1 Discuss the difference between indemnity value and replacement value in insurance policies.

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1 Questions with Guided Answers by Sharon Taylor 2013 Reed International Books Australia Pty Limited trading as LexisNexis. Permission to download and make copies for classroom use is granted. Reproducing or distributing any material from this website for any other purpose requires written permission from the Publisher. Chapter 16: Insurance: Income Protection, Health and General 1 Discuss the difference between indemnity value and replacement value in insurance policies. Replacement cost or replacement value (RV) The term replacement cost or replacement value refers to the amount that an entity would have to pay, at the present time, to replace any one of its assets. Replacement cost is not market value, but is instead the cost to replace an item or structure at its pre-loss condition. Indemnity value (IV) cover This is the value of the item at the time of the loss. Payment of the indemnity value is designed to put you in the same financial position you were in immediately before the loss occurred. This therefore takes into account the issue of depreciation. 2 What conditions apply if the insured suffers a partial disability and a claim is made under income protection insurance? The income protection policy is designed to replace, in part, the insured s income while the insured is totally disabled (not necessarily permanently). The payment of the benefit commences following a waiting period and continues until the insured is no longer totally disabled or the benefit period expires. For an additional premium, the policy can be extended to include partial disablement. There are a range of additional covers provided by the policy; some of these are included in the policy at no extra charge and for others an additional premium is payable 3 Why is it advisable to have business overhead insurance? Business overhead expense coverage is designed to reimburse a business owner's overhead expenses while he or she is disabled. A business overhead expense policy pays a benefit of one to two years after a waiting period. Generally, there are two conditions which must be met to trigger the payment of benefits: Financial Planning in Australia 5e Questions: Ch 16 Page 1

2 total disability due to injury or sickness; the expenses covered by the policy must be incurred during the disability. Eligible business overhead expenses include: employee salaries; employment taxes; employee benefit costs; rental payments for property and equipment; principal and interest on mortgaged business property; utilities; accounting and legal fees; business insurance expenses; interest on business debts; property taxes; general office supplies. Business continuation/buyout coverage provides the funds to back a disability buyout agreement. 4 What is meant by the concept of subrogation? The principle of subrogation supports the principle of indemnity. Subrogation means substituting the insurer in place of the insured in order to collect from a third party for a loss covered by insurance. The insurer (eg, Fireman's Fund, or Nationwide) pays the insured (their policy owner) for a loss, and the insured gives up their right of action against the negligent third party. An example will help to clarify this principle. Assume that a driver ran a red light and damaged Susan's car. Further, assume that Susan had collision coverage under her auto insurance policy. Susan could collect from the other driver (or the driver's insurer) or from her own insurer. If her insurer paid for Susan's loss, the insurer will then try to collect from the negligent driver for the loss paid to Susan. Subrogation accomplishes three things. First, it prevents the insured from collecting twice (once from their own insurer and once from the negligent third-party) for the same loss. It also makes the negligent third party, the person responsible for the loss, bear the burden of the loss. Finally, subrogation leads to lower insurance rates. Through subrogation recoveries, insurers can recover money paid to their own insureds. Subrogation recoveries help to hold down insurance premiums. Insureds should be careful not to impair the right of their insurer to proceed against third parties. Interference with the insurer's right to collect from the third party may jeopardise recovery from their own insurer. Financial Planning in Australia 5e Questions: Ch 16 Page 2

3 5 Why is it important to establish a detailed record of your contents when seeking to arrive at a sum insured under a house and contents policy? Home and contents insurance is designed to protect your biggest asset and everything inside of it against natural disasters and other damage. However, with the number of different products on the market, it s virtually impossible for the average consumer to perform an effective home insurance comparison. And then there's the frustration involved when trying to decipher the terms and conditions. If you choose and pay to insure your home, the sum insured will be shown on your certificate. Home means the residential building and the following elements owned by you and situated at your address: garages and other domestic outbuildings; fixtures including fixed wall, ceiling and floor coverings, excluding carpet; insulation; clothes lines; masts and aerials; paved driveways and paths; pergolas, gazebos, awnings and shade sails; in-ground pools; saunas and spas; gates and fences; private wharves, jetties and pontoons not used for commercial purposes. Home does not mean: any item included under the definition of contents; trees, indoor or outdoor plants, flowers, shrubs, hedges, lawns and landscaping. Your policy documentation will outline exactly what your insurer expects from you if you wish to claim. Ensure you follow the correct procedure, so that your claim is processed as quickly and efficiently as possible. For example, you are usually requested to inform your insurer as soon as you need to make a claim. In addition, if you make a claim for damage to, or loss of a high-value item, you should be able to provide receipts, valuations and/or photos to prove its value. When you make a claim, your insurer will ask for any additional information you can provide. For this reason it is important to note down the details of the incident which led to your claim. In addition, you should aim to keep original documents such as receipts, invoices, instruction manuals and/or photographic evidence that help confirm the value, make and model of an item for which you are claiming. This evidence should also confirm the date when you purchased the item, and the supplier from which you bought it. If someone broke into your property, you should inform the police. The police will provide you with a crime reference number, which Financial Planning in Australia 5e Questions: Ch 16 Page 3

4 helps ensure that your claim is processed as soon as possible by your insurer. 6 When does the concept of co-insurance have relevance? Definition: coinsurance is a requirement in a policy that the insured insure a minimum percentage of an asset's value. It is called coinsurance because, if the insured fails to purchase the required policy limits as required, they become a coinsurer on any loss. Examples: a property policy with an 80% coinsurance requirement would mean the policy holder must purchase a minimum of $80,000 in coverage on property worth $100,000 (80% of $100,000 = $80, Discuss three forms of compulsory insurance. The four main areas of compulsory insurance in Australia are third party motor vehicle insurance, workers compensation, professional indemnity insurance and public liability insurance. Compulsory third party insurance (CTP) In Australia during the 1930s, insurance cover was an option many drivers didn t take up. Consequently, if they injured a third party with their vehicle, that person received little or no compensation. Third parties included passengers, other drivers and pedestrians, and the only way they could seek compensation for injury in motor vehicle accidents was to prove negligence by the at fault driver through the common law system. This was an expensive business and, if the driver had insufficient funds, both the driver and their victim would end up suffering financially. To overcome this, each state and territory introduced a law requiring motor vehicle owners to obtain compulsory third party insurance (CTP). Workers compensation This is compulsory insurance that all employers must have to protect their employees against work-related injury or illness. It allows an injured worker to make an insurance claim for medical and rehabilitation expenses and receive lump sum payments for permanent impairment. It was introduced to Australia in the early 1900s and, like CTP insurance, each state and territory adopted its own unique yet similar versions. Financial Planning in Australia 5e Questions: Ch 16 Page 4

5 It was introduced at roughly the same time as the minimum wage and the pension and was seen as part of a new era of workers rights in Australia. Today, all employers who pay more than $7,500 in wages or employ an apprentice or trainee must have workers compensation insurance. Professional indemnity insurance This insurance protects professionals from claims of negligence made by their clients. While not compulsory in many industries, it is mandatory for legal practitioners, insurance brokers, medical practitioners, some accountants and those contractors working with government bodies. Medicine is an area where negligence claims are particularly prevalent and all practising medical practitioners must have medical indemnity insurance. Historically, this was provided in Australia by medical defence organisations (MDOs). With the financial demise of many of these providers, in 2003 the government appointed APRA (Australian Prudential Regulation Authority) to supervise the industry and required medical indemnity insurers to be licensed under the Insurance Act Today, the term professional has been widened to include many more industries. Basically, anyone providing professional services is open to claims being made against them and, in these litigious times, everyone from architects to real estate agents is taking out professional indemnity insurance. Public liability insurance This protects your business against injury or property damage suffered by a third party on your premises. It is compulsory insurance for community organisations and property management organisations and often a condition of trade for retailers leasing their premises. Public liability dates back to the tort law of negligence in common law, under which a person, business or organisation can be sued for acts of negligence or omission. In Australia, it is regulated by each individual state and territory and premiums are monitored by the federal government through the ACCC and ASIC. Today, many community groups and sporting clubs are finding it difficult to continue operating due to the high cost of public liability insurance and the government is under pressure to introduce legislation that will exempt such groups from liability. Financial Planning in Australia 5e Questions: Ch 16 Page 5

6 8 Discuss the use of professional indemnity insurance and when it is appropriate. What is professional indemnity insurance? Professional Indemnity insurance was designed for professionals who provide advice or a service to their customers. It is designed to protect you against legal costs and claims for damages to third parties which may arise out of an act, omission or breach of professional duty in the course of your business. If a mistake or omission occurs in the course of your work that results in financial loss or injury to a third party (eg, a customer), that customer may take legal action against you to recover their losses. Professional indemnity insurance seeks to protect both your assets and your reputation, should this occur. Why do I need it? Defending yourself from a professional conduct claim can cost you time, money and damage your reputation, regardless of whether the allegations are founded or not. If things do go wrong, you could be held responsible not only for your own actions, but for those of your partners, employees or volunteers. A professional indemnity insurance policy safeguards you and your business by providing cover against such claims, including the cost of defending the action, so you can conduct your business with the confidence that both your assets and your reputation are protected. Financial Planning in Australia 5e Questions: Ch 16 Page 6