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Insurance
Major Reference
GEORGE E. REJDA
7th Edition (2011)
E-mail: paulkm@cc.kuas.edu.tw
PART TWO
Law And the Insurance Contract
Chapter 5 Legal Principles in Insurance
Chapter 6 Analysis of Insurance Contracts
PART SIX
The Private Insurance Industry
Chapter24 Types of Private Insurers and Marketing
Systems
Chapter25 Functional Operations of Private Insurance
Chapter26 Financial Operations of Private Insurers
Chapter 5
Legal Principles
in Insurance
Agenda
Principle of Indemnity
Principle of Insurable Interest
Principle of Subrogation
Principle of Utmost Good Faith
Requirements of an Insurance Contract
Distinct Legal Characteristics of Insurance
Contracts
Law and the Insurance Agent
4
Principle of Indemnity
The insurer agrees to pay no more than
the actual amount of the loss
Purpose:
To prevent the insured from profiting from a
loss
To reduce moral hazard
Principle of Indemnity
In property insurance, indemnification is based on
the actual cash value of the property at the time of
loss
There are three main methods to determine actual
cash value:
Replacement cost less depreciation
Fair market value is the price a willing buyer would pay a
willing seller in a free market
Broad evidence rule means that the determination of ACV
should include all relevant factors an expert would use to
determine the value of the property
Principle of Indemnity
There are some exceptions to the principle of
indemnity:
A valued policy
pays the face amount of insurance if a total loss
occurs
Principle of Indemnity
There are some exceptions to the principle of
indemnity:
Replacement cost insurance
means there is no deduction for depreciation in
determining the amount paid for a loss
Principle of Indemnity
()
60%
60%
Principle of Indemnity
There are some exceptions to the principle of
indemnity:
A life insurance contract is a valued policy that
pays a stated sum to the beneficiary upon the
insureds death
10
Principle of Indemnity
There are some exceptions to the principle of
indemnity:
A life insurance contract
It is difficult to determine accurately the value
of a human life, and the amount paid may
substantially exceed the economic value of the
insureds life. The human life value approach
gives a crude estimate of how much a person's
life is worth, but few people insure their lives
fully, and all losses are total.
11
12
Purpose:
To prevent gambling
To reduce moral hazard
To measure the amount of loss
13
16
16
A.
B.
(Mortgagee)
C.
17
D.
(
)
18
(Invoice Value)
(
)
19
A.
()
B.
20
1.
21
22
2.
23
4.
(434
)
24
1.
(1122,1123)
(1114)
A.
100111161
1003
25
26
()
27
3.
4.
28
6.
1114
29
1117
30
31
Reasons:
A. life insurance is not a contract of indemnity but is a
valued policy that pays a stated sum upon the insureds
death.
32
Reasons:
B. the beneficiary has only a legal claim to receive the policy
proceeds, the beneficiary does not have a show that a loss
has been incurred by the insureds death.
33
(Proceed)
34
Principle of Subrogation
Insurer is entitled to recover from a
negligent third party any loss payments
made to the insured.
Substitution of the insurer in place of the
insured for the purpose of claiming indemnity
from a third person for a loss covered by
insurance.
35
Principle of Subrogation
Purposes:
To prevent the insured from collecting
twice for the same loss
36
Principle of Subrogation
Importance of Subrogation
The insurer is entitled only to the amount it
has paid under the policy
The insured cannot impair the insurers
subrogation rights
Subrogation does not apply to life insurance
and to most individual health insurance
contracts
The insurer cannot subrogate against its
own insureds
37
148
38
39
41
42
(Binder)
43
Consideration
the values that each party exchange
The value that each party gives to the other.
A. Insured's consideration generally is payment of the first
premium.
B. Insurer's consideration is the promise to perform the contract.
44
45
46
(Commutative
Contract)
48
enforceable promise
(Bilateral Contract)
most commercial contract are bilateral contract in nature. Each
party makes a legally enforceable promise to the other party.
49
50
(character)(moral)(credit)
(assignment)
51
(endorsement)
52
54
(
)
55
Aleatory Contract
Binder
Commutative Contract
Concealment
Conditional Contract
Conditional Premium
Receipt
Consideration
Contract of Adhesion
Estoppel
56
Implied Powers
Innocent Misrepresentation
Legal Purpose
Material Fact
Pecuniary Interest
Personal Contract
Principle of indemnity
57
Chapter 6
Analysis of
Insurance
Contracts
Agenda
59
60
61
64
66
Conditions
are provisions in the policy that qualify or
place limitations on the insurers promise to
perform
If policy conditions are not met, insurer
can refuse to pay the claim
Insurance policies contain a variety of
miscellaneous provisions
e.g., cancellation, subrogation, grace
period, misstatement of age
68
69
()
70
(4)Miscellaneous provision
In Property and Liability Insurance
1.Cancellation clause
()
71
72
3.Assignment
()
73
74
75
76
77
78
79
80
81
82
83
84
Definition of an Insured
An insurance contract must identify the
persons or parties who are insured under the
policy
The named insuredis the person or persons
named in the declarations section of the policy
The first named insured has certain additional rights
and responsibilities that do not apply to other named
insureds
A policy may cover other parties even though they
are not specifically named
e.g., the homeowners policy covers resident relatives
under age 24 who are full-time students away from
home
Definition of an Insured
1.
2.
86
Earthquake Endorsement
87
88
(4)()
An endorsement attached to a contract generally takes precedence
over any conflicting terms in the contract.
89
Deductibles
A deductible
is a provision by which a specified amount
is subtracted from the total loss payment
that otherwise would be payable
A deductible is not used in life insurance because the insureds
death is always a total loss.
90
Deductibles
The purpose of a deductible is to:
Eliminate small claims that are expensive to handle
and process
Reduce premiums paid by the insured
Under the large loss principle, insurance should pay for
high severity losses; small losses can be budgeted out of
the persons income
Deductibles
With a straight deductible
, the insured must pay a certain amount
before the insurer makes a loss payment
e.g., an auto insurance deductible
1
5
2
92
Deductibles
An aggregate deductible
means that all losses that occur during a
specified time period are accumulated to
satisfy the deductible amount
()
93
94
95
96
97
(Insurable value)
(Actual cash value)
=(Replacement cost)
(Accumulated depreciation)
(1)Full Insurance
1,500,000
1,500,000300,000
98
(2)Under Insurance
1,500,000
1,000,000300,000
( ) =
99
(3)Over Insurance
1,500,000
2,500,000300,000
1.()
2.()
100
Coinsurance
A coinsurance clause
in a property insurance contract encourages the
insured to insure the property to a stated
percentage of its insurable value
If the coinsurance requirement is not met at the
time of the loss, the insured must share in the
loss as a coinsurer
Coinsurance
1,500,000
600,00080%coinsurance clause
1,200,000300,000
( x )
=
600,000 (1500,000 x 80%) X 300,000
= 150,000
102
Coinsurance
The purpose of coinsurance
is to achieve equity in rating
104
105
Coinsurance
Coinsurance problem
1.Inflation can result in a serious coinsurance penalty if the amount
of insurance is not periodically increased for inflation.
2.Insured may incur a coinsurance penalty if property values
fluctuate widely during the policy period
3.If a small loss occurs, the insured may incur financial hardship if
he or she is required to take a physical inventory of the undamaged
and damaged goods
106
107
The purpose is
to reduce premiums
108
Other-insurance Provisions
The purpose of other-insurance provisions is to
prevent profiting from insurance and violation of
the principle of indemnity
109
Other-insurance Provisions
Under a pro rata liability provision, each
insurers share of the loss is based on the
proportion that its insurance bears to the total
amount of insurance on the property
(1)Pro rata liability
1:500,000A
300,000 B100,000 C100,000
100,000
Other-insurance Provisions
Under contribution by equal shares, each insurer shares
equally in the loss until the share paid by each insurer
equals the lowest limit of liability under any policy, or
until the full amount of the loss is paid
total paid
50,000
50,000
50,000
total paid
100,000
200,000
200,000
111
112
113
114
Other-insurance Provisions
Under a primary and excess insurance provision, the
primary insurer pays first, and the excess insurer
pays only after the policy limits under the primary
policy are exhausted
Other-insurance Provisions
The coordination of benefits provision
116
All-Risks Policy
Coinsurance Clause
Equity in Rating
Exclusions
Insuring Agreement
Named Insured
117
Corridor Deductible
Declarations
Elimination(Waiting)Period
Straight deductible
118
Chapter 24
Types of Private
Insurers and
Marketing
Systems
Agenda
Overview of Private Insurance in the
Financial Services Industry
Types of Private Insurers
Agents and Brokers
Types of Marketing Systems
Group Insurance Marketing
120
Commercial banks
Savings and loan institutions
Credit unions
Life and health insurers
Property and casualty insurers
Mutual Funds
Securities brokers and dealers
Private and state pension funds
Government-related financial institions
121
122
Convergence
Existing financial institutions now sell a wide variety
of financial products that earlier were outside their
core business area
123
124
125
126
Stock insurers
Mutual insurers
Reciprocal exchanges
Lloyds of London
Blue Cross and Blue Shield Plans
Health maintenance organizations (HMOs)
Other types of private insurers
127
128
129
130
132
133
135
137
138
139
(Insurance Broker)
A surplus lines broker is licensed to place business with
a nonadmitted insurer
Surplus lines refer to any type of insurance for which there
is no available market within the state, and coverage must
be placed with a nonadmitted insurer
140
Managerial system
Branch offices are established in various areas
The branch manager is responsible for hiring and training new agents,
and receives a commission from the insurer
Insurer pays expenses of the branch office
141
142
Marketing Systems
in Property and Liability Insurance
The independent agency is a business firm
that usually represents several unrelated insurers
Agents are paid a commission based on the amount of
business produced, which vary by the line of insurance
Agency owns the expirations or renewal rights to the
business
143
Marketing Systems
in Property and Liability Insurance
A direct writer is an insurer in which the salesperson
is an employee of the insurer, not an independent
contractor.
Employees are usually compensated on a salary plus
arrangement
144
Chapter 25
Functional
Operations of
Private Insurers
Agenda
147
Underwriting
Underwriting refers to the process of
selecting, classifying, and pricing applicants
for insurance
A statement of underwriting policy
establishes policies that are consistent with
the companys objectives, such as
Acceptable classes of business
Amounts of insurance that can be written
149
Underwriting
Important principles of underwriting:
The primary objective of underwriting is to attain an
underwriting profit
The second principle is to select prospective
insureds according to the companys underwriting
standards
The purpose of underwriting standards is to reduce
adverse selection against the insurer
Adverse selection is the tendency of people with a
higher-than-average chance of loss to seek insurance
at standard rates. If not controlled by underwriting,
this will result in higher-than-expected loss levels.
Underwriting
Underwriting starts with the agent in the field
Information for underwriting comes from:
The application
The agents report
An inspection report
Physical inspection
A physical examination and attending physicians report
MIB report
Production
Production refers to the sales and
marketing activities of insurers
Agents are often referred to as producers
Life insurers have an agency or sales department
Property and liability insurers have marketing
departments
152
Claim Settlement
The objectives of claims settlement
include:
Verification of a covered loss
Fair and prompt payment of claims
Personal assistance to the insured
Claim Settlement
The claim process
begins with a notice of loss
Next, the claim is investigated
A claims adjustor determines if a covered loss has
occurred and the amount of the loss
Reinsurance
Reinsurance
is an arrangement by which the primary
insurer that initially writes the insurance
transfers to another insurer part or all of the
potential losses associated with such
insurance
The primary insurer is the ceding company
The insurer that accepts the insurance from the
ceding company is the reinsurer
The retention limit is the amount of insurance
retained by the ceding company
The amount of insurance ceded to the reinsurer is
known as a cession
155
Reinsurance
Reinsurance is used to:
Increase underwriting capacity
Stabilize profits
Reduce the unearned premium reserve
The unearned premium reserve represents the
unearned portion of gross premiums on all
outstanding policies at the time of valuation
156
158
Types of Reinsurance
1.Facultative reinsurance
2.Treaty reinsurance
under treaty reinsurance, if the business falls within the
scope of the agreement, the primary company must cede
insurance to the reinsurer and the reinsurer must accept.
159
Types of Reinsurance
B.Types of automatic treaties
(1)Quota share
Types of Reinsurance
(3)Excess of loss
=
=
161
Reinsurance Alternatives
Some insurers use the capital markets as
an alternative to traditional reinsurance
Securitization of risk
means that an insurable risk is
transferred to the capital markets
through the creation of a financial
instrument, such as a futures contract
162
Reinsurance Alternatives
Catastrophe bonds are corporate bonds that
permit the issuer of the bond to skip or
reduce the interest payments if a
catastrophic loss occurs
Catastrophe bonds are growing in importance and
are now considered by many to be a standard
supplement to traditional reinsurance.
163
Investments
Because premiums are paid in advance, they
can be invested until needed to pay claims and
expenses
Investment income is extremely important in
reducing the cost of insurance to policyowners
and offsetting unfavorable underwriting
experience
Life insurance contracts are long-term; thus,
safety of principal is a primary consideration
In contrast to life insurance, property
insurance contracts are short-term in nature,
and claim payments can vary widely
depending on catastrophic losses, inflation,
164
medical costs, etc
165
166
167
Chapter 26
Financial
Operations of
Private Insurers
Agenda
Property and Casualty Insurers
Life Insurance Companies
Ratemaking in Property and Casualty
Insurance
Ratemaking in Life Insurance
The Financial Crisis and Insurers
170
171
172
173
177
179
Underwriti ng Expenses
Premiums Written
181
Financial Statements of
Life Insurers
The balance sheet
The assets of a life insurer have a longer
duration, on average, than those of property
and casualty insurers
Because many life insurance policies have a
savings element, life insurers keep an interestbearing asset called contract loans or policy
loans
A life insurance company may have separate
accounts for assets backing interest-sensitive
products, such as variable annuities
182
Financial Statements of
Life Insurers
Policy reserves are a liability item on the balance
sheet that must be offset by assets equal to that
amount
State laws specify the minimum basis for calculating policy
reserves
Financial Statements of
Life Insurers
Policyholders surplus is less volatile in the life
insurance industry than in the property and
casualty insurance industry
Benefit payments, including death benefits
paid to beneficiaries and annuity benefits paid
to annuitants, are the life insurers major
expense
A life insurers net gain from operations equals
total revenues less total expenses,
policyowner dividends, and federal income
taxes
184
185
187
190
191
193
194