CHAPTER 2 Insurance INTRODUCTION PART 1: INSURANCE IN GENERAL INSURANCE IN GENERAL PAYMENT OF THE PREMIUM

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1 CHAPTER 2 Insurance INTRODUCTION In this chapter, the law of insurance is presented. Insurance law contains elements of contract law because insurance is a contract. What makes up the offer, the acceptance, and the consideration will be discussed. What the contract is about will be discussed, as well as who may obtain the contract and how the contract is arranged. The chapter also deals with the types of insurance policies that are available, and the principles of life, health, automobile, home, and business insurance. Annuities are also covered. PART 1: INSURANCE IN GENERAL INSURANCE IN GENERAL Insurance law is contract law because insurance is a contract between the insurer or underwriter (the party assuming the risk in return for payment of a premium) and the insured/assured or insuree (the person who obtains or is covered by the insurance on his or her health, life, or property). Insurance covers the insured, but it may also cover an additional insured another person. For example, David takes out health insurance that covers not only himself but his wife Kristi and his son David, Jr. A contract exists between David and the health insurance company that the company will pay David the costs incurred as a result of his illness or the illness of his wife or child. Refer to Exhibit 2-1. EXHIBIT 2-1 HOW INSURANCE IS A CONTRACT Offer Provide insurance to protect against a type of loss for a price. + Acceptance The person seeking insurance agrees to the offer. + Consideration The insurance premiums are paid for coverage. = Contract The insurance policy constitutes the actual contract. PAYMENT OF THE PREMIUM The insurer agrees to compensate the insured for loss of a specified subject or item caused by specified perils if the person seeking the insurance pays an insurance premium. The premium is a sum of money paid to the insurer or underwriter as consideration for the insurance. In a single premium insurance policy, the insured makes only one premium 1

2 2 CHAPTER 2 payment; this single premium is enough to provide coverage, and no other premiums are due. An example of a single premium insurance policy is air travel insurance, which pays the beneficiary in the event that the insured is killed while on a specific flight. The insured buys the air travel insurance for one flight, pays the single premium, and the policy is cancelled at the safe conclusion of the trip. However, if the plane crashed and the insured were killed, the air travel insurance would pay the full value of the policy. INSURABLE INTEREST In order to obtain insurance, the person seeking the insurance must have an insurable interest, a real and substantial interest in the property. In order to have insurable interest, the person must suffer a pecuniary loss the loss of money or something of monetary value if something happens to the property. Not only must there be an insurable interest, but the property or interest must also be insurable, that is, capable of being insured against loss, damage, illness, or death. The amount of insurance a person can purchase is determined by the insurable value of the property or interest for insurance purposes. For example, Madge inherits an old vase from her mother s estate. She has the vase appraised and discovers that it is worth over $4,000. Because she is the owner of the vase, she has an insurable interest in the vase: harm to or destruction of the vase would cause pecuniary loss. Madge could obtain up to $4000 in insurance for the vase because that is its appraised value. However, if the policy has a deductible, the amount she can recover will be reduced by that deductible. A deductible is the part of the insured loss that must be paid or borne by the insured before he or she is entitled to recover any amount. If the insurance on the vase has a $500 deductible, then the amount recovered from the insurance company would be $3,500 $4,000 less the amount of the $500 deductible. The amount of the deductible is contained in the insurance policy in the deductible clause. Refer to Exhibit 2-2 for a summary of the requirements for insurance to apply. EXHIBIT 2-2 NECESSARY ELEMENTS FOR AN INSURANCE POLICY TO APPLY Insurable Interest The person must have a real and substantial interest in the property. Potential for Pecuniary Loss The loss of money or something of monetary value if something happens to the property. Insurable The property must be capable of being insured against loss, damage, illness, or death. Insurable Value The value of the property or interest for insurance purposes must be determined. Deductible The part of the insured loss that must be paid or borne by the insured before he or she is entitled to recover any amount must be determined

3 INSURANCE 3 INSURANCE COMPANIES Insurance is purchased from an insurance company, whose business is to make and enter into contracts of insurance. There are generally two types of insurance companies: mutual companies and stock companies. A mutual insurance company is a company whose fund for the payment of losses consists not only of the company capital but also of premiums paid by the insured. The people who become insured become members of the association and contribute either cash or premium notes. A premium note is a promissory note given to the company by the insured for the entire amount of the premium or a part thereof. A participating policy may be issued by the mutual company. This is an insurance policy in which the insured participates in the profits by receiving dividends or rebates from future premiums. A stock insurance company may also issue a participating policy. A stock insurance company is one that is organized according to the laws governing business corporations, having sold shares of capital stock which, with current income and accumulated surplus, make up the fund that is used to pay the claims of the insured. Policyholders are not members of a stock insurance company and do not receive any dividends from any surplus unless they own stock in the company. INSURANCE AGENTS In order to purchase insurance, a person may contact an insurance agent. An insurance agent is an individual employed by an insurance company to solicit insurance business. The agent does not represent the purchaser of the insurance; he or she represents the insurance company. (See Chapter 13 Agency, in the main text.) An agent can be a general agent, one who has the general oversight of the company s business in a state or a large section of the country. An agent may also be a local agent, one whose functions are limited to some particular locality. An agent can also be a soliciting agent, who has authority only to solicit insurance, submit the application to the company, and perform acts that are incidental to these powers. A person seeking insurance may also contact an insurance broker, who is an intermediary between the insured and the company. An insurance broker solicits insurance from the public under no employment agreement from any specific company and places orders of insurance with the company selected either by the insured or by the broker. The insurance broker is an agent on behalf of the insured and can be an agent for the insurance company. See Exhibit 2-3 for a summary of insurance sellers. EXHIBIT 2-3 SELLERS OF INSURANCE General Agent An agent who can sell insurance and has general oversight of a company s business in a state or a large section of the country. Local Agent An agent whose functions are limited to some particular locality, for example, a city or part of a state. Soliciting Agent An agent who has authority only to solicit insurance and submit the application to the insurance company. Insurance Broker A person who is an intermediary between the insured and the company. An insurance broker solicits insurance from the public under no employment agreement from any specific company and places orders of insurance with the company selected either by the insured or by the broker.

4 4 CHAPTER 2 BINDERS, RISKS, RATINGS, AND LOSSES Upon receipt of an application for insurance, the insurance company may issue an insurance binder. This is a memorandum of the insurance coverage agreement giving temporary protection pending the issuance of the formal policy while the company is investigating the risks and setting the premium rates. For example, Hamish takes out insurance on himself. The company issues a binder that provides for temporary protection. If any event that is covered by the insurance occurs, then the binder is the proof of the coverage. Once the final amount of the premium is determined, a permanent policy will be issued. Risk is the danger or hazard of loss of the property that is insured, or the likelihood that what is insured against will actually happen. After considering the risk, the amount of the premium is set. This process is the determination of the insurance rating: How big a risk of loss is the individual or how big a risk is the property? If the individual or property is a large enough risk, then hazardous insurance may be issued. Hazardous insurance is insurance on property that is in unusual or peculiar danger of being destroyed by fire. For example, a couple builds their home at the edge of a forest that has suffered ten forest fires in the past twenty years. Because of the frequency of incidents of forest fires, the home is considered a high-risk property, and hazardous insurance is issued. Hazardous insurance also applies to people whose occupation exposes them to special or unusual danger, for example, police officers or firefighters. If the risk of loss is too great to be paid by a single company, insurance companies may combine to form an insurance pool, sharing premiums and losses so as to spread the risk among them. One company will not have to pay any claim by itself; rather, several companies will pay any claims. Loss is the fact that the item has been lost or destroyed. Many types of loss can be suffered in insurance law. Actual loss results from the real and substantial destruction of the property insured. If a home is destroyed by a tornado, the actual loss is the loss of the home because it was destroyed by the tornado. A casualty loss is the complete or partial destruction of property resulting from an identifiable event of a sudden, unexpected, or unusual nature. Casualty losses can be deducted from taxes. A pecuniary loss is the loss of money or something that has monetary value, for example, a stock or bond. Consequential losses are those not directly caused by damage but arising from the results of the disaster. For example, the cost of lodging after an individual s home is destroyed in a fire is a consequential loss. The loss of the house is the actual loss; not having somewhere to live is the consequential loss. A direct loss results immediately from an occurrence. It is not a remote loss because of some of the consequences or effects of the loss. If one s home is destroyed by fire, the direct loss is the loss of the home. Anything else that happens, such as the cost of another place to live while the home is being rebuilt, is a consequence of the direct loss. A constructive loss results from injuries to the property, without its destruction, that renders it valueless to the insured, or loss that prevents its restoration to the original condition except a cost exceeding the value of the item. The item is not totally destroyed and may still retain some value, but it has become useless to the person who owns it. For example, a car is wrecked so badly that it cannot be driven again. It has lost use to the owner, but may still be used for parts, so it has value to someone else. A constructive total loss occurs when the insured item of property has lost its total usefulness and the insured is deprived of its benefits totally. The item may not be totally destroyed, but it has become useless to anyone. A partial loss is the loss of a part of a thing or part of its value or damage to the item that is not the actual or constructive total loss. The damage done is not enough to amount to a total loss. A disaster loss is the loss suffered in an area that has been declared a disaster area by the President of the United States. See Exhibit 2-4 for a summary of the types of losses a person can suffer.

5 INSURANCE 5 EXHIBIT 2-4 TYPES OF LOSSES Loss An item has been lost or destroyed. Actual Loss The loss resulting from the real and substantial destruction of the property insured. Casualty Loss The complete or partial destruction of property resulting from an identifiable event of a sudden, unexpected, or unusual nature. Pecuniary Loss The loss of money or something that has monetary value (e.g., a stock or bond). Consequential Loss The loss is not directly caused by damage, but arises as a result of a disaster. Direct Loss A loss resulting immediately from an occurrence; it is not a remote loss because of some of the consequences or effects of the loss. Constructive Loss The item is not totally destroyed, but it has become useless to the person owning it. It may still have value. Constructive Total Loss The insured item of property has lost its total usefulness and the insured is deprived of its benefits totally. The item is not totally destroyed, but it has become useless to anyone. Partial Loss A loss of a part of a thing or part of its value or damage to the item that is not the actual or constructive total loss. Disaster Loss The loss suffered in an area that has been declared a disaster area by the President of the United States. PROOF OF LOSS AND ADJUSTERS In order to collect from an insurance company, the insured will have to submit proof of loss, a formal statement that gives the company enough information to enable it to determine the extent of its liability under a policy. Once the company receives a report of a loss, it will appoint an insurance adjuster who will determine and report the actual loss and settle the claim against the insurer. Either the insurance company or the insured may hire the adjuster. POLICY OF INSURANCE GENERAL PRINCIPLES The policy of insurance is the written instrument that sets out the contract of insurance. The insurance policy and will states that the insurer, because of the consideration paid (the premium), will indemnify the other party (the insured) for losses insured against. To indemnify the insured is to restore the person in whole or in part by payment, repair, or replacement of the item that was destroyed. The policyholder is the person who owns the policy of insurance, whether he or she is the insured or not. For example, a parent can purchase a life insurance policy for the life of his or her child. The child is the insured but the parent is the actual policyholder because he or she owns the policy as a result of his or her paying the premiums for it. TYPES OF INSURANCE POLICIES IN GENERAL There are many types of insurance policies and terms contained in them. An assessable policy is one under which the policyholder may be held liable for the losses of the insurance company beyond the company s policy reserves. A policy reserve is the funds held by the

6 6 CHAPTER 2 insurance company specifically to meet its policy obligations. If this reserve is exhausted, then the company may attempt to collect the amount it had to pay over its policy reserve from the policy holders. In an interest policy, the insured has a real, substantial, and assignable interest in the thing insured. For example, Corlas has a real interest in her home; she is the owner. The policy she would purchase would be an interest policy. In contrast, a wager policy is one for which the insured has no real interest in the subject matter; the insured could not sustain any possible loss by the harm suffered by the item. Such policies are generally illegal and are not generally written because the insured does not have an insurable interest. For example, if Gavin took out an insurance policy on his friend Nestor s home a home in which he has no interest this would be a wager policy. An open policy is one in which the value of the subject matter that is insured is not fixed or agreed upon in the policy, but will be estimated in case of loss. Quint takes out an open policy on his house that is then destroyed by fire. There is no amount specified in the policy, so the amount Quint would receive for the loss is the assessed value of the home when it was destroyed by the fire. In a value policy, the value of the subject matter insured is fixed for the purposes of the insurance and is stated on the face of the policy. For example, Monette insures her home for $150,000, and this is stated in the policy. See Exhibit 2-5 for a summary of the different types of insurance policies. EXHIBIT 2-5 SUMMARY OF THE DIFFERENT TYPES OF POLICIES Assessable Policy A policy under which the policyholder may be held liable for the losses of the insurance company beyond the company s policy reserves, which are the funds held by the insurance company specifically to meet its policy obligations. If this reserve is exhausted, then the company may attempt to collect the amount it had to pay over its policy reserve from the policy holders. Interest Policy The insured has a real, substantial, and assignable interest in the item insured. Wager Policy A policy in which the insured has no real interest in the subject matter; the insured could not sustain any possible loss by the harm suffered by the item. Such policies are generally illegal and are not generally written because the insured does not have an insurable interest. Open Policy The value of the subject matter that is insured is not fixed or agreed upon in the policy, but will be estimated in case of loss. Value Policy A policy in which the value of the subject matter insured is fixed for the purposes of the insurance and is stated on the face of the policy. Policy value is the amount of cash available to the policyholder upon surrender or cancellation of the insurance policy. If the insurance policy is cancelled, this is the amount of money the policyholder will receive. The policy year begins with the date of the commencement or anniversary of the insurance policy. For example, Hattie purchases insurance on September 16, The policy year would start on September 16, 2005, the date the policy was purchased. GENERAL TYPES OF INSURANCE INTRODUCTION Certain words and phrases are used to describe broad categories of insurance that are available, the sorts of claims that are covered, how claims are paid, and the purposes of the insurance. These terms may also apply to more specific types of insurance. Such terms are more descriptive and can apply to life, health, accident, auto, or fire insurance.

7 INSURANCE 7 RISK INSURANCE AND ANNUITIES Accident insurance is a form of insurance that indemnifies the insured against expenses, loss of time, and suffering that result from accidents that cause physical injury. If the policyholder is hurt or injured, this type of insurance will provide him or her payments for losses caused by injury. Accident insurance is also known as indemnity insurance. All risk insurance is a type of policy that ordinarily covers every loss that may happen, except by fraudulent acts on the part of the insured. This is also known as comprehensive insurance. First party insurance applies to the insured s own person or property. A consumer insures his or her car or house with first party insurance. Annuity insurance provides periodic payments to the insured for either a stated period or for life. These payments can be into a retirement account or an account that provides monthly payments for a period of years. An annuity is the right to receive a fixed, periodic payment either for life or for a set number of years. ASSESSMENT AND OLD LINE INSURANCE Assessment insurance is a type of mutual insurance in which the policyholders are assessed as losses are incurred. Payments to the insured are not fixed, but rather are dependent on the collection of assessments necessary to pay the amounts insured. The more claims that are filed, the higher the assessed amount will be because the company has to pay the claims made. The fewer claims that are paid, the lower the amounts that are assessed will be. Old line insurance sets definite premiums and fixes the insurer s liability. The policyholder knows the amount of premiums he or she will pay for the amount of insurance purchased. These amounts are set out in the agreement. CASUALTY INSURANCE Casualty insurance is concerned with the losses caused by injuries to persons and the legal liability imposed upon the insured for the injury or damages caused to the property of others. If the policyholder hurts someone or damages another s property, casualty insurance will pay for the harm caused. Casualty insurance does not pay for any loss suffered by the policyholder because of an accident; rather, it is intended to pay others for the damages caused by an accident that is the policyholder s fault. Casualty insurance is also known as liability insurance because it covers the liability incurred by the policyholder. For example, Bebe takes out a policy of casualty insurance to pay the claims of customers who might be injured in her store. A customer slips and falls in Bebe s store; the insurance will pay the customer for the harm caused by the slip and fall. CONCURRENT INSURANCE Concurrent insurance is insurance coverage under two or more similar insurance policies of varying dates and amounts. One insurance policy is supplemented by the other: the second covers the costs that the first policy does not. A potential policyholder of concurrent insurance should look for an excess clause, which limits the liability of the insurer to the amount the other insurance did not pay. For example, Karyn s first health insurance policy paid all but $200 of her medical bills. The other insurance policy will pay only up to $200 the amount the first insurance did not pay. The person insured cannot collect more than the actual cost of the loss. An umbrella policy is a type of insurance protection

8 8 CHAPTER 2 against losses in excess of the amounts covered by other liability or casualty insurance companies. FLOATER INSURANCE AND BLANKET POLICIES Floater insurance (or a floater policy) isatype of insurance that applies to moveable property whatever its location if the property is within the territorial limits established by the policy. Any loss to the property that happens within the territorial limits will be covered by the policy. For example, Mike insures his boat and there is a territorial limit set. As long as the boat is within the territory established by the policy, any loss to the boat is covered. But if the loss happens outside the territorial limit set, then there is no coverage. A blanket policy covers more than one type of property in one location, or one or more types of property in more than one location. For example, a homeowner s policy covers the loss of the home, all of its contents, and any other property damaged that is located in or on the home. Refer to Exhibit 2-6 for a summary of the different types of insurance. EXHIBIT 2-6 SUMMARY OF THE DIFFERENT TYPES OF INSURANCE Accident Insurance Insurance that indemnifies the insured against expenses, loss of time, and suffering that result from accidents causing physical injury; also known as indemnity insurance. All Risk Insurance A type of policy that ordinarily covers every loss that may happen, except by fraudulent acts on the part of the insured. This is also known as comprehensive insurance. First Party Insurance Insurance that applies to the insured s own person or property. Assessment Insurance A type of mutual insurance where the policyholders are assessed as losses are incurred. Payments to the insured are not fixed, but are dependent on the collection of assessments necessary to pay the amounts insured. Old Line Insurance Sets definite premiums and fixes the insurer s liability. Casualty Insurance Insurance that covers the losses caused by injuries to persons and the legal liability imposed upon the insured for the injury or damages caused to the property of others. Concurrent Insurance Insurance coverage under two or more similar insurance policies of varying dates and amounts. Umbrella Policy A type of insurance protection against losses in excess of the amounts covered by other liability or casualty insurance companies. An umbrella insurance policy covers the losses not covered by the other insurance policies. Floater Insurance Insurance that applies to moveable property whatever its location if the property is within the territorial limits established by the policy. Blanket Policy A policy that covers more than one type of property in one location, or one or more types of property in more than one location. EXCESS INSURANCE, UNDERINSURANCE, AND MUTUAL INSURANCE Excess insurance is coverage against losses in excess of a stated amount or in excess of coverage provided under another insurance contract or policy. Underinsurance is insurance coverage for less than the value of the property. For example, if a house is worth $100,000 and is insured for $110,000, it has excess insurance. If it is insured for $90,000, then it is underinsured.

9 INSURANCE 9 Mutual insurance covers groups of people. Mutual insurance is of three varieties: cooperative insurance, fraternal insurance, and group insurance. Cooperative insurance is a form of mutual insurance in which the policyholders are the owners. The policyholders may be assessed for losses in part or in their entirety. Cooperative insurance may also be nonassessable. Fraternal insurance is a form of life or accident insurance provided by a fraternal or beneficial association. A member of such an organization, or the member s heirs, in case of death, is paid a stipulated sum of money out of funds raised for that purpose by the payment of dues or assessments by all other members of the association. Group insurance is a form of insurance where groups of people usually employees are offered insurance in consideration of a flat periodical premium either totally paid by the employer or partly by the employer and partly by the employees. The members of the group are covered either by a single master policy or individual policies. In group insurance, the single insurance policy that covers all of the insured is the master policy. The individuals who are covered by this policy will receive a certificate indicating they are participating in the group insurance. See Exhibit 2-7. EXHIBIT 2-7 GROUP INSURANCE Cooperative Insurance A form of mutual insurance in which the policyholders are the owners. The policyholders may be assessed for losses in part or in whole. Alternatively, the insurance may be nonassessable. Fraternal Insurance A form of life or accident insurance provided by a fraternal or beneficial association. A member of such an organization (or his or her heirs in case of death) is paid a stipulated sum of money out of funds raised for that purpose by the payment of dues or assessments by all members of the association. Group Insurance Groups of people usually employees who are offered insurance in consideration of a flat periodical premium either totally paid by the employer or partly by the employer and partly by employees. The members of the group are covered either by a single master policy or by individual policies. GOVERNMENT INSURANCE CROP INSURANCE Government is responsible for the issuance of several types of insurance policies. One type of government insurance is crop insurance, which is coverage against financial loss due to the destruction of agricultural products from rain, hail, and other elements of nature. The Federal Crop Insurance Corporation, a federal agency, sponsors crop insurance. FDIC Another type of government insurance is provided by the Federal Deposit Insurance Corporation (FDIC), which is an independent agency of the executive branch of government that provides deposit insurance. (See Chapter 6, Administrative Law, in the main text.) This insurance covers, up to the statutory limit, deposits in qualified banks and savings and loans. If a depositor loses his or her money because a bank that is FDIC-insured fails, then the amount that the person loses is insured up to the current statutory limit of $100,000. The person can recover the amount of his or her loss up to $100,000.

10 10 CHAPTER 2 LIFE, WAR, CRIME, AND FLOOD INSURANCE National service life insurance is life insurance that is underwritten and offered by the federal government to war veterans. If one is not a veteran of a war, he or she is not eligible for this type of insurance. Warrisk insurance is offered by the federal government to protect persons against wartime loss of vessels and property on the high seas. Shipowners who lose their vessels because of an act of war may file a claim against war risk insurance. Crime insurance protects the insured from losses resulting from criminal activity against the insured, such as burglary or theft. The federal government sponsors crime insurance for people who live in high crime areas. Flood insurance indemnifies someone because of loss caused by flood; it is required by lenders in areas designated as potential flood areas. This type of insurance is privately issued, but it is subsidized by the federal government. SOCIAL INSURANCE Social insurance is a comprehensive social welfare plan established by law and based on programs that spread the cost of the benefits among the total population rather than on individual recipients. The basic federal and state social insurances currently used are old age, survivors, and disability insurance, Medicare, Medicaid, unemployment insurance, and worker s compensation insurance. Unemployment insurance is a form of taxation collected from businesses to fund unemployment payments and benefits. Unemployment insurance is intended primarily for people who find themselves unemployed through no fault of their own. Worker s compensation insurance is purchased by employers to cover payments to employees who are injured in accidents arising out of their employment. (See Chapter 18, Labor and Employment Law, in the main text.) If a beneficiary wants to make sure he receives the maximum benefit from insurance, he or she can arrange for an insurance trust. An insurance trust is an agreement between the insured and a trustee that the proceeds of a policy will be paid directly to the trustee, who is to invest and distribute the proceeds to the beneficiary in a manner and at such time as directed in the trust agreement. PART 2: SPECIFIC TYPES OF INSURANCE LIFE INSURANCE IN GENERAL The first type of specific insurance that will be discussed here is life insurance. In general, life insurance is a contract between the holder of the policy and the insurance company in which the company agrees, in return for payment of premiums, to pay a specified sum the face value of the policy to a designated beneficiary upon the death of the insured. Generally someone takes out a life insurance policy to benefit someone else not himself or herself. WHOLE LIFE INSURANCE There are two broad types of life insurance: whole life and term life. In whole or straight life insurance, premiums are paid for as long as the insured is alive. The premium remains the same, and the insurance builds up cash reserves. Because of these cash reserves, the

11 INSURANCE 11 whole life policy is an asset that can be borrowed against. If the insured receives an advance on the value of the policy, but does not have to pay it back, this is a policy loan. The value of the policy is reduced by the amount that was advanced to the insured. The face value of the policy never goes down unless there is a policy loan. TERM LIFE INSURANCE In term life insurance or a term policy, premiums are paid for a specified or limited period of time. Such a policy is renewable from term to term (it can be cancelled at the expiration of a term); the premiums may increase as the policy holder gets older because the risk increases; it has no cash surrender value; and it does not build up cash reserves. A term life insurance policy is not an asset that can be borrowed against. Also, the amount that a person can receive under the policy may decrease depending on the terms of the policy. See Exhibit 2-8 for the differences between whole life and term insurance. EXHIBIT 2-8 WHOLE LIFE INSURANCE OR TERM LIFE INSURANCE WHOLE LIFE INSURANCE 1. Premiums are paid as long as the insured is alive. 2. Premiums stay the same. 3. Policy builds up cash surrender value. 4. Policy is an asset that can be borrowed against. 5. Face value never decreases. TERM LIFE INSURANCE 1. Premiums are paid for a set period of time. 2. Premiums can increase. 3. Policy has no cash surrender value. 4. Policy is not considered an asset for loans. 5. Face value can decrease. There are several different forms of these basic insurance policies. Old line life insurance is insurance available at a level or flat rate. The premium is fixed (will not increase or decrease); it is payable without condition at stated intervals; and upon death a certain sum of money will be paid without condition. Endowment insurance (or an endowment policy) is a type of life insurance that combines the features of life insurance with those of investments. The endowment policy is for a stated period of time and premiums are paid during this time. If the insured is still alive after the stated period of time, the face value is paid to the insured. If he or she dies before the stated period of time, the face value is paid to his or her beneficiary. Endowment insurance may be a type of limited payment life insurance, where the premiums are payable for a definite period of time. Upon completion of this period of time, the policy is paid for in full. For example, Clayton takes out an endowment life insurance policy when he is 20 years old and pays on it for thirty years. If he is still alive after thirty years, he will receive the face value of the policy. If he has died, then his named beneficiary will receive the value of the policy. The policy would be a paid up policy, one on which no additional payments of the premium are to be made.

12 12 CHAPTER 2 Decreasing term insurance is a term life insurance policy where the premiums stay the same, but the face value of the policy declines. Decreasing term insurance provides a death benefit, but the amount declines throughout the term of the policy to zero at the end of the term. For example, Benita takes out a decreasing term life insurance policy for $40,000. The premium stays the same throughout the life of the policy. The amount her beneficiaries will receive upon her death will decline the older she gets. The amount may ultimately be nothing. Group term life insurance is coverage provided by an employer for a group of employees. Such insurance is renewable on a year-to-year basis and does not accumulate any value. Group term life insurance may be regular term insurance or it may be decreasing term insurance. In renewable term life insurance, the premiums are level during each term, but increase at each term as the insured ages. The insured can renew the policy for additional terms without having to undergo a medical examination. Convertible life insurance is a form of term life insurance that gives the insured the right to change the policy to whole life insurance without a medical examination. See Exhibit 2-9 for a summary of the different types of life insurance. EXHIBIT 2-9 TYPES OF LIFE INSURANCE Old Line Life Insurance The premium amount stays the same and is due at set intervals. There are no conditions that have to be met before payment will be made. Endowment Insurance The premiums are paid for a certain, set period of time. If the person who took out the insurance is still alive at the end of this period, he or she will receive the benefits. If not, the benefit goes to the named beneficiary. Decreasing Term Insurance Term life insurance where the premiums stay the same but the face value of the policy declines. Decreasing term provides a death benefit, but the amount declines throughout the term of the policy until it reaches zero at the end of the term. Renewable Term Life Insurance The premiums are level during each term, but increase at each term with the age of insured. The insured can renew the policy for additional terms without having to undergo a medical examination. Convertible Life Insurance A form of term life insurance that gives the insured the right to change the policy to whole life insurance without a medical examination. JOINT LIFE INSURANCE Joint life insurance is a type of life insurance for two or more people and is payable on the death of the first to die. The remaining insured will share in the proceeds. For example, Paul, Candy, and Steven take out a joint life insurance policy for $60,000. When one of the insured dies, the remaining two will share $60,000, receiving $30,000 each. Last survivor insurance is life insurance on two or more people, but is not payable until the death of every one of the insured. For example, if Wes and Grace took out last survivor insurance and named their daughter as the beneficiary, their daughter would not receive the benefits until both of her parents had died. DOUBLE INDEMNITY If a life insurance policy has a double indemnity clause, the beneficiary will receive twice the amount of the face value of the policy if a certain event takes place. For example, Faisal takes out a $40,000 life insurance policy with a double indemnity clause. The clause states

13 INSURANCE 13 that if Faisal is killed while driving his 18-wheeler truck, then the face value doubles. If Faisal dies while operating his big rig, his beneficiary would receive $80,000 instead of $40,000. If Faisal dies of natural causes, then the beneficiary would receive $40,000. A policy may have an aviation clause that limits the liability on the insurance company if death or injury is connected to a specified type of aviation. For example, Faisal s policy also has a clause that states if he is killed while flying a private plane, the face value is reduced by 50%. If he is killed in a crash of a private plane he is flying, his beneficiary would receive $20,000. Extended term insurance is a provision in most policies that continues the existing amount of life insurance for as long a period of time as the policy s cash value will purchase the insurance. The cash value of the policy will pay the premiums, keeping the policy in effect until there is no more cash surrender value. HEALTH INSURANCE Health insurance is a contract whereby the insurer is obligated to pay for any expenses related to a bodily injury, disablement, sickness, or death by accidental means, or for the expenses accrued in preventing any sickness. The insurer may also have to pay a monetary or pecuniary benefit if any of these conditions happen. The policy may contain a preexisting condition clause. This clause limits coverage for a condition the insured had when the policy was first taken out. It may not cover the condition until a certain period of time has passed or it may never cover the condition. Group health insurance provides insurance coverage for employees or other members of the group covered under a group policy for hospital, surgical, and other medical expenses. Major medical insurance provides coverage for large medical, surgical, and hospital expenses of the insured. AUTOMOBILE INSURANCE IN GENERAL Automobile insurance may include insurance against the loss or damage to a car caused by fire, windstorm, theft, collision, or other hazard. Auto insurance may also be against the legal liability for personal injuries or property damage that is caused by the operation of the motor vehicle. A policy of indemnification protects the owner/operator of a vehicle from liability to a third person. It may also include protection to the owner/operator of the vehicle if the other driver does not have insurance. COLLISION AND LIABILITY Collision insurance is auto insurance that covers losses caused by collision with another vehicle. Collision insurance covers damages to the owner/operator s property and the property of another if the owner/operator is responsible for the harm. Collision coverage does not cover bodily injury or any other type of liability that may arise as a result of the collision. Convertible collision insurance is a policy that has a lower premium, but will require

14 14 CHAPTER 2 a higher premium after the first loss or claim. The insured pays one premium, and as long as he or she does not have an accident, that will remain the premium. In the event of an accident, the premium will be increased to indicate the fact that the insured had the wreck. Liability insurance is auto insurance that covers suits against the insured for such damages as injury or death to other drivers and passengers, property damage, and other damages caused. No-fault auto insurance is a policy in which claims for personal injury and sometimes property damage are made against the claimant s own insurance company regardless of who was at fault. Only in cases of serious personal injury and high medical costs may the injured innocent party seek payment from the other insurance company. If the owner/operator of the automobile has other insurance available, the pro rata clause in his or her car insurance, if there is a pro rata clause, will apply. A pro rata clause states that when an insured has other insurance available, the company will be responsible for only a proportion of the loss. This portion is determined by the ratio between the policy limit and total limits of all other available insurance. See Exhibit 2-10 for a summary of clauses in auto insurance. EXHIBIT 2-10 COVERAGE AND CLAUSES IN AUTOMOBILE INSURANCE Collision Coverage Auto insurance that covers losses caused by collision with another vehicle. Convertible Collision A policy that has a lower premium but will require a higher premium after the first loss or claim. Liability Coverage Auto insurance that covers suits against the insured for such damages as injury or death to other drivers and passengers, property damage, and other damages caused. No-fault Coverage Insurance in which claims for personal injury and sometimes property damage are made against the claimant s own insurance company regardless of who is at fault. Pro Rata Clause Clause that states when an insured has other insurance available, the company will only be responsible for a portion of the loss. This portion is determined by the ratio between the policy limit and total limits of all other available insurance. PROPERTY INSURANCE LEASE AND MORTGAGE INSURANCE There are several different types of insurance for real property, depending on the nature of the ownership or possession of the property. Lease insurance protects against losses sustained through the termination of the lease as a result of such hazards as fire. The specific hazards covered are listed in the policy. Mortgage insurance provides benefits that are to be used to pay off a mortgage if the insured dies, or to meet mortgage payments if the insured becomes disabled and cannot make payments. It is also insurance against the loss to the mortgagee in the event of a default on the mortgage and the amount received from the sale is insufficient to satisfy the debt. TITLE INSURANCE A title company issues title insurance after doing a title search that ensures the accuracy of the search against claims of title defects. Title insurance protects against the loss or damage resulting from defects or failure of title to a particular parcel of land, or from the enforcement of liens existing against the land.

15 INSURANCE 15 RENTER S AND HOMEOWNER S INSURANCE Renter s insurance is for people who rent an apartment. It insures against some or all of the risks of loss to personal property or personal liability for harm caused in the rented premises. Homeowner s insurance is insurance against some or all the risks of the loss of personal property or the home itself, and against personal liability for harm caused on the premises. Fire insurance protects against losses caused to houses, buildings, furniture, ships in port, or merchandise caused by accidental fires happening within a prescribed period of time. If the fire insurance policy sets a specific period of time of coverage, it is also known as a time policy. In fire insurance, a total loss is the complete destruction of the insured property by fire so that nothing of value remains. MARITIME INSURANCE Marine insurance is insurance against certain perils or sea risks that a ship, freight, or cargo may be exposed to during a certain voyage or during a fixed period of time. Cargo insurance is specifically for cargo. A claim can be made against it if the cargo does not arrive at its destination in the same condition it was in at the beginning of the trip. If, during the trip, the cargo had to be thrown overboard to save the ship, the loss may be shared by the shipowner and the owners of the cargo. This is known as the general average loss. BUSINESS INSURANCE Because businesses can suffer a wide variety of losses, they have a wide range of insurance from which to choose. A business can elect to be protected from loss of profit, loss of employees, or even loss of business. COMMERCIAL TRANSACTION INSURANCE Commercial insurance indemnifies a business for loss by reason of a breach of contract on the part of another contracting party. Credit insurance, a type of commercial insurance, indemnifies a business for losses due to death, disability, insolvency, or bankruptcy of a debtor. Credit insurance usually covers the amount due to the company. Accounts receivable insurance is for losses suffered as a result of an inability to collect money owed because of the destruction of records indicating how much money is owed to the company by whom. If a fire destroys all the records of a company so that company has no way of knowing its accounts receivable, then it may file a claim against this type of insurance. BUSINESS LOSS INSURANCE Business interruption insurance is a type of insurance that protects a business from losses due to an inability to operate because of fire or other hazards. For example, if a business is damaged in a tornado and is unable to operate, this insurance will pay for the losses suffered. Profit insurance pays for the loss of profits a business owner would have had if the damage or loss had not happened. If a business loses its merchandise in a fire but is able to keep on operating, the profit insurance will pay the owner for the profit he or she lost as a result of the fire.

16 16 CHAPTER 2 Businesses may have an employee who is vital to their operation. If that employee dies or is disabled, the business could suffer losses while it searches for and trains a replacement. Or, a business partner could die and the remaining partners wish to buy out his or her part of the business. Business insurance protects a business in the event of the death of a key employee. Key man life insurance is a type of business insurance that insures the life of a key officer or employee in the company. Upon that employee s death, the company is the beneficiary of the life insurance and collects the monetary payment. Partnership insurance is life insurance on the different partners in a partnership. It is designed to enable the remaining partners to buy out the deceased partner s estate. See Exhibit 2-11 for a summary of types of business insurance. EXHIBIT 2-11 BUSINESS INSURANCE Commercial Insurance Pays a business for loss by reason of a breach of contract on the part of another contracting party. Credit Insurance Pays a business for losses due to death, disability, insolvency, or bankruptcy of a debtor. Accounts Receivable Insurance Pays for losses suffered as a result of an inability to collect money owed because of the destruction of records indicating how much money is owed to the company. Business Interruption Insurance Protects a business from losses due to an inability to operate because of fire or other hazards. Profit Insurance Pays the loss of profits a business owner would have had if the damage or loss had not happened. Key Man Life Insurance The business insures the life of a key officer or employee in the company. Upon that person s death, the company is the beneficiary of the life insurance and collects the monetary payment. Partnership Insurance Life insurance on the different partners in a partnership. Proceeds from the policy enable the remaining partners to buy out the deceased partner s estate. FIDELITY INSURANCE Businesses hope that their employees and agents are honest, but if they are dishonest, a business can face liability consequences. Fidelity insurance is a form of insurance that guarantees the honesty of an officer, agent, or employee of the insured. If the employee, officer, or agent turns out to be dishonest, the policy will indemnify the employer for any losses suffered as a result of the employee s dishonesty. Fidelity and guaranty insurance not only protects the insured from an employee s dishonesty, but also provides credit insurance and title insurance. The fidelity bond is the actual contract of insurance. Surety and fidelity insurance protects the business from the dishonesty of its employees, its agents, and the public its customers. See Exhibit EXHIBIT 2-12 FIDELITY INSURANCE Fidelity Insurance Guarantees the honesty of an officer, agent, or employee of the insured. Fidelity and Guaranty Insurance Protects the insured from an employee s dishonesty, but also provides credit insurance and title insurance. Fidelity Bond The actual contract of insurance. Surety and Fidelity Insurance Designed to protect a business from the dishonesty of its employees, its agents, and the public (its customers).

17 INSURANCE 17 LIABILITY INSURANCE Because an employer may be held responsible for the harm suffered by its employees in the event of an accident, injury, or death, the business may take out employer s liability insurance. This insurance indemnifies the insured business from losses caused by being liable for harm caused to another by an employee. This insurance is for claims that are not covered by worker s compensation. A business may also want to protect itself from losses caused by claims of damages and injury from the consumers of its goods and services. It may purchase product liability insurance, which protects the insured manufacturer and supplier from the claims arising out of the use of their products. To protect itself against claims of harm caused by its vehicles or to cover harm to its vehicles, a business may use fleet insurance, a blanket policy that covers a number of vehicles owned by the business. A business may also want to protect its intangible assets. For example, a patent is an intangible asset a company may want to protect. Patent insurance protects against a loss caused by the infringement of an insured company s patent. It also protects against losses caused by a claim of patent infringement against the insured company. If a business is fed up with the high cost of insurance, it may self insure. Self insurance is a plan by which a company places aside in a fund sufficient sums of money to cover any liability losses that may be sustained. The type of losses a company may set aside money for are those due to unemployment claims, worker s compensation claims, liability claims, or other claims. It is common for a business to self insure up to a certain amount, and then obtain liability insurance for any amounts in excess of the fund. Doctors, lawyers, accounts, psychiatrists, counselors, and other professionals have their own type of business insurance. This is malpractice insurance, which protects professional people against claims of negligence that are brought against them. The cost of such insurance is determined by the type of medicine a person practices and the number and types of claims that have been made against the insured. ANNUITIES IN GENERAL Another type of insurance is an annuity. An annuity is the right to receive a fixed, periodic payment, either for life or for a period of years. The payments represent a partial payment of the capital that was used to create the annuity and the return or interest that is earned by the capital. The person who establishes the annuity is the annuitant. An annuity policy is an insurance policy that provides for monthly or periodic payments to the insured to begin at a fixed time and to continue throughout the life of the annuitant. There are several types of annuities and several terms that define provisions of the annuity. For example, the term annuity certain means that an annuity is payable for a certain period of time, no matter when the annuitant dies. STRAIGHT AND VARIABLE ANNUITIES A straight annuity is a contract, usually issued by an insurance company, to make periodic payments in monthly or yearly increments. The amount of the payment is fixed. A

18 18 CHAPTER 2 variable annuity is a contract that provides payments to the annuitant in varying amounts depending on the success of the investments of the insurance company. The amounts that will be paid by the annuity are not set; they do vary. A cash refund annuity is an annuity policy that provides for a lump sum payment upon the death of the annuitant of the difference between the total amount of money received and the price paid for the annuity. If the price was $5,000, and only $2,000 was received, the lump sum that is to be paid is $3,000. REFUND, LIFE, AND CONTINGENT ANNUITIES A refund annuity assures a specific annual sum to the annuitant with the additional assurance that if the annuitant dies prematurely, the estate will be paid an additional amount that represents the difference between the purchase price and the amount that was actually received. A life annuity pays an income to the annuitant only during his or her lifetime. When the annuitant dies, even if the death is premature, no other payments will be received. A contingent annuity is a funded annuity that states payments will begin to be made when an uncertain event happens. For example, the annuity will begin upon the death of the annuitant s grandparent. A deferred annuity is one where payments will begin at some future date, provided the annuitant is alive on that date. A fixed annuity guarantees fixed payments to the annuitant either for life or for a fixed period of time. JOINT ANNUITIES A joint annuity is paid to two named persons until one of them dies. When the first person dies, the annuity ends. A joint and survivorship annuity is an annuity with two or more people named, paying them during the period of their lives. When one of the annuitants dies, the annuity continues paying the remaining annuitants, the survivors. A private annuity is created by contract for periodic payments to be made to the annuitant from a private company instead of a public or life insurance company. See Exhibit 2-13 for a summary of the different types of annuities. EXHIBIT 2-13 ANNUITIES Annuity Policy Insurance policy that provides for monthly or periodic payments to the insured to begin at a fixed time and to continue through the life of the annuitant. Annuity Certain An annuity payable for a certain period of time, no matter when the annuitant dies. Straight Annuity A contract issued by an insurance company to make periodic payments at monthly or yearly increments. The amount of the payment is fixed. Variable Annuity The contract provides payments to the annuitant in varying amounts depending on the success of the investments of the insurance company. Refund Annuity An annuity that assures a specific annual sum to the annuitant with the additional assurance that if the annuitant dies prematurely, the estate will be paid an additional amount that represents the difference between the purchase price and the amount that was actually received. Life Annuity An annuity that pays an income to the annuitant only during his or her lifetime. When the annuitant dies, no other payments will be received. Contingent Annuity A funded annuity that states payments will begin when an uncertain event happens. Deferred Annuity An annuity where the payments will begin at some future date, provided the annuitant is alive on that date.

19 INSURANCE 19 Fixed Annuity An annuity that guarantees fixed payments to the annuitant either for life or for a fixed period of time. Joint Annuity An annuity that is paid to two named persons until one of them dies. When the first person dies, the annuity ends. Joint and Survivorship Annuity An annuity with two or more people named, paying them during the period of their lives. When one of the annuitants dies, the annuity continues paying the remaining annuitants. Private Annuity An annuity created by contract for periodic payments to be made to the annuitant from a private company instead of a public or life insurance company. SUMMARY There are many types of insurance designed to cover many types of losses. Several terms may apply to the broad categories of insurance, while more definite terms apply to more specific types of insurance. Several terms may apply to one type of policy to fully delineate that policy and its terms and clauses.

20 CHAPTER 2 REVIEW KEY TERMS AND PHRASES accident insurance actual loss additional insured annuitant annuity annuity certain annuity insurance auto insurance aviation clause binder blanket policy business interruption insurance capital loss cargo insurance cash refund annuity casualty insurance casualty loss collision insurance comprehensive insurance concurrent insurance consequential loss constructive loss constructive total loss credit insurance decreasing term insurance deductible deductible clause deferred annuity deposit insurance direct loss double indemnity clause endowment insurance endowment policy excess clause excess insurance face value Federal Deposit Insurance Corporation (FDIC) fidelity and guarantee insurance fidelity bond fidelity insurance fixed annuity fraternal insurance general average loss group health insurance group insurance group term life insurance health insurance homeowner s insurance indemnify indemnity insurance insurable interest insurance insurance adjuster insurance agent insurance broker insurance company insurance pool insurance premium insurance rating insurance trust joint annuity key man life insurance liability insurance life insurance loss major medical insurance malpractice insurance marine insurance mortgage insurance mutual insurance company no-fault auto insurance old line life insurance partial loss policy value policy year preexisting condition clause pro rata clause proof of loss renewable term life insurance risk self insurance single premium insurance social insurance soliciting agent stock insurance company title insurance total loss umbrella policy underwriter unemployment insurance value policy REVIEW QUESTIONS SHORT ANSWER 1. What is accident insurance? 2. What is the purpose of accounts receivable insurance? 3. What is considered an actual loss? 4. What is comprehensive insurance? 5. What is casualty insurance? 6. What is considered a capital loss? 20