be sure to
compare the value of your car for getting you to school or work with the cost of these
coverages.
g. Health Care Costs
Health insurance is one way people protect themselves against economic losses
due to illness, accident, or disability. Health coverage is available through private
insurance companies, service plans, health maintenance organizations, and government
programs. Employers often offer health insurance, called group health insurance, as part
of an employee benefits package, and health care providers sell it to individuals.
Affordable health care has become one of the most important social issues of our
time. News broadcasts abound with special reports on “America’s health care crisis” or
politicians demanding “universal health insurance.” “Unless we fix our health care
system—in both the public and private sectors—rising health care costs will have severe,
adverse consequences for the federal budget as well as the U.S. economy in the future.”
This is one of the key messages that politicians have been delivering across the country in
town-hall style meetings, in speeches, and on radio and television programs.
The health care debate still continues, even though the U.S. Supreme Court
upheld the law on June 28, 2012. Polls have suggested both that the public is opposed to
reform as passed and that the public is firmly behind the reforms in place, and opponents
have vowed that the debate will continue into the future. The Republicans labeled the Act
“a fiscal Frankenstein,” “a decisive step in the weakening of the United States,” and “one
of the worst offenses of social engineering legislation in the history of the United States,”
while the Democrats hailed the law as “a new day in America,” and that it would
“improve the quality of life for millions of American families.” Something tells us this is
far from the end of the debate. Let us stay tuned!
What do an aging and overweight population, the cost of prescription drugs, the
growing number of uninsured, and advancements in medical technology have in
common? These and other factors all add up to rising health costs. The United States has
the highest per capita medical expenditures of any country in the world. We spend twice
as much on health care as the average for the 24 industrialized countries in Europe and
North America. The average per capita cost for health care was estimated to be $11,670
in 2019. It seems that, year after year, there is a third sure thing for U.S. citizens besides
death and taxes: higher health costs.
Health care costs were estimated at $3.9 trillion in 2019, or 18.1 percent of GDP.
The latest projections from the Centers for Medicare and Medicaid Services show that
under the new tax legislation, by 2026 annual health care spending is expected to grow to
$5.7 trillion, or almost 19.7 percent of GDP. Yet about 32 million people, or 9.6 percent
of adults and children, have no health insurance.
In the United States, administrative costs consume nearly 11 percent of health
care dollars, compared to 1 percent under Canada’s socialized system. These costs
include activities such as enrolling beneficiaries in a health plan, paying health insurance
premiums, checking eligibility, obtaining authorizations for specialist referrals, and filing
reimbursement claims.
According to the administrator for the Centers for Medicare and Medicaid, Seema
Verma, “In 2017, President Trump issued an executive order that promotes health care
choice and competition across the United States. The order will slow the rapid rise in
health care costs, foster competition in health care markets, so that patients and the
American people may receive better value for our investment in health care. Patients
must be at the center of cost and quality decisions, empowered with information they
need to make the best choices for themselves and their families.”
h. Health Insurance and Financial Planning
Health insurance is a form of protection to alleviate the financial burdens
individuals suffer from illness or injury. According to the Centers for Medicare and
Medicaid Services, health insurance includes both medical expense insurance and
disability income insurance. Health insurance, like other forms of insurance, reduces the
financial burden of risk by dividing losses among many individuals. It works in the same
way as life insurance, homeowner’s insurance, and automobile insurance. You pay the
insurance company a specified premium, and the company guarantees you some degree
of financial protection. Like the premiums and benefits of other types of insurance, the
premiums and benefits of health insurance are figured on the basis of average experience.
To establish rates and benefits, insurance company actuaries rely on general statistics that
tell them how many people in a certain population group will become ill and how much
their illnesses will cost.
Medical expense insurance and disability income insurance, discussed in this last
section, are an important part of your financial planning. To safeguard your family’s
economic security, both protections should be a part of your overall insurance program.
There are many ways individuals or groups of individuals can obtain health insurance
protection. Planning a health insurance program takes careful study because the
protection should be shaped to the needs of the individual or family. For many families,
the task is simplified because the group health insurance they obtain at work already
provides a foundation for their coverage.
Group plans comprise about 90 percent of all the health insurance issued by
health and life insurance companies. Most of these plans are employer sponsored, and the
employer often pays part or most of their cost. However, not all employers provide health
insurance to their employees. The Tax Cuts and Jobs Act of 2017 requires large
employers (more than 50 employees) to provide health insurance coverage to all
employees. Because insurance premiums have outpaced inflation for more than a decade,
employers are increasing the share paid by employees and offering cheaper plans.
In June 2018, the U.S. Department of Labor expanded access to affordable health
coverage options for small businesses and their employees through Association Health
Plans (AHPs). These plans allow small businesses and selfemployed workers to join
together to obtain health care coverage as if they were a single large employer, which can
be be less expensive and better meet the needs of their employees. AHPs cannot charge
higher premiums or deny coverage because of preexisting conditions or cancel coverage
because an employee becomes ill. Other organizations, such as labor unions and
professional associations, also offer group plans. Group insurance will cover you and
your immediate family. Group insurance seldom requires evidence that you are insurable,
if you enroll when you first become eligible for coverage.
The Health Insurance Portability and Accountability Act of 1996 (HIPAA)
legislates new federal standards for health insurance portability, nondiscrimination in
health insurance, and guaranteed renewability. The law provides tax breaks for long-term
care insurance and authorizes various government agencies to investigate
Medicare/Medicaid fraud and abuses. This landmark legislation gives millions of workers
the comfort of knowing that if they change jobs, they need not lose their health insurance.
For example, a parent with a sick child can move from one group plan to another without
lapses in health insurance and without paying more than other employees for coverage. In
addition to providing health care portability, this law created a stable source of funding
for fraud control activities. The protection group insurance provides varies from plan to
plan. The plan may not cover all of your health insurance needs; therefore, you will have
to consider supplementing it with individual health insurance.
Individual health insurance covers either one person or a family. If the kind of
health insurance you need is not available through a group, you should obtain an
individual policy—a policy tailored to your particular needs—from the company of your
choice. This requires careful shopping, because coverage and cost vary from company to
company. For example, the premiums for similar coverage can vary up to 50 percent for
the same person, according to Mark Gurda, president of Castle Group Health in
Northbrook, Illinois. Moreover, the rules and regulations vary from state to state. Find
out what your group insurance will pay for and what it won’t. Make sure you have
enough insurance, but don’t waste money by overinsuring. Remember, the opportunity
cost of not being adequately insured can be extremely high.
A sign that your group coverage needs supplementing would be its failure to
provide benefits for the major portion of your medical care bills, mainly hospital, doctor,
and surgical charges. If, for example, your group policy will pay only $1,000 per day
toward a hospital room and the cost in your area is $1,500, you should look for an
individual policy that covers most of the remaining amount. Similarly, if your group
policy will pay only about half the going rate for surgical procedures in your area, you
need individual coverage for the other half.
Medical coverage of nonworking spouses is a concern when couples divorce.
Under federal law, coverage under a former spouse’s medical plan can be continued for
36 months if the former spouse works for a company with 20 or more employees.
Premiums will be totally paid by the individual and can run as high as $12,000 annually.
If there are children and the custodial parent doesn’t work, the working parent usually
can still cover the children under an employer’s group plan.
The federal Consolidated Omnibus Budget Reconciliation Act of 1986 (COBRA)
requires many employers to offer employees and dependents who would otherwise lose
group health insurance the option to continue their group coverage for a set period of
time. Employees of private companies and state and local governments are covered by
this law; employees of the federal government and religious institutions are not. Read the
nearby Financial Literacy for My Life box, “All You Need to Know about COBRA,” to
learn about COBRA’s continuation coverage.
i. Types of Health Insurance Coverage
Hospital expense insurance pays part or the full amount of hospital bills for room,
board, and other charges. Frequently, a maximum amount is allowed for each day in the
hospital, up to a maximum number of days. More people have hospital insurance than
any other kind of health insurance.
Surgical expense insurance pays part or the full amount of the surgeon’s fees for
an operation. A policy of this kind usually lists a number of specific operations and the
maximum fee allowed for each. The higher the maximum fee allowed in the policy, the
higher the premium charged. People often buy surgical expense insurance in combination
with hospital expense insurance.
Physician expense insurance helps pay for physician’s care that does not involve
surgery. Like surgical expense insurance, it lists maximum benefits for specific services.
Its coverage may include visits to the doctor’s office, x-rays, and lab tests. This type of
insurance is usually bought in combination with hospital and surgical insurance. The
three types of insurance combined are called basic health insurance coverage.
One of these features is a deductible provision that requires the policyholder to
pay a basic amount before the policy benefits begin—for example, the first $500 per year
under an individual plan and a lesser amount under a group plan. (Sometimes part or all
of the deductible amount is covered by the benefits of a basic hospital and surgical plan.)
The other feature is a coinsurance provision that requires the policyholder to share
expenses beyond the deductible amount. Many policies pay 75 or 80 percent of expenses
above the deductible amount; the policyholder pays the rest.
A hospital indemnity policy pays benefits only when you are hospitalized, but
these benefits, stipulated in the policy, are paid to you in cash and you can use the money
for medical, nonmedical, or supplementary expenses. While such policies have limited
coverage, their benefits can have wide use. The hospital indemnity policy is not a
substitute for basic or major medical protection but a supplement to it. Many people buy
hospital indemnity policies in the hope that they will make money if they get sick, but the
average benefit return does not justify the premium cost.
Dental expense insurance provides reimbursement for the expenses of dental
services and supplies and encourages preventive dental care. The coverage normally
provides for oral examinations (including x-rays and cleanings), fillings, extractions,
inlays, bridgework, and dentures, as well as oral surgery, root canal therapy, and
orthodontics. As with other insurance plans, dental insurance may have a deductible and
a coinsurance provision, stating that the policyholder pays from 20 to 50 percent after the
deductible.
A recent development in health insurance coverage is vision care insurance. An
increasing number of insurance companies and prepayment plans are offering this
insurance, usually to groups. Vision and eye health problems are second among the most
prevalent chronic health care concerns, affecting more than 160 million Americans. Good
vision care insurance should cover diagnosing and treating eye diseases such as
glaucoma, periodic eye examinations, eyeglasses, contact lenses, and eye surgery. In
considering vision and dental coverage, you should analyze their costs and benefits.
Sometimes these coverages cost more than they are worth.
Dread disease, trip accident, death insurance, and cancer policies, which are
usually sold through the mail, in newspapers and magazines, or by door-to-door
salespeople working on commission, are notoriously poor values. Their appeal is based
on unrealistic fears, and a number of states have prohibited their sale. Such policies
provide coverage only for specific conditions and are no substitute for comprehensive
insurance.
Most older Americans will be cared for at home; family members and friends are
the sole caregivers for 70 percent of the elderly population. A recent study by Americans
for Long-Term Care Security (ALTCS) found that one out of five Americans over age 50
is at risk of needing some form of long-term care within the next 12 months. The same
study revealed that more than half of the U.S. population will need long-term care during
their lives. 2 While older people are more likely to need long-term care, your need for
long-term care can come at any age. In fact, the U.S. Government Accountability Office
estimates that 40 percent of the 13 million people receiving long-term care services are
between the ages of 18 and 64.
Long-term care can be very expensive. As a national average, a year in a nursing
home can cost over $97,000; a semi-private room in some regions can cost as much as
$291,996 (in Alaska). Bringing an aide into your home just three times a week to help
with dressing, bathing, preparing meals, and similar household chores can easily cost
$3,000 a month. The annual premium for LTC policies can range from under $2,000 up
to $16,000, depending on your age and the choices you make. The older you are when
you enroll, the higher your annual premium. Typically, individual insurance plans are
sold to the 50-to-80 age group, pay benefits for a maximum of two to six years, and carry
a dollar limit on the total benefits they will pay.
Long-term care insurance is not for everyone; it is rarely recommended for people
under 60. If you are over 60, you may consider it if you wish to protect your assets, but if
you have substantial wealth ($2 million or more) or very little (less than $250,000), the
premium can be a waste of money. However, if your employer pays the premium, the
Health Insurance Portability and Accountability Act of 1996 treats a long-term care
premium as a tax-deductible expense for the employer. Explore services available in your
community to help meet long-term care needs. Care given by family members can be
supplemented by visiting nurses, home health aides, friendly visitor programs, home-
delivered meals, chore services, adult day care centers, and respite services for caregivers
who need a break from daily responsibilities.
All health insurance policies have certain provisions in common. Be sure you
understand what your policy covers. Even the most comprehensive policy may be of little
value if a provision in small print limits or denies benefits. An insurance company
usually allows you a minimum of 10 days to review your health insurance policy, so be
sure to check the major provisions that affect your coverage. Deductible, coinsurance,
and stop-loss provisions were discussed under major medical expense insurance. Other
major provisions are described in the following sections.
j. Private Sources of Health Insurance and Health Care
More than 800 private insurance companies sell health insurance through either
group or individual policies. Of these two types, group health insurance represents about
90 percent of all medical expense insurance and 80 percent of all disability income
insurance. The policies insurance companies issue provide for payment either directly to
the insured for reimbursement of expenses incurred or, if assigned by the insured, to the
provider of services.
Most private insurance companies sell health insurance policies to employers,
who in turn offer them as fringe benefits to employees and employees’ dependents. The
premiums may be partially paid by employers. The Health Insurance Portability and
Accountability Act, as discussed earlier, requires employers to keep detailed records of
all employees and dependents covered by the company’s health plan. As of September
23, 2012, all health insurance companies and group health plans are required to give you
a summary of the health plan’s benefits and coverage.
The Blue Cross and Blue Shield Association is a national federation of 36
independent community-based and locally operated Blue Cross and Blue Shield
companies. The Association owns and manages the Blue Cross and Blue Shield
trademarks and names in more than 170 countries, and grants licenses to independent
companies to use the trademarks and names in various geographical areas. Each state has
its own Blue Cross and Blue Shield. The Blues plans, the nation’s oldest and largest
family of health benefits companies, play an important role in providing private health
insurance to more than 106 million Americans.
During the 1970s and 1980s, increasing health care costs spurred the growth of
managed care. Managed care refers to prepaid health plans that provide comprehensive
health care to members. Managed care is offered by health maintenance organizations,
preferred provider organizations, exclusive provider organizations, point-of-service plans,
and traditional indemnity insurance companies.
A recent industry survey estimated that 85 percent of employed Americans are
enrolled in some form of managed care. Managed care companies now provide
information that helps you better manage your health care needs. Health plans have
launched internet programs that allow you to access medical research, support groups,
and professional advice, and to exchange e-mail with health care providers. The best-
known managed care plans are health maintenance organizations and preferred provider
organizations, which offer a wide range of preventive services.
Prepaid managed care is designed to make the provision of health care services
cost-effective by controlling their use. Health maintenance organizations are an
alternative to basic and major medical insurance plans. A health maintenance
organization (HMO) is a health insurance plan that directly employs or contracts with
selected physicians, surgeons, dentists, and optometrists to provide health care services in
exchange for a fixed, prepaid monthly premium. HMOs operate on the premise that
maintaining health through preventive care will minimize future medical problems.
The preventive care HMOs provide includes periodic checkups, screening
programs, diagnostic testing, and immunizations. HMOs also provide a comprehensive
range of other health care services. These services are divided into two categories: basic
and supplemental. Basic health services include inpatient, outpatient, maternity, mental
health, substance abuse, and emergency care. Supplemental services include vision,
hearing, and pharmaceutical care, which are usually available for an additional fee.
A preferred provider organization (PPO) is a group of doctors and hospitals that
agree to provide health care at rates approved by the insurer. In return, PPOs expect
prompt payment and the opportunity to serve an increased volume of patients. The
premiums for PPOs are slightly higher than those for HMOs. An insurance company or
your employer contracts with a PPO to provide specified services at predetermined fees
to PPO members.
Preferred provider organizations combine the best elements of the fee-forservice
and HMO systems. PPOs offer the services of doctors and hospitals at discount rates or
give breaks in copayments and deductibles. PPOs provide their members with essentially
the same benefits HMOs offer. However, while HMOs require members to seek care
from HMO providers only (except for emergency treatment), PPOs allow members to use
a preferred provider—or another provider for a higher copayment—each time a medical
need arises. This combination of allowing free choice of physicians and low-cost care
makes PPOs popular.
The exclusive provider organization (EPO) is the extreme form of the PPO.
Services rendered by nonaffiliated providers are not reimbursed. Therefore, if you belong
to an EPO, you must receive your care from affiliated providers or pay the entire cost
yourself. Providers typically are reimbursed on a fee-for-service basis according to a
negotiated discount or fee schedule.
A point-of-service plan (POS), sometimes called an HMO-PPO hybrid or open-
ended HMO, combines characteristics of both HMOs and PPOs. POSs use a network of
selected, contracted, participating providers. Employees select a primary care physician,
who controls referrals for medical specialists. If you receive care from a plan provider,
you pay little or nothing, as in an HMO, and do not file claims. Medical care provided by
out-of-plan providers will be reimbursed, but you must pay significantly higher
copayments and deductibles. Hybrid plans are useful if you want to try managed care but
don’t want to be locked into a network of doctors. A drawback is that they cost more than
HMOs.
The distinction among HMOs, PPOs, EPOs, and POSs is becoming blurred. PPOs
and POS plans combine features from both fee-for-service and HMOs. PPOs and POS
plans offer more flexibility than HMOs in choosing physicians and other providers. POS
plans have primary care physicians who coordinate patient care, but, in most cases, PPOs
do not. Premiums tend to be somewhat higher in PPOs and POS plans than in traditional
HMOs. As cost reduction pressures mount and these alternative delivery systems try to
increase their market share, each tries to make its system more attractive. The evolution
of health care plans will likely continue so that it will become increasingly difficult to
characterize a particular managed care delivery system as adhering to any particular
model.
Home health care providers furnish and are responsible for the supervision and
management of preventive medical care in a home setting in accordance with a medical
order. Rising hospital care costs, new medical technology, and the increasing number of
elderly and infirm people have helped make home care one of the fastest-growing areas
of the health care industry. Spending on home health care has been growing at an annual
rate of about 20 percent over the past few years. This rapid growth reflects (1) the
increasing proportion of older people in the U.S. population, (2) the lower costs of home
health care compared to the costs of institutional health care, (3) insurers’ active support
of home health care, and (4) Medicare’s promotion of home health care as an alternative
to institutionalization. Home health care consists of home health agencies, home care aide
organizations, and hospices, facilities that care for the terminally ill.
Some companies choose to self-insure. The company runs its own insurance plan,
collecting premiums from employees and paying medical benefits as needed. However,
these companies must cover any costs that exceed the income from premiums.
Unfortunately, not all corporations have the financial assets necessary to cover these
situations, which can mean a financial disaster for the company and its employees.
