CREDIT LIFE and DISABILITY INSURANCE

Transcription

1 A STUDY GUIDE FOR CREDIT LIFE and DISABILITY INSURANCE GARY FAGG AND ANGELA HAMMERLY

2 Published by CREDITRE CORPORATION 330 Grapevine Highway Hurst, TX Phone: (817) Fax: (817) ISBN

3 HOW TO USE THIS STUDY GUIDE This study guide was written to accompany the textbook, Credit Life and Disability Insurance. The intent of this guide is to reinforce and simplify the concepts presented in the textbook. All page number references apply to the textbook. The order of the subject matter in this study guide differs from that of the textbook. This ordering is designed to introduce and lead the reader through the many facets of the credit insurance industry. Familiarity with the terms and formulas explained in earlier lessons is a prerequisite for understanding subsequent lessons. A reader who is new to the subject matter of credit insurance should follow the order of this study guide. Each lesson contains objectives, key words, an outline of the suggested reading material and review questions. A suggested course of study for any lesson is: Read the objectives and key words of the lesson. Read the material in the textbook, noting key words and important topics indicated by the objectives. Helpful Hints: Read the outline to reinforce your knowledge and clear misunderstandings. Re-read the objectives. Make sure you can perform these objectives. Complete the review questions at the end of the lesson. Check your solutions. Always make sure you can solve any examples given in the text and in the outline. You will be asked to perform these skills in the review questions. Keep a calculator handy when you are reading sections that involve mathematical problems. Special Note: Refer to the Glossary in the textbook when needed. Information that is shown in bold italic typeface updates or adds to the information contained in the textbook.

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5 TABLE OF CONTENTS Page Section I: Basic Lessons Lesson One: Introduction, Terminology, History... 1 (Refer to pp. xiii-xxi, ) Lesson Two: Credit Life Insurance (Refer to pp. 1-20) Lesson Three: Credit Disability Insurance (Refer to pp ) Lesson Four: Direct Writers, Captives, and Producers (Refer to pp , 49-61) Lesson Five: Home Office Operations I (Refer to pp , 130) Lesson Six: Home Office Operations II (Refer to pp ) Lesson Seven: Premiums I (Refer to pp ) Lesson Eight: Premiums II (Refer to pp ) Lesson Nine: Reserves (Basic) (Refer to pp ) Lesson Ten: Profitability (Refer to pp )

6 Page Section II: Advanced Lessons Advanced Lesson One: Captive Reinsurance (Refer to pp , 62-85, ) Advanced Lesson Two: Reserve Methods (Detail) (Refer to pp ) Advanced Lesson Three: Statutory and GAAP Accounting (Refer to pp ) Advanced Lesson Four: Federal Income Taxation of Life Insurance Companies (Refer to pp ) Advanced Lesson Five: Regulation of the Credit Insurance Industry (Refer to pp ) Advanced Lesson Six: Studies of Consumer Attitudes and Claim Costs (Refer to pp ) Advanced Lesson Seven: Property and Casualty Products (Refer to pp ) Section III: Answers to Study Guide Review Questions...181

7 LESSON ONE: INTRODUCTION, TERMINOLOGY, HISTORY (REFER TO PP. xiii-xxi, PP ) OBJECTIVES You will have mastered this lesson when you are able to: 1. Define or identify the Key Words of this lesson. 2. List the common characteristics of current credit insurance policies. 3. Discuss the founding of the credit insurance industry. 4. Outline the growth of credit insurance from 1917 to present. 5. List the market segments for the credit insurance industry. 6. List the purposes of a trade association. Page 1

8 KEY WORDS account borrower collateral consumer credit insurance Consumer Credit Insurance Association credit disability insurance credit life insurance creditor debt debtor democratization of credit evidence of insurance financial institution gross minus refunded premiums gross written premiums lender lending institution Morris Plan Banks Morris Plan Insurance Society net written premiums premium refunds premium producer single premium Uniform Small Loan Act of 1916 written premiums Page 2

9 OUTLINE A. INTRODUCTION Consumer Credit Insurance: Life or disability insurance sold in conjunction with a loan associated with the purchase of consumer goods. Credit Life Insurance: Insurance that pays off a loan obligation if the insured borrower or co-borrower dies. Credit Disability Insurance: Insurance that provides a monthly benefit equal to a loan's monthly payment if the borrower is disabled. Common Characteristics of Current Credit Insurance Policies B. TERMINOLOGY The average policy size is under $20,000, and the term of insurance is short, generally under sixty-one months. The premium charged is a single premium paid at the inception of the policy. The premium is included in the amount advanced and is financed along with the principal of the loan. No underwriting conditions are imposed to qualify for the insurance except a maximum age limitation. The same premium rate is charged regardless of age or sex. Coverage matches the loan obligation. Insurance terminates when the loan obligation ceases. The first beneficiary of the policy proceeds is the lender, who uses the proceeds to extinguish the loan obligation. Any additional proceeds are paid to the second beneficiary or the estate of the insured. Policy forms contain few exclusions. Lender or Producer: The corporate entity offering credit insurance to the consumer. It is often the corporate entity providing the funds (which may be called creditor, financial institution or lending institution)-such as banks, credit unions, etc. But the term may also apply to other places where the product is actually sold, such as automobile dealerships. An insurer may refer to a particular lender or producer as an account. Page 3

10 Borrower or Debtor: The consumer entering into the debt obligation. Loan or Debt: The obligation to repay money entered into by the borrower or debtor in exchange for cash or consumer goods. Evidence of Insurance: A form stating the conditions and coverage of the insurance. If the borrower is insured under a group policy, he receives a certificate of insurance. If he is insured under an individual policy, he receives an individual policy. The generic term policy is often used to refer to both forms. Premium: The amount paid by the borrower for the insurance, also called the gross premium. Single Premium: The total cost of the insurance paid at the time the policy or certificate is issued (usually financed along with the principal of the loan). Premium Refunds: The portion of the original single premium representing the unused insurance which is returned to a borrower who terminates the insurance before maturity. Gross Written Premiums: The total premiums collected by the lender on all new policies issued. Written Premiums (or Net Written Premiums): The total gross written premiums less the premium refunds paid on terminated policies. Also called gross minus refunded (G-R) premiums. C. HISTORY OF THE CREDIT INSURANCE INDUSTRY The Establishment of Morris Plan Banks Before 1910, bankers would only lend to those individuals who had deposits in the bank or could provide unimpeachable collateral. The lending practices of the day led Arthur J. Morris to develop an idea for the democratization of credit; i.e., a bank should be willing to lend money if the borrower could show good character and the earning power to repay the debt. In 1910, Morris organized a bank in Norfolk, Virginia based on this principle. Morris formed the first bank holding company to aid in establishing other banks that would adhere to his lending ideology. Page 4

11 Morris franchised these types of banks nationwide, calling them Morris Plan Banks. The Morris Plan Bank concept spread. At its peak, 170 were operating. The Establishment of The Morris Plan Insurance Society Morris realized that the death or disability of the borrower cut off the borrower's earning power, the collateral of the loan. This situation led Morris to develop the concept of credit insurance. In 1917, Morris established The Morris Plan Insurance Society, a credit insurance company with the motto, "No man's debt should live after him." Other Early Credit Insurers The Credit Life Insurance Company Prudential Insurance Company of America Old Republic Life Insurance Company Credit Union National Association Mutual Insurance Society Growth of Credit Life Insurance The credit life insurance industry experienced steady growth during the pre-wwii era Credit life insurance in force declined during WWII as consumer spending was curtailed present day. Credit life insurance in force grew tremendously for a variety of reasons: Increase in spending on consumer goods Broadening of state insurance laws Acceptance of the product by lenders Group versus Individual Policies Before 1960, the industry was generally divided between insurers writing under group policy forms and those writing under individual policy forms. As group statutes became more permissive, credit insurers wrote a

12 traditional group policy in order to benefit from the simpler administration procedures and special deductions under the 1959 Tax Act. By 1970, 84% of all credit insurance was written on a group plan. Development of Credit Disability Insurance The first credit disability insurance policies paid off the loan if the insured met the conditions for being totally and permanently disabled. By 1950, a product providing a monthly benefit equal to the loan's monthly payment during the insured's continued disablement replaced the original concept. Credit disability insurance has grown rapidly in the last twenty years. D. THE ADOPTION OF CREDIT INSURANCE PROGRAMS BY VARIOUS MARKET SEGMENTS Market Segments Automobile dealers and manufacturers Credit unions Commercial banks Finance companies Sales finance operations, such as furniture and appliance stores Small loan companies and industrial banks Factors Affecting the Acceptance of Credit Insurance by Lenders In the 1950s, there were heated debates on the interpretation of state laws and regulations based on the provisions of the Uniform Small Loan Act of The debates centered on whether a charge could be made for credit insurance sold in conjunction with small loans. They were resolved by the development of the NAIC Model Regulations and by the amendment of state banking and loan laws that specifically authorized the sale of credit insurance with a contributory charge. In 1972 the Federal Reserve Board decided to permit a bank holding company to own an insurance subsidiary. E. TRADE ASSOCIATIONS Definition: An organization of insurers formed to promote the industry and to assist in development of regulations. Page 6

13 Consumer Credit Insurance Association (CCIA): The primary trade association of credit insurers. Founded in 1951, it now has over 200 member companies and concentrates on the credit insurance industry. Other trade associations serve many types of insurers, with credit insurance as only one aspect of their activities: American Council of Life Insurance (ACLI) National Association of Life Companies (NALC) Health Insurance Association of America (HIAA) Page 7

14 REVIEW QUESTIONS 1. Insurance that pays off the loan obligation if an insured borrower or co-borrower dies is called. 2. A is the corporate entity which offers the credit insurance product to the consumer. 3, is the primary trade association for the credit insurance industry. 4. Two purposes of a trade association are: 5. All of the following are common characteristics of current credit insurance policies except: (1) No underwriting conditions are imposed and very few exclusions are contained in a policy. (2) The average policy size is less than $20,000. (3) The term of insurance is less than sixty-one months. (4) The rate of the policy varies with respect to the age of the borrower. (5) The premium is usually financed along with the principal of the loan. 6. Which of the following contributed to the growth of the credit insurance industry? A. The adoption of Regulation "W" in B. The expansion of Morris Plan Banks. C. Increases in the cost of consumer goods. Page 8

15 D. The founding of the Morris Plan Insurance Society. (1) A, B and C only (2) B, C and D only (3) B and C only (4) A, C and D only 7. Why did the development of the Morris Plan Bank trigger the founding of the Morris Plan Insurance Society? 8. List five market segments of the credit insurance industry. Page 9

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17 LESSON TWO: CREDIT LIFE INSURANCE (REFER TO PP. 1-20) OBJECTIVES You will have mastered this material when you are able to: 1. Define or identify the Key Words of this lesson. 2. List the loan conditions affecting credit life insurance for closed-end loans. 3. List the alternatives utilized to compensate for group maximum limits. 4. List the differences between group and individual policies. 5. State the criticisms of gross coverage and net payoff coverage. 6. State the common eligibility requirements and exclusions for credit life insurance. 7. Explain the difference(s) between initial net and gross indebtedness. 8. Given the type of loan, state the credit life insurance product(s) commonly offered. 9. List the types of consumer credit transactions. Page 11

18 KEY WORDS balloon loan cash loan closed-end loan consumer credit transaction contributory coverage credit card lending critical period life coverage effective date fixed rate loan installment loan group maximum limit group policy gross coverage gross indebtedness individual policy initial gross indebtedness initial net indebtedness installment sales contract joint life insurance level-decreasing insurance level loan monthly outstanding balance net payoff coverage net indebtedness non-contributory coverage open-end loan partial coverage insurance principal scheduled interest charges single payment loan term of coverage termination date total amount advanced truncated life insurance coverage uniform decreasing term life insurance variable rate loan Page 12

19 OUTLINE A. CREDIT LIFE INSURANCE Definition: Term life insurance purchased in conjunction with a consumer credit transaction (cash loan, installment sales contract, or credit card borrowing), excluding first mortgage loans, which provides a death benefit sufficient to pay off the credit obligation in the event of an insured's death during the term of coverage. B. INDEBTEDNESS Initial net indebtedness: The total amount advanced, which normally includes the principal of the loan plus the insurance premium. Initial gross indebtedness: Initial net indebtedness plus the scheduled interest charges. Net indebtedness: The amount due under a debt obligation at any time. This normally includes the outstanding principal and insurance premium amounts, plus any accrued interest since the last payment. Gross indebtedness: The sum of the remaining scheduled payments due under a debt obligation. This includes the net indebtedness plus the unearned interest charges. C. CLOSED-END LOANS Installment Loans Conditions: A loan with both the amount and term fixed; the principal is repaid in equal monthly payments. The monthly payment is the initial gross indebtedness divided by the term of the loan. Each payment provides for payment of interest charges (based on net indebtedness at the beginning of that month). The outstanding balance at any time is the net indebtedness. Insurance: Decreasing term insurance. Example: Fixed interest rate automobile loan. Level Loans Conditions: A single payment loan in which the payment is due from the borrower at maturity. Since the interest accrues as time elapses, the net indebtedness increases during the term of the loan. The gross indebtedness remains level during the term of the loan. Page 13

20 Insurance: Level term insurance for the amount of initial gross indebtedness. Example: Short term personal loans. Balloon Loans Conditions: A loan repaid in equal periodic payments with an additional lump sum payment at maturity. Insurance: A combination of level and decreasing term insurance. Example: Automobile leases. D. OPEN-END LOANS Conditions: A loan repaid with monthly payments ranging from a minimum payment up to the payment of the full outstanding balance. Insurance: Insurance to meet the outstanding balance; i.e., net payoff coverage. Example: Credit card borrowing or a line-of-credit. E. LOAN CONDITIONS FOR STANDARD CREDIT LIFE INSURANCE ON CLOSED- END LOANS Term of Coverage is determined by the term of the loan. Effective Date and Termination Date are set by the corresponding dates of the loan. The principal, initial net indebtedness, and initial gross indebtedness of the loan affect the death benefit, which in turn affects the type of coverage and premium charged. Number of borrowers affects coverage; either single life or joint life coverage will be offered. The rate of interest and whether it is fixed or variable affect the type of coverage, the amount of benefits and the premium charged. F. GROUP AND INDIVIDUAL POLICIES Individual Policy: The contractual relationship is between the borrower and the insurance company. The borrower receives an individual policy as evidence of insurance. Page 14

21 Group Policy: The contractual relationship is between the lender and the insurance company. The borrower is enrolled in the group and receives a certificate of insurance. Group Maximum Limits: Laws and regulations in some states restrict the amount of insurance which can be provided by group insurance. However, insurance can be provided on loans when the initial indebtedness exceeds such limits by: Offering the insurance on an individual policy Offering the insurance with a death benefit equal to the maximum allowed or the remaining indebtedness, whichever is less, i.e., a level-decreasing insurance policy Offering partial coverage under the state maximum G. GROSS COVERAGE VERSUS NET PAYOFF COVERAGE Gross Coverage: Amount of insurance covers the gross indebtedness of the loan. Uniform decreasing term life insurance is the resulting plan. Criticism: Amount of insurance exceeds the net indebtedness. Net Payoff Coverage: Amount of insurance covers the net indebtedness of the loan but limited to the scheduled net indebtedness plus an amount sufficient to cover a specified number of delinquent payments (usually two). Criticism: Amount of insurance may not be sufficient to pay loan balance if the borrower has been delinquent in payments. Critical Period Coverage: Amount of insurance offered is limited to a fixed number of monthly payments. This coverage provides loan payments for a period of time so that the financial stability of the insured's household can be regained. H. PREMIUM MODE Single Premium: A premium to pay for the full coverage provided and charged to the insured at the inception of the loan. The premium is added to the principal of the loan and is financed. Premium rates are expressed per $100 of initial gross indebtedness, and per year of coverage. Page 15

22 Monthly Outstanding Balance (MOB): A premium collected monthly. Premium rates are expressed per $1,000 of insurance in force. I. CONTRIBUTORY AND NON-CONTRIBUTORY INSURANCE Contributory Insurance: Coverage provided with the borrower paying an identifiable charge. This is the common form of credit insurance. Non-contributory Insurance: Coverage provided without an identifiable charge to the borrower. This is commonly found in credit unions. J. COVERAGE PERIOD Generally, the coverage period is the same as the term of the loan. Truncated Life Coverage: Usually net payoff coverage for the full outstanding net indebtedness, but death must occur during the term of insurance coverage. The insurance term is less than the term of the loan. K. ELIGIBILITY REQUIREMENTS AND EXCLUSIONS Eligibility Requirements A person must be under a specified age, generally sixty-five. The borrower may be required to sign a good health statement. An application with health questions may be required for larger amounts. Exclusions If suicide occurs within a specified period after issue (six months to two years), no benefit is paid; but the estate receives a refund of the unused insurance premium. Page 16

23 REVIEW QUESTIONS 1. Cash loans, installment sales contracts, and credit card borrowing are all types of 2. The total amount advanced (including the insurance premium) plus the scheduled interest charges over the loan term equals the 3. Under an individual policy, the contractual relationship is between the and the 4. Under a group policy, the contractual relationship is between the and the 5. Credit unions often provide life insurance coverage to borrowers without an identifiable charge. This is called coverage. 6. State the difference between critical period coverage and truncated life coverage. Explain the reason for each coverage. 7. Decide whether the following statement is true or false. Justify your answer. Single premiums are usually charged in conjunction with credit card borrowing. 8. Which of the following statements are true regarding the advantages of offering group policies versus individual policies? A. Group policies may permit simpler administration procedures. B. The insurer charges higher premium rates on group policies. C. Special federal income tax deductions for group business were provided by the 1959 Tax Act. Page 17

24 D. Individual policies have maximum limits set by the various states. E. Individual policies are often sold if the insurer desires to ask health questions. (1) A, B and C only (2) B, C and D only (3) C, D and E only (4) A and E only (5) A, C and E only 9. Which of the following are common eligibility requirements and exclusions for credit life insurance? A. A person must be under a specified age to be eligible. B. Suicide within a specified time after issue is excluded. C. A good health statement may be required for eligibility. D. The occupation of the borrower is considered for eligibility. E. Medical information about the borrower is usually required for coverage. (1) A, B and C only (2) A, B, D and E only (3) A, C and D only (4) B, D and E only Page 18

25 LESSON THREE: CREDIT DISABILITY INSURANCE (REFER TO PP ) OBJECTIVES You will have mastered this material when you are able to: 1. Define or identify the Key Words of this lesson. 2. Determine the benefits payable, given: a. date of disability b. elimination period c. retroactive or non-retroactive benefits d. monthly benefit e. date disability ceases 3. Determine whether benefits are payable in a situation when the six and six exclusion is in effect. 4. Describe the difference(s) between critical period disability coverage and truncated disability coverage. 5. Describe 14NR, 14E and 14R. Page 19

26 KEY WORDS actively-at-work anti-selection any occupation disability critical period disability coverage dismemberment benefit elimination period his (or own) occupation disability lump sum coverage monthly benefit gross coverage non-retroactive benefits preexisting condition presumptive test of disability retroactive benefits six and six exclusion total and permanent disability truncated disability coverage waiting period Page 20

27 OUTLINE A. CREDIT DISABILITY INSURANCE Definition: Disability insurance purchased in conjunction with a consumer credit transaction which provides a monthly benefit equal to the required monthly payment, while the insured is disabled, during the term of coverage. Alternatively, a few policies provide a lump sum benefit if the insured is totally and permanently disabled. Definition of Disability His occupation disability: A person is unable to perform the essential tasks of his usual occupation. This is now also called own occupation disability. Any occupation disability: A person is unable to perform the duties of any occupation for which the person is reasonably suited by reason of education, training, or experience. Total and permanent disability is determined by one of two methods: Presumptive Test of Disability: If the borrower is disabled for a specific number of days, usually ninety days, he is considered totally and permanently disabled. If the insurer can determine that the disability is total and permanent, then the benefit is paid. This method is used in the credit union market. B. CHARACTERISTICS OF DISABILITY PRODUCTS All disability policies provide gross coverage. The monthly benefit is equal to the monthly loan payment, which includes interest charges. Elimination Period: The period of disability before any benefits are payable, also called the waiting period. The period is usually 14 or 30 days but may be 7 or 90 days. Determine if benefits are payable: Example 1 Elimination period: 7 days Length of Disability: 10 days Page 21

28 Benefits are payable since the length of disability exceeds the elimination period. Example 2 Elimination period: 30 days Length of Disability: 25 days Benefits are not payable since the length of disability does not exceed the elimination period. Elimination Period Benefits Non-retroactive Benefits: Benefits begin after the elimination period has been completed. Retroactive Benefits: Benefits are payable from the first day of the elimination period, once the elimination period is completed. Calculation of Disability Benefits: Example 1 Plan of Insurance: 14R (14 day elimination period, retroactive benefits) Length of Disability: 16 days Monthly loan payment: $ ) Determine if any benefits are payable. Since the length of disability exceeds the elimination period, benefits are payable. 2) Determine the number of days benefits are payable. 14R means that benefits are payable from the first day of disability. Therefore, benefits for 16 days are payable. 3) Calculate the amount of benefits payable. Amount of Benefits = number of days x monthly payment =16x _ $ Page 22

29 Example 2 Exclusions Plan of Insurance: 14E Length of Disability: July 10th through August 31st Monthly Payment: $ ) Determine if any benefits are payable. Since the length of disability is greater than 14 days, benefits are payable. 2) Determine the number of days the insured was disabled. Number of days in July 31 - days in July not disabled - 9 Number of days disabled in July 22 Number of days disabled in August: 31 Total days disabled = = 53 3) Determine the number of days benefits are payable. Since the plan of insurance is 14E, benefits are payable from the 15th day of disablement = 39 days 4) Calculate the amount of benefits. Amount of Benefit - number of days x monthly benefit 30 Preexisting Conditions =39x = $ Definition: An impairment for which the insured has been treated prior to the effective date of insurance. Page 23

30 Six and Six Exclusion Definition: The exclusion from coverage of a disability if the insured becomes disabled from a preexisting condition within six months after the effective date, if any treatment for that preexisting condition occurred within the six months prior to the effective date. Determine if benefits are payable when a six and six exclusion is in effect: Example 1 Effective Date: January 1, 1989 Last Date of Treatment: September 1, 1988 Date of Disability: July 15, 1989 Example 2 The preexisting condition was treated within six months before the effective date, but the disability occurred over six months after the effective date. Benefits are payable. NOTE: As long as the disability occurs after six months from effective date, benefits are payable. Effective Date: June 1, 1989 Last Date of Treatment: November 1, 1988 Date of Disability: July 1, 1989 Other Exclusions The preexisting condition was last treated seven months prior to the effective date. Benefits are payable provided the elimination period conditions are met. Normal pregnancy, self-inflicted injuries, acts of war, and aviation on nonscheduled flights are also excluded. Coverage of normal pregnancy is required in Massachusetts, Nevada and New York. Eligibility Requirements Only the primary borrower is eligible for coverage in most cases. Joint insurance is rarely offered in the U.S. but is available in Canada. Coverage is offered if the primary borrower is under age sixty-five. Page 24

31 The borrower must also be actively-at-work; i.e., working thirty or more hours per week on the effective date of the insurance. C. BENEFITS ON VARIOUS TYPES OF LOANS Closed-End Installment Loans The monthly payment defines the monthly disability benefit. The maximum benefit at any time equals the sum of the remaining payments. Single Payment Loans When offered, the benefit is a lump sum equal to the outstanding balance of the loan. However, the only coverage offered requires total and permanent disability. Open-End Loans Monthly payment benefit This policy usually has a 14- or 30-day elimination period and may have either retroactive or non-retroactive benefits. The benefit is the minimum monthly payment due, generally the amount needed to repay the balance of the loan on the date of disability within 24 months. Lump Sum Benefit D. COVERAGE PERIOD The benefit is the outstanding balance of the loan on the date of disability, usually with a 90-day elimination period. Customarily, credit disability policies provide coverage and benefits for the full term of the loan. Critical Period Disability Coverage Definition: Coverage offered for the full term of the loan, but with the benefit limited to a specified number of monthly payments, or the remaining payments if less. This coverage is usually offered on loans over sixty months to decrease the borrower's total dollar outlay while offering essential protection. Page 25

32 Truncated Disability Coverage Definition: Coverage offered during a portion of the term of the loan. Benefits are paid only if the disability occurs during the term of coverage. Monthly benefit payments continue only until the end of the term of insurance. For example, on a ten-year loan, truncated coverage may be offered for the first five years. A disability must occur during the first 60 months. In addition, all benefits cease at the end of the 60 month coverage period. Page 26

33 REVIEW QUESTIONS 1. If the borrower is working thirty or more hours per week on the effective date of insurance, he/she is considered 2. (Circle One) Increasing the elimination period will raise/lower/not affect the premium. 3. benefits provide for the payment of benefits from the first day of disability. 4. A ninety-day period of disability is common for the determination of disability. In questions 5-8, calculate the amount of benefits payable: Use the information below to answer questions 5 and 6. Joan Doe is insured by a credit disability insurance policy. Payment is due on the first day of each month. Plan: 14E. Monthly loan payment: $ If Joan is disabled 45 days, what benefits are paid? 6. If Joan is disabled 14 days, what benefits are paid? Use the information below to answer questions 7 and 8. John Smith is insured by a credit disability insurance policy. Payment is due on the first day of each month. Benefits: 30R. Monthly loan payment: $ If John is disabled from July 30 through August 31, what benefits are paid? 8. If John is disabled from July 25 through August 8, what benefits are paid? Page 27

34 Use the information given below to answer questions State only whether benefits are payable. Effective date of credit disability insurance: January 1, 1989 Exclusions: Six and Six Exclusion in effect (Assume the cause of disability is the preexisting condition) 9. Last date of treatment: September 1, 1988 Date of disability: April 1, 1989 Are benefits payable? 10. Last date of treatment: March 1, 1988 Date of disability: February 1, 1989 Are benefits payable? 11. Last date of treatment: August 1, 1988 Date of disability: September 1, 1989 Are benefits payable? 12. All of the following are common exclusions for credit disability insurance EXCEPT: (1) Self-inflicted injury (2) Normal pregnancy (3) Preexisting condition (4) Aviation on scheduled flights (5) Acts of war 13. Variations of the six and six exclusion exist. Read the information below and answer the following: Effective date of credit disability insurance: January 1, 1989 Exclusion: One year - two year exclusion Last date of treatment: September 1, 1988 What is the earliest date that disability from the preexisting condition can occur so that benefits are payable? Explain. Page 28

35 LESSON FOUR: DIRECT WRITERS, CAPTIVES, AND PRODUCERS (REFER TO PP , 49-61) OBJECTIVES You will have mastered this material when you are able to: 1. Define or identify the Key Words of this lesson. 2. List the types of life insurance companies. 3. Describe the relationship between a direct writer and a captive reinsurer. 4. State the additional responsibilities of the direct writer if captive reinsurance is involved. 5. List the possible sites to form a captive. 6. List the producers of credit insurance. 7. Specify the data needed to calculate a producer's penetration rate. 8. List the administrative functions of a direct writer. Page 29

36 KEY WORDS acceptance corporation assume (the risk) assuming reinsurer captive insurance company cede ceding insurer controlled foreign corporation direct-writing captives direct writer domestic insurer domicile exotic reinsurance company extraterritorial regulations finance and insurance specialist line-of-credit mutual life insurance company non-controlled foreign corporation penetration rate reinsurance reinsurer retention retrocede retrocessionaire retrospective compensation stock life insurance company Page 30

37 OUTLINE A. DIRECT WRITERS Definition: The insurance company issuing the policy. The contractual agreement is between the policyholder and the direct writer. The direct writer must meet the obligations guaranteed by the policy, regardless of any reinsurance arrangements. Types of Insurance Companies Stock Life Insurance Companies: Stockholders provide the capital to start the company, which they own and control. Profits are paid to stockholders as common stock dividends. Mutual Life Insurance Companies: The policyholders own the company. The control of the company is in the hands of the Board of Directors and management. Profits are returned to the policyholders as policyholder dividends. Types of Direct Writers Selling Credit Insurance Full-Line Ordinary Companies Credit Insurance Specialty Companies Direct-Writing Captives Formation of a Direct-Writing Insurance Company Substantial time and significant capitalization are required. The specific requirements vary from state to state. A direct writer is incorporated in one state, its state of domicile. In this state, it is considered a domestic insurer. Once the direct writer is incorporated, it can apply for licenses in other states. The direct writer is considered a foreign insurer in these states. Reinsurance Definition: The transfer of risk from one insurance company (the ceding company) to another insurance company (the assuming company). The direct writer cedes the risk to the reinsurer who assumes the risk. If the reinsurer does not want to retain all of the risk it assumes, it will retrocede a portion of the risk to a second reinsurer, the retrocessionaire. Page 31

38 B. CAPTIVE INSURANCE COMPANY (CAPTIVES) Definition: An insurance company owned by a producer which accepts the underwriting risk on the business sold by the producer. Formation of a Captive Insurance Company Within the United States, a captive may be formed and licensed in only one state; the requirements vary from state to state. Arizona is the logical choice. A captive can also be formed outside of the United States in Bermuda, the Cayman Islands, the Turks and Caicos or other sites; these are called offshore captives. Controlled foreign corporations are offshore reinsurance companies which do not qualify as non-controlled and are subject to U.S. taxation as any U.S. corporation. Most offshore credit insurance captives are in this category. Non-controlled foreign corporations are offshore reinsurance companies that are not subject to United States taxation until the profits are brought back into the U.S. Exotic Reinsurance Company Definition: A reinsurance company with more than one class of stock. It may be onshore or offshore. An exotic is formed by a group of producers, usually a group of automobile dealers. The profit on each dealer's business inures to that dealer's class of stock. Advantages of an Exotic The overhead operating costs of the captive are distributed. The volume may qualify the captive for lower administrative fees from the direct writer. Disadvantages of an Exotic Serious problems arise when one class has bad loss experience. If one dealer goes bankrupt, the captive fails to receive premiums. Page 32

39 C. PRODUCERS OF CREDIT INSURANCE Definition: The corporate entity offering the product to the borrower. Credit insurance is offered to the borrower at the place where the loan is extended. Therefore, the primary producers are lending institutions including the following: Banks Credit Unions Finance Companies Production Credit Associations (now called Farm Credit Banks) Savings and Loan Associations Credit insurance is also offered in conjunction with installment sale contracts where the thrust of the business is the sale of consumer goods or services. These businesses include: Acceptance Corporations Automobile, Mobile Home and Recreational Vehicle Dealers Retail Outlets Penetration Rates Definition: The number of borrowers electing to purchase coverage divided by the number of loans extended in which the borrower qualifies for insurance, often expressed as a percentage. A penetration rate of over 60% on life insurance is considered excellent. A penetration rate of 40% to 60% on disability insurance is considered acceptable. Higher penetration rates generally result in better loss experience. Calculation of a Penetration Rate: Example At a certain automobile dealership, 250 loans were extended where the borrowers qualified for insurance. One hundred life insurance policies were sold. Page 33

40 Penetration rate = number of policies sold total number of qualified buyers =.40 = 40% Page 34

41 REVIEW QUESTIONS 1. Regardless of any reinsurance agreement, the must meet the obligations guaranteed by the policy. 2. The two types of life insurance companies are and 3. is the transfer of risk from the insurance company issuing the policy to another insurance company. 4. A direct writer formed in Arizona and licensed in all other states is considered a/an insurer in Arizona and a/an insurer in other states. 5. List five producers of credit insurance: 6. All of the following statements can correctly be made about an exotic reinsurance company: A. An exotic is formed by a group of producers. B. The combined volume of the producers may qualify for lower administrative fees by the direct writer. C. Investment income is spread equally among the producers. D. Most exotics are formed by groups of automobile dealers. E. The direct writers of an exotic vary from producer to producer. (1) A, B, C and D only (2) A, C, D and E only (3) A, B and D only (4) B and D only (5) A, B and D only

42 7. Last year a producer extended 500 loans and 305 borrowers elected to purchase life coverage while 135 elected to purchase disability coverage. Calculate the producer's penetration rates for both life and disability coverages. Life Disability 8. Describe the purpose of an F & I specialist. 9. List the five primary administrative functions of a direct writer. 10. Which of the following correctly describes the relationship between a captive reinsurer and the direct writer? A. A captive reinsurer takes over the majority of the direct writer's administrative functions. B. Most captives accept 100% of the risk where permitted. C. With the acceptance of risk, a captive reinsurer becomes responsible to the insureds. D. A captive reinsurer does not have to be licensed in the state where the policy is sold. (1) D only (2) B and D only (3) C and D only (4) A and B only Page 36

43 LESSON FIVE: HOME OFFICE OPERATIONS 1 (REFER TO PP ,130) OBJECTIVES You will have mastered this material when you are able to: 1. Define or identify the Key Words of this lesson. 2. List the major responsibilities of the various departments of a credit insurance company. 3. Describe the differences between front commissions and retroactive commissions. 4. List the actions an examiner must take to adjudicate a death claim; a disability claim. 5. List the typical investments of a credit insurance company. Page 37

44 KEY WORDS assignment of commissions case reserve claimant commission caps compensating balances contestable period contingent commission Continuance of Disability Form experience refund first and final front commission general agent good health statement guaranteed issue limit non-resident agent override commission policyholder dividends report and remittance resident agent retroactive commission return commission service fees Page 38

45 OUTLINE A. SALES AND SALES ADMINISTRATION Sales Staff Internal sales staff may be adequate for regional companies. Widely licensed insurers may utilize independent general agents who will provide local sales and service. Responsibilities of the Sales Staff Solicit new accounts Service existing accounts by: Sales Administration Training the producers' personnel Working with producers when problems arise Monitoring producers' financial experience, taking corrective action when necessary, such as: Adjusting commissions Cancelling business Filing for rate increases Reviewing policy forms and limits Implementing rate changes and product modifications A separate section of the sales department that handles the administrative functions and maintains contact with the accounts on day-to-day operational matters. Responsibilities of Sales Administration The initial setup work for a new account. This includes supplying the account with reporting procedures, forms and rate calculation materials. On-going service requirements for accounts, such as changes in procedures, policy forms, rates and compensation. Insuring that all agents meet the licensing requirements. Page 39

46 B. COMPENSATION TO HOME OFFICE SALES STAFF, GENERAL AGENTS, AND PRODUCERS Home Office Personnel are salaried employees. General Agents are compensated in either or both of the following ways: Override Commission: A percentage of premium paid to the agent on the business he produces. The usual procedure is to apply the override percentage to the gross premium collected minus the refunds paid for the month. Override commissions are generally paid as front commissions, i.e., the entire amount of commissions is paid as the premium is collected. These are guaranteed commissions. These commissions emphasize producing new business, rather than the profitability of the business. Retroactive or Contingent Commission: Compensation that is dependent upon the profitability of the general agent's business. The general agent and the insurer share the following: Earned premiums less incurred claims, less paid compensation to accounts and override commissions, less the insurer's expense charge. Producer Compensation includes at least one of the following methods: Front Commission: Guaranteed compensation usually expressed as a percentage of net written premium. Service Fee: Payment for the actual cost of offering the products. Some state and federal regulations do not allow the payment of commissions to financial institutions, but permit payment of service fees. Experience Refund or Retroactive Commission: A portion of compensation that may be paid contingent on the profitability of the producer's business. The calculation is similar to the formula for a general agent's contingent commission. Although a producer may not be responsible for a loss, a negative balance would be carried forward to future accounting periods. Policyholder Dividends In a mutual insurance company, policyholders receive an equitable distribution of profits annually. Page 40

47 For group credit business, the producer is the group policyholder. The allocation by policyholder generally follows the formula for experience refunds. However, expense is allocated to the producer for actual expenses incurred for processing the producers' business rather than a set charge. All profitable policyholders are eligible for a dividend. Unprofitable policyholders usually do not receive a dividend. Allocation among profitable policyholders may not be an exact reflection of the individual producer's experience; i.e., some pooling of claims or expenses may be used. The calculation also reflects the practice of retaining a small portion of the profits as a permanent surplus of the insurer and the practice of pooling the loss experience on small policyholders. Limitations on Compensation Some states impose limitations on maximum compensation paid by insurers to general agents and producers (called commission caps). They are designed to protect insurer solvency and to impose controls on product pricing. Compensating Balances C. AGENT LICENSING In exchange for the credit insurance business of a financial institution, an insurer may offer to maintain deposits in the institution, often equal to one year of written premiums. When the interest paid on these deposits is less than market rates, the deposits are considered compensating balances. State laws and regulations require that an agent must be licensed in his state of residency. In this state, he is a resident agent. If licensed in other states, he is a non-resident agent. Agent licensing requirements to sell credit insurance are simplified or eliminated in most states if the person selling the product to the borrower does not receive a commission for the sale. Page 41

48 D. PREMIUM BOOKING Report and Remittance Generally, a producer submits monthly reports regarding business processed for the month. These reports include: Business issued Refunds made Remittance for the gross premiums collected minus the refunded premiums, less any deducted compensation, is submitted to the insurer along with supporting documentation (consisting of a copy of the group certificate or individual policies). Billing Method An application for insurance is received by the producer. The applications are submitted to the insurer who prepares a bill and then presents it to the producer. Various Methods of Booking Business Most insurers book the business as received. The producer is notified of necessary corrections, missing data, or cancellations. Corrections are made in subsequent reports. Monthly outstanding balance business requires little auditing. Detected errors are corrected in subsequent reports. A report received without money requires the insurer to maintain a listing of amounts due from producers. A second system is necessary to verify that all producers provide reports. E. CLAIMS ADMINISTRATION The principles of claims administration are: Consistency of claim handling Timely processing Adherence to policy provisions

49 Life Claims Claims processing is relatively simple, and payments are usually made within seven working days. Processing Requirements Completed claim form Certified copy of the death certificate Copy of the evidence of insurance An examiner must verify: The deceased is the insured. The date of death is between the effective date and expiration date of the insurance and a refund has not occurred. The age on the death certificate is consistent with the age on the insurance policy. Disability Claims Claims processing is more difficult for disability policies due to the exclusions and the determination of disability. Open files are classified as continuing claims in the payment status or pending claims under investigation. Closed files are those for which the final payment has been made because of termination of disability, expiration of coverage, or denial. Examiners must determine: Is the claimant disabled? Has the disability occurred during the policy term? Have all policy conditions been met? Are any policy exclusions applicable? Examiners have four choices for action on a claim.

50 Develop the file: To secure all the basic information to adjudicate, or process, the claim. Pay Deny Payment may be first and final; i.e., a claim involving one payment. Payment may continue for several years in which case the claimant must complete a Continuance of Disability form every days. Investigate The examiner reviews evidence of insurance and policy forms to determine the conditions and exclusions of the coverage. Form letters, phone calls and inspection companies may be used for inquiry. Auditing of the Claims Department Internally, the department measures and tracks time and quality of service. Audits are also performed by the corporate internal audit staff. These audits concentrate on timeliness, accounting and conformance with corporate policy. On triennial examinations, state examiners sample claim files for consistency, fairness and accuracy. F. INVESTMENT DEPARTMENT Investment departments attempt to match the terms of invested funds with the terms of the underlying liabilities. Since credit insurance is short-term in nature, a large portion of invested assets are short to medium term investments, such as: Certificates of deposit Short-term bonds Page 44

51 Checking accounts Savings accounts Other Responsibilities Reconcile bank statements Monitor the activity in trust accounts of captive reinsurance companies Compare the amount of letters of credit posted to the required balance (of offshore captives with letters of credit in lieu of a custodial trust) Page 45

52 REVIEW QUESTIONS 1. are guaranteed commissions paid to a general agent which emphasize producing new business. 2. The type of producer compensation that is contingent upon the profitability of the business is called 3. When handling a disability claim, an examiner has four options. List them. 4. In exchange for the credit insurance business of a financial institution, an insurer may offer to maintain deposits in the institution in accounts which pay less than the market rate of interest. These are known as 5. List the items included in a producer's monthly report. 6. Which of the following are responsibilities of the sales force? A. Solicitation of new producers B. The training of the producers' personnel C. The monitoring of producers' financial experience D. Providing the producer with rate calculation material E. Supplying the producer with reporting procedures (1) A, B and E only (2) A, B, C and E only (3) A, B and C only (4) B, D and E only (5) B and D only Page 46

53 7. List the principles of claims administration: 8. State the reasoning for the following statement, "Disability claims are more difficult to process than death claims." 9. A. List the typical investments made by a credit insurance company. B. What is the common characteristic of all of these investments? Why? Page 47

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55 LESSON SIX: HOME OFFICE OPERATIONS II (REFER TO PP ) OBJECTIVES You will have mastered this material when you are able to: 1. Define or identify the Key Words of this lesson. 2. Given the type of clause within a policy form, describe its contents and purposes. 3. List the major difference between group and individual policy forms. 4. List the procedures that are followed in filing a policy. Page 49

56 KEY WORDS claim clauses coverage clause deemer provision eligibility clause Flesch Scoring Method grace period incontestability insurable interest insuring clause misstatement of age clause refinanced loan variable reference basis Page 50

57 OUTLINE A. GROUP POLICY FORMS The basic concept of group insurance is that the contractual relationship is between the insurance company and the group policyholder (the lender). A group master policy is issued to the lender by the direct writer. Provisions Insuring Clause: The clause that describes the benefits paid under the various life and disability plans. The group certificate provided to the insured may contain all possible options, and the desired benefits are selected by marking the appropriate benefit box. Eligibility Clause: The specific requirements that the insureds must meet, such as a maximum age limitation and an actively-at-work test. Coverage Clause This clause specifies the date when insurance begins and ends. The purpose of the clause is to measure the effective date from the first date of the loan. On refinanced loans, the effective date of the suicide clause, the incontestable period and the preexisting conditions clause are often modified to use the date of the original loan, at least to the extent of the amount refinanced. For example, if a person has a $1,000 indebtedness which is refinanced in conjunction with a new loan for $2,500 then immediately commits suicide, $1,500 of the claim would be denied. However, the decision of the refinanced $1,000 would be based on the date of the original loan, its suicide provision and the date of death. Considerations and Premiums Clause A consideration clause is necessary for legal purposes, since the policy is a legal contract. The premium rates are defined for the plans of insurance, usually by reference to a schedule or the group application.

58 Reports Lenders are required to maintain records of the insureds under the group policy. Reports must be sent to the insurer and must include: Information about the insureds Amounts and terms of the debts Copies of certificates Cancellations Changes Additions Grace Period: The lender is permitted a 30 or 31 day grace period for the remittance of premium to the insurer. Entire Contract The basic idea of this clause is to state that the written contract contains all of the terms of the agreement. This clause also contains general statements required of all group policies. For instance, "fin defense... of the insured." In defense of a claim, the insurer can only apply statements made in the written application of the insured. (A copy of which must be attached to the document given to the insured.) Individual Certificates: The insurer guarantees that each debtor will receive an individual certificate. The certificate is a concise version of the group policy provisions as they pertain to the insured. Termination of Insurance: Clauses will specify conditions of termination of the group policy and the individual borrower's coverage. On a group policy termination, the insurer is responsible for all business in force unless the business is reinsured to another insurer. Individual coverage termination occurs when the term expires, the debtor requests cancellation, or the loan is terminated prior to the scheduled maturity date. Incontestability: This clause states that misrepresentations in the application cannot be used as a defense for a claim if death or disability occurs after the contestable period. This period is usually two years. Page 52

59 Misstatement of Age Case One: The borrower misstates his age so that he is eligible for insurance, but his true age exceeds the eligibility requirement. The claim is denied regardless of the contestable period on the basis that the insurance was never in force. Case Two: The borrower states his true age, however, his true age exceeds the eligibility requirement. The insurer must recognize the situation and rescind the certificate. The time to rescind the certificate is limited in some states to 60 or 90 days after the effective date. Claim Clause: Several clauses define the process of claim filing and the beneficiaries under the policy. Exclusions Clause: The exclusions for credit disability insurance are outlined, such as six and six exclusion, suicide during the contestable period, etc.. Definitions Clause This clause will define a variety of terms found in the contract, such as: Accident Sickness Disability: his (or own) occupation; any occupation General Clauses: The general clauses are representative of a variety of general provisions. Some may be required by the state, while others serve to cover minor items of the contract. B. INDIVIDUAL POLICY The contractual relationship is between the insured borrower and the insurer. The individual policy is used for several reasons: A state's group statutes may contain maximum limits on group policies. Underwriting of the policy may be desired by the insurer; i.e., health questions may be required, and insurers often use an individual policy instead of a group policy (some states do not permit health questions on group policies). Page 53

60 The insurer generally issues individual policies. Provisions generally follow the description of the group policy. C. POLICY FILING The development of a policy form is a long and tedious process. Time for final approval can range from one to eighteen months. The form must meet the credit insurance regulations of each state where approval is desired. The general process is: A draft form of the policy is prepared. An initial review is made for compliance with the state regulations where the policy is to be filed. A master policy filing manual is referenced. Filing requirements: Filing fees are required by most states. Readable forms are required in many states; the readability is judged by the Flesch scoring method. Rates must be filed: Compliance with state maximum rates is required. Actuarial justification is needed for age-rated policies, critical period coverage, and MOB disability plans. A package is assembled for submission to each state where approval is desired. It generally includes: Two copies of the form completed using "John Doe" information A letter describing the submission Filing fee Long delays often occur. Initial feedback may take from thirty to ninety days. Some states have a deemer provision in their laws and regulations which provide that a filing is deemed approved unless the department objects within a specified period of time, usually thirty days.

61 Trends of Policy Filing Many states require that a form be submitted and approved by the insurer's domiciliary state before submission to other states. Submission of solicitation and advertising material is now requested by some states.

62 REVIEW QUESTIONS 1. The is used by many states to determine a policy's level of readability. 2. A is a regulation in many states that protects the insurer from an overextended policy approval period. 3. List the possible reasoning for writing an individual policy instead of a group policy. 4. Read the following information and answer the questions that follow. A 48-month credit life policy with a suicide provision of two years was accepted by the insurer. A. If the insured committed suicide during the third year of the policy term, would the death benefit be paid? Why or why not? B. If the insured committed suicide during the second year of the term, would the death benefit be paid. Why or why not? 5. Circle the correct response. If an insured misstates his age on a policy and is actually above the maximum age limit, death benefits are (payable/not payable) after the contestable period. Page 56

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