INSURANCE CONTINUING EDUCATION Earn Credit in 3 EASY STEPS: Hours $49.00 * 21 Hours $69.00 *

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1 INSURANCE CONTINUING EDUCATION Earn Credit in 3 EASY STEPS: 1 READ this book. 2 COMPLETE the open-book exam. 3 SUBMIT for scoring via Fax, Mail, or Online! OR Hours $49.00 * 21 Hours $69.00 * * Plus Mandatory Illinois Department of Insurance Credit Reporting Fee Updated Illinois Law: Total CE Requirement Is Now 24 Credit-Hours 21 Credit-Hours of Convenient Self-Study Education is Permitted 3 Credit-Hours of Instructor-Led Ethics Training Is Required Earn Credit By Completing The Courses Provided In This Book, Then Register to Complete Your Ethics Course Requirement. Call or Visit Our Website For Our Upcoming Class Schedule. EARN UP TO 21 CREDIT-HOURS OF STATE-APPROVED CONTINUING EDUCATION Course One Everyone Needs Insurance 11 Credit Hours, Approved In Illinois For The Following Licensees: Life, Accident/Health, Property, Casualty, Fire, and Motor Vehicle Course Two Limiting Your Professional Risks 10 Credit Hours, Approved In Illinois For The Following Licensees: Life, Accident/Health, Property, Casualty, Fire, and Motor Vehicle Provided By INSURANCE EDUCATION DIVISION REAL ESTATE INSTITUTE (800)

2 FREQUENTLY ASKED QUESTIONS How can I enroll and submit my exam(s) to the school? You can enroll and submit your course exam(s) by fax or mail using either the form on page 122 or the form on the back cover. Courses may also be completed at our website. Online exams are identical to those printed in this book. What is the passing score required to earn credit for each of the courses in this book? The state of Illinois requires a passing score of at least 70% on each exam. Most students pass on the first attempt. However, course enrollments include a second attempt, if necessary. How quickly will you grade my exam and report my course completion(s) to the state of Illinois? We will process your course enrollment and grade exams within one business day of receipt. All successful course completions are reported to the state within two business days. Why does the school charge a credit reporting fee? In March 2011, the Illinois Department of Insurance began requiring a fee to be paid for each course credit-hour reported. Our course pricing remains the same, but students are required to pay this Department-mandated fee. State fees are subject to change without notice. Please visit our website or call for current fees. How can I keep records of courses I have completed with your school? Upon successful course completion, we will provide you with a Certificate of Completion for your records. How can I be sure that I have not already completed these courses? These courses were created by the Real Estate Institute and are not available through other course providers. If you are concerned about course repetition, please call us to learn about additional courses. I want to take advantage of the discounted 21 credit-hour program, but I don t need that many credit hours. What should I do? If completing both courses in this book will cause you to exceed your 21 credit-hours that may be completed by self-study, up to 12 credit hours may be carried forward to your next renewal period. However, you may also take advantage of our discounted 21 credit-hour program and complete only one course at this time to satisfy your current requirement. You can then submit the other exam within six months of your enrollment to be used toward your next renewal period. I sell long-term care insurance. Is there a special requirement I need to consider? Yes, a special training and continuing education requirement affects all resident producers who sell or solicit any type of long-term care insurance. We offer the required training course and continuing education through convenient self-study. Please contact us or visit our website for additional information. Illinois requires 3 credit-hours of instructor-led Ethics training. How do I satisfy the new continuing education requirement? We offer programs to satisfy this requirement. Please call or visit our website to learn more. PLEASE CALL US WITH ANY ADDITIONAL QUESTIONS! INSURANCE EDUCATION DIVISION REAL ESTATE INSTITUTE (800)

3 EVERYONE NEEDS INSURANCE Continuing Education for Illinois Insurance Professionals

4 EVERYONE NEEDS INSURANCE Copyright by Real Estate Institute All rights reserved. No part of this book may be reproduced, stored in a retrieval system or transcribed in any form or by any means (electronic, mechanical, photocopy, recording or otherwise) without the prior written permission of Real Estate Institute. A considerable amount of care has been taken to provide accurate and timely information. However, any ideas, suggestions, opinions, or general knowledge presented in this text are those of the author and other contributors, and are subject to local, state and federal laws and regulations, court cases, and any revisions of the same. The reader is encouraged to consult legal counsel concerning any points of law. This book should not be used as an alternative to competent legal counsel. Printed in the United States of America. P4 All inquiries should be addressed to: Real Estate Institute 6203 W. Howard Street Niles, IL (800)

5 EVERYONE NEEDS INSURANCE TABLE OF CONTENTS INTRODUCTION... 1 CHAPTER 1 MOTOR VEHICLE INSURANCE... 1 Introduction... 1 The Tort Liability System and Automobile Insurance... 1 Personal Auto Policy: Overview... 1 The Declarations Page... 1 Insuring Agreement and Definitions... 1 Eligible Vehicles... 2 Personal Auto Policy: Liability Coverage... 2 Insured Persons... 2 Supplementary Payments... 3 Exclusions... 3 Limit of Liability... 4 Out of State Coverage... 4 Other Insurance... 5 Personal Auto Policy: Medical Payments Coverage... 5 Exclusions... 5 Limit of Liability... 6 Other Insurance... 6 Personal Auto Policy: Uninsured Motorists Coverage... 6 Exclusions... 7 Limit of Liability... 7 Other Insurance... 7 Underinsured Motorist Coverage... 7 Personal Auto Policy: Coverage for Damage to Automobile. 8 Exclusions... 8 Limit of Liability... 9 Payment of Loss... 9 No Benefit to Bailee Other Insurance Appraisal Personal Auto Policy: Duties After an Accident or Loss Personal Auto Policy: General Provisions Personal Auto Policy: Insuring Motorcycles and Other Vehicles Approaches for Compensating Automobile Accident Victims Automobile Insurance for High-Risk Drivers Cost of Automobile Insurance Territory Age, Sex Use of The Automobile Driver Education Good Student Discount Number and Type of Automobiles Individual Driving Record Purchase Higher Deductibles Improved Driving Record Conclusion CHAPTER 2 HOMEOWNERS AND PERSONAL PROPERTY INSURANCE Introduction The History of Property Insurance Negligence The Language of Liability Insurance Summary Homeowners Insurance Introduction Coverage and Limits of Liability Types of Homeowners Policy Forms and Their Coverages HO-1 and HO-2 Policy HO-3 Policy HO-5 Policy HO-4 and HO-6 Policies HO-8 Policy Homeowners Insurance Property Coverage Section I The Dwelling Detached Structures Located on the Property Personal Property Loss of the Use of the Structure Additional Coverage Homeowners Insurance Liability Coverage Section II Personal Liability Exclusions Filing the Homeowners Insurance Claim Replacement Cost Coverage Dwelling Claims Personal Property Claims Other Homeowners Insurance Concepts Subrogation Statements Salvage Non-Waiver Agreement Cancellation Homeowners Insurance Concluding Thoughts Personal Property Insurance Introduction Inland Marine Insurance Inland Marine Insurance Definition Inland Marine Floater Characteristics Inland Marine Floater Provisions Inland Marine Floater Exclusions Personal Articles Floater Personal Property Floater Scheduled Personal Property Floater Unscheduled Personal Property Newly Acquired Property Property Not Covered Personal Effects Floater Personal Effects Coverage Property Excluded All-Risks Coverage Other Exclusions Limitations on Certain Personal Effects Personal Umbrella Liability Insurance Nature of Personal Umbrella Insurance Excess Liability Insurance Broad Coverage Self-Insured Retention Personal Umbrella Coverages Personal Umbrella Exclusions Watercraft Insurance Hull and Trailer Loss Exposures Homeowners Policy Physical Damage Coverage Personal Auto Policy Personal Damage Coverage Liability Loss Exposure Homeowners Policy Liability Coverage Outboard Motor and Boat Insurance Outboard Motor and Boat Insurance Exclusions Watercraft Package Policies Personal Yacht Insurance Uninsured Boaters Coverage Uninsured Boaters Coverage Exclusions Specialized Coverages Ocean Marine Specialized Coverage Inland Marine Specialized Coverage Ocean Marine Insurance Hazards Covered Other Types of Ocean Marine Coverage Conclusion Personal Property Insurance Real Estate Institute

6 EVERYONE NEEDS INSURANCE CHAPTER 3 UNDERWRITING PROPERTY AND CASUALTY INSURANCE Major Underwriting Goals Underwriting Gains Contribution to Society Maintaining a Strong Insurance Industry Individual and Class Underwriting Underwriting Individuals Underwriting By Class Specific Underwriting Factors and Practices Loss History Accident Record Fault Number of Accidents Commercial/Personal Risks Property Losses Liability Losses Recommendations for Improvement Traffic Violations Non-Verifiable Record Sources of Information Driving Record Condition of Property Age of Buildings Value of Buildings Occupancy of Buildings Neighborhood Age of Insured Sex Marital Status Occupation Stability Social Maladjustment Attitude Criminal Record Mental Incompetence Physical Impairments Alcohol and Drugs Foreign Born Related Business Prior Insurance Prior Cancellation Conclusion CHAPTER 4 LIFE INSURANCE The Life Insurance Policy Uses of Life Insurance Life Insurance as a Property The Life Insurance Application Three Parties to an Application Insurable Interest The Application Form Minor Applications Correcting Applications Incorrect or Incomplete Applications Representations and Warranties Fraud Concealment Conditional Receipt Policy Effective Date / Backdating How Much Life Insurance Do I Need? Types of Life Insurance Term Insurance Whole Life Insurance Universal Life Insurance Variable Life Insurance Adjustable Life Insurance Modified Life Insurance Family Life Insurance Types of Insurance Companies Stock Life Insurance Company Mutual Insurance Company Fraternal Benefit Society Government Insurance Programs Reciprocals Lloyd s of London Insurer s Financial Status Life Insurance Policy Provisions Ownership Clause Entire Contract Clause Incontestable Clause Suicide Clause Grace Period Reinstatement Clause Misstatement of Age Beneficiary Designation Change of Plan Provision Exclusions and Restrictions Premiums Parts of the Premium Net and Gross Premium Mortality Level Premiums and Reserves Insurance Age Payment of Premiums Settlement Options Lump Sum Settlement Proceeds and Interest Fixed Years Installments Life Income Joint Life Income Fixed Amount Installments Other Mutually Agreed Method Non-Forfeiture Options Cash Surrender Value Reduced Paid-Up Insurance Extended Term Insurance Automatic Premium Provision Dividend Accumulations to Avoid Lapse Dividend Options Cash Payment Reduction of Premium Accumulation of Interest Paid-Up Additions One-Year Term Life Insurance Policy Riders Waiver of Premium Accidental Death and Dismemberment Guaranteed Purchase Option Life Insurance Underwriting Underwriting Factors for Individual Coverage Underwriting Actions Delivering the Policy Policy Effective Date Delivery Agents Responsibilities Regarding Delivery Income Tax Benefits of Life Insurance Conclusion FINAL EXAM Real Estate Institute

7 EVERYONE NEEDS INSURANCE INTRODUCTION Insurance professionals can impact customers lives in many different ways. Whether providing a renters policy for a young adult moving into his or her first apartment or providing long term care insurance for a senior citizen, insurance producers walk side by side with their customers through life s various stages. In these materials we examine some of the insurance policies and services which can be offered throughout a customer s lifetime. First we discuss motor vehicle insurance, often the first occasion for interaction between a customer and an insurance professional. Next we discuss homeowners and personal property insurance. Following that discussion, we discuss underwriting issues related to property and casualty insurance. We then explain life insurance and annuities, products which the insurance customer will require when reaching certain life milestones. By understanding many different insurance products and underwriting rationale, you will develop a better capacity for advising your insurance prospects and customers regarding their options for optimal insurance protection. CHAPTER 1 MOTOR VEHICLE INSURANCE Introduction Automobile accidents can cause financial and economic havoc to individuals and families. Legal liability arising out of the negligent operation of an automobile can reach traumatic levels. Medical expenses, pain and suffering, the death of a family member, and the damage or loss of property, or loss of the automobile itself can be devastating. The insurance buying public relies on insurance producers for guidance toward the proper insurance policy. The Tort Liability System and Automobile Insurance Each individual has certain legal rights. A legal wrong is a violation of the individual s legal rights or a failure to perform a legal duty owed to an individual or to society as a whole. A tort is a legal wrong. Specifically, a tort can be defined as a legal wrong, other than a breach of contract, for which the law allows a remedy in the form of money damages. The person who is injured or harmed (called the plaintiff or claimant) by the actions of another person (called the defendant) can sue for damages. Torts can generally be classified into three categories: Intentional torts. An intentional act or omission that results in harm or injury to another person or damage to the person s property. (For example, assault, battery, trespass, false imprisonment, fraud.) Absolute liability. Absolute liability exists when a party is liable for damages even though that party s fault or negligence cannot be proven. Examples of circumstances giving rise to absolute liability include occupational injury, blasting operations that injure another person, manufacturing of explosives, and crop spraying by airplanes. Negligence. Negligence is a tort that results in harm or injury to another person. Negligence typically is defined as the failure to exercise the standard of care required by law to protect others from harm. The meaning of the term standard of care is based on the care required of a reasonably prudent person. Actions are compared with the actions of a reasonably prudent person under the same circumstances. The standard of care required by law is not the same for each wrongful act. Liability coverage is the most important part of the Personal Auto Policy. It protects a covered person against a suit or claim arising out of the negligent ownership or operation of an automobile. Personal Auto Policy: Overview The Personal Automobile Policy (also referred to as the Personal Auto Policy ) is designed to be the most commonly purchased insurance policy for the average family automobile. The Insurance Services Office (ISO) first introduced the Personal Auto Policy in The ISO form of the Personal Automobile Policy is written in simplified English, making it easier to read and understand than earlier contracts of automobile insurance. It contains simple definitions and short sentences. Highly technical terms have been eliminated from the policy, and the policy language is informal and personal. The Personal Auto Policy emphasizes liability protection, making it the first coverage in the policy. (As a comparison, a Homeowners Policy provides liability protection as the last coverage in the policy.) The nature of the property covered, mobile rather than stationary, makes the Personal Auto Policy quite different from a Homeowners Policy. The potential number of non-family members using an automobile is greater than those potentially living in the family house. The possibility that the insured may drive several different non-owned automobiles also makes the Personal Auto Policy a more complicated policy with respect to defining the insured. The Personal Auto Policy begins with a Declarations page, an Insuring Agreement, and Definitions. (Examples of policy language appear in shaded boxes throughout this chapter.) The Declarations identify the named insured, the vehicles covered, and the premium charged for the coverage. The Insuring Agreement makes the contract effective. The Declarations Page The Declarations Page is the first part of most insurance contracts. Declarations are statements that provide information about the property being insured. Information contained in the Declarations Page is used for underwriting and rating purposes and for identification of the property to be insured. The Declarations section can be found on the first page of the policy or on a policy insert. In some contracts the declarations are part of the written application that is attached to the policy. In property insurance, the declarations section contains information concerning the identification of the insurer, name of the insured, location of the property, period of protection, amount of insurance, amount of the premium, size of the deductible (if any), and other relevant information. The Declaration Page lists a single limit of liability for the insurer, such as $100,000. This is the limit for all types of damage an insured may cause, including bodily injury and property damage. If judgments are greater than this limit, the insured, not the insurer, pays the excess. The Personal Auto Policy may also be written on a split limit basis (e.g. $50,000 / $100,000 / $25,000). When coverage is written with split limits of $50,000 / $100,000 / $25,000, the insurer will pay only $50,000 to any one individual and only $100,000 for one accident for bodily injury liability. The $25,000 indicates the maximum amount which the insurer will pay for property damage liability. Insuring Agreement and Definitions After the Declarations Page, the Personal Auto Policy sets forth the Insuring Agreement and Definitions. The Insuring Agreement states that, In return for payment of the premium and subject to all the terms of the policy, the insurer agrees with the insured as follows: The definitions and body of the insurance policy then follow that Insuring Agreement. Definitions in a standard Personal Auto Policy may include the following: Real Estate Institute 1

8 EVERYONE NEEDS INSURANCE Throughout this policy, you and your refer to: The named insured shown in the Declarations; and The spouse if a resident of the same household. We, us and our refer to the Company providing this insurance. For purposes of this policy, a private passenger type auto shall be deemed to be owned by a person if leased: Under a written agreement to that person; and For a continuous period of at least 6 months. Bodily injury means bodily harm, sickness or disease, including death that results. Business includes trade, profession or occupation. Family member means a person related to you by blood, marriage or adoption that is a resident of your household. This includes a ward or foster child. Occupying means in, upon, getting in, on, out or off. Property damage means physical injury to, destruction of or loss of use of tangible property. Trailer means a vehicle designed to be pulled by a: Private passenger auto; or Pickup or van. It also means a farm wagon or farm implement while towed by one of the above. Eligible Vehicles Only certain types of vehicles are eligible for coverage under the Personal Auto Policy. An eligible vehicle is a four-wheel motor vehicle (other than truck-type) that is owned by the insured or is leased by the insured for at least six continuous months. Pickups and vans are also eligible for coverage if the vehicle is not customarily used in the insured s business or occupation other than farming or ranching. A vehicle that is owned by a family farm or ranch partnership or corporation is eligible for coverage if the vehicle is garaged principally on the farm or ranch, and other eligibility requirements are met. A private passenger automobile owned by two or more resident relatives or two or more non-related individuals living together can be insured by adding a miscellaneous type vehicle endorsement to the policy. Motorcycles, motor homes, motor scooters, golf carts, and similar vehicles can be insured under the Personal Auto Policy by adding the same endorsement to the policy. The actual definition for eligible vehicles may include the following: Your covered auto means: Any vehicle shown in the Declarations. Any of the following types of vehicles on the date you become the owner: A private passenger auto; or A pickup or van. This provision applies only if: You acquire the vehicle during the policy period. You ask us to insure it within 30 days after you become the owner. With respect to a pickup or van, no other insurance policy provides coverage for that vehicle. If the vehicle you acquire replaces one shown in the Declarations, it will have the same coverage as the vehicle it replaced. You must ask us to insure a replacement vehicle within 30 days only if: You wish to add or continue Coverage for Damage to Your Auto. It is a pickup or van used in any business other than farming or ranching. If the vehicle you acquire is in addition to any shown in the Declarations, it will have the broadest coverage we now provide for any vehicle shown in the Declarations. Any trailer you own. Any auto or trailer you do not own while used as a temporary substitute for any other vehicle described in this definition which is out of normal use because of its: Breakdown; Repair; Servicing; Loss; or Destruction. Personal Auto Policy: Liability Coverage After the Declarations Page, Insuring Agreement and Definitions, Part A of the Personal Auto Policy then sets forth Liability Coverage. Part A sets forth its own Insuring Agreement which describes the major promises of the insurer regarding liability coverage. In the Insuring Agreement, the insurer agrees to pay damages for bodily injury or property damage for which the insured is legally responsible because of an automobile accident. The insuring agreement in Part A may read as follows: We will pay damages for bodily injury or property damage for which any covered person becomes legally responsible because of an auto accident. We will settle or defend, as we consider appropriate, any claim or suit asking for these damages. In addition to our limit of liability, we will pay all defense costs we incur. Our duty to settle or defend ends when our limit of liability for this coverage has been exhausted. We have no duty to defend any suit or settle any claim for bodily injury or property damage not covered under this policy. Liability coverage is generally written as a single limit that applies to both bodily injury and property damage liability. That is, the total amount of insurance applies to the entire accident without a separate limit for each person. The Personal Auto Policy can also be written with split limits. Split limits mean the amounts of insurance for bodily injury liability and property damage are stated separately. In addition to the payment for damages for which the insured is legally liable, the company also agrees to defend and pays all legal defense costs. The defense costs are paid in addition to the policy limits. However, the company s duty to settle or defend the claim ends when the limit of liability has been exhausted. Once the policy limits are paid out, the company has no further obligation to defend the insured. The company also has no obligation to defend any claim not covered under the policy. Insured Persons Part A of the Personal Auto Policy provides liability coverage for four different categories of parties: Category 1 You or any family member for the ownership, maintenance or use of any auto or trailer. In Category 1 the named insured and resident family members are covered for the ownership, maintenance, or use of any auto, whether it is owned or borrowed, unless exclusions apply. Category 2 Any person using your covered auto Real Estate Institute 2

9 EVERYONE NEEDS INSURANCE Category 2 relates to any person using a covered auto. The car owner s insurance, not the driver s insurance, would pay a claim if the owner allows another party to borrow his or her car. Coverage on the auto involved in an accident is considered primary coverage. If the owner s insurance is exhausted by the claim, then the driver could turn to his own insurer to pay the remainder of the claim until his own insurance was exhausted. Category 3 For your covered auto, any person or organization but only with respect to legal responsibility for acts or omissions of a person for whom coverage is afforded under this part. Category 4 For any auto or trailer, other than your covered auto, any other person or organization but only with respect to legal responsibility for acts or omissions of you or any family member for whom coverage is afforded under this Part. This provision applies only if the person or organization does not own or hire the auto or trailer. Categories 3 and 4 recognize that in some situations, people or organizations other than a driver can be sued due to a driver s negligence. In some of these instances the Personal Auto Policy will cover the liability of these people. Assume that a trade union sends a member, John, to buy some supplies for a union picnic. Also assume that John uses his own car. If an accident occurs during this trip, the Personal Auto Policy would cover the trade union s liability in a suit resulting from the accident. The union s liability arises because John was technically an agent of the union while on his way to purchase supplies for the picnic. The difference between Categories 3 and 4 is the difference between the insured driving an owned or non-owned vehicle. Supplementary Payments Under the Personal Auto Policy, the insurance company may provide liability coverage beyond its stated limit of liability by making certain supplementary payments. Part A of the Policy describes five categories of supplementary payments: Up to $250 for the cost of bail bonds required because of an accident, including related traffic law violations. The accident must result in bodily injury or property damage covered under this policy. Premiums up to $250 may be paid for bail bonds arising out of an automobile accident that results in property damage or bodily injury. Payment would not be made for a traffic violation such as a speeding ticket except if an accident occurs. Premiums on appeal bonds and bonds to release attachments in any suit we defend. Interest accruing after a judgment is entered in any suit we defend. Our duty to pay interest ends when we offer to pay that part of the judgment, which does not exceed our limit of liability for this coverage. Premiums on appeal bonds and any bond to release an attachment of property in any suit defended by the insurer are also paid as supplementary payments. If interest accrues after a judgment is handed down, the interest is also paid as a supplementary payment. However, any prejudgment interest is subject to the policy s liability limits. Up to $50 a day for loss of earnings, but not other income, because of attendance at hearings or trials at our request. Other reasonable expenses incurred at our request. The insured may be a defendant in a trial and be requested to testify, and the policy will cover up to $50 per day for loss of earnings. If the insured incurs meal or transportation expenses as a result of requests by the insurer, those expenses would be paid as a supplemental payment. Exclusions Part A of the Personal Auto Policy next details the specific exclusions to liability coverage. Specifically, the insurance company will not provide liability coverage for any person: Who intentionally causes bodily injury or property damage. For example, if the insured intentionally runs over a bicycle with his car, the property damage is not covered. For damage to property owned or being transported by that person. For example, if a suitcase or camera were damaged in an automobile accident while a person is on vacation, the damage would not be covered. For damage to property: Rented to; Used by; or In the care of that person. This exclusion does not apply to damage to a residence or private garage. For example, if the insured rents skis that are damaged in an automobile accident, the property damage is not covered by the policy. However, if the insured rents a house and carelessly backs into a partly opened garage door, the property damage would be covered by the policy. For bodily injury to an employee of that person during the course of employment. This exclusion does not apply to bodily injury to a domestic employee unless workers compensation benefits are required or available for that domestic employee. The intent here is to cover the employee s injury under a workers compensation law. However, a domestic employee injured during the course of employment would be covered if workers compensation benefits are not required or available. There is no liability coverage on a vehicle while it is being used to carry persons or property for a fee. If bus drivers or taxicab drivers are on strike and the insured transports passengers for a fee, the policy s liability coverage does not apply to that circumstance. For that person s liability arising out of the ownership or operation of a vehicle while it is being used to carry persons or property for a fee. This exclusion does not apply to a share-the-expense car pool. While employed or otherwise engaged in the business of: Selling; Repairing; Servicing; Storing; or Parking vehicles designed for use mainly on public highways. This includes road testing and delivery. This exclusion does not apply to the ownership, maintenance or use of your covered auto by: You; Real Estate Institute 3

10 EVERYONE NEEDS INSURANCE Any family member; or Any partner, agent or employee of you or any family member. If a person is employed or engaged in the automobile business, liability arising out of the operation of vehicles in the automobile business is excluded from coverage under the policy. The automobile business refers to the selling, repairing, servicing, storing, or parking of vehicles designed for use mainly on public highways. This also includes road testing and delivery. If an automobile mechanic has an accident and injures someone while road testing an insured s car, the Personal Auto Policy liability coverage does not apply to that circumstance. However, if the insured is sued because he is the owner of the car, coverage applies. The intent of this exclusion is to exclude loss exposures that should be covered under the employee s liability policy, such as a garage policy. Maintaining or using any vehicle while that person is employed or otherwise engaged in any business (other than farming or ranching) not described in the prior exclusion. This exclusion does not apply to the maintenance or use of a: Private passenger auto; Pickup or van that you own; or Trailer used with a vehicle described in above. The purpose here is to exclude liability for commercial vehicles and trucks that are used in a business. However, if a party drives your car on company business, the Personal Auto Policy liability coverage remains in force. Using a vehicle without a reasonable belief that the person is entitled to do so. For example, if the insured s car is stolen, and someone is injured in an ensuing accident, the injured party is not covered under the insured s liability policy. For bodily injury or property damage for which that person: Is an insured under a nuclear energy liability policy; or Would be an insured under a nuclear energy liability policy but for its termination upon exhaustion of its limit of liability. A nuclear energy liability policy is a policy issued by any of the following or their successors: American Nuclear Insurers; Mutual Atomic Energy Liability Underwriters; or Nuclear Insurance Association of Canada. Each of the above exclusions relate to the actions of a person, whether the insured or another party using the insured s vehicle. The Personal Auto Policy also presents exclusions which are tied to a particular type of property. Specifically, the Personal Auto Policy does not provide liability coverage for the ownership, maintenance or use of: Any motorized vehicle having fewer than four wheels. Motorcycles, motor scooters, mini-bikes, mopeds, and trail bikes are excluded under the policy; however, the insured may add a miscellaneous vehicle endorsement to the policy in order to cover these types of vehicles. Any vehicle, other than your covered auto, which is: Owned by you; Furnished or available for your regular use. The insured may occasionally drive another person s car and still have coverage under the policy; however, if a non-owned vehicle is driven regularly or is furnished or made available for regular use, the Personal Auto Policy liability coverage will not apply to use of that vehicle. If the insured s employer furnishes the insured with a car, or if a car is available for regular use in a company carpool, the liability coverage will not apply to use of that vehicle. Any vehicle, other than your covered auto, which is owned by, furnished or available for the regular use of any family member. If a son or daughter drives a non-owned vehicle on a regular basis, or the vehicle is furnished or made available for their regular use, the liability coverage does not apply. However, this exclusion does not apply to your maintenance or use of any vehicle, which is: Owned by a family member; or Furnished or available for the regular use of a family member. The exclusion does apply to the named insured and spouse, or if a mother occasionally drives a car owned by another household member, (for example, a son or daughter), the mother s Personal Auto Policy provides coverage while driving her son s or daughter s car. Limit of Liability The next portion of Part A of the Personal Auto Policy explains the limits of liability under the policy: The limit of liability shown in the Declarations for this coverage is our maximum limit of liability for all damages resulting from any one-auto accident. This is the most we will pay regardless of the number of Insureds; Claims made; Vehicles or premiums shown in the Declarations; Vehicles involved in the auto accident. We will apply the limit of liability to provide any separate limits required by law for bodily injury and property damage liability. However, this provision will not change our total limit of liability. The company s maximum limit of liability from any single automobile accident is the amount stated in the Declarations. This is true regardless of the number of insureds, claims made, vehicles or premiums shown in the declarations, or vehicles involved in the auto accident. Out of State Coverage The Personal Auto Policy next provides details regarding out of state liability coverage: If an auto accident to which this policy applies occurs in any state or province other than the one in which your covered auto is principally garaged, we will interpret your policy for that accident as follows: If the state or province has: A financial responsibility or similar law specifying limits of liability for bodily injury or property damage higher than the limit shown in the Declarations, your policy will provide the higher specified limit Real Estate Institute 4

11 EVERYONE NEEDS INSURANCE If an accident occurs in a state that has a financial responsibility law with higher liability limits than the limits shown in the declarations, the Personal Auto Policy automatically provides the higher specified limits. A compulsory insurance or similar law requiring a nonresident to maintain insurance whenever the nonresident uses a vehicle in that state or province, your policy will provide at least the required minimum amounts and types of coverage. If the state has a compulsory insurance or similar law that requires a nonresident to have insurance whenever he or she uses a vehicle in that state, the Personal Auto Policy also provides the required minimum amounts and types of coverages. No party will be entitled to duplicate payments for the same elements of loss. Other Insurance The final section of Part A of the Personal Auto Policy explains the policy s liability coverage benefits in the event the insured carries other, additional insurance: If there is other applicable liability insurance we will pay only our share of the loss. Our share is the proportion that our limit of liability bears to the total of all applicable limits. However, any insurance we provide for a vehicle you do not own shall be in excess over any collectible insurance. In some cases, more than one automobile liability policy covers a loss. If other applicable liability insurance applies to an owned vehicle, the company pays only its pro rata share of the loss. The company s share is the proportion that its limit of liability bears to the total applicable limits of liability under all policies. However, if the insurance applies to a non-owned vehicle, the company s insurance is in excess over any other collectible insurance. Personal Auto Policy: Medical Payments Coverage Part B (or sometimes included as Part B1) of the Personal Auto Policy sets forth Medical Payments Coverage for the insured. Part B s insuring agreement sets forth the company s promises regarding its coverage of medical payments required as a result of bodily injury arising out of an automobile accident. Specifically, the policy may provide: We will pay reasonable expenses incurred for necessary medical and funeral services because of bodily injury: Caused by accident; or Sustained by an insured. We will pay only those expenses incurred within 3 years from the date of the accident. The company will pay all reasonable medical and funeral expenses incurred by an insured within three years from the date of the accident. The benefits limits apply to each insured that is injured in the accident. Medical payments coverage is not based on fault. If an individual is injured in an automobile accident and that individual is at fault, medical payments can still be paid to the individual and to other injured passengers in the car. The Personal Auto Policy defines Insured as used in this part B as: You or any family member: While occupying or As a pedestrian when struck by: a motor vehicle designed for use mainly on public roads or a trailer of any type. The named insured and family members are covered if they are injured while occupying a motor vehicle or are injured as pedestrians when struck by a motor vehicle designed for use mainly on public roads. If a farm tractor, snowmobile, or bulldozer injures an individual, that individual s injury is not covered. Any other person while occupying your covered auto. If an individual owns his car and is the named insured, all passengers in his car are covered for their medical expenses under his policy. However, if the insured is operating a nonowned vehicle, other passengers in the car (other than family members) are not covered for their medical expenses under his policy. The reason for this is to cause the other passengers in the non-owned vehicle to seek protection under the medical expense coverage that applies to the nonowned vehicle. Exclusions Part B of the Personal Auto Policy provides specific exclusions to medical payments coverage. The insurer will not provide medical payments coverage for any person for bodily injury : Sustained while occupying any motorized vehicle having fewer than four wheels. If the insured is injured while operating a motorcycle or moped, medical expense coverage does not apply. Sustained while occupying your covered auto when it is being used to carry persons or property for a fee. This exclusion does not apply to a share-the-expense car pool. Sustained while occupying any vehicle located for use as a residence or premises. If the insured owns and occupies a house trailer as a residence, medical expense coverage does not apply to injuries arising out of use of that vehicle. Occurring during the course of employment if workers compensation benefits are required or available for the bodily injury. Coverage does not apply if the injury occurs during the course of employment and workers compensation benefits are required or available. Sustained while occupying or when struck by, any vehicle (other than your covered auto) which is: Owned by you; Furnished or available for your regular use. The purpose here is to exclude medical payments coverage on an owned or regularly used car that is not described in the policy and for which an appropriate premium has not been paid Real Estate Institute 5

12 EVERYONE NEEDS INSURANCE Sustained while occupying, or when struck by, any vehicle (other than your covered auto ) which is: Owned by any family member; Furnished or available for the regular use of any family member. However, this exclusion does not apply to you. If a son living at home owns a car that is separately insured, and the parents are injured while occupying the son s car, the parent s medical expenses would be covered under their policy. Sustained while occupying a vehicle without a reasonable belief that that person is entitled to do so. If a covered auto is stolen, the thief has no coverage for medical payments. Sustained while occupying a vehicle when it is being used in the business of an insured. This exclusion does not apply to bodily injury sustained while occupying a: Private passenger auto; Pickup or van that you own; Trailer used with a private passenger auto or pickup or van that you own. The purpose here is to exclude medical payments coverage for non-owned trucks and commercial vehicles used in the business of an insured person. The exclusion does not apply to a private passenger auto (owned or non-owned), an owned pickup or van, or trailer used with any of the preceding vehicles. Caused by or as a consequence of: Discharge of a nuclear weapon (even if accidental); War (declared or undeclared); Civil war; Insurrection; Rebellion or revolution. From or as a consequence of the following, whether controlled or uncontrolled or however caused Nuclear reaction; Radiation; Radioactive contamination. If the insured drives his car in the vicinity of a nuclear power plant and a nuclear meltdown occurs, the radiation exposure is not covered. Limit of Liability The next portion of Part B of the Personal Auto Policy explains the limits of liability for medical payments coverage: The limit of liability shown in the Declarations for this coverage is that our maximum limit of liability for each person injured in any one accident. This is the most we will pay regardless of the number of: Insureds; Claims made; Vehicles or premiums shown in the Declarations; Vehicles involved in the accident. Any amounts otherwise payable for expenses under this coverage shall be reduced by any amounts paid or payable for the same expenses under Part A or Part C. No payment will be made unless the injured person or that person s legal representative agrees in writing that any payment shall be applied toward any settlement or judgment that person receives under Part A or Part C. Other Insurance The final section of Part B of the Personal Auto Policy explains the policy s liability coverage benefits in the event the insured carries other, additional insurance: If there is other applicable auto medical payments insurance we will pay only our share of the loss. Our share is the proportion that our limit of liability bears to the total of all applicable limits. However, any insurance we provide with respect to a vehicle you do not own shall be excess over any other collectible auto insurance providing payments for medical or funeral expenses. Personal Auto Policy: Uninsured Motorists Coverage Some people drive without liability insurance, causing exposure to risk for other parties in the event of an automobile accident. Part C of the Personal Auto Policy sets forth Uninsured Motorists Coverage for the insured. The uninsured motorists coverage is designed to pay for the bodily injury (and property damage in some states) caused by an uninsured motorist, hit-and-run driver, or by a driver whose company is insolvent. Part C s insuring agreement sets forth the company s promises regarding uninsured motorists coverage. Specifically, the policy may provide: We will pay damages which an insured is legally entitled to recover from the owner or operator of an uninsured motor vehicle because of bodily injury: Sustained by an insured; Caused by an accident. The owner s or operator s liability for these damages must arise out of the ownership, maintenance or use of the uninsured motor vehicle. Any judgment that is for damages arising out of a suit brought without our written consent is not binding on us. The company pays the damages that an insured person is legally entitled to receive from the owner or operator of an uninsured motor vehicle because of bodily injury caused by an accident. However, the coverage applies only if the uninsured motorists are legally liable. If the uninsured motorists are not liable, the company will not pay for the bodily injury. For purposes of Uninsured Motorists Coverage, Insured means: You or any family member ; Any other person occupying your covered auto; Any person for damages that person is entitled to recover because of bodily injury to which this coverage applies sustained by one of the above parties. Uninsured motor vehicle means a land motor vehicle or trailer of any type: To which no bodily injury liability bond or policy applies at the time of the accident; To which a bodily injury liabilities bond or policy applies at the time of the accident. In this case its limit for bodily injury liability must be less than the minimum limit for bodily injury liability specified by the financial responsibility law of the state in which your covered auto is principally garaged. This means the maximum amount paid for a bodily injury usually is limited to the state s financial responsibility or compulsory insurance law requirements Real Estate Institute 6

13 EVERYONE NEEDS INSURANCE Which is a hit and run vehicle whose operator or owner cannot be identified and which hits: You or any family member; A vehicle which you or any family member are occupying or; Your covered auto. If a hit-and-run driver strikes the named insured or any family member while occupying a covered auto, non-owned auto or while walking, the uninsured motorists coverage will pay for the injury. To which a bodily injury liabilities bond or policy applies at the time of the accident and the bonding or insuring company: Denies coverage; Is or becomes insolvent. However, uninsured motor vehicle does not include any vehicle or equipment: Owned by or furnished or available for the regular use of you or any family member ; Owned or operated by a self-insurer under any applicable motor vehicle law; Owned by any government unit or agency; Operated on rails or crawler treads; Designed mainly for use off public roads while not on public roads; While located for use as a residence or premises. Exclusions Part C of the Personal Auto Policy also provides exclusions to its Uninsured Motorists Coverage. Specifically, the Personal Auto Policy states that the insurer will not provide Uninsured Motorists Coverage for bodily injury sustained by any person: While occupying, or when struck by, any motor vehicle owned by you or any family member which is not insured for this coverage under this policy. This includes a trailer of any type used with that vehicle. This exclusion was designed to prevent free uninsured motorists coverage on automobiles owned by the named insured or family member. If that person or the legal representative settles the bodily injury claim without our consent. If a person settles a bodily injury claim without the company s consent, coverage does not apply. The purpose of this exclusion is to protect the company s interest in the claim. While occupying your covered auto when it is being used to carry persons or property for a fee. This exclusion does not apply to a share-the-expense car pool. Using a vehicle without a reasonable belief that that person is entitled to do so. If a thief steals the insured s car and is later injured by an uninsured motorist, the thief is not covered under the insured s policy. The exclusions also state that uninsured motorists coverage shall not apply directly or indirectly to benefit any insurer or self-insurer under any of the following or similar law: Workers compensation law; Disability benefits law. The uninsured motorist coverage cannot directly or indirectly benefit a workers compensation insurer or self-insurer. A workers compensation insurer may have a legal right of action against a third party who has injured an employee. If an uninsured driver injures an employee who receives workers compensation benefits, the workers compensation insurer could sue the uninsured driver or attempt to make a claim under the injured employee s uninsured motorist coverage. This exclusion prevents the uninsured motorist coverage from providing benefits to the workers compensation insurer. Limit of Liability The next portion of Part C of the Personal Auto Policy explains the limits of liability for uninsured motorists coverage under the policy: The limit of liability shown in the Declarations for this coverage is our maximum limit of liability for all damages resulting from any one accident. This is the most we will pay regardless of the number of: Insureds ; Claims made; Vehicles or premiums shown in the Declarations; Vehicles involved in the accident. Any amounts otherwise payable for damages under this coverage shall be reduced by all sums: Paid because of the bodily injury by or on behalf of persons or organizations that may be legally responsible. This includes all sums paid under Part A; and Paid or payable because of the bodily injury under any of the following or similar law: Workers compensation law; Disability benefits law. Any payment under this coverage will reduce any amount that person is entitled to recover for the same damages under Part A. The amount paid under the uninsured motorist s coverage can be reduced under certain conditions. The amount paid is reduced by any sums paid by the negligent driver or organization legally responsible for the accident or by any benefits payable under workers compensation, disability benefits, or similar law. Other Insurance The next section of Part C of the Personal Auto Policy explains the policy s liability coverage benefits in the event the insured carries other, additional insurance: If there is other applicable similar insurance we will pay only our share of the loss. Our share is the proportion that our limit of liability bears to the total of all applicable limits. However, any insurance we provide with respect to a vehicle you do not own shall be excess over any other collectable insurance. Underinsured Motorist Coverage In addition to uninsured motorist coverage, underinsured motorist coverage can be added to the Personal Auto Policy to provide more complete protection. This coverage pays damages for a bodily injury caused by the ownership or operation of an underinsured vehicle. The maximum amount paid under this coverage is the underinsured motorists limit less the amount paid by the negligent driver s insurer Real Estate Institute 7

14 EVERYONE NEEDS INSURANCE Underinsured Motorist Coverage and Uninsured Motorist Coverage are exclusive and do not duplicate each other. An insured can collect on one coverage or the other, but not both. The conditions that must be satisfied before an underinsured motorist s coverage can be written are: Higher uninsured motorist coverage limits must be carried than the limits required by the state s financial responsibility or compulsory insurance law. Both the uninsured and the underinsured motorist coverage must be written for the same amount of insurance. The underinsured motorist coverage must apply to all automobiles covered under the policy. Personal Auto Policy: Coverage for Damage to Automobile Part D of the Personal Auto Policy sets forth coverage in the event of damage to the insured s automobile. Part D s insuring agreement explains the company s promises regarding its coverage of damage to the auto. Specifically, the policy may provide: We will pay for direct and accidental loss to your covered auto or any non-owned auto, including their equipment, minus any applicable deductible shown in the Declarations. We will pay for loss to your covered auto caused by: Other than collision only if the Declarations indicate that Other Than Collision Coverage is provided for that auto; Collision only if the Declarations indicate that Collision Coverage is provided for that auto. If there is a loss to a non-owned auto, we will provide the broadest coverage applicable to any your covered auto shown in the Declarations. The company agrees to pay for any direct and accidental loss to a covered auto or any non-owned auto, including its equipment, less any applicable deductible. A covered auto can be insured for both (1) a collision loss and (2) an otherthan-collision loss (formerly called comprehensive coverage). A collision loss is covered only if the declaration page indicates that collision coverage is provided for that auto. Coverage for an other than collision loss is in force only if the declarations page indicates that other than collision coverage is provided for that auto. If both coverages are selected, the premium for each coverage is shown separately on the declaration page. Part D of the Personal Auto Policy contains certain definitions: Collision means the upset of your covered auto or its impact with another vehicle or object. Collision losses are paid regardless of fault. If the insured causes the accident, the insurer will pay for the damage to his car, less any deductible. If another driver damages his car, he can collect from the negligent driver (or the negligent driver s insurer), or from his insurer. If an insured collects from his own company, he must give up subrogation rights to his company, thus allowing the company to seek reimbursement from the other driver s insurance company. Loss caused by the following is considered other than collision : Missiles or falling objects; Fire; Theft or larceny; Explosion or earthquake; Windstorm; Hail, water or flood; Malicious mischief; Riot or civil commotion; Contact with bird or animal; Breakage of glass. If breakage of glass is caused by a collision, the insured may elect to have it considered a loss caused by collision. This is important because both coverages (collision loss and other-than-collision loss) may be written with deductibles. Without this qualification, an insured would have to pay two deductibles if the car had both body damage and glass breakage in the same accident (assuming both coverage s are elected). By treating glass breakage as part of the collision loss, only one deductible has to be satisfied. Non-owned auto means any private passenger auto, pickup, van or trailer, not owned by or furnished or available for the regular use of you or any family member while in the custody of or being operated by you or any family member. However, non-owned auto does not include any vehicle used as temporary substitute for a vehicle you own which is out of normal use because of its: Breakdown; Repair; Servicing; Loss; Destruction. A non-owned auto is defined as any private passenger auto, pickup, van or trailer not owned by or furnished or made available for the regular use of the named insured or family member, while it is in the custody of or is being operated by the named insured or family member. The key point is not how frequently an insured individual drives a non-owned auto, but whether the vehicle is furnished or made available for that individual s regular use. Note that Part D coverages that apply to a covered auto also apply to a temporary substitute vehicle for that auto. Part D also provides that the insurer will pay the insured certain amounts for transportation expenses. The policy may specifically provide the following: In addition, we will pay up to $10 per day, to a maximum of $300, for transportation expenses incurred by you. This applies only in the event of the total theft or your covered auto. We will pay only transportation expenses incurred during the period: Beginning 48 hours after the theft; Ending when your covered auto is returned to use or we pay for its loss. Payments can be for a train, bus, taxi, rental car, or any other transportation expense. Exclusions As with other coverages in the Personal Auto Policy, Part D s auto damage coverage is subject to specific exclusions: We will not pay for: Loss to your covered auto, which occurs while it is used to carry persons or property for a fee. This exclusion does not apply to a share-the-expense car pool. Damage due and confined to: Wear and tear; Real Estate Institute 8

15 EVERYONE NEEDS INSURANCE Freezing; Mechanical or electrical breakdown or failure; Road damage to tires. This exclusion does not apply if the damage results from the total theft of your covered auto. The intent of this exclusion is to cover tire defects under the tire manufacturer warranty and to exclude normal maintenance costs of operating an automobile. Loss due to or as a consequence of: Radio active contamination; Discharge of any nuclear weapon (even if accidental); War (declared or undeclared); Civil war; Insurrection; Rebellion or revolution. Loss to equipment designed for the reproduction of sound. This exclusion does not apply if the equipment is permanently installed in your covered auto or any non-owned auto. Loss to tapes, records or other devices for use with equipment designed for the reproduction of sound. An endorsement can be added that covers tapes, records, or other devices owned by the named insured or family members. Loss to a camper body or trailer you own which is not shown in the Declarations. This exclusion does not apply to a camper body or trailer you: Acquire during the policy period; Ask us to insure within 30 days after you become the owner. Loss to any non-owned auto or any vehicle used as a temporary substitute for a vehicle you own, when used by you or any family member without a reasonable belief that you or that family member is entitled to do so. Loss to: TV antennas; Awnings or cabanas; Equipment designed to create additional living facilities; or Loss to any of the following or their accessories; Citizens band radio; Two-way mobile radio; Telephone; Scanning monitor receiver. This exclusion does not apply if the equipment is permanently installed in the opening of the dash or console of your covered auto or any non-owned auto. The auto manufacturer for the installation of a radio must normally use this opening. Losses to any custom furnishings or equipment in or upon any pick-up or van. Custom furnishings or equipment include but are not limited to: Special carpeting and insulation, furniture, bars or television receivers; Facilities for cooking and sleeping; Height-extending roofs; Custom murals, paintings or other decals or graphics. A special customizing equipment endorsement can be added that covers the excluded furnishings or equipment by payment of an additional premium. Loss to equipment designed or used for the detection or location of radar. This exclusion has been incorporated into the policy because radar detection equipment is designed, and has been used, to circumvent state and federal speed laws. Loss to any non-owned auto being maintained or used by any person while employed or otherwise engaged in the business of: Selling; Repairing; Servicing; Storing; Parking vehicles designed for use on public highways. This includes road testing and delivery. The above are business loss exposures that should be covered under a commercial garage policy. Loss to any non-owned auto being maintained or used by any person while employed or otherwise engaged in any business not described in the prior exclusion. This exclusion does not apply to the maintenance or use by you or any family member of a non-owned auto which is a private passenger auto or trailer. The above is a business loss exposure that should be insured by a commercial policy covering the business. Limit of Liability The next portion of Part D of the Personal Auto Policy explains the limits of liability for auto damage coverage under the policy: Our limit of liability for loss will be the lesser of the: Actual cash value of the stolen or damaged property; or Amount necessary to repair or replace the property. However, the most we will pay for loss to any nonowned auto which is a trailer is $500. The actual cash value of the vehicle at the time of loss is determined by adjusting for depreciation and the physical condition of the damaged property. If the vehicle is declared a total loss, the amount paid is the actual cash value of the vehicle (less any deductible). An adjustment for depreciation and physical condition will be made in determining actual cash value at the time of loss. Payment of Loss The next section of Part D describes the manner in which the insurer will pay for loss resulting from damage to the auto: We may pay for loss in money or repair or replace the damaged or stolen property. We may, at our expense, return any stolen property to: You; The address shown in this policy. If we return stolen property we will pay for any damage resulting from the theft. We may keep all or part of the Real Estate Institute 9

16 EVERYONE NEEDS INSURANCE property at an agreed or appraised value. In the case of an expensive antique or customized car, a stated amount endorsement can be inserted in the policy. If the stated amount of insurance is less than the actual cash value of the car, only the amount of insurance is paid (less any deductible). If the stated amount of insurance exceeds the actual cash value of the car, or the amount necessary to repair or replace the car, the lower of these latter two figures is the amount paid (less any deductible). No Benefit to Bailee Next, Part D of the Personal Auto Policy states that auto coverage shall not directly or indirectly benefit any carrier or other bailee for hire. In other words, any hired driver will not be entitled to collect from the insurance company for any damage to the automobile. Only the owner of the car is entitled to collect from the insurer for damage to the automobile. Other Insurance As with other sections of the Personal Auto Policy, Part D discusses the consequences of the insured carrying additional automobile coverage: If other insurance also covers the loss we will pay only our share of the loss. Our share is the proportion that our limit of liability bears to the total of all applicable limits. However, any insurance we provide with respect to a non-owned auto or any vehicle used as a temporary substitute for a vehicle you own shall be excess over any other collectible insurance. Appraisal The final section of Part D of the Personal Auto Policy covers the use of an appraisal to determine the amount of loss: If you and we do not agree on the amount of loss, either may demand an appraisal of the loss. In this case, each party will select a competent appraiser. The two appraisers will select an umpire. The appraisers will state separately the actual cash value and the amount of loss. If they fail to agree, they will submit their differences to the umpire. A decision agreed to by any two will be binding. Each party will: Pay its chosen appraiser; Bear the expenses of the appraisal and umpire equally. We do not waive any of our rights under this policy by agreeing to an appraisal. The appraisal provision is intended to set forth an equitable solution to determine the amount of the loss in the event that the parties can not agree on their own. Personal Auto Policy: Duties After an Accident or Loss Part E of the Personal Auto Policy describes the duties and obligations of the insured in the event of an accident or loss. The individual insured must follow these procedures in order to obtain the benefits of the policy. A typical Personal Auto Policy may set forth the duties and obligations as follows: We must be notified promptly of how, when and where the accident or loss happened. Notice should also include the names and addresses of any injured persons and of any witnesses. A person seeking any coverage must: Cooperate with us in the investigation, settlement or defense of any claim or suit. Promptly send us copies of any notices or legal papers received in connection with the accident or loss. Submit, as often as we reasonably require to physical exams by physicians we select and to examination under oath. We will pay for these exams. Authorize us to obtain: Medical reports; Other pertinent records. Submit a proof of loss when required by us. A person seeking Uninsured Motorist Coverage must also: Promptly notify the police if a hit and run driver is involved; Promptly send us copies of the legal papers if a suit is brought. A person seeking Coverage for Damages to Your Auto must also: Take reasonable steps after the loss to protect your covered auto and its equipment from further loss. We will pay reasonable expenses incurred to do this; Promptly notify the police if your covered auto is stolen; Permit us to inspect and appraise the damaged property before its repair and disposal. Under no circumstances should the insured admit that he caused the accident. The question of negligence and legal liability will be resolved by the insurers involved (or court of law if necessary) and not by the insured. The insured does not have the right to admit that he is responsible for the accident. Personal Auto Policy: General Provisions Part F of the Personal Auto Policy contains a list of general provisions which apply to the policy. The following are examples of provisions which appear in Part F: Bankruptcy Bankruptcy or insolvency of the insured shall not relieve us of any obligations under this policy. Changes This policy contains all the agreements between you and us. Its terms may not be changed or waived except by endorsement issued by us. If a change requires a premium adjustment, we will adjust the premium as of the effective date of change. We may revise this policy form to provide more coverage without additional premium charge. If we do this, your policy will automatically provide the additional coverage, as of the date the revision is effective in your state. Fraud We do not provide coverage for any insured that has made fraudulent statements or engaged in fraudulent conduct in connection with any accident or loss for which coverage is sought under this policy. Legal Action Against Us No legal action may be brought against us until there has been full compliance with all the terms of this policy. In addition, under Part A, no legal action may be brought against us until: We agree in writing that the Insured has an obligation to pay; or The amount of that obligation has been finally determined by judgment after trial. No person or organization has any right under this policy to bring us into any action to determine the liability of an Real Estate Institute 10

17 EVERYONE NEEDS INSURANCE Insured. Our Right To Recover Payment If we make a payment under this policy and the person to or for whom payment was made has a right to recover damages from another we shall be subrogated to that right. That person shall do: Whatever is necessary to enable us to exercise our rights; and Nothing after loss to prejudice them. However, our right in this paragraph does not apply under Part D, against any person using your covered auto with a reasonable belief that that person is entitled to do so. If we make a payment under this policy and the person to or for whom payment is made recovers damages from another that person shall: Hold in trust for us the proceeds of the recovery; and Reimburse us to the extent of our payment. Policy Period And Territory This policy applies only to accidents and losses, which occur: During the policy period as shown in the Declarations; or Within the policy territory. The policy territory is: The United States of America, its territories or possessions. Puerto Rico. Canada. This policy also applies to loss to, or accidents involving, your covered auto while being transported between their ports. Termination This policy may be cancelled during the policy period as follows: The named insured shown in the Declarations may cancel by: Returning this policy to us; Giving us advance written notice of the date cancellation is to take effect. We may cancel by mailing to the named insured shown in the Declarations at the address shown in this policy: At least 10 days notice; If cancellation is for nonpayment of premium; If notice is mailed during the first 60 days this policy is in effect and this is not a renewal or continuation policy; or at least 20 days notice in all other cases. After this policy is in effect for 60 days, or if this is a renewal or continuation policy, we will cancel only: For nonpayment of premium. If your drivers license or that of Any driver who lives with you Any driver who customarily uses your covered auto has been suspended or revoked. This must have occurred: During the policy period; or Since the last anniversary of the original date if the policy period is other than 1 year. If the policy was obtained through material misrepresentation. Two Or More Auto Policies If this policy and any other auto insurance policy issued to you by us apply to the same accident, the maximum limit of our liability under all the policies shall not exceed the highest applicable limit of liability under any one policy. Personal Auto Policy: Insuring Motorcycles and Other Vehicles The basic Personal Auto Policy does not provide coverage for motorcycles, motor homes or off-road vehicles; however, a miscellaneous-type vehicle endorsement can be added to the Personal Auto Policy to provide coverage for motorcycles, motor homes, mopeds, golf carts, dune buggies, and other vehicles. Snowmobiles and large trucks, however, cannot be added to the policy with the miscellaneous type vehicle endorsement. The endorsement provides the same coverages that are found in the Personal Auto Policy, and it has a schedule that describes the vehicle to be covered, the limits of liability for each coverage, and the premium owed. If the miscellaneous type vehicle endorsement is added to the Personal Auto Policy, there are certain conditions that should be brought to the policyholder s attention: First, liability coverage generally does not apply if the insured is operating a non-owned motorcycle. Second, property damage to a non-owned vehicle is excluded; a borrowed or rented vehicle would not be covered. Third, passenger hazard exclusion is available; this excludes liability for bodily injury to any passenger on the vehicle. The election of this exclusion reduces the premium. Finally, the amount paid for any physical damage loss to the vehicle is limited to the lowest of: The stated amount shown in the endorsement. The actual cash value. The amount necessary to repair or replace the property (less any deductible). Approaches for Compensating Automobile Accident Victims The Personal Auto Policy provisions described above have evolved as a balance between the insurance companies requirements to operate a profitable insurance business and public policy considerations with respect to society and the individual consumer. The following concepts have affected the development of the standard Personal Auto Policy and may also supplement or modify the standard form insurance policy in some states. Financial Responsibility Laws. These types of laws require persons to furnish proof of financial responsibility up to certain minimum dollar limits. Financial responsibility laws can be divided into two broad categories: Security-type. Security and proof method. Under a security-type law, a person involved in an automobile accident is required to furnish proof of financial responsibility up to certain minimum dollar limits. Purchasing an automobile liability policy for the specified limits, posting a bond, or depositing securities or money in the amount required by law can establish proof of financial responsibility. The person may also establish responsibility by showing that the person is a qualified self-insurer. Under the security-and-proof method, the driver s license and vehicle registration can be suspended unless the involved person submits security to pay for a judgment arising out of a current accident and also shows proof of financial responsibility for future accidents. Both conditions must be met before the driver s license and registration is restored Real Estate Institute 11

18 EVERYONE NEEDS INSURANCE Some flaws in the financial responsibility laws are: There is no guarantee that all accident victims will be paid. Financial responsibility laws normally have no penalties other than the loss of driving privileges. Accident victims may not be fully indemnified for their injuries. Most financial responsibility laws require only minimum liability insurance limits. If the bodily injury exceeds the minimum limit, the accident victim may not be fully compensated. There may be considerable delay in compensating the accident victim if the case goes to trial. Compulsory Insurance Laws. These laws require the owners and operators of automobiles to carry automobile liability insurance at least equal to a certain amount before the automobile can be registered and licensed. More than half of the states have enacted some type of compulsory automobile liability insurance law as a condition for driving within the state. Compulsory insurance laws are considered superior to financial responsibility laws because they provide a stronger guarantee of protection to the public against loss. However, compulsory insurance laws also have certain flaws: A compulsory insurance law may not reduce the number of uninsured motorists. Drivers may let their insurance lapse after the vehicle becomes licensed. Compulsory laws do not provide complete protection. The laws require only a minimum amount of liability insurance, which may not meet the full needs of the victims. Payment to all injured persons is not guaranteed. Some injured victims may not be compensated because they are injured by an out-of-state, uninsured driver. Compulsory laws do not prevent or reduce the number of automobile accidents, which ultimately is the heart of the automobile accident problem. Unsatisfied Judgment Funds. Some states have established unsatisfied judgment funds for compensating innocent accident victims. An unsatisfied judgment fund is a fund established by the state to compensate victims who have exhausted all other means of recovery. To receive compensation from the unsatisfied judgment fund, the accident victim first must obtain a judgment against the negligent motorist who caused the accident and must show that the judgment cannot be collected. The negligent motorist is not relieved of legal liability when payments are made out of the fund. The negligent motorist must repay the fund or lose his or her driver s license until the fund is reimbursed. Uninsured Motorist Coverage. The insurer agrees to pay the accident victim who has a bodily injury (or property damage) caused by an uninsured motorist, by a hit-andrun driver, or by a driver whose company is insolvent. No-Fault Automobile Insurance. No-fault insurance means that after an automobile accident each party collects from his or her own insurer, regardless of fault. It is not necessary to determine who is at fault and prove negligence before a loss payment is made. A true nofault law places some restrictions on the right to sue the negligent driver who actually caused the accident. If a claim is below a certain dollar threshold, ($2,500 for example) the motorist would not be permitted to sue but would instead collect from his or her own insurer. If the injury exceeds the threshold amount, the injured person has the right to sue the negligent driver for damages. A verbal threshold means that a suit for damages is allowed only in serious cases, such as those involving death, dismemberment, disfigurement, or permanent loss of a bodily member or function. Under a pure no-fault law, the injured cannot sue at all, regardless of the seriousness of the claim, and no payments are made for pain and suffering. In effect, the tort liability system is abolished. The insured person receives unlimited benefits from his or her own insurer for medical expenses and the loss of wages. Under a modified no-fault law an insured person has the right to sue a negligent driver only if the claim exceeds the monetary or verbal threshold. An add-on plan pays benefits to an accident victim without regard to fault, but the injured person still has the right to sue the negligent driver who caused the accident. Arguments for no-fault laws. Difficulty of determining fault. Most accidents occur suddenly and unexpectedly, and details surrounding them can seldom be accurately determined. Limited scope of reparations system. Smaller claims may be overpaid, while serious claims may be underpaid. Small claims may be over-compensated because inflated settlements cost insurers less than taking claims into court. Large proportion of premium dollars used to pay legal costs. Delay in payments. Large numbers of claims may not be promptly paid because of investigations, negotiations, and wafting for court dates. Seriously injured persons or their survivors had to wait an average of sixteen months for final payment from automobile liability insurance. Arguments against no-fault laws. The defects of the negligence system are exaggerated. Claims of efficiency and premium savings are exaggerated. Safe drivers may be penalized. The present system needs only to be reformed, rather than completely overhauled. Basic characteristics of no-fault laws. About half the states have some type of no-fault insurance plan in existence. The majority of states have modified no-fault plans where restrictions are placed on the right to sue. No-fault benefits are provided by adding an endorsement to the automobile insurance policy. The endorsement is typically called personal injury protection coverage. The following no-fault benefits are typically provided: Medical expenses usually paid up to some maximum limit. No-fault benefits are made for a stated percentage of the disabled person s weekly or monthly earnings, with a maximum limit in term of time and duration. Benefits are also paid for essential service expenses for certain services ordinarily performed by the injured person. Funeral expenses are also paid up to some limit. Survivors loss benefits can also be paid to eligible survivors, such as a surviving spouse and dependent children. Automobile Insurance for High-Risk Drivers Drivers who have difficulty obtaining automobile insurance through normal market channels have an opportunity to Real Estate Institute 12

19 EVERYONE NEEDS INSURANCE obtain automobile insurance in the residual market (the shared market). In this market automobile insurers participate to make insurance available to drivers unable to obtain coverage in the standard market. Assigned Risk Plans. Under this arrangement, all automobile insurers in a state are assigned their proportionate share of high-risk drivers based on the amount of automobile liability insurance premiums written in the state. Persons applying for insurance in an automobile insurance plan must show that they have tried but were unsuccessful in obtaining automobile insurance within sixty days of the date of application. Premiums paid for the insurance are substantially higher than the insurance obtained in the voluntary markets. A company is not required to insure a high-risk driver for more than three years. The major advantage of the Assigned Risk Plan is that a high-risk driver generally has at least one source for obtaining liability insurance. The major disadvantages of Assigned Risk Plans include the following: Despite higher premiums paid by high-risk drivers, the automobile insurance plans have incurred substantial underwriting losses. High premiums may cause many high-risk drivers to remain uninsured. The driver does not have a choice of insurer, since the state assigns the driver to a particular insurer. Joint underwriting associations. A joint underwriting association is an organization of automobile insurers in which high-risk business is placed in a common pool, and each company pays its pro-rata share of pool losses and expenses. Some states have established joint underwriting associations to make automobile insurance available to high-risk drivers. Reinsurance facilities. Under this arrangement, the company must accept all applicants for insurance, whether both good and bad drivers. If the applicant is considered a high-risk driver the company has the option of placing the driver in the reinsurance pool. In the past, the reinsurance facilities have experienced substantial underwriting losses. Specialty automobile insurers. Specialty automobile insurers are companies that specialize in insuring motorists with poor driving records. These companies typically insure drivers who have been cancelled or refused insurance, teenage drivers and drunk drivers. The premiums are substantially higher than premiums paid in the normal or standard markets. Cost of Automobile Insurance There are a number of major factors for determining the rates of private passenger automobile premiums. Territory Each state is divided into rating territories: a large city, a suburban, or a rural area. Largely, the territory where the automobile is principally used and garaged determines the base rate. Age, Sex Most states permit age and sex to be used as factors in determining premiums. Age is an important rating since young drivers account for a disproportionate number of accidents. Young male drivers who own or are the principal operators of automobiles normally pay the highest rates, since this group has the highest accident rate and the most costly accidents. Use of The Automobile Insurers classify automobiles on the basis of the purpose for which the car is driven. Pleasure use; not used in business or driven to work less than a specified distance, for example, less than three miles one way. Driven to work; not used in business but driven less than a specified number of miles to work each day. Business use; customarily used in business or professional pursuits. Farm use; garaged on a farm or ranch, and not used in any other business or driven to school or other work. A car classified for farm use has the lowest rating factor, using a car for business purposes requires a higher rating factor. Driver Education This discount is based on the premise that driver education courses for teenage drivers can reduce accidents and hold down insurance costs. Good Student Discount This discount is available from a limited number of companies and is based on the premise that good students are better drivers. To qualify the driver must be a full time high school or college student and be at least sixteen years of age. A school official must sign a form certifying that the student has met the scholastic requirements. Number and Type of Automobiles The multi-car discount is based on the assumption that two cars owned by the same person will not be driven as frequently as only one car owned by the same person. The year, make and model of the cars also affect the cost of insurance on the car. Individual Driving Record Some companies offer safe driver plans where the premiums paid are based on the individual driving record of the insured and operators who live with the insured. In states that have an accident point system, the actual premium paid may be based on the total number of accumulated points assessed against the insured s driving record. Purchase Higher Deductibles If the insured purchases a higher deductible on collision and comprehensive insurance, the premium can be reduced by as much as twenty percent. Improved Driving Record A clean driving record covering the previous three years can substantially reduce the premiums of a high-risk driver. A conviction for drunk driving can be extremely costly when purchasing automobile insurance. Conclusion Approximately $100 Billion a year in damage is estimated to be caused by automobile accidents. This damage includes destroyed property, medical and funeral expenses, and the lost income of people involved in accidents. Since auto insurance is the first experience for most people with respect to the insurance industry, it is especially important for the agent to provide these purchasers the extra attention and care they need and desire in order to create a lifetime relationship with the purchaser Real Estate Institute 13

20 EVERYONE NEEDS INSURANCE CHAPTER 2 HOMEOWNERS AND PERSONAL PROPERTY INSURANCE Introduction While many people first interact with an insurance agent with respect to automobile insurance, some individuals first experience with an insurance agent occurs when obtaining a homeowners or renters insurance policy. For some customers, the insurance professional will need to advise regarding the benefits of other property insurance products covering various types of personal property. In this chapter, we explore homeowners insurance and many types of personal property insurance. We begin with some background regarding the history of property and liability insurance, the two major components of homeowners and personal property coverage. The History of Property Insurance The first fire insurance company in the United States was established in 1734 and was called the Friendly Society for the Mutual Insurance of Houses Against Fire. By 1740 this firm was out of business as a result of a fire in Charles Town, South Carolina that wiped out most of the town. Originally insurance policies were written to cover a single peril. After the disastrous fire of 1740 several other fire companies were formed. These insurers used a risk classification method basing rates on the construction materials used in the building of the dwelling. Thus a building constructed of brick would have a more favorable risk rating than one made of wood. The early fire policies differed from company to company and from state to state. They were full of conditions and exclusions and often difficult for the average person to understand. The definition of terms varied from company to company and in general lacked uniformity. If an insured needed additional coverage such as for wind damage or other peril, the additional coverage was written as a separate policy. Often times these additional perils were not even covered by the same company. Many consumer complaints and court decisions eventually led to the first uniform property insurance policy called the 165 Line New York Standard Fire Policy of This was the only insurance policy first standardized by law. This policy became the basis for all property insurance coverage and is still used as a basic form in some states. Because the standard fire policy covers only the perils of fire, lightning, and removal of covered property from endangered premises, it is never used alone and endorsements are added to cover additional perils. This extended coverage (EC) includes: Windstorm. Hail. Explosion. Riot. Aircraft. Vehicle Damage. Smoke. When these endorsements are added a vandalism and malicious mischief endorsement may also be added. Although the standard fire policy offered basic protection, many insurers argued that a policy which offers broader coverage would be to the benefit of both the insured and the insurer. A policy that covered both property and liability in one policy would do much more to serve the needs of all parties. Insurance companies felt that they would benefit from such a policy in at least three ways: Decreased adverse selection against the company. Reduction in overall administrative and underwriting costs. Increased policy retention. In the late 1940 s insurers were permitted by insurance regulators to combine property and casualty perils into one policy. Many formats and combinations of coverage sprung out from this deregulation. In 1976 the Insurance Service Office (ISO) developed a homeowners program that incorporated the pertinent provisions of the 165-line policy as part of what became known as the Homeowners 76. The Homeowner 76 simplified the language of the fire contract. The changes made the policy easier to read and created a homeowners policy with five sections: Definitions. Coverage. Perils Insured Against. Exclusions. Conditions. This original policy was revised in 1982, 1984, and 1991 to arrive at the present format of the policy. Some states have approved a variation of the 1991 format, which was introduced in A further adaptation was unveiled in 2000, and many states have adopted this most recent variation of the homeowners policy. Under the ISO Homeowners Program the basic policy covers: A dwelling that is owner occupied. A dwelling where no more than two families and not more than two roomers or boarders per family occupy the dwelling. The owner-occupant has purchased the full homeowners package. The dwelling is used only for residential purposes. A homeowners policy cannot be written on a property to which farm forms or rates apply. The policy cannot be written on a mobile home. Additional policies have been developed as part of the ISO Homeowners Program in order to provide additional coverages for various circumstances. We will discuss these policies and coverages later in these materials. Negligence Distinguished from actual property loss, liability losses are losses incurred by individuals as a result of their actions toward other people or their property. When an individual is required to make financial restitution to another person for loss to them or their property a liability loss has occurred. In the civil legal system, when an individual violates the rights of another that individual has committed what is known as a tort. A tort can either be intentional or unintentional. Liability insurance provides coverage for unintentional torts. Negligence is a key factor in determining liability. In order for a person to be liable to another, that individual must have been negligent. Negligence is defined as the lack of reasonable care that is required to protect others from the unreasonable chance of harm. Four factors must be present in order to establish negligence: There must be a legal duty owed. Legal duty owed is that obligation that we all have toward another to reasonably protect their rights and property. Within that duty there are several levels of accountability depending on the relationship and conditions. A person invited to our home is owed the highest degree of care. An individual performing a service in our home is owed a lower degree of care. And a trespasser is owed the lowest degree of care. A breach of that legal duty must occur. Breach of legal duty occurs when it is established that standard care was not taken, and that lack of precaution caused harm to another individual or their property Real Estate Institute 14

21 EVERYONE NEEDS INSURANCE There must be proximate cause. The proximate cause is the action that occurred and directly resulted in harm or damage. The action must be continuous and unbroken. If the action is interrupted by an intervening action, then this new action becomes the proximate cause. There must be damages. The last element in establishing negligence is damage. If no harm came to an individual or their property then there was no negligence and therefore no claim. When an individual either contributes or assumes some of the potential for harm, the ability to collect damages either is decreased or removed entirely. Assumption of risk is a factor that enters the picture when an individual attends a concert or a sporting event and is injured. By that individual s presence at that event, that individual has assumed some of the risk involved in attending such an event. When both parties contribute to the negligence, this is known as contributory negligence or comparative negligence. The degree of which each contributed is taken into account in arriving at a payment, or perhaps a non-payment, of damages. The last factor that comes into play in determining liability for negligence is a statute of limitations. A statute of limitation requires that a suit must be filed within a specified period of time in order to be valid under the law. If the suit has not been filed within the required period of time, then a party cannot be held accountable for negligence which occurred prior to that time period. The Language of Liability Insurance The following terms are commonly used when discussing liability and liability insurance: Absolute Liability is a liability imposed by law on those participating in activities that are considered hazardous. Negligence is not a requirement for payment of damages in the event of absolute liability. Damages are a monetary compensation awarded by a court to an injured party. Declarations are that section of an insurance contract that shows who is insured, what property or risk is covered, when and where the coverage is effective and how much coverage applies to loss. Deductible is the dollar amount the insured must pay on each loss to which the deductible applies. Defense Costs are the legal expenses that must be paid by the insurer to defend suits brought against the insured. Degree of Care is the extent of legal duty owed by one person to another. Indemnity is the principle of insurance that provides that when a loss occurs, the insured should be restored to the proximate financial condition he or she occupied before the loss occurred. Occurrence is a loss that occurs over a specific time and place or over a period of time. Post-judgment interest is interest accruing on a judgment after an award has been made, but before payment is made by the insurance company. Pre-judgment interest is interest awarded to compensate a third party for interest he or she might have earned if compensation had been received at the time of injury or damage, rather than at the time of judgment. Proximate Cause is an action that, in a natural and continuous sequence, produces a loss. Punitive Damages are damages intended to punish the defendant in an effort to discourage others from behaving in the same manner. Service Bureau is an organization that gathers, pools, and analyses statistics from its member insurance companies to establish loss costs used in determining insurance rates. Supplementary Payments Coverage is a coverage that provides extra coverage over and above the insured s limit of liability. Commonly included are defense costs, first aid expenses, bond premiums, and post-judgment interest. Third Party is the individual receiving the award in a liability case. Tort is a civil wrong for which monetary damages are paid. Vicarious Liability is liability that a person or business incurs because of the actions of others for whom they are responsible. For example, vicarious liability may cause a loss to be incurred as a result of the actions of family members or employees of the insured. Summary Concepts of both property insurance and liability insurance combine to form the backbone of Homeowners and Personal Property Insurance. The homeowner seeks protection from both loss of property and possible liability to third parties. With this background regarding property insurance and liability insurance, we now begin to examine Homeowners Insurance in more detail. Homeowners Insurance Introduction Coverage and Limits of Liability The front page or the Declaration Page of the homeowners insurance policy shows exactly what is covered and for how much. The front page contains the following information: Name of the Insurance Company and address. Name and address of the insured and address of the insured property. The agent s and agency name and address. Policy number. Policy period showing the effective date, expiration date, and time. The coverage and premium breakdown: Property Coverage Section I: Dwelling Limits of Coverage Detached Structures Limits of Coverage Personal Property Limits of Coverage Loss of Use Limits of Coverage Section I Deductible Amount of Deductible Liability Coverage Section II Personal Liability, Each occurrence Limits of Coverage Medical Payments to others, Each person Limits of Coverage Policy forms and endorsements and charges. Rating information. Mortgagee s name and address. Signature of insurance company officer. Types of Homeowners Policy Forms and Their Coverages There are several standard policies available and they contain a standardized numbering system throughout the United States, as follows: HO-1: Basic Form for Homeowners. HO-2: Basic Form for Homeowners with similar coverage available for mobile home owners. HO-3: Special Form for Homeowners. HO-4: Renters or Tenants Insurance. HO-5: Comprehensive Form for Homeowners Real Estate Institute 15

22 EVERYONE NEEDS INSURANCE HO-6: Condominium Unit owners insurance. (There is no HO-7 Form) HO-8: Market Value or Older Home Form for Homeowners. The HO stands for Homeowners and the number following that designates the specific policy package. HO-1 and HO-2 Policy These two forms are referred to as Named Peril Policies and in these two forms the same perils are applied to the dwelling and personal property coverage. HO-1 covers the insured against the following losses: Fire and lightning. Removing damaged property. Explosion. Hail or windstorm. Smoke damage. Riots and civil commotion. Damage to dwelling caused by vehicles or aircraft. Theft. Breakage of glass. Malicious mischief or vandalism. HO-1 is becoming less and less popular due to the fact that each of the above losses is usually limited by a paragraph of numerous exclusions. Although the cost of HO-1 is low, the old adage still applies: You get what you pay for. HO-2 covers the following losses: Fire and lightning. Removing damaged property. Explosion. Hail and windstorm. Riot/civil commotion. Damage to dwelling caused by vehicles or aircraft. Damage from smoke that is sudden or accidental. Falling objects. Weight of ice, sleet or snow. Theft. Breakage of glass. Collapse of building. Accidental ruptures of hot water heater or steam heater. Accidental overflow of water from a plumbing appliance. Freezing of heating, air conditioning or plumbing appliances. Accidental injury from electrical currents artificially generated. The HO-2 form gives a more Broad form of coverage than HO-1 and the exclusions are not as intensive as those in HO- 1. HO-3 Policy HO-3 covers against each of the perils shown for the HO-1 and HO-2 policies above and any other peril that is not specifically excluded from coverage. As a result of the extensive perils, the HO-3 policy is the one most commonly used by homeowners. The extensive coverage is referred to as all risk coverage to the dwelling. The all-risk coverage significantly sets the HO-3 policy apart from the HO-1 and HO-2. The following are examples of exclusions from coverage: Flood. Surface water. Waves and tidal waves from other bodies of water. Back-up water and sewage or drains. Water below the surface of the ground that flows, seeps or leaks through side walls, driveways, basements, walls, foundations, through doors, windows or floors. Earth movement, volcanic eruption, earthquake, landslide, mudflow, earth sinking, shifting or rising. Damage to air conditioning, heating and plumbing systems caused by leaking or as a result of freezing if failure to heat or shut off water. Wear and tear. Deterioration. Marring or scratching. Mechanical breakdown, inherent vice or latent defect. Rust. Wet or dry rot. Mold. Act of war. Smog. Contamination. Acts of Government. Nuclear reactions. Smoke from industrial operations or agricultural smudging. Shrinkage, cracking, settling, bolting, expansions of walls, floors, roofs, ceilings, foundations, patios, pavement. Domestic animals, insects, rodents, vermin, and birds. Continuous leakage from within a plumbing system or seepage. Theft to a dwelling under construction including materials and supplies. Vandalism and glass breakage. Wind, ice, hail, snow or sleet damage to outdoor television antennas or outdoor radio antennas including towers, masts and wiring. HO-5 Policy The HO-5 is very similar to the HO-3 policy in that again, the dwelling is covered on an all risk basis. Personal property, however, also is covered on an all risk basis under the HO-5 policy. This constitutes the major difference between the HO-3 and the HO-5. The HO-5 policy is the most comprehensive standard homeowners policy available. However, the coverage in this policy is quite expensive for the homeowner. This policy is rarely used today because agents prefer to attach endorsements to the HO-3 policy in order to create a custom policy serving the customer s needs. HO-4 and HO-6 Policies The HO-4 is a tenant s policy designed for people who rent houses or apartments, and it also applies to owners of cooperative apartments. The HO-6 is a condominium owner s policy. Both are very similar. Both cover personal property and improvements to the residence made by the insured. Improvements can be cosmetic such as additions, paneling or shelves. The HO-4 affords coverage of up to 10% of the policy amount for improvements. Therefore if personal property is insured for $50,000 dollars, $5,000 would cover improvements. The HO-6 affords a straight $1,000 for improvements. Neither the HO-4 nor the HO-6 provides any coverage for building structures. In the case of condominiums, an owner s association insures the structure and public areas, so the condominium owner need only insure the contents and limited improvements. Both the HO-4 and the HO-6 forms are named peril forms, which means the property is insured for damage resulting from certain perils. HO-4 and HO-6 policies cover personal property against the following named perils: Fire and lightning. Removal. Windstorm or hail. Explosion Real Estate Institute 16

23 EVERYONE NEEDS INSURANCE Riot or civil commotion. Aircraft. Vehicle. Smoke. Vandalism or malicious mischief. Theft. Falling objects. Weight of ice, snow, or sleet. Collapse of building. Damage from hot water heating systems. Damage from appliances or plumbing. Damage from freezing of plumbing appliances. Damage from electrical currents artificially generated. Payment under both HO-4 and HO-6 is based on the actual cash value of the property, rather than the replacement cost. HO-8 Policy The HO-8 Policy offers coverage for the same named perils as the HO-1 Policy, but this policy does not insure the replacement cost of the dwelling. Instead, the HO-8 Policy only provides payment in the amount of the actual cash value of the dwelling. The HO-8 Policy also provides payments in the amount of repairs to the existing dwelling, as long as those repairs do not exceed the value of the dwelling. Homeowners Insurance Property Coverage Section I The Property Coverage section of each form of Homeowners Policy covers five basic areas: The dwelling. Detached structures located on the property. Personal property. Loss of the use of the structure. Additional coverage. The Dwelling The dwelling consists of the home itself (the actual living structure) and includes attached structures, such as a garage. In the policy declaration page this coverage will be shown as: Section I, Coverage A. The major portion of coverage in a homeowners policy is designed to pay the cost of rebuilding the structure. A common misunderstanding in this area of coverage is that the homeowner does not actually insure the dwelling for its value on the open market. This is because the land on which the house is built has a value, and the value of that land is not to be included in the coverage amount. Only the cost of the structure is included in the insurance amount. A helpful way to determine the cost of the structure is to contact a Builder s Association to find out what the cost per square foot is in the area of the dwelling s location. By taking the total square footage of the house and multiplying it by the local per-square-foot building cost, an individual can obtain a pretty good idea of the cost required to replace the structure. Many homeowners follow a standard rule of thumb by insuring the structure for at least 80% of the actual cost to rebuild the structure. If the property is secured by a loan, the lender typically requires that the structure be insured for 100% of the actual cost to rebuild the structure. Detached Structures Located on the Property These consist of structures that are on the same parcel of land, but are not attached directly to the home itself. This could be a shed for tools, a greenhouse in the yard, or some other structure that would be defined as a non-attached covered structure. Protection for these unattached structures is provided under Section I, Coverage B. Personal Property A very important coverage under any residential insurance policy is the personal property coverage. The contents of a home such as furniture, stereos, televisions, appliances, clothing, and the like are considered personal property. These items are covered under Section I, Coverage C. Personal property will be covered as long as the insured owns the property notwithstanding where the insured uses the property. The loss to property does not have to occur at the covered dwelling. Should the insured have personal property of others that is located at the home, this too is covered under the policy. In other words, personal property owned by a tenant in a rented house would not be covered by the homeowners policy, but personal property brought by a guest visiting the insured would be covered. It is important to know that personal property coverage is not unlimited. In fact, unless endorsements are purchased for specific coverage, the personal property protection can be rather limited. For example, there is a limit of coverage for loss of personal property. Without further endorsements, this amount is typically 50% of the total amount that the home is insured for under Coverage A. So, if a home is insured for $100,000, the loss for personal property limits would be $50,000. In addition, there are specific limits of liability that apply to the following personal property items: Money, bank notes, bullion, gold other than gold-ware, silver other than silverware, platinum, coins, and medals. Maximum liability $200. Additional dollar coverage will cause additional premiums. Securities, accounts, deeds, evidence of debt, letters of credit, notes other than bank notes, manuscripts, passports, tickets, and stamps. Maximum liability, $1,000. Additional dollar coverage will cause additional premiums. Watercraft, their trailers, furnishings, equipment and outboard motors. Maximum liability, $1,000. Since coverage is so low in this area, most homeowners choose to purchase separate boat insurance. Trailers not used with watercraft. Maximum liability, $1,000. Grave markers. Maximum liability, $1,000. This is not a frequent issue for homeowners. Theft of jewelry, watches, furs, precious and semiprecious stones. Maximum liability, $1,000. Many people get caught short with this coverage and need to buy endorsements to protect items worth more than $1,000. Loss of firearms by theft. Maximum liability, $2,000. Theft of silverware, silver-plated ware, gold-ware, goldplated ware, and pewter-ware. Maximum liability, $2,500. Included here are flatware, hollowware, tea sets and trays, and trophies made of these metals. Property on the residence premises used for business purposes. Maximum liability, $2,500. Should an insured have an office in the home or work out of the home and have computers, desks, and other equipment, additional protection is required since the homeowners policy severely limits coverage for these business items. Personal property away from the residence used for business purposes. Maximum liability, $250. The homeowners policy sets forth specific exclusions to coverage. Articles which are expressly excluded from the homeowners policy must be separately described and insured by endorsement in order to achieve coverage. If the insured elects to specifically cover these items by endorsement, the coverage will be determined by the language of that endorsement and will not be protected by Coverage C. Animals, birds, or fish. Although they may be invaluable to the insured, nothing will be paid for their loss under the homeowners policy. Motor Vehicles and all other motorized land conveyances. Normally these items are protected under Real Estate Institute 17

24 EVERYONE NEEDS INSURANCE an automobile insurance policy. However, there are two exceptions to this exclusion: The vehicle is not subject to motor vehicle registration and is used to service an insured s residence. or, The vehicle is designed to assist the handicapped. Aircraft and their parts. The insured will need to purchase separate aircraft insurance. Property of roomers, boarders, and other tenants except property of roomers related to the insured. These items are covered under renter s insurance, rather than the homeowners policy. Property in an apartment regularly rented or held for rental to others by an insured. Again, these items are covered under renter s insurance. Property rented or held for rental to others off the residential premises. Again, renter s insurance is required to obtain coverage over these items. Books of account and drawings. Included here are records of bookkeeping that are on paper, electronic data, computer software, and other paper containing business data. Credit cards. The basic homeowners policy does not protect the insured against the loss of credit cards or credit fraud. However, coverage can be obtained under the additional coverage section of a policy. The following thefts are also excluded under Coverage C: Anything stolen by the insured. Anything stolen from a part of the residence rented to another person. Theft to a building that is under construction. Items stolen from a secondary residence unless the insured is living there when the theft occurs. Theft of watercraft, outboard motors, trailers, or campers which occurs away from the residence premises. Loss of the Use of the Structure A homeowners policy provides funds to compensate for the loss of the use of property in the event of damage by a peril covered under the policy. This coverage is provided under Section I, Coverage D. The insured can elect to receive compensation for loss of use in one of two ways: Payment for additional living expenses. Additional living expenses usually require a higher monthly outlay than one would normally pay at home. If an individual s home is destroyed by fire, it would be necessary to rent another residence while that home is being rebuilt. The policy will pay additional living expenses that are incurred in order to allow the household to maintain its normal standard of living. Payment for the fair retail value of the uninhabitable property. The insured may receive a benefit that will pay the fair retail value for the residence less any expenses that do not continue while the home is not fit to live in. Whichever benefit one chooses to receive, the benefit will only be paid for the shortest time required to replace or repair the damages to the property, or if the insured permanently relocates, the shortest time within which the individual can relocate. Note that if the property that became uninhabitable WAS NOT the insured s principal place of residence, the insured will only be compensated for additional living expenses as the fair retail value option is not available to the insured. Additional Coverage As mentioned above, the HO-3 homeowners policy is the insurance policy most commonly purchased by homeowners. The following additional coverage can be obtained under the HO-3 homeowners policy: Property removed. If for example, wind destroys the walls of a home and the insured wants to have this property removed, the cost to do so can be paid for under additional coverage. There is a 30-day limit for this coverage to apply. Service charges of the fire department. The policy will pay up to $500 for the liability for any fire department charges incurred because the fire department was called upon to save or protect the property. In most cases, the city provides this service without charge and no payment is made by the homeowners policy, but this benefit is still made available as additional coverage. Reasonable repairs. The policy covers reasonable costs incurred by the insured to make necessary repairs to prevent the property from further damage. Debris removal. If it is necessary to remove debris that is created by a covered loss, the homeowners policy will pay for the removal. The amount available for debris removal is included in the total limit of liability. Should the removal expense exceed that amount, an additional 5% of the total limit of liability may be made available as additional coverage to complete the job. Trees, shrubs, and plants. Should a covered loss (other than windstorm) damage or destroy trees, shrubs, or plants the policy will pay up to 5% of the limit of liability that applies to the dwelling with a maximum of $500 for any one tree, shrub, or plant. Commercial growing is not covered. Forgery, counterfeit money, credit card and fund transfer card. The HO-3 policy will pay up to $500 for the following: Forgery or alteration of a check that causes a loss. Unauthorized use or theft of an ATM card that results in a loss. Unauthorized use of credit cards issued in the name of the insured. If the insured in good faith accepts counterfeit U.S. or Canadian paper currency. Collapse. Any collapse of a building or collapse of part of a building will be covered if the collapse causes the insured a direct physical loss and the collapse is caused by one of the following means: Hidden insect damage. The weight of the building s equipment, contents, people or animals. Rain collecting on the roof and causing damage or collapse. Hidden decay. Defective material used in construction, renovation or remodeling, provided the collapse occurs during the course of such work. Note Collapse does not include any damages that may be caused by bulging, expansion, settling, cracking or shrinking. Homeowners Insurance Liability Coverage Section II Coverage for liability under each form of homeowners policy is found under Section II, Coverage E Personal Liability. This coverage provides that if a claim is made or a suit is brought against an insured for damages because of bodily injury or property damage caused by an occurrence to which the coverage applies, the insurance company will: Pay up to the limit of liability if the insured is legally liable; and Real Estate Institute 18

25 EVERYONE NEEDS INSURANCE Provide defense by counsel even if the suit is groundless, false or fraudulent. In addition to the coverage for damages described in Coverage E, Coverage F of the homeowners policy specifically covers the cost of medical payments for individuals who are injured while at the insured location, as long as the injured party is at the property with the permission of the insured. Medical expenses will be paid under the homeowners policy in the following cases: An injury which requires medical payments arises out of a condition on the insured property or the ways immediately adjoining. For example, if a tree that is rooted in an insured s yard has a branch that hangs over to the neighbor s yard and that branch falls and hits the neighbor on the neighbor s property, the insured s homeowners policy will cover the neighbor s medical costs arising out of injury from the tree branch. Bodily injury is caused as a result of activities by the insured. Should an insured be riding a horse on the insured property or hit a golf ball from the insured property, the insured s homeowners policy will pay medical bills for a third party injured by that activity. A residence employee causes bodily injury to a party in the course of the employee s work at the property. Maids, butlers and domestic help would fall under this category of coverage. Bodily injury caused by an animal owned or in the care of the insured. For example, dog bites are covered here. Personal Liability Exclusions The liability portion of the homeowners policy will not cover the following: Bodily injury to the insured. If the insured is injured at home due to his or her own negligence, the policy will not pay any amount to the insured. Damages caused by failure to render professional services or by rendering professional services. If the insured is a carpenter and work performed by the insured is defective and causes damages, the homeowners policy will not pay for those damages. Damages caused by motor vehicles. Motor vehicle insurance must be provided by a separate motor vehicle policy. Damages caused by operation of an aircraft. Again, separate insurance must be carried here. On the other hand, injuries caused by model hobby planes will be covered. Communicable diseases. The homeowners policy does not provide liability protection for the transmission of a disease. War. Any damage that a war causes is specifically excluded from coverage under the homeowners policy. Workers Compensation injuries. Should an individual covered by his or her employer s workers compensation coverage become injured while working at a home covered by a homeowners policy, the homeowners policy will not pay for damages arising from injury to that individual. Damages caused by watercraft. If while using the craft, damages result, they will not be paid by the homeowners policy, even if the craft is used on the insured property. Separate coverage must be obtained to insure these matters. Non-insured locations. If the insured own other property that is not listed on the homeowners policy, the insured will not receive liability protection under the policy from any damages which occur at the other property. Intentional acts of the insured. If the insured intends to harm another party, the homeowners policy will not provide liability protection for that action. Business activities. Should there be any damage as a result of business pursuits by the insured, the homeowners policy will not cover any such occurrence. Filing the Homeowners Insurance Claim In general, there are four factors necessary in order for a loss to be covered by homeowners insurance: Losses must be accidental. Insurance policies insure against risks. If a loss is certain to occur, there is no risk involved. As a result, losses must be accidental. Losses resulting from deterioration are generally thought to be the result of a certainty; after all, everything wears out sooner or later. For this reason, losses caused by deterioration are not deemed accidental and are not covered by homeowners insurance. Losses must be caused by extraneous factors. This means an external cause of damage must cause the loss. As an example, an extraneous factor would include wind damaging patio furnishings. Should a loss be caused by an inherent physical condition, rather than an extraneous factor the loss would not be covered under the homeowners insurance policy. Losses were not caused by deliberate action on the part of the insured. Any deliberate action by the insured which causes a loss to any insured property or liability to any third party is not covered under the homeowners insurance policy. The insured cannot deliberately destroy property that is insured and expect the insurance carrier to pay for that damage. Similarly, the insured cannot expect the insurance company to cover liability for intentional injury to a third party. Losses must involve covered, legal property. Illegal items and contraband are not covered by insurance. If an insured possesses an illegal whiskey still in his home and the still is damaged by a covered peril, that loss will not be covered under the policy. If a loss meets each of the above criteria, the insured may be able to file a claim for loss under the homeowners policy. Note that one of the elements of a valid claim is that the insured must actually sustain a loss. When a claim needs to be filed, the following must be kept in mind: A policyholder normally has a strong and favorable position where claims are concerned. As a rule, the courts usually resolve questions on claims in favor of the policyholder (the insured). The overall effect of court decisions has been to broaden the coverage of homeowners policies beyond the plain language of the policy. Although companies differ in their approach to claims, most work to provide good service to their customers. However, the policyholder must carefully monitor the claim adjustment process in order to assure fair, proper treatment of claims. In approximately 80% of all claims, less than 10% of the property insured is affected by loss. Therefore, it could be said that individuals are buying insurance to only cover 10% of the property in question and coverage will be adequate 80% of the time. Replacement Cost Coverage All homeowners policies contain a replacement cost provision that requires the insured to purchase an amount equal to 80% of the replacement cost of the dwelling. This requirement simplifies the determination of insurance rates across properties and allows premiums to be based on a fixed cost per $100 worth of insurance. Calculating replacement cost for the purpose of buying insurance is somewhat different than estimating the cost of Real Estate Institute 19

26 EVERYONE NEEDS INSURANCE buying a new home. There are two reasons why one needs to accurately determine the replacement cost of a home. First, to be certain that the coverage is adequate and that it complies with the replacement cost requirement. Second, the insured wants to be secure in the fact that he is not being sold an excessive amount of insurance with the higher premiums that go along with that excessive amount. Note that replacement cost coverage applies only to buildings and not the personal property covered under the policy. The insurance company may attach a penalty to a replacement cost claim due to insufficient coverage, as the homeowners policy stipulates that payment is to be based on replacement cost less the appropriate penalty or the actual cash value of the repairs, whichever is greater. As a result, claim payment based on actual cash value of repairs may be higher than the net claim payment (factoring in the penalty) for replacement value on a property which is not adequately insured. When claims are paid under the replacement cost coverage, the insurance company is permitted to determine its obligation three different ways and choose the method that works best for the company. These three choices are as follows: On policy limits. The most the company ever will pay is the amount of insurance that applies to the property covered. On the cost of replacement. This would be based on the cost of an equivalent building at the same location. On the actual amount spent in completing repairs. Replacement cost can be defined as the cost to replace damaged property with property which is: Of like kind and quality. Similar in basic style. Similar in basic quality. Similar in basic function. Remember that the policy provides coverage for replacement costs, not reproduction costs. Reproduction costs are defined as the costs for replacing property exactly as it was, down to the last detail. There is one interesting loophole in replacement cost coverage: The repair work need not be performed in order to replace the actual property at the original location. In some states, reconstructing property at any location, including a different city or state, will qualify for coverage under a replacement cost claim. Dwelling Claims When an insured has a claim for a damaged dwelling or other structure, the insured must realize that the claims process may be an involved and complicated process. There are four important steps to filing a claim on a dwelling. They are: Determining coverage. The insured must first determine what is and is not covered by the homeowners policy. If there is a difference between the cost to repair and the amount of the claim, it could result in out of pocket expenses to the insured. In other words, if coverage is lacking in certain areas, it may be necessary for the insured to take measures throughout the adjustment process to cover shortages on his or her own. Determining the scope of repairs. This is the insurance company s description of work that will be included in repair estimates. It can also be referred to as the scope of damage, the description of work, or the job description. The claims representative will prepare most scope of repairs documentation. The insured must review with the claims representative all of the work to be considered in the scope of repairs. Often, there are contentious aspects in determining the scope of repairs. For example, the insurance company representative (also referred to as the adjuster ) may feel that a bedroom was not damaged enough by smoke to warrant painting it; or the representative may believe that a soiled carpet can be cleaned rather than replaced. The adjuster works for the insurance company and may try to convince the insured to accept a scope of repairs that will ultimately lower the cost of the repair. Determining the cost to repair. Once the scope of repairs is determined, it must be converted into an agreed cost to repair. The insurance company is in a strong position compared to the position of the insured when determining the cost of repair. This is particularly true because most insurance companies use a contractor estimate to establish a cost to repair. The insurance company controls the estimate process and may receive quotes from parties which typically provide low estimates. Notwithstanding the relative positions of strength in determining the cost to repair, the process should be handled fairly and adhere to common conventions used to determine the cost. For example, contractor profit and overhead allowances must be included in determining the cost to repair. The insurance company cannot omit this component of the repair cost. The policyholder must be diligent in negotiating the cost to repair in order to receive the most favorable possible outcome. Determining the amount of the claim. This part of the claims process is relatively easy, as the appropriate deductibles are subtracted from the agreed cost to repair. Portions of the loss that are not covered by the homeowners policy will also be subtracted from the cost to repair to determine the final amount of the claim. Once all figures are agreed upon, including the cost to repair, the actual cash value amount of claim, and any pending replacement cost claim, the insured and the insurance company will sign documentation agreeing to the numbers and providing for payment to the insured or direct payment to contractors. Personal Property Claims A personal property claim is very similar to a dwelling claim. The claims process follows four steps similar to those steps for processing a claim on a dwelling: Determine coverage. The insured should determine what personal property is covered by reviewing the policy and carefully reviewing the exclusions in the policy that specifically refer to personal property. Determine the scope of loss. The scope of the loss determines the actual property which will be included in the claim. The insured should always complete an inventory on his or her own, rather than simply leaving this task to the insurance company representative. If the insured can present an accurate and detailed claim of loss, the insurance company will be able to more quickly determine the scope of loss. The insured must provide adequate documentation regarding lost or damaged personal property in order to facilitate the claims process. The insured will benefit from prior records of personal property inventory. Individuals who have photographed or videotaped evidence of the existence of lost or stolen personal property will be in a good position to clearly establish the scope of loss. Often, it may be difficult to determine whether damaged items can be cleaned or need to be replaced. If the Real Estate Institute 20

27 EVERYONE NEEDS INSURANCE insurance company agrees to clean the item and the cleaning is unsuccessful, the property will be replaced. Determine the replacement cost. Once the parties determine the scope of loss, they may determine the replacement cost of the property. This involves a substantial amount of work obtaining cost estimates for each item of personal property included within the scope of loss. The insured must monitor this process and provide price references as necessary to help determine the appropriate replacement cost. Determine the amount of the claim. The final step is determining the actual cash value of the claim. If the insured will not actually replace the property, the insurance company may only be required to pay the actual cash value of the lost or damaged item rather than the full replacement cost. Obviously, the insurance company will not be anxious to pay out the full dollar amount of the replacement cost without assurance that the insured will actually replace the property. This is particularly true because the value of most personal property significantly depreciates over time, and there may be a large dollar gap between the actual cash value and the replacement cost. As a result, the insured will likely have to show evidence of actual purchase of the replacement item in order to receive payment of the replacement cost as final settlement of the claim. Other Homeowners Insurance Concepts An agent s understanding of the following terms and concepts is essential to offering and describing homeowners insurance to customers. Subrogation Subrogation is the substitution of one party in place of another party in respect to a claim or a lawful right. When one party negligently damages another person s property, the injured party has the right to recover any damages. When the insurance company pays the injured party for the loss, the company takes over the rights of recovery that previously belonged to the injured party. In other words, subrogation permits the insurance company to step into the shoes of its insured in order to seek reimbursement for amounts which it pays to the insured under the homeowners policy. Subrogation evolved in order to prevent injured parties from receiving a windfall by collecting from both the insurance company and the responsible party. If an insured suffers a loss, the insurance company must pay the claim on a timely basis. The insurance company cannot force the insured to seek recovery from the responsible party. Often, an insurance company will stand aside and allow a third party to compensate an insured, but this can only occur with the consent of the insured. After the claim is paid, the insurance company will try to obtain restitution for the damages from the party which caused the damage. Statements Under the homeowners policy, the insured is to provide certain claim statements. There are two kinds of statements which the insured may be asked to give in regards to a claim: An informal statement taken by the company representative upon inspection of the loss. This kind of statement is either handwritten or recorded on tape. The statement is taken in order to record facts and document the insured s story. The existence of a recorded statement lessens the probability of an insured changing the story over time. A formal statement under oath. If requested by the company, a formal statement can be required under a homeowners policy. It is usually taken by an attorney and is, in effect, sworn testimony. If the insured lies in this statement, he would be guilty of perjury. If the insured refuses to give a formal statement under oath, the claim may be rendered void. The insurance company s decision to request a formal statement usually indicates that the company believes something is suspicious about the claim. Salvage The insurance company has the right to salvage property such as fixtures, appliances and any other part of a building as long as the insured has been paid for a total loss. Sometimes, the salvage goods will be sold back to the insured, however, the insured is under no obligation to accept this offer. For the most part, insurance companies will seek the services of a salvage company and do not care to directly involve themselves in this process. After the salvage company subtracts expenses and a percentage for profit, the balance goes to the insurance company as a return on the salvage operation. Non-Waiver Agreement By merely investigating the facts of a case, the insurance company can sometimes lose its rights to deny a claim as a result of the legal concept of estoppel. In the event a company leads a policy holder to believe that a claim will be paid or implies that it will be paid in some manner, estoppel may prohibit the insurance company from denying the claim. The insurance company may be prohibited from denying the claim even if subsequently uncovered facts clearly indicate that the claim should not be covered by the policy. To avoid the possibility of coverage by estoppel, many insurance companies investigating questionable claims require the insured to sign a non-waiver agreement that states that the insured understands that the company will not be required to pay the claim merely because the company explores the facts regarding the claim. Cancellation The company or the insured may cancel a homeowners policy. If the company cancels, the insured is entitled to the full amount of unused premiums on a pro rata basis. The insured need only notify the company in writing to cancel the policy. The insurance company must provide no less than five days notice before canceling a homeowners policy. This period of time is intended to provide a window for the homeowner to obtain a new policy. Homeowners Insurance Concluding Thoughts For many of your prospects, purchasing homeowners or renters insurance may be their first experience purchasing insurance. As you offer homeowners and renters insurance policies to potential customers, it is important that you ask enough questions to obtain a full understanding of the insured s needs. You should also be aware that a number of states require specific policy endorsements which are created specifically for the state. Personal Property Insurance Introduction As described above, the basic homeowners policy usually contains various limitations and exclusions on coverage. Therefore persons who are owners of valuable personal property often need broader and more comprehensive coverage than is provided by the basic homeowners policy. This broader and more comprehensive coverage may be obtained through appropriate personal property insurance. Inland Marine Insurance The very first form of personal property insurance coverage was an Ocean Marine policy. The policy was written to provide financial protection for owners of ships in case their property or cargo was lost at sea. Ocean marine policies insured the cargo from port to port. Later on, a clause was added to also insure cargo while it was being transported on land. As an end result, policy coverage extended from the original point of departure until the final destination point to include both ocean and inland transportation of those goods Real Estate Institute 21

28 EVERYONE NEEDS INSURANCE Eventually a separate policy was developed that dealt only with the insuring of the goods while being transported on land and the policy became known as an inland marine policy (in contrast to the ocean marine policy). Inland Marine policies eventually began to provide a broad coverage for other property of a floating or moveable nature. Inland marine policies were offered on an all risk basis rather than a named peril basis as offered in most existing casualty policies. Inland Marine Insurance Definition Inland marine policies generally cover property that is transported from one place to another (excluding transfer over waterways). This property includes goods in transit and other property transported over roadways and bridges or under tunnels. Information transferred via television broadcasting towers or other communication transfer devices may also be covered by an inland marine policy. Inland Marine Floater Characteristics Various floater policies can also be used to cover personal effects and property. The floater policy will provide coverage to items that float or move along with the covered property while it is changing locations. An inland marine floater has four major characteristics. Tailored coverage. A personal articles floater provides coverage for nine optional classes of personal property. We will list each of these classes later in these materials. This type of floater permits the insured to select coverage for the class or classes of property needed. It is also possible to write each of these types of coverage on separate floaters. For example, any of the following floaters are possible: Jewelry floater. Fur floater. Coin collection floater. Stamp floater. Camera floater. Selection of policy limits. As we have discussed, the basic homeowners policy has limitations on coverage of certain types of valuable property. The insured must look to a floater policy in order to obtain higher limits of coverage. Also, as a rule, when a basic homeowners policy combines the value of certain types of personal property with the value of unscheduled personal property it is possible that the combined total may exceed the homeowners policy limits on personal property. Here again, the floater policy can provide higher limits. Extensive coverage to perils covered. When a floater is written it usually provides coverage on a risks of direct physical loss basis. The floater covers all risks of direct physical loss to the property that is described except specifically excluded losses. The commonly excluded losses will be discussed later in these materials. Worldwide coverage. The property described in most floaters will be covered anywhere in the world with the exception of fine arts, which are usually covered only in the United States and Canada. Inland Marine Floater Provisions The following policy provisions appear in most Inland Marine Floater policies: Loss settlement. The amount that will be paid for a covered loss will be the lowest of the following four amounts: The actual cash value of the property at the time of loss or damage. The amount for which the insured could reasonably expect to repair the property to its condition which existed prior to the loss. The amount for which the insured could reasonably expect to replace the property with property substantially identical to the article lost or damaged. The insurance company can purchase much of the property insured in a floater at discounted prices. Therefore the insurance company may want to replace the lost or damaged item itself rather than provide cash reimbursement to the insured. Should the insured reject the replacement offer, the insurance company s cash reimbursement will then be limited to the amount for which the insured could reasonably be expected to replace the item. This amount will equal the discounted price which the insurance company would have paid to replace the item, even if the insured does not have access to that same discount. The amount of insurance stated in the policy. Loss to a pair, set, or parts. In the event that there is loss or damage to a covered property in a pair or set, such as the loss of one earring, the amount to be paid is not based on a total loss. The insurance company may either repair or replace any part to restore the pair or set to its pre-loss value or pay the difference between the actual cash value of the pair or set before and after the loss. Loss clause. The loss clause provides that the overall limit of the insurance policy will not be reduced in the event of payment of a claim, except that the overall limit of the policy will be reduced in the event of payment on account of a total loss of a scheduled item. If the amount of the insurance is reduced because of a total loss of a scheduled article, the insurance company will either refund the unearned premium or apply the unearned premium to the current premium due if the scheduled article is replaced with another item. Claim against others. This policy provision is very similar in nature to the subrogation clause. If a loss occurs and the insurance company believes that the insured can recover the payment for that loss from the person or parties responsible, then the loss payment to the insured will be considered a loan that must be repaid out of any funds recovered from others. The insurance company will expect the insured to cooperate with any attempt the insurance company makes to recover from others responsible for that loss. Should the recovery attempt be unsuccessful the insured will not be required to pay the loan on the loss settlement. Insurance not to benefit others. No organization or other person that may have custody of the insured property and which is paid for services can benefit from the insurance on the property. The purpose of this provision is to prevent a third party who caused the loss from denying liability for payment by stating that the property is insured. The statement that the insurance is not for the benefit of third parties helps to retain the insurance company s right of subrogation and a cause of action against the negligent party. Other Insurance. In the event that there is other insurance at the time of loss that applies to the property, that insurance is considered excess insurance over the primary insurance policy. The primary insurance policy will pay its benefit in full, and the insured may then turn to the second insurer Real Estate Institute 22

29 EVERYONE NEEDS INSURANCE Inland Marine Floater Exclusions As a general rule, inland marine floaters provide coverage to property on an all-risks basis. Physical loss to covered property is provided for all cases other than the following exclusions: Wear and tear. Deterioration. Inherent vice. Insects or vermin. Mechanical breakdown or failure. Electrical breakdown or failure. Repairing the property. Adjusting the property. Servicing the property. Maintaining the property. In addition, inland marine floaters contain general exclusions for loss related to war, nuclear reaction, and radiation. Personal Articles Floater The Personal Articles Floater (often referred to as the PAF) is a particular type of insurance floater which provides coverage over nine optional classes of personal property. Coverage follows the property worldwide, except for fine arts. The nine classes of personal property that can be insured under a Personal Articles Floater are: Jewelry. Furs. Cameras. Musical instruments. Silverware. Golfer s equipment. Fine arts. Postage stamps. Rare coins/current coins. Certain newly acquired items of property such as jewelry, furs, cameras, and musical instruments will be automatically covered for 30 days without specific itemization, provided that insurance was already written on that class of property. The amount of insurance on newly acquired property is limited to the lower of 25 percent of the amount of insurance for that class of property or $10, The property must be reported to the company within 30 days of purchase in order for the coverage to continue. The insured will be charged an additional premium for coverage from the date of acquisition. We will now examine each of the nine classes of personal property which may be covered under a Personal Articles Floater: Jewelry. Coverage on personal jewels applies anywhere in the world. Each item of jewelry, including watches, necklaces, and rings, must be scheduled with a specific amount of insurance. Jewelry is very carefully underwritten by the insurance company as a result of the significant hazard of loss. As a rule, the insurance company will require either the original bill of sale or a signed appraisal before the jewelry is insured. The insured must also possess satisfactory financial resources to suggest that the jewelry was not stolen, and the insurance company will want to know that the insured is not in the habit of losing or misplacing articles. Furs. The PAF can be used to insure: Personal furs. Items consisting principally of fur. Garments trimmed in fur. Fur rugs. Imitation fur. Again, each item must be separately listed with a specific amount of insurance shown for each item. As with jewelry, furs are very carefully underwritten. Cameras. A PAF can also be used to insure each of the following items. Each of these items must be individually described and valued. Photographic equipment. Cameras. Projection machines. Portable sound equipment. Recording equipment. Motion picture cameras. Motion picture projectors. Films. Binoculars and telescopes. Exceptions to the rule requiring the scheduling of items would be miscellaneous smaller items, carrying cases and filters, provided that the total value of the nonscheduled (or blanketed ) items is not more than 10% of the total amount of the insurance on cameras. Musical Instruments. The following items can be covered under a PAF: Musical instruments. Instrument cases. Sound equipment. Amplifier equipment. Should a musical instrument be used and played for pay during the policy period it will not be covered unless an endorsement is added reflecting this business use. Business equipment will require a higher premium. Silverware. Silverware and gold-ware may also be covered under a PAF. Silver pens, pencils and smoking implements may not be insured as silverware. These types of property instead may be insured as jewelry. Golfer s equipment. Golf equipment such as golf clubs and golf clothes will be covered. Other golf equipment may also be insured under a PAF. Clothing contained in a locker is also covered while the insured is playing golf. Golf balls are covered only in the event of fire and burglary if there are physical marks of forcible entry into the building, room or locker. Fine Arts. Fine arts can include the following: Paintings. Antique furniture. Rare books. Rare glass. Bric-a-brac (knick-knacks). Manuscripts. Fine arts are insured on a valued basis and must therefore be on a schedule with the amount that was paid for that item. Damages are paid on an actual cash value basis up to the stated value. Newly acquired fine arts will be automatically insured for ninety days without scheduling. The insured is required to notify the insurance carrier within ninety days of acquisition and the additional premium due will accrue from date of acquisition. The limit on fine arts property is subjected to 25% of the total insurance. Fine arts are subject to three major exclusions: Real Estate Institute 23

30 EVERYONE NEEDS INSURANCE Damage caused by repairing, or retouching. Breakage of art glass windows, glassware, statuary, marble, bric-a-brac, porcelains, and similar fragile articles. However, the exclusion does not apply if fire, lightning, explosion, aircraft, collision, windstorm, earthquake, flood, malicious damage or theft, and derailment or overturn of a conveyance causes the breakage. Loss to property on exhibition at fairgrounds or at national or international expositions is excluded unless the premises are covered by the policy. Stamp and coin collections. These collections are insured for loss anywhere in the world. The stamps and coins may be insured in one of two ways: scheduled basis or blanket basis. The scheduled basis is suggested if the items are extremely valuable. In this way each item is specifically listed and insured. Under the blanket basis the insurance applies to the entire collection since each item is not separately described. In the event of a loss to a scheduled item, the amount to be paid is the lowest of the following: Actual cash value. The amount for which the property would reasonably be expected to be repaired. The amount for which the property would reasonably be expected to be replaced. The amount of insurance. In the event of a loss to an item covered on a blanket basis, the amount paid will be the cash market value at the time of loss. There is a $1,000 maximum on any unscheduled coin collection. There is a $250 maximum limit on any of the following: Single stamp or single coin. Individual article. Single pair. Single block or single series. Single sheet or single cover. Single frame or single card. In addition, for any stamps or coins insured on a blanket basis, the company is not liable for a greater proportion of any particular loss than the proportion which the amount of insurance on blanket property bears to the actual cash market value of the property at the time of loss. For example, suppose that the insured owns an unscheduled coin collection which is insured on a blanket basis for $500. One coin worth $50 is stolen. At the time of theft, the entire collection has an actual current market value of $1,000. Since the proportion of insurance on the collection compared to actual cash value of the collection is 50%, the insured s maximum recovery for the loss of the coin will be $25 (50% of the coin s $50 cash value). Had the insured purchased $1,000 worth of insurance, the $50 loss would have been paid in full. For stamp and coin collections, damage from any of the following causes is excluded from coverage under the PAF: Fading. Creasing. Denting. Scratching. Tearing. Thinning. Transfer of colors. Inherent defects. Dampness. Extremes of temperature. Depreciation. Damage from being handled. Damage from being worked on. Mysterious disappearance, other than in the event where the item is scheduled or specifically insured, or is mounted in a volume and the page to which it is attached is also lost. Property lost in the custody of transportation companies. Shipments by mail other than registered mail. Theft from any unattended motor vehicle. Personal Property Floater This floater provides extensive coverage on personal property owned or used by the insured that is kept at the insured s residence. This rider will also provide worldwide coverage when this property is temporarily away from the residence. The property is issued on a special all-risk basis. This means all direct losses are covered unless specifically excluded. Scheduled Personal Property Floater This floater is used to provide coverage for personal articles and valuable items that do not fall within the nine categories previously listed for the Personal Articles Floater. Examples of such items are: Dentures. Typewriters. Camping equipment. Wheelchairs. Stereo equipment. Grandfather clocks. This is not a complete list, as almost any kind of personal property may be insured under a scheduled personal property floater. This type of coverage is quite flexible and may be adapted to meet the needs of the individual insured. Insurance producers will often be asked what type of personal property should be scheduled on a personal property floater. As a general rule, valuable personal property should be scheduled and specifically insured under a floater policy. Diamond rings, fur coats and other jewelry of high value should be specifically scheduled. The following types of personal property should also be considered for scheduled coverage: Unique objects. Works of art. Rare antiques. Paintings. Stamp collection. Rare coin collection. Portable property. Cameras. Camera equipment. Musical instruments. Sports equipment. Fragile articles. Glassware. Statuary. Scientific instruments. Typewriters. Home computers. Business or professional equipment Real Estate Institute 24

31 EVERYONE NEEDS INSURANCE Since the basic homeowners policy provides coverage for personal or business property only to a maximum of $2,500 on the resident premises and $250 away from the resident premises, the insurance producer may recommend that the property be more adequately insured by scheduling the property with a stated amount of insurance shown for those items. Unscheduled Personal Property The Personal Property Floater also may be used to insure the following classes of unscheduled property: Silverware, gold-ware, pewter-ware. Clothing. Rugs and draperies. Musical instruments and electronic equipment. Paintings and other art objects. China and glassware. Major appliances. Guns and other sports equipment. Cameras and photographic equipment. Building additions and alterations. Bedding and linens. Furniture. All other personal property and professional books while on the residence. Each of the above categories carries a maximum limit for recovery for the particular category. The floater also carries a maximum limit spreading across all of the categories which matches the total policy limit. Newly Acquired Property Any newly acquired property will automatically be covered under a Personal Property Floater for up to the lower of 10% of the total amount of insurance or $2,500. Insurance on newly acquired property may be applied to any of the enumerated categories. Newly acquired property at the principal residence of the insured will be covered for thirty days from the time the property is moved there. The coverage on the newly acquired property is subject to the amount of the insurance for each enumerated category. Property Not Covered The personal property floater will not cover any of the following personal property: Animals, fish, birds. Boats, aircraft. Trailers, campers. Motorcycles, motorized bicycles. Motor vehicle equipment, motor vehicle furnishings. Property pertaining to a business, property pertaining to a professional. Property pertaining to an occupation. Property usually kept somewhere other than the insured s residence throughout the year. Additionally the personal property floater places specific limits on certain property. For example: $100 limit on money. $100 limit on unscheduled coins. A $500 limit on unscheduled securities, notes, stamps, passports, tickets, jewelry, watches, and furs. The personal property floater also excludes certain losses such as: Animals owned or kept by the insured. Mechanical or structural breakdown. Water damage. Any work on covered property except jewelry, watches, or furs. Dampness/extreme changes of temperature except if caused by snow, rain, hail or sleet. Bursting of pipes. Bursting of apparatus. Acts or decisions of any person, group, organization or government body. Wear and tear. Deterioration. Inherent vice. Insects or vermin. Marring or scratching of property. Breakage of eyeglasses. Glassware. Fragile article. Lightning. Theft. Vandalism. Malicious mischief. Personal Effects Floater The Personal Effects Floater (PEF) is designed for travelers who want coverage on their personal effects while traveling. The PEF will provide coverage on the personal property of tourists and travelers anywhere in the world. However, this will only be in effect while the covered property is away from the residence premises. This coverage will apply to: the insured, his or her spouse, and any unmarried children who permanently reside with the insured. Personal Effects Coverage Property normally worn or carried by an individual comes under the heading of personal effects. Coverage for personal effects will include: luggage, clothes, cameras, and sports equipment while the insured is traveling or on vacation. Property Excluded The following property is excluded under PEF coverage: Automobiles, motorcycles, bicycles or boats. Accounts, bills, currency, deeds, evidence of debts, or letters of credit. Passports, documents, money, notes, securities or tickets. Transportation. Household furniture. Household animals. Automobile equipment. Salesperson samples or merchandise for sale or exposition. Physicians/surgeons equipment. Artificial teeth. Artificial limbs. Theatrical property. All-Risks Coverage Personal effects will not be covered on an all-risks basis. Risks of direct physical loss to a property are covered except as follows: Damage to personal effects from: Wear and tear. Gradual deterioration. Inherent vices. Vermin. Insects. Damage while property is being worked on. Breakage of articles of a brittle nature unless caused by: Fire Real Estate Institute 25

32 EVERYONE NEEDS INSURANCE Theft. Accidents to a conveyance. Other Exclusions In addition to the exclusions previously mentioned, the following exclusions also are present in the PEF: Personal effects are not covered while on the named insured s residence premises. Property in storage is not covered. Personal effects in the custody of students while in school are not covered except for loss by fire. Limitations on Certain Personal Effects Jewelry, watches and furs are subject to a single article limit of 10% of the total amount of the insurance, with a maximum of $100. A careful review of the prospect s assets and needs will help determine the necessity for any of these additional coverages. Personal Umbrella Liability Insurance A serious personal liability lawsuit can reach catastrophic levels for the party defending the lawsuit, as the judgment may potentially exceed the individual s insurance policy liability limits. Once these liability limits are exhausted the insured is often forced to pay a substantial amount out of his pocket. Thus, individuals may require increased protection against catastrophic lawsuits. Individuals that usually need this protection include: Highly paid executives. Physicians. Surgeons. Dentists. Attorneys. Do not be misled to assume that only those listed above need this protection. Considering the increased frequency of liability lawsuits and the complexities of modern living, most people may actually require this protection. Such additional insurance protection can be provided by a personal umbrella liability insurance policy. Nature of Personal Umbrella Insurance The umbrella package is designed to provide the insured with coverage in the event of: A catastrophic claim. A lawsuit. A judgment. The amount of umbrella coverage can range from $1,000,000 to $10,000,000. The contract usually covers the entire family worldwide. The umbrella typically covers liability losses associated with the: Home. Automobile. Boats. Recreational vehicles. Sports. Other personal activities. While it is true that an umbrella policy is not a standard contract, umbrellas do have some common features such as: A self-insured retention which must be met with certain losses covered by the umbrella policy but not covered by an underlying insurance policy. The umbrella policy provides excess coverage over basic underlying policies, such as personal auto, and homeowners insurance. Coverage is broad and includes coverage for some losses not covered by underlying contracts. Excess Liability Insurance The umbrella policy pays only after the limits of the underlying policy are exhausted. Some umbrella policies require that the insured carry certain minimum amounts of liability on the basic underlying contracts. For example, on an automobile policy the minimum liability coverage required on the basic contract could be: $100,000 per person for bodily injury liability. $300,000 per occurrence of bodily injury liability. $25,000 for property damage liability. A combined single limit of $300,000. On a homeowners policy the minimum required on the basic contract could be $100,000 of personal liability. If a watercraft is involved, liability exposure requirements may be $500,000 of single limit underlying coverage. Broad Coverage With respect to personal loss exposures, the personal umbrella policy provides broad coverage. The personal policy coverage also covers certain losses that the underlying contract may not cover after the insured meets certain selfinsured retention requirements. These losses include: Personal injury. Libel claims. Slander. Defamation of character. False arrest. False imprisonment. Humiliation. Here are five specific examples of claims that may be paid by umbrella insurance companies: The insured slandered two police officers. The insured borrowed a tractor and damaged it. After a self-insured retention was met the umbrella covered the loss. The mast on a rented boat broke during a race and seriously injured a crewmember. Primary coverage was not available to the insured. The insured rents a car in England and is involved in a serious accident. The personal umbrella covered the loss since only limited underlying coverage was available. The insured s spouse rents a motorcycle and is involved in a serious accident. Since the underlying automobile/homeowner contracts do not cover the ensuing third-party claim, the umbrella pays the claim. Self-Insured Retention When an umbrella policy covers a loss which is not covered by the underlying insurance policy, a self-insured retention or deductible must be met. As a rule this deductible is at least $250 per occurrence and can be higher. Personal Umbrella Coverages Personal umbrella coverage may include coverage for each of the following: Personal injury liability. The insured s liability for personal injury is covered under the personal umbrella policy. Personal injury is defined to include: Bodily injury. Sickness. Disease. Disability. Shock. Mental anguish. Mental injury. This definition can also include: False arrest. False imprisonment. Wrongful entry. Wrongful eviction Real Estate Institute 26

33 EVERYONE NEEDS INSURANCE Malicious prosecution. Humiliation. Libel. Slander. Defamation of character. Invasion of privacy. Assault and battery (not intentionally committed or directed by a covered person). Property damage liability. Property damage can be defined as physical injury to tangible property and includes loss of use of the injured property. The umbrella insurance company agrees to pay losses for which the insured is legally liable and which exceed the retained limit. The retained limit is either: The total of all applicable limits of all required underlying contracts and any other insurance available to a covered person, or The self-insured retention if the loss is not covered by the underlying insurance. Defense costs. Typically, legal defense costs in addition to the policy limits are paid under the personal umbrella policy. Defense costs include: Payment of attorney s fees. Premiums on appeal bonds. Court costs. Interest on the judgment. Legal costs. However, some personal umbrella policies will include the cost of defending the insured as part of the total loss. It is possible that in a catastrophic judgment the insured may have to absorb part of the loss. Still, most umbrella policies will provide and pay the legal defense costs of a covered loss if that loss is not covered by any underlying insurance. Personal Umbrella Exclusions Like other types of personal property insurance, the personal umbrella provides specific exclusions to coverage. Here are some of the more common exclusions found in personal umbrella policies: Worker s compensation. Any obligation for which the insured is legally liable under workers compensation, disability benefits, or similar law is not covered by the umbrella. Fellow employee. Some personal umbrella contracts exclude coverage for any insured (other than the named insured) who injures a fellow employee in the course of employment arising out of the use of any of the following: Automobile. Watercraft. Aircraft. Care, custody or control. Damage to property owned by a covered person is excluded under all personal umbrella contracts. Most contracts also exclude damage to a non-owned aircraft and non-owned watercraft in the insured s possession. However most umbrellas will cover damage to: Property rented to the insured. Property used by the insured. Property in the care of an insured. Note that the umbrella contract will not cover aircraft or watercraft which fall into one of the three above categories. Nuclear energy. All personal umbrella policies contain a nuclear energy exclusion. Intentional acts. Any act directed by or committed by a covered person with the intent to cause personal injury or property damage will not be covered by the umbrella contract. Aircraft. Umbrella policies will not cover any liability arising out of ownership, maintenance, use or loading or unloading of an aircraft. Watercraft. Larger watercraft are usually excluded from umbrella coverage, including: Inboard watercraft. Inboard/outboard watercraft exceeding 50 horsepower. Outboard motors of more than 25 horsepower. Sailing vessels of more than 26 feet long. Professional liability. While many insurance companies do not offer this coverage and virtually all umbrella policies exclude professional liability, some companies will cover certain professional liability losses with an endorsement and by charging a higher premium. Officers and directors. This exclusion does not apply to a non-profit corporation or organization. It does exclude coverage for an act or failure to act as an officer, trustee or director of a corporation or association. Recreational vehicles. Liability arising as a result of ownership or maintenance of golf carts is excluded. Watercraft Insurance The homeowners policy only provides limited coverage for watercraft owned by the homeowner. As a result, the homeowner must obtain separate coverage under a watercraft policy in order to fully protect watercraft from loss. Watercraft insurance can cover various watercraft which range in size, such as: Rowboats. Canoes. Outboard motorboats. Inboard motorboats. Dinghies. Sailboats. Speedboats. Houseboats. Yachts. Hull and Trailer Loss Exposures Watercraft as well as their equipment, trailers and furnishings may be exposed to a wide variety of theft and physical damage loss. Examples of possible damage or loss include the following: Two speedboats collide. A sailboat is overturned in heavy winds. A boat sinks in a severe storm. A sandbar strands a houseboat. An outboard motor falls into a lake. A boat trailer is stolen. An explosion seriously damages a boat Real Estate Institute 27

34 EVERYONE NEEDS INSURANCE Homeowners Policy Physical Damage Coverage Watercraft and trailers are covered under Section One of a homeowners policy for physical damage and theft. However this coverage is very limited. The major limitations on coverage are as follows: Direct loss to: Watercraft. Trailers. Furnishings. Equipment. Outboard motors from windstorm or hail are covered ONLY if the property is inside a fully enclosed building. Theft of: Watercraft. Trailers. Furnishings. Equipment. Outboard motors away from the resident premises are specifically excluded. Watercraft and other boating property are covered only for a limited number of named perils. Coverage on each of: Watercraft. Trailers. Furnishings. Equipment. is limited to a maximum of $1,000. Personal Auto Policy Personal Damage Coverage An automobile policy is not designed nor does it cover any physical damage to boats. The boat trailer however can be insured for physical damage loss under a personal auto policy. The trailer must be described fully in the declarations of the auto policy. Liability Loss Exposure When an insured owns or operates watercraft, the insured may be exposed to a wide variety of liability loss exposure, such as: A water-skier is injured because of excessive speed. A boat runs into swimmers and seriously injures them. A boat collides with a dock causing property damage. Two boats collide injuring the occupants. A child falls overboard and drowns and was not provided a life preserver by the boat operator. Homeowners Policy Liability Coverage Section II of a homeowners policy provides personal liability insurance and it covers certain watercraft loss exposures providing the boat is under a specified size and length. Personal liability insurance provides the insured with protection against bodily injury or property liability that arises out of the use or operation of certain owned watercraft. The liability protection can also apply on an excess basis for certain covered non-owned watercraft. There are however several important categories of watercraft liability that the homeowners policy excludes from coverage. These include: Owned watercraft regardless of size with inboard or inboard/outboard motor power. Rented watercraft with an inboard or inboard/outboard motor power with more than 50 horsepower. An owned or rented sailing vessel that is more than 26 feet in length. Watercraft powered by one or more outboard motors with more than 25 horsepower if the motors were owned by the insured at the inception of the policy and not declared or reported. However, watercraft powered by outboard motors with more than 25 horsepower are covered if the motors were acquired prior to the policy period and providing the insured declared them at the time of policy inception or declared them within forty-five days of acquisition. The above exclusions do not apply when the craft is in storage. Outboard Motor and Boat Insurance This specific type of watercraft insurance is designed for those who own motorboats and for those who have adequate personal liability coverage under their homeowners policy or under a comprehensive personal liability policy but desire broader physical damage insurance on their boat. An Inland Marine Floater can also provide this protection. Although floaters are not standard they do contain some common features such as: Covered property. The insured selects the property to be insured. The floater can be written to cover the following: Hull. Motor or motors. Boat equipment. Boat accessories. Boat carrier. Boat trailer. Covered property is written on an actual cash value basis and may contain a deductible of $25, $50, $100 or some greater amount. Covered Perils. The floater can be written on named perils or risks of direct loss basis. Most floaters currently are written on the risks of direct loss basis. The coverage does not include the liability for bodily injury, loss of life, or illness of individuals. It is assumed that the insured has proper liability insurance under a homeowners or liability policy to cover any third party bodily injury claims. The floater, however, may provide collision damage liability insurance that protects the insured from a claim for property damage from the owner of another boat if the insured s boat happens to collide with another boat while it is afloat. Outboard Motor and Boat Insurance Exclusions Outboard motor and boat insurance contracts do have exclusions. Some of the common exclusions are as follows: Business pursuits. No coverage will be afforded if the boat is used as a public conveyance for carrying passengers for compensation. No coverage will be provided if the boat is rented to others. Coverage is excluded for race boats or boats in speed contests. Repair or service. Coverage is excluded for loss or damage from: Refinishing. Renovating. Repair is not covered. The person who is repairing the boat would be responsible for any damage. General risks of direct loss. Coverage will not be provided for loss or damage from: Wear and tear. Gradual deterioration. Vermin. Marine life Real Estate Institute 28

35 EVERYONE NEEDS INSURANCE Rust. Corrosion. Inherent vices. Latent defect. Mechanical breakdown. Freezing. Extremes of temperature. Watercraft Package Policies Many insurance companies have developed special boat owners policies that combine liability coverage, physical damage coverage, and medical payments coverage. These boat owners policies contain certain common characteristics: Physical damage coverage. Currently most boat owners policies are written on a direct and accidental loss basis. The insurance company agrees to pay for direct or accidental loss to covered property under the physical damage insuring agreement. All losses are covered except those specifically excluded. The physical damage covers the boat, equipment, accessories, motor, and trailer. In addition, if the boat collides with another boat, gets damage from heavy winds, or is stolen, the loss is covered. Liability coverage. Liability insurance that covers the insured for bodily injury and property damage, liability from a neglect ownership or operation of the boat, is included in a boat owner s policy. Should the insured accidentally damage another boat or injure swimmers, for example, protection is provided under the liability coverage. Medical payments coverage. This is similar to the medical payments coverage found in an automobile insurance contract. Medical payments will be made for all medical expenses incurred within three years from the date of a watercraft accident that causes bodily injury to a covered person. Under medical payments coverage, a covered person is defined as the insured, a family member, or any person while occupying the covered watercraft. Under the medical payments coverage section, expenses will be paid for reasonable charges for the following: Medical. Surgical. X-ray. Dental. Ambulance. Hospital. Professional nursing. Prosthetic devices. Funeral services. Other coverage. The following may also be found in a boat owners policy: Cost of removing a wrecked vessel. Cost of removing a sunken vessel. The following are commonly excluded from physical damage coverage under a boat owners policy: Wear and tear. Inherent vice. Latent defect. Mechanical breakdown. War. Nuclear hazard. Damage caused by repair (except fire). Damage caused by restoration process (except fire). Carrying persons for a fee. Carrying property for a fee. Renting covered property. Racing covered property (except sailboats). Speed testing covered property (except sailboats). Infidelity of persons to whom covered property is entrusted. Portable electronic equipment. Photographic equipment. Water sport s equipment. Fishing gear. Cameras. Fuel. Portable radios. Fishing equipment. The following are commonly excluded from medical expense coverage under a boat owners policy: Intentional injury. Intentional damage. Renting the watercraft to others. Carrying persons for a fee. Carrying property for a fee. Using watercraft in a race (except sailboats). Using watercraft in a speed test (except sailboats). Losses covered under worker s compensation. Losses by a nuclear energy liability policy. Contractual liability. Personal Yacht Insurance This type of policy is for larger boats such as inboard motorboats and cabin cruisers. Personal Yacht insurance provides hull insurance, protection and indemnity insurance, optional coverage and warranties. Hull insurance. This protection refers to physical damage on the boat. This coverage also applies to sails, tackle, machinery, furniture, and the boat itself. This insurance provides all-risks protection. For example if the boat is damaged by: heavy seas, collision, flood or sinking because of an insured peril, the loss is covered. A deductible of varying amounts will apply to all physical damage and losses. Protection and indemnity insurance. This coverage provides the boat owner with coverage for bodily injury and property injury on an indemnity basis. If for example the boat were to smash into a marina and injures several persons the loss to the dock as well as any bodily injury would be covered under Protection and Indemnity Insurance. Optional coverage. The boat owner may add several options to your personal yacht policy, such as, medical payments coverage, liability of the insured to maritime workers injured in the course of employment, boat trailer insurance, land transportation insurance and a water-skiing clause. Warranties. Several warranties and promises are provided with yacht insurance. If the insured violates a warranty, higher premiums may be required to be paid to the insurance company. The major warranties on yacht insurance are as follows: Seaworthiness warranty. The insured warrants that the vehicle is in seaworthy condition. Lay-up warranty Real Estate Institute 29

36 EVERYONE NEEDS INSURANCE The insured warrants the vehicle will not be in operation during certain periods, such as winter months. Navigational limits warranty. The vessel will be used only in territorial waters described in declarations. Private pleasure warranty. The insured warrants the vessel will not be hired or chartered. Uninsured Boaters Coverage As is the case with automobile insurance where an individual can purchase uninsured motorist protection, boat packages also include an option for uninsured boat coverage. The company agrees to pay damages that a covered person is legally entitled to recover from an insured boat owner or operator due to bodily injury sustained by a covered person in a boating accident. Uninsured Boaters Coverage Exclusions The uninsured boater s coverage has several exclusions. Bodily injury from the following are excluded: While occupying or struck by any watercraft owned by the insured or family member that is not insured under the policy. If the bodily injury claim is settled without the insurance company s consent. While operating a covered watercraft which is carrying persons or property for a fee. While occupying a covered watercraft being rented to others. Using a watercraft without a reasonable belief that the person is entitled to do so. Occupying a watercraft without the reasonable belief that the person is entitled to do so. In the event there should be a disagreement as to whether a covered person is legally entitled to recover damages from the uninsured boat owner or operator, or on the amount of damages, the coverage has an arbitration provision which states that each party selects an arbitrator. The two arbitrators then select a third arbitrator. Those arbitrators have thirty days to agree on the selection of the third arbitrator. If the two arbitrators take longer than thirty days to identify the third arbitrator, then a judge in a court of law will be permitted to appoint the third arbitrator. Specialized Coverages As your clients become involved in business transactions, their needs for insurance will increase and may include a need to protect goods in transport. Marine insurance is a broad term including ocean and inland marine insurance. The Nationwide Marine Insurance Definition, published by the National Association of Insurance Commissioners, includes imports, exports, domestic shipments, and means of communications, and personal and commercial property floaters as marine insurance. In this section, we will discuss various types of specialized Marine Insurance. Ocean Marine Specialized Coverage First we cover specialized coverage which applies to Ocean Marine policies. Bumbershoot liability. Bumbershoot coverage is a particular form of umbrella liability designed for accounts where the principal exposure is marine and involves the operation of vessels and use of docks. The Bumbershoot covers: protection and indemnity; general coverage, collision, salvage charges, labor; all other legal and contractual liability including employers liability, liability under admiralty laws or the Longshoremen s Act, automobile liability, and those hazards usually associated with general liability insurance. Insured s net retention of at least $100,000 is usually required. Charter boats. Standard protection and indemnity forms issued in conjunction with Hull insurance policies on vessels exclude coverage on the use of a boat for hire or charter. Under certain circumstances, a Protection and Indemnity form, broader in coverage than a standard general liability contract, is issued to an owner or operator of such a vessel used for carrying passengers for sightseeing, fishing, transportation, entertainment or marine observations on a fee basis. Coverage for liability also may be arranged on a liability form with rates set in the specialty market at a surcharged rate. Vessels under 40 feet in length are rated at 50% of those over 40 feet. Coverage usually is subject to a deductible. Liability exposure is of more concern to underwriters than loss or damage to the hull. Operation of a restaurant and serving of alcoholic beverages are also principal hazards on larger vessels. Ship charterer legal liability. This insurance is designed to protect a vessel charterer against liability incurred for loss of, or damage to, the vessel. Liability is ordinarily limited to damage caused in loading or unloading or failure to provide a safe berth. Policies may be written on an open basis with a flat premium charged for each voyage, or each voyage may be written separately. Ship repairer legal liability. This coverage protects an individual ship repairer, marina or boat yard operator for legal liability to the vessel s owner for damage to the vessel being repaired. This care, custody or control coverage provides only property damage liability and may be extended to include insured s legal liability for damage to other property caused by a collision (or otherwise), while the vessel is being repaired or tested. Inland Marine Specialized Coverage When clients become involved in business they will develop very specialized needs. Specialized coverage may also be obtained under an Inland Marine policy. Different types of specialized coverage include: Builders risk. Builders Risk policies cover buildings or structures during the construction, renovation or repair process. While coverage is often tailored to meet the needs of each customer, the vast majority of policies also cover building materials destined to become a permanent part of the building or structure. This property is covered while in transit, at temporary storage locations and while stored at the job site. Builders Risk policies are an important insurance product within the construction industry because the vast majority of banks require evidence of Builders Risk insurance prior to closing on a construction loan. In addition, two of the most frequently used construction contracts (the Association of General Contractors and the American Institute of Architects Contract for Construction) contain specific provisions outlining requirements for Builders Risk insurance. Even putting these requirements aside, few, if any, companies can afford to invest in construction without insurance protection. Any business entity with a financial interest in property under construction, renovation or repair needs Builders Risk insurance. Typical policyholders include: Real estate developers. Building owners. Home builders Real Estate Institute 30

37 EVERYONE NEEDS INSURANCE General contractors. Municipalities. Colleges and universities. Computerized business equipment. Computerized Business Equipment policies can cover all types of automated equipment capable of accepting and processing data. While we typically think of computers as the primary subject of this coverage, automated manufacturing equipment, computerized medical equipment, flight simulators and any number of other types of specialized equipment can be eligible for coverage. Coverage may also include the software and data used by this equipment as well as business income and extra expense exposures that may arise for a loss to such equipment or data. Coverage typically applies onpremises, while in transit and while temporarily away from covered locations. Laptops and portable computers are covered worldwide. Technology represents a significant investment to many businesses. Computerized Business Equipment coverage is important to any business entity that relies on technology in their daily operations. The greater the dependence on technology, the more important it becomes to purchase specialized coverage on such a critical aspect of operations. Contractor s equipment. Contractor s Equipment Coverage can cover scheduled, leased and miscellaneous property of the contractor. In addition, this coverage may be extended to include any similar property of others for which the contractor may be liable. This coverage can be further extended to include: Additionally acquired equipment coverage extending up to the policy limit for equipment which the insured buys, leases, rents or borrows for defined period of days. Rental expense reimbursement coverage, which pays up to a defined limit for rental expenses in the event that covered equipment is damaged in a covered loss. Installation floater coverage extends to property intended for installation while at a job site, at any other location, or in transit. Valuable papers coverage provides insurance for items such as blueprints and other documents of value to the contractor. Contractors Equipment is owned or leased to perform a specific function. Use of the equipment is directly related to generating revenue, fulfilling a contract or providing maintenance. Without working equipment or the means to replace equipment as soon as possible, a contractor s obligations cannot be fulfilled. The Contractors Equipment policy helps owners expedite the repair or replacement of damaged or stolen equipment. In addition, because of the high cost of the equipment many banks and lending institutions require insurance on the equipment. Any business entity with a financial interest in construction or other heavy equipment needs Contractors Equipment insurance. Typical policyholders include: Real estate developers. Building owners. Home builders. General contractors. Municipalities. Street and road contractors. Excavation contractors. Port facilities. Warehouse operators. Fine arts. Corporations and commercial accounts may have valuable works of art not specially covered as Fine Arts under standard package policies and Marine coverage fits the bill. Fine Arts coverage extends to works of art at a permanent location, in transit and while loaned to others. Agreed Value Fine Arts coverage ensures that collections are treated properly with a form that addresses the specific collection needs, with availability of breakage coverage, special pairs and sets coverage, and flood and earthquake coverage. For significant corporate collections, or for artwork and collectibles in commercial settings, insurers offer comprehensive coverage for a broad spectrum of paintings, sculpture, prints and multiples, as well as more specialized collections of historical, cultural or technological significance. Installation coverage. Installation policies insure building materials and components, machinery, and specialized equipment while being installed in a building or structure or erected or fabricated at a specific location. Typical types of property include heating, ventilating, air conditioning and electrical systems; and wallboard, tile, carpeting and other interior finish material. More specialized installations include wastewater treatment facilities and controls, pipelines, electrical, telephone and cable television lines; and radio and cellular telephone towers. Coverage is typically effective from the time the customer s financial interest in the property begins until the interest ceases, including while the property is in transit, at temporary storage locations and while stored at the job site. The vast majority of Installation policies are written for subcontractors (trade subcontractors in particular). Any business entity having a financial interest in property being installed, erected or fabricated may have a need for Installation coverage. Typical policyholders include: Specialty contractors. Government authorities and municipalities. Utilities (water, gas, telephone, electrical). Manufacturers, wholesalers, and retailers of machinery, equipment and materials, who also install what they sell. Marine underwriting specialists have written all types of installation projects, including low hazard residential electrical systems and tenant finishes, helicopter assisted tower installations, and the delicate relocation of a lighthouse threatened by erosion. Standard programs offer coverage against risks of direct physical loss or damage (subject to certain policy exclusions), or coverage tailored to a specific, complex project. Manufacturers coverage. A Manufacturers Output Policy includes coverage for the personal property of a business at specific, as well as unnamed, locations, including while in transit. Personal property coverage includes such items as machinery, equipment, furniture, fixtures and stock, improvements, and includes any other similar property of others for which an insured is liable Real Estate Institute 31

38 EVERYONE NEEDS INSURANCE Coverage extensions include: Accounts Receivable and Valuable Papers coverage, and Fire Protection System Recharge Expense coverage. Motor truck cargo legal liability. Motor truck cargo policies insure common and contract carriers for loss or damage to cargo in their care, custody or control. Coverage is provided on a legal liability basis as determined by the contract of carriage between the motor carrier and the shipper (pursuant to a bill of lading or other specially negotiated contract). Generally, a carrier is liable for the safe delivery of the property entrusted to it, not only while on the carrier s vehicles, but also while temporarily at terminals awaiting shipment. An insurer s Motor Truck Cargo Legal Liability policy is designed to cover that liability on behalf of the carrier. Museum coverage. Some Marine policies offer coverage developed specifically to insure museum-quality objects. The policy insures museum owned property at scheduled locations, on exhibition or on loan to other organizations. The policies also offer coverage for property in transit and the property of others for which the policyholder is legally liable. Coverage is available for art, history, natural history, science and technology and sports museums. Some insurers also offer coverage for specialized institutions such as aviation and automobile museums. In the United States, there are more than 12,000 museums eligible for this coverage. The market is expected to expand as the number of specialty museums and local historical societies continues to grow. Many of these smaller museums have no coverage for their collections because they perceive that one-of-a-kind objects are invaluable and therefore uninsurable. Although an exact replacement is not available, insurance can offer curators the opportunity to supplement the remaining collection with artifacts of the same genre to keep and preserve the mission of the museum. Scheduled property. Scheduled Property coverage is designed to cover property that is unique or unusual or which is not typically covered under any other marine or property coverage. Coverage is available to protect against risks of direct physical loss or damage (subject to certain inland marine exclusions). Any commercial property owner with property that travels from location to location or who needs coverage for other than real property or contents is a candidate for Scheduled Property coverage. Scheduled Property coverage is desirable for any business entity that wants insurance protection for unique property ranging from structures outdoors to movable property. Some of the unusual types of risks eligible for this coverage include: Circus rides. Locomotives and rail cars. Voting machines. Transit systems. Water storage tanks. Antique cars and race cars. Ski lifts. This type of coverage may be tailored to the specific property. Coverage applies to property wherever it is located - at a specific location, in transit or at a temporary location. Valuation options of all types are available including agreed amount, actual cash value or replacement cost. Transportation. Transportation insurance typically covers a shipper s interest in property while in transit by public motor carrier, contract carrier, railroad, air carrier, or while on the shipper s own vehicles. The coverage form is often extended to provide insurance for loss to property while it is being loaded and unloaded. A Transportation policy pays up to the limit of insurance, regardless of the extent of the carrier s legal liability or the carrier s ability to meet its financial obligations. In today s fast paced world, insureds don t necessarily have time to spend collecting reimbursement from a carrier in the event of a loss, so the transportation policy covers these losses up front. Some Transportation policies also pay for certain losses even when the carrier may not be liable, such as Acts of God (flood, earth movement, etc.). And if the insured cannot collect the invoice amount from a consignee because of loss or damage during a shipment, the policy will cover the insured s interest in the lost or damaged property. Any business that deals in a moveable product needs coverage for incoming and outgoing shipments, whether the business is a manufacturer, a wholesaler, a retailer or a distributor. Ocean Marine Insurance Ocean marine policies were the first form of insurance coverage. They were written to provide financial protection for the owners of ships and cargoes in the event their property was lost at sea. The cargo was insured from port to port. Ocean marine policies still offer this coverage today and include Ocean Cargo, Commercial Hull, Hull Builders Risk, Marina Operators, Boat Dealers, Ship Repairers, Stevedores, Wharfingers and Charterers. Marine policies can be written to cover the movement of any legal goods. The property insured is not itemized in the policy, which is written generally to cover goods and merchandise. Certain types of property are not included under the general category of goods and merchandise and need to be specifically covered. These excluded items include livestock, frozen foods, refrigerated meats, poultry, game, as well as bullion, securities and similar property. The marine policy may be written not only to cover the value of the shipped goods but also import duties and freight charges. Hazards Covered Perils of the sea. Under this coverage fall all perils which are peculiar to transportation and which cannot be prevented by any reasonable efforts of humans. Perils of the sea must be fortuitous; in other words, due to an uncontrollable action of the sea, not within the control of any person. Fire. Fire is not a peril of the sea, but the policy covers this risk. On the other hand, there is no coverage against fire which is due to the inherent combustibility of the goods being carried. Combustible cargoes sometimes are insured with special, additional coverage specified in a policy. Barratry of the master. Violation of trust of the master is covered provided it is not done in concert with the ship owner. Barratry is a specific term used to describe this type of maritime treachery. Assailing thieves Real Estate Institute 32

39 EVERYONE NEEDS INSURANCE Although petty thievery is not covered by the policy, theft accompanied by violence is covered. Jettison. Cargo thrown overboard is covered if the property was thrown overboard in order to attempt to preserve the property from loss. All other perils. The policy covers all other perils which shall come to the hurt, detriment or damage of the goods. The clause would appear to make the policy cover against all risks, which is definitely not correct. It means only perils of a character similar to those insured. Explosion. Most marine policies specifically cover the risk of explosion, whether on land or sea. Latent defects in machinery, hull, appurtenances. Most marine policies are extended to cover damage caused by bursting of boilers, breakage of shafts or through any latent defects in the machinery, hull or equipment, and through faults and errors in navigation or management of the vessel. Other Types of Ocean Marine Coverage In addition to the specific perils listed above, Ocean Marine Policies may be modified to include each of the following types of coverage: Charterers legal liability. When a shipper contracts with a ship owner to use the owner s vessel, this arrangement is considered a charter. Depending on the type of charter, the charterer is held legally responsible for certain liabilities and properties of the vessel. Depending on the type of contract the charterer enters into, the charterer may become liable for certain exposures related to the operation of the vessel. There are three types of commonly used charters: Voyage charter. A charterer who contracts the entire vessel for a single voyage or series of consecutive voyages is considered a Voyage Charterer. In a Voyage Charter, the shipper in most cases is liable for a safe berth, loading and the unloading. The ship owner retains the responsibility for navigation, operation of the vessel and all expenses. Time charter. A charterer who contracts to hire the entire vessel for a specific period of time is called a Time Charterer. In a Time Charter, the shipper is responsible for paying for the ship s fuel and for providing a safe berth at the port of delivery. The ship owner remains responsible for navigation and the expenses of operating the vessel. Bareboat charter. A charterer who contracts to hire the entire vessel without a crew, stores or provisions is called a Bareboat Charterer. In a Bareboat Charter, the ship owner is liable for the full operation of the vessel. Hull protection and indemnity coverage. Hull policies cover physical damage losses to the vessel arising out of numerous perils, while protection and indemnity policies cover the liability of the vessel owner for bodily injury (including death) or property damage arising out of specific types of accidents. Hull and Protection and Indemnity coverage is often tailored for each customer. Typically hull coverage is written together with the protection and indemnity coverage. Hull policies are a necessary part of the shipping industry. Without hull coverage, a prospective buyer of a vessel will be unable to obtain a loan to finance the purchase. Hull coverage will protect the interests of the bank and the vessel owner if a loss does occur. Protection and Indemnity policies are also necessary. Without protection and indemnity coverage, most vessels would not be permitted to sail. The majority of labor unions require that a fleet have coverage for the crewmembers in case they become ill, injured, or are killed while employed by the vessel. Without evidence of adequate Protection and Indemnity insurance, the vessels would not be manned and cargo would not leave the ports. Any commercial ship owner and/or operator of an inland/ocean-going vessel needs Hull Protection and Indemnity insurance. Typical policyholders include: Container vessel owners. Bulk-carrying vessel owners. Tanker vessel owners. Barge owners. Ferry owners. Heavy lift vessel owners. Marina operators legal liability. Marinas provide a number of services to the owners of private pleasure crafts including renting dock space, fueling, storage, launching and hauling. The marina must exercise the appropriate care to protect its customers pleasure craft, equipment on board and motors that are in the marina s care, custody or control. If negligent in such duties, a marina may be held liable for any loss or damage to their customer s property. Marina Operators Legal Liability covers the insured s liability for loss of or damage to customers private pleasure watercraft, equipment on board and motors that are in the marina s care, custody or control. Any individual or any entity with a financial interest in a marina or yacht club should obtain Marina Operators Legal Liability. Typical policyholders include yacht club owners and marina owners. Ocean cargo. Ocean Cargo policies cover physical loss or damage to goods and merchandise that are shipped by various types of carriers; i.e., rail, air, water, and motor truck. Besides just covering goods while in transit overseas, the coverage form can be broadened to cover the goods while temporarily stored at international and domestic warehouses, while being shipped domestically or while at a domestic or foreign processor. Ocean Cargo coverage is tailored to meet the needs of each customer. Ocean Cargo policies are a necessary part of the shipping industry. Without Cargo coverage, international transactions would not take place. When a bank finances the purchase of goods, the buyer is required to provide evidence of adequate insurance prior to any advancement of money. Once proof of adequate insurance has been given to the bank, the shipment of the goods can commence. Ocean Cargo insurance typically protects the interests of the bank, the seller of the goods and the buyer of the goods. Any individual or any entity with a financial interest in goods or merchandise being shipped internationally should obtain Ocean Cargo insurance. Typical policyholders include: Multi-national companies. Wholesalers and distributors. Manufacturers and processors. Shipping companies. Importers and exporters. Ship repairers legal liability. A shipyard performing repairs on a vessel has certain responsibilities to the vessel owner for the safety of their property. The shipyard must anticipate the hazards to which the property is subject and must exercise the Real Estate Institute 33

40 EVERYONE NEEDS INSURANCE appropriate care to protect this property. If negligent in such duties, the shipyard may be held liable for loss or damage to this property. When a shipyard is repairing a customer s vessel, there is a bailment between the shipyard and vessel owner while the vessel is in the care, custody, or control of the shipyard. This bailment makes the shipyard liable for certain damages and the shipyard must exercise an ordinary degree of care to protect its customer s property. The Ship Repairers Legal Liability coverage form provides liability coverage for this exposure. Ocean Marine Specialists must work with each customer to develop a coverage form that fits the specifications of the customer. The insurer s ocean marine claim surveyors, adjusters, and settling agents must all work together providing the customer the best coverage available to meet the customer s requirements. Stevedore s legal liability. When a vessel enters a port, its cargo needs to either be loaded or unloaded safely and expeditiously so the vessel can set sail again with limited delays. An independent contractor called a Stevedore is usually responsible for the loading and unloading operations at a port. The Stevedore can be legally liable for damage to vessels, cargo, and property located on the premises they are conducting their operations on. Coverage provides protection to the Stevedore for their ordinary liability to exercise an appropriate degree of care for vessels, cargo and property in their care, custody or control. Terminal operator s legal liability. A terminal operator can perform many functions including warehousing services such as pick and pack operations, labeling, inventory control and local trucking. In addition, the operator may provide a safe berth for vessels and have employees that load and unload vessels. One common exposure that exists in all of these operations is the terminal operator s legal liability exposure while goods and property of others are in their care, custody or control. A terminal operator provides an extended range of services that can include operations provided by a Wharfinger, Stevedore and Warehouseman. When determining coverage needs, it is important to examine the services that the insured provides their customers. Wharfingers legal liability. When a vessel enters a port it must have a safe berth before it can be loaded or unloaded. The Wharfinger (pronounced war-fin-jer ) provides the vessel owner with a safe berth, watches over the vessel, and exercises the appropriate care to protect the vessel from loss or damage. The Wharfinger is held liable for the vessel while it is in their care, custody or control. They also have certain responsibilities for the safety of the vessel. This liability is the principal exposure covered by a Wharfingers policy. Conclusion Personal Property Insurance As an insurance agent, you can offer an incredible variety of services and products to customers seeking personal property insurance. You can inform the customer that protection need not be confined to the standard homeowners policy, as inland marine, ocean marine and umbrella coverage can be tailored to provide the specific protection which the customer requires. If the customer is involved with a business enterprise, you and the customer must consider additional forms of coverage. By understanding the various options available to the customer and the multiple types of personal property insurance coverage, you will be able to better service each of your customers and offer valuable counsel to existing and potential new clients. CHAPTER 3 UNDERWRITING PROPERTY AND CASUALTY INSURANCE Knowledge of the insurance products to be offered to customers is essential for any insurance producer. The insurance producer must also understand the underwriting process by which insurance companies determine whether to offer insurance to a particular individual. Your customer may ask you specific questions regarding the underwriting process, and your answers may help that customer decide that your products and services are worthy of his/her investment. In this chapter we examine the underwriting of property and casualty insurance. Many underwriting practices have been in place for hundreds of years; however, changes to these practices are inevitable. Traditional underwriting practices may continue to appear perfectly logical to an experienced underwriter, but newer laws and regulations are forcing changes to some of those practices as longtime underwriting practices must give way to new concepts. Major Underwriting Goals Underwriting of all types is designed to accomplish three major goals. Underwriting helps the company to achieve underwriting gains. Underwriting positively contributes to society. Underwriting assists in maintaining a strong, solvent industry which can serve the public in the future. Each of these goals must be recognized and understood before changes in practices can be successfully adapted to new regulations and pressures. Underwriting Gains The first goal of underwriting is to help to achieve underwriting gains. In stock insurance companies, these gains can be called profits. For mutual insurance companies, the gains result in increased dividends or surplus. In all cases, the goal is to be able to show a gain after paying claims and expenses. Underwriting contributes to these gains by selecting applicants who fit within the parameters of the rates which have been developed. Every rate structure contemplates a certain type or class of risk. Underwriting has the responsibility of accepting and retaining those properties and exposures which fit the expected pattern. Underwriting gains cannot be achieved by accepting applicants whose probability of loss is greater than that which is anticipated by the rates. Applying contract provisions which are contemplated by the rate structure, can make a further contribution. Coverage cannot be unduly broadened, exclusions cannot be removed and conditions cannot be waived without jeopardizing the expected underwriting gains. Rates, contracts and selection are closely related. Improper use of any of these factors can destroy all hope of underwriting gains. If any of the three is inadequate, one or both of the others must be adjusted accordingly, or underwriting losses will occur. Total responsibility does not fall on the underwriters. Those who promulgate rates and those who draft contracts carry a share of the burden. But in the final analysis, it is the underwriter who must select applicants who fit the rates and contract provisions which have been designed to produce underwriting gains. If artificial restraints are imposed on underwriting, either rate must be increased or contracts restricted; otherwise underwriting gains cannot be realized Real Estate Institute 34

41 EVERYONE NEEDS INSURANCE Contribution to Society Insurance contributes a great deal to society. In fact, it is difficult to imagine how our civilization could exist without insurance. Society benefits from insurance by the reduction in uncertainty which insurance provides. With this lessening of uncertainty, people can buy and furnish houses, establish manufacturing and processing firms, stock warehouses and retail establishments, and conduct the distribution of goods. If this uncertainty was not reduced, people would not necessarily be willing to embark on these ventures. Perhaps more importantly, lending institutions would not be able to finance these enterprises, so anything beyond a cottage-type of business would be almost impossible. Most of the recent strides in industrial and technological fields would have been unthinkable, and most consumers would not have been able to accumulate the volume of goods which help mark the affluence of society. Insurance companies supply a good share of the funds which finance long-term investments. The insurance companies accumulation of capital, which is needed to guarantee the payment of future losses, can be used to promote expansion in home ownership as well as in business and industrial fields. Another major benefit of insurance is the promotion of competition which results from the stability and reduction of uncertainty which are present in our economy. Small firms can compete with large enterprises because they do not need to accumulate large sums of money to help survive disasters. The protection given through insurance permits every firm to survive both heavy losses to property and claims for liabilities. Thus funds can be used for growth, and society benefits from the resulting competition. Underwriters are the focal point through which most of the benefits of insurance are supplied to society, as the underwriters arrange to protect almost every conceivable type of loss in a manner which meets society s needs. When new exposures to loss arise, underwriters develop methods of insuring those exposures. Two important aims of underwriters are to support activities which will benefit society, and to oppose changes which will tend to restrict these benefits. Underwriters must not only analyze the immediate results of changes but also their longrange effects. Every underwriting action and every underwriting rule or guide should be considered in light of the ultimate effect on society as a whole. Maintaining a Strong Insurance Industry The greatest contribution that underwriters can make to their companies and to society is to help maintain a strong and solvent insurance industry. Underwriting gains, as discussed earlier, are an essential element in maintaining this strength. Another factor is steady, solid growth; this requires an analysis of markets and a selection of applicants who represent a broad, desirable spread. Still another element is an ability to meet the needs of buyers of insurance, for only in this way can insurance companies survive. In all of these areas underwriting contributes best when it classifies and accepts applicants on the basis of reasonable criteria, equitably applied. A constant objective of underwriting must be to analyze selection standards, change the standards and classifications when conditions require and administer them fairly in daily activities. Society benefits directly from the existence of strong and stable insurance companies. Only this type of insurer can meet the needs of the public. The future demands of a changing society will place new burdens on the insurance industry. New energy requirements, advanced technologies, the challenges of space travel, the opportunities for increased leisure activities, the opening of markets in undeveloped lands and all of the other possibilities which will be presented by changing world will require even more insurance protection than is available today. A strong, solvent insurance industry is a necessity if artificial brakes are not to be applied to these many new possibilities for fortune and growth. Underwriters must develop appropriate analysis of characteristics of applicants in order to find meaningful factors upon which to base underwriting selection. This is the challenge of the future for underwriters. Laws and regulations will impose new rules. But underwriting must survive if a strong insurance industry is to exist. This will require adaptation by underwriters, through the use of revised approaches which will achieve the established objectives. Individual and Class Underwriting Underwriters can react in many different ways to newly adopted rules and regulations. If the underwriter does not carefully consider the ultimate consequences of that reaction, the underwriter may react in ways which will damage the underwriter s reputation. In the long run, the damage will be irrevocable and will affect the entire insurance industry. Underwriting Individuals The only really viable alternative is to underwrite by applying the underwriter s intelligence and knowledge. This will include securing more facts, evaluating applicants as individuals, making objective analyses and taking prompt action in conformity with the laws and regulations. As a starting point, underwriters must know why certain underwriting rules or guides were used in the past. For example, an applicant s occupation may frequently be used as one underwriting factor. The applicant s occupation is not a factor because there is anything inherently wrong with people who are engaged in the particular occupation. They are not wicked, dishonest nor abhorrent. Rather, experience has likely shown that persons in that particular occupation tended to be unstable with respect to location, frequently moving from place to place. This instability can be a problem to insurers, so caution will historically have been used in determining whether to accept applicants who were engaged in that occupation. The occupation should not have been a firm rule but just a guide (although it is likely that some underwriters always used it as an unacceptable factor). Suppose that a new law or regulation provides that occupation will be prohibited as a factor in underwriting. The instability of the applicant may still be a problem to the insurer, so the application may still need to be rejected by the underwriter. The reason for the rejection will not be the occupation, but the instability of the applicant s residency. This instability can be indicated by factors other than occupation and may only be discovered by more intensive investigation by the underwriter. Occupation cannot be used as a reason for underwriting action, but it can still point out the need for more facts which may make the application unacceptable. If unstable conditions are not found, and other negative factors are not present, the application should be accepted. The key to better underwriting will be to secure all relevant information about the applicant. No longer will it be enough to find out a few facts, such as occupation, and then take action. Instead, the underwriting process will have to focus on the residency of the applicant and the likelihood for frequent movement. Both objective and subjective information can be secured by the underwriter, depending upon the circumstances and the management of the insurer. Objective information. The most reliable data is that received from objective outside sources. Motor vehicle reports and accident information from the file are the most common forms of Real Estate Institute 35

42 EVERYONE NEEDS INSURANCE objective data for vehicle insurance. The condition of the property, photographs, a doctor s report of physical impairments and the length of driving experience are other examples for various lines. Subjective information. Purely personal and private information may be used under some circumstances. Ordinarily, this is best if secured from the applicant, not from outside sources. The application, telephone verification and a renewal questionnaire are devices which are used to obtain facts from applicants and policyholders. Some insurers have used psychologically oriented selfcompletion questionnaires as investigative tools for new applicants, particularly for personal automobile insurance. Some of these sources may arouse antagonism from applicants or producers, but they are illustrations of the sources that are available to the underwriter. Right to privacy laws and other restraints imposed by government can restrict the information available to the underwriter. Such laws certainly make the underwriter s job more difficult and require more innovation to locate permissible data. Underwriting By Class As described above, the first step in underwriting requires that the underwriter secure as much relevant information about the individual as is necessary or available. The second step is analysis of that information. There are two different ways of analyzing an insurance application: by class and by individual risk. Traditionally, personal lines have been subject to class underwriting. This means that classes or groups are identified as being problems and are not written as a general rule. Underwriters recognize that some individuals in each class would be acceptable; however, it would be more expensive to find these individuals through the underwriting process, and there is usually not much information readily available upon which to make the decision. If an exception is made and a loss occurs, criticism may result. On the other hand, there will be no criticism if the applicant is rejected. Commercial lines more commonly use individual risk underwriting. More complex factors are present, and premiums are high enough to permit more investigation. In most companies, even under individual risk underwriting, certain groups are identified as presenting problems, and these groups may be placed on an unacceptable risk list. Still, exceptions are made for meritorious applicants based on individual characteristics. This pattern is common among larger commercial risks; smaller ones may be handled more on a strict class basis. This traditional difference between class and individual risk underwriting is disappearing in today s social and regulatory climate. People no longer tolerate being handled as members of a class without regard to individual characteristics. Many newer laws and regulations are aimed at precisely this factor. Since some physically impaired people are good drivers, it is no longer permissible to reject them simply because other physically impaired people may be problem drivers. Rather, the rules prohibiting the use of certain characteristics require that each person be considered on the basis of individual factors alone. The analysis of applicants, under government regulations, must include a study of individual characteristics, not just the group to which the applicant belongs. This does not necessarily involve a great deal more time and expense. Rather, it takes only a little more effort to consider whether the applicant is different, in some relevant way, from the other risks of the same type. If so, the differences must be analyzed. This type of analysis is new for most underwriters, particularly those handling personal lines. Education, training and frequent audits will be needed to make underwriters more familiar with these processes of analysis. After obtaining and analyzing information, the third step in underwriting is to make a decision and take action. This can be a perilous part of the process, or it can be a golden opportunity to serve the public and the industry. The manner in which underwriting guides are written and the way that the reasons for adverse action are stated can be very important. This is the point at which the true intentions of the insurance companies are measured. Underwriters should avoid using words like location, sex, age and marital status when rejecting or canceling insurance. These may be factors to be considered in the evaluation, but they cannot be used as the primary reason for rejection. Reasons must be given, and these reasons should be specific. Underwriters should stop using such general terms as condition of the property. The public insists upon knowing why adverse action is taken. The reasons must be clearly explained. Action must be taken promptly. Restrictions place a burden on underwriters to avoid procrastination. Many states prohibit cancellation of new policies after a discovery period usually about 60 days. Non-renewals are often permitted only if notice is sent to the policyholder well in advance of the expiration date. These rules require prompt and firm action, preventing the delays which previously marked the decision-making process of some underwriters. In summary, underwriters must avoid the specific use of factors which are prohibited, although these factors may be used as indicators along the path. Applicants and policyholders must often be analyzed as individuals, not as members of a class or group. Actions must be taken promptly, and always in compliance with the laws. Rejection or cancellation may be taken only for relevant reasons, and never because of factors which are prohibited. The reasons must be explained in specific terms. The previously mentioned approaches are the general approaches which must be followed by underwriters under government restraints. As a first step, management of the company should outline general principles, indicating how underwriting is to be conducted. These principles, which should be stated in broad terms, will give the necessary guidance to underwriters. It is obvious that compliance with all laws and regulations should be the cornerstone of these principles. General statements are needed as to the degree of investigation to be followed, the method of communicating decisions, and the handling of complaints. Such a statement of principles will supplement the underwriters with knowledge of general approaches to be used and will provide a broad base of guidance for future underwriting. Specific Underwriting Factors and Practices Desk underwriters need specific instructions on practices to be followed when they encounter problematic applications. While general statements are helpful, they are inadequate for the day-to-day handling of individual risks. Statements of general principles must first be developed and adopted by insurance company management. Such statements are needed before desk underwriters can make decisions which follow the wishes of management. Without such statements, underwriters can be expected to continue the old practices which have led to an atmosphere of public criticism of underwriting and demands for change. In addition to the company s statement of general principles, underwriters must learn the laws and regulations affecting the insurance being underwritten. Controls must be established to be certain that both new and existing laws and regulations are communicated to all underwriters. Next, supervisors must conduct enough audits to be certain that Real Estate Institute 36

43 EVERYONE NEEDS INSURANCE underwriters are following the statement of principles and all of the applicable laws and regulations. Much more than this is needed, however, if underwriting is to survive as it is known today. The spirit as well as the letter of laws and regulations must be followed. Most rules have loopholes if someone looks hard enough for them. If underwriters find loopholes in laws or regulations and underwrite on that basis, further restrictions will be adopted by government to close the loopholes. Complaints and criticisms must be heard and addressed by the insurance industry. When reasonable adaptations to underwriting practices can be made to meet those objections, this should be done. The difficult problem is to separate those comments which are reasonable and logical from those which are not. The application of these principles will not be easy. The reasons for each type of criticism must be understood in order to allow for proper changes to exiting standards. The following sections list factors used by insurance companies to determine underwriting decisions. These sections describe information regarding each factor and suggest certain recommendations for handling some of the complaints which have been lodged against the insurance industry s underwriting practices related to these factors. Loss History The record of past losses remains as one of the best factors which underwriters can use in the selection process. It is factual, relevant and well accepted as a factor which reasonably separates one risk from another. At the same time, underwriters must realize that not all losses can be considered as factors. Some losses are perceived by the public as being of types which do not reflect adversely on the individual involved. If the loss was not recent, or if the applicant was not at fault, its importance is diminished or removed. Accident Record Automobile underwriters should continue to use accident records as one of the primary underwriting selection tools. When facts are available, most accidents are reliable indicators of desirability and are generally accepted as such. Modifications in some past rules or guides are needed, however. Underwriters must not consider those types of accidents which do not have a clear relationship to possible future accidents. Also, they must not use the types of accidents which are specifically prohibited by statute or regulation. Fault The question of fault is most important. Although statistical studies do not separate accidents by fault, and automobile insurance underwriters, for example, may feel that all accidents indicate a driving pattern, the public generally does not see the relevance of not-at-fault accidents in the underwriting process. Most underwriters, for some time, have given little weight to the most obvious of the not-at-fault accidents. They disregard those where an applicant was struck while legally parked or while stopped for a traffic signal. In the future, the definition of not-at-fault accidents will likely be expanded. An applicant who recovers in full from another party is of the firm opinion that no fault should be affixed to his or her behalf. Underwriters should take such factors into account and not consider those accidents where an applicant was not charged with fault. The determination of fault is not easy, particularly with accidents that occur before risk is insured. Sometimes the determination can be made only by securing a copy of a police report or by contacting the previous insurer. These sources may be expensive and may even be prohibited by law. This leaves the underwriter with no alternative but to accept the description of the accident as given by the applicant, subject to verification by an official motor vehicle accident report, as much as possible. Modern traffic conditions lead to many accidents where fault is difficult to ascertain. Events happen quickly and each party may feel that the other person was completely at fault. Applicants who feel that they were without fault in an accident will resent being underwritten on the basis of an atfault accident. This resentment could be translated into legislation which would deny all accident information in the underwriting process. Underwriters will likely view the value of past accidents as predictors of the future as too great to jeopardize by making arbitrary decisions on some close calls. As a result, if fault does not appear to fall on the applicant, the underwriter will generally ignore that accident. Number of Accidents Underwriters not only consider every accident, they sometimes decide that one accident in the experience is too many to permit acceptance. Companies attempting to set predetermined standards may state that an applicant is unacceptable if there have been any accidents during the past two or three years. This approach may be too severe for the future. The traffic congestion of today, especially in the larger cities, makes it extremely difficult to avoid an occasional small accident. A blind spot during a lane change, vision obscured by a wet window in the rain, a sudden change in a traffic signal, an unexpected stoppage of traffic all can result in accidents. A driver who is usually very careful and who has been accident-free for years may incur one incident of this type. All that is required is a moment s inattention or carelessness. It would not be reasonable to refuse insurance to an applicant who has incurred just one loss of this type. Two or more accidents might be; but only one accident, perhaps in many years, does not make a driver a poor risk in the minds of most people. The solution is to consider more carefully the type of loss rather than just the number. If that one loss occurred shortly after midnight on a Saturday night and was the result of apparent high speed and possible drinking, the underwriter would be justified in being concerned. On the other hand, if the loss happened at 5:15 on a Tuesday evening and was a small rear-end accident on a crowded expressway, it is difficult to maintain that this is a good indication of possible future accidents. Underwriters must stop playing a numbers game and start analyzing the losses. Two or three small accidents scattered over a three-year period may be less indicative of future loss involvement than one recent accident where the circumstances indicate that a driving problem exists. No known legislation has attempted to control the number or type of accidents which can be considered in underwriting. This situation does not mean that these factors can be disregarded. Abuse of the privilege of considering accidents in the selection process may lead to restrictions. Automobile underwriting today requires more than a simple statement on the maximum number of accidents permitted during a specified period. Underwriters must secure all pertinent information concerning details of accidents from whatever sources are reasonably available. They then must analyze the losses to see if an indication of a poor driving pattern exists. If it does, underwriting action can be taken with little fear of challenge. But if it does not, there may be severe criticism of action taken solely because the loss is on record. Continuing action of the latter type may lead to restrictive legislation or regulation. Commercial/Personal Risks When an individual drives a vehicle as part of his or her job, it raises an additional underwriting issue: Should accidents occurring as part of the job be included when underwriting a personal automobile policy? The analysis of individual Real Estate Institute 37

44 EVERYONE NEEDS INSURANCE losses, rather than merely counting the number, will take care of the problem of differentiating between commercial and personal risks in most cases. An applicant, who incurs accidents because of poor driving, whether in a truck or a car, should bear the responsibility under all types of vehicle insurance. If the underwriter looks at the facts surrounding each loss, most of the pressure to disregard accidents from another line of insurance will disappear. Naturally, where laws prohibit consideration of accidents from another line, such as emergency vehicles, there is no opportunity to use such losses in the selection of risks. Property Losses Consideration of the degree of fault or responsibility should be a part of the underwriting process on property as well as automobile claims. The type of loss and the circumstances surrounding the loss are clues to the degree to which the applicant could have prevented the loss. Although there is no known legislation on the use of property losses, underwriters should not take advantage of this situation. Reckless disregard of factors causing a loss could lead to restrictions, and these probably will be stricter than those which underwriters would impose on themselves. Thus, isolated losses from factors beyond the control of the applicant should be disregarded or used with care. If conditions have changed, this fact should be part of the analysis. Intelligent underwriting requires nothing less. At the same time, a pattern of losses may reveal conditions which are likely to lead to future losses. Repeated windstorm or hail losses may indicate that the location of property is in a pocket where such losses are common. Repeated crime losses may show that the neighborhood is conducive to those types of losses and that the pattern can be expected to continue. Normal underwriting practices should continue, but these must be tempered with careful consideration of the circumstances surrounding the loss, not just a tabulation of the number of losses. Liability Losses Both personal and commercial liability losses should be handled much the same as property losses. Laws have not yet been enacted to regulate the use of these losses, but unreasonable application of underwriting rules could lead to controls. The facts surrounding losses should be analyzed carefully. If there is no pattern, and the loss was beyond the control of a reasonable person, the underwriter should not make the decision on that loss alone. On the other hand, a pattern of loss, or failure to take normal precaution against injury, is valid underwriting criteria. Recommendations for Improvement Property and liability losses often are the result of unsafe conditions. Rather than refuse insurance because of these conditions, or raise the premium, it would be better for underwriters to recommend improvements which would reduce future losses. This approach recognizes a responsibility on the part of underwriters to furnish insurance whenever possible and also to reduce losses and injuries. Underwriters who analyze losses often are able to see conditions which should be corrected. If these are not obvious, engineers or inspectors can be used to identify unsafe practices, and their reports can be part of the analysis of the cause of the loss. In addition, such reports can be the basis of recommendations for improvement. The underwriter, wishing to serve the public and avoid undue regulation, must do more than accept or reject applications. An effort must be made to write insurance, tailoring the contract and the rate to the risk. An important part of this approach is to discover areas where conditions can be improved and to recommend action to the applicant. Additional expense will be incurred by this approach; however, more business will be written and fewer losses may be incurred. More importantly, this approach will help to fulfill the duty of supplying coverage in the most economical fashion to every deserving risk. Universal use of this approach will go a long way toward limiting future adverse legislation and regulation. Traffic Violations Underwriters can continue to use traffic violations in selection and rating. This use is subject to specific state laws or regulations which limit the use of certain types of violations by underwriters. Where possible, however, underwriters should use judgment in their consideration of violations. The emphasis should be on those convictions which appear to have some element of future accident predictability. Equipment violations should be given little weight; on the other hand, they may indicate a careless attitude, an I-don tcare approach to automobile safety. Where this appears to be the case, further investigation is needed to determine the facts. In other cases, equipment violations should be ignored. Each case must be separately evaluated by the underwriter. Non-Verifiable Record The term non-verifiable driving record relates to the practice of refusing to insure newly licensed drivers because they do not have any past driving record, good or bad. Rules determining the definition of a verifiable record must be applied in a reasonable, nondiscriminatory fashion. The time period must not be excessive; three years is a maximum period in most cases. If used the rule must apply to all applicants and not be used as a screening device for youthful operators. For example, assume there is a middle-aged couple with a clean accident and conviction record but with only one of them who drives. If the non-driving spouse then gets another car and starts to drive, the non-verifiable rule must be applied, exactly as it would be if the new driver were a youth just starting to drive. Sources of Information In determining the record of traffic violations, it is crucial that underwriters use all reliable sources of information. Motor vehicle reports (MVRs) are the best source of information. They must be secured where it is important to see the traffic record. Arrangements should be made to secure MVRs as quickly and inexpensively as possible. Arrangements can often be made to secure MVR information directly from the computers of the state motor vehicle departments, either directly by the insurer or through a service organization. Prompt information is of great value in effective selection of applicants. Some traffic violation information, like some accident data, is not always available through an MVR. For example, some traffic courts have adopted the procedure of sending violators to a traffic school. Upon completion of the course, the record of the violation is destroyed. No entry is ever made on the MVR. This procedure may be effective from the standpoint of law enforcement officials, but it destroys the concept of underwriting on the basis of past driving performance. Underwriters must establish techniques for securing information on all traffic violations as much as possible. Proper questioning on the application is one source. Effective investigation technique is another. Driving Record The most significant factor which can be used in underwriting and rating of motor vehicle insurance is the driving record. Traffic violations are the major component of driving records, although accidents are usually included. Almost everyone Real Estate Institute 38

45 EVERYONE NEEDS INSURANCE who agrees that some type of selection and rating differences are justified will concur that the driving record is most critical. A risk should not be accepted if a driver s license is suspended or revoked. To supply insurance to such persons is to encourage them to drive in violation of law. When investigation reveals that the license of a driver is not valid, the application should be rejected. The only exception is a case where it is represented that the person without a license will not drive. If this is verified, the factor can be disregarded. After the license is reinstated, the underwriter should analyze the reason for suspension or revocation and not reject the applicant only because of the previous action by licensing authorities. Condition of Property Underwriters have more opportunity to practice individual risk selection on the basis of property condition than on most other factors. By avoiding arbitrary rules and looking at specific risk characteristics, underwriters can improve their selection practices and still avoid the objections of regulators. Both automobile and property lines are subject to underwriting on the basis of property condition. Condition of automobile. Good underwriting requires consideration of the automobile s condition. It is important that judgment be applied uniformly and that only relevant conditions be taken into account. Mechanical deficiencies should be handled carefully. If critical functions are involved, such as brakes or lights, the risk should not be accepted. Public safety, as well as insurance principles, requires that automobiles with serious deficiencies such as the foregoing should not be encouraged to operate on the streets. The proper underwriting technique is not to merely reject insurance. Such action may cause the owner to drive without insurance or to seek another insurer which may not discover the problem. Rather, the underwriter should point out the deficiency, suggest that it be corrected and offer to write the insurance when correction is made. In this manner, the financial exposures of the public and the owner will be protected, and the insurer will write another policy. Before this corrective action can be taken, the condition must be identified. If the facts are reported on the application, the underwriter can act immediately. If not, the condition can be determined only by an inspection on a new submission if it is economically feasible to do so. On existing policies, a claims report may indicate the existence of problems. In either case, it is important that the underwriter secure the facts. Then the alternatives can be considered and one of these should certainly be to recommend correction of the mechanical deficiency as a condition to writing or continuing insurance. Unrepaired damage can be handled in the same way. Minor damage can be ignored, except perhaps to note its existence so that it is not included again under the settlement of a later loss. More serious damage can be dangerous to pedestrians or occupants. Again, the best procedure is not to reject coverage automatically, but to be certain that the facts are correct and to then recommend correction. If repairs are made, the risk will be satisfactory from that standpoint, and a policy might be saved. Underwriters should not conclude that, as a class, people who do not correct mechanical defects or repair body damage are undesirable. There may be many reasons why improvements have not been made. If the specific condition of an individual automobile is poor, insurance should not be written. But if the correction is made, this factor should be disregarded. Underwriting consideration should be given to the actual condition of the vehicle, not the underwriter s opinion as to why the deficiency was not corrected until an underwriter made a demand. Altered cars, or those decorated, do not necessarily indicate an undesirable risk. Some operators of these vehicles are inclined to speed and take chances in close situations, but others are good, safe drivers. The fact that a person likes a showy car does not mean that person also drives in a careless fashion. This is a factor which should be checked carefully but then underwritten on the facts of each individual case. When underwriters of automobile insurance are considering a vehicle s condition, two rules must be followed. The first is to get the facts, to find out what is actually the case on a specific risk rather than to make assumptions based on experience with the class. The second rule is to apply judgment to each risk based on its individual characteristics, and not because it is a member of a group of risks. As with the driving record, the condition of a specific risk being considered is a critical factor. This applies to the mechanical condition, any un-repaired damage and any showy alterations. Condition of buildings. The condition of buildings must be carefully underwritten. Deficiencies which present an abnormal degree of risk must be corrected before insurance can be written. On the other hand, underwriters must guard against taking action solely on the basis of outward appearances. Uncut grass and peeling paint may be indicative of a careless attitude which may also be reflected in frayed wiring and overloaded circuits. These conditions may also indicate a temporary illness of the applicant or a temporary financial reversal, neither, of which has adverse implications from an underwriting standpoint. The underwriter would be justified to refuse writing insurance where the condition of property is so poor that the chance of loss is materially increased; however, the underwriter would not be justified to reject a risk because the condition of the building does not measure up to the standard of neatness which an underwriter feels is desirable. Neither the property application itself nor a related line such as automobile should be rejected merely because the housekeeping is poor by an underwriter s standards, provided the condition does not really increase the chance of a loss. Furthermore, outright rejection is undesirable in cases where the condition of property is so poor that insurance cannot be written. Rather, the underwriter should point out the types of improvements which could be made to achieve acceptability. Reasonable demands for improvements will benefit all parties and are perfectly legitimate. Again, however, the demands must be reasonable and not arbitrary. Underwriters must recognize that standards of neatness vary by individuals, and only those repairs which actually affect the exposure to losses must be demanded. When problem areas such as poor wiring and other so-called faults of management are identified, the property owner should be notified. This gives the owners an opportunity to correct the problem. Then, if correction is made, the coverage can be written. This approach accomplishes several things: more business is written, property owners are educated on proper methods of maintaining buildings and public relations are improved. This course of action is much better than merely rejecting the risk, if the condition is one which can be improved. The facts must be obtained before such decisions can be made. Sometimes the answers on the application are sufficient, particularly if a photograph of property is also available. Other times, an inspection is needed. The producer, a field underwriter or special agent, or an inspection company can perform these inspections. Regardless of the method used, it is essential that the Real Estate Institute 39

46 EVERYONE NEEDS INSURANCE underwriter have the facts available before taking action on the condition of the property. As a matter of procedure, the facts should be obtained, usually by physical inspection, before rejecting a risk because of poor condition, whether this involves actual unsafe conditions or poor maintenance of the building. Age of Buildings The age of a building on its own is not a reliable indication of its desirability as an insurance risk. After a few years, deterioration sets in, but repairs or renovation can offset this. Age may be a preliminary indication that there may be problems with the property. An older home, perhaps one over 25 years of age, certainly should be checked carefully. There may be problems in wiring, overloading of circuits or in the heating system. On the other hand, each of these potential problems can be corrected. A house can be rewired, new circuits can be added and a new heating system can be installed. With such improvements, a 40-year-old house may be safer than one which is 25 years old. Only proper inspection can determine if these improvements have been made. The acceptability of a property risk should not be based on its age alone. If it is older, but the critical parts have been modernized and the building has been maintained properly, the age should not be a factor. Two areas may be affected by the age of a building. One is the rate and the other is the type of coverage being offered. Rates can vary by the degree of exposure to loss. A 40- year-old house which has not been modernized is ordinarily more susceptible to fire losses than a five-year-old house, and the rates can vary. Value of Buildings It is imperative that underwriters determine the approximate value of buildings before writing property insurance. Securing the proper insurance-to-value ratio is the key to the profitable writing of property insurance. By encouraging property owners to insure property for close to its full insurable value, the insurance company increases the overall amount of insurance purchased across its portfolio. As a result, the insurance company is able to offer a lower premium rate to consumers while maintaining higher overall profitability by expanding its customer portfolio. A coinsurance clause helps to discourage the customer from under-insuring property. The coinsurance clause provides that the insurance company pay a reduced benefit on a claim if the amount of insurance carried by the insured is less than a required amount stated in the policy. This amount may be 100% of the replacement value of the property or some lesser percentage. Under many homeowners policies, insurance companies require that the property is insured for no less than 80% of the replacement cost. As a result, underwriters will not write a policy for less than 80% of the replacement cost. This may present a problem for low-income applicants who cannot afford the premium on 80% of the replacement cost of the property. This underwriting guideline has come under criticism from parties who believe that the insurance company is arbitrarily denying coverage to low income consumers. As a result of the impact on profits, underwriters do not want to write a policy for less than 80% of replacement cost. At the same time, there is strong pressure to offer homeowners coverage to all people who desire that coverage, as the practice is viewed as unfair discrimination toward low income consumers. As an answer to this criticism, the insurance industry has worked to develop a homeowners policy that does not contain the replacement cost provision; instead, structures can be insured for actual cash value. An actual cash value homeowners insurance policy includes basic coverage of fire, extended coverage, vandalism and malicious mischief, burglary or crime coverage, and liability coverage. The policy provides replacement cost coverage on partial losses up to the actual cash value of the covered property. Even under an actual cash value policy, there still may be a conflict between the insurer and the consumer regarding the minimum amounts of insurance which must be written. Reasonable minimum amounts must be agreed upon because minimum amounts of premium are needed to cover expenses, and there is a point below which property is simply uninsurable other than in a specialty market. A strong tendency exists for underwriters to keep pushing the minimum amount of insurance upward. As building costs increase, the cut-off point for desirability rises; values rise with building costs. Some people feel that special handling should be taken with owners of small or low-valued homes so as to be accommodated in the regular market. Underwriters should resist the tendency to set ever-increasing minimum values and should try to offer insurance to most risks. Rates and minimum premiums may need to be raised if the statistics justify this action, but acceptability should not be affected. The value of a building, above a reasonable minimum, should not be a factor in underwriting. The risk should be eligible, and acceptability should be based on other factors. Just as the underwriter tries to avoid under-insurance, they must also avoid over-insurance in order to reduce or eliminate the temptation for arson. This can be accomplished only by an inspection of every structure on which there is any suspicion that the amount of insurance requested is in excess of the value. Occupancy of Buildings Underwriters are justified in considering the occupancy of buildings in determining whether to write a policy, provided the considerations are based on fact and are not arbitrary. Dwelling risks with commercial types of occupancies present different characteristics than those with only residential occupants. Some of these business pursuits may have little impact on desirability, but others can substantially increase the chance of loss. Underwriters who have identified the differences and who feel that some exposures are greater than appropriate can consider these occupancies as unacceptable. Little criticism can be expected by the underwriter if the rules are based on objective factors. However, a preferable course of action would be to accept the risk and charge a higher premium if this can be accomplished. Tenant-occupied dwellings may well require different rates than owner-occupied dwellings. As for acceptability, there may be reasons for refusing to write a policy on tenantoccupied property; for example, if theft losses on such occupancies are higher than justified by the rates typically used to handle the exposure. The problem with underwriting rules regarding types of occupancy is that they may appear to actually be based on other factors, such as the location of the neighborhood in which the property is located. Still, rules regarding type of occupancy generally are satisfactory if based on actual experience and if applied uniformly to all such risks. Vacancy can be a problem in both personal and commercial risks. Extended vacancy of a building can lead to deterioration, vandalism and a temptation for arson. Underwriters are justified in rejecting applications for insurance where extended vacancy exists at a property. This action is even permitted by state regulatory plans where very few underwriting criteria are allowed in order to protect high-risk insurance consumers and high-risk properties. However, this rule must be tempered with reason, and no declination is justified if the vacancy is for a limited time only between changes of occupants Real Estate Institute 40

47 EVERYONE NEEDS INSURANCE Commercial risks must be written on the basis of occupancy. Nevertheless, this should just be the starting point. Almost all occupancies can be improved by the use of protective measures. The blanket listing of occupancies as being unacceptable, without consideration of the individual risk characteristics, can only lead to criticism and more regulation. It would be much better for underwriters to try to find a means of accepting every applicant rather than to exclude some risks by type of occupancy alone. This approach means that more inspections will be needed along with a careful preparation of recommendations and verification that they have been completed. If reasonable and necessary improvements are not made, the underwriter will not be forced to accept the risk. But if substantial compliance with recommendations is verified, the risk should be accepted. Rates may need to vary by occupancy, but the insurance should be made available. The use of protective devices can be encouraged by underwriters. Underwriters should require alarms, dead bolts, barred windows or other devices where these devices will improve borderline risks. Underwriters should consider the actual occupancy of each applicant and the problems associated with that commercial occupancy. Inspections may be required to secure all of the necessary information, although detailed information may already be available from local insurance services offices which hire inspectors and engineers for that purpose. Recommendations for improvements should be made, but only where needed and never on an indiscriminate basis. The conditions and hazards of each risk should be analyzed, and the insurance should be written if a means could be found to do so. Only in this way will underwriters discharge their duties to both the public and to their companies. Neighborhood Insurance practices based on risk location must change. If revisions are not made voluntarily, they will be mandated by government decree. Both risk selection and rating will be affected. The unethical practice of underwriting discrimination based upon risk location is referred to as redlining. More specifically, redlining has been referred to as a practice which results in significant fair or unfair geographic discrimination in terms of rates, extent of coverage or availability of coverage. Whatever reasons underwriters use to explain subjective selection based on geographic location, the public and the regulators simply will not tolerate the practice. Selection must be based on the characteristics of the risk itself, not the neighborhood. This approach must also extend to the evaluation of producers to be employed by insurance companies. A company should not refuse to appoint a producer because of the latter s office location or the location of his or her customers. Existing producers should not be terminated or restricted because of location either. Age of Insured Underwriters have long felt that since accident frequency of youthful drivers, as a class, is considerably above the average, special attention should be given to all members of that class. Young people have been driving only a relatively short time; too brief a period to have established their own patterns. Individuals may have good driving records, but this may stem from their limited access to an automobile and to careful driving because they know they are being watched. The only safe approach is to limit acceptability of the class members and to charge higher rates to all of them until they have reached enough maturity to establish their own driving patterns. Elderly drivers have been viewed in much the same fashion as youthful operators. They are mature and have demonstrated their method of driving, but some loss of ability is common as a person ages. Again, the uncertainty concerning the class is present. Knowing that some persons lose some of their driving ability above age 68 or 70, underwriters tend to reject all such applicants. In some instances this practice has continued even while actuaries have determined that elderly drivers are better than the average driver, and reduced rates have replaced the former surcharges. Individuals in both of the aforementioned groups argue that they should be evaluated on their own performance. They resent being grouped with other drivers of similar ages, some of who have poor driving records. Sex Underwriters have been having difficulty in adjusting to the concept of ignoring sex in both selection and rating. Statistics have seemed to support different rates and selection patterns by sex, particularly in youths. Even though some later statistics appear to erase many of the differences, these statistics are not yet concrete enough to convince underwriters to change voluntarily. Where statistics are credible and irrefutable, insurers may be able to use different classifications for a time, although this may disappear in the near future. Where data is not so certain, underwriters should probably drop all consideration of these factors; any continuation under these circumstances will only lead to further laws and regulations with respect to underwriting. Marital Status Marital status virtually has been eliminated as an underwriting factor. This factor is expressly prohibited in many states. In addition, single, separated, widowed and divorced persons represent such a large share of the market that the industry has determined that any underwriting rejections based solely on marital statuses would cause considerable harm to the insurance policy sales. Occupation The occupation of the applicant is not considered to be a valid selection factor. Its use is prohibited in some states. In other states, the trend is the same, and most observers agree that a reasonable approach to underwriting requires that occupation not be used as a selection device. This is not to say that occupation must be completely ignored. It might be a clue to other factors which should lead to rejection of the application. The occupation may indicate a risk which needs to be investigated in certain respects in order to determine acceptability. The characteristics of the individual applicant should be the guide, not the occupational group in which the applicant falls. If some occupations are marked by certain undesirable traits in many cases, the individuals who bear those traits may need to be rejected. On the other hand, those who do not show those traits should not be rejected simply because they work in that occupation. Specific examples, using traditional groups, illustrate the practices which should be used. Travel. There is no doubt, that some people who travel extensively are more exposed to theft and loss than normal. This increased exposure can be caused by the merchandise carried, the type of transportation used, the geographic area traveled, the type of living quarters used while traveling and the attitude of the applicant toward protecting property. If an applicant has a history of losses because of these characteristics, the application may need to be rejected, or limited in perils or by deductibles, because of those losses. In such cases, the underwriting action is taken because of loss history, not the occupation itself Real Estate Institute 41

48 EVERYONE NEEDS INSURANCE An applicant who travels in the course of work but who has not had any such losses is apparently not subject to these adverse traits exhibited by others. A good loss history can be due to many factors. If such is the case, an individual should not be rejected on the basis of the occupational hazards. Each individual applicant should be underwritten on other aspects of loss exposures, not just the fact that travel is an inherent part of the occupation. Transients. Exactly the same type of approach should be used during the underwriting of applicants whose occupations are historically considered to be held by transients. Many of these people are in the restaurant, hotel and other such service based industries and may drift from job to job, but many others are just as steady as office workers. Most of the potential underwriting problems of people in these occupations can be specifically identified. Excessive usages of alcohol or drugs, high incomes that attract lawsuits and poor premium payment records are major concerns. Each of these may be justification for taking underwriting action. When a person in one of these transient-type occupations is found to present a specific problem, action should be taken on that basis. On the other hand, if an individual applicant does not present these problems, action should not be taken solely because of occupation. The emphasis should be on the individual characteristics of the applicant, not on the general characteristics of the group in that occupation. Other factors. The same type of handling is desirable on applicants in other occupations. Military, students, ministers and other groups which concern some underwriters, can include both acceptable and unacceptable risks. The underwriter should get the facts about the specific qualities of each applicant and make a decision on that basis, not on the occupation itself. Illegal activities are the exception. No government agency would require the writing of insurance on known illegal activities. Where the facts show that the applicant is engaged in such activities as smuggling or maintaining a house of ill repute, rejection is the only reasonable course of action. Stability An applicant s stability is not a reliable underwriting factor without further clarification of the term. Factors which indicate stability or instability must be used carefully, as some may be prohibited by law or common practice as underwriting factors. Some of these are discussed in other sections, such as marital status and occupation. Other factors which are sometimes applied are the period of time on the job or in the area, the number of jobs or addresses during recent years (such as five years) and transient types of living quarters (hotels or motels, for example). Underwriters can use such factors if they can prove that the chance of loss is increased in such cases. Some companies may have statistics on policyholders with hotel or post office box addresses. With adequate proof of an impact on losses, such rules can be used. Without statistical proof, underwriters should not use these stability factors as primary selection rules. However, information on these items can be gathered because they might point to other types of problems. Tenants may offer particular problems. The loss ratio on tenants homeowner policies may be worse than for policies which insure the dwelling as well as contents and personal liability. If certain groups of tenants can be identified as being worse than the average, such as those who have lived in four or more locations during the past five years, this could be used as a selection factor. In the absence of such specific statistics, rate adjustments are a more logical solution than merely assuming that all tenants are unstable. Commercial underwriters could justify the use of a years-inbusiness rule for acceptability, based on statistics showing failures and bankruptcies. Such an arbitrary rule, particularly if it is longer than one year, will restrict sales and may be considered unreasonable. It would be preferable to use this as a guide, but to look at the work history and experience of the applicant in making the final decision. Social Maladjustment The involvement of applicants with such social agencies as welfare and public health clinics may be statistically proven to increase loss frequencies. However, this factor should never be used as a sole reason for taking underwriting action. As with other factors, this type of involvement may indicate other problems. When such is the case, action may be required because of these other factors. Underwriters should disregard any apparent social maladjustment in applicants, especially if this is indicated by contacts with social agencies, unless other adverse factors are present. Attitude Underwriters are interested in every factor that may affect the chances of loss involving applicants and policyholders. Thus, underwriters could be expected to use study results which show that certain attitudinal characteristics have been present in a large number of fatal accidents. The use of these characteristics has not been prohibited. At the same time, underwriters should be aware that abuses of a factor such as this could lead to restrictions. Underwriters wanting to use the attitude of the applicant as a selection tool will have difficulty in securing accurate information. An investigation report is virtually the only source which can be used to underwrite prospective new clients. With these reports, there is always the danger of a personality clash between the investigator and the applicant or a set of circumstances which the investigator might read incorrectly. A neighbor may bear a grudge toward a person and will accuse that person of belligerence or argumentativeness. Caution must be exercised in using information secured from a single source when it involves a factor of this type. Information on existing policyholders may be secured from claims reports. This may be the best source to learn about attitude because it is at the time of a loss that verbal accusations, negativism, belligerence and similar traits are most likely to be revealed. The potential problem of a personality clash is present here too, so care must be taken in using this information. When adverse attitudes have been verified, underwriters may take action on that basis. They must realize that such a decision is subject to challenge and perhaps reversal by a regulator. On a case-by-case basis though, this factor may be very relevant and defensible. Too much use of this factor can lead to problems. Taking action on borderline cases, or without proper verification, could cause regulations to be imposed. Therefore, this characteristic should be employed only in serious cases, and then only with other types of problems which indicate the desirability of underwriting actions. Criminal Record Underwriters who become aware of an applicant s criminal record must give serious consideration to this factor. Certain types of past criminal activity, combined with the temptations and opportunities of many lines of insurance, could substantially increase the chances of loss. On the other hand, other types of past criminal activity may have no relationship to the exposures of a particular line of insurance. Where this is the case, no underwriting action is justified Real Estate Institute 42

49 EVERYONE NEEDS INSURANCE The individual circumstances of each case are extremely important. The date of the crime may govern; a conviction for car theft by a youth may not be relevant to the exposures when that person has grown to middle age. The type of crime may be important; assault and battery may be no problem for fire insurance but critical to automobile insurance. A record of petty theft or shoplifting may not concern an automobile underwriter but may be very important to a commercial underwriter. In every case, the underwriter must secure all of the relevant factors when a criminal record is discovered. This factor may justify a rejection. Many cases, however, will not be affected by this factor, and no action is warranted. Where circumstances do not call for underwriting attention, a setting aside of this information will both help sales and assist in keeping outside restrictions to a minimum. Mental Incompetence Underwriters cannot ignore evidence of mental incompetence of applicants. This condition can be very serious, particularly while driving a car. The pressures of driving, or even of living under many conditions, are great enough for normal people without adding the extra factor of mental instability. This condition is difficult to measure. There are many degrees of incompetence. Some people can respond to treatment, resulting in complete recovery. A blanket approach is not valid. The facts of each case must be obtained. When they indicate a non-harmful degree of incompetence, or a full recovery, the factor may be ignored. When the facts indicate potential problems, careful consideration must be given. All of the available facts about each such case must be analyzed. The decision must be based on these facts, whether to accept or reject. When care is taken, and the decision is based on a careful weighing of the facts, underwriters can expect support for their actions, rather than criticism. Physical Impairments Studies have shown that physically handicapped drivers are generally no worse than average drivers. In many cases, they are better. In the face of these indications, underwriters must abandon their long-held impression that driving problems are expected when insuring applicants with physical impairments. Where laws prohibit the use of these factors in the selection of risks, naturally these laws must be followed. In other states, judgment must be used, but with consideration of each individual case, not a blanket refusal to write such applicants. The only line of property/liability insurance in which the physical condition of the applicant has been used by underwriters is automobile insurance, both personal and commercial. The problem, then, is to determine those characteristics which actually affect driving ability. Different types of disabilities can offer different types of concerns for underwriters. Orthopedics. The orthopedic group includes those physically handicapped persons who do not have use of one or more extremities because of loss, paralysis or serious deformity. The underwriter may need to secure and verify additional information about these disabled drivers. Medical. Physical impairments which might be called medical or seizures include heart ailments, diabetes, and epilepsy. Although studies have not been detailed on each of these, indications are that these persons generally have better driving records than the average. This means that underwriters are not justified in automatically rejecting applicants having these conditions. At the same time, underwriting is concerned with individual applicants, and some persons having these impairments may be subject to driving problems. Doctor statements can be particularly helpful to the underwriter in these cases. Hearing impairments. There are many types and degrees of hearing impairments. Most people with hearing impairments can hear traffic noises, often with the use of hearing aids, even though many of them cannot distinguish words. It is this ability to hear traffic sources that is crucial to automobile underwriters. Studies conducted in some states have indicated that people with impaired hearing are better drivers than the average. Other studies have arrived at the opposite conclusion. There is only one-way to for the underwriter to reconcile these conflicting reports; underwrite on an individual basis. Undoubtedly, some hearing impaired people are excellent drivers while others have poor driving records. This is the same as for any other group. A blanket rule for all members of a group simply does not fit. Impaired sight. Different degrees of impaired sight also are found in the population. Many drivers wear glasses and most of these drivers enjoy adequate correction to permit normal living. Fire insurance, health insurance and other lines probably should not apply underwriting selection because of total or partial blindness, unless actual experience indicated that such action is justified. Some states have adopted laws or regulations which refer to the physically handicapped or the partially sighted. These terms would apply to impaired sight unless specifically excluded. Where these controls are in effect, underwriters must not use these factors in the selection process, of course. In other states, each individual applicant should be considered on the merits of the case. Serious impairment of sight could be justification for refusing to write automobile insurance, but it seldom would be justified on other lines. If the impairments are not serious, the applicant should be accepted. Alcohol and Drugs Underwriters are justified in being concerned about the use of alcohol and drugs by drivers. Studies have indicated that usage is increasing and is a contributing factor in accidents. Alcohol is estimated to be involved in roughly one-half of all highway fatalities, according to various surveys conducted by the National Safety Council and others. Drugs are being identified as a factor in an ever-increasing number of accidents. The picture is not yet clear as to the volume of cases involving only drugs or those involving both alcohol and drugs. Foreign Born The national origin or ancestry of an applicant should not be a cause for rejection. Both laws and the present climate prohibit taking underwriting action because of this factor. Most applications for insurance no longer request information on national origin or ancestry. Seldom do they request answers concerning the ability of the applicant to read, speak or understand English. In spite of suspected underwriting problems because of these deficiencies, the information simply is not available on most new submissions. However, these facts will come to the attention of underwriters in some cases. Producers concerned about a language deficiency might add comments to applications. Often, a claim will reveal the problem, and the adjuster may point this out to the underwriter. Where language or comprehension difficulty is discovered, the underwriter should not take action solely on that fact. This is prohibited in many states and would be criticized in others. At the same time, this information does not need to be ignored. Further investigation might be conducted to Real Estate Institute 43

50 EVERYONE NEEDS INSURANCE determine if there are other potential problems. Some persons with language difficulties may be found to have poor driving records, whether related to this factor or not. Other problems may also be found and the combination of borderline items may be enough to justify declination or cancellation. Underwriting action should never be taken solely because of the national origin or ancestry of an individual. This factor can be used as one item in the total picture, and may point to other deficiencies which would require action. Related Business Underwriters should no longer require the purchase of other policies with the same company before a requested coverage is written. The economies in investigation and underwriting expenses, and the desire for a more profitable coverage to offset an unprofitable one, simply cannot be justified. Each line should be priced so that it can stand on its own. Current underwriting standards discourage requiring an applicant to purchase additional policies as a condition to approval. Regulators agree that potential insureds have a right to purchase the coverage s they desire, from the companies they desire, without any requirements of related business by the insurer. The requirement may be aimed only at efficiency, but it comes across poorly to applicants. Prior Insurance Underwriters are taught to secure as much information as possible in order to select applicants intelligently. One item of information which was used regularly was the name of the prior insurer, if any. This practice could continue if its only purpose was to verify the accident record from the prior insurer. While some insinuations have been made about exchanges of privileged information and some underwriters feel that the Fair Credit Reporting Act (including related state laws) may prohibit this practice, this is probably a valid source of reliable information. Unfortunately, it is difficult for underwriters to ignore other facts which reach them. If the prior insurer is a substandard writer, an underwriter may find it difficult to overlook this. If no insurance is reported to have been carried, it is a natural tendency to wonder if something is being hidden. This related use of the information that arouses suspicions among regulators. Underwriters have only two possible paths of action in such cases. Use the name of the prior insurer only as a means of securing facts about the losses which have occurred and disregard all other possible uses of the information. Underwriters should not even request data about the prior insurer. Prior Cancellation In the previous section, it was indicated that underwriters might want to continue to secure specific information concerning a prior insurer. Regardless of most information, it is obvious that no action should be taken solely because of a previous rejection or cancellation. Severe criticism will result from underwriting decisions based solely on the actions of others. Underwriting rules are presumed to be different by company. One of the quickest ways to arouse antagonism is to reject or cancel coverage solely because another underwriter took similar action. This does not mean, however, that an underwriter should ignore the actions of prior insurers. In fact, this may be the most valuable item of information which is secured by finding out about the previous insurer. This factor is one of the best examples of how balanced underwriting can be practiced. The secret is how underwriters use the information that a prior insurer had obtained to reject or cancel the coverage. The wrong course is to automatically reject the applicant. Not only will this bring down the wrath of regulators, it may also cause the rejection of some business which would be perfectly acceptable since insurers aim at different sectors of the market. The right course is to use the fact of a prior cancellation as another warning flag. A smart underwriter will immediately start to secure more information about the applicant. Such investigation may reveal a poor driving record or other such factors which would be adequate cause for rejection. This last factor to be discussed, the rejection or cancellation by a prior insurer, is a good illustration of how underwriters can continue to select risks under the watchful eye of governmental regulators. Factors which have caused concern to underwriters in the past, need not be ignored. However, they should not lead to a blind reaction based on past practices. Rather, these factors can point out the need for the securing of more facts before accepting an applicant. Then, based on complete information, a decision can be made which complies with the laws and regulations and still senses the needs of the company and the public. Conclusion As an insurance producer, you are likely to be asked significant questions by your customers regarding the underwriting process and the likelihood of your customer obtaining a policy. The preceding description of the multitude of issues involving property and casualty underwriting should help you identify many of the concerns which can be expected from customers. Underwriting will continue to evolve in a manner which balances fairness with the profittaking nature of the business of insurance Real Estate Institute 44

51 EVERYONE NEEDS INSURANCE CHAPTER 4 LIFE INSURANCE Having already examined automobile insurance, homeowners insurance and personal property insurance and the underwriting issues associated with those property and casualty policies, we now turn to a discussion of life insurance. Many individuals will turn to his insurance producer for advice regarding the sensitive subject matter of life insurance. While customers may be hesitant to discuss the purchase of an insurance policy which contemplates their demise, life insurance is one of the most important products which an individual must consider obtaining in order to provide financial security to loved ones. The Life Insurance Policy Life insurance is a contract between an individual and an insurance company. In this contract, the insurance company agrees to pay a stated amount of money to a beneficiary, under certain conditions, in exchange for a sum of money called the premium. It is important that you understand that a life insurance policy, like any other insurance policy, is in fact a legal contract. In other words, it is an agreement between the parties that the insurance company shall perform in exchange for the premium that is paid to the company. Uses of Life Insurance Life insurance is primarily used to function in personal and family situations. As a rule a person s death creates an immediate need for money. The following is a list of some of the needs that might be created from a person s death. Expenses created by final illness. Burial and funeral expenses. Debts that are due at time of death. Costs to administer the estate. Federal and state death taxes. Inheritance taxes. Money may also be needed to provide for the following: Payoff mortgages or purchase a new home. Provide an education for children. Meet unexpected financial needs. Life insurance can also provide benefits for business situations. Here are a few examples: Loss caused by death of a key employee. Collateral for loans. Buy-out of the business interest of a deceased owner. Fringe benefits for employees. Life Insurance as a Property Very few people consider the fact that life insurance is a property. Where else could an individual make a premium payment of $100, and create an immediate estate or property valued at $250,000? Of course, that is possible with life insurance. Here are some advantages of life insurance as property: As an asset it is very secure. There is no managerial care required for the property. It can be purchased in any desired amount. It provides a reasonable rate of return. Proceeds are payable immediately upon death of the insured. The insured chooses the method of payment for premiums. The Life Insurance Application Three Parties to an Application A life insurance application contains three parties: The Proposed Insured. This is the person whose life is being insured by the life insurance policy. The Applicant. This is the person that is making application to the insurance company for the life insurance and may or may not be the proposed insured. The Policyowner. This is the person that usually pays the premiums and the person who retains all rights to any values or options contained in the policy. The great majority of policies are issued on the application of the person to be insured who is also the owner of the policy. In the typical situation, the policyowner, the applicant, and the insured will be the same person. There are, however, many policies issued where someone other than the insured applies for and owns the policy. The situation in which someone other than the insured is the policyowner is referred to as Third party ownership. This type of arrangement is often found in family situations where, for example, a wife will insure her husband, or vice versa, or a parent will insure children. Third-party ownership is also often found in business situations, where a business insures the life of a key employee, for example. Another common third-party ownership arrangement is where a creditor owns a policy on the life of a debtor. Insurable Interest For a life insurance policy to be issued, an insurable interest between the insured and the policyowner must be present. In this regard, it is necessary to examine insurable interest from two standpoints. First, we ll look at the situation in which a person applies for insurance on the life of another. Then, we ll look at insurable interest when a person applies for insurance on his or her own life. We will examine the conditions that must be present to satisfy the insurable interest requirements in each of these situations. Again, to purchase life insurance on the life of another, an insurable interest in the life of the proposed insured must exist. The policyowner must benefit, either emotionally or financially, by the insured continuing to live. Generally, for an insurable interest to exist, the potential emotional loss must arise from love and affection which grows from a close blood relationship, or marriage. And, of course, where one s own life is concerned, each person has an unlimited insurable interest in his or her own life. Suppose that a life insurance policy could be sold when no insurable interest requirements existed. If a person could apply for insurance on the life of another without this interest, then the policyowner would stand to gain, and suffer no emotional loss, by the insured s death. As such, a life insurance policy would constitute a mere wager which would be clearly against public policy, and therefore illegal. An insurable interest may arise out of a close blood relationship, but being the relative of a potential policyowner does not automatically establish an insurable interest. For example, under most circumstances, a person would probably find it difficult to establish an insurable interest in an aunt, uncle, or cousin unless the policyowner could show that a significant financial or emotional loss would result upon the death of the relative. There is another important aspect of insurable interest; the relationship between a policyowner and a creditor. This relationship brings about another type of insurable interest. A creditor can establish an insurable interest with a debtor. For instance, assume a bank loans $5,000 to an individual. Obviously, the bank will suffer financially if the debtor dies before the loan is repaid. This fact establishes the insurable interest between the bank and the debtor. For this reason, the bank can purchase life insurance on the life of the debtor and receive the death benefit of the life insurance policy, but only in an amount which reflects the balance of the unpaid loan, should the debtor die prior to repaying the loan. Insurance purchased by a creditor on the life of a debtor must be in an amount that approximates the size of the debt. So, if a debtor owes a creditor $1,000, the creditor could not Real Estate Institute 45

52 EVERYONE NEEDS INSURANCE purchase a $10,000 life insurance policy on the life of the debtor. For this reason, most credit life insurance purchased on the life of a debtor has a reducing death benefit, which keeps pace with the diminishing loan balance. Therefore, if a debtor owes $5,000 to be repaid over a period of five years, the death benefit might begin at $5,000 to match the original amount of the loan. However, this policy would eventually reduce to $0 at the end of five years when the loan has been repaid. The Application Form In order for a person to purchase life insurance they must make a request to the insurance company of their choice. The form on which this request is made is the application. Most companies now require that the proposed insured be physically present in front of the agent while the questions on the application are answered. The application is crucial in that it provides the data that the underwriters and insurance company will use to determine whether to issue a policy. The application is a life insurance company document containing questions and information, which the company uses in evaluating the insurance risk and in properly preparing the policy if one, is issued. The agent completes the application by asking the applicant the questions. The information requested on the application generally includes items such as the applicant s full name and address, age, sex, marital status, occupation, medical and family histories, present physical condition, and a description of the type and the amount of insurance applied for. It also includes the name of the person who is the beneficiary of the insurance along with data on other insurance owned and applied for, as well as whether or not the applicant was ever refused life insurance. In view of the importance of the application, it is essential that the application be completed fully and accurately. If the application is incomplete, the underwriting process and policy issue will be delayed until the necessary information is obtained. The company depends upon accurate information to make a proper evaluation of the proposed insured. When the proposed insured signs the application, it constitutes a formal request to the company that a policy be issued on the proposed insured s life. In addition, the signature on the application indicates that the information is true and correct to the best of the knowledge of the proposed insured. Minor Applications In most states a person is not considered an adult until the person is 18 years of age. As a rule, minors are not permitted to enter into contracts. However, life insurance is the exception in that a person is a minor only until age 15. In the event that the proposed insured is younger than age 15, one of the following persons must sign the application on behalf of that child: The mother or father. A court appointed guardian of the minor. The child s grandparent. Correcting Applications Should it be necessary to correct a mistake regarding information given on the application, the proposed insured must initial any and all changes on that application. Mistakes on the application can be costly especially when the company is usually paying an outside reporting service to conduct an inspection. Any changes that are made on a completed application must have the approval of the proposed insured. The normal procedure is to return the incorrect application to the agent who in turn will take it to the insured to have the corrections initialed. Incorrect or Incomplete Applications Should an application contain incorrect or incomplete information it should not be taken lightly. In the event that the company has already made a decision on a risk based on these inaccuracies, it could result in a serious loss. If the error is discovered after the issuance of a policy, the company can cancel or rescind the entire contract from the date of issue. Of course, this must take place before the incontestability clause of the contract takes effect. The incontestability clause provides a date after which the insurance company cannot contest the information in the application. Representations and Warranties All statements on applications are regarded as representations. When a person makes a statement that person believes to be true, the person is in effect making a representation of the truth. While it is possible that a representation may be found to be untrue, a person who makes a representation believes it to be true. A warranty on the other hand is a statement made with such absolute certainty that it is guaranteed to be true. No statement on an application is considered a warranty. A false representation can be defined as a misrepresentation. Fraud There are three elements necessary to constitute a fraud. They are: A person makes an intentional misrepresentation of what is known to be a material fact. The person has intent to gain advantage from the misrepresentation. A person relies upon that misrepresentation and suffers a loss. Concealment Concealment is closely akin to misrepresentation when it comes to information included on a policy application. While misrepresentation as stated earlier is something known to be untrue, concealment is withholding of facts that the applicant should have given to the insurance carrier at the time of application. Conditional Receipt It is best to always collect the first full premium from the applicant at the time of application. The receipt that is located at the bottom of the application is called a conditional receipt. The word conditional is very important because the agent is not guaranteeing that the policy will be issued. Issuance of the policy is subject to the full approval of the insurance carrier. The conditional receipt serves two functions: It acknowledges the first full premium. It states in very clear terms that the policy acceptance is subject to the approval of the carrier. In the event the proposed insured dies before the policy is issued, the premium will be returned to the beneficiary. Policy Effective Date / Backdating Full protection takes effect as of the policy effective date. The policy effective date is the date on which the contestable period begins. The policy effective date also is the date on which the suicide clause in the life insurance policy begins to run. The suicide clause provides that a beneficiary will not be paid a benefit under the life insurance policy if the insured commits suicide within a certain period of time following the policy effective date. Policies can be backdated a certain number of months. As a rule, the maximum is to backdate six months. Most companies allow backdating for sales reasons. For example: Real Estate Institute 46

53 EVERYONE NEEDS INSURANCE Often, backdating can save an age by one year for the proposed insured and this can result in a lower premium for the proposed insured. Backdating is useful to assist the policyowner in coordinating dates to fit their income pattern. Perhaps the backdating may change the policy premium due date to closely match payday. Occasionally some policy forms have minimum and maximum age limits and backdating may help to put the applicant s age within the window of acceptable age limits. How Much Life Insurance Do I Need? As an insurance agent, you will undoubtedly be asked the question: How much life insurance do I need? This is an important question to answer because the majority of families in America are inadequately insured. As a general rule it is said that a person should carry life insurance equal to five or six times their annual earnings. Types of Life Insurance There are many types of life insurance available. We will discuss the following: Term insurance. Whole life insurance. Universal life insurance. Variable life insurance. Adjustable life insurance. Modified life insurance. Family life insurance. Term Insurance This is the most basic type of life insurance. Some of its characteristics are as follows: Term Insurance provides only temporary protection from one to twenty years or until the insured reaches a specified age. Should the insured be alive at the end of the term period the protection expires. Term Insurance has no cash value or savings element. It is strictly pure protection. Term Insurance can be renewable and/or convertible. Renewable means that you can continue the coverage for additional periods without proof of insurability. As a rule, the premium increases each time the policy is renewed based on the age of the insured at the time of renewal. Convertible means that the term policy can be exchanged for some type of cash value insurance without proof of insurability. The premium for a term insurance policy is based on a person s age, health, whether or not he or she smokes and the amount of coverage. Term insurance premium prices are easier to understand than other life insurance policies. One simply pays a specified price for each $1,000 of death benefits. Term Insurance comes in a variety of policies. These include: Yearly renewable term. This type of policy is issued for a one-year period and the policyowner has the right to renew coverage for successive one-year periods. If term insurance is not renewable, the company selling the policy can require a medical examination when each period begins. Five, ten, fifteen or twenty year term. Although a one-year term is the least expensive, term insurance can be purchased for a specific period such as five, ten, fifteen or twenty years, and in some instances even longer periods. The premium remains level during the policy term, and the premium will increase if the policy is renewed at the end of the term. Term to age sixty-five or seventy. In this instance the term insurance is provided to a stated age. The premium remains level during the policy term and the insurance expires when the stated age is attained. As a general rule, the insured has the right to convert this term insurance to a cash value policy; however the policy must be converted sometime prior to the expiration date. Decreasing term. With a decreasing term policy, although the premiums remain level during the policy term, the face amount of insurance gradually decreases over time. For example a $100,000 policy issued for a decreasing term of 30 years could decline to $50,000 by the end of the twentieth year and zero by the end of the thirtieth year. Re-entry term. With this policy the premiums are based on a low-rate schedule. Under the terms of this policy, however, the insured must repeatedly demonstrate evidence of insurability, usually every one to five years. Whole Life Insurance Whole life insurance is so named because it lasts for the insured s whole life. The premium stays the same forever. Critics of whole life state that the policyholder overpays for that protection during the younger years of the insured, which would negate the savings during later years. Whole life insurance contains the basic elements of term insurance, with an investment element added. The insured pays a premium amount greater than the premium which would be paid for term insurance, and that portion of the payment is invested for accumulation over the life of the insurance policy. The growth on that investment is not taxable to the insured. This favorable treatment of return on investment is unique to life insurance and offers a substantial wealth accumulation vehicle. Traditional whole life is different from term insurance because it offers both protection and cash value. With a whole life policy, the cash value builds slowly. Life insurance companies stress it as a positive for its value as a savings account. Cash value is money that would be paid to a policyholder when the policy is surrendered. This is sometimes called the surrender value of the policy. With whole life, part of the premium buys the insurance, and part goes toward the cash value. This interest is tax-deferred and remains tax free if a person never utilizes the cash value before his or her death. Some examples of whole life insurance include: Ordinary life insurance. Ordinary life insurance is a form of whole life insurance. Lifetime protection is provided until age 100 and the premiums remain level. In the event the insured is still alive at age 100, the full-face amount will be paid without death having to occur. Limited payment life insurance. This is another form of whole life insurance. Although the premiums are level, they are only paid for a certain number of years. After that payment period the policy becomes fully paid up. Limited-payment policies can be issued for ten, twenty or thirty years. A policy that is paid up at age sixty-five or seventy is also available. The premiums for limited-payment policies are higher than an ordinary life insurance policy but the cash value is also higher. Endowment insurance. This is the third basic type of whole life insurance. An endowment pays policy proceeds to the named beneficiary if the insured dies within a certain period. If the insured survives to the end of the stated period, the policy proceeds are paid to the policy owner Real Estate Institute 47

54 EVERYONE NEEDS INSURANCE Universal Life Insurance This variation upon whole life insurance became extraordinarily popular after its introduction. Universal life policies are sold as investments that combine insurance protection with savings. Actually, a universal life policy can be defined as a flexible premium deposit fund that is combined with monthly renewable term insurance. Here s how it works: FIRST An initial specific premium is paid. Then expenses are deducted from the gross premium and the balance is credited to the policy s initial cash value. SECOND A monthly mortality charge is deducted from the cash value to pay for the pure insurance protection. FINALLY The remaining cash value is then credited with interest at a specified rate. Universal Life has the following basic characteristics: Protection, savings, and expense components are separated. There is a stated investment return. The plan offers considerable flexibility to the insured by permitting the insured to increase or decrease the premium and the corresponding death benefit during the life of the policy. Cash withdrawals are permitted. In some states, universal life is referred to as flexiblepremium adjustable life. This describes many of its benefits. Universal life can be a useful tool to meet changing needs. It can also be useful if one s income fluctuates from year to year. A person can vary his or her premium if he or she has a year with lower income. When someone varies his or her premium, the death benefit will fluctuate along with it. Universal life offers tax advantages to the insured because the investment value grows without current taxation. The tax on the interest is deferred while the policy is in force and until the funds are withdrawn. Variable Life Insurance With a variable life insurance policy, the face amount of insurance varies according to the investment experience of a separate account that is maintained by the insurer. This is the perfect solution to the problem of inflation quickly eroding the real purchasing power of life insurance. Under the variable life insurance policy the premiums are invested in equities or other investments. Should the investment experience be favorable, the face amount of insurance is increased. However, should the experience be unfavorable, the amount of insurance is reduced. In no event, however, can the amount of insurance be reduced below the original face amount. The variable life insurance policy was designed to maintain the real purchasing power of the death benefit. Variable life is not just another name for whole life. Variable life combines many features of traditional whole life with the new element of investment choice. That element is for the insurance purchaser who can live with elements of risk. Along with the freedom of choosing one s own investments comes the inevitable risk. Variable life insurance can offer higher investment yields than a traditional whole life policy, but one must assume a greater degree of risk. Variable life might be justified if the minimum death benefit guaranteed by the policy satisfies a person s needs, and he or she can afford to play with the policy in the hopes of achieving a better-than-average return for his or her family. Adjustable Life Insurance This variation on the whole life policy permits changes to be made in the following areas: Amount of life insurance. Period of protection. Amount of premium. Duration of premium-paying period. This type of insurance is frequently called Life Cycle insurance because policy changes may be made to conform to different periods in the insured s life. Within certain limits, the policyowner can make the following adjustments as the situation warrants: Reduce or increase the amount of insurance. Shorten or lengthen the period of protection. Increase or decrease the premiums paid. Lengthen or shorten the period for paying of premiums. A cost of living provision can also be attached to the adjustable life policy and this will in fact maintain the real purchasing power of the insurance. Modified Life Insurance This is a type of life insurance policy in which the premiums are reduced for an initial period of three to five years and then the premiums increase thereafter: The initial or reduced premium as paid in the beginning is slightly higher than term insurance rates but substantially lower than the premium paid for an ordinary life policy issued at the same age. There are different types of modified life insurance: Under one type the term insurance is used for the first three to five years and then automatically converts into an ordinary life policy at a premium that will be higher than what would have been paid for a regular ordinary life policy issued at the same age. Under another type, the approach is to redistribute the premiums by charging lower premiums during the early years of the policy but higher premiums thereafter. Modified life insurance can be attractive to individuals who expect their incomes to increase in the future. Family Life Insurance This is a variation upon the whole life policy designed to insure all family members in one policy. This policy is sold in units that state the amount and types of life insurance on the family members. One unit for example may consist of the following: $5,000 of ordinary life on the head of the family. $2,000 of term to sixty-five on the spouse. $1,000 of term Insurance on each child up to stated age. As a rule, term insurance under the family life policy can be converted to some form of permanent insurance. Typically the children s protection can be converted up to five times the face amount without proof of insurability. There is no additional premium if another child is born, and newborn children are usually automatically covered after a fifteen-day waiting period. This type of policy is no longer very common. Types of Insurance Companies Having examined types of life insurance policies, we now examine the structure of the life insurance companies offering those policies. Life insurance companies can be organized in several ways; however, most are organized either as stock companies or as mutual companies. Stock Life Insurance Company A stock life insurance company gets its name from its basic ownership characteristic. The stockholders, people who have bought stock in the company, own a stock company. The stockholders may or may not also be policyowners. The sole function of the stockholders is to elect a board of directors who in turn will guide the operation of the company. If the company is successful financially, the stockholders will receive dividends, which are paid for each share of stock owned. A stock life insurance company is in business to make a profit for the stockholders Real Estate Institute 48

55 EVERYONE NEEDS INSURANCE Mutual Insurance Company A mutual insurance company is also a corporation, and it also derives its name from its basic ownership characteristic. Unlike a stock company, which is owned by its stockholders, a mutual company has no stockholders. Control in a mutual company rests with the policyowners who mutually own the company. The policyowners elect a board of directors, and any profits are returned as dividends to the policyowners in the form of reduced costs for insurance. It should be mentioned here that dividends from a mutual company are not profits in the mercantile or commercial sense but rather the return of an overcharge of premium. For example, a mutual life insurance company might sell life insurance at one specific age for $20 per $1,000 of face amount. Once a dividend has been declared, each policyowner might then receive credit on the premium statement in the amount of $2 per $1,000. Thus, the ultimate cost for the insurance is $18 per $1,000 of face amount. While not true in every case, mutual insurance companies usually issue participating life insurance policies. The term participating means that if the company realizes a savings in death claims due to a lower mortality rate, or an increase in the interest earned, or if it realizes some efficiency in its operation which reduces expenses, these savings or profits are passed along to the policyowner in the form of policy dividends. Thus, the policyowner in a mutual life insurance company participates in any savings or profits enjoyed by the company. Insurance agents should not imply to clients that a stock company is better from an organizational standpoint than a mutual company, or vice versa, or that participating policies are better than nonparticipating ones. Both types of companies and both policies are acceptable. Before any life insurance company can sell insurance in any state, it must be licensed to sell insurance or, as it is called, admitted to that state. An insurer that is admitted to a state is authorized to do business in that state. If an insurer is not admitted to a state, it is unauthorized to do business in that state. Fraternal Benefit Society Another type of insurer with which you should be familiar is the fraternal benefit society, also known as a fraternal. A fraternal insurer is a social and benevolent organization, which provides, among other services, life insurance benefits for members. Each state defines and provides for the regulation of fraternal benefit societies in its insurance laws. But, although the exact definition of a fraternal may differ from state to state, an organization usually must have certain characteristics to qualify as a fraternal benefit society. First, the organization generally must exist only for the benefit of its members and of their beneficiaries and be non-profit. Second, it must be organized without capital stock. A third characteristic is that the society usually must be organized on a lodge system. This means that the organization must have local lodges or chapters, which hold regular meetings to carry on the activities of the society. Finally, the organization must have a representative form of government. There must be a governing body chosen by the members directly or by delegates, in accordance with the organization s bylaws or constitution. Government Insurance Programs Government Insurance Programs have been established for a variety of reasons throughout history. Social insurance programs have been created to allow the government to make compulsory a program lacking equity in order to cover fundamental risks and to redistribute income. Government insurance programs have been created when private insurers would have been subjected to adverse selection or were incapable of meeting society s needs. By its administration of various Federal insurance programs, the U.S. government has become the largest insurer in the world. These various programs include Social Security, Medicare, and the railroad retirement, disability, and unemployment programs. Reciprocals Reciprocals are groups of individuals (called subscribers ) who are insured under an arrangement where each subscriber is both an insured and an insurer. In other words, the other members of the group insure each subscriber. However, the liability of each subscriber is limited. The administrator of the reciprocal is the attorney-in-fact. He or she is granted this power by the subscribers through a broad power of attorney and receives a percentage of the gross premiums paid by the subscribers. Other than this payment to the attorney-in-fact and administrative expenses, the cost to the reciprocal is limited to the amount of the losses that occur. Any unused premiums are returned to the subscribers. Lloyd s of London Lloyd s of London is a name familiar to many in the insurance industry. However, perhaps the most interesting fact about Lloyd s of London is that it is not an insurer nor does it issue policies. Rather, Lloyd s of London is an association of members who write insurance for their own accounts. The New York Stock Exchange bears the same relationship to stock purchases as Lloyd s bears to the purchase of insurance. Like the New York Stock Exchange, Lloyd s provides quarters for its members as well as procedures for business transactions. Though neither organization engages in trade, each provide facilities and rules that govern how its members will pursue trade. In addition, Lloyd s maintains worldwide underwriting information and a complete record of losses. It also aids in loss settlements and supervises salvage and repairs throughout the world. At Lloyd s, an insurance transaction begins when a proposal is placed before the underwriting members, or their agents, by a licensed broker. The broker prepares the policy and submits it to the Policy Signing Office where the policy is examined. If the policy conforms to agreed-upon rules, it is submitted to the underwriters. Those underwriters who wish to participate in the policy affix their signatures or underwrite the risk. American Lloyd s associations operate under the same principles and methods as Lloyd s of London. Insurer s Financial Status Changing economic conditions and highly publicized failures of financial institutions (from savings and loan companies to insurance companies) have focused much attention on the financial status of private insurers. Independent rating services provide ratings consumers can use to measure the status of an insurance company and compare it to others. The two most popular rating services are A.M. Best Company and Standard and Poors. The A.M. Best Company looks at profitability, leverage, and liquidity and assigns ratings from A++ (Superior) to C (Fair) and below. Standard and Poor s focuses on the claims paying ability of an insurer and offers ratings from AAA (Superior) to D (Insurers placed under an order of liquidation). In most cases, insurance companies pay a fee to be rated by a rating service. Other rating services include Moody s Investors Service (measuring financial strength), and Duff and Phelps (measuring claims paying ability and managerial soundness). In addition to private rating services the National Association of Insurance Commissioners measures company performance and prepares analytical reports as part of the Insurance Regulatory Information System (IRIS). Agents have access to IRIS ratios, which serve as indicators of a company s financial condition in various areas Real Estate Institute 49

56 EVERYONE NEEDS INSURANCE Life Insurance Policy Provisions It may surprise people that many insurance agents have never read the required policy provisions that are contained in every policy that they sell. It is important that you realize that policy provisions are in fact contractual provisions and govern what the policyowner can and cannot do with the policy you have sold them. Here is an overview of the list of provisions and then we will discuss them individually. Ownership clause. Entire contract clause. Incontestable clause. Suicide clause. Grace period. Reinstatement clause. Misstatement of age. Beneficiary designation. Change of plan provision. Ownership Clause The owner of a life insurance policy can be the applicant, the insured, or the beneficiary. In most cases, the applicant and insured are the same person. Under the ownership clause, the policyowner possesses all contractual rights in the policy while the insured is still alive. These rights include the selection of a settlement option, naming and changing the beneficiary designation, election of dividend options, and other rights. These contractual rights typically can be exercised without the beneficiary s consent. In addition, the ownership clause provides for a change in ownership. The policyowner can designate a new owner by filling out an appropriate form with the company. The insurer may require that the life insurance policy be endorsed to show the name of the new owner. Entire Contract Clause The entire contract clause states that the life insurance policy and attached application constitute the complete contract between the insurer and policyowner. No statement can be used by the insurer to void the policy unless the statement is a material misrepresentation and is part of the application. In addition, any officer of the company cannot change the terms of the policy unless the policyowner agrees to the change. Incontestable Clause Under the incontestable clause, the company cannot contest the policy after the policy has been in force two years during the insured s lifetime. The insurance company has two years to discover any irregularities in the contract, such as a material misrepresentation or concealment. If the insured dies after that time, the death claim must be paid. For example, if John conceals a cancer operation when the application is filled out and dies after expiration of the incontestable period, the death claim will be paid. The purpose of the incontestable clause is to protect the beneficiary if the insurance company tries to deny payment of the death claim years after the policy is issued. Since the insured is dead, allegations by the insurer concerning statements made in connection with the application cannot be easily refuted. After the incontestable period has expired, with few exceptions, the company must pay the death claim. Suicide Clause A typical suicide clause states that the face amount of the policy will not be paid if the insured commits suicide within two years after the policy is issued. The only payment is a refund of the premiums. The purpose of the suicide clause is to reduce adverse selection against the insurer by providing the insurer some protection against an individual who purchases a life insurance policy with the intention of committing suicide. Grace Period A grace period is another important contractual provision. A typical grace period gives the policyowner thirty-one days to pay an overdue premium. The life insurance remains in force during the grace period. If death occurs during the grace period, the overdue premium usually is deducted from the policy proceeds. Reinstatement Clause If the premium is not paid during the grace period, a life insurance policy may lapse for nonpayment of premiums. The reinstatement clause allows the policyowner the right to reinstatement of a lapsed policy under certain conditions: The insured must provide evidence of insurability, a condition that insurers often waive for lapses of less than two months. All overdue premiums plus interest must be paid. A policy loan must be repaid or reinstated. The policy must not have been surrendered for its cash value. The lapsed policy must be reinstated within five years. If the policyowner wishes to continue the same type of life insurance coverage, it usually is more economical to reinstate a policy than to buy a new one. This is because a new policy is likely to have a higher premium, since it will be issued when the insured is older than at the time of issuance of the first policy. Misstatement of Age The insured s age may be misstated in the application. Under the misstatement clause, the amount paid is the amount of life insurance that the premium would have purchased at the insured s correct age. For example, assume that Mary s correct age is thirty but is incorrectly recorded in the application as age twenty-nine. Assume that the premium for an ordinary life application at age twenty-nine is $14 per $1,000 and $15 per $1,000 at age thirty. If Jane has $15,000 of ordinary life insurance and dies only 14/15 ths of the proceeds will be paid, or $14,000. Beneficiary Designation The beneficiary is the person or party named in the policy to receive the policy proceeds. There are numerous beneficiary designations in life insurance. They include the following: The primary beneficiary is the first party who is entitled to receive the proceeds at the insured s death. The contingent beneficiary is the beneficiary entitled to the policy proceeds if the primary beneficiary is not alive. A revocable beneficiary designation means that the policyowner has the right to change the beneficiary designation without the beneficiary s consent. An irrevocable beneficiary designation means that the policyowner cannot change the beneficiary without the irrevocable beneficiary s consent. A specific beneficiary designation means that the beneficiary is named and can be identified. For example, Martha Smith may be specifically named to receive the policy proceeds if her husband should die. A class beneficiary designation means that a specific individual is not named but is a member of a group to whom the proceeds are paid. One example of a class beneficiary designation would be children of the insured. Change of Plan Provision The change of plan provision allows the policyowner to exchange the present policy for a different one. If the change is to a higher premium plan, such as exchanging an ordinary life policy for an endowment at age sixty-five, the policyowner must pay the difference in cash Real Estate Institute 50

57 EVERYONE NEEDS INSURANCE values between the two contracts plus interest at a stipulated rate. Since the net amount at risk is reduced, evidence of insurability is not required. Some insurers also allow the policyowner to change to a lower premium policy, such as exchanging an endowment contract for an ordinary life contract. The insurer refunds the difference in cash values to the policyowner. However, evidence of insurability is required since the net amount at risk is increased. Exclusions and Restrictions Life insurance policies contain very few exclusions and restrictions. The more common ones are as follows: Certain activities which are considered dangerous such as flying, hang-gliding, auto racing or skydiving may either be excluded or covered if an additional premium has been paid. The suicide clause described above, which excludes payment of the face amount in the event of suicide within two years of the issue date. An aviation exclusion may be present in the policy and would exclude death coverage from an aviation accident other than as a passenger on a regularly scheduled airline. The war exclusion is designed to control adverse selection during times of war and may be inserted to exclude payment if death occurs as a result of war. Premiums There are two basic ways to purchase a life insurance policy. The first is by paying the entire cost in one lump-sum payment. This is the single premium method. The second method of purchasing a policy is by the payment of periodic premiums. Rather than making a single payment for the insurance, the policyholder makes annual, semi-annual, or more frequent payments. A single premium policy is seldom purchased because of the large lump-sum payment that is generally required. The typical policyholder finds the periodic payments much easier to make. A second reason why single premium policies are seldom purchased concerns the cost of the policy if the insured dies in the early years of the contract. In this situation, the amount paid for the insurance under the periodic method will be less than the single premium amount. Parts of the Premium There are three basic factors which affect the premium charged for a life insurance policy. The first factor is mortality. Mortality refers to how many people within a given age group will die each year. The second factor is interest. Interest refers to the earnings the company receives on the premium dollars it invests. The third factor is expenses. Expenses are all of the costs the company incurs in selling, issuing, and servicing its policies. We said earlier that as one grows older, the cost of insurance increases. The reason for this is that as one grows older, the chance of death increases. Insurance companies use mortality tables and other statistics to determine the number of insureds within each age group, who will die each year. What would happen if more people died in a year than the company had predicted? The company will pay out more for death claims than was anticipated. Another factor which influences the cost of insurance is the interest income that the company earns from its investments. Insurance companies receive millions of dollars each month in premium dollars. And, while each company has death claims and other expenses, the costs for these claims and expenses should be less than the total premiums received. By law, a life insurance company is permitted to invest this extra money to obtain additional revenue in the form of interest. Most life insurance companies invest in stocks, bonds, construction projects, and in a variety of other ventures designed to provide a return on their investment. The principal, as well as the interest earned, on these investments establishes a fund to pay all death claims as they occur and also helps to offset the cost of insurance. Naturally, the insurance company is not permitted to keep all the money it receives. Expenses, of course, have to be paid. In addition to death claims, expenses include such items as: Agent s commissions. Salaries. Advertising. Physical examinations. Legal costs. Policy issue costs. Here is a very simple formula which indicates how these factors affect premium costs: Death claims + Other expenses - Investment interest earned = Premium to be charged. Keep in mind that no company determines the premium to be charged by the simple method we have described above. This simplified approach merely describes the important relationship between these factors. Net and Gross Premium The premium that a company charges for a life insurance policy is called the gross premium. When a company is calculating the premium for a policy, it begins by determining the net premium. Once the net premium has been computed, the company then adds the expense factor, or loading, to this net premium to arrive at the gross premium. Mortality An insurance company obviously cannot know when a particular insured will die. However, by using the mathematical concept of probability, the company can predict with a great deal of accuracy the number of insureds who will die each year. This prediction of future mortality is made on the basis of past mortality experience and assumes that future experience will parallel past experience. But, if past mortality is to be a reliable basis for prediction, accurate data must be kept on a large group of representative individuals for a sufficiently long period of time. Information on past mortality is analyzed and arranged in a table called the mortality table which shows probable death or mortality rate at a specific age. Beginning with a given number of individuals at a given age, the mortality table shows the number of people out of the group who probably will die at each age and the number who will survive. Remember that even if the mortality rates and the mortality table are accurate, a company which wants a reliable estimate of future mortality must apply the rates to a large enough group of individuals for the law of averages to operate. Level Premiums and Reserves Since few policies are purchased by the single premium method, once the net single premium is computed, the company then converts that premium into a net level premium. Let s now turn to the concept of level premiums. The early renewable term premium, also called natural or step-rate premium, increases each year as the insured ages and the risks of mortality increase. The premium rises rather gradually during the younger ages, but increases sharply for the older ages. As a result, the premiums can become prohibitively expensive for most insureds at the older ages. To overcome the problem of annually increasing premiums, companies develop the level premium plan. With this plan, the premium remains the same during the premium payment Real Estate Institute 51

58 EVERYONE NEEDS INSURANCE period rather than increasing as the probability of death increases. This level premium is higher than the natural or yearly renewable term premium in the early years of the policy, but it is lower than the natural premium in the later years. Under the natural premium plan, the net premium charged policyowners each year is just sufficient to pay the expected claims for the year. This is not true for the level premium plan. The net level premium payments made in the early years of the contract are greater than the amount needed to pay the policy claims during those years. By investing the excess part of the premium in the early years, the company accumulates funds to cover the deficiency which occurs in the latter years. These funds which the company holds to meet future policy obligations constitute the policy reserve or simply the reserve. The reserve is the amount that, together with future premiums and interest earnings, will be sufficient for the company to pay all future policy claims, based on the company s mortality and interest assumptions. Thus, the reserve is a liability - future obligation to the company. Because a company s ability to fulfill its contract obligations depends upon sufficient policy reserves, each state requires a company to maintain certain minimum reserves. State laws specify the mortality table and the assumed rate of interest to be used in calculation of the legal minimum reserves. Because of these state regulations, reserves are often called legal reserves. Insurance Age Premium charged for life insurance depends upon the insured s age. This is true because the mortality factor is one of the three basic elements of the premium and the mortality factor varies with an insured s age. However, the age used to determine the premium is the insured s insurance age. The insured s insurance age may, or may not, be the same as his or her actual or chronological age. A company may use one of two methods of determining an insurance age: In the first method, an insured s insurance age is his or her age at the insured s nearest birthday. If the insured turned age 30 less than 6 months ago, the insured s age would be 30. However, if the insured s 30th birthday was more than 6 months ago, the insurance age would be 31 since the next birthday would be nearer than the last. Although the nearest birthday is the more commonly used method, some companies may use the insured s last birthday to determine the insurance age. The insurance age under this method is the same as the insured s actual age, regardless of the number of months since his or her last birthday. Payment of Premiums The policyholder of a life insurance contract has a choice regarding how to pay premiums. Premiums generally can be paid annually, semiannually, quarterly, monthly or through monthly bank drafts. The company usually offers a discount for paying the premiums annually. The most popular method of payment is monthly bank draft. Settlement Options When benefits are paid following the death of the insured the payments of benefits is referred to as settlement of the policy. The following is an overview of the settlement options and then we will review them one at a time. They are: Lump sum settlement. Proceeds and interest. Fixed years installments. Life income. Joint life income. Fixed amount installments. Other mutually agreed methods. Lump Sum Settlement This is when the beneficiary receives the policy proceeds in a single payment following the death of the insured. Proceeds and Interest Under this option the insurance company will hold the policy proceeds and make interest payments to the beneficiary. The minimum interest rate is spelled out in the policy and the company may pay a higher rate at its discretion. The beneficiary still has the right to withdraw all or part of the proceeds of the policy at any time. Fixed Years Installments With this option the insurance company pays the proceeds in equal monthly payments. The recipient of the proceeds chooses the number of years for which payments will be made. The amount received monthly depends on three factors: Policy proceeds. Number of years for which payments are to be made. Interest rate paid by the insurance company. Again, under this settlement option the beneficiary still has the right to withdraw all or part of the proceeds at any time. Life Income Under this settlement option the beneficiary will receive equal monthly payments for the life of the beneficiary. The amount of monthly payments depends on four factors: Policy proceeds. Beneficiary s sex. Beneficiary s age at time payments begin. Period certain for which payments are guaranteed. When payments are guaranteed for a period certain, such as ten years, payments will be made for the specified number of years regardless or whether the beneficiary lives to the end of that period. Should the beneficiary die during the period certain payments will continue to the beneficiary s designated successor. For example: A beneficiary is going to receive $ a month for 10 years certain. This means that should the beneficiary live the entire ten years he will receive $ a month. After ten years there are no more benefits paid. However, if the beneficiary dies in the sixth year the remaining four years of $ per month will go to his designated successor. Joint Life Income When this option is chosen, equal monthly payments will be made so long as either payee is alive. This option may be used when an insured contributes to the support of his or her parents. In the event of the insured s death, the parents, as beneficiaries, would receive monthly income for the rest of their lives. The amount of the monthly benefits would depend on two factors: The policy proceeds. Parents ages at time they begin to receive benefits. However, under this option the beneficiaries typically do not have the right to discontinue the monthly payments and receive the balance in a lump-sum settlement. Fixed Amount Installments Using this settlement option, the insurance company makes equal payments per month, or at longer intervals, in an amount chosen by the policyowner or beneficiary Real Estate Institute 52

59 EVERYONE NEEDS INSURANCE All proceeds held by the insurance company will earn interest. If the monthly payment is greater than the monthly interest earned, the balance of the proceeds held by the insurance company decreases each month until the total proceeds and interest due are paid out. Under this option the beneficiary may withdraw the unpaid balance at any time. If the beneficiary dies before the installment payments are completed, the unpaid balance is paid to the beneficiary s estate. Other Mutually Agreed Method On occasion a life insurance company may allow the policyowner to designate other payment methods. An example of this may be that the proceeds and interest are to be paid to the insured s spouse for the spouse s lifetime and, upon the spouse s death, a lump-sum settlement is to be made to the insured s children. Non-Forfeiture Options Life insurance policies contain non-forfeiture options. They are designed to give the insured ways in which he or she may gain continued value from a policy in the event the insured is unable to continue premium payments. The five non-forfeiture options are as follows: Cash surrender value. Reduced paid-up insurance. Extended term insurance. Automatic loan provision. Dividend accumulations to avoid lapse. We will now discuss each of these non-forfeiture options. Cash Surrender Value If the policyowner is unable to continue paying premiums, he or she may surrender the policy and request that the company pays the cash surrender value of the policy, if any. As a rule most policies have no cash value whatsoever for the first two to three years. The cash surrender value usually consists of the following: The policy cash value. Cash value of paid-up additions. Dividends. The cash surrender value can be reduced by: Any policy loans that are outstanding. Accrued loan interest on outstanding policy loans. It is important to know that all coverage ceases when the policy is cash surrendered. Payment is usually made in one lump sum and in some cases in accordance with one of the other policy settlement options already discussed. Reduced Paid-Up Insurance Under this option the policyowner may request that the cash value of the policy be used to keep a reduced amount of paid-up insurance in force under the same policy. Usually the policy has a table contained in it that shows the amount of reduced insurance in any given year which the cash value would purchase in that year. Although the policy has had its face reduced, the policy will continue to earn cash value and pay dividends if applicable. Extended Term Insurance This option allows the same face amount of the policy to remain in effect for a specified number of years and days. Again, as with reduced paid-up insurance the policy will contain a table showing how long in years and days the original face amount will remain in force during any given surrender year. The length of time in years and days is calculated by taking the policy s cash surrender value, the insured s age and sex at the time premiums were discontinued, and using that cash surrender value to purchase term insurance for a specified amount of years and days. Under this option the policy does not continue to earn cash value or pay dividends. Automatic Premium Provision It is possible for the insured to authorize the insurance company to make an automatic loan from the policy s cash value to pay any premium not paid by the grace period. Dividend Accumulations to Avoid Lapse When the policy pays a dividend, the dividend accumulations may be applied to any premium not paid by the end of the grace period. In the event the amount of accumulated dividends is not enough to pay the entire premium coverage will then be extended in proportion with the amount of premium paid by the accumulated dividends. As a result of this a new grace period will start at the end of extension coverage. Dividend Options If a life insurance contract is a participating policy that means that the policyowner is entitled to an annual dividend paid by the insurance company. Participating policies afford the policyowner the opportunity to participate in the earnings of the insurance company through these dividend payments. The following are ways in which a policyowner may use his or her dividends: Cash payment. Reduction of premium. Accumulation of interest. Paid-up additions. One-year term. Cash Payment Under this dividend option the insurance company sends the insured a check equal to the amount of the declared dividend payment. Reduction of Premium The premium due on the policy for the upcoming year will be reduced by the amount of the current years declared dividend and the balance becomes the new premium due for the upcoming year. Accumulation of Interest The dividend may be held by the insurance company to accumulate interest paid at the rate that is specified in the contract. The insured has the right to withdraw the accumulated dividends at any time. Should the accumulated interest and dividend be on deposit with the company at the time of the insured s death, the accumulated interest and dividend will be paid along with the policy proceeds. Paid-Up Additions This option enables the insured to receive additional amounts of life insurance by using the dividend to purchase paid-up additions. The additional insurance will be the same kind and subject to the same provisions as the original policy. Again, on the insured s death, paid-up additions of insurance will be paid along with the policy proceeds. One-Year Term Some policies permit dividends to purchase additional oneyear term coverage. The amount of the one-year term coverage would be added to the face amount of the base policy in the event of the insured s death. Life Insurance Policy Riders Most insurance agents are familiar with the term endorsement. However in life and health insurance the word rider is used in lieu of the word endorsement. The effect is the same in that riders modify the coverage of the basic policy the same as an endorsement would Real Estate Institute 53

60 EVERYONE NEEDS INSURANCE The most commonly used riders in life insurance policies are: Waiver of premium. Accidental death and dismemberment. Guaranteed purchase option. Waiver of Premium This rider protects the insured in the event he or she becomes totally disabled. The waiting period is usually six months, and if the insured continues to be disabled after the six-month waiting period, the premium payments on the policy will be waived by the insurance company. Many policies will also refund the premium that was paid by the insured during the six-month waiting period. The cost for this coverage is a bargain to the insured, and no policy should be sold without this rider. Accidental Death and Dismemberment The amount paid in the event of accidental death of the insured is usually twice the policy s regular face amount. This benefit is often referred to as double indemnity. As a rule the accidental death rider is very carefully worded to define exactly under what circumstances this benefit will be paid. The most liberal of the definitions is accidental bodily injury. The less favorable wording would be that death must occur by accidental means. For example, with the language by accidental means, if an insured died from a broken neck after intentionally diving into the shallow end of a swimming pool the policy would not pay the accidental death benefit because the action of diving into this pool wasn t accidental. However, if the insured accidentally fell into the pool and drowned the benefit would be paid. On the other hand, under the accidental bodily injury definition, even the intentional diving into the pool would have been paid because the broken neck was an accidental injury notwithstanding the intentional dive into the shallow water. Normally the death caused by the accident must consummate itself within ninety to one hundred eighty days of the incident in order for the double indemnity benefit to be paid under the rider. While the accidental death benefit is paid to the beneficiary after the death of the insured, the dismemberment portion of the rider provides that the dismemberment benefit will be paid directly to the insured, rather than the beneficiary. Dismemberment benefits typically are paid for: Loss of sight. Loss of hand or hands. Loss of foot or feet. Regarding the loss of hand or foot, the loss typically must involve complete severance through or above the wrist or ankle joint. Loss caused by amputation is excluded unless medically necessary and as the result of an accidental injury. Guaranteed Purchase Option This rider is used most frequently with whole life insurance rather than term insurance. Under this option the company guarantees the insured that he or she may purchase additional amounts of coverage without evidence of insurability. These additional purchases are usually made at specific time intervals or upon events that change the insured s family status. For example, some policies permit additional purchases of life insurance under the following circumstances: Every fourth policy anniversary year. The insured purchases a new home. The insured gets married. The birth of a new child. The premium charge for the additional coverage is typically based on the type of insurance purchased and the insured s age at the time of exercising the option. Life Insurance Underwriting The ultimate purpose of life insurance underwriting is to develop a profitable book of business for the insurance company. In order to accomplish this goal the life insurance underwriter attempts to provide coverage for a diversified group of insureds whose expected death rate is the same or lower than what is expected of the population as a whole. Underwriting Factors for Individual Coverage Life insurance is priced on a class basis. Perspective clients of the insurance company are classed on the basis of a number of factors that help to predict expected mortality rates. The principal rating factors are: Age. Mortality rates are measured in terms of deaths per one thousand persons, and this of course increases with age. Thus the older you are the more life insurance costs because you are closer to death than a younger person. Sex. On average, women in the United States live approximately seven years longer than men. Therefore cost for life insurance on a woman is lower than on a man of the same age. For example a thirty-year old male may pay the same premium as that of a thirty-three-year old female. Health. The health of an individual as well as the health history of that individual s family helps the underwriter to determine if the applicant presents an average or better than average risk to the insurance company. In evaluating an insured s health the company will consider whether the applicant or family members have had any of the following illnesses: Cancer. Heart disease. Hypertension. Diabetes. As a general rule, persons whose health history include the above diseases will likely have a higher than normal mortality rate. Most insurance companies are now offering discounted rates to non-smokers due to the link between smoking and lung and heart disease. Occupation and avocation. Since certain occupations and avocations pose hazards, such as flying and scuba-diving, applicants who engage in these hobbies are likely to have a higher than normal mortality rate. Personal habits. If a life policy is for a large amount of coverage the insurance company will more than likely investigate the personal circumstances of the insured s life. For example areas such as alcohol or drug use, poor driving record or financial problems may be taken into consideration. Foreign travel or recent immigration. People who travel or reside outside the United States may be exposed to diseases not commonly found in this country. Additionally, mortality rates vary from country to country. Therefore if a person is applying for life insurance shortly before leaving the country, special medical tests or a postponement of coverage may take place Real Estate Institute 54

61 EVERYONE NEEDS INSURANCE Underwriting Actions Based on the information that the underwriter receives from the applicant, one of three actions may be taken. They are as follows: Rate the applicant standard and charge the normal premium. Rate the applicant substandard and charge a higher premium. Decline the coverage. In addition to the above three actions many insurance companies recognize preferred risks and they will actually reduce premiums for those preferred risks. Delivering the Policy Policy Effective Date The effective date of a life insurance policy is very important since this is the date on which coverage actually begins for the insured. As discussed earlier in these materials, the policy effective date will also have significance with regard to the incontestable and suicide clauses. To determine the effective date of the policy, we must examine the principle of contract law known as offer and acceptance. If a proposed insured signs the application and submits it with the first premium to the company, an offer to buy insurance has been made by the proposed insured. If the insurance company issues the policy, as applied for, then offer and acceptance occurs. That is, the proposed insured has made an offer to purchase a life insurance contract, and the insurance company has accepted that offer. So far, we have assumed that the premium was submitted with the application. However, there are two other possibilities to consider regarding the effective date of the policy. The first occurs when an application is submitted without the premium. In this case, the applicant has made no offer. The applicant has only extended an invitation to the company to make an offer. The insurance company makes the offer when it issues a policy as applied for and delivers it to the applicant. Further, the offer is accepted when the applicant pays the premium, assuming any other conditions have been fulfilled. The date of payment of the premium becomes the effective date of the policy. In situations where the initial premium does not accompany the completed application, most companies state in the application that the proposed insured must be in good health at the time of policy delivery before coverage becomes effective. So, before accepting the initial premium and leaving the policy with the insured, the agent must obtain a signed statement of the prospective insured s continued good health. This statement and the initial premium are then transmitted to the company. The final possibility occurs when the premium is submitted with the application but no receipt is given. If this is the case, then the policy s effective date is generally the date that the policy is issued and delivered. Delivery Delivery of the policy constitutes the company s acceptance of the applicant s offer the application and initial premium. A policy is considered delivered when one of the following three events occurs: The policy is actually handed over in person. The policy is mailed to the policyholder. The policy is mailed to the agent for unconditional delivery to the policyholder. Delivery, then, does not usually have to be accomplished by the manual transfer of the policy to the policyholder. Delivery accomplished by means other than a manual transfer is called constructive delivery. If a policy is not, or cannot, be delivered, then the policy is not in effect, as policy delivery has not been accomplished. Two other situations should be noted: When the applicant wants to examine the policy for a time before paying the initial premium, and the policy is left with the applicant for inspection, he or she should sign a receipt for the policy, referred to as an inspection receipt. This acknowledges that the policy is in the insured s possession for inspection purposes only and that the initial premium has not been paid and that the insurance is not in effect. An applicant may ask the company to give the policy for which they are applying a date earlier than the application date. The reason for this backdating is usually to obtain a lower premium. Premium paid for life insurance depends, among other factors, on the insured s age. So, in order to obtain a lower insurance age, and, as a result a lower premium, backdating is used. Agents Responsibilities Regarding Delivery The agent should deliver the policy to the client as soon as possible after the policy is issued. This is especially important when no premium was submitted with the application, because the coverage will not become effective until the policy is delivered and the first premium paid during the continued good health of the proposed insured. The agent also has a responsibility to explain the policy s provisions, riders, and exclusions at the time of delivery of the policy. Income Tax Benefits of Life Insurance By building income tax benefits into life insurance, public policy encourages individuals to purchase life insurance and obtain income security in the event of death. Specific income tax benefits of life insurance include the following: Death benefits are income tax-free. The primary advantage of life insurance is that the policyowner contributes a sum as a premium amount, and when he or she dies the whole death benefit amount is passed on to the insured s beneficiaries tax-free. This is good for the beneficiaries as well as society since these beneficiaries do not become financially dependent upon society as a result of the death of the insured. The death benefits of life insurance policies have been exempted from income taxation in order to promote this societal benefit. Current earnings and gains not currently taxed. The second advantage of life insurance is that during the insured s lifetime, and while the policy is in force, all interest earned, dividends earned and/or capital gains realized on the policy investments are not subject to current income tax. The taxation is deferred until the gains are taken from the policy by the policyowner. All investment life insurance policies enjoy tax-deferral on this buildup and a possibility of total tax-exemption on investment returns within the contract, which occurs when the proceeds are disbursed as death benefits. In other words, if the policyowner never takes the gains from the policy, there will never be tax on the policy s investment gains and the death benefit will be paid to the beneficiaries tax-free. Policy tax basis includes amounts paid for life insurance and expenses. The third income tax benefit of life insurance containing investment capital is that the amount of money which the insured recovers tax-free when surrendering a life insurance policy includes all the life insurance costs that the policy has charged during the time the policy has been in force. These costs are paid on a pretax basis even when a policy is surrendered Real Estate Institute 55

62 EVERYONE NEEDS INSURANCE Tax-free use of untaxed earnings and gains. The fourth income tax benefit of life insurance depends on whether or not the insured incurs taxation as a result of using the monies accumulated within the life insurance policy while it is still in force. The insured could use these monies by withdrawing them, borrowing them from the insurance company or pledging the policy as collateral for a loan. The tax code permits tax-free use of these funds up to certain prescribed levels. Any insured should always obtain competent tax advice before accessing insurance policy funds in order to confirm that the use will be permitted free from tax. Conclusion Any insurance agent selling life insurance policies to customers must maintain solid knowledge of the types of life insurance policies and the provisions of each policy in order to answer any questions and offer competent service to customers. By demonstrating command of the subject matter, the insurance agent will benefit from additional referrals and recommendations from satisfied, happy clients Real Estate Institute 56

63 EVERYONE NEEDS INSURANCE Below is the Final Examination for this course. Turn to page 122 to enroll and submit your exam(s). You may also enroll and complete this course online: Your certificate will be issued upon successful completion of the course. FINAL EXAM 1. A is a legal wrong. A. contract B. tort C. liability D. standard of care 2. Part A of the Personal Auto Policy provides liability coverage for different categories of parties. A. two B. three C. four D. five 3. There is NO liability coverage on a vehicle while it is being used. A. in traffic B. for personal use C. by a family member D. to carry persons or property for a fee 4. The company s maximum limit of liability from any single automobile accident is the amount stated in the. A. Declarations B. Synapsis C. Predictions D. Provisions 5. Under a Personal Auto Policy, the company will pay all reasonable medical and funeral expenses incurred within years from the date of the accident. A. two B. three C. four D. five 6. The amount paid under uninsured motorists coverage may be reduced by any benefits payable under. A. workers compensation law B. policy limits C. premiums D. gasoline expenses 7. If the vehicle is declared a total loss, the amount paid is the. A. initial purchase price B. actual cash value C. amount requested by the insured D. amount of premiums paid EXAM CONTINUES ON NEXT PAGE Real Estate Institute 57

64 EVERYONE NEEDS INSURANCE 8. Part of the Personal Auto Policy describes the duties and obligations of the insured in the event of an accident or loss. A. B B. C C. D D. E 9. A clean driving record covering the previous years can substantially reduce the premiums of a high-risk driver. A. two B. three C. four D. five 10. is a key factor in determining liability. A. Premium amount B. Age C. Income D. Negligence 11. The HO-6 policy is a policy. A. renter's B. condominium owner's C. all-risk D. premium free 12. The dwelling consists of the home itself and includes. A. attached structures B. personal property C. automobiles D. animals 13. policies generally cover property that is transported from one place to another. A. Homeowners B. Inland marine C. Crime insurance D. Personal auto 14. Property described in floaters will be covered anywhere in the world, EXCEPT FOR: A. jewelry. B. furs. C. cameras. D. fine arts. 15. Stamps and coins may be insured in one of two ways: scheduled basis or. A. blanket basis B. article basis C. premium basis D. homeowner basis EXAM CONTINUES ON NEXT PAGE Real Estate Institute 58

65 EVERYONE NEEDS INSURANCE 16. The umbrella policy pays only after the limits of the underlying policy are. A. established B. broken C. modified D. exhausted 17. One important aim of underwriters is to support activities which will benefit: A. premium reduction. B. bankruptcy attorneys. C. society. D. courts. 18. cannot be used as a reason for underwriting action. A. Accident fault B. Occupation C. Property condition D. Number of accidents 19. can restrict the information available to the underwriter. A. Right to privacy laws B. Insurance policies C. Standard practice D. Objective sources 20. The most significant factor which can be used in underwriting and rating of motor vehicle insurance is. A. driver occupation B. family size C. automobile size D. driving record 21. Securing the proper is the key to profitable writing of property insurance. A. office B. stockholders C. insurance-to-value ratio D. premium reduction 22. Underwriters are rejecting applications for insurance where extended vacancy exists at a property. A. justified in B. prohibited from C. to be fined for D. to be imprisoned for 23. The only line of property/liability insurance in which the physical condition of the applicant has been used by underwriters is. A. crime insurance B. homeowners insurance C. inland marine insurance D. automobile insurance EXAM CONTINUES ON NEXT PAGE Real Estate Institute 59

66 EVERYONE NEEDS INSURANCE 24. No action should be taken solely because of a. A. misrepresentation B. fraudulent act C. history of drug abuse D. previous rejection or cancellation 25. For a life insurance policy to be issued, between the insured and the policy owner must be present. A. an insurable interest B. an application C. an adult guardian D. a contract 26. In most states, a person is not considered an adult until the person is years of A. 13 B. 18 C. 21 D insurance contains the basic elements of term insurance, with an investment element added. A. Whole life B. Traditional C. Premium D. Batch 28. offers tax advantages to the insured because the investment value grows without current taxation. A. Health insurance B. Key man coverage C. Term life D. Universal life 29. A stock life insurance company is in business to make a profit for the. A. insureds B. stockholders C. policyowners D. government 30. Control in a mutual insurance company rests with the. A. insureds B. stockholders C. policyowners D. government END OF EXAM Turn to page 122 to enroll and submit your exam(s) Real Estate Institute 60

67 Notes

68 Notes

69 LIMITING YOUR PROFESSIONAL RISKS Continuing Education for Illinois Insurance Professionals

70 LIMITING YOUR PROFESSIONAL RISKS Copyright by Real Estate Institute All rights reserved. No part of this book may be reproduced, stored in a retrieval system or transcribed in any form or by any means (electronic, mechanical, photocopy, recording or otherwise) without the prior written permission of Real Estate Institute. A considerable amount of care has been taken to provide accurate and timely information. However, any ideas, suggestions, opinions, or general knowledge presented in this text are those of the author and other contributors, and are subject to local, state and federal laws and regulations, court cases, and any revisions of the same. The reader is encouraged to consult legal counsel concerning any points of law. This book should not be used as an alternative to competent legal counsel. Printed in the United States of America. P4 All inquiries should be addressed to: Real Estate Institute 6203 W. Howard Street Niles, IL (800)

71 LIMITING YOUR PROFESSIONAL RISKS TABLE OF CONTENTS ABOUT THIS COURSE CHAPTER 1 INSURANCE FRAUD INSIDE AND OUT Introduction Consumer Views on Fraud Defining Fraud How Premiums Impact Insurers Public Image Decreasing Fraud Through Better Service Societal Views on White-Collar Crime Insurers Reluctance to Fight Fraud Learning About Fraud and Becoming Proactive Stopping Fraud Before It Starts Early Red Flags Auto Insurance Fraud Organized Crime and Staged Accidents Organized Crime and Real Accidents Organized Fraud s Effect on Premiums Unorganized Auto Insurance Fraud Red Flags and Auto Insurance Fraud Medical Insurance Fraud Examples of Medical Insurance Fraud Detecting Medical Insurance Fraud Workers Compensation and Disability Insurance Fraud Life Insurance Fraud Life Insurance Fraud Overseas Murder and Fraud Property Insurance Fraud Dealing With Fraud in Catastrophic Situations Fraud Detection Tools Fraud From the Inside CHAPTER 2 COMPENSATION ISSUES The Need for Fair Agent Compensation The Struggling Ethical Producer Typical Compensation for Insurance Producers The Positives of Levelized Commissions The Negatives of Levelized Commissions Company Perspectives on Levelized Commissions Promoting Levelized Commissions in the United States The Positives of Fees The Negatives of Fees Additional Compensation Methods Choosing a Compensation Method Commission Disclosure The Case Against Commission Disclosure The Case for Commission Disclosure Dealing With a Consumer s Response Rebating Problems With Rebating The Competition Argument The Discrimination Argument A Contrary Opinion on Rebating Making Ethical Conclusions About Rebating Insurance Brokers and Contingent Commissions Contingent Commissions and Adverse Selection Disclosure of Contingent Commissions Contingent Commissions and Bid Rigging The Effects of Settlements The Future of Contingent Commissions CHAPTER 3 FEDERAL REGULATION OF THE INSURANCE INDUSTRY Background Purposes and Expectations Financial Holding Companies and Financial Activities Federal Law, State Law and Preemption Protecting Privacy Financial Privacy Rule Safeguards Rule Pretexting Provisions Privacy at the State Level Bank Insurance Disclosures The Insurance Disclosure The Credit Disclosure Delivering Disclosures GLBA Enforcement at the Bank Insuring Domestic Abuse Victims Creating Uniformity in the Regulation of Insurance Producers Reciprocity and Uniformity Requirements The Producer Licensing Model Act Ten Years of the GLBA GLBA Summary CHAPTER 4 PROTECTING YOURSELF PROFESSIONAL LIABILITY INSURANCE Introduction What Do Directors and Officers Do? D & O Liability Risks Class Actions vs. Derivative Actions Risks at Private Companies The Securities Act of The Business Judgment Rule Directors and Officers Coverage (D & O) Deterioration of the Business Judgment Rule Escott v. BarChris Construction Co Smith v. Van Gorkom A Temporary D & O Crisis The Effects of Sarbanes-Oxley on Directors and Officers Section 302 of Sarbanes-Oxley Section 402 of Sarbanes-Oxley The D & O Market in the 21 st Century Providing Services and Managing Liability Liability Risks for Medical Professionals Doctors and Punitive Damages The Cost of Malpractice Insurance Liability Risks for Legal Professionals Liability Risks for Building and Design Professionals Liability Risks for Insurance Professionals Liability and the Producer-Consumer Relationship Avery v. Diedrich Liability and Insurer Solvency Liability and Procedural Duties The Need for Professional Liability Insurance Aren t Professionals Already Covered? Obtaining Professional Liability Insurance An Assortment of Policies What is D & O Insurance? Who Can Be Covered by a D & O Policy? What is Covered by a D & O Policy? Sides of a D & O Insuring Agreement Side A Coverage Side B Coverage Side C Coverage Problems With Entity Coverage Side A-Only Coverage Real Estate Institute

72 LIMITING YOUR PROFESSIONAL RISKS Errors and Omissions Insurance and Malpractice Insurance Medical Records Associates v. American Empire PMI Mortgage v. American International Who is Covered Under an Errors and Omissions or Malpractice Policy? Package Deals Employment Practices Liability Insurance Fiduciary Liability Insurance Deductibles and Co-Payments Benefit Limits Towers of Coverage Liability Premiums What is a Claim? Claims-Made Policies and Occurrence Policies Pros and Cons of Occurrence Policies Media Liability Insurance Reporting Liability Claims Prior Acts Nose Coverage Tail Coverage Coverage After Mergers, Acquisitions and Bankruptcies Defense Costs Duty to Defend Timing of Defense Benefits Reservation of Rights Settlements Hammer Clauses Allocation Issues Policy Exclusions Coverage Under Other Polices Conduct Exclusions Insured vs. Insured Exclusion Investigations Pollution Exclusions National Union v. U.S. Liquids Owens Corning v. National Union Pollution Claims Foreign Claims Other Exclusions Policy Rescissions and Severability Conclusion FINAL EXAM Real Estate Institute

73 LIMITING YOUR PROFESSIONAL RISKS ABOUT THIS COURSE While it is certainly important for agents and brokers to become increasingly knowledgeable about the distinct products that they sell, insurance producers should not forget that specializing in a particular line of insurance does not excuse them from needing to understand other insurance-related topics. On a daily basis, each licensed insurance producer will have to be mindful of various issues that may have little to do with his or her specific area of expertise. No matter if they re used to working on the life side, the property side, the health side or the liability side of the business, members of the insurance community are likely to confront many of the same ethical challenges and be expected to live up to many of the same legal standards. The following course material was compiled in order to stress some of those general commonalities. It assumes that some issues, such as insurance fraud and producer compensation, have an effect on the way insurance professionals and the public perceive one another. Furthermore, it supposes that all agents and brokers will be interested in knowing how to do their jobs successfully without inviting legal trouble from regulators or policyholders. In a section about insurance fraud, students will read about insurers opinions of this crime, consumers opinions of this crime and why those opinions often do not match. As should be expected, students will learn about how various frauds are committed and how to spot them. But perhaps more importantly, the material suggests how producers and other professionals can address the problem in ways that might attract greater public support. For obvious reasons, compensation is an important topic for producers and the people they serve. A portion of this material explains how agents and brokers are paid and how each method of compensation might influence a consumer s view of an insurance adviser. Midway through the course, the emphasis will shift slightly from ethical issues to legal ones. Material on the Gramm-Leach- Bliley Act explains that, although insurance is generally a stateregulated industry, there are strict federal rules that carriers must obey. Our study of the GLBA and its accompanying regulations will highlight the kinds of products that can be sold by various financial institutions and specify the procedures that those institutions must follow in order to preserve people s privacy. At the same time, we will acknowledge the history behind the federal regulation of insurance and note the competition that may arise between insurance companies and other entities. After acknowledging the ethical and legal responsibilities of carriers and producers, we will conclude by examining professional liability insurance and explain how this product can be utilized by many people who are accused of wrongdoing. Students will review the liability risks that are faced by various professionals in their business dealings, and will even be reminded of the need to properly insure themselves. For those readers who are curious about the specifics of policy language, we have also included an in-depth presentation of directors and officers (D & O) forms, errors and omissions forms and more. Considering all the time agents and brokers spend on managing other people s risks, it can sometimes be easy to forget that insurance can be a risky business for the people who sell it. The industry, the government and the buying public all have ideas regarding what a producer should and should not do. Failing to abide by those standards could jeopardize people s trust in insurance professionals and might produce financial and legal problems for sellers and carriers. By taking the time to understand those risks, producers move one step closer toward avoiding unwanted outcomes. CHAPTER 1 INSURANCE FRAUD INSIDE AND OUT Introduction When advocacy groups such as the Coalition Against Insurance Fraud (CAIF) claim that instances of insurance fraud add up to roughly $80 billion each year, you might reply instinctively with the same dismissive line that a comedian once used in response to a government report that said a certain percentage of Americans do not fill out their census forms: How do they know that? Fraud, after all, differs from crimes like theft, battery and assault in that those crimes are usually noticed by a victim. If someone breaks into your home, you will likely find damage to a door or a window, along with the empty spaces where your prized possessions once stood. You will probably file a police report, and an officer will give you the old We ll let you know if we hear anything speech. Law enforcement officials might never even come close to snatching your burglar, but they will at least document the fact that a crime has been committed. With fraud, there are no broken locks, shattered windows or empty spaces that make the misdeed obvious. Instead, at its core, there is a psychological trespass, an attempt by one person to take advantage of another s trust. Sometimes our instincts and our detective skills allow us to uncover a lie. But our judgment is bound to fail us occasionally, and other people s lies will be able to hide themselves within our trusting nature. Whether by failing to cover their tracks or by leaking their plans to the wrong individual, every single person who has ever been exposed as part of a fraud was a sloppy liar, and because we can only base fraud statistics on the people who have been caught, those statistics can never accurately account for the good liars who go undetected as they bilk insurers out of big bucks. That said, the inevitable softness of the $80 billion estimate should in no way give our society an excuse to brush off the need to lobby for increased fraud awareness. For those readers who are inclined to ignore the prevalence of insurance schemes, we shall assume for a moment that the $80 billion figure from the CAIF is a great exaggeration. For argument s sake, we will chop the estimate down by more than one-half to roughly $30 billion, a more conservative number that many other insurance experts have cited. To put that number in perspective, losses from Hurricane Andrew totaled somewhere between $15 billion and $26 billion, and insured losses from the September 11 terrorists attacks came to roughly $38 billion. As all insurance professionals who lived through those events know, the catastrophic level of destruction greatly affected the availability of affordable coverage in the damaged areas (not to mention other parts of the United States) for several years. If anything good can be said about fraud, it is only that it is less physically dangerous than a hurricane or a terrorist attack. But even if we decide that the $30 billion price tag for fraud is the more accurate estimate, we are still acknowledging that, from a financial perspective, the insurance industry is suffering financial losses on par with an Andrew-like hurricane or a terrorist attack every year, all because of lies. And, of course, the asterisk that must follow the $80 billion could just as easily mean that fraud costs insurers even more than the CAIF suggests. Consumer Views on Fraud For emotional reasons, we might avoid thinking about the prevalence of fraud. If we allow ourselves to believe that our fellow human beings, the people we put our trust in every day, are capable of stealing $80 billion or more, we may risk having to deal with sad, cynical thoughts that conflict with our desire to feel safe and happy. We may become upset when, for example, we are forced to think about an innocent motorist who died when a driver from behind intentionally crashed into Real Estate Institute 67

74 LIMITING YOUR PROFESSIONAL RISKS her so that he could pocket some cash through his no-fault auto policy. But professional insurance producers should not relegate their sadness solely to those sorts of situations. Instead, they should realize the enormity of a societal problem and feel upset because most Americans admit to tolerating insurance fraud and because that tolerance is often directly linked to a poor opinion of the insurance industry. The aforementioned CAIF conducted a phone survey in 1997, quizzing 602 respondents about their attitudes toward insurance and fraud. The results of this study seem to prove that people can have divisive attitudes about ethics even when a given issue has undeniably negative connotations attached to it. Insurance companies, who have an obvious incentive to take strict stances against fraud, would probably like all of their clients to be what the study called moralists. These people believe there is absolutely no excuse for committing fraud and that anyone who engages in it deserves punishment. Moralists made up the largest group in the survey, but that should not necessarily reassure insurers and make them think the average person sees eye-to-eye with the industry. In fact, the moralists were merely the victors of a tight four-group race, accounting for roughly 31 percent of respondents. Twenty-two percent of people fit into a category called realists. These respondents generally agree with moralists that committing insurance fraud is wrong, but they do not believe in prosecuting fraud with an iron fist. They even recognize some situations in which fraud is acceptable. About a quarter of the participants had a more passive take on insurance fraud. These people, termed conformists, reason that insurance fraud is so common that it is an acceptable crime, if not an encouraged one. If insurers can view moralists as their allies in a war against fraudsters, people who the study called critics might be viewed as their enemies. Critics do not just tolerate fraud. They often justify it by accusing insurers of mistreating consumers and having excessively greedy agendas. Critics belonged to the smallest group in the CAIF study but still accounted for a significant 21 percent of respondents. The big picture developed by this study is clear: Insurance fraud occurs on such a frequent basis because only one-third of our society refuses to tolerate it. If the industry wants to live to see a day when only amoral creatures engage in fraud, its prevention strategy must be aggressive and aim to change a lot of people s minds. Defining Fraud Before you can convince someone to think differently about anything, you need to step away from your own situation, block out as many personal biases as possible and try to understand the other person s opinion, as well as the reasoning that nurtures that opinion. You want to know not only what the person thinks but also why the person thinks that way. If insurance professionals step far enough out of their work environments, they might learn, much to their surprise, that what is obviously fraud to them is something else to the average consumer. Many people who work for insurance companies have a broad definition of fraud that encompasses any embellishment or lie that affects a person s insurance coverage. Many consumers, though, use a less inclusive definition. They agree with insurers that outright lying constitutes fraud, but they also believe that embellishing facts on an application or claim form is worthy of a lesser charge. To illustrate the different definitions, let us use a medical example. Pretend you are given blood tests by your doctor that cost about $100 combined and are not covered by your health insurance. After your appointment, your physician prepares a bill for your insurance company and lists different tests. These tests are very similar to the ones he actually performed, but they cost $150 and are covered in full by your insurer. If we use the first definition (the one more common among insurers), your doctor has committed insurance fraud by exaggerating his performed services to the insurance company and affecting your coverage. People who use the second definition might view the situation differently. You went to the doctor for blood tests, and he provided them to you. Though his billing of similar tests involved some deception, it was not as if he claimed to have performed a clearly unrelated procedure such as some form of cosmetic surgery. He knowingly stretched the truth. But did he really commit fraud? In order to avoid overblown semantic arguments, we will use the first, broad definition from this point forward whenever referring to insurance fraud. Now that we have addressed the fact that many people put conditions on what can be considered fraud, we can move forward and examine why consumers allow themselves to set those conditions in the first place. To insurance professionals whose self-concepts are grounded in their work, someone who commits insurance fraud is merely a thief who has no ethical principles. Sometimes the details of an exposed scam sadly support such a harsh judgment of fraudsters. At other times, however, people deceive and steal from insurers for what they believe to be matters of principle rather than greed. In these cases, insurance professionals certainly need not excuse fraud, but they should note the criminal s motives. If enough principled people justify insurance fraud in a given circumstance, it might be a sign that the public has a major problem with the industry and that one way to prevent fraud might be to provide better service at a more economical price. How Premiums Impact Insurers Public Image Seemingly all of the justifications people give for either committing or tolerating fraud are linked to the insurance industry s poor public image. To many consumers, an insurance company epitomizes all that is wrong with big business. When legitimate claims get stuck in limbo and issues cannot be resolved in a timely fashion, policyholders feel as though they have been unfairly caught in the impersonal and inefficient traps of bureaucracy. At the same time, the seemingly unsympathetic service provided by some companies and the steep asking prices for some policies can lead people to believe the insurance industry is nothing but a capitalistic monster whose only goal is to take other people s money. Because the industry has not been successful in altering this perception among many policyholders, insurance fraud is sometimes not viewed by the perpetrator as a crime but as a situation in which the victimized little people have evened the score against a big bully. Insurers (as well as many consumers) might deem this line of reasoning ridiculous, but it prevails whenever people get into car accidents and bill their insurers for preexisting damage because they feel like they have paid more than enough in premiums to justify the charge. Insurers can play fair by keeping policy prices proportional to the amount of risks that the policies absorb. Those companies that overcharge for insurance are bound to further the moneyhungry monster perception and are essentially begging their customers to do business with a competitor. Insurance companies with good intentions already understand this and might only need an occasional reminder of it now and then when bottom-line business pressure starts to mount. And yet, industry veterans who have done their best to exemplify fairness throughout their careers probably realize that no matter how low they go in terms of policy pricing, there will always be customers who feel as though they pay way too much for insurance. For whatever reason, it seems psychologically difficult for some people to believe they are paying a fair price for something that has not produced tangible benefits. Unless a person gets into a situation that calls for a major claim, that person might not realize how valuable insurance coverage truly is. So, to a degree, arguing with consumers about prices or Real Estate Institute 68

75 LIMITING YOUR PROFESSIONAL RISKS trying to improve the industry s image by dropping rates might not produce all the desirable results. But just because a price reduction campaign might not prove effective in the long run does not mean insurers are completely incapable of shaping their public image and debunking the flawed notion that a fraudster is a modern-day Robin Hood who seizes money from the corporate world and puts it back into consumers pockets. Insurance professionals can increase their chances of winning people over to their side in the fight against fraud by highlighting how a victory for the industry would also be a victory for law-abiding policyholders. That, by itself, is not fresh advice. For years, insurance professionals have claimed fraud punches the public in the pocketbook and raises premiums, some say, by as much as 15 percent for each customer. They have also argued that every second an insurer spends dealing with a fraudulent claim is a second that could have gone toward processing legitimate claims. The public, though, has not seen enough action behind insurers words to fully buy into those arguments. A number of people are convinced that, even though fraud probably affects premium rates, insurers would just as soon keep prices the same if fraud decreased. When confronted directly with this cynical assumption, insurers can cite examples of decreased fraud giving birth to cheaper policies. Greater fraud prevention supposedly had something to do with the reduced auto rates New Yorkers paid in 2005, and, according to the Wall Street Journal, insurers who had fled New Jersey started writing coverage in the state again in recent years, perhaps because of increasingly favorable fraud statistics. Yet in some ways, insurers who care about decreasing fraud have shot themselves in the foot by either keeping rates steady despite lower documented cases of fraud or by underpublicizing those mentioned instances when less fraud has allowed them to improve services and lower prices. As any journalist is bound to contend, an event or development that gets lost in the news shuffle and does not reach a broad audience might as well have never occurred, at least as far as the general public is concerned. If insurance professionals want fraud to secure a prime spot on the public s agenda, they must be more aggressive in promoting awareness of events, developments and statistics that prove insurance companies are not merely looking out for themselves and are not unwilling to share the benefits that could be created from a relatively fraud-free business environment. Decreasing Fraud Through Better Service Effective public relations campaigns require tremendous patience, resources and tact. Instead of embarking on that broad kind of endeavor, insurance professionals can personalize their efforts and change their public image one person at a time through improved customer service. Though logic supports the hypothesis that less fraud will allow for quicker legitimate claim processing, some consumers have had such disheartening experiences with insurance companies that they question the industry s commitment to paying legitimate claims in the first place. This image problem seems particularly prevalent among health insurance customers. There are several reasons why some people hate going to doctors. You might know someone who has hesitated to seek out medical treatment because the person feared getting some bad news. Maybe, at some point in your life, you put off a doctor s visit because you worried about losing a day s pay or getting on your boss s bad side. These sorts of problems, troubling as they may be, are beyond an insurance producer s control. One would think that having medical insurance would at least calm down the nervous job-conscious individual when he gets sick or suffers an injury. It seems logical that, disregarding all other factors, medically insured people would not delay or avoid treatment. Despite that logic, it is not uncommon for medically insured people in the United States to have serious misgivings about receiving treatment for serious ailments specifically because they dread having to deal with an insurance company. Many people have come down with a serious illness, suffered a significant injury or coped with a chronic condition and determined that dealing with their insurance company is harder than dealing with their health issues. The typical story goes something like this: An insured patient visits a physician, believing that treatment is covered under the terms and conditions of a health insurance policy. A few weeks pass, and then the patient receives a billing statement in the mail, which says either that the insurance company has denied the claim in full or that the policy only covers a portion of the treatment. At this point, the patient digs out a statement of benefits and tries to figure out why the claim was not paid. The material that the insured received from the insurance company when signing up for the coverage certainly makes it seem as though the policy covers the treatment. The patient dials up the insurer and talks to a customer service representative, who explains why the claim was not processed in the expected way. The patient is not satisfied by these explanations and spends several lunch breaks trying to speak with additional company representatives, insisting again and again that the insurer is responsible for reimbursing the physician. Sometimes the patient gives up and accepts the amount initially proposed by the insurance company, and sometimes helpful case workers find a way to resolve the issue in the policyholder s favor. But no matter the outcome, the patient notes all the resulting stress and lost time from the ordeal and perhaps feels more than a little uneasy from that day forward whenever an insurance statement arrives in the mail. For chronically ill patients who frequently have to argue with their insurer about what a policy does and does not cover, the claims process can be emotionally taxing. The patients may discuss their insurance problems with their physicians. The physician, wanting quick reimbursement for treatment, might be sympathetic and willing to file mildly exaggerated claims that increase the chances of an insurer paying enough to cover the actual cost of treatment. Instead of feeling like a criminal, the patient has a self-image of a seriously wronged person who engages in fraud out of necessity because an insurance company refuses to make good on what he or she believes to be legitimate claims. Not all medical insurance customers and health care providers have exaggerated on claim forms. Unfortunately, however, enough of them can probably empathize or sympathize with the hypothetical patient enough to give this sort of fraud a pass. Just like the consumer complaints about premiums, claims disputes will never go away, no matter how much insurance professionals refine their business practices to more outwardly showcase their fairness and compassion. But as is the case with the premiums issue, the industry is not powerless when it comes to changing how the public generally perceives the claims process. The agent or broker making personal sales can discuss specific gaps in coverage with consumers so that there are fewer surprises when a claim is denied. Insurance producers selling group policies, such as medical plans offered by businesses to employees, can distribute statements of benefits that are rich in detail and devoid of any language that a typical policyholder might deem vague, unclear or misleading. If insurance companies present their policies to consumers via overgeneralizations, half-truths and unnecessarily complex ideas, they will perpetuate the poor public perception of their business. Societal Views on White-Collar Crime Even when nurturing mutually beneficial relationships between themselves and consumers, insurance companies are still Real Estate Institute 69

76 LIMITING YOUR PROFESSIONAL RISKS handicapped in their anti-fraud pursuits by law enforcement priorities that conflict with greater fraud prevention. In this regard, insurance professionals are hampered not only by the people who make laws and police the people, but also by society as a whole. According to National Underwriter, insurance fraud was the second most costly form of white-collar crime in the United States leading into the 21 st century, outdone only by tax evasion. Insurers estimate that approximately 10 percent of claims are fraudulent, with some of those claims being completely bogus but with most featuring exaggerations. But as striking as those statistics may be, their impact on the public and law enforcement is dulled by the general population s passive perception of white-collar crimes. In a world where terrorism, war, gang violence, road rage and school shootings are common enough to dominate a nightly newscast, non-violent offenses such as insurance fraud can become nearly acceptable afterthoughts. Our hierarchy of needs places physical preservation over financial success, and we demand that people in power protect us from the blood and bullets before they start worrying about how to protect our dollars and cents. Perhaps people who commit insurance fraud for purely selfish reasons recognize that law enforcement officials can only stretch themselves so far when investigating criminal acts and that fraud is a low-risk crime as long as physical threats to our survival force police and politicians to look the other way when they notice fiscal wrongdoing. Maybe they believe our often limited understanding of how white-collar crimes negatively affect the common person will lead us to excuse their actions with a slap on the wrist, as if the clean-cut business executive who steals money by manipulating data and telling lies is so much more respectable and worthy of our mercy than the unshaven, unemployed drifter who picks our pocket on the subway. Or maybe the white-collar criminal is unable to view the rest of us at a distance and has merely allowed himself to believe the popular myth about how sneaky financial crimes do not really hurt anybody. The rise and fall of the energy company Enron did not directly relate to the insurance business; however this example of corporate greed probably attracted more wide-ranging attention than any other instance of white-collar crime in our history. This type of activity forces us to wonder if society s attitudes about such crime have changed in recent years. Did the guilty parties in the Enron debacle actually believe that business crimes were not serious offenses? Do Americans, having learned about all the regular men and women who lost so much because of Enron, now have an adequate understanding of how white-collar crime can endanger their well-being? And will that understanding result in citizens putting more pressure on those in power to prosecute those sorts of criminals? Or was Enron just an oddity, a situation that we only reluctantly addressed because it became too much of an obvious problem for us to ignore any longer? If the latter question is the one closest to the truth, insurance professionals might feel more than a little uncomfortable as they try to imagine just how out of control insurance fraud may have to be in order for the public, law enforcement and lawmakers to finally get together and do what is required to stop it. Insurers Reluctance to Fight Fraud Even among their peers, insurance producers have noted somewhat soft approaches to fighting fraud. Unhappy with the prevalence of fraud but resigned to its existence, some insurance professionals believe their individual actions cannot single-handedly stop the offenders who cheat insurers out of money. They often reason that paying questionable claims or agreeing to quick settlements in claim disputes is cheaper than fighting it out with a policyholder in a courtroom. On a case by case basis, such reasoning often makes sense. But when insurers agree to pay a potentially fraudulent claim or settle with a policyholder without much of a fight, they are not merely making a single financial compromise that settles an individual claim. Instead, with each compromise, they add to a pile of money that slowly but surely grows and becomes a significant portion of the $80 billion or so that insurers say they lose each year to fraud. Learning About Fraud and Becoming Proactive If they wish, insurance professionals who care about fraud can focus on improving the industry s image or changing society s views on white-collar crime. We know that changes in public opinion tend to occur gradually. Waiting for such changes, assuming they will occur at all, is unlikely to reduce the serious insurance fraud problem today or tomorrow. With this in mind, the most immediate progress in the fight against fraud can only be made by people in the insurance business. Until consumers, law enforcement officials and lawmakers offer greater anti-fraud support to the industry, insurance professionals must join together to help themselves. If the insurance community is to ever truly unite to combat fraud, it must do away with the notion that fraud is something to detect after a policyholder files a claim. Besides unnecessarily burdening claims departments with nearly all of the physical tasks related to fraud detection, this notion ignores the ethical responsibilities all agents and brokers have to insurance companies. Whether they are employed by an insurer or hired by a policyholder, ethical insurance professionals must bring consumers and insurers together only in good faith and should not transfer high risks to an insurer without informing the carrier of the risks. This obligation applies to health insurance agents who work with chronically ill clients, auto insurance agents who work with inexperienced drivers and, yes, all agents and brokers who work with any consumer who seems likely to have fraud-related motives. Through this course material, agents and brokers will learn about fraud that occurs in various lines of insurance and how to spot it. Insurance producers will also be alerted to situations in which people within their industry have hurt the anti-fraud cause through their own fraudulent activity. It is hoped that continuing education students can absorb this information and use it to make the insurance community a safer place for buyers and sellers to conduct honest business. Stopping Fraud Before It Starts While the individual agent or broker is not expected to take on the role of a police inspector, he or she is expected to keep an eye out for red flags of fraud, document any of those flags as they pertain to a particular consumer and share the documented concerns with those in his or her organization. Although many insurance companies hire professional investigators to observe, interview and analyze prospective and current policyholders who seem intent on committing fraud, any informed agent or broker with analytical thinking skills can contribute greatly to fraud prevention. Early Red Flags Fraud schemes differ from one line of insurance to the next, but some general red flags seem to apply to all types of insurance at the application stage. Some possible signs of fraud are concretely visible on an application, while others become noticeable only once insurance producers look more closely and observe how an applicant acts and how the pieces of information provided by the applicant fit together to form a bigger picture of the person s credibility. Still, in keeping with this bigger picture idea, it is important to note, throughout a policy s life cycle, that the existence of a single red flag or even several red flags does not necessarily prove a consumer has committed insurance fraud or is even considering it. Insurance professionals must analyze each customer s circumstances within a reasonable framework and not put every consumer in a needlessly defensive position. Ideally, by sharing suspicions of fraud with other professionals and analyzing these situations collectively, insurance Real Estate Institute 70

77 LIMITING YOUR PROFESSIONAL RISKS producers can increase their chances of exposing fraud and minimize the number of false accusations that penalize innocent consumers. As you read the following hypothetical example, which incorporates several red flags suggesting fraud, you will probably realize that some of the presented red flags could be explained innocently on their own terms and would not necessarily justify a fraud investigation. But, just as you would in a real-life situation, you will notice how accumulating facts and analyzing those facts can help you form a clearer picture of a prospective insured at the application stage. Louise works as an insurance agent and has been in the business for a long time. Most of her new clients come to her through referrals, either by co-workers who are planning their retirement or by her own longtime customers who know she will treat their friends and family members honestly and fairly. James became one of Louise s potential clients merely by chance. He had cold-called Louise s company in search of a policy, and she just happened to be the agent who picked up the phone. When James visited Louise s office to apply for a policy, Louise noticed almost immediately how restless he seemed, leaning forward on the edge of his chair. She also noted some odd entries on James application. Apparently James had lived in three different cities in the previous two years and now had his mail sent to a P.O. Box in a small town. Louise had taken the long drive down to the same town once or twice to visit a relative and thought to herself that this guy had come a long way just to apply for insurance. Louise became more uncomfortable when she got to the spot on the application for a home phone number, and she asked James why he had left this portion blank. James said he did not have a permanent phone at the moment but that he could be reached at his mother s number for the time being. Louise next asked for a photo I.D. and noticed James had crossed the line that separates restlessness from genuine annoyance. He sighed in frustration and said he had left his wallet in his car, which was parked several blocks away, and asked Louise if she really needed an I.D. in order to process his application that day. Louise held firm, and James left the office, returning a minute later with a driver s license that had been issued five days earlier. Louise then steered the conversation toward policy specifics. To her, James seemed to want an unusually large amount of coverage. He said over and over again that he wanted to err on the side of caution and claimed to not care how much he had to pay in monthly premiums for comprehensive insurance. Near the end of their appointment, Louise explained how the company would go about processing James application and how, if approved, he could pay premiums via checks payable to the insurance company. James said he would prefer to pay in cash and was prepared to make a payment or two on the spot if doing so would mean quicker approval. Louise declined his offer and promised to contact him at his mother s house once his application had been fully processed. After James left, Louise documented her many suspicions, mentioning that, in her opinion, this applicant appeared likely to commit insurance fraud. An underwriter at her company read her report, performed a credit check on James and discovered that he owed thousands of dollars to various lenders and thousands more to his ex-wife for child support. A few days later, Louise sent a letter to James P.O. Box and used the phone number James had given her to leave a message on an anonymous answering machine. The insurance company had denied his application. Granted, our example is absurd because James did absolutely nothing to make himself seem like an honest person. You, the reader, probably stopped giving him the benefit of the doubt long before you reached the part about Louise s company denying the application. But that, of course, is the point. A reasonably intelligent insurance producer who gathers facts and analyzes them can indeed aid insurers by spotting red flags of potential fraud and certainly has the ability to detect possible fraud in situations that are not nearly as blatant and ridiculous as this example. Auto Insurance Fraud For a long time, insurance fraud was thought of as something an individual committed alone or with a few close confidants. But today, it almost seems as though those were the innocent good old days, back when individuals committed fraud but thought it best not to get too many strangers directly involved in their scams. Modern auto insurance fraud is often an example of organized crime and involves many participants. Auto insurance fraud rings can be extremely complex. In some instances, these operations have included drivers, passengers, witnesses, doctors, lawyers and police officers in their schemes. Each of these participants takes a cut of the billions of dollars it is believed vehicle insurers lose each year because of phony claims. Organized auto insurance fraud is more than just a serious problem for insurance companies who want to keep their money out of crooks hands. Perhaps more than any other kind of insurance fraud committed on the consumer s end, auto insurance fraud deserves the attention of all people; those with insurance and those without, those who drive and those who ride in the passenger s seat. Rather than a seemingly victimless crime, this range of deceptions often hurts the innocents among us. To better understand why, let s look at an example of how an auto insurance fraud ring functions. Organized Crime and Staged Accidents Rob is part of an auto insurance fraud ring and is one of two passengers, plus a driver, in an inexpensive car. As they ride down some of the quieter roads in an area where reasonably high speed limits are permitted, Rob and the other passenger are watching for certain kinds of drivers. The less witnesses, the better, so they ideally want to find someone who is traveling alone. A nice car would be preferable, too, the kind of model that people could probably only afford if they had decent jobs and the kind that the owner might insure heavily to compensate for even a single scratch on the beautiful machine. They look at license plates as well, hoping to spot a tourist who would not want to waste time and money to challenge an insurance matter in a faraway state court. After what seems like an hour, they finally settle on a car they can all agree on, a car driven by a man who has no idea he is about to become a victim of a fraud. Rob s driver follows the man and is eventually able to move in front of the other vehicle. Keeping an eye on the distance between the two cars and adjusting his speed for a preferable amount of impact, Rob s driver slams on the breaks, and Rob holds his breath for a split second to brace himself for the forceful push that occurs when the two cars meet. Rob s fellow passenger is all set with his fake vomit, ready to moan, groan and rub his stomach at the very second when the innocent driver approaches. Meanwhile, Rob tries to focus on what to say about his back, not wanting to overdo it. (That might call for x-rays and other unbiased medical tests that could expose the fraud.) But Rob wants the innocent driver to believe he is dealing with enough soreness and pain to warrant a few grimaces and mumbles, especially when turning his neck a certain way. The innocent driver would normally be cursing at Rob and his friends, but his heart softens as Rob says he feels a little dizzy. Rob and the other members of the ring apologize to the innocent driver all at the same time, competing with one another so much that all he can really make out is something about an animal jumping in front of the car and the word sorry again and again. After swapping driver information, one of the co-conspirators tells the victim they have been on the phone with the police to report the accident. Sometimes when doing these jobs, that is Real Estate Institute 71

78 LIMITING YOUR PROFESSIONAL RISKS indeed what is happening, but on other occasions it has been found that the companion is phoning an off-duty police officer who is in on the scheme. After the accident is squared away, Rob and his gang visit a personal injury attorney who will fight for assorted reimbursements from any applicable insurance companies and who gets all of them an appointment with the same doctor. The doctor s office is as basic as they come, with no modern equipment in sight or any other visibly sick patients waiting for their own appointments. The doctor s practice, Rob knows, is only a front for these insurance scams and, come to think of it, so is the body shop that estimated the allegedly major damage on Rob s already beat-up jalopy. If those mechanics knew how little they were making from these scams compared to the big cuts that the lawyer and doctor take home each time, they would probably threaten to expose the whole operation. But there is no need to hold a grudge against the doctor. After all, she s the one who testifies to insurance companies and courts about Rob s phony back problems, headaches and other nagging soft-tissue ailments that are difficult to disprove. She and the lawyer are the ones with enough power and prestige to get the insurance companies to pay the claims. The innocent driver will get his car fixed, and he will walk away without a scratch on his body. In this regard, this accident is different from the one in which a scam artist hit and killed a 71- year-old grandmother named Alice Ross and the one in which a driver who was supposed to hit another vehicle accidentally hit a telephone pole and killed 64-year-old Altagracia Arias, who was supposed to witness the staged crash. Rob might think about these two cases of organized auto insurance fraud gone wrong and feel sad for a moment or two, but this feeling quickly goes away when he is reminded of the insurance checks that will soon be coming his way. From Rob s point of view, there s no need to feel guilty, no need to be sad. Nobody died from what took place not today anyway. Organized Crime and Real Accidents Sometimes, an accident is not staged in any way, but doctors, lawyers and their associates work with victims to build a fraudulent case after the fact. Many small, local newspapers summarize accident reports in each issue, and any persistent reporter can usually obtain a copy of a police report or at least get a glance at one for note-taking purposes. For a fee, people called ringers or steerers might impersonate someone from the press or take advantage of a source at a police station or an insurance company and gather the names of people involved in recent car accidents. This person might then contact accident victims and, if they have not yet contacted their insurance company, the ringer will suggest they hold off until a particular doctor examines them. If the ringer has reason to believe that an insurer already knows about the accident, he or she might tell victims that their insurer insists they see a specific doctor. At that point, the ringer moves out of the picture, having not committed any claims fraud, and allows the lawyers and doctors to handle the rest of the situation. Maybe these scams work because the doctor and lawyer actually convince the patient that he or she suffers from certain after-effects from the accident. Maybe there are legal, physical or financial threats involved. Or maybe the accident victims recognize an insurance scam when they see one and are perfectly willing to become players in the master plan if doing so might net them a few bucks. Organized Fraud s Effect on Premiums Organized auto insurance fraud has attracted so many people and gone undetected for so long that, in many states, particularly those with no-fault auto insurance laws, responsible drivers have struggled to obtain affordable, highquality coverage. As mentioned earlier in this text, fraud prevention allegedly helped drop auto rates in the no-fault state of New York in 2005, but in the not too distant past, an increased number of drivers had no choice but to accept the comparatively expensive coverage offered by the government, as traditional insurers became weary and more selective when selling policies to new customers. Perhaps deciding that enough was enough, Allstate Insurance Co. filed a $107 million lawsuit in 1998 against 45 individuals, including lawyers and doctors, who allegedly participated in auto insurance fraud rings. Unorganized Auto Insurance Fraud As much as this material emphasizes organized auto insurance fraud, it is not meant to imply that less organized, less complex auto fraud committed by a single person or a select few no longer deserves any attention. Insurance professionals must still fight against some policyholders who engage in more traditional schemes, such as reporting a car as stolen when the owner can no longer make payments on the vehicle. Insurers who base auto rates on geography, a somewhat unpopular practice among many urban consumers, need to look out for people who use fake addresses to lower their premiums. More recently, according to National Underwriter, the rise in e-commerce has allowed some fraudsters to insure their beat-up old cars online and then claim the car was damaged in an accident. Some insurers have also been seriously bothered by teenage daredevils with passions for drag racing. In contrast to the classic game of chicken, in which the winner s rewards consist of bragging rights and the continued use of all four limbs, today s victorious street racers often take home a customized part of losers cars as their trophies. For the hotshot driver who treats each one of his car s bells and whistles as if they were his children, the loss of a race and, therefore, a prized accessory can seem unbearable. In order to compensate for these losses, some racers tell police officers and insurance companies that their vehicles and accessories were stolen, vandalized or damaged in a legitimate accident rather than gambled away or wrecked in a contest. Red Flags and Auto Insurance Fraud Of course, if an insurance producer only had to memorize a few red flags in order to put a stop to fraudulent claims, insurance fraud would not be much of an important subject for continuing education. In terms of auto fraud, as well as fraud in connection with other coverage, the developers of this course do not naively believe that the general tips found in this text can end fraud. Yet for nearly every section of the industry, there are a handful of common-sense red flags that can at least help professionals minimize such crime. Before you even begin scrutinizing a particular claim for hints of fraud, you should realize that many successful perpetrators do not just become involved with a single scam. Many of them have committed fraud before. For this reason, you might find it helpful to view information about a potential fraud as if it were only one piece of a puzzle. Something might appear innocent within the context of a single claim but might not when viewed with the other claims the person has filed. One claim might lead you to investigate another, which might then make you want to review the person s application. Little discrepancies might convince you that digging for more facts to unearth the truth is worth the effort. To guard against fraud rings, insurance professionals should take note of doctors and lawyers who seem to be involved in an unusually large number of accident cases. Does one doctor typically diagnose patients only with those soft-tissue ailments mentioned earlier, such as back pain and headaches that are difficult to disprove? Do many of the doctor s referrals come to him via a lawyer? Similar advice applies to the people directly involved in auto accidents. Members of a fraud ring often switch roles from one accident to the next. A driver in one crash could be a passenger in another crash. If someone has been listed as a Real Estate Institute 72

79 LIMITING YOUR PROFESSIONAL RISKS driver or passenger in several accidents, insurance professionals might want to examine the circumstances of each event in order to discover any suspicious similarities. Looking into claims involving people with similar names is also helpful and, as we will discuss later, simpler than ever before thanks to search engine technology and shared claims information among insurance companies. There are many signs of unorganized auto insurance fraud. An insurance investigator should become somewhat suspicious when a claim for a totaled vehicle comes from a policyholder who suffered no injuries, and the same can be said of claims filed for extensive medical procedures by people who showed no sign of discomfort when they reported a fender-bender to the police. If a policyholder calls to say his car was stolen, an insurance company might want to investigate any recent reports of accidents that might have involved the lost vehicle. Sometimes criminals are easier to spot from the start, and the investigator needs to do less digging to find the truth. Alarm bells should automatically go off when a person claims to have lost control of a car in the rain when there have been no recent reports of rain in the area. If an unemployed teenager with several speeding tickets to his name claims someone stole his $30,000 sound system and ran a key across his customized paint job, your instincts should tell you something. Again, odd circumstances do not prove fraud. Maybe it did rain in the driver s neighborhood but not near yours. Maybe the teenager has parents who spoil him rotten. But such odd circumstances should absolutely force all employees who are working on questionable claims to use their heads and be alert to the possibility of fraud. Medical Insurance Fraud The majority of this course focuses on insurance fraud committed by policyholders. Agents and brokers who provide health coverage could certainly create a decent-sized list of this kind of activity as it pertains to their business. That list might include instances of patients abusing prescription drug plans by forging doctors signatures and placing orders for medicines at multiple pharmacies. Perhaps that list would also include policyholders who mark former spouses and grown children down on their health plans as dependents, a deception that insurers can remedy relatively easily by checking public records. But according to a study reported by the Journal of the American Society of CLU & ChFC (a financial industries trade publication), health care providers are more likely to commit insurance fraud than patients. On one hand, this makes sense, given the managed care systems in the United States, where many policyholders pay a small fee when visiting a physician and let the provider deal with the necessary claims forms. Because the contact between physician and insurer drastically exceeds the contact between patient and insurer, there is a larger window open for the physician to commit fraud as opposed to the patient. Even if patients receive regular statements from their insurance company about approved benefits and rendered services, they are unlikely to examine their records for billing errors made by a physician unless they have a problem with how much they, themselves, must pay to the provider. Still, the many documented cases of fraud committed by health care providers may be difficult for insurers to stomach considering the mutually beneficial relationship that ought to exist between the insurance and medical professions. If people did not put a premium on health care for themselves and their loved ones, consumers would have little reason to buy health insurance, and if insurance companies did not exist, physicians would struggle to secure payment for their services and would almost certainly need to more actively market themselves in order to attract a desired number of patients. Deep down, health care providers and insurers probably understand that they need each other to survive. However, the relationship between the two professional groups has always been a seemingly begrudging one at best. From some doctors perspectives, insurance companies have been stubbornly tight with money and dangerously intrusive when it comes to treatment issues. Good doctors want to be compensated fairly for their services and wish they had the freedom to serve patients without an insurer telling them that a patient does not need a particular medicine or surgical procedure. Meanwhile, a good insurer wants to be certain that physicians are not violating the trust that the company has given them by demanding payment for services not rendered. More so than any other topic discussed in this course, medical insurance fraud refuses to allow us to stereotype perpetrators as unethical under all circumstances. Sometimes, as in the opening discussion involving the frustrations consumers encounter when dealing with their insurance companies, this kind of fraud seems to operate in a stubborn cycle. In order to provide patients with the best care possible and to ensure that they receive payment for providing this care, physicians might deem it necessary to adjust a claim. At the same time, insurers realize physicians are adjusting claims, thereby cheating the system, and the insurance companies react by getting tougher on health care providers and patients and being even more strict about what their policies will and will not cover. With each side adjusting to the other s new positions, questions must be addressed by compassionate and fair insurers, as well as compassionate and fair doctors. Professional insurers must ask themselves if they have reached a point where their anti-fraud efforts, which take power away from physicians and reduce the number of affordable treatment options for patients, are actually encouraging health care providers to commit more fraud. Do some insurers enforce such strict rules when managing health care that sometimes the only option for a doctor with a sick patient is to break those rules? Meanwhile, medical professionals must ask themselves how they can justify fraud for the good of a patient today if their actions will almost certainly force insurance companies to become even more involved in treatment issues tomorrow. They must understand that insurers have justified reasons to protect themselves from fraud and that even though there are many good and fair doctors in the system, there are also some bad and selfish practitioners whose frauds have nothing to do with what is best for patients. All insurers and physicians may be caught in a vicious cycle, but there is reason to believe that those unethical and selfish practitioners played a major role in initially setting the cycle in motion. Those practitioners should not be allowed to cheat insurance companies. If insurance companies do not stand up to these unethical doctors by tightening their overall hold on health management, all insureds might suffer the consequences. Examples of Medical Insurance Fraud The most indefensible forms of medical insurance fraud are those that cheat patients as well as insurers. Suppose Mary injures her back and goes to a clinic that she assumes employs specialists who can help her condition. This is a very busy clinic, but with one look inside, Mary senses something is different about it. As she observes others and goes through her own appointment, she thinks that this is the fast-food, assembly-line version of health care. The employees engage no one in conversation and have an unstated yet still obvious agenda that involves getting patients in and out the door as quickly as possible so that they do not crowd the lobby. A woman who looks like a nurse runs through some standard procedures, taking Mary s temperature and checking her weight. Mary tries to go into detail about exactly where and when her back hurts, but the nurse seems focused on something else, looking at the clipboard filled with Mary s insurance information and not looking up or taking notes as Mary describes her symptoms. The nurse rushes Mary into a back room filled with bubbling hot tubs like those Mary has seen in spa brochures. She tells Mary to get in, leaves her Real Estate Institute 73

80 LIMITING YOUR PROFESSIONAL RISKS there for 15 minutes and returns to get her out of the tub and to schedule a follow-up appointment. Two weeks later, Mary receives a statement from her insurance company in regard to her trip to the clinic. She expects trouble, believing there is no way on earth her insurer is going to cover a quarter-hour soak in a whirlpool. But to her surprise, she owes nothing. However, the insurer has paid for some tests Mary does not remember having done and is also paying the clinic a few hundred dollars for some muscle therapy she has never heard of. Mary tosses the statement in a drawer, winces again as she rubs her back and decides to contact a certified medical doctor who might be better equipped to help her manage her pain. The details in that example were contrived for simplicity and clarity s sake, but the story s general outline is based on numerous examples of seedy medical operations that have successfully bilked millions of dollars out of insurance companies by charging them for procedures that were never performed or for unsophisticated services made to sound like comprehensive, specialized treatment. As reported by the Wall Street Journal and other news outlets, the state of Florida recognized the serious problems caused by these insurance schemes and took it upon itself to expose the people behind them. Inspectors discovered rudimentary setups, some under the supervision of a licensed physician and others operating thanks to a stolen doctor s billing number. In many cases, the lax attention these clinics received from regulators, as well as the pressure on insurers to pay claims quickly, allowed these crooks to reap large profits. By the time investigators received a tip about a suspicious clinic, there was already a good chance that the operation had packed up and reopened elsewhere, and the money for the phony treatments had already been doled out by the insurance companies. Other medical insurance scams involve purely selfish motives of patients as well as physicians. In a scheme known as Renta-Patient, doctors appeal to policyholders desperation or greed by rewarding them for undergoing pointless medical procedures. A patient might receive the nose job he or she always wanted with the understanding that the surgeon will bill the insurer for necessary surgery as opposed to a cosmetic operation. Sometimes patients are paid in cash for acting as guinea pigs. In an absurd travel promotion, as reported by Knight Ridder Tribune Business News, some 1,800 Utah residents were involved in a scam in which policyholders received an all-expenses-paid trip to California in return for undergoing such procedures as colonoscopies. Insurers in Utah said total claims from the venture amounted to $27 million. Among more legitimate health care providers, some hospitals have been accused of billing Medicare for procedures performed by resident employees as opposed to the faculty physicians listed on claim forms. Individual physicians have been accused of upcoding, billing insurers for more expensive procedures that are only somewhat related to those actually performed on a patient. Other physicians unbundle their services by charging insurers for each individual service provided to a patient when those services should be grouped together and billed at a lesser rate. Some doctors get caught billing an insurance company twice for one procedure. In a striking example that seems to incorporate unbundling and double-billing, investigators at Pennsylvania Blue Shield recalled a health care provider who administered chemotherapy in split doses so that he could double his profits. Detecting Medical Insurance Fraud Claims departments and investigative teams can sometimes spot medical insurance fraud merely by looking at a situation and applying some common sense to it. One doctor obviously could have benefited from a crash course in mathematics and personal stamina when he claimed to treat 200 patients a day. To catch potential fraud that is not so obvious, many medical insurance companies have utilized software that scrutinizes doctors billing practices and alters questionable bills automatically. You will read more about this software when we later turn our attention to anti-fraud tools. Workers Compensation and Disability Insurance Fraud Workers compensation fraud, which National Underwriter once estimated at costing insurers $5 billion each year, is yet another complex crime that professional insurers ought to examine from various angles. Stereotypically, this type of fraud brings lazy employees to mind who either stage accidents or fake injuries in order to avoid going to work. But stopping there and only noting that aspect of the issue would be detrimental to the insurance community and unfair to the many hardworking people who deserve financial assistance when their jobs take dangerous turns. From an insurance perspective, workers compensation fraud is as much an employer problem as it is an employee problem, with many companies actively deceiving insurers to obtain coverage and discouraging injured laborers from claiming the benefits rightfully owed to them. Before we examine some of the more complex sides of these crimes, let us start comfortably by exploring the stereotypical employee fraud that most people associate with workers compensation and highlight some red flags that might help employers and insurance professionals detect it. If a workers compensation claim doesn t seem to make sense, it is more than likely that some kind of investigative team will be called in to handle the situation. Sometimes insurance companies employ their own teams, and sometimes employers or insurance companies outsource the work to private investigators. No matter who ultimately takes control of an investigation, fellow employees and supervisors must be thorough when gathering facts about an alleged accident and when sharing that information with those people responsible for further investigation. All witnesses to an accident should be interviewed as soon as possible so that their recollections can either confirm or contradict the injured person s story. If an employer can only provide vague reports of an incident, the investigator s job becomes tougher, and an accusation of fraud could unfortunately boil down to nothing more than one person s word against another s. An employee s status with a company can hint at the truth surrounding an accident. If an organization has announced layoffs, a person who believes he or she will soon be one of those laid off might panic and turn to workers compensation fraud. Coworkers are important sources of information in these situations because they might have been the audience for an injured person s thoughts. Or, in a more optimistic outcome, they might be able to assure doubters that the person was a dedicated employee who would probably not engage in serious deceit. Temporary employees and new hires who make workers compensation claims often arouse some suspicion because their coworkers have not known them long enough to vouch for their character. Accidents involving no witnesses are obvious causes for concerns. This is especially the case when they allegedly occur on Monday mornings, since some workers might try to make their employer responsible for injuries they actually suffered on weekends. These employees will seem even less credible if they have reputations around the office as athletes, physical risk-takers or avid outdoorsmen. Once the worker is out of the office, investigative teams can observe the person from afar. If the employee has a second job, a team might visit the second workplace to see if the injured person shows up for duty. Sometimes teams catch an allegedly disabled person moving heavy furniture, playing an Real Estate Institute 74

81 LIMITING YOUR PROFESSIONAL RISKS aggressive game of softball or taking part in other strenuous activities that seem to contradict an injury claim. When these significant discoveries are made, they may lead to a claim being denied, thereby saving the insurer and employer money. In some cases, however, these seemingly defenseless exhibitions of physical strength are not clean-cut examples of people getting caught in a lie. Some injured parties have successfully argued that an investigator merely observed them on one of their better days or did not take note of the many hours or days they spent recovering from the heavy lifting or the softball game. As weak as those lines of defense may seem, most professional fraud investigators attempt to strengthen their cases against supposed insurance cheaters by documenting an extensive pattern of suspicious activity before challenging a claim. Red flags also fly when people injure themselves at work despite having a reasonably safe job. Though freak accidents do occur, an employer or an insurer might wonder, for example, why a receptionist or clerical employee has filed for workers compensation benefits twice in the past five years. In more perilous lines of work, however, fraud detection can seem insurmountably difficult. Consider, if you will, the construction industry. Here is a field that is packed with physical risks and is destined to produce a relatively high amount of legitimate disability claims. Construction workers undoubtedly realize this, and some of the dishonest ones might try to commit fraud, expecting their false injury claims to sneak past insurers discerning eyes. Like medical insurers, those professionals who offer workers compensation policies to high-risk businesses can sometimes feel ethically torn. They are smart enough to know that some people are engaging in fraud, yet greater scrutiny of claims could inadvertently clog the flow of benefits to deserving recipients and make insurers seem guilty of unethical, if not illegal, conduct. Logic suggests that because people who own construction companies will likely pay a large premium for workers compensation coverage, these employers should be just as serious about fraud prevention as insurers. Undoubtedly, many business owners subscribe to this ethical attitude. But too many others focus on the price of workers compensation coverage (which most businesses are required by law to purchase) and perpetrate their own brand of fraud, believing that cheating insurers and employees out of money and benefits is the best way to keep premiums down. Though individual insurers may differ in how they underwrite workers compensation, they generally base their decisions about these policies on the number, salaries and job duties of the employees who will be covered by a policy. High-risk business owners have been known to misrepresent all of those factors when applying for coverage. Rather than listing their entire workforce on a payroll, a construction company might pay some laborers either partially or entirely under the table. Instead of listing employees properly as roofers, a company might put them in a comparatively safer category, such as general carpentry. These examples nearly mirror a real development, covered by the San Diego Business Journal, in which six construction companies were charged with defrauding several area insurers out of $5.5 million. Life Insurance Fraud Life insurance fraud has probably been around as long as insurance itself. History tells us, for example, that two women were hanged in 1884 by authorities in Liverpool, England for allegedly poisoning men in order to collect beneficiary payments. Yet despite its extensive history, this brand of fraud is still an understandably delicate issue. Imagine, for a moment, that your spouse or someone else close to you has just died and someone from an insurance company insinuates that you may be guilty of faking the death or even murdering your loved companion for an insurance check. Most insurers don t want to be seen as heartless and are willing to accept a minimal amount of fraud to avoid this kind of perception from the public. This type of fraud intrigues us, maybe because many of the related scams seem like storylines from crime novels. These frauds make us furious for reasons that have nothing to do with stealing from insurance companies and everything to do with using other people as pawns in selfish games of life and death. Before discussing specific examples, we will first examine life insurance fraud at its lightest level; light only in the sense that even though money might be stolen from an insurance company, the perpetrator s selfishness does not extend to the physical endangerment of innocent people. If someone wanted to commit life insurance fraud 20 years ago, he or she would have bought a policy and waited roughly two years before putting the scheme into full operation. Back then, two years seemed like a safe enough holding period to avoid much suspicion from insurance companies. Today, with more and more fraud cases mirroring one another, some insurance professionals now say they are tempted to search for signs of fraud as far back as five years. The more intricate life insurance fraud schemes in the United States tend to involve relatively small policies from several companies. Utilizing small policies for these deceptions serves two purposes. First, it allows the criminals to maximize coverage without seeming suspicious to any one insurer. Secondly, because smaller policies are less likely to require physical examinations from policyholders, it gives perpetrators the occasional option of taking out policies on unsuspecting individuals. Once the policy has been in effect for a reasonable amount of time, the thief tries to secure a falsified death certificate in the insured s name. In one of the more elaborate frauds to attract media attention, this step in the scheme process was completed by a ring-leading funeral director who shared in the insurance payouts. In another case, a woman merely photocopied her deceased first husband s certificate and doctored it so that her living husband was listed. Arguably the most darkly amusing examples of attempted life insurance fraud are those in which one spouse runs a scam, while the other spouse remains completely oblivious to it. The clueless husbands and wives get up every morning, kiss their partners goodbye, go to work and come back home to their companions, all the while not realizing that, at least as far as an insurance company is concerned, they are supposed to be dead. Investigators arriving at homes of alleged widows to discuss beneficiary issues have been greeted at the door by some understandably confused yet very much alive husbands. One woman, profiled in Forbes magazine, could not understand why her allegedly deceased husband got so upset at her for faking his death without even telling him first. He s such a jerk, she said in prison. If it weren t for him, I wouldn t be in here. Life Insurance Fraud Overseas People intent on faking someone s death in order to collect life insurance benefits have had greater success when they have used foreign settings in their stories. A husband might claim, for example, that his wife traveled to Central America and died there. Cultural and political factors are keys to making these scams work. In Mexico, for instance, autopsies are not as common as they are in the United States. This would prevent insurers from routinely verifying deaths by matching a body s fingerprints to those of the policyholder. Deaths are even tougher to prove when they occur in Third World countries where recordkeeping systems are basic at best and, therefore, more easily corruptible. Political strife also hinders fraud prevention, particularly when civil wars claim so many casualties that authorities cannot accurately document all deaths. A combination of all these elements might explain why 80 percent of the insurer-investigated deaths in Haiti reportedly turn out to be fakes Real Estate Institute 75

82 LIMITING YOUR PROFESSIONAL RISKS It is also worth noting that foreign countries have their own problems with insurance fraud. In South Africa, where the AIDS virus has spread at alarming rates over the years, it appears as though it is an open secret that some doctors knowingly provide infected patients with clean bills of health so the sick can obtain life insurance. Murder and Fraud Some insurance producers encounter situations that seem to point toward murder. Suppose a woman claims her husband died in a fall while rock climbing, yet word gets out that the man suffered from a nearly incapacitating fear of heights. Or maybe the insurer is investigating an accidental drowning of a man s wife, and the producer finds out that the woman could not swim and did not bring a change of clothes along with her for what was supposed to be a week-long boat trip. Perhaps a policyholder has lost his wife and children in a fire and the producer discovers that his first wife died in similar circumstances and that the man was once investigated for mail fraud. Is it the ethical responsibility of the producer to make the insurer aware of his concerns? As human beings, we would probably like to come to the comforting conclusion that these situations add up to nothing but coincidences and that the people who we shake hands with and do business with would never do the terrible things that these various clues suggest. Yet that faith is shaken whenever we read or hear news reports about people who committed fraud through means that would not factor into even our worst nightmares. Consider these three examples compiled from court documents and news reports: In 1990, former Prudential Insurance Co. agent Joseph Earl Meling bought life insurance for his wife Jennifer worth $700,000. The day after coverage went into effect, in February 1991, Meling complained to his wife about her snoring and convinced her to take a dose of the 12-hour decongestant Sudafed. Jennifer Meling went into a coma, and her husband called 911 in hysterics. The operator wondered if Meling s display of panic was an act, and so did medical professionals who tried to treat his wife but could not figure out what had caused her symptoms. When offered permission to see his spouse at the hospital, Meling declined but did suggest to the doctors that she might have been suffering from cyanide poisoning. Sure enough, the Sudafed tablet Jennifer had taken that night was laced with poison, and the medical team was able to save her life. Later, in front of family and police, Meling said he knew he would probably be suspected of the poisoning, especially since he was due to collect so much money through Jennifer s life insurance. But he assured everyone that her coverage exempted poisoning. Two other area residents were not as lucky as Jennifer Meling. Kathleen Danicker and Stan McWhorter, both in their 40s, died from ingesting cyanide-laced Sudafed later that month. The deaths forced the drug s manufacturer to order a recall, which determined that someone had tampered with five packages of the medicine. It turned out Meling had not only lied about the poison exemption on his wife s policy. He had specifically asked if the insurance covered that peril. Handwriting experts determined he had signed for a pound of sodium cyanide at a chemical plant prior to the poisoning, and authorities accused him of tampering with multiple packs of Sudafed in order to cause a massive recall and draw attention away from his motive to kill his wife. Meling was found guilty of murder and other charges and sentenced to life in prison. The United States Court of Appeals for the Ninth Circuit affirmed a district court s rulings in The only detail missing from Meling s calculus was the identity of the people he would kill. That he was unaware of the victims identities does not make his conduct any less culpable, U.S. Circuit Judge Alex Kozinski wrote. Nor does the victims anonymity make his crime any less gruesome. If anything, the randomness of the act only renders it more cruel. In another case, Paul Valdos and Kenneth McDavid had died six years apart, in 1999 and 2005 respectively, but the differences between them in death pretty much ended there. Both men had been found in Los Angeles alleys with fatal upper-body wounds and tire marks on their bodies, apparent victims in murders that involved no witnesses. Coming forward to identify both bodies were Helen Golay and Olga Rutterschmidt, grandmotherly types who apparently befriended them when the men were homeless and who had subsequently put them up in apartments with paid utilities for about two years before the accidents. Supposedly, the relationships between the men and these seemingly good Samaritans was so strong that Valdos and McDavid listed them as beneficiaries for several small life insurance policies. Even though Valdos had children who survived him, it was Golay and Rutterschmidt who were allowed to claim his body and bury it in an unmarked grave. Realizing these connections, authorities probed deeper into both cases. A review of the numerous insurance policies revealed that Golay and Rutterschmidt assumed various identities in relation to the men. Sometimes they claimed to be their business partners, other times their aunts, cousins or even fiancées. Some insurers suspected fraud when it came time to pay the death benefits, but they said the women knew how to fight the system and that there were legal issues that prevented the companies from revoking the policies. According to the Associated Press, undercover agents began tracking the women and observed a blind man, Josif Gabor, accepting a ride from Rutterschmidt and writing on a series of forms en route to a bank. Sorting through trash that the woman discarded at the branch, officials found ripped envelopes with an insurance company s name on them, as well as bank documents featuring Gabor s name. Investigators also found rubber stamps designed to form several men s signatures among the women s possessions. In federal fraud charges brought against the women in May 2006, officials alleged Golay and Rutterschmidt had scammed insurance companies out of more than $2 million in claims related to the Valdos and McDavid deaths. The women pleaded not guilty. Meanwhile, investigators had been building a murder case around a 1999 Mercury Sable station wagon. Records showed that an hour before anyone found McDavid s body, Golay had ordered a car towed a few blocks away from the crime scene. The same kind of vehicle, with damage to its front, was later abandoned near Rutterschmidt s apartment. Though the car was never registered in either woman s name, police discovered a note in Golay s daily planner that listed a matching license plate number. Checking the car for evidence, police found DNA on the underside that they said matched McDavid s. In 2008, Golay and Rutterschmidt were sentenced to life in prison for first-degree murder and conspiracy to commit murder for financial gain. In another real-life example, Dina Abdelhaq s daughter Lena died before the child reached three weeks of age, an apparent casualty to Sudden Infant Death Syndrome (SIDS), a rare condition that usually only strikes babies who are put to sleep on their bellies and whose mothers have substance abuse problems. Yet Dina Abdelhaq had no known drug problems at the time and was a veteran mother who, family members said, knew how to take proper care of her children. When Lena died, the family said Abdelhaq went into a deep depression and got hooked on gambling at casinos, an unshakable habit that put her deep in debt by the time she gave birth to another daughter, Tara, roughly 15 months later. When Tara was born, family and friends gave Abdelhaq $380 and, according to taped conversations reported in the Chicago Tribune, the mother said she bought a life insurance policy for the child to be like a savings plan. She later said an Allstate Real Estate Institute 76

83 LIMITING YOUR PROFESSIONAL RISKS Insurance Co. agent pressured her into purchasing a $200,000 policy for the baby girl, though the insurance employee said it was Abdelhaq who pursued the policy and that the purchase seemed suspicious because the mother was in debt and did not have life insurance for herself or her other children. Ten days after the policy went into effect, Abdelhaq phoned her husband and told him Tara was sick. Despite her husband s orders to take her to the emergency room, the mother decided to wait and see if the child improved. The next day, Abdelhaq screamed in front of the baby s crib. Tara, with blood near her nose, was dead at the age of seven weeks. Telling people she had lost another child to SIDS, Abdelhaq tried to collect on Tara s insurance policy. Allstate employees suspected fraud and reported the situation to police. Authorities brought fraud charges against Abdelhaq in 1998, accusing her of killing her daughter to pocket insurance money. Besides building a circumstantial case around the woman s past, which involved gambling problems, bad checks and other frauds, prosecutors said the odds of two daughters dying from SIDS were highly unlikely. Though the condition was once thought to run in families, scientists now say there is conclusive evidence to show it is not a genetic disorder. An expert witness, who had studied thousands of SIDS cases, said he had never encountered a child in his research who died with blood near the nose, and he suggested the bleeding resulted from pressure put on Tara s blood vessels, possibly during suffocation. A jury convicted Abdelhaq in February 1999, and she was sentenced to 21 years in prison. You might have noticed that of the three examples, the Abdelhaq case most specifically mentions an insurance agent, and, indeed, this case deserves to be viewed as more than just a chilling instance of a consumer trying to defraud an insurance company by any means necessary. Tara Abdelhaq s death should make insurance professionals stop for a moment and realize that their sales practices can play a role in immensely serious outcomes. Insurance professionals know that something is only insurable if it has financial value to the applicant. Adults, for example, buy life insurance policies so that their spouses and children are compensated for the income that they will no longer have access to after a death. With this in mind, it is true that a life insurance policy for a child could pay for death-related expenses. But does a child s death typically leave the parents with one less source of income? Even if we agree that life insurance for children can serve a valid purpose, we can also agree that a $200,000 policy is unusual and probably without purpose for a newborn or for any child who is not keeping his or her family fed by singing, dancing or acting in big-time show business. Yes, it was the insurance company that reported Abdelhaq to authorities, and the agent who handled her application apparently did suspect something was wrong. But if this case teaches us anything, it is that recognizing an ethical issue without addressing it is perhaps even worse than not recognizing it at all. Though no insurance company should be judged based on one agent s action or inactions, the insurer may have reinforced the negative stereotype of the insurance industry by only acting when it came time to pay up on Abdelhaq s policy. Poor public perception acts as a huge barrier to fraud prevention. This situation and others like it force consumers to confront the following question: Do insurance companies really care about preventing fraud for the good of society, or are they willing to tolerate a potential crime as long as someone is paying premiums and has not yet filed a claim? Property Insurance Fraud Property insurance fraud often involves expensive items such as jewelry and paintings. Many companies who insure these items can link fraud cases to the appraisal process. An applicant might purchase a phony gemstone, purposely submit fraudulent valuations to the insurer and buy coverage for thousands of dollars above the item s actual worth. Eventually, the client will call the insurance company and report the stone stolen or severely damaged. The trade publication Best s Review has reported on a different kind of fraud that has particularly applied to jewelry appraisals. In this case, applicants defraud insurers because they, too, were duped by an inaccurate appraisal. Suppose Lindsey spots a diamond for sale by a jeweler for $5,000. She pays the price gladly, and why not? The jeweler has appraised the stone at an even $6,500, and Lindsey figures she can eventually make a nice profit from her purchase. The jeweler gives her receipts and other necessary forms documenting the diamond s value, and she is able to insure her find for the full $6,500. Lindsey has a friend who knows a thing or two about valuable jewelry, and she cannot resist showing her the diamond, expecting her friend to congratulate her for spotting such a fine specimen. But instead of patting her on the back, the friend tells Lindsey that the diamond is worth a couple hundred dollars at most and points out the clues that led her to that conclusion. For obvious reasons, this news upsets Lindsey greatly. She becomes instantly mad at the jeweler for conning her and mad at herself for believing a deal that was too good to be true. Lindsey could sue the jeweler for blatantly lying to her and giving her false documentation of the jewel s worth, but after thinking it over she realizes, with all the time and money she would probably spend on a lawyer and a potential court proceeding, she would be lucky if she got half of her money back from the crook. On the other hand, she still has the insurance policy for $6,500. Maybe if she tells a few lies or stages a burglary, she can file a claim and be done with the embarrassing mess. Even in less extreme situations, buyers and insurers ought to know that some sellers will fudge on appraisals. After all, the seller wants customers to believe he or she has gotten a great deal and that the item sold is worth much more to the consumer than what he or she has paid for it. For this reason, even when an applicant appears to be requesting coverage in good faith, it is often wise for an insurance company to obtain an appraisal from an unbiased third party. Along with serving the insurer s best interests, this practice can also help the consumer by either confirming an item s value or alerting the buyer to potential fraud that would have otherwise gone undetected. Property insurance fraud might also involve arson. Fraud in connection with arson seems to be one of the most difficult insurance crimes to prevent, but industry professionals can still rely on some of the general red flags discussed earlier in this text. Does the applicant seem overwhelmed with debt? Does the applicant appear anxious to buy excessive coverage for a building without considering the cost? Does the applicant have any history of fraud? Dealing With Fraud in Catastrophic Situations In recent years, insurers have had to deal with more catastrophes than they might have ever imagined. To its credit, the insurance industry paid most claims related to 9/11, even though it could have challenged them based on traditional insurance responses to acts of war. The industry compensated policyholders even more for damage done by Hurricane Katrina, a storm that overtook 9/11 as the most costly catastrophe in our nation s history. Yet even before the first claims came in from the hurricane, some insurance professionals knew from past experiences that a few policyholders would dare to use widespread tragedy as a springboard for fraudulent schemes. After 9/11, for example, one man claimed his wife went out on a job interview at the World Trade Center and never came home again. Nearly $300,000 into the scam, an insurance worker called a local sheriff s department and talked to someone who had just received an invitation to Thanksgiving from the allegedly dead Real Estate Institute 77

84 LIMITING YOUR PROFESSIONAL RISKS woman. Such scams are known to us obviously because the people behind them were caught. Insurance companies and law enforcement believe many more cases go undiscovered. Rather than become discouraged or cynical based on these kinds of cases, insurance professionals can take pride in the many claims they honored following catastrophes and be proud that they helped many people without putting them through extensive scrutiny. These frauds should not necessarily fill the insurance community with shame, as long as an overwhelming majority of processed claims provide financial assistance to people who are beginning the long task of rebuilding their lives. Fraud Detection Tools Though insurance producers should not allow themselves to become so swept up by the wonders of anti-fraud technology that they ignore what their experiences and instincts tell them, today s insurers have a great friend in the Insurance Services Office, Inc., (ISO) or at least in the fraud database that the company oversees. Before the ISO set up its current service, criminals had a decent chance of committing frauds in multiple lines of insurance without having their frauds linked together by investigators. Despite multiple databases, insurers did not share enough information with one another about their customers for fraud prevention purposes. A questionable claim might have been found in one database but not another. The ISO s more centralized fraud database has helped investigators connect crimes more easily than they could in the past, but the technology itself has been just as beneficial. Search engine capabilities now allow insurers to perform a wide variety of exploratory investigations of potential fraud. In addition to searching for multiple claims with the same name, address or Social Security number, fraud-conscious professionals can view records featuring different variations on names, addresses and Social Security numbers that the perpetrator might change from one crime to the next. On the human side, many insurers personally employ or enlist the services of a Special Investigative Unit (SIU). This team, made up of members with insurance, law enforcement and detective skills, delve into all available data about a suspicious claim, interview witnesses to accidents (including the claimant) and may engage in surveillance work. For some insurers, having a permanent SIU is a luxury they cannot afford. People who have stuck with an SIU for a long period of time, however, typically cite their unit s cost efficiency. SIU proponents have been known to say that for every dollar spent on a unit, an insurer saves $10 thanks to the team s effective anti-fraud work. If an insurance producer suspects a claimant of fraud, he or she should alert the SIU, assuming the company employs one, and let the specialists do a more thorough investigation. The use of an SIU however, does not exempt other insurance professionals from any further ethical responsibilities. If you call in an SIU, you ought to understand what the unit will and will not do in order to determine a claim s validity. An insurance company should consider ethical issues, such as personal privacy and deception, and determine if its SIU s tactics are likely to produce results without breaking any laws or any ethical standards that the company wants to uphold. Insurance companies specializing in certain lines of coverage have sometimes utilized fraud detection tools that cater more to their specific needs. Medical insurers, for example, began using software programs in the 1990s that automatically reduce reimbursements for health care providers whose claims suggest errors or fraud. These tools can spot irregularities, such as claims filed on behalf of male patients for gynecological treatments and multiple bills for the same service. Cigna Corp., which has used a program called ClaimCheck, reported that the bill-cutting software saved the company about $60 million during its first four months of use, but doctors have expressed concern with these supposed anti-fraud tools. In their mission to stop fraud, doctors say, these software programs sometimes unilaterally void many legitimate claims. Physicians have reported instances when they have examined a patient during an office visit, performed a biopsy or analyzed a urine test to diagnose the patient and only been reimbursed for the tests. In more extreme cases, doctors say they have performed multiple surgeries on a patient, yet the software only reimbursed them for the first procedure, as if the additional surgery should have been done for free. The bill-cutting software might catch the occasional thief, but it also presents negative possibilities for patients. Because some insurers have not adequately explained to doctors how their software analyzes claims, physicians have suggested they may have to compensate for the software s sometimes unfavorable determinations by charging patients more for treatment up front. Some have even wondered if a few health care providers will avoid performing various precautionary tests and exploratory procedures if they think an insurer s software will prevent them from being paid for the services. The prevalence of bill-cutting at major medical insurance companies was responsible, in part, for multiple class-action lawsuits filed on behalf of health care providers near the turn of the century. Demanding payment for services dating as far back as 1996, providers settled with many insurers, including Cigna, for hundreds of millions of dollars. In addition to the financial compensation, Cigna agreed to improve its communication with physicians and institute a system whereby providers could re-file disputed claims. Fraud From the Inside Most of this chapter has focused on fraud committed by people from outside the insurance community. It would be wrong, however, to suggest that this is a completely consumer-driven problem that insurance professionals will never detect among their supervisors, peers or competitors. Some corporate executives, agents and brokers give ethical insurance producers a bad name by committing or becoming involved in fraud. While fraud awareness is necessary when working with clients, agents and brokers must also address fraud within their own ranks by reporting known misdeeds to authorities and setting high ethical standards for themselves and their coworkers. Recent examples of alleged insurance fraud from the inside include the following: Lloyd s of London was accused of concealing its exposure to asbestos risks in order to attract investors. The asbestos situation allegedly jeopardized the solvency of some Lloyd s syndicates, cost people their investments and devastated some investors to the point of suicide. A financier allegedly transferred $200 million from five insurers reserve accounts to a brokerage firm and then used the money for himself. Authorities claimed the CEO of Near North Insurance Brokerage Inc. used millions of dollars that should have gone to insurers and policyholders to finance his personal projects and company operations. Summit National Life went insolvent, allegedly because an executive had transferred money to his other companies, purchased phony reinsurance and spent millions of the organization s dollars on his house. One of only two insurers to go bust from September 11, airline insurer Fortress Re allegedly fooled its parent company, a Japanese insurer, by buying cheap reinsurance that acted more like a loan than traditional coverage. A life insurer for Cicero, Illinois invested money into failed business ventures instead of paying claims and put the town in debt Real Estate Institute 78

85 LIMITING YOUR PROFESSIONAL RISKS A Florida auto insurer charged consumers, including the state s insurance commissioner, an estimated $4 million for coverage that policyholders never requested. Sometimes an entire company is one big fraud. According to the Government Accountability Office, 200,000 policyholders in the United States had fake coverage from bogus insurers between 2000 and Unknowingly armed with the phony benefits, those policyholders rang up a total of $252 million in unpaid claims during that span. Many phony insurers prey on the poor, the elderly, the immigrant community and sick people who have been denied coverage elsewhere. These predators offer rates that truly are too good to be true and sometimes use company names that are similar to those of respectable insurers. Though these companies and the counterfeit coverage they sell have not been licensed or approved by the state, many of the bogus insurers employ licensed agents, hoping that the salesperson s credibility will be enough to avoid suspicion. A portion of these agents claim they sell these policies in good faith, only to realize later that they have been fooled just as much as their customers. Certainly, as an insurance producer, you should research the credentials of companies you plan to represent. At other times, an insurance company and its policies are legitimate but individuals do all the defrauding. In a relaxed and unorganized work environment in which job duties are not specifically defined and errors are nearly untraceable, claims adjusters might manipulate forms so that they or an accomplice can receive checks that should go to a health care provider or a policyholder. In the cases of unethical agents and brokers, frauds are perpetrated because of various types of greed. When this greed is exposed, members of the producer s community tend to express shock and tell reporters things like, He was such a nice man! or I used to sit next to her in church every Sunday. These statements lend support to an intriguing aspect of the consumer-insurer relationship. As much as the public seems to dislike insurance companies in an abstract sense, people generally have positive feelings about their own agent or broker. The industry as a whole, they might say, is unfair, corrupt and cold-blooded, but agent John Smith and broker Jane Jones are ethical professionals who would not steal a stick of gum even if the grocer left the room. With these sentiments in mind, agents and brokers have even clearer incentives to learn about fraud and to actively discourage their peers from engaging in it. As difficult as insurance sales is now, imagine how difficult the job would be if a majority of people had negative opinions of their personal agents or brokers because too many of them acted unethically. As easy as it is to view fraud prevention as something the claims department should handle, the customer probably does not have a trusting relationship with his or her claims adjuster. Nor is the person likely to have a trusting relationship with toplevel insurance executives or trade groups, who have traditionally been the ones to make the case for greater fraud awareness. If the industry wants to reach its customers and convince them that insurance fraud is a problem worth tackling, it may discover that agents and brokers are its best messengers. CHAPTER 2 COMPENSATION ISSUES The Need for Fair Agent Compensation Nobody and everybody wants to talk about compensation at the workplace. All employees and independent business professionals inevitably evaluate their income at various points in their lives and wonder if the money they make equals the amount of hard work and skill they put into their jobs. At the same time, many people feel uncomfortable addressing their true feelings about the size of their salaries, wages or commissions and their desire to take home dollars that match what they deserve. Employees do not want to fall into a trap of revealing their displeasure about the numbers on their paychecks and risk being thought of as ungrateful, greedy or uncommitted to their work-related obligations. Insurance producers, as well as anyone else with a sales position, can have an especially tough time actively addressing their compensation concerns because they need to worry about more than just how employers and peers will judge them. They must also deal directly with the public and face consumers who will question sometimes out loud if the seller cares more about earning a commission than treating them fairly. The reader might assume that a course like this will chastise agents and brokers for accepting large commissions, but that is not nearly the case here. Insurance agents and brokers work just as hard as people in other businesses and deserve proper compensation from their clients and employers. However, because the industry can sometimes overemphasize the need for agents to make the sale, and because commissions can serve practically as the only source of income for some insurance producers, even the ethical agent or broker can feel pressured to bring in new customers at any cost. Ideally, insurance companies would probably like their agents to focus on long-term, profitable careers in sales and service, but it is understandably difficult to think about the future when competition, inexperience or other factors make sales elusive in the present. The nerve-wracking grind of meeting, greeting and trying to make deals with potential customers, coupled with minimal success, can push some agents into situations where a particular sale, or even any sale for that matter, can be the difference between them having a future in the insurance industry and dropping out of the profession altogether. Many agents deal with their frustrations by doing the latter. Others who struggle decide to give themselves more time to learn more about the business, develop more relationships with customers and perhaps rely on a little luck without giving up on their insurance careers. A third group, though, might reason that financial stability and eventual success should overrule an insurance producer s obligation to treat consumers in an ethically upright manner. Despite the fact that such behavior gives the public an excellent reason to take its business elsewhere, these producers deceptively sell unnecessary policies with high premiums merely so they can pocket commissions. The agents and brokers who engage in this activity, though proportionately small in number, give the insurance industry a bad reputation when they coerce people into unnecessarily switching to a new policy so that the agent can claim a large first-year commission. They ignore honest customer service when they set people up with expensive or excessive coverage solely to collect a larger amount of paid premiums. They exhibit trickery when they falsely advertise their products and make a client believe that he or she has invested in retirement accounts when the money has really gone toward a life insurance policy or vice versa. The Struggling Ethical Producer There are many good agents and brokers in this world. These insurance producers are honest, productive people who insurance companies should want to work with. But, in some Real Estate Institute 79

86 LIMITING YOUR PROFESSIONAL RISKS cases, these professionals are struggling regardless of their character and experience and are working more for less pay. Over the years, insurers have discovered that cutting commissions is an easy way to temporarily save money when business is bad or when insured losses are larger than expected. This seemed to have occurred in Florida following Hurricane Andrew and the big hit insurers took from that disaster, the most costly American catastrophe until the September 11 terrorist attacks. According to one insurance producer quoted in the Wall Street Journal, some companies in the state reduced commissions to such a low level that if an agent had to travel a long distance to close a sale, the resulting compensation would not have been enough to cover gas. With the incentive for an agent to sell policies in parts of Florida so small, it became difficult for even the fairest insurance producer to offer coverage to local residents. Florida eventually tackled the problem by enacting laws and establishing a special insurance system to accommodate coastal businesses and homeowners, but that temporary crisis provides us with an example of how unreasonable compensation can hurt agents, insurers and consumers and create the potential for questionable ethical practices. In cases such as Florida s, insurance producers have only a few choices: They can wait out the tough times and accept extremely low commissions in the hope that business will improve. They can look for jobs with insurers who will pay them higher commissions. Or, in a worst-case scenario, they can give into the temptations of the make the sale at any cost philosophy and manipulate the consumer into buying insurance products at prices that will at least help agents and brokers get the most out of those small financial rewards. Typical Compensation for Insurance Producers Particularly over the past 15 years or so, insurers have experimented with various forms of compensation in order to rightly reward agents for their work, protect parent companies interests and play fairly with the buying public. The most traditional form of compensation for an insurance producer pays the agent or broker a large percentage of paid premiums during the first year of a policy and a very small percentage of paid premiums upon renewal. This classic rewards plan allows agents and brokers to receive payment in as uncomplicated a fashion as possible. There is almost never any need to negotiate with the customer because the producer s assorted services all come included within that set percentage. Many agents like the traditional first-year commission system because it is what they know and because it compensates them quickly for their labors. Most agents do the bulk of their work during the initial sale stage and can often spend weeks or months lining up a new account. So, logic suggests they should get paid near that time instead of over a period of several years. Relatively new agents often prefer the first-year commission system because it allows them to earn significant money with a few big sales as they try to build up their small and new client base. On the downside, compensation via commission seems to always get the blame whenever unethical insurance salespeople take advantage of buyers. More than any other compensation method, the first-year system discourages longterm service to the customer and emphasizes the sale. Because the commissions arrive in the policy s first year, there is also a smaller window of opportunity for insureds to realize they have been victimized by an unethical person and to cancel the policy before the unethical agent receives significant compensation. In a disturbing study conducted in the United Kingdom (where insurance compensation issues have often preceded those in the United States), the Consumers Association found that among a sample of financial planners (which included insurance agents and brokers), one in five gave detrimental advice to people. That detrimental advice would have almost always led to higher commissions for the planners than they would have received by giving more beneficial advice, the association said. In a mild compromise between the traditional commission system and consumer protection, some insurance companies now pay their agents a first-year commission based on an agent s total business in a given time frame instead of rewarding the employee for each individual sale. It has not yet been determined if this has made a difference in producers dealings with consumers. The Positives of Levelized Commissions Due in part to unethical conduct by some insurance producers and the resulting bad publicity, many companies have at least considered changing their compensation systems to one involving levelized commissions. Under this form of compensation, an agent who might have normally received a 50 percent first-year commission and little else afterward would instead possibly receive a 15 percent commission for the first five years of a policy and a smaller commission in later years. Because the levelized commission spreads itself out over several years, the producer-consumer relationship can differ greatly compared to the relationship in the first-year system. Whereas first-year commissions can tempt an agent to snag a client, make a sale and then concentrate on finding another fresh buyer, levelized commissions inevitably emphasize service to existing clients. The agent s continued commission is tied on a long-term basis to the individual consumer, and the agent does not want to lose the client to a competitor. In some ways, the levelized commission system is like an annuity, giving the agent a dependable, small income each year. That dependability can serve an agent well during dry spells when industry-wide sales slump or when an experienced seller simply suffers through some bad professional luck. The Negatives of Levelized Commissions Still, it may seem silly or even unacceptable to some agents when they have devoted a large portion of their energy to a recent sale and are paid for that work in yearly installments, as if their employer were buying a car or paying off a loan. New agents, in particular, might find themselves struggling with levelized commissions because they have not worked with enough clients to keep the money coming in. Under these circumstances, one hopes that insurance companies find ways to take care of promising young agents who might consider leaving the industry if they believe they will have to wait too long before they start making good money. Some companies who favor levelized commissions have addressed this issue by increasing base salaries for new agents or by providing them with allowances to cover various expenses. The rookie independent agent, who does not receive a salary and is not affiliated with a particular company, is probably the person least likely to endorse levelized commissions, since compensation from the first year might hardly constitute much of an income. Company Perspectives on Levelized Commissions With levelized commissions encouraging agents to devote more of their time to helping existing clients, one may wonder if this compensation method hurts insurers by sacrificing sales for service. Agents should keep in mind, however, that ethical customer service to existing clients can serve as a great sales tool. The customer who trusts the agent who sold him a homeowners policy and who knows he will receive excellent service from that agent is more likely to go to the same agent when he wants to purchase a life insurance policy or some other form of coverage. Consumers who come to trust an agent or broker are also likely to recommend that agent or broker to friends and colleagues. Meanwhile, the added service element of levelized commissions ideally benefits the insurance company by minimizing cancellations and not forcing the organization to replace an old account with a new one. Insurance companies Real Estate Institute 80

87 LIMITING YOUR PROFESSIONAL RISKS undoubtedly want to increase overall sales, but it is still cheaper for the company to process a renewed policy than to process a new one. The fear surrounding levelized commissions and new agents aversion to them contrasts with the reality at Acacia Mutual Life Insurance Co., where, beginning in the mid-1990s, all agents were compensated through some form of a levelized commission. A year after implementing the new compensation system, the company suffered no significant, permanent loss of agents, as reported by National Underwriter. Promoting Levelized Commissions in the United States Some insurers have packed additional incentives into their levelized commission plans in order to make them more attractive to hesitant agents. The Wall Street Journal reported John Hancock Insurance and Financial Servicies was prepared in January 1997 to offer agents the option of receiving commissions of up to 12.5 percent during a policy s first five years, at least 4.5 percent in additional years, plus sales bonuses, renewal bonuses and allowances. But the acceptance of levelized commissions among insurers has been lukewarm and slow overall, partially due to legal issues. A long-standing New York regulation defined agent compensation strictly enough to initially prevent insurers from trying levelized commissions in that state. In time, New York granted insurers more leeway in regard to compensation, but even after the occasional state-level challenge, levelized commissions are still not nearly as prevalent in the United States as they are in other countries, such as Canada. The Positives of Fees Many financial planners have a long history of charging fees for their services instead of commissions, but it has taken longer for fees to become popular in the insurance industry. Perhaps best-suited to the broker-consumer dynamic, fee compensation tends to involve a greater understanding between parties that the professional is receiving compensation in part for his or her specialized knowledge and experience. A professional who charges a fee is also likely to focus on providing specific services to customers. This might mean that consumers are charged a certain amount if the insurance producer handles a claim for them and a separate amount if the producer handles a renewal. Or it might mean that the professional has itemized all the services he or she will perform for clients, totaled the prices for all of those individual services and arrived at a flat fee for consumers to pay. From an ethical standpoint, fees lessen the potential for real or perceived conflicts of interest. Because the insurance producer does not receive a commission, consumers need not worry so much about being sold policies that they do not need or want. The compensatory fee is known to all parties from the beginning of service and will generally not change no matter how much a person ultimately spends on insurance policies. Like agents who work for levelized commissions, insurance producers who make their livings through fees will struggle to survive without conducting business in an ethical, serviceoriented style. They still must use sales skills, but instead of selling policies, they are ultimately selling themselves and trying to make the case that they are worthy of advising the public in policy decisions. Some consumers like the fee system because fees can be less mysterious than commissions. When someone s money goes toward a commission, that person is almost never aware of exactly what services are being paid for with those dollars. A consumer might wonder what the agent actually did or will do to earn an 80 percent commission during the first year of a life insurance policy. When a commission does not seem to add up to the amount of service provided by the agent, the policyholder might feel cheated. Fees, on the other hand, can allow consumers to see exactly what they are paying for: Service X at a set price and Service Y at another. The Negatives of Fees Detailed disclosure, perhaps the most beneficial aspect of the fee compensation system for the public, also represents a major reason why many insurance producers dislike charging fees. Unless the fee is derived from some sort of hourly rate, the insurance producer must face the difficult task of assigning some sort of price to every service provided. Among the many tough questions for these professionals are the following: How much is advice really worth in dollars and cents? How much should a person charge for handling a claim or for making a phone call on a client s behalf? An astute businessperson takes the time to figure out how much services really cost, but for the insurance professional with nothing but an agent s background at a huge company, making those price determinations can be very difficult. That difficulty only grows worse when the producer deals with consumers who wonder why they have to pay a set amount of dollars for a service that would have been included in a traditional commission-based transaction. Even though producers display excellent ethical character whenever they disclose costs to consumers, they must always prepare themselves for disagreements about the price and value of those services. Additional Compensation Methods Insurance producers have utilized other compensation systems besides traditional first-year commissions, levelized commissions and fees. Though a rarity in the insurance business, a few companies discourage most kinds of sales bonuses and instead pay their employees primarily on a salary basis. For the agent, under these circumstances, there is little opportunity to supplement one s income with sales commissions, but the ethical concerns of consumers are bound to be at a near low as a result. Salaried employees have few reasons to manipulate or trick potential customers into buying insufficient, excessive, needless, deceptive, or outrageously priced policies, and the public is smart enough to realize that. Norwich Union, the largest insurer in the United Kingdom, said in 1994 that it would stop paying its sales staff solely through commissions. We ve carried out market research that shows that customers have more confidence in sales consultants on salaries than in commission-only salespeople, a spokeswoman told National Underwriter at the time. Rather than pursuing new business, we want to develop our existing, warm customer base and good, quality business, which stays with us. One insurer, Life USA, has compensated independent insurance agents with stock every time they make a sale for the company. An independent agent confronted with such compensation must consider the ethical questions involved with accepting that reward. In this case, is the agent obligated to tell consumers about any financial interest he or she has with an insurance company? Does the agent s independent title become meaningless? Will consumers assume the agent is intentionally steering them toward the insurer who is offering the stock regardless of what they need, want or can afford? Choosing a Compensation Method Some agents and brokers will have opportunities to choose their form of compensation. These professionals should consider all of these mentioned compensation systems and weigh their strengths and weaknesses on both personal and societal scales. Other professionals will always have their payment method chosen for them by employers, but that is no reason to ignore the ethical issues involved with compensation. Whenever possible, professionals should gravitate toward an employer who clearly upholds ethical principles that are similar to their Real Estate Institute 81

88 LIMITING YOUR PROFESSIONAL RISKS own. When that is not possible, a professional should at least call attention to compensation systems that might prevent him or her from earning the public s trust. No one wants to feel ashamed of making money, and as long as insurance producers receive compensation that ethically befits their service, they can enjoy the fruits of their labor with a clear conscience. Commission Disclosure There is obviously more of a personal incentive for agents to sell a policy that would net them a large commission instead of a small one, and although most insurance producers do their jobs independent of personal motives, enough selfish agents and brokers have forced the public to sometimes grow suspicions of a producer s solicitations. Many people within the insurance industry believe sellers of policies should disclose the commissions they earn, either during the sales presentation or upon the buyer s request. It is felt that this would serve to protect consumers and put their minds at ease. Some people say this disclosure helps insurance customers evaluate the information and advice that an agent or broker gives them. In most cases, a producer s commission does not expose overwhelming personal bias. It is likely that even an agent who made a 90 percent first-year commission on a high-priced life insurance policy treated the corresponding customer fairly. But commission disclosure helps insureds evaluate the potential for personal bias on their own and gives them at least one more tool to use as they attempt to make an informed decision. The Case Against Commission Disclosure Many insurance professionals have no qualms about disclosing their commissions, but just as many seem reluctant to do so, citing matters of practicality and principle. Some agents and brokers believe commission disclosure can confuse the consumer and detract attention from more important issues. Once they know an agent s commission, consumers might focus too much of their attention on that figure and ignore other important elements of the agent s sales presentation, including a policy s depth of coverage and other features that could benefit buyers. Also, if commissions become public knowledge, competitors might use compensation as part of their sales pitches. One agent might try to convince a customer that another agent s commission is too high and ethically questionable. Some producers have even wondered if the push for disclosure is, in fact, part of an attempt by insurance companies to lower agent commissions. Allegedly, if consumers learn how much an agent makes from a sale and enough of them respond unfavorably, parent companies will have an excuse to pay agents less and increase corporate profits. Particularly when regulatory bodies or trade associations debate mandatory commission disclosure, some insurance producers who oppose such measures point toward fairness. To them, forcing agents and brokers to disclose commissions seems unfair while professionals in the banking industry, who sometimes sell insurance products, do not need to follow the same rule. Similar logic applies in a more general sense as well. If the law does not require carpet salespersons or telemarketers for publishing houses to reveal their commissions, why should insurance producers be treated differently? Unethical market conduct in the United Kingdom and Australia resulted in disclosure requirements for many producers in those parts of the world, and some observers linked lower sales figures and decreases in the agent population to the changes. (According to National Underwriter, though, U.K. sales had fallen before the disclosure requirements went into effect.) Perhaps those observers made a valid connection between disclosure and sagging sales, but the ethical insurance producer must consider more than the financial bottom line when forming opinions and making decisions. The Case for Commission Disclosure Our culture seems to teach us that it is rude to ask people how much money they make, but one can argue that an agent or broker is ethically obligated to reveal commissions to consumers. It is the consumers, after all, who fund commissions in the first place through their premiums. Though lower commissions do not necessarily mean cheaper policies for the buying public, a person who inquires about commissions is probably acting like a smart shopper. Agents and brokers should consider their own buying histories and think about the times when they seriously wondered how the money they gave to a business, charity or other entity was actually being spent. Whether or not they ultimately choose to reveal their commission rates, professionals should realize the information indeed relates to the consumer in some way and is therefore not as personal as many producers might like to think. Dealing With a Consumer s Response For those agents who view disclosure as a matter of ethical responsibility, the practical challenge of dealing with a customer s reaction still exists. No agent wants to argue about commissions or lose business over the issue. No one wants a customer to conclude a meeting by saying something like, With that kind of commission, I m better off buying my insurance on the internet. Even before questionable market conduct sparked the disclosure debate in this country, some agents did not have a problem with discussing their commissions with prospective customers, and many of those agents have said they can count the number of times they have been asked about compensation on either one hand or none. On those occasions when a consumer does express displeasure after learning about a commission, the agent or broker might find it helpful to emphasize his or her special qualifications and expertise. Many consumers do not take the time to interview agents about their credentials, individual strengths or moral character, opting instead to initially go with whichever agent answers their phone call. If a commission seems like a barrier to a sale, the agent has an opportunity to fill in the positive information that the customer never bothered to investigate. If agents can accurately present themselves as ethical professionals, they may be able to turn their compensation into a meaningless point. Rebating Most consumers probably do not realize they can sometimes negotiate with insurance agents and get them to accept lower commissions. Rebating is perhaps the most controversial practice in the insurance world that involves decreased agent compensation. Agents who rebate will usually return anywhere between 50 percent and 90 percent of their first-year commissions to customers in exchange for doing business with them. In most cases, agents reserve rebating for big groups who purchase disability or life insurance policies, which tend to have high commission rates attached to them. All states outlawed rebating during early parts of the 20th century, mainly to prevent large insurance companies from killing off smaller insurers who could not afford to offer returns on commissions. The practice remained illegal throughout the country until the late 1980s, when California actively changed its related laws and when multiple courts ruled that Florida regulations that prohibited rebating were unconstitutional. The remaining 48 states have not followed suit, and, in some cases, have taken even stronger stances against rebating since the developments in the two coastal states. When Florida and California balked at tradition, insurers elsewhere began worrying that their local customers might purchase insurance through agents in those states and wait for Real Estate Institute 82

89 LIMITING YOUR PROFESSIONAL RISKS their rebate checks to arrive in the mail. In response, Illinois, for example, made it illegal not only for insurers to rebate in the state but also for residents to accept rebates from agents in other parts of the country. Even in those few places where rebating is legal, most agents who offer the discounts keep quiet about them and will not offer to return a portion of their commission to a client unless they are either asked directly about a discount or are competing against another person for the business. Problems With Rebating Insurance companies get an obvious benefit from rebating when the clients they desire come their way because of an agent s agreement to accept a smaller commission. Consumers get benefits, too, when rebating saves them money and nurtures enough competition to prevent price fixing. So why do so many people, including executives at some of the world s biggest insurers, think rebating is such a bad thing? The Competition Argument One argument has remained the same since those initial antirebating regulations went into effect all those years ago. Depending upon one s perspective, rebating might prevent price fixing and enhance a free market, or it might do just the opposite. To understand this point, consider, for a moment, the heated debate in this country about large discount retailers. A person on one side of the argument might say that Wal-Mart and similar stores help the market and consumers by offering products at a low price and challenging other businesses to lower their prices in the spirit of healthy competition. Another person with an opposing point of view might say those retailers actually endanger a free market and could ultimately hurt consumers by driving other stores out of business, limiting consumer choices and slowly but surely gaining the power to fix prices as each competitor fades away. The Discrimination Argument Another ethical factor brought up by people who oppose rebating is the practice s alleged potential to create discrimination. Unless an insurance company or an agent gives rebates to all customers, some people obviously end up paying more for coverage than others. Carriers who offer rebates should consider a popular principle that guides many ethical insurers: Whether consumers are black, white, male, female, young, old, married, single, employed by a small company or part of a big corporation, the prices they pay for insurance should be determined by their risk potential and nothing else. A Contrary Opinion on Rebating Despite the alleged problems with rebating, some high-ranking members of the insurance and legal worlds have viewed the practice differently. In Dade County Consumer Advocate s Office v. Department of Insurance and Bill Gunter (the 1984 case that has served as the legal precedent for rebating in Florida), the Court of Appeals of Florida, 1 st District said rebates did not jeopardize insurers solvency, that rebating is fair and that it does not constitute undesirable discrimination in a free market economy. Making Ethical Conclusions About Rebating No matter how an insurer feels about rebating, the competing legal views on the subject with Florida and California at one end of the issue, and the rest of the country at the other present the insurance professional with many important ethical choices. Some producers will conclude that even if they disagree with the rebating regulations in their state, the law must be followed without question or deviation. Some people living in places where rebating is permissible might still not engage in it, believing that ethical issues like potential discrimination, as well as the possibility of negative market disruption, should take priority over the benefits of selling more insurance. Other producers in those states might conclude nearly the opposite, that an ethical obligation to serve consumers by getting them the best prices possible should guide their conduct and that the rules in Florida and California make the insurance world a safer place for the public. Some people in Florida and California might feel ethically obligated to work toward changing their state s laws to be more like the rest of the country. Conversely, many professionals in the other states might feel ethically obligated to work toward changing their laws to be more like those in Florida and California. It s not surprising that insurance professionals have uniformly passionate, yet ultimately wide-ranging views on this issue. Ethical insurance professionals are not pre-programmed robots. They question their own actions, as well as those of their employers and peers, while also thinking about consequences for themselves, consumers and their industry. Insurance Brokers and Contingent Commissions Contingent commissions. Kickbacks. Market service agreements. Placement service agreements. Double dipping. No matter what you call them or how you characterize them, commissions paid by insurance companies to brokers have created a tremendous stir over the past decade, raising questions about ethics and the law. Once considered prevalent mainly in commercial lines of insurance, these commissions have caught the attention of insurance regulators in several states and are now known to be common in various other lines as well. This controversial compensation method, which we will refer to as the contingent commission method, tends to take on two forms. In the case of volume override commissions, insurance companies give a broker a bonus if premiums received from the broker s collective group of clients exceed a set amount. In the other common contingent commission arrangement, insurers pay a broker profitability-based commissions if the broker s clients prove to be low-enough risks for the company to make a particular profit from their premiums. Volume override commissions tend to be most popular at big brokerage firms, while profitability-based commissions are generally more common among small brokerages. When brokers commissions became a major ethical issue, some longtime professionals had trouble making sense of all the fuss. Contingent commissions had been a part of life for insurers and brokers from as far back as they could remember. But based on subsequent surveys and even the stunned reactions of high-ranking government officials, it seems clear that people within the insurance industry had either explained the commissions to consumers poorly or had grossly misunderstood the public s preexisting knowledge of them. In an attempt to educate consumers, some brokers defend themselves by pointing out that commissions or other types of compensation (some known to the customer and some not) are common in many sales positions and professions, be it the video store clerk, the telemarketer or the insurance agent. But explaining and justifying contingent commissions solely in this way is probably not the best idea for brokers. This defense can potentially sound like an adult s take on the childlike justification, But everyone else is doing it. This statement usually lacks enough substance to win many arguments. More importantly, this way of thinking ignores the central ethical issue involved with contingent commissions for brokers. Based on the concept of agency, an insurance producer acting as broker for the insured is obligated to ultimately serve the insured s interests and not those of an insurance company. Whether or not a conflict of interest actually exists, there is absolutely the potential for one whenever brokers accept compensation from insurers. Most consumers believe the broker they are working with should be representing only the consumer s interest, and they become concerned when they Real Estate Institute 83

90 LIMITING YOUR PROFESSIONAL RISKS realize the broker is being compensated by the insurance company. When brokers receive volume override commissions, many consumers are forced to wonder if the insurance they buy through an intermediary is, in fact, the best available coverage, or if brokers are steering them toward certain insurance companies products in order to reap personal rewards. Similar logic holds true for any broker who accepts profitabilitybased commissions. Would a broker confirm the fears of the Consumer Federation of America and discourage clients from filing claims, all in the name of protecting a low-risk portfolio with a particular insurer? Brokers who have accepted contingent commissions from insurers might not be guilty of wrongdoing, but they must understand that their actions have, at the very least, given the public reason to become suspicious. They should also realize that if they demand commissions from insurance companies, they might perform an unnecessary disservice to the overall insurance market. Big insurance companies can probably afford to reward brokers for bringing business their way, but many small insurers presumably cannot offer quite as much. Contingent Commissions and Adverse Selection Some brokers turn down contingent commissions, but those who take them say they deserve the compensation because their work and reputation help insurers fend off adverse selection. Adverse selection occurs whenever an insurance company lacks enough information about people s risk potential to properly price coverage for them. If a company s underwriting staff cannot paint a reasonably clear picture of a consumer s risk potential, that person ends up paying either too much for insurance or not enough. According to a study conducted by the University of Pennsylvania and sponsored by the American Insurance Association, a producer who knows the customer can sometimes notice levels of risk that an underwriter cannot detect. Also, to the benefit of both insurers and consumers, insurance companies sometimes trust a broker s judgment enough to make more aggressive bids on policies for potential insureds who would otherwise pay more for coverage. Disclosure of Contingent Commissions Among those people who recognize the potential for conflicts of interest when brokers representing consumers accept contingent commissions, some do not consider the compensation to be totally unethical. Taking a moderate stance in the debate, they have no problem with brokers who take the commissions, as long as the brokers disclose them to clients. Yet, even within that group of people, arguments persist over what constitutes proper disclosure. One faction believes brokers should only need to disclose contingent commissions when their clients ask about them. This position corresponds to the way brokers must operate in the United Kingdom, where agents and consumers have long debated disclosure issues. Other consumer-conscious individuals have wondered how well a don t ask, don t tell policy on contingent commissions protects the general public. In 2006, the International Underwriting Association of London discovered that 80 percent of corporate insurance buyers (the section of the population which first raised the issue) did not know brokers could accept contingent commissions. In 1999, the Risk and Insurance Management Society said it favored commission disclosure upon the customer s request, but as state governments and regulators exposed more and more unethical market conduct that involved broker compensation, the association changed its position and now favors disclosure to all consumers. Some producers say it is difficult to calculate the amount of contingent commission made from an individual transaction because many of the rewards involve cumulative sales over a long stretch of time, but some brokers have figured out how to do the math and how to explain it to their clients. Either through regulatory pressure or their own desire for disclosure, brokerages reveal contingent commissions on websites, in contracts and in other places. Calculating contingent commissions for customers might require additional spending and more-detailed recordkeeping, but those might be small prices to pay in exchange for the public s increased confidence in the insurance industry. Contingent Commissions and Bid Rigging Though it is possible that contingent commissions were always fated to become an ethical concern for insurance producers no matter the personalities involved, New York s former Attorney General Eliot Spitzer was probably most responsible for making the issue a highly publicized matter in the early 21 st century. Influenced in part by strong lobbying from the Washington Legal Foundation, Spitzer instigated investigations of contingent commissions in multiple insurance lines, and regulators and politicians in several other states followed suit. Spitzer, in particular, was aggressively successful in getting major brokerage firms and insurance companies to cooperate with investigations and to acknowledge poor market conduct as it related to sales compensation. Marsh and McLennan, one of the largest U.S. insurance brokerage firms at the time of Spitzer s probes, received $845 million in contingent commission fees in 2003, proving that allegedly small rewards can add up to an indisputably significant amount of money. According to the Los Angeles Times, employees at one Marsh office said their employers discouraged them from setting clients up with coverage from a particular insurer because Marsh was in danger of reaching an agreed-upon cap on contingency payments from that company. Spitzer also accused Marsh of bid rigging, a major ethical and legal violation in which a firm gives phony bids to consumers in order to mislead buyers into believing that the broker s favored insurer has made the best offer of coverage. Sometimes insurers cooperate with brokers in the bid-rigging process because they believe that if they give an erroneous bid in the present, brokers will obligingly send business their way in the future. Sometimes the insurer-broker relationship is tenser, with firms allegedly threatening to boycott a broker if he or she does not agree to rig bids. In connection to the Spitzer investigation, one Marsh broker pleaded guilty to asking for rigged bids, and multiple producers pleaded guilty to providing them. Probes into Marsh s U.K. division revealed no bid rigging, but, according to the Wall Street Journal, contingent commissions had some influence on the way producers performed their duties. In the United States, investigations caused Marsh s stock to plummet. Perhaps dreading the worst, the company stopped taking contingent commissions on new business, put expected commissions from old and existing business into a settlement fund and laid off approximately 3,000 employees. Marsh finally settled with Spitzer by agreeing to pay $850 million over a fouryear period to customers who agreed not to sue the company. In a separate matter related to bid rigging, Zurich Financial Services made an initial insurance bid and was told by an Aon broker that the bid could be increased and still represent the lowest bid for the consumer. Zurich eventually settled with three states for $153 million and for $172 million in a second suit filed by nine states. Aon settled with Spitzer for $190 million. Other outcomes of the various probes into commissions and big rigging included an $80 million settlement with ACE, a $27 million settlement with Arthur J. Gallagher & Co. and guilty pleas from workers at AIG American General, who Spitzer charged with scheming to defraud. The Effects of Settlements In the aftermath of the Spitzer investigations, some brokers and agents endured suspensions, and some longtime Real Estate Institute 84

91 LIMITING YOUR PROFESSIONAL RISKS employees lost their jobs. In the heat of the bad press and the lawsuits, some insurance companies and brokerages either put an end to contingent commissions at their places of business or agreed to phase them out. Regulators and politicians in some states have proposed greater disclosure of contingent commissions and stiffer penalties for lawbreakers in the insurance community. California, for example, has proposed a $10,000 fine and loss of license for brokers and independent insurance agents who put their own interests ahead of a consumer s needs and do not actively pursue the best available coverage for clients. The Future of Contingent Commissions Even after all the media attention and the industry shakeups that Spitzer and state regulators have produced, there are no guarantees that contingent commissions will become things of the past. Insurance consumers, assuming they know about the commissions in the first place, do not like these rewards to brokers, but some of them worry about the negative consequences that might materialize if the payments end. In the absence of commissions from insurance companies, brokers might raise their rates in order to keep making consistent profits. Insurance companies, too, might raise their prices because, if contingent commission arrangements end, the companies might lose business that would have normally been steered in their direction by favored brokers. These are worthy concerns for the insurance producer, ones that can call for tough decisions about how professionals should conduct themselves. But that should not come as a surprise to the reader. After all, making a decision about ethics is rarely easy. Sometimes the ethical thing to do is obvious, yet it asks us to sacrifice some of what we value, including greater financial success. At other times, the ethical choice is less obvious to us, and we struggle to decide on a course of action despite our good intentions. But with time, experience, continued study and constant thought, we can gradually become more confident that the hard decisions and sacrifices we make are professionally and personally the right ones. All hardworking people deserve to make money, but true professionals understand that the quest for fair financial treatment for themselves must be balanced with their commitment to fair financial treatment of consumers. CHAPTER 3 FEDERAL REGULATION OF THE INSURANCE INDUSTRY Background Banks, securities firms and insurance companies have arrived at a point in time when they are reasonably able to band together and offer a wide range of financial products to the public. But for companies that had always wanted to provide insurance policies, annuities, mortgage loans and other products all under one roof, it was a long wait. For centuries, legislation in the United States kept banks out of what were believed to be risky businesses so that depositors funds were not put in danger. In effect, this meant that there were relatively few chances for banks to become involved in the underwriting of insurance or securities. All the way back in 1864, for example, banks were given the power to carry out tasks directly necessary and incidental to their business. At the time, however, selling insurance was not considered an incidental activity and was therefore prohibited within banking circles. Later, in an attempt to boost faith in banks after the stock market crash of 1929, Congress passed the Glass-Steagall Act, which prevented commercial banks (generally those that take deposits and make loans) from affiliating with any entity that was principally engaged in the sale of securities. Yet at other important moments, the walls that separated the various sections of the financial world crumbled bit by bit. By 1916, state banks in some parts of the country were being allowed to sell insurance. Meanwhile, the Office of the Comptroller of the Currency (OCC) had determined that too many national banks were failing in small towns and decided that federal depository institutions needed to become more competitive. With these economic conditions in mind, the federal government ruled that a national bank could enter into the insurance business if it was located in a town with 5,000 residents or less. Restrictions have lessened at a swifter pace over the past 25 years. In 1986, the OCC started letting national banks sell insurance products in larger towns and cities if the transaction was conducted through a subsidiary in a town of under 5,000 people. A decade later, the U.S. Supreme Court s ruling in NationsBank of North Carolina v. Variable Annuity Life Insurance Co. upheld the right of commercial banks to sell annuities. All the while, local laws were sometimes allowing state banks into the insurance game, and loopholes in federal laws were often big enough for the occasional bank-sponsored insurance product to slip its way through the market. The insurance industry challenged many of these developments in court, but the challenges were ultimately ineffective. During the 1980s and early 1990s, Congress debated the deregulation of financial industries on a number of occasions. These legislative attempts at regulating the entry of banks into the investment and insurance businesses generally did not amount to any real change, but two significant events near the end of the 20 th century helped force the government s hand. The first of the two events was the Supreme Court s ruling in Barnett v. Nelson, a Florida case that centered on conflicts between federal insurance laws and state insurance laws. In 1974, Florida had enacted a statute that made it illegal for agents to sell insurance in any part of the state if they were affiliated with a bank holding company, which can be defined as an entity that has a controlling interest in one or more banks. Some 20 years later, plaintiffs argued the state statute was unlawfully ignoring the provisions of the 1916 federal statute regarding permissible insurance activities in small towns. The state responded with a two-part argument that touched on the federal statute as well as a historic federal insurance law known as the McCarran-Ferguson Act. Under that law, which classically distanced the insurance industry from federal regulation, a state insurance statute can be preempted by a Real Estate Institute 85

92 LIMITING YOUR PROFESSIONAL RISKS federal law only if the federal law relates specifically to insurance. In Florida s eyes, the 1916 statute related specifically to banks but not to insurance. The Supreme Court interpreted the matter differently, reasoning that the federal statute related specifically to insurance and that the intent of the 1916 Congress had been for the statute to reign over conflicting state laws. In short, the McCarran-Ferguson Act, which had kept federal regulators out of insurers hair for years, proved to be more penetrable than expected. The second significant event occurred on April 6, 1998, when the world was alerted to a merger between Citicorp (a bank holding company) and Travelers Group (a multifaceted entity that, among other things, was engaged in the underwriting of insurance). Although this merger that gave us Citigroup was technically in violation of the Glass-Steagall Act, provisions in the Bank Holding Act of 1956 gave the newly formed financial organization at least two years to divest itself of its underwriting business and avoid criminal charges. Rather than pushing Citigroup to make a few extra deals and comply with federal law, the two-year grace period was treated as a chance to rally lawmakers behind the idea of making major changes to federal financial regulations. Citigroup s gamble against compliance paid off. On November 12, 1999, President Bill Clinton signed the Financial Services Modernization Act of 1999 into law, effectively repealing the restrictions within Glass-Steagall and allowing entities like Citigroup to exist concurrently as a bank, insurance company and securities broker. In time, Citigroup spun off its insurance wing into another company, but it was able to do so on its own terms. Meanwhile the aforementioned Barnett decision served as a guiding light for lawmakers, who referenced the case directly in the law s text and used it to shape the government s formal stance on the preemption of insurance statutes in the 21 st century. Purposes and Expectations For all the attention it received in the business press and elsewhere, the Financial Services Modernization Act of 1999 (more commonly known as the Gramm-Leach-Bliley Act, in honor of its congressional sponsors) wasn t exactly shocking or revolutionary in scope. As stated earlier, financial institutions that really wanted to dip their toes simultaneously into commercial banking, investment banking and insurance could often find a way to do it by relying carefully on technicalities in federal and state laws. So it wasn t as if, at long last, a law had finally come along and made the impossible possible. But what Gramm-Leach-Bliley did do was give banks, insurers and investment firms a clearer path toward unification. If a bank had always wanted to purchase or partner up with an insurer but had not done so for fear of being in noncompliance with U.S. regulations, that bank could finally turn to the GLBA, follow its specifics and feel reasonably confident that it was obeying federal rules. By publicly reducing the hoops that banks, insurers and securities brokers had to jump through in order to underwrite, market and sell one another s products, Congress hoped to encourage and foster greater competition among various financial institutions. Ideally, this increased competition would create better deals for consumers and make shopping for financial products a more convenient experience for the public. To many who watched the law unfold, the GLBA seemed like an invitation for businesses to follow Citigroup s example and become financial supermarkets, where everything from shares in a mutual fund to a supplemental health insurance policy could be secured in a single trip to the same storefront. The occasional pundit suggested that the law was a step that would lead the United States away from its financial traditions and toward bancinsurance or universal banking, a one-stopshop configuration that had already become common in parts of Europe and Latin America. To date, America has not embraced universal banking or turned its back on the classic distribution methods for insurance products. There are many reasons why this is so, and we will eventually address those reasons. Drawing attention to them now, however, would cause us to get too far ahead of ourselves and our proper study of the GLBA. If we are to understand the observed effects of this law, we need to first become familiar with what the law actually says. At the same time, it will be important for us to note that there are aspects of the GLBA that may apply to even those insurance professionals who are not affiliated in any way with a bank or brokerage firm. Admittedly the following explanations of the GLBA s main insurance-centric points are not a substitute for consultation with legal professionals. But they ought to call the reader s attention to such important topics as privacy, disclosure and the way banks and insurance companies can lawfully offer similar financial products. Financial Holding Companies and Financial Activities Despite the flexibility that the GLBA created for various financial institutions, the law still does not make it possible for just any bank to suddenly start selling insurance. In general, the rights within the GLBA are granted to financial holding companies. A financial holding company, as defined by the National Information Center, is a financial entity engaged in a broad range of banking activities. Bank holding companies, which have controlling interest in one or more banks, may become financial holding companies by applying for that designation with the Federal Reserve System. To be approved as a financial holding company, all depository institutions that are controlled by the bank holding company must be well-capitalized and well-managed. Unlike most bank holding companies, a financial holding company can engage in the underwriting of insurance. In fact, the GLBA permits financial holding companies to engage in any activity that is financial in nature, incidental to a financial activity or complementary to a financial activity. A financial holding company is also free to buy shares of companies that perform these kinds of activities. In the text of the GLBA, Congress specified several activities as being financial in nature. These activities include the following: Lending, exchanging, transferring, investing for others or safeguarding money or securities Insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability or death, or providing and issuing annuities, and acting as principal, agent or broker for purposes of the foregoing, in any state Providing financial, investment or economic advisory services, including advising an investment company Issuing or selling instruments representing interests in pools of assets permissible for a bank to hold directly Underwriting, dealing in or making a market in securities Engaging within the United States in any activity that a bank holding company may engage in outside of the United States While laying out these specific examples of lawful financial activities, the GLBA s authors also recognized that the preceding list could never be a complete one. The law gives the Treasury Department and the Federal Reserve Board the power to cooperatively consider whether other activities are financial in nature. When deciding whether an activity is financial in nature, authorities are expected to consider the following things: The purpose of the GLBA How the market for financial products has changed or is expected to change Real Estate Institute 86

93 LIMITING YOUR PROFESSIONAL RISKS How technology has changed or is expected to change The reasonable things a financial institution must do in order to remain competitive and serve its clients efficiently Federal Law, State Law and Preemption Students of the GLBA might be confused by the law because it simultaneously seems to confirm and limit each state s power to regulate insurance. The legislation s authors specifically reiterate that the McCarran-Ferguson Act shall remain the general rule of the land, meaning that insurance regulation will continue to be a state-based endeavor. However, via the GLBA, the federal government has stated that any state law or regulation that significantly interferes with a bank s ability to engage in the insurance business is preempted by federal law. In other words, it is illegal for any state law or regulation to go against the purpose of the GLBA and discriminate against financial holding companies that are involved in insurance. The GLBA s power to preempt some state laws raises an obvious yet excellent question: What specific kinds of insurance restrictions can a state put on a bank and not be in conflict with federal law? As an answer to that query, the GLBA mentions several safe harbor provisions, which allow states to prohibit banks from doing the following activities: Requiring that insurance for a loan or extension of credit be issued or underwritten by someone associated with a bank or its affiliates Varying extensions of credit or services depending on whether a customer has obtained insurance from a depository institution, a favored insurer, a favored agent or a favored broker Using advertising that could cause a reasonable person to think the state or federal government endorses the bank or its affiliates or guarantees investment returns and payment of claims Giving commissions or brokerage fees to unlicensed or improperly licensed persons Paying referral fees to employees only when a referred person buys insurance Releasing customers insurance information (other than to an officer, director, employee, agent or affiliate of a depository institution) for the purpose of selling or soliciting insurance without their consent Using the health information in a person s insurance records improperly Failing to disclose in writing that a customer s choice of insurer will not affect credit eligibility or credit terms Failing to disclose that an insurance policy is not a deposit, not insured by the Federal Deposit Insurance Corporation, not guaranteed by the bank and, if applicable, subject to a possible loss of principal Using the same document to complete a credit transaction and an insurance transaction Including the expense of insurance premiums in a primary credit transaction without consent Failing to maintain separate books and records relating to insurance and failing to make those books and records available to the state Requiring that a debtor, insurer, agent or broker pay a separate charge in connection with handling insurance that is required for a loan or extension of credit For examples of state laws that have been preempted by the GLBA because they significantly interfered with banks ability to become involved in insurance, we can turn to a dispute between the state of Massachusetts and one of its banking associations. At issue were multiple elements within a consumer protection law. Among other things, the law prohibited bank employees from making insurance referrals unless a customer asked about insurance, and it prevented unlicensed employees from receiving referral fees in all cases. Furthermore, if a customer applied for a loan or line of credit, the bank could not solicit insurance to that customer until the loan or credit was approved. From the state s point of view, the law did not infringe on banks right to sell insurance. Rather, it was merely influencing the time and manner in which insurance products could be sold. Yet a counterpoint was made that those restrictions on time and manner effectively negated a bank s potential success in the insurance business. The section of the GLBA regarding approval of loans and credit seemed to ignore the fact that few banks would approve a loan if applicants didn t already have insurance in place. Meanwhile state-based statistics strongly suggested that the prohibitions on referrals and referral fees were hindering sales. One member of the bank association handled zero insurance referrals in the state over a six-month period, despite having Massachusetts as its main customer base. Yet, over that same period, the bank handled 4,200 referrals in Maine, where different laws applied. While insisting that its ruling did not interfere with the state s power to regulate insurance, a district court deferred to the GLBA and granted summary judgment for the banking association. The issue of preemption is made even more complicated within the GLBA because the law allows states to enact their own rules and regulations as a matter of implementing privacy provisions and disclosure requirements. These state-level rules and regulations can be as strict as a state deems necessary, as long as they satisfy the minimum requirements spelled out in the GLBA and other federal documents and as long as their strictness does not conflict with the GLBA s purpose. Protecting Privacy By allowing banks, insurers and securities firms to become tightly intertwined, the GLBA also made it more likely that people s personal information would be shared among businesses. To protect against the possibility that these businesses would infringe upon individual privacy rights, the GLBA includes provisions to protect consumers personal financial information. There are three principal parts to the privacy requirements: The Financial Privacy Rule The Safeguards Rule The pretexting provisions The GLBA gives authority to eight federal agencies and the states to administer and enforce the Financial Privacy Rule and the Safeguards Rule. These two regulations apply to financial institutions, which include not only banks, securities firms and insurance companies, but also companies providing many other types of financial products and services to consumers. Among these services are lending, brokering or servicing any type of consumer loan, transferring or safeguarding money, preparing individual tax returns, providing financial advice or credit counseling, providing residential real estate settlement services and collecting consumer debts. The Financial Privacy Rule governs the collection and disclosure of customers personal financial information by financial institutions. It also applies to companies that are not financial institutions but still receive such information. The Safeguards Rule requires all financial institutions to design, implement and maintain safeguards to protect customer information. The Safeguards Rule applies not only to financial institutions that collect information from their own customers, but also to financial institutions, such as credit reporting agencies, that receive customer information from other financial institutions. The pretexting provisions of the GLBA protect consumers from individuals and companies that obtain personal financial information under false pretenses, a practice known as Real Estate Institute 87

94 LIMITING YOUR PROFESSIONAL RISKS pretexting. An example of pretexting would be a phone survey that claims to be gathering information to help insurance companies create new policies but, in truth, will be using the acquired information to sell insurance to the consumer, or in a worst scenario, steal a person s identity. Financial Privacy Rule Protecting consumer information held by financial institutions is at the heart of the GLBA s privacy provisions. The GLBA requires companies to give consumers privacy notices that explain the institutions information-sharing practices. In turn, consumers have the right to limit some, although not all, sharing of their information. The GLBA s privacy provisions apply to financial institutions that offer financial products or services to individuals. This, of course, includes insurance businesses. The law requires that financial institutions protect information collected about individuals, but it does not apply to information collected in business or commercial activities. A company s obligations under the GLBA depend on whether the company has consumers or customers who obtain its services. A consumer is an individual who obtains or has obtained a financial product or service from a financial institution for personal, family or household reasons. A customer is a consumer with a continuing relationship with a financial institution. Generally, if the relationship between the financial institution and the individual is significant and/or long-term, the individual is a customer of the institution. For example, a person who purchases an insurance policy from an insurer is considered a customer of the company and of the insurance producer who assisted in the purchase. However, a person who makes application or discloses personal financial information during an interview is considered to have a consumer relationship with the company and producer. Privacy Notices The difference between consumers and customers is important because only customers are entitled to automatically receive a financial institution s privacy notice. Although there are some exceptions, consumers are entitled to receive a privacy notice from a financial institution only if the company shares the consumers information with companies not affiliated with it. Customers, on the other hand, must receive a notice every year for as long as the customer relationship exists. The privacy notice must be delivered to individual customers or consumers by mail or in person; it may not be posted on a wall with the mere hope that the customer sees it. Reasonable methods to deliver a notice may depend on the institution s business. For example, an insurance company taking applications at its Web site may post its privacy notice on its Web site and require online consumers to acknowledge receipt as a necessary part of an application. An insurance company that gives out privacy notices in connection with a group plan can send them to the plan sponsor rather than to each covered individual. Restrictions on this practice may apply, depending on how the insurer uses the information. Many GLBA regulations and privacy laws that have been enacted at the state level do not mandate that an insurance agency send out its own privacy policy if it only shares a person s personal information with its parent insurer and if that parent insurer sends out its own privacy policy. Similarly, in what has become known as the agent exclusion, individual insurance licensees in these states do not need to send out privacy notices of their own if all of the following statements are true: The licensee works for or represents another licensee (known as a principal ) who is subject to the GLBA s privacy requirements. The principal sends out privacy notices. The licensee does not share a person s information with anyone but the principal and the principal s affiliates. The privacy notice itself must be a clear, conspicuous and accurate statement of the company s privacy practices. Though the government allows policy notices to be written inhouse, a proper privacy policy should contain the following kinds of disclosures: The kind of information that the company collects about its consumers and customers The parties with whom the company shares the information The manner in which the company protects or safeguards the information The privacy notice applies to the non-public personal information that the company gathers and discloses about its consumers and customers. Non-public personal information could be information that a consumer or customer puts on an application, information about the individual from another source (such as a credit bureau) or information about transactions between the individual and the company (such as an account balance). Indeed, even the fact that an individual is a consumer or customer of a particular financial institution is non-public personal information. But information that the company has reason to believe is lawfully public, such as mortgage loan information in a jurisdiction where that information is publicly recorded, is not restricted by the GLBA. In more concrete terms, a person s income, health information and Social Security number would be covered by the law in most cases. Opting Out Under the GLBA, consumers and customers have the right to opt out of having their information shared with some third parties. When the law requires that companies give people the chance to opt out of information sharing, customers and consumers must take action in order to keep their information private. Required actions might include having to check a box on an opt-out form or having to phone a toll-free number provided by the company. If a customer or consumer receives or is exposed to an opt-out notice and does not respond, the company is free to share the person s information in the manner spelled out in the privacy notice. To meet minimum GLBA requirements, a privacy notice must explain a reasonable way in which a person can opt out of information sharing. For example, providing a toll-free telephone number or a detachable form with a pre-printed address is a reasonable way for consumers or customers to opt out; requiring someone to write a letter as the only way to opt out is not acceptable. The privacy notice also must explain that consumers have a right to say no to the sharing of certain information (including credit report or credit application information) with a financial institution s affiliates. An affiliate is an entity that does one of the following: Controls the company Is controlled by the company Is under common control with the company Still, there are many other forms of sharing that consumers and customers cannot control. For example, a financial institution is free to share people s information in the following situations: An outside company needs access to information in order to provide essential services like data processing or servicing accounts. The personal information is being sought by law enforcement. An outside service provider needs customer data in order to effectively market the financial company s products or services Real Estate Institute 88

95 LIMITING YOUR PROFESSIONAL RISKS A financial institution wishes to report relevant customer data to a credit bureau. Sharing and disclosure of the information is required by law enforcement or by subpoena. A financial institution needs to implement ways to track who has opted out of information sharing. Failure to comply with a customer or consumer s stated wishes could lead to significant legal trouble and harsh penalties. Permitted Disclosure of Received Non-Public Personal Information The GLBA puts some limits on how anyone who receives nonpublic personal information from a financial institution can use or re-disclose that information. Take the case of an insurance company that discloses customer information to a service provider responsible for mailing premium notices, where the consumer has no right to opt out. The service provider may use the information for the limited purpose of mailing the notices. It may not sell the information to other organizations or use it for marketing. However, it s a different scenario when a company receives non-public personal information from a financial institution that provided an opt-out notice and the consumer didn t opt out. In this case, the recipient steps into the shoes of the disclosing financial institution, and may use the information for its own purposes or re-disclose it to a third party, consistent with the financial institution s privacy notice. That is, if the privacy notice of the financial institution allows for disclosure to other unaffiliated financial institutions (like insurance providers), the recipient may re-disclose the information to an unaffiliated insurance provider. Safeguards Rule Adequately securing customer information is not only the law. It also makes good business sense. When you show customers that you care about the security of their personal information, you increase their level of confidence in your business. Poorly managed customer data can lead to identity theft and other harmful crimes. In an environment that entails the sharing of information among financial institutions, business professionals are advised to implement safeguards that help keep sensitive information from falling into the wrong hands. In response to privacy requirements in the GLBA, the Federal Trade Commission (FTC) adopted the Safeguards Rule in May of 2000 and required that all businesses under FTC jurisdiction abide by it. Although the insurance business is not under the control of the FTC, it is possible for businesses that fall under these rules to become involved in an insurance transaction. The Safeguards Rule applies to businesses, regardless of size, that are significantly engaged in providing financial products or services to consumers. In addition to developing their own safeguards, financial institutions are responsible for taking steps to ensure that their affiliates and service providers safeguard the customer information that is in their care. This is why it is good business to check out the practices of firms you do business with and confirm that they are in compliance with the rule. The text of the Safeguards Rule was written in an understandable and relatively brief format. Therefore, we have included most of the actual rule below. We have removed some of the specific references to sections of the law that will not affect your understanding of the rule. STANDARDS FOR SAFEGUARDING CUSTOMER INFORMATION 1. Purpose and scope (a) Purpose. This part, which implements sections 501 and 505(b)(2) of the Gramm-Leach-Bliley Act, sets forth standards for developing, implementing, and maintaining reasonable administrative, technical, and physical safeguards to protect the security, confidentiality, and integrity of customer information. (b) Scope. This part applies to the handling of customer information by all financial institutions over which the Federal Trade Commission ( FTC or Commission ) has jurisdiction. This part refers to such entities as you. This part applies to all customer information in your possession, regardless of whether such information pertains to individuals with whom you have a customer relationship, or pertains to the customers of other financial institutions that have provided such information to you. 2. Definitions (a) In general except as modified by this part or unless the context otherwise requires, the terms used in this part have the same meaning as set forth in the Commission s rule governing the Privacy of Consumer Financial Information. (b) Customer information means any record containing non-public personal information about a customer of a financial institution, whether in paper, electronic, or other form, that is handled or maintained by or on behalf of you or your affiliates. (c) Information security program means the administrative, technical, or physical safeguards you use to access, collect, distribute, process, protect, store, use, transmit, dispose of, or otherwise handle customer information. (d) Service provider means any person or entity that receives, maintains, processes, or otherwise is permitted access to customer information through its provision of services directly to a financial institution that is subject to this part. 3. Standards for safeguarding customer information (a) Information security program. You shall develop, implement, and maintain a comprehensive information security program that is written in one or more readily accessible parts and contains administrative, technical, and physical safeguards that are appropriate to your size and complexity, the nature and scope of your activities, and the sensitivity of any customer information at issue. Such safeguards shall include the elements set forth in section 4 of this rule and shall be reasonably designed to achieve the objectives of this part, as set forth in paragraph (b) of this section. (b) Objectives. The objectives of the Act, and of this part, are to: (1) Insure the security and confidentiality of customer information; (2) Protect against any anticipated threats or hazards to the security or integrity of such information; and (3) Protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. 4. Elements In order to develop, implement, and maintain your information security program, you shall: (a) Designate an employee or employees to coordinate your information security program. (b) Identify reasonably foreseeable internal and external risks to the security, confidentiality, and integrity of customer information that could result in the unauthorized disclosure, misuse, alteration, destruction or other compromise of such information, and assess the sufficiency of any safeguards in place to control these risks. At a minimum, such a risk assessment should include consideration of risks in each relevant area of your operations, including: (1) Employee training and management; (2) Information systems, including network and software design, as well as information processing, storage, transmission and disposal; and Real Estate Institute 89

96 LIMITING YOUR PROFESSIONAL RISKS (3) Detecting, preventing and responding to attacks, intrusions, or other systems failures. (c) Design and implement information safeguards to control the risks you identify through risk assessment, and regularly test or otherwise monitor the effectiveness of the safeguards key controls, systems, and procedures. (d) Oversee service providers, by: (1) Taking reasonable steps to select and retain service providers that are capable of maintaining appropriate safeguards for the customer information at issue; and (2) Requiring your service providers by contract to implement and maintain such safeguards. (e) Evaluate and adjust your information security program in light of the results of the testing and monitoring required by paragraph (c) of this section; any material changes to your operations or business arrangements; or any other circumstances that you know or have reason to know may have a material impact on your information security program. Implementing Safeguards The Safeguards Rule requires financial institutions to develop a written information security plan that describes their program to protect customer information. The plan must be appropriate for the financial institution s size and complexity, the nature and scope of its activities and the sensitivity of the customer information that it handles. As part of its plan, each financial institution must do each of the following: Designate one or more employees to coordinate the safeguards. Identify and assess the risks to customer information in each relevant area of the company s operation and evaluate the effectiveness of the current safeguards for controlling these risks. Design and implement a safeguards program, and regularly monitor and test it. Select appropriate service providers, and contract with them to implement safeguards. Evaluate and adjust the program in light of relevant circumstances, including changes in the firm s business arrangements or operations, or the results of testing and monitoring of safeguards. These requirements are designed to be flexible. Each financial institution should implement safeguards appropriate to its own circumstances. For example, some financial institutions may choose to describe their safeguards programs in a single document, while others may memorialize their plans in several different documents, such as one to cover an information technology division and another to describe the training program for employees. Similarly, a company may decide to designate a single employee to coordinate safeguards or may spread this responsibility among several employees who will work together. An insurance producer should be aware of how and where they fit into the safeguards of the companies with which they work. In addition, a firm with a small staff may design and implement a more limited employee training program than a firm with a large number of employees. A financial institution that doesn t receive or store any information online may take fewer steps to assess risks to its computers than a firm that routinely conducts business online. When a firm implements safeguards, the Safeguards Rule requires it to consider all areas of its operation, including three areas that are particularly important to information security: employee management and training; information systems; and managing system failures. Firms should consider implementing the following practices in these areas: Employee Management and Training The success or failure of an information security plan depends largely on the employees who implement it. A company may want to: Check references prior to hiring employees who will have access to consumer or customer information. Ask every new employee to sign an agreement to follow the organization s confidentiality and security standards for handling non-public financial information. Train employees to take basic steps to maintain the security, confidentiality and integrity of customer information, such as: Locking rooms and file cabinets where paper records are kept. Using password-activated screensavers. Using strong passwords. Changing passwords periodically, and not posting passwords near employees computers. Encrypting sensitive customer information when it is transmitted electronically over networks or stored online. Referring calls or other requests for customer information to designated individuals who have had safeguards training. Recognizing any fraudulent attempt to obtain customer information and reporting it to appropriate law enforcement agencies. Instruct and regularly remind all employees of your organization s policy - and the legal requirement - to keep customer information secure and confidential, and post reminders about their responsibility for security in areas where such information is stored. Limit access to customer information to employees who have a business reason for seeing it. For example, grant access to customer information files to employees who respond to customer inquiries, but only to the extent they need it to do their job. Impose disciplinary measures for any breaches. Information Systems Information systems include network and software design and information processing, storage, transmission, retrieval and disposal. Here are some suggestions from the FTC on how to maintain security throughout the life cycle of customer information - that is, from data entry to data disposal: Store records in a secure area. Make sure only authorized employees have access to the area. For example: Store paper records in a room, cabinet or other container that is locked when unattended. Ensure that storage areas are protected against destruction or potential damage from physical hazards, like fire or floods. Store electronic customer information on a secure server that is accessible only with a password - or has other security protections - and is kept in a physically-secure area. Don t store sensitive customer data on a machine with an internet connection. Maintain secure backup media, and keep archived data secure, for example, by storing it off-line or in a physically secure area. Provide for secure data transmission (with clear instructions and simple security tools) when you collect or transmit customer information. Specifically: If you collect credit card information or other sensitive financial data, use a Secure Sockets Layer (SSL) or other secure connection so that the information is encrypted in transit Real Estate Institute 90

97 LIMITING YOUR PROFESSIONAL RISKS If you collect information directly from consumers, make secure transmission automatic. Caution consumers against transmitting sensitive data, like account numbers, via electronic mail. If you must transmit sensitive data by electronic mail, ensure that such messages are passwordprotected so that only authorized employees have access. Dispose of customer information in a secure manner. For example: Hire or designate a records retention manager to supervise the disposal of records containing nonpublic personal information. Shred or recycle customer information recorded on paper, and store it in a secure area until a recycling service picks it up. Erase all data when disposing of computers, diskettes, magnetic tapes, hard drives or any other electronic media that contain customer information. Effectively destroy the hardware. Promptly dispose of outdated customer information. Managing System Failures Effective security management includes the prevention, detection and response to attacks, intrusions or other system failures. Consider the following suggestions: Maintain up-to-date and appropriate programs and controls by: Following a written contingency plan to address any breaches of your physical, administrative or technical safeguards; Checking with software vendors regularly to obtain and install patches that resolve software vulnerabilities; Using anti-virus software that updates automatically; Maintaining up-to-date firewalls, particularly if you use broadband internet access or allow employees to connect to your network from home or other off-site locations; and Providing central management of security tools for your employees and passing along updates about any security risks or breaches. Take steps to preserve the security, confidentiality and integrity of customer information in the event of a computer or other technological failure. For example, back up all customer data regularly. Maintain systems and procedures to ensure that access to non-public consumer information is granted only to legitimate and valid users. For example, use tools like passwords combined with personal identifiers to authenticate the identity of customers and others seeking to do business with the financial institution electronically. Notify customers promptly if their non-public personal information is subject to loss, damage or unauthorized access. Pretexting Provisions As we mentioned earlier, another provision in the GLBA prohibits pretexting. Pretexting is the practice of obtaining customer information from financial institutions under false pretenses. The FTC has brought several cases against information brokers who engage in pretexting. Under the GLBA it is illegal for anyone to: Use false, fictitious or fraudulent statements or documents to get customer information from a financial institution or directly from a customer of a financial institution. Use forged, counterfeit, lost or stolen documents to get customer information from a financial institution or directly from a customer of a financial institution. Ask another person to get someone else s customer information using false, fictitious or fraudulent statements or using false, fictitious or fraudulent documents or forged, counterfeit, lost or stolen documents. Pretexting can lead to identity theft. Identity theft occurs when someone wrongfully uses personal identifying information to open new charge accounts, order merchandise or borrow money. Consumers targeted by identity thieves usually don t know they ve been victimized until the thieves fail to pay the bills or repay the loans, and collection agencies begin dunning the victimized consumers for payment of accounts they didn t even know they had. According to the FTC, the most common forms of identity theft are: Credit card fraud - A credit card account is opened in a consumer s name or an existing credit card account is taken over. Communications services fraud - The identity thief opens telephone, cellular or other utility service in the consumer s name. Bank fraud - A checking or savings account is opened in the consumer s name, and/or fraudulent checks are written. Fraudulent loans - The identity thief gets a loan, such as a car loan, in the consumer s name. Privacy at the State Level Though the GLBA ordered insurance companies to follow several rules as a means of protecting people s privacy, it certainly was not the first piece of legislation to do so. In 1982, the National Association of Insurance Commissioners (NAIC) drafted its Insurance Information and Privacy Protection Model Act. This model, like others created by the NAIC, lacks legal authority on its own terms. However, states frequently adopt major portions of NAIC models and effectively use them as templates for their local insurance laws. In states where the NAIC privacy model has been adopted, insurance licensees are likely to be held to strict standards that go beyond the GLBA requirements. Most significantly, the NAIC model requires that insurers use opt-in privacy forms rather than opt-out privacy forms. In an opt-in situation, people who do not respond to a privacy notice are not consenting indirectly to the sharing of their personal information. Unless the GLBA has exempted the sharing from its privacy rules, a company that uses an opt-in notice cannot share information without receiving verifiable consent from the individual. Compared to the GLBA, the NAIC model also demands that privacy notices contain more information about how an insurer gathers personal data and how a policyholder can monitor the accuracy of that information. According to the model act, a privacy notice must explain the kinds of methods an insurer can use in order to obtain information about its clients. The same notice must also instruct recipients on how to access their personal information. Insureds are allowed to make a written request for all the personal information an insurance company has about them, and the insurer is required to comply within 30 business days of receiving the request and a reasonable fee. Along with their personal information, policyholders have a right to know the identities of all parties who have received the information within the past two years. Unlike the GLBA, the NAIC s model act puts constraints on insurers that are exposed to information pertaining to people s mental and physical health. Privacy provisions for health information were not added to the GLBA because such Real Estate Institute 91

98 LIMITING YOUR PROFESSIONAL RISKS provisions could already be found in the Health Insurance Portability and Accountability Act and its related regulations. To ensure proper compliance and proper handling of clients personal information, licensees should examine applicable insurance laws in their respective states. Bank Insurance Disclosures In addition to their concerns about privacy, the federal government and some business professionals worried that the entry of banks into the insurance business could confuse shoppers and have a negative impact on prospective borrowers. In the interest of consumer protection, it would be important for bank customers to know that insurance was different than CDs and other products that are typically marketed by banks. It would also be important for credit applicants to not feel as though the fate of their loan application relied on their purchase of a bank s latest insurance policy or annuity. In an effort to make consumer protection a reality, lawmakers and regulators made certain disclosure forms a big part of GLBA compliance. These disclosures, which we will call the insurance disclosure and the credit disclosure, are required whenever a depository institution or one of its representatives sells insurance to an individual for personal, family or household purposes. The Insurance Disclosure The insurance disclosure needs to be made to an individual before any applicable insurance sale is finalized. In clear, understandable language, it must disclose the following: The item being sold is an insurance product and not proof of a deposit. The item being sold is not insured by the Federal Deposit Insurance Corp., the federal government or the depository institution. The item being sold is not guaranteed by the depository institution. The item being sold entails some investment risk. In some cases, the insurance disclosure does not need to contain all of the preceding elements. For example, since flood insurance in the United States is underwritten by the federal government, a person who purchases flood insurance from a bank should not be told that the government doesn t back up the policy. Similarly, disclosure of investment risk should not be made when the product being sold lacks an investment component. It would be necessary when a person is buying a variable annuity, but not when a person is buying a term life insurance policy. The insurance disclosure also must appear in all advertisements or marketing materials that are not considered general in nature. However, banks and their affiliates may use short-form disclosure language in various kinds of visual media, including on print ads, posters, billboards and automatic teller machines. The government-approved short-form language appears below: NOT A DEPOSIT NOT FDIC-INSURED NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY NOT GUARANTEED BY THE BANK MAY GO DOWN IN VALUE The Credit Disclosure The credit disclosure must be made to an individual when the person applies for credit and is offered insurance before the credit has been approved. The disclosure is not required when applicants already know that a depository institution has granted their request for credit. It is also not required when people apply for insurance from their bank without also applying for credit. When required, the credit disclosure must inform recipients of the following: They will not be denied credit if they decline to purchase insurance from a depository institution or one of its affiliates. Their lending agreement will not be impacted negatively if they purchase insurance from a nonaffiliate. Delivering Disclosures In order to comply with GLBA regulations, a bank representative must provide these various disclosures both orally and in written form, barring a few exceptions. Insurance sales conducted through the mail or over the internet do not require an oral disclosure, though online applicants can opt to receive non-electronic forms and are not allowed to bypass screens related to these disclosures. When an insurance sale is conducted primarily over the phone, the seller affiliated with a depository institution must send out written disclosure forms to the applicant within three business days. Business days include all days other than Sundays and holidays that are observed by the Federal Reserve. An insurance sale that has been conducted by a depository institution or an affiliate is not valid unless the applicant acknowledges having received the insurance and credit disclosures. This acknowledgement can be made at the time the disclosures are made or at the time the sale is being finalized. If the sale is conducted over the internet, through the mail or in person, the acknowledgement must be in a written or electronic form. If the sale is conducted over the phone, the seller must obtain oral acknowledgment from the applicant and then make a reasonable effort to obtain an electronic or written acknowledgement. According to regulators, a reasonable effort can be made by sending a self-addressed envelope along with the disclosure forms or by making a follow-up phone call to an unresponsive applicant. Depository institutions and their affiliates should document their reasonable efforts in order to avoid regulatory problems. The aforementioned disclosures do not need to be made at renewal time if they were provided to the policyholder at an earlier date. Within the context of the GLBA s requirements, regulators have defined a renewal to mean a continuation of the same kind of insurance from the same carrier, regardless of any changes in premiums, terms and conditions. Insurance upgrades are considered renewals and do not require a new round of disclosures unless they involve a different kind of insurance than had been in force previously. GLBA Enforcement at the Bank Although many sections of the GLBA apply to insurance transactions that are completed over the phone, online or in an affiliate s office, a few rules apply specifically to insurance sales in bank buildings. These portions of the law explain where an insurance sale may take place within a bank and who may conduct the transaction. According to GLBA regulations, a bank that sells insurance or annuities must, to a reasonable extent, compartmentalize its public offices and branches so that people are not encouraged to purchase insurance products in the same place where they make deposits. In short, this means that bank employees and bank representatives are generally prohibited from selling insurance in teller lines or at teller windows. Regulators say banks do not need to put up signs that publicly delineate deposit areas and insurance areas, but banks may do so if they wish. Even when it is takes place at a bank, an insurance sale can only be conducted by a licensed insurance professional. If a bank customer comes to a teller window and inquires about the bank s insurance products, the teller can only refer the customer to a properly licensed individual. The GLBA permits tellers and other bank employees to receive rewards for referrals, but these rewards can only amount to a nominal, one-time fee. Importantly, a customer s choice to actually Real Estate Institute 92

99 LIMITING YOUR PROFESSIONAL RISKS purchase insurance can have no bearing on a teller s referral fee. Insuring Domestic Abuse Victims In recent years, a handful of life and health insurers have tried to avoid unwanted risk by denying affordable insurance benefits to victims of domestic abuse. As part of their defense, these insurers have claimed that covering these people and their rage-inflicted injuries would force companies to raise premiums on all policyholders. However, public reaction to this discriminatory practice has been largely negative, and many states have responded by passing laws that prohibit it. The GLBA s authors instilled that popular position into federal law, making it illegal for a bank to deny health insurance or life insurance to someone on the basis of domestic abuse. Creating Uniformity in the Regulation of Insurance Producers A major portion of the GLBA did not have an impact on clients and customers but was of special interest to insurance producers, particularly those who wanted to sell insurance in multiple states. Despite the law s stated support for the McCarran-Ferguson Act and state-centered regulation of insurance, the GLBA s supporters seemed more intent than ever before on creating national uniformity in regard to licensing and reciprocity. To ensure swift action by the states to comply with the new regulations, the GLBA actually set forth an ultimatum. If requirements related to licensing reciprocity were not met within a specified time frame, the NAIC was to oversee the creation of a group named the National Association of Registered Agents and Brokers (NARAB). The purpose of NARAB would be to provide a mechanism through which uniform licensing, appointment, continuing education and other insurance producer sales qualification requirements would be adopted and applied on a multi-state basis. At the same time, NARAB would aim to preserve the right of states to license, supervise and discipline insurance producers and enforce laws related to consumer protection and trade practices. The legislators who put these rules together felt so strongly about the need for uniformity and reciprocity that they even created steps that would be taken if the NAIC did not take action on these issues. The NAIC moved swiftly, and the creation of NARAB has not been required. However, the creation of NARAB will be reconsidered if the states stop providing reciprocity to one another and do not solve this problem amongst themselves within two years. The portions of the GLBA that pertain to NARAB appear here: GRAMM-LEACH-BLILEY ACT Subtitle C National Association of Registered Agents and Brokers SEC STATE FLEXIBILITY IN MULTISTATE LICENSING REFORMS. (a) In General.--The provisions of this subtitle shall take effect unless, not later than 3 years after the date of the enactment of this Act, at least a majority of the States (1) have enacted uniform laws and regulations governing the licensure of individuals and entities authorized to sell and solicit the purchase of insurance within the State; or (2) have enacted reciprocity laws and regulations governing the licensure of nonresident individuals and entities authorized to sell and solicit insurance within those States. (b) Uniformity Required.--States shall be deemed to have established the uniformity necessary to satisfy subsection (a)(1) if the States (1) establish uniform criteria regarding the integrity, personal qualifications, education, training, and experience of licensed insurance producers, including the qualification and training of sales personnel in ascertaining the appropriateness of a particular insurance product for a prospective customer; (2) establish uniform continuing education requirements for licensed insurance producers; (3) establish uniform ethics course requirements for licensed insurance producers in conjunction with the continuing education requirements under paragraph (2); (4) establish uniform criteria to ensure that an insurance product, including any annuity contract, sold to a consumer is suitable and appropriate for the consumer based on financial information disclosed by the consumer; and (5) do not impose any requirement upon any insurance producer to be licensed or otherwise qualified to do business as a nonresident that has the effect of limiting or conditioning that producer s activities because of its residence or place of operations, except that countersignature requirements imposed on nonresident producers shall not be deemed to have the effect of limiting or conditioning a producer s activities because of its residence or place of operations under this section. (c) Reciprocity Required.--States shall be deemed to have established the reciprocity required to satisfy subsection (a) (2) if the following conditions are met: (1) Administrative licensing procedures.--at least a majority of the States permit a producer that has a resident license for selling or soliciting the purchase of insurance in its home State to receive a license to sell or solicit the purchase of insurance in such majority of States as a nonresident to the same extent that such producer is permitted to sell or solicit the purchase of insurance in its State, if the producer s home State also awards such licenses on such a reciprocal basis, without satisfying any additional requirements other than submitting (A) a request for licensure; (B) the application for licensure that the producer submitted to its home State; (C) proof that the producer is licensed and in good standing in its home State; and (D) the payment of any requisite fee to the appropriate authority. (2) Continuing education requirements.--a majority of the States accept an insurance producer s satisfaction of its home State s continuing education requirements for licensed insurance producers to satisfy the States own continuing education requirements if the producer s home State also recognizes the satisfaction of continuing education requirements on such a reciprocal basis. (3) No limiting nonresident requirements.--a majority of the States do not impose any requirement upon any insurance producer to be licensed or otherwise qualified to do business as a nonresident that has the effect of limiting or conditioning that producer s activities because of its residence or place of operations, except that countersignature requirements imposed on nonresident producers shall not be deemed to have the effect of limiting or conditioning a Real Estate Institute 93

100 LIMITING YOUR PROFESSIONAL RISKS producer s activities because of its residence or place of operations under this section. (4) Reciprocal reciprocity.--each of the States that satisfies paragraphs (1), (2), and (3) grants reciprocity to residents of all of the other States that satisfy such paragraphs. (d) Determination.- (1) NAIC determination.--at the end of the 3-year period beginning on the date of the enactment of this Act, the National Association of Insurance Commissioners (hereafter in this subtitle referred to as the NAIC ) shall determine, in consultation with the insurance commissioners or chief insurance regulatory officials of the States, whether the uniformity or reciprocity required by subsections (b) and (c) has been achieved. (2) Judicial review.--the appropriate United States district court shall have exclusive jurisdiction over any challenge to the NAIC s determination under this section and such court shall apply the standards set forth in section 706 of title 5, United States Code, when reviewing any such challenge. (e) Continued Application.--If, at any time, the uniformity or reciprocity required by subsections (b) and (c) no longer exists the provisions of this subtitle shall take effect 2 years after the date on which such uniformity or reciprocity ceases to exist, unless the uniformity or reciprocity required by those provisions is satisfied before the expiration of that 2-year period. (f) Savings Provision.--No provision of this section shall be construed as requiring that any law, regulation, provision, or action of any State which purports to regulate insurance producers, including any such law, regulation, provision, or action which purports to regulate unfair trade practices or establish consumer protections, including countersignature laws, be altered or amended in order to satisfy the uniformity or reciprocity required by subsections (b) and (c), unless any such law, regulation, provision, or action is inconsistent with a specific requirement of any such subsection and then only to the extent of such inconsistency. (g) Uniform Licensing.--Nothing in this section shall be construed to require any State to adopt new or additional licensing requirements. Sections 322 through 335 of GLBA go on to establish the alternative if the goals of section 321 are not met. The formation of the National Association of Registered Agents and Brokers would accomplish these goals. SEC NATIONAL ASSOCIATION OF REGISTERED AGENTS AND BROKERS. (a) Establishment.--There is established the National Association of Registered Agents and Brokers (hereafter in this subtitle referred to as the Association ). (b) Status.--The Association shall- (1) be a nonprofit corporation; (2) have succession until dissolved by an Act of Congress; (3) not be an agent or instrumentality of the United States Government; and (4) except as otherwise provided in this Act, be subject to, and have all the powers conferred upon a nonprofit corporation by the District of Columbia Nonprofit Corporation Act (D.C. Code, sec. 29y-1001 et seq.). SEC PURPOSE. The purpose of the Association shall be to provide a mechanism through which uniform licensing, appointment, continuing education, and other insurance producer sales qualification requirements and conditions can be adopted and applied on a multistate basis, while preserving the right of States to license, supervise, and discipline insurance producers and to prescribe and enforce laws and regulations with regard to insurance-related consumer protection and unfair trade practices. SEC RELATIONSHIP TO THE FEDERAL GOVERNMENT. The Association shall be subject to the supervision and oversight of the NAIC. Reciprocity and Uniformity Requirements Subtitle C of the GLBA provides the states with two approaches to avoid creation of NARAB. The first is for states to recognize and accept the licensing procedures of other states on a reciprocal basis so agents will not be required to meet different standards in each state. In order to achieve reciprocity under the NARAB provisions, a majority of states and U.S. territories must have laws and regulations that guarantee reciprocal treatment for non-resident agents doing business in more than one state. The required reciprocity will be reached if a majority of states and territories do all of the following: Permit a producer licensed to sell insurance in his or her home state to sell in non-resident states after satisfying only minimum requirements, such as submission of a licensing application and payment of all applicable fees. Accept the satisfaction by a producer of his or her home state s continuing education requirements. Do not limit or condition producers activities because of residence or place of operations (except that counter-signature requirements are still permitted). Grant reciprocity to all other states meeting reciprocity requirements. Alternatively, the states can avoid the creation of NARAB by adopting uniform laws and regulations regarding non-resident agent licensing. Laws and regulations will be deemed to be uniform under the NARAB provisions if the states do each of the following: Establish uniform criteria for integrity, personal qualifications, education, training and experience of licensed insurance producers. Establish uniform continuing education requirements. Establish uniform ethics course requirements. Establish uniform criteria regarding the suitability of insurance products for specific customers. Do not limit or condition producers activities due to residency or place of operations. The Producer Licensing Model Act The NAIC s Producer Licensing Model Act has been used as the primary vehicle for the states to implement the GLBA s reciprocity requirements. The NAIC asserts that adoption and implementation of the model act does much more than simply satisfy the minimum requirements of the GLBA. It creates a foundation for achieving the ultimate goal of uniformity among the states for agent licensing. As of August 2004, 49 states and Guam had passed the Producer Licensing Model Act or other licensing laws with the intent of satisfying the reciprocity licensing mandates of the GLBA. Forty-two of those states have been certified by the NAIC as meeting the requirements for producer licensing reciprocity. Ten Years of the GLBA Roughly a decade after the law s entry into the business world, insurers, bankers and legal professionals continue to dissect the GLBA. In many ways, the legislation has done what it was intended to do. With a majority of banks reporting at least some insurance revenue as early as 2002, and with insurers Real Estate Institute 94

101 LIMITING YOUR PROFESSIONAL RISKS occasionally becoming involved in the issuance of CDs and auto loans, the case can be made that competition among various financial institutions has increased by at least a degree or two. The GLBA can also be credited with effectively encouraging greater licensing reciprocity among the states. Yet in spite of these accomplishments, the GLBA has not lived up to everyone s expectations and has sparked a few debates. Surprisingly so or not, the GLBA has not enticed many major financial institutions to join forces in the spirit of the Citicorp/Travelers Group partnership of 1998, and universal banking has not expanded significantly in the United States. Though there has been some blending of banking and insurance services at some companies, banks have not seized the opportunity to become involved in all aspects of the insurance business. With banks generally getting higher returns on equity than insurance companies, the risks involved with underwriting have yet to appeal to most depository institutions. The GLBA has also failed to quash all concerns related to reciprocity for insurance producers, who sometimes claim licensing requirements prevent them from doing their jobs to the best of their ability. A bill that made its way to Congress in 2008 with bipartisan support addressed this issue by calling for what has been billed as NARAB-II, a proposed nonprofit association that would oversee the implementation of licensing standards and reciprocity among the states. As presented to the House of Representatives, NARAB-II wouldn t change licensing requirements for agents and brokers who conduct business in their home state, but multi-state producers would be able to avoid additional licensing requirements in other states if they paid a fee and lived up to the association s standards. Sparked in part by the debate over licensing and reciprocity, the NAIC reported in early 2008 that states were in high compliance with 26 of its 37 licensing standards, which were adopted for GLBA purposes. GLBA Summary The GLBA has already provided significant benefits with respect to multi-state coordination and reciprocity. The financial privacy and safeguards rules have also been widely implemented and provide significant information to the consumer. Insurance professionals will continue to feel the impact of this important federal law. CHAPTER 4 PROTECTING YOURSELF PROFESSIONAL LIABILITY INSURANCE Introduction All experienced insurance producers have come to understand that there are universal risks that human beings face every day, including the risks of death, disease, personal injury and property damage. Products that address these risks are discussed constantly within the industry, marketed effectively to the public and detailed extensively in countless texts. Receiving less attention are those risks that apply to people in certain kinds of situations. The following course material addresses those less-discussed and sometimes lessunderstood risks, with an emphasis on the insurance needs of business professionals. Students will learn about or be reminded of the various insurance products that are geared specifically toward high-ranking corporate executives, doctors, lawyers, architects and others whose jobs expose them to greater liability risks than the average person. By studying this material, producers will also recall that they, too, are often viewed as professionals who can benefit from solid insurance coverage. The material speaks to those producers who have an interest in directors and officers insurance, errors and omissions insurance or malpractice insurance and contains general overviews and specifics of all three products. But as valuable as that information might be, it represents only a portion of what professional liability producers must know in order to do their jobs as effectively as possible. While insurance professionals should obviously be able to understand and explain the products and services that are provided by their industry, they may struggle to succeed if they do not put these products and services into specific contexts and understand how a particular policy may or may not satisfy each professional s unique needs. Producers will probably have a hard time selling a directors and officers liability policy, for example, if they do not first grasp what roles directors and officers play in an organization. With that in mind, the material is as much about the risks encountered by various professionals as it is about insurance products. By applying such important background information to their business interactions with corporate directors and officers, lawyers, doctors and others, producers may become better equipped to match clients with the proper insurance product and may be more apt to recognize major deficiencies in coverage. What Do Directors and Officers Do? Directors and officers are business professionals who push their company toward achieving its financial and societal goals. Whether they serve or work for publicly held corporations, private companies or non-profit entities, their judgments and decisions can be monumental in size and can create positive and negative consequences that affect a company s workforce, clients and major investors. A board of directors sits atop a company s chain of command and is expected to use its nearly supreme power to suit the collective interests of all shareholders. For directors of large and publicly traded companies, such responsibility might entail representing thousands of investors from around the globe. However, at many small and private companies, an organization s directors are also its sole shareholders. Board members who are employed by the company or have an otherwise personal stake in the company s success or failure are known as inside directors. Those directors who do not work for the company and do not have a personal stake in the company s success or failure are known as outside directors and are usually recruited by the board to add expertise, prestige and unbiased perspectives to the company s dealings. Both inside and outside directors serve by the consent of a company s shareholders, who can remove, reelect or install board members at regularly scheduled shareholder meetings Real Estate Institute 95

102 LIMITING YOUR PROFESSIONAL RISKS A board of directors tangible duties may include but are not necessarily limited to the following tasks: Hiring and firing major personnel Voting to endorse or discourage big business deals Formulating company policies pertaining to financial strategies Setting salary figures for executive positions No matter the specifics of their decisions, directors must abide by various ethical standards that have long been a foundation for corporate law in the western world. When entrusted with shareholders money, a director takes on fiduciary duties of care, good faith, loyalty and obedience. A duty of care requires a person to become reasonably informed about a situation before making a decision and discourages even supposed experts from taking possibly hasty actions. A duty of good faith forces directors to perform with unwavering honesty and encourages them to withhold no material information from shareholders. A duty of loyalty ought to prevent directors from engaging in business activities that promote personal gain at the expense of shareholders and should entice directors to disclose any actual or perceived conflicts of interest that could arise in a given situation. A duty of obedience requires a director to act in a manner that is compliant with the company s charter and bylaws. Many directors devote no more than a few hours each week to their board-related service and appoint officers (such as chief executive officers, chief financial officers and various managers) to handle important daily business tasks. A company s officers are often expected to adhere to similar principles of care, good faith, loyalty and obedience. Additional duties of directors and officers are detailed in the American Bar Association s Model Business Corporation Act, which has been adopted in some form or another by many states. Some larger states like Illinois have also developed their own statutes to address these issues. D & O Liability Risks This assortment of fiduciary duties leaves even careful directors and officers vulnerable to numerous liability risks. According to a 2007 item in the University of Chicago Law Review, a publicly held company stands a 2 percent chance each year of being named as a defendant in a shareholder class action suit, and even if shareholders could be eliminated as sources of complaints, directors and officers would still have to worry about avoiding lawsuits that may be brought by customers, regulators, colleagues and employees. A public company s directors and officers are especially susceptible to harmful allegations when their company s stock drops dramatically in value. Shareholders, as well as the Securities and Exchange Commission (SEC), seem more inclined than ever before to investigate suddenly failing companies in attempts to detect unlawful business practices, including failures to honor fiduciary duties and violations of federal securities laws. After scouring company reports and prospectuses, angry shareholders and government officials might allege that upper management filed inaccurate or misleading information with the SEC and thereby permitted corporate stock prices to become inflated far beyond their true value. Of recent concern have been instances of backdating. As part of compensation packages, many companies give their directors and officers the option of purchasing company stock at a price determined by the organization. Backdating occurs when the price associated with stock options corresponds with a lower, earlier price that was in effect before the company ever granted such benefits to the recipient. Because the recipient is able to purchase company stock at a lower than current price, he or she will ultimately be able to sell the stock at a greater profit. On its own terms, backdating is not always illegal. However, a company s directors and officers expose themselves to tremendous liability when they receive or offer backdated stock options without proper disclosure. When documented inadequately, backdating can skew company earnings and allow other stockholders to successfully claim that management falsified or misrepresented materially important information to investors. If proven to be true, these accusations could make directors and officers liable for any monetary losses that a company s backers may have incurred. Directors and officers face other liability risks when their companies go through transitions and restructurings. Mergers and acquisitions that turn sour tend to make disgruntled parties wonder if directors acted responsibly and in shareholders best interests. Shareholders might also allege that corporate decision makers did not satisfactorily seek out the best possible business deal for investors. It is also possible that affected employees will file suit in response to the undesirable changes that often occur at the workplace following a major business transaction. Class Actions vs. Derivative Actions For the purpose of future reference, it may be important to note here that many lawsuits filed against directors and officers (especially those actions involving securities) can be categorized as either class actions or derivative actions. Even readers without any legal background are likely to already be somewhat familiar with the concept behind class actions. These actions basically involve several plaintiffs who have similar claims against the same defendant. At least within the context of corporate liability, class actions are usually filed by shareholders for their own relief and typically seek major monetary settlements or judgments. Derivative actions arise when shareholders (who may or may not have lost money caused by a director or officer s alleged misconduct) file a suit on a company s behalf. Rather than asking for financial restitution, plaintiffs in derivative suits often seek settlements or judgments that will instigate improved corporate governance and managerial changes. Any money that passes from defendants to plaintiffs in a derivative action goes to the company that is linked indirectly to the case. This does not mean, however, that a victorious shareholder gains nothing personal by pushing forward as the plaintiff in a derivative action. A well-publicized prosecution by the shareholder in a derivative action could perhaps save a company s reputation during a critical period and put a company s falling stock back on the rise. Risks at Private Companies Though many of the preceding examples of liability risks involve publicly traded stock and might seem like they are major issues only for the big companies that one reads about in national business publications, several additional liability issues can realistically affect directors and officers at companies of nearly all sizes and configurations. Management at a private company is a solid target for suits when a business is forced to declare bankruptcy. This is especially true when a creditor provided financial assistance to a company just prior to the bankruptcy and was not allegedly aware of the company s financial troubles. Leaking confidential information about one s company to a competitor or any other party for the purpose of financial gain could trigger legal action against directors and officers. It s also possible that controversial hiring and firing decisions will provoke civil rights litigation. The Securities Act of 1933 Life was not always so risky for directors and officers, and, consequently, there was not always a need for them to insure their personal assets against legal claims. Individual directors and officers were barely exposed to liability until the federal government passed major securities legislation in response to the Great Depression. Among other laws, a Real Estate Institute 96

103 LIMITING YOUR PROFESSIONAL RISKS Depression-era Congress enacted the Securities Act of 1933 and the Securities Exchange Act of Together, these laws created the Securities and Exchange Commission (SEC) and began requiring that any offer or sale of securities using the means and instrumentalities of interstate commerce be registered and that documentation be filed with the new federal agency. These laws also allowed buyers of federally registered securities to sue various parties if there were any false or misleading statements within securities registration documents. On the basis of the acts, anyone who buys a security that is linked to false or misleading SEC statements can sue the following persons: Signers of the disputed registration documents A company s directors and officers Partners in a business Future directors and officers who consented to have their names listed on securities documents Accountants and appraisers who put the securities documents together Underwriters of the disputed securities The individuals listed above may escape liability in some cases. A person can avoid liability if he or she resigned from the company before registration documents were filed with the SEC and informed the company and the SEC that he or she would not be responsible for the contents of future registration documents. People are also exempt from securities liability if they had no reason at any time to believe that there were any misstatements or misrepresentations in securities documents or if, upon discovering misstatements or misrepresentations, they promptly reported the problems and proclaimed their innocence to the public and the SEC. Trusted experts whose statements were used or interpreted improperly in relation to securities documents are additionally shielded from liability. However, in order for any of these protections to apply, the accused needs to have taken the kinds of measures and precautions that would have been expected of a prudent and reasonable person. In assessing prudence and reasonableness in federal securities cases, the judiciary tends to compare plaintiffs business practices to the way people would treat or protect their own property. The Business Judgment Rule Directors and Officers Coverage (D & O) Though the Securities Act created a big enough stir in the 1930s for insurers to introduce coverage that was aimed specifically at directors and officers, it took several decades for business professionals to be concerned enough to consider purchasing directors and officers coverage (D & O). In the years following the landmark securities laws, it was still far more likely that an angry shareholder would bring a company to court rather than pursue litigation against specific high-ranking individuals. In the few cases that did specifically name directors and officers as defendants, executives often benefited from broad judicial interpretations of the business judgment rule. The business judgment rule is a commonly cited legal concept that attempts to fairly address the fact that a company s decision makers are not infallible. The rule generally makes it legally acceptable for directors and officers to make mistakes or unpopular decisions, as long as the following criteria have been met: The people who made the decision lacked a conflict of interest. The people who made the decision were reasonably informed in regard to material facts and issues. The people who made the decision acted honestly. The people who made the decision were not acting beyond the boundaries of their authority. The rule is also applied by the courts to the decisions that directors or officers fail to make. Deterioration of the Business Judgment Rule Over time, the courts adopted a less rigid approach to the business judgment rule, and shareholders began having more success in court when challenging the decisions of directors and officers. Escott v. BarChris Construction Co. The case Escott v. BarChris Construction Co. has been cited by insurance experts as one example of a court tightening a director or officer s responsibilities in regard to due diligence. BarChris specialized in serving the bowling industry and capitalized on a boom in that sport following the 1952 invention of automatic pin-setting machines. According to court documents, the company had become the number-three builder of bowling lanes by 1960 and had constructed roughly 3 percent of all lanes nationwide. As far as the public knew, BarChris did not operate bowling alleys; it built the interior lanes, installed the necessary equipment and then sold the alleys to a third party, who leased the alleys to the construction company s customers. The company typically received a small down payment before starting work on an alley and received the rest of its compensation in the form of notes, payable at a later date, as work on an alley neared completion. By 1960, BarChris assumed it could survive if one of its customers were to unexpectedly back out of a deal for one of the company s alleys, but the business was unprepared when the bowling bubble burst in the early part of the decade. With too much supply and too little demand for lanes, the company was forced to repossess several alleys and chose to operate them on its own. Meanwhile, the company continued the construction of lanes, even though buyers had pulled out of deals midway through projects. In 1961, BarChris filed documents with the SEC in order to sell debentures (instruments similar to bonds), but the company s financial struggles caused it to default on those debentures during the following year and eventually file for bankruptcy protection. BarChris failures provoked a lawsuit from more than 60 shareholders, who alleged the company had included errors and omitted material information from its SEC filings. Among those named in complaints were the signers of the SEC documents (including BarChris directors), the company s auditors and eight investment banking firms that had acted as underwriters. Though courts did not agree with the suing shareholders on all counts, they did say the company had inappropriately included mere projections in its earnings statements, had wrongfully included a loan as part of company sales figures and had misstated its sales figures and operating income for 1960 by roughly $700,000 and $300,000 respectively. A judge also ruled that BarChris sales, profits and liabilities for 1961 were inaccurate to the point of being material misrepresentations and that the company s decision to operate bowling alleys in addition to constructing them made the stated nature of the business misleading to investors. In response to some of the plaintiffs accusations, BarChris officials claimed the auditing firm involved with the case was an expert on which the company had relied and said, based on their alleged due diligence, they had no reason to believe the SEC documents had included any false or misleading statements. This defense did not satisfy a U.S. district court, which suggested that handing off responsibilities to supposed experts did not shield directors and officers from liability and that signing one s name on an SEC document creates liability for the signer, even if the person allegedly did not understand or even read the document. Smith v. Van Gorkom Other rulings in the late 1960s amounted to additional victories for shareholders. But with the annual number of cases against Real Estate Institute 97

104 LIMITING YOUR PROFESSIONAL RISKS directors and officers still in single digits during parts of the 1970s, there was no prolonged liability-related crisis that kept directors and officers in fear of being inadequately insured. Times had changed by the 1980s, when hundreds of lawsuits were being filed. Directors and officers of top companies were reacting nervously to shareholder-friendly decisions, including the one handed down in Smith v. Van Gorkom, which made directors and officers liable for a bad business deal despite an absence of fraud or bad faith. The Van Gorkom case centered on the controversial purchase of a company, TransUnion, by corporate takeover specialist James A. Pritzker. A TransUnion director had negotiated a proposed cash-out merger with Pritzker and called a board meeting in order to discuss the deal with colleagues. According to court documents, most of the board members did not know ahead of time that the meeting would involve their consideration of a merger agreement, and when they did learn of the Pritzker offer, their knowledge of it was confined to what was told to them in an oral presentation given by the negotiator, who allegedly understood the gist of the merger agreement but had not read it. In essence, the merger agreement called for Pritzker to purchase interests in TransUnion at $55 per share, a $17 bump from the company s reported market value of $38 per share. Despite having claimed in the past that TransUnion s stock had been undervalued in the market due to tax issues, the board spent two hours discussing the proposal, compared the $55 dollar offer to the $38 market value and voted to accept the merger agreement without conducting any valuation studies. According to some defendants in the case, the board s decision was based, in part, on legal advice it received, which cautioned that rejection of the merger agreement could leave directors susceptible to shareholder suits. The original agreement between Pritzker and TransUnion permitted the latter company to receive competitive offers from other suitors for 90 days as long as TransUnion did not actively solicit those offers. But, when many TransUnion managers threatened to leave the company, Pritzker removed the ban on open solicitation in return for management s promise to stay on board for an additional six months. In a second meeting, TransUnion s board of directors approved this amendment to the merger agreement, allegedly without having examined it in written form. The board also called in an investment adviser to help with any competing offers that came in, though this person was not asked to give an opinion of the preexisting Pritzker offer. Two other proposals, both of them larger than Pritzker s, eventually came to TransUnion s attention. These two prospective deals were accompanied by timing and funding problems and fell apart before directors could vote on them. During a third meeting, the board reviewed the chronology of events related to the Pritzker merger agreement and voted unanimously to accept the agreement again and recommend it to shareholders, who did indeed approve it on a later date. In response to a class action suit filed by TransUnion shareholders, a court applied the business judgment rule to the case s details and determined that the board of directors had made an informed decision and that shareholders had voted in favor of the merger after being made reasonably informed of the agreement by the board. On appeal, the Supreme Court of Delaware reversed the lower court s ruling, claiming that the board was not reasonably informed of the merger agreement when it voted on the deal and that shareholders, as a result, had not been told all they needed to know about the Pritzker arrangement. In stating its case, the court said that, contrary to claims made by the defense, the board had not adequately considered the merits and faults of the merger agreement during all three board meetings. From the court s perspective, the board s second meeting (the one pertaining to the solicitation amendment) had nothing to do with reconsidering the merger agreement; instead, it was all about setting up the possibility for additional agreements between TransUnion and Pritzker. Furthermore, the court said the solicitation amendment would have only let the TransUnion board back out of the merger agreement if the company had managed to consummate another agreement with another buyer and get it approved by shareholders within the 90-day period for active solicitation. Because neither of the two competing offers had made it to a shareholder vote, the court found that the board s third meeting (the one pertaining to its final vote on the Pritzker agreement) was not an opportunity for the directors to seriously reconsider the deal. Had the board voted against the agreement at that third meeting, it could have paved the way for a breach of contract dispute. The court said shareholders could not have made an informed decision about the Pritzker suit since they did not know how much TransUnion shares were really worth at the time, and it concluded that the board s actions amounted to a breach of fiduciary duties. According to the court, Fulfillment of the fiduciary function requires more than the mere absence of bad faith and fraud. Representations of the financial interests of others impose on a director an affirmative duty to protect those interests and to proceed with a critical eye in assessing information of the type and under the circumstances presented here. In short, the business judgment rule, cited by the earlier court, could not shield the directors from liability. The case resulted in a $23.5 million judgment against the directors. A Temporary D & O Crisis Some insurance veterans, as well as observers of corporate America, have since credited the Van Gorkom case with ushering in a D & O insurance crisis that affected many companies during the 1980s. Good demand for protection enticed insurers to continue selling liability policies to directors and officers, but underwriting became tighter, coverage became more restrictive and premiums went up for some businesses. Seemingly for the first time, the availability of adequate insurance coverage became a sticking point for those business professionals who were asked to serve on corporate boards. For example, according to the Wall Street Journal, the manufacturing company Armada lost eight of its 10 board members, including its chairman and CEO, when the company opted not to absorb the $720,000 annual premium for a $10 million D & O liability policy. At the same time, some companies attempted to keep their D & O premiums down by putting restrictions on the kinds of suits shareholders could bring against directors. As the size and frequency of securities suits grew, the federal government tried to find ways to weather the storm. One such effort arrived in the form of the Private Securities Litigation Reform Act of Under the act, a securities suit may be dismissed if the plaintiff fails to make specific charges against a defendant. Plaintiffs cannot base their entire case on a mere decline in a security s value. They must allege that the defendant made misleading statements or omissions, point to the exact misleading statements or omissions and explain how a defendant s actions constituted a misleading statement or omission. There also must be an allegation that misrepresentations led to economic losses for the plaintiff. The Effects of Sarbanes-Oxley on Directors and Officers Despite the change in federal law mentioned above, D & O insurance continued to be a must-have benefit for many people associated with Fortune 500 companies. Even inside the most ethically upright boardrooms, the possibility of a single eightfigure judgment against directors and officers was still frighteningly strong, and liability concerns became even more urgent when massive financial failures at companies such as Enron and WorldCom became front-page news Real Estate Institute 98

105 LIMITING YOUR PROFESSIONAL RISKS With corporate scandals resulting in significant losses for Americans of all classes and backgrounds, it was inevitable that post-enron directors and officers would be subjected to greater regulatory scrutiny and ordered to perform their duties with a higher degree of care. The Enron and WorldCom fallouts were at least partially responsible for the bipartisan passage of the Public Company Accounting Reform and Investor Protection Act on July 30, Among other things, this act more commonly known as SOX or Sarbanes-Oxley in honor of its two main congressional sponsors did the following: Set up auditing requirements for U.S. companies and some foreign companies Forced public companies to disclose changes in their financial health Denied executives the right to sell their company stock during blackout periods Gave whistleblower protection to people at public companies who report poor accounting practices to proper authorities The act also extended the timeframe during which a plaintiff may sue for securities-related damages. Prior to SOX, stockholders could sue directors and officers in a securities case no later than one year after learning about possible impropriety or three years after the impropriety allegedly occurred. SOX changed the limit on these actions, and investors can now file securities suits no later than two years after learning about possible impropriety or five years after the impropriety allegedly occurred, whichever happens sooner. In printed form, Sarbanes-Oxley fills more than 60 standard pages and was broken down by its authors into more than 40 sections. Rather than go into detail about the entire law, we will focus on two sections of the act that should stand out for many directors, officers and insurance professionals. The two parts of the act that receive special mentions here are sections 302 and 402. Section 302 of Sarbanes-Oxley Section 302 of Sarbanes-Oxley deals mainly with the periodic financial reports that public companies must file with the SEC in accordance with the Securities Exchange Act of These reports cannot contain untrue or misleading statements nor have material information omitted from them. When executives sign these reports, they certify that they have read and reviewed the reports contents. Section 302 of SOX makes the people who sign SEC reports responsible for a public company s internal controls, which are designed to prevent inaccurate accounting. Signers are required to review a company s internal controls no earlier than 90 days before they put their name to an SEC report and must make their findings a part of that SEC report. Signers must tell the company s auditors and board of directors about any existing or potential problems that may be attributable to faulty internal controls and about any instances of fraud that involve someone who is associated with the company s internal controls. Corrective measures taken by signers in regard to internal controls must be noted in SEC reports. In addition, public companies are not exempt from the requirements in section 302 if they restructure themselves and head overseas. Section 402 of Sarbanes-Oxley Under Section 402 of Sarbanes-Oxley, a public company cannot directly or indirectly give credit to its directors and officers or arrange for a director or officer to receive credit or a loan. Among other exceptions, this prohibition does not apply to credit or loans that pre-date Sarbanes-Oxley, as long as the credit or loans are not renewed and there are no modifications made to the lending or crediting agreements. Section 402 is particularly important to insurance professionals because of the popularity of split-dollar life insurance policies. Split-dollar life insurance policies are bought by companies and insure the lives of their employees. When the insured person dies, the company receives either the policy s cash surrender value or the amount of money it paid in premiums for the insurance. Any excess death benefits go to the insured s chosen beneficiary. Split-dollar life insurance may be structured as either an endorsement policy or an assignment policy. In an endorsement split-dollar arrangement, the premium-paying company owns the policy on the employee s life. In an assignment split-dollar arrangement, the employee owns the policy on his or her own life but assigns part of the policy to the premium-paying company, as if the insured were borrowing money from the company and using part of the death benefit to repay the loan. In response to SOX, insurers contended that split-dollar arrangements constituted rewards to employees rather than loans. But with the IRS already treating some of these arrangements as loans for tax purposes, many companies did not know how to proceed with sales of these policies. Section 402 contained no definitions of loan or credit as they pertained to securities law, and the SEC gave no indication to carriers that it would provide any guidance on the issue in the near future. Some legal and insurance experts predicted that the uncertainty over split-dollar life insurance and the criminal penalties attached to Section 402 (individual penalties of up to $5 million and 20 years in prison, and company penalties of up to $25 million for a violation) would eradicate this popular employee benefit from publicly held companies. Unfavorable rulings by the Internal Revenue Service have made the use of split-dollar life insurance even less desirable. The D & O Market in the 21 st Century For obvious reasons, the passage of Sarbanes-Oxley and the general public s attention to the scandals at companies like Enron caused directors and officers to focus even more on their exposure to liability. With the new law in place and corporate restatements on the rise, publicly held businesses worried that they would soon be confronted with suits, regardless of any actual wrongdoing on their parts. At this point, it was clear that having a corporate secretary take accurate, extensive notes at board meetings or not being present when controversial decisions were made would not always save a director or officer from serious legal trouble. Faced not only with the potential for courtroom defeats but also with the prospect of having to pay steep settlements and enormous defense fees, directors and officers once again turned to their companies and began asking questions about their D & O liability coverage. In general, people s liability concerns did not lead them to resign from their high-ranking positions. Companies, nonetheless, began to recognize that having a solid D & O liability insurance package in place could be good for their bottom lines and that decent coverage was one of several valuable recruiting tools within a competitive market for prospective board members. In a survey conducted by the professional services firm Towers Perrin, roughly half of respondents at public and private companies said prospective directors and officers had asked about D & O liability insurance in Approximately 20 percent of respondents at public companies said prospects inquiries had led to a change in the kind of coverage offered by their company. Of course, insurers that specialized in D & O policies had been keeping close tabs on the developments at Enron and in Washington. They understood, at least equally as well as their clients did, that the Sarbanes-Oxley requirements and the public s increasing vigilance toward corporate fraud had helped liability for directors and officers balloon to previously unseen proportions. They knew that with greater risks to insureds came greater risks for insurance companies, which, at the end of the day, would be the entities responsible for paying those expectedly higher defense fees and plaintiff awards. Some also reasoned that potential prison terms for Sarbanes-Oxley Real Estate Institute 99

106 LIMITING YOUR PROFESSIONAL RISKS violations would entice even innocent companies to settle with their accusers at the insurer s expense rather than do battle in court and risk being put behind bars. These factors made underwriting D & O liability risks more challenging for insurance companies, and many providers decided to use greater caution by increasing premiums and reevaluating the risks posed by certain clients. An energy trade publication claimed in 2003 that oil and gas companies, which had collectively been subjected to only one securities-related class action suit prior to the Enron debacle, were having serious problems securing adequate liability coverage for themselves and their employees. Today, companies desire for coverage and insurers occasional hesitancy in offering it send the same basic yet important message: The liability risks for directors and officers in the 21 st century are real and should not be taken lightly. Providing Services and Managing Liability It would be silly for us to digest all this information and assume that a company s directors and officers are the only people who expose themselves to professional liability at work, or more importantly, that directors and officers are the only people who can protect themselves through specially tailored liability insurance. Professional liability insurance which, for our purposes, is a somewhat broad product category that includes errors and omissions coverage and malpractice insurance is commonly bought by medical professionals, engineers and lawyers. It may also be useful for accountants, real estate professionals and, of course, insurance producers. In fact, just about anyone who performs a service and passes himself or herself off as an expert might be more exposed to liability than the common worker. By drawing attention to their credentials, these professionals allow clients to expect reasonably high levels of care and quality in the services provided to them. When these services do not live up to those standards, there is not only the possibility that a lawsuit will materialize but also a chance that the plaintiff will receive a large monetary judgment from a judge or jury. Liability can arise from the allegedly low quality of a provided service, as well as from the professional s failure to provide the service in a timely manner. Contrary to a surprisingly popular belief, a client who has an issue with the quality or speed of professional services can successfully sue for an amount above what he or she paid for the services. Liability Risks for Medical Professionals From the general public s perspective, professional liability insurance is probably associated mostly with the malpractice coverage that protects the personal assets of medical workers. Risk management is important for doctors, nurses and even the world s remaining midwives because, through their actions and advice, these assorted professionals may establish relationships with patients that create a duty of care. In some cases, the professional s duty to care properly for patients may apply not only to his or her personal actions and advice but also to any actions or advice rendered by medical staff members who are under the professional s supervision. Furthermore, the duty of care is not necessarily confined to a hospital or a doctor s office. Depending on the circumstances, a medical professional may unknowingly establish a duty of care and create liability issues by casually diagnosing people s problems in informal settings, such as at a party or on the street. Doctors and Punitive Damages Few readers will be shocked to read that the medical malpractice issue is a tremendously controversial one that divides patients and politicians and sometimes pits doctors and insurers against legal professionals. At issue is the manner in which many malpractice settlements and judicial rewards incorporate much more than tangible economic damages. Defendants and their insurance companies are often being asked or ordered to pay for seemingly incalculable damages, including patients pain and suffering as well as punitive damages, which are designed to punish or make an example of alleged wrongdoers. States and the federal government have been slow to put limits on these non-economic damages, and some people believe that damages for pain, suffering and punitive purposes are being inflated unfairly by allegedly self-interested attorneys who work on a fee that is contingent on the size of the settlement. Others, however, point to instances in which doctors have acted irresponsibly in monitoring a mother s pregnancy or operated on the wrong body part and say limits on punitive damages do a disservice to irrevocably harmed patients and families. The Cost of Malpractice Insurance No matter if major malpractice victories for plaintiffs are the result of a few overly aggressive attorneys, a handful of disturbingly incompetent physicians or some combination of these two causes, the bottom line here is that the medical community has lost enough court battles in the past few decades for there to be a long-standing coverage crisis in the United States. Over the years, many insurance companies have either raised premiums considerably for medical malpractice clients or stopped selling policies that help medical workers manage their liability risks. While many doctors have gulped at the sight of their rising insurance costs and have reluctantly continued paying premiums, others have responded differently with changes in the way they structure their personal finances and the way they interact with patients. Rather than pay high premiums for malpractice insurance, a physician might opt to go bare and purchase no coverage at all. As precautionary measures, the bare practitioner might transfer his or her personal assets to a spouse in order to keep them off-limits in a settlement or unfavorable court decision, or the person might force prospective patients to sign long-winded forms that limit their right to sue in the event of medical negligence. But, as has been pointed out by contributors to such legal and medical publications as Medical Economics, these defensive strategies have holes in them. A nasty divorce could work against a doctor who transferred all wealth to a spouse, and a form that overly prohibits patients from suing their doctors may be deemed unenforceable by some courts. Insurance and medical experts sometimes argue that the high cost of malpractice coverage has direct and indirect effects on patients. For example, a doctor might compensate for higher insurance premiums by charging more for services. A physician might also feel inclined to practice defensive medicine, which sees the patient being subjected to arguably unnecessary treatments in order to protect the doctor from potential suits. Though defensive medicine can help doctors pinpoint a proper diagnosis by eliminating some long-shot possibilities, its critics claim it is responsible for a significant portion of health care costs in this country and is therefore partially to blame for rising health insurance premiums. Coverage shortages also have the potential to create physician shortages. Skilled doctors in high-risk medical fields have been known to stop offering certain services in attempts to save on insurance and reduce liability risks. Others have moved their practices to states where malpractice insurance is cheaper, have become specialists in less hazardous areas of medicine or have decided to save money and stress by completely abandoning their medical careers. Liability Risks for Legal Professionals Malpractice claims against lawyers may result from any instance in which a lawyer makes an error that has a negative impact on a client s case or causes unreasonable financial damage to the client. Since wronged individuals are more likely to receive compensation from a negligent lawyer when that lawyer is covered by malpractice insurance, legislators from across the Real Estate Institute 100

107 LIMITING YOUR PROFESSIONAL RISKS country claim an attorney s insurance status is a material fact that should be disclosed to prospective clients. The American Bar Association has supported insurance disclosure requirements for lawyers, and, by 2007, roughly 20 states had put such disclosure requirements in place, according to the San Francisco Chronicle. In general, the states that mandated disclosure required lawyers to either reveal their insurance status on annual reports (which were subsequently made available by the states over the internet) or disclose their coverage status on documents sent to clients. Like liability coverage for doctors, malpractice policies for legal professionals are expensive. Annual premiums can amount to thousands of dollars, and many small law firms have determined that they would rather take their chances and go bare than put down piles of money for sufficient insurance. When reporting on a potential malpractice insurance disclosure law for California legal professionals, the trade publication Lawyers USA cited a 2001 study, which found that nearly 20 percent of private-practicing lawyers in the state lacked coverage. In 2007, Oregon was offering legal malpractice insurance at set prices and was the only state in the country that required lawyers to be covered by a malpractice policy. Liability Risks for Building and Design Professionals Professional liability insurance is also a frequently important product for engineers, architects and other skilled people who are responsible for building or designing various structures. These professionals can find themselves in legal trouble if construction takes longer or ends up costing more than was originally agreed upon by the builder and the client. A job completed on time and under budget can be problematic, too, if the finished structure presents safety hazards to clients or the public. Someone who is injured at a property might sue a designer s client, who might turn around and sue the designer for negligence. Or a physically injured party might take direct legal aim at a design or construction company and its workers. It should be noted, however, that many states have enacted right to repair laws, which allow builders to fix structural problems within a specific time period and avoid a potential lawsuit. Liability Risks for Insurance Professionals With so much of an insurance producer s time devoted to sales and the management of other people s risks, it is possible for producers to become distracted by daily business tasks and unintentionally ignore the liability risks in their own lives. This is unfortunate for a number of reasons. On a societal level, a producer who does not adequately understand the liability risks within his or her profession could engage in unintentionally negligent behavior that does significant damage to innocent consumers. On a personal level, agents and brokers who do not know how to manage their own professional liability are putting their careers and personal assets at great risk. Liability insurance for insurance producers, which falls under the category of errors and omissions coverage, was relatively uncommon as recently as 20 years ago. But today s disputes between carriers and policyholders are often traced by one party or the other to a producer s alleged misconduct, making a quality errors and omissions policy more of a valuable safeguard than in decades past. A producer can be sued if he or she was poorly trained in a policy s features and exclusions and misrepresented those features and exclusions to insureds. Misrepresentations made by the insurance producer may lead to successful legal outcomes for policyholders if the misrepresentation occurred prior to a claim and influenced an insured s choice to purchase a policy. On the other hand, a misrepresentation is a comparatively minor problem, at least from a legal standpoint, if it is made after the policyholder has filed a claim, since the misrepresentation had no bearing on the person s decision to buy the policy in the first place. Liability and the Producer-Consumer Relationship In some cases, knowing a policy from cover to cover and being able to answer a prospect s questions will still not be enough to protect an insurance professional when a client suffers an uninsured loss. Some courts have ruled that producers have special relationships with their clients, which make insurance producers responsible not only for explaining policy issues and obtaining requested coverage but also for assessing a client s risk potential and alerting an insured to coverage gaps. A court might rule that a producer had a heightened duty to advise an insured under the following circumstances: There was a long-term relationship between the producer and the insured. The producer charged a fee for services in addition to a commission. The producer was the insured s lone source for insurance information. This does not mean, however, that producers with a duty to advise are free to make statements and recommend courses of action that are beyond their areas of expertise. Insurance agents can be sued successfully, for example, if the advice they dispense to clients relates to financial planning as opposed to risk management. Avery v. Diedrich On the opposite end of the spectrum is the belief that an insurance producer is not an adviser and should therefore follow through with securing the coverage requested by a prospect, even if the producer disagrees personally with that course of action. Proponents of this belief may even go so far as to argue that there is an implied contract between the producer and the prospect and that a producer s failure to obtain requested coverage for a prospect represents a breach of that contract. This general idea was addressed in the case Avery v. Diedrich. In the Avery case, a couple inherited property that was insured by a $150,000 homeowners policy and asked an insurance agent to increase coverage on the home to $250,000. The agent, having visited the home, doubted the property was worth that much and said a $100,000 increase on a $150,000 policy might arouse suspicion at an insurance company. The owners agreed to have the home reassessed and to get back in contact once the assessment was completed. The couple went ahead with the assessment, but no one alerted the agent to this fact until after a fire had destroyed the home at a replacement cost of $250,000. The couple sued the agent and got a favorable ruling from a circuit court, which said the agent should have followed through on his insureds requests for enhanced coverage and was therefore liable for the loss. On appeal, the Court of Appeals of Wisconsin, District Two acknowledged that state law made agents liable for losses when they agree to obtain coverage for consumers and do not follow through. But the court said an agent is not liable when a consumer requests coverage and the agent does not agree to obtain it. Liability and Insurer Solvency Sometimes a producer s liability is tied not to misrepresented or unsuitable policy terms and conditions but to the financial health of the insurance company that issued the policy. Unfortunately, unforeseen catastrophes, poorly analyzed business plans or some combination of the two can push an insurer into a state of insolvency. When insolvencies occur, policyholders valid claims may not be paid. A claimant might have to wait several years before he or she is reimbursed for an insured loss and even then might still only receive a mere fraction of a claim. Policyholders who find themselves in this distressing situation might point their finger at an insurance producer and wonder if the person should be punished for putting them in such a mess Real Estate Institute 101

108 LIMITING YOUR PROFESSIONAL RISKS A court ruled in one case that an agent is not liable when he or she places coverage in good faith with a seemingly healthy insurer and insolvency occurs at a later date. However, producers might be liable for clients losses when they knowingly place coverage with a financially shaky insurer that ultimately becomes insolvent. Liability and Procedural Duties So far, our exploration of an insurance producer s liability risks has focused mainly on big-picture concepts such as suitability, service and knowledge. These concepts should be unquestionably important to the professional who wants to serve the public admirably and keep legal disputes at a minimum, but the reader should not forget that there are also some procedural aspects of an agent s job that are just as relevant to our liability discussion. In regard to policy application forms, insurance producers can get into legal trouble if they allow a prospect to merely sign a blank form and then fill in the requested information on their own. If producers receive a completed application and believe it contains an error, they should probably not make any corrections to the document without first checking in with the prospect and the insurance company. When coverage has been issued, a legally prudent producer should report claims to carriers in a timely manner. Coverage that is to be replaced should not be cancelled until coverage under the replacement policy has taken effect. The Need for Professional Liability Insurance Having established what some of the major liability risks are for people in various professions, we ought to state something that every successful insurance producer probably already understands: Merely recognizing that a risk exists does not, on its own, make people any less susceptible to unpleasant perils. People who are worried that a certain risk may have a negative impact on their lives need to take the next proactive step and find ways to manage that risk. As in most of the risks we face in our lifetime, we can reduce our exposure to professional liability by altering our behavior and adhering strictly to various rules. But nothing can guarantee we will avoid all legal problems. A single, uncharacteristically lazy error in judgment can saddle an otherwise upright professional with a guilty verdict from a court, and careful business practices are not always going to help good people pay to defend themselves against others who are intent on filing frivolous lawsuits. Because mistakes happen and because a client s motives and sense of reasonableness can be so unpredictable, professional liability insurance exists as an extra layer of protection for riskaverse businesspersons in many professions and industries. Aren t Professionals Already Covered? Most people who could benefit from a professional liability policy do not need to hear an insurance producer go on and on about how insurance, as a general product, can reduce economic hardship during a crisis. They see the value in insurance and have demonstrated their understanding of risk management by obtaining homeowners insurance, health insurance, life insurance and auto insurance for themselves and their loved ones. Still, these veteran insurance buyers might need a producer to point out how a professional liability policy fits into and enhances their coverage portfolio. In truth, some prospective clients might be correct when they claim to have no need for professional liability insurance. But their reasoning is probably faulty if it is based on the premise that they are protected from professional liability through their homeowners policy or a general liability policy. The liability side of a homeowners policy provides almost no protection for a homeowner s business even if the business is operated from the home. While certainly more businessfriendly than homeowners insurance, coverage under general liability policies has gotten narrower over the past few decades and is unlikely to protect policyholders when they are negligent in their renderings of professional services. Obtaining Professional Liability Insurance If potential buyers recognize the possible need for a professional liability insurance policy, they might next want to know how this product is made available to insureds and what the market for the product is like. Professional liability insurance is often secured for individuals by their company. Insurance producers might be covered for errors and omissions through their agency, and lawyers might be covered for malpractice through their firm. When a company purchases liability insurance for its professionals, it may choose to also include coverage for contracted workers and former personnel in addition to current full-time employees. If a professional is not covered by his or her company or does not believe that the company s professional liability coverage is sufficient, that person can shop for an individual policy. Desired liability coverage may be bought on the mainstream insurance market from an admitted insurance company, which has had its policies and premiums approved by the insurance department in the buyer s state. The assorted coverage crises among the professional ranks have also seen a lot of companies and individuals buying professional liability insurance alternatively from a non-admitted carrier. A nonadmitted carrier is an insurance company that has not had its rates or policies approved by the insurance department in the buyer s state. Non-admitted carriers do not escape regulation entirely, but their policyholders will not be reimbursed by a state guaranty fund in the event of insolvency, and some other consumerfriendly features may be missing from their products. A producer typically cannot pair a prospect with a non-admitted insurance company unless the prospect has been denied coverage by admitted carriers. An Assortment of Policies For simplicity s sake, this course material groups malpractice insurance, errors and omissions insurance and directors and officers (D & O) insurance together whenever possible. Yet the reader should keep in mind that an insurance company will probably not underwrite and offer all kinds of professional liability insurance in the same way. A given carrier might feel comfortable giving reasonably priced liability insurance to lawyers but demand that doctors pay comparatively high premiums for malpractice coverage. An insurer that is a leader in errors and omissions coverage for insurance agents might not even have an errors and omissions product on the market that covers architects or engineers. Such non-uniformity in the liability market probably does not come as much of a surprise to readers and is in no way meant to imply that insurance companies are engaging in unethical discrimination toward certain members of the professional world. After all, each professional group presents a unique brand of liability risks to the insurance community. Directors and officers, for example, expose their liability insurers to securities-related liability while not exposing them to many risks pertaining to health issues. The reverse is true for doctors with malpractice coverage. A doctor s liability insurer may have to brace itself for a wrongful death claim but will probably not need to worry so much about a physician getting into trouble with the SEC. The differing risks that apply to directors, officers, doctors, lawyers and other groups are reflected not only in the cost and availability of job-specific liability policies but also within the content of the insurance contracts. The remainder of this section addresses the contractual relationship that exists between a professional liability insurance provider and its policyholders. Many of the general topics covered in the following pages are relevant in some way to all of the professions we explored in earlier sections, but special attention has been paid to specific professions where possible Real Estate Institute 102

109 LIMITING YOUR PROFESSIONAL RISKS and appropriate. Students who plan on serving professional clients well are advised to familiarize themselves with each client s unique set of liability risks in order to find and negotiate policy language and features that best meet the buyer s needs. What is D & O Insurance? As we focus less on liability risks and more on liability coverage, it will be important for us to understand some basic distinctions between D & O insurance and all the other insurance policies that are featured in this chapter. To an extent, D & O insurance is like malpractice insurance for highranking decision makers at public, private or non-profit companies. On a fundamental level, the insurance is meant to protect directors and officers when they perform their duties in good faith but are still personally sued by shareholders or other parties. Over time, D & O insurance has evolved into a product that also repays companies when they indemnify their directors and officers directly for any loss of personal assets. It even sometimes covers the company as a whole against losses incurred in securities disputes. Coverage for individuals is limited to the liability that stems specifically from their roles as directors and officers and usually does not extend to any rendering of professional services. If doctors serve on a company s board of directors, they may be covered for the unpopular business decisions they make at board meetings. However, they will not have coverage under their D & O policy for any mistakes they make in treating or advising patients. For the purpose of another example, consider a person who has multiple roles in a company, serving as a board member and as general counsel. A D & O policy might cover the person for legal advice given to the board but leave the individual uncovered for the services and advice that are provided beyond the boardroom. Who Can Be Covered by a D & O Policy? Despite being a single contract, a D & O insurance policy can cover several people. In addition to covering current directors and officers, a policy might provide protection for past directors and officers, as long as a claim relates to their previous service as a director or officer. It might also protect future directors and officers as they assume their positions. Directors and officers insurance can even be set up to cover lower-ranking employees when they are named in suits along with directors and officers. A company s D & O policy might cover directors and officers when they serve concurrently as directors or officers with other organizations. When this coverage exists, it is often limited to instances in which the director or officer was specifically asked by the company to serve on the board of directors of a nonprofit organization. Coverage that extends to a for-profit director or officer s service at a non-profit organization is limited to the individual and does not protect any other board members at the non-profit entity. The typical D & O policy insures inside directors and outside directors, making no distinction between the two. But recent years have seen the development of a small market for D & O coverage that has been geared specifically toward outside directors, who may want to distance themselves from insiders in serious legal disputes. What is Covered by a D & O Policy? D & O insurance can reimburse directors, officers and companies for monetary losses that stem from a suit, including defense costs, settlement costs and damages awarded to plaintiffs by a court. Most but not all D & O policies limit coverage to claims in which a person or other entity is seeking monetary damages from an insured party. This means that the D & O insurer can refuse to reimburse a person or company for legal costs when the central legal issue is an alleged criminal act that does not involve economic damages to plaintiffs and when the company is being investigated by the federal government for possible misconduct. Other D & O policies cover these claims under limited circumstances. Sides of a D & O Insuring Agreement Unlike insurance for workers compensation and personal automobiles, liability insurance for directors and officers has no standard form. However, the typical D & O policy has a threesided insuring provision, also known as an insuring agreement. An insuring agreement or insuring provision explains the circumstances under which an insurer will pay a claim. Coverage under the insuring provision of a D & O policy can be broken down into Side A coverage, Side B coverage and Side C coverage. Side A Coverage Side A is the classic coverage that has existed ever since insurers started selling D & O policies in the 1930s. It protects directors and officers personal assets by paying for defense costs, settlements and court-awarded damages when a company cannot or will not compensate or indemnify its directors and officers for those losses. Side A is especially important when derivative suits are possible, because states may prohibit companies from indemnifying their directors and officers for derivative losses. Unless the specific details of a claim allow the insurer to invoke a policy exclusion, claims made against Side A will be honored if they are reported in a timely manner and do not exceed a policy s monetary limits. In some cases, there will be no deductible for a Side A claim. Side B Coverage Side B of a D & O insurance policy allows a company to be reimbursed by the insurance company when it indemnifies its directors and officers in liability disputes. When D & O coverage was introduced to the world, Side B was nonexistent because companies were not yet allowed to indemnify their directors and officers for liability losses. This prohibition faded away for the most part, and Side B now accounts for the majority of D & O claims at many companies. A company s stance on indemnification for its directors and officers will depend on what state law forbids, what state law requires, what state law permits and whether or not a company wants to exercise its options under state law. If a state has adopted the most recent edition of the Model Business Corporation Act, which was proposed by the American Bar Association, indemnification in that state is not permissible when a director profited illegally from his or her actions. Under the model act, a director can be indemnified under the following circumstances: He or she acted in good faith. He or she performed duties in a manner that was in the company s best interests. In the event of a criminal proceeding, he or she did not reasonably believe that a crime was being committed. The act allows directors and officers to receive advance money from their company for defense purposes if they attest to their good faith in writing and agree to repay defense costs to the company if a final judgment by a court ever makes them ineligible for indemnification. The act does not call for directors to prove their ability to repay defense costs before they are allowed to receive them. The act states that directors must be indemnified for their losses when they defend themselves successfully in court. Side C Coverage As helpful as D & O policies might have been during their first 60 years or so in existence, sides A and B brought along some initially unforeseen complications. Then, as now, plaintiffs assumed that a company s pockets were often deeper than those of its directors and officers, so many securities cases and other suits named companies as defendants along with the names of allegedly negligent individual executives Real Estate Institute 103

110 LIMITING YOUR PROFESSIONAL RISKS Shared liability among directors and officers and their companies created confusion as to how settlement costs, legal fees and damages would be handled by a D & O insurer. Would a policy cover all claims under this circumstance, or would it only cover the directors and officers losses and require the company to pay for its own defense costs and damages? Unsurprisingly, insurance companies tended to prefer the latter, more limited interpretation of the typical D & O insuring agreement, while businesses favored a broader reading of an insurer s coverage obligations. Confusion over shared liability was supposed to have decreased after most D & O insurers raised their premiums and added Side C or entity coverage to their policies. Side C is liability insurance that covers a company when it is accused, along with its directors and officers, of wrongdoing. On occasion, it may also cover a company even when an individual director or officer has not been named in a legal complaint. For publicly held companies, coverage under Side C may be limited to claims stemming from state or federal securities cases or perhaps to employment-related disputes. Private companies, which do not sell securities to the public, might have Side C coverage that is limited to employment practices liability. Students will read more about employment practices liability later. Problems With Entity Coverage Side C may have created just as many allocation problems as it solved. Critics of entity coverage have argued that, when coupled with the company reimbursement provisions under Side B, Side C ignores the original purpose of D & O insurance and makes the product more of a company-geared item than something that protects individuals from losing their personal assets. Many directors and officers fear that claims under sides B and C could swallow up all available benefits under a D & O policy and leave individual directors and officers with no remaining protection against Side A claims. The benefits available to companies under sides B and C of a D & O policy also put directors and officers Side A coverage in jeopardy when a company is facing bankruptcy. Because companies receive money from insurers through sides B and C of a policy, bankruptcy courts have sometimes treated D & O insurance entirely as a company asset and have blocked the flow of insurance benefits that would have otherwise gone to individual insureds under Side A. Side A-Only Coverage Many D & O insurance producers believe the problems made possible by sides B and C can be managed adequately through the purchase of Side A-only coverage. As its name suggests, Side A-only insurance is supplemental D & O insurance that only covers Side A claims. Side A-only might just increase the amount of money made available for Side A claims and entail all the exclusions that apply to Side A in the primary policy. Or, with difference-incondition Side A-only, the supplemental coverage s exclusions may be narrower than the exclusions in the primary policy. For example, a claim that has been denied under the terms and conditions of a primary D & O policy because it pertains to pollution may be covered under Side A-only. Side A-only has existed since the 1980s but wasn t sold very often at first. According to an article in the Employee Relations Law Journal, some people were not in favor of the product, believing that its widespread acceptance would ultimately encourage companies to avoid indemnifying their directors and officers when legal problems arose. The added insurance became a hot topic in the early 21 st century as class actions against Enron and other companies reached their conclusion. The fallout at Enron resulted in directors and officers at that company having to give up millions of their own dollars to plaintiffs in class actions. A handful of D & O producers cautioned that clients without Side A-only coverage left themselves susceptible to a similar fate. An opposing group, while not dismissing all uses for Side-A only, looked at the details in the Enron example and suggested that the facts of the situation did not merit such a strong sales pitch. Those who think the importance of Side A-only has been overblown point out that Side A-only coverage would not have helped the Enron directors and officers because settlements in that case required that the defendants not be indemnified in any way for certain losses. Errors and Omissions Insurance and Malpractice Insurance Other kinds of liability insurance, including errors and omissions coverage and malpractice coverage, tend to be geared chiefly toward individuals who perform professional services. Professional services can be defined as work done for clients that requires special knowledge and is usually associated more with intellectual skills than with physical labor. In general, errors and omissions coverage or malpractice insurance is useful when professional services do not live up to clients expectations. Client dissatisfaction may be linked to a contract dispute and a professional s alleged failure to render a service as promised, or it might be tied to negligence in the performance of services. As it applies to professionals, negligence may be defined as the failure to act in a manner that would be suitable for a reasonable person with comparable knowledge and skill. Like D & O coverage, liability insurance for people who perform professional services will usually cover defense and settlement costs, in addition to court-awarded damages. Some policies may also cover legal expenses when a professional has not been named as a defendant in a legal case but gives a deposition in court. Just as a D & O policy will probably not shield board chairpersons against liability in their non-board activities, a single errors and omissions policy or malpractice policy will probably not adequately cover a professional who splits his or her time between two dissimilar jobs. Someone who practices law and sells insurance will probably need at least one malpractice policy to cover liability encountered through legal work and at least one errors and omissions policy to cover liability encountered in the insurance business. When a person has multiple professional roles that are closely related to one another, it may be a bit easier to find desired coverage all in one insurance package. An errors or omissions policy for an insurance agent, for example, might expand coverage so that the agent is also covered when acting as an insurance instructor or as a notary public. When professionals get their liability insurance through the company they work for, they may only be covered for the liability they face while working for or representing that particular company. In a hypothetical example, independent insurance agents who only have errors and omissions coverage through their business relationship with Insurer X might only be covered by that insurance while representing Insurer X. When they represent Insurer Y, they might either have no protection under Insurer X s policy or need to pay a steep deductible in order for Insurer X s coverage to apply at all to their liability with Insurer Y. Major and perhaps unexpected coverage gaps are also possible if a policy applies only to professional acts and uses a very strict definition of that term. For example, one accounting firm s errors and omissions policy might be broad enough to protect the company and its employees when someone at the firm makes a costly typing error. However, another firm s policy might exclude claims related to a typing error because the insurance company does not consider data entry to be something that requires a professional s skill and intellect. The importance of understanding what is and is not a professional act can be detected in two real-life court cases: Medical Records Associates v. American Empire and PMI Mortgage v. American International Real Estate Institute 104

111 LIMITING YOUR PROFESSIONAL RISKS Medical Records Associates v. American Empire In the first case, a company was sued for overcharging a client for copies of medical records. After settling the suit with the client, the company demanded that its errors and omissions insurer indemnify it for legal and settlement costs. In evaluating the insurance dispute, the United States Court of Appeals for the First Circuit noted that errors and omissions coverage is not meant to be an all-encompassing product that covers all of a professional s risks, said billing was not a professional service offered by the company and determined that clerical-type errors and omissions were not covered by the company s policy. According to the court, Even tasks performed by a professional are not covered if they are ordinary activities achievable by those lacking the relevant professional training and experience. PMI Mortgage v. American International In the PMI case, a company had been sued for allegedly receiving kickbacks in exchange for giving mortgage companies a good deal on their insurance. The suit had been settled for $10 million, with the company s insurer AISLIC having already advanced roughly $1 million to PMI to cover defense costs and other legal expenses. According to court documents, the AISLIC policy was supposed to cover the Loss of the Insured arising from a Claim for any actual or alleged Wrongful Act of any Insured in the rendering or failure to render Professional Services. Professional Services were defined in the policy as Those services of the Company permitted by law or regulation rendered by an Insured pursuant to an agreement with the customer or client as long as such service is rendered for or on behalf of a customer or client of the Company: (i) in return for a fee, commission or other compensation or (ii) without Compensation as long as such non-compensated services are rendered in conjunction with services rendered for Compensation. After a court ruled that the settlement costs did not need to be paid by the insurer because the circumstances of the case did not involve professional services, AISLIC filed suit in an attempt to recoup the money it had already advanced to PMI for defense fees and other legal expenses. From PMI s point of view, it was at least entitled to the defense benefits. After all, the original suit had centered on an alleged violation of the Real Estate Settlement Procedures Act, a law that applies to professionals in the real estate and mortgage industries. So if the company was being accused of violating a law aimed at professionals, wouldn t that mean that the suit had indeed involved professional services? A lower court didn t think so and said the suit revolved around administrative tasks, but the United States Court of Appeals for the Ninth Circuit felt otherwise. In its opinion, the court said the alleged kickbacks involved clients and professional insurance services and were therefore covered under the AISLIC policy. Who is Covered Under an Errors and Omissions or Malpractice Policy? In addition to taking different stances on what services and acts should be covered by their various professional liability policies, insurance companies often have their own views as to exactly who should be covered by their products. A doctor s malpractice insurance might provide some liability protection for nurses who are under the doctor s supervision or might leave a nurse entirely unprotected. If a non-professional, such as a clerical worker, commits an error or omission that breeds major economic damages for clients, that person might or might not be covered by a company s professional liability insurance policy. Consultants at law firms, insurance companies or engineering companies might be insured by a company policy, or they might need to shop for professional liability insurance on their own. Package Deals Besides the basic coverage available through D & O insurance, errors and omissions insurance and malpractice insurance, many professionals who run their own businesses believe it is in their best interest to purchase other kinds of liability policies, too. At least two products employment practices liability insurance and fiduciary liability insurance could probably be the focus of a separate insurance course, but they deserve, at least, their own paragraphs in this material because they are often purchased as add-ons to D & O policies or marketed as part of comprehensive insurance products that combine some of the liability insurance features we have already addressed. Employment Practices Liability Insurance Employment practices liability insurance pays defense costs, settlements and damages when companies, directors, officers or lower-ranking employees are accused by current, former or prospective employees of violating their rights. There are several situations that could lead to an employment practices liability claim, such as retaliation (in which an employee complains about an aspect of the workplace and is unfairly punished for speaking up), company monitoring of employees computer use, sexual harassment and the innumerable chances for discrimination in the hiring, firing and promoting of workers. This broad assortment of liability risks helps make employment practices liability the most frequent source of D & O claims at many private companies and nonprofit organizations. Policy features, exclusions and premiums may depend on the number of employee-friendly laws in a buyer s state and on the risks presented by a particular business. When underwriting this coverage, the insurer will probably take the following factors into account: The nature of the business being insured The number of people being employed at the business The business s history of employment practices claims The backgrounds of the individuals that are to be insured by the policy Coverage under an employment practices liability policy may be contingent on employees completing a training program that educates them about workplace issues. Fiduciary Liability Insurance Under the Employee Retirement Income Security Act of 1974 (ERISA), benefit plan administrators can be held personally liable for their mistakes. In addition to other plan concerns, company officials risk being sued by current employees, former employees and families if they make investment decisions that have a negative impact on benefits. They also could face trouble if the fees employees must pay in order to be covered by a plan are not considered reasonable. On its own, a D & O policy usually does not cover ERISA claims, but fiduciary liability insurance can be bought in conjunction with a D & O policy to guard against these risks. Like the other policies we have addressed in this chapter, fiduciary liability insurance can cover defense costs, settlements and damages. Insured parties may include a company, its directors and officers and past, present and future plan administrators. Fiduciary liability insurance is sometimes packaged with employee benefit liability insurance, which addresses similar risks but does not cover ERISA claims. An employee benefit liability policy might cover claims in which a plan administrator either made errors that prevented an employee from joining a plan or gave employees the wrong impression of what benefits were available through a plan Real Estate Institute 105

112 LIMITING YOUR PROFESSIONAL RISKS Deductibles and Co-Payments A professional liability policy be it an errors and omissions contract, a D & O contract or a malpractice contract will probably cover valid claims for one year before needing to be renewed by mutual consent of the policyholder and the carrier. But, as is the case with many other insurance products, the fact that a claim is valid under the policy language hardly exempts the policyholder from having to pay any portion of that claim. Insureds should expect to pay deductibles and co-payments, which let the insurance company take some of the financial risk off its own shoulders and give it back to clients. The deductible is the amount, expressed in dollars, which policyholders must pay on their own before an insurance company applies policy benefits to a claim. No matter the type of professional liability policy, the deductible is unlikely to be small. Deductibles for errors and omissions and malpractice policies can be in the thousands, and a few D & O deductibles have been higher than $1 million. Producers can negotiate with carriers in order to arrive at a deductible that reflects the buyer s risk tolerance and financial resources. In exchange for a lower deductible, the buyer will usually pay higher premiums. In exchange for lower premiums, the buyer will have to take on more risk by agreeing to a higher deductible. The deductible in a professional liability policy can be applied in a number of different ways. A policy might call for a one-time aggregate deductible of $1,000, for example, while another policy might call for a $1,000 deductible on each claim filed during the policy s term. A per-claim deductible, which tends to shelter the insurer from numerous small claims, does not need to be entirely inflexible. Related claims can be grouped together for the sake of the deductible. It is even possible to combine claims from a civil suit and claims from a criminal proceeding if all claims stemmed from the same error, omission or negligent act. A professional liability policy might make exceptions for certain claims and require the policy s owner to pay no deductible at all in those cases. For instance, some but not all policies impose a deductible upon settlements and damages, while applying consumer-friendly, first-dollar coverage to defense costs. This approach protects insureds from having to lose money as the result of frivolous lawsuits. As we noted earlier, a D & O policy might have no deductible for Side A claims but require deductibles to be met for Side B claims and Side C claims. D & O policies may also have one deductible for claims involving an individual director or officer and another deductible for claims involving two or more directors or officers. In addition to a deductible, professional liability policies might list a co-payment, which requires the insured to pay a portion of all claims even after a deductible has been satisfied. For example, a policy might require an insurer to pay 95 percent of each claim after a deductible has been met and require the insured to pay the remaining 5 percent. Benefit Limits When big or frequent liability claims arise, it will be important for insureds to know how close they are to reaching their benefit limit. A policy might have a per-claim benefit limit that caps coverage on each claim or an aggregate benefit limit that suspends coverage when total claims during a coverage period reach a certain dollar amount. A policy may have both a per-claim benefit limit and an aggregate benefit limit. Like a deductible, a benefit limit might not apply to all kinds of claims. Buyers who are worried that expensive defense costs might erode their coverage and leave them with few benefits for settlements can shop around for a professional liability policy that excludes defense costs from benefit limits. A wide range of benefit limits are common in the professional liability market. Sales professionals report that an insurance agent can have anywhere from $500,000 to several million dollars in errors and omissions coverage. Architects typically protect themselves with at least $1 million in liability insurance, and D & O policies often max-out somewhere in the neighborhood of $10 million. Towers of Coverage In actuality, companies or professionals can probably snare as much liability insurance as they feel is necessary. To get it, they just need to be prepared to work with multiple insurers. Many professionals buy policies from multiple carriers and construct high towers of coverage. At the base of a tower is the primary insurance policy, which is likely to be affected whenever an insured files a claim. Supplemental policies are stacked on top of the primary insurance policy and are put to work when benefits under the primary policy have been exhausted. When benefits under the primary policy and a supplemental policy have reached their limits, coverage under the next policy in a tower can kick in. Insurance brokers are deeply involved in assembling towers of coverage for companies and are often responsible for ensuring that the multiple policies from multiple insurers fit together without leaving coverage gaps. At first, layering policy upon policy might seem like an expensive approach to risk management. Though this financial assessment is probably true in many cases, buyers should remember that, at some point in a tower, higher levels of coverage start to become considerably less expensive. This eventual drop or leveling in price occurs when the probable size of a claim is highly unlikely to affect the upper portion of an insured s tower. Liability Premiums Whether a person or company is planning to buy a new professional liability insurance policy or is hoping to renew an existing contract, price is certain to be a concern. Like all other kinds of insurance, professional liability coverage is priced based on the various risks that an insured party presents to an insurance company. When underwriting a candidate for professional liability insurance, a carrier must take into account not only the probable frequency of claims but also the probable size of those claims. For obvious reasons, a client s claims history and legal history will have a significant effect on the way a carrier views the client s risk potential. A history of claims from an old policy could jeopardize the client s chances of getting a new policy at a desired price, and claims on an existing policy could lead to trouble at renewal time. Claims or no claims, the insurer will probably be interested to know if the client has been sued and, if so, under what circumstances. A spotless history, however, is sometimes not all a client needs to receive preferred premiums and benefits. After all, a lawabiding, ethically upright client can sometimes be named in a suit, and shady clients can get lucky and avoid having to go to court for years on end. To minimize the luck factor, an insurer may ask new or renewing clients about the safeguards they have put in place to keep claims at a minimum. The client s experience level can also have an effect on premiums. Like a newly licensed driver applying for auto insurance, freshly licensed insurance producers might need to wait a few years before they become eligible for less expensive errors and omissions coverage. The price for policies will often depend on the specifics of the services that are provided by the insured. Premiums for legal malpractice coverage may depend on the area of law that an attorney practices. Likewise, doctors in one line of medicine will pay different rates than physicians with other specialties. If an individual has a specialty within a profession, the insurer might base part of a premium on how often the person ventures outside of that specialty to perform services. For example, a design professional who focuses strictly on environmental engineering might be able to get a better rate Real Estate Institute 106

113 LIMITING YOUR PROFESSIONAL RISKS than someone who works as a structural engineer and as an environmental engineer. Regardless of the risks that an applicant presents to an insurer, a professional liability policy may have a minimum premium that must be paid in full before coverage begins. What is a Claim? Once companies and professionals have secured a professional liability policy and coverage has begun, their next concern will be how to deal with claims made against the insurance. First and foremost, covered individuals ought to have a clear understanding of what constitutes a claim under their contract. In general, a claim is a demand for money from the insurance company, but policy language can contain a definition that is much less or much more specific than that. At its most formal, a claim can be a professionally prepared legal document. At its most informal, a claim may be a verbal demand for damages. Claims-Made Policies and Occurrence Policies Based on the way they handle claims, insurance contracts can be deemed either claims-made policies or occurrence policies. Claims-made policies cover claims that arise during the applicable coverage period. If damage is done during the coverage period but a person waits until after the coverage period to make a claim, the insurance company can deny the claim. On the other hand, a claim on an occurrence policy can be made at any time, as long as the damage that provoked the claim was done during the coverage period. As an example, think of a doctor who performed surgery on a patient in 2006 and was sued yesterday for performing the surgery in a negligent manner. Then pretend that the doctor had left the medical profession at the end of 2006 and did not renew his malpractice insurance. If the doctor s insurance was written on a claims-made basis, he might not be covered at all and need to pay out of pocket to defend himself. However, he might still have coverage if his insurance was written on an occurrence basis, since coverage under an occurrence policy depends on when the alleged wrongdoing took place and does not depend on the timing of a claim. Pros and Cons of Occurrence Policies Some experts in their fields advise their fellow professionals to buy an occurrence policy if one is made available to them. The coverage is broader than claims-made coverage and puts less pressure on insureds to report claims quickly. But occurrence policies have their drawbacks. The reduction in time sensitivity can give insureds a false sense of security and make them think that their coverage for past errors lasts forever. In reality, each occurrence policy like any other kind of insurance only provides benefits up to a certain dollar amount. If previous claims have exhausted policy benefits, an otherwise valid claim can be denied by the insurance company. Occurrence policies also tend to be more expensive than claims-made policies because the policies benefits can last longer. With an occurrence policy, an insurance company is obligated to pay claims after cancellation and therefore absorbs risks for a longer period of time. Conversely, insurers can charge less for a claims-made policy because they do not need to honor claims after a cancellation, unless the policyholder opts for extended coverage and pays an additional fee. Particularly in regard to professional liability, determining coverage under an occurrence policy can be challenging for an insurer. While other kinds of insurance claims (such as property claims under fire or auto policies) can be easily traced to a specific event that occurred on a specific date, insurers may struggle to determine exactly when an error, omission or an instance of professional negligence took place. Because an insurer cannot count on a professional to always document errors in judgment as they occur, insurance companies may find it easier to offer professional liability insurance through claims-made policies. Media Liability Insurance For various reasons, occurrence policies for professional liability insurance are far less common today than they were in years past. In fact, media liability insurance may be the only kind of liability coverage that a modern-day insurer will provide customarily on an occurrence basis. This insurance, which protects insureds against claims involving libel and slander, is different compared to the other kinds of coverage we have addressed thus far, in that a media liability claim can almost always be traced back to a specific event that occurred on a specific date. Libel can be traced back to the date when the allegedly libelous comments were published, and slander can be traced back to the date when the allegedly slanderous comments were spoken to the public. Reporting Liability Claims Most D & O, errors and omissions and malpractice insurance contracts are claims-made policies. These polices can make the timely reporting of claims more important than many insureds realize. In fact, it is not uncommon for an otherwise valid claim to be denied by an insurer all because a policyholder did not report it promptly to the carrier. For clarity purposes, reporting a potential or real claim may be defined as communicating with the insurer about the claim in a reasonable way. It is advisable and sometimes necessary for insureds to report not only the existence of a claim but also the potential for a claim as soon as possible. The demands made on a policyholder to report potential claims comprise what is sometimes known as a notice of circumstance. Depending on the policy, an insured might need to provide notice of circumstance within 60 to 90 days of knowing about a potential claim. Still, an insurer s strict attitude toward the reporting of claims can occasionally work in the consumer s favor. Among the claims-made policies that require insureds to give notice of potential claims, a few make it possible for policyholders to report potential claims, cancel their coverage and still be covered for defense and settlement costs if a real claim arises at a later date. Prior Acts Like all kinds of claims-made policies, liability insurance for professionals can have major gaps near the beginning and the end of coverage periods. Most of these policies contain some kind of prior acts exclusion, which excuses the insurer from having to cover claims when an insured s error, omission or negligent behavior occurred before the liability insurance took effect. Suppose an uninsured insurance agent works with clients and performs his duties negligently. Then, before the affected clients become aware of the negligence, the agent buys an errors and omissions policy for himself. Two months later, a client realizes she has been wronged and files suit against the agent. The opposing parties work out a settlement, and claims are then filed with the agent s insurance company. Although the claims are made within the coverage period, the insurer is able to deny the claim because the negligence leading up to the claim occurred before the agent bought his policy. Nose Coverage Many insurance companies offer nose coverage, which protects insureds when a claim occurs during a coverage period but the error, omission or negligence occurred before the coverage period. In other words, nose coverage can handle claims that would otherwise be denied on the basis of a prior acts exclusion. Nose coverage is often bought when a client switches from a claims-made policy to an occurrence policy, but it can also be bought by people who are replacing one claims-made policy Real Estate Institute 107

114 LIMITING YOUR PROFESSIONAL RISKS with another and by people who have never had any form of professional liability insurance. Nose coverage is not necessary if a client is replacing an occurrence policy, since prior acts excluded by a new claims-made or occurrence policy are likely to be covered under a lapsed or cancelled occurrence policy. The extent of an insured s nose coverage depends on a retroactive date. When a claim arises and the related act was committed on or after the retroactive date, the nose coverage kicks in and protects the insured. When a claim arises and the related act was committed before the retroactive date, the insured is not protected by the nose coverage. If the buyer purchases nose coverage from the start, the policy s retroactive date will typically not change when the client renews coverage. If the buyer does not purchase nose coverage from the start, renewed policies will have a retroactive date that reaches as far back as the day coverage originally began. So, in spite of the typical one-year coverage period for most professional liability policies, someone who bought a policy on Jan. 1, 2008 will continue to be covered for acts committed on and after that date in subsequent years, as long as the policyholder pays premiums on time and renews the insurance consistently. When companies or individuals purchase a new claims-made liability policy instead of renewing an old one, they can arrange for nose coverage to retroactively date back to the first day of coverage under the old policy. If clients have never had a professional liability policy, the insurer can arrange for nose coverage that dates back to the day a company or individual first started providing professional services. Tail Coverage Tail coverage can be an alternative to nose coverage if a client is replacing a claims-made policy or has no intention of renewing or replacing a claims-made policy. Tail coverage gives insureds an extended reporting period, which allows clients to report professional liability claims and have them covered even if coverage has otherwise been cancelled or has expired. This coverage does not apply to errors, omissions or negligent acts that occur after a policy has been cancelled, but it does protect former policyholders when an act that was committed during the policy period creates legal problems in the present. Perhaps the easiest way to understand how tail coverage works is to think of a retired professional. Pretend an attorney retired at the end of 2007 and chose not to renew her malpractice insurance for In 2008, a former client sued the attorney for negligence, claiming that she had an improper and damaging effect on a court case. Although the attorney cancelled her insurance coverage in 2007, her defense costs and other legal expenses might still be paid for by her old insurer if she had purchased tail coverage. Insurers are often required to offer tail coverage to insureds when liability insurance is cancelled or not renewed. Exceptions to this requirement might include cases in which a policyholder has not paid premiums or has misrepresented facts to the insurance company. Research conducted for this course showed that tail coverage often lasts within the range of three to six years, though coverage of one year is not unheard of and coverage over an insured s lifetime may be possible. An insured usually has a month or two to consider an offer for tail coverage and can accept the offer by paying for the coverage with a lump sum. The premium for tail coverage is typically based on the price of liability insurance during the old policy s final year. The lawyer in the preceding example, for instance, would have probably paid a tail premium equal to her 2007 annual premium, multiplied by 100 percent, 150 percent or some higher percentage. An insurer may provide discounted tail coverage to clients who are canceling their policies due to retirement or disability. It should be noted that many people use the terms tail coverage, extended reporting period and discovery period interchangeably, while others use these phrases to mean slightly different things. To some producers, a discovery period is a short-term extended reporting period that is included within a professional liability policy at little or no charge. These producers may reserve the term tail coverage for longer and pricier extended reporting periods that the insurer sometimes offers to clients at its own discretion. Coverage After Mergers, Acquisitions and Bankruptcies When companies protect their directors, officers and various employees through a corporate-bought liability policy, it is important for insureds to understand how coverage may be affected by their organization s business decisions and financial health. Coverage in the event of a merger or acquisition will depend on policy language. A newly acquired company might have temporary tail coverage through its own insurer or might be covered temporarily through the new parent company s policy. Bankruptcies can be a problem for anyone at a failing company but present specific insurance problems for directors and officers. As was mentioned earlier, entity coverage under Side C of a D & O policy can make the coverage property of the company. When deemed company assets by a court, D & O insurance benefits may be frozen, leaving individual directors and officers to pay their own legal expenses until various financial knots can be untangled. In order to evaluate their exposure to this potential gap in coverage, directors and officers may want to find out if their company has purchased Side A-only insurance. Defense Costs Even careful and ethical professionals may have to defend themselves against charges of negligence, malpractice or some other alleged misdeed, and even a suit that leads to a dismissal or a not guilty verdict can be an extremely expensive distraction for the accused. On its own, the cost of defending oneself against bogus charges can equal thousands of dollars, or perhaps even more if a person employs top-notch representation in a drawn-out court case. With the price of pleading their innocence often running so high, many companies and individuals place as much importance on a policy s ability to absorb defense costs as they do on its ability to cover settlements and court-awarded damages. Almost all D & O policies, errors and omissions policies and malpractice policies force an insurer to pay defense costs when a suit involves an act or risk that is covered under the insurance contract. Once it begins paying these costs, the insurer generally cannot suspend payments unless it can conclusively show that the suit does not involve a covered act or can conclusively show that it is within its rights to cancel coverage. Though insured persons can take comfort in knowing that their policy will help them pay for legal fees under several circumstances, they should not ignore the limitations and particulars of their contract s defense provisions. Unlike many forms of general liability insurance, the kinds of insurance we have focused on in these pages usually apply defense costs to policy limits. In other words, if an insurance agent is covered by a $500,000 errors and omissions policy and his insurer pays out $500,000 for defense costs, there will be no money left over to cover settlements, court-awarded damages or any other claims. It is also important to remember that an insured may need to pay for some defense costs out of pocket until a policy s deductible has been satisfied. Duty to Defend When a suit is filed against an insured, the professional s relationship with a carrier will depend on whether the policy puts a duty to defend upon the insurance company s shoulders. When a policy creates a duty to defend, the Real Estate Institute 108

115 LIMITING YOUR PROFESSIONAL RISKS insurance company is responsible for contesting claims with plaintiffs. This responsibility can give the insurer immense control over the defense process. In cases in which a duty to defend exists, the insurer can choose the defense team that will be entrusted with handling the suit, or it can pre-approve a list of legal professionals and require a client to choose defense counsel from that list. A duty to defend can also give an insurer the power to approve defense strategies. Many liability policies for professionals and high-ranking corporate officials do not create a duty to defend. However, the absence of a duty to defend does not allow an insurer to avoid paying defense costs, and it does not completely eliminate an insurer s power over the defense process. A professional liability insurer without a duty to defend cannot force legal counsel upon a defendant, but it may still have the right to veto the insured s choice for representation. After a defense team has been put in place, the insurer can refuse to pay attorneys fees if the services being provided by the defense team or the costs of those services are not considered reasonable. From a procedural standpoint, an insurer without a duty to defend may still require that an insured s lawyers work on an hourly basis and keep an accurate record of the time they spend performing various tasks. Regardless of a policy s aggregate benefit limit, the insurance contract can impose a per-hour cap on reimbursable attorneys fees. Even without a duty to defend, the insurer often must be kept in the loop throughout the stages of a case so that it can evaluate the size of potential claims and get an idea of when a court decision or settlement might be forthcoming. Timing of Defense Benefits Due to the huge expenses involved with defending oneself in a lawsuit, it will be important for professional liability clients to know when they can expect to receive reimbursements for defense costs. Policy benefits that cover defense costs can either be advanced to defendants when a lawsuit is filed, or they can be paid to insureds at a later date after legal services have already been rendered. Nearly every insurance customer would probably prefer to receive money for defense costs as an advance, since this kind of arrangement puts less economic stress on the insured and can give an innocent professional more courage to refute a plaintiff s charges. If defendants need to bankroll their own defense before benefits arrive, they may worry about not having enough personal assets to pay for their immediate expenses and could end up accepting an unfavorable settlement out of desperation. If clients can get an advance from their insurer for legal expenses, they may be more likely to hold out for a fairer settlement or seek an appeal of a court s unfavorable ruling. Many insurers will advance some defense money to their clients, perhaps operating under the assumption that clients are innocent until proven guilty. But some guilty verdicts, such as those pertaining to fraud, can lead an insurer to rescind its generosity and require the insured to return the advanced funds. Reservation of Rights The possibility that an insurer may demand repayment of defense costs is often articulated in a reservation of rights letter, which is sent to an insured by the carrier if the validity of a claim is uncertain. Through this notice, the insurer informs the insured that it will give the person the benefit of the doubt and cover defense costs related to a questionable claim. Yet if the company later determines that the claim should not be covered under the policy for any reason, the reservation of rights allows the insurer to stop paying defense costs, deny coverage of any eventual settlement or court-awarded damages and possibly recoup insurance money from the client. Settlements With all the exciting courtroom drama that can be found on television shows, in movies and in popular fiction, it can be easy for people outside the legal profession to forget that a huge number of lawsuits don t go on long enough to merit a final verdict from a jury or judge. Defendants may have several reasons to prefer a settlement over continued court proceedings, and many of those reasons have little to do with the accused actually being at fault. For one, the judicial process can be very tedious, with people on both sides of a suit often waiting several years for a final verdict. As more and more money, energy, worry and patience is invested in a case, defendants might believe it is in their best economic, physical and emotional interests to put an end to all the legal fighting and get on with their lives. Sometimes, too, innocent defendants check their emotions at the door, take a step back from their situations and recognize that, for whatever reason, a judgment in their favor is highly unlikely. Perhaps a professional s defense is too packed with jargon and technical know-how for a jury of laypersons to sympathize with. A medical malpractice case, for example, might hinge on a complex anatomical issue, while a corporate director s defense in a liability case might be linked to a dry and complicated securities law. Or maybe the professional is tempted to settle a suit because a court s harsh verdict could put the person s financial health in serious danger. When a court is likely to award damages to a plaintiff that are in excess of a defendant s insurance benefits, the defendant s legal team will probably level with its client and recommend settling the suit. Though liability insurers and their clients can benefit from settling certain claims, a carrier and an insured may become annoyed with each other when one of them wants to settle a case and the other wants to fight it. Luckily for each of them, many professional liability insurers recognize the potential for tension and address this issue in their policies so that both sides may understand their rights. If a client wants to settle a suit against an insurer s wishes, the insurer cannot prevent a settlement from taking place. It makes no difference if the insurer suspects that the client committed fraud or some other wrongful act and is hoping to use a court s final ruling as grounds for denying a claim or rescinding coverage altogether. Clients just need to give notice to their insurer when they are prepared to settle with plaintiffs. Similar notification will be necessary if a client intends to admit guilt in a case in the hope of receiving a lighter sentence. Often, the insurer is the one that wants to settle, and a client is the one who wants to prolong a legal dispute. When this occurs, many liability policies purchased from non-admitted carriers put the policyholder at the mercy of the insurer and let the carrier settle a case on its own. Other policies feature a consent to settle clause and require that the client approve a proposed settlement before it can be executed. A consent to settle clause might only let the client give a yes or no response to a proposed settlement, while leaving the person in the dark about the size and particulars of the deal. In most forms, a consent to settle clause is only relevant if a client s refusal to settle is reasonable. Otherwise, an insurance company may be able to settle with a plaintiff without the policyholder s approval. Hammer Clauses Other pieces of a professional liability policy respect an insurer s desire to settle claims but allow clients to continue fighting a lawsuit if they so choose. When a client does not consent to a proposed settlement, the insurance company can invoke a policy s hammer clause. A hammer clause basically states that the insurer will cover a liability claim equal to the amount of a proposed settlement and will deny any liability claim that is in excess of that amount Real Estate Institute 109

116 LIMITING YOUR PROFESSIONAL RISKS Suppose an attorney was sued for malpractice and that the plaintiff was originally willing to settle the case for $500,000. The attorney did not agree to the deal, and his insurer invoked his policy s hammer clause. If the attorney ends up losing his case and is required to pay the plaintiff $500,000 or less, he may be able to have his claim covered nearly in full by his insurer. However, if he loses and must pay $1 million to the plaintiff, he will need to pay at least $500,000 out of his own pocket. Some hammer clauses only make the insured responsible for paying excessive damages and excessive settlements, while keeping coverage of defense costs intact. Others can introduce limits on defense benefits. It s also possible for a policy to contain a soft hammer clause, which splits the responsibility for paying excessive claims between the insurer and the client. By invoking a soft hammer clause, the insurer might agree to pay claims equal to a proposed settlement and cover 50 percent of claims above that amount. A few policies contain carrot clauses, which do not penalize clients for turning down a settlement but give them a positive incentive to accept one. For instance, under a carrot clause, clients might be able to reduce their deductible if they agree to settle a suit early. Allocation Issues An insurer s responsibility to pay liability claims can get complicated when a lawsuit names two or more defendants. If one defendant is covered by a policy and another defendant is not covered by a policy, should the insurer have to pay all legal fees related to the case, or should it only pay a portion of them? What about cases in which all defendants are covered by a policy? Should one insured s claim take precedence over another insured s claim? All these questions relate to an issue called allocation, which involves how benefits from a single policy are distributed to multiple parties. Allocation is particularly important for people who are insured by D & O policies, because shareholders, employees and other common plaintiffs in D & O cases often file charges against individuals and companies via the same suit. There appears to be no strict standard that D & O insurers apply to allocation situations, but we can still address possible courses of action in a general manner. As a general rule, a D & O insurer will cover defense costs for an uninsured individual when the same legal services are provided to an insured individual at no additional cost. However, if an attorney performs a service specifically for the uninsured defendant, the cost of that service will not be covered by the insurance company. A similar rule tends to apply when a single insured is sued for some acts that are covered by a policy and some acts that are not covered by a policy. The insurer will likely pay the cost of defending the covered portion of a claim, while making the defendant responsible for the uncovered portion of a claim. When a company is sued along with a director and officer, a D & O insurer may rely on a priority of payments clause to determine who should be the first to receive policy benefits. Usually, a priority of payments clause favors an individual director or officer over a company. Claims made against Side A of the policy tend to be paid first, followed by claims made against Side B. Claims related to entity coverage (Side C) are typically last in line, making it less probable that a claim against the company will erode benefits for individuals. Bear in mind, however, that the priority of payments clause may only apply to actual claims and not to potential claims. So if the insurer expects a claim under Side A of a policy and has actual claims that factor into sides B and C, the insurer might be able to go ahead and pay the B and C claims without needing to wait on the A claim. Policy Exclusions As helpful as D & O policies, errors and omissions policies and malpractice policies can be for clients, they do tend to contain many exclusions. It is best for a client to understand these exclusions before a claim arises. When an insurance professional discloses and explains policy exclusions to a buyer early in their relationship, the client has more time to fill in coverage gaps, and the potential for coverage disputes is reduced. The next few pages highlight many of the exclusions that apply to various liability policies. Though readers should note that many of the mentioned exclusions are reserved for specific groups of professionals, there is also some occasional overlap. Coverage Under Other Polices All the professional liability policies discussed in this text tend to exclude coverage of perils and events that can be covered by another kind of insurance policy. Claims for property damage and bodily injury may be covered by a company s general liability insurance, so a professional liability policy is unlikely to pay such claims. Product liability insurance is its own product and is also excluded from professional liability contracts. The same is true for insurance that protects companies and individuals who are accused of slander or libel. It may be possible for a company to purchase all these other kinds of insurance from the same carrier as part of a package that also includes professional liability coverage or D & O coverage. Conduct Exclusions D & O insurance policies contain conduct exclusions, which allow an insurer to deny a claim if it was caused by an insured who acted extremely improperly in the course of his or her duties. The most popular conduct exclusion in a D & O policy gives the insurer the right to deny a claim if the insured has committed fraud by withholding information or misrepresenting facts to people who deserved to know the truth. From the buyer s perspective, the policy should allow an insurer to deny claims on the basis of fraud only when the fraud has been conclusively proven. Without this kind of limit in place, the insurer could deny claims, including defense costs, when a plaintiff accuses an insured of fraud without having sufficient evidence to back up the charge. Depending on the policy, an insurer can deny a D & O claim when there has been either fraud in fact or a final adjudication of fraud by a court. Since exploring the nuanced definition of fraud in fact would probably steer this text off course, suffice it to say that an exclusion of fraud in fact can give the insurer a better chance of denying a claim. An exclusion based on a final adjudication is simpler to understand and is probably more beneficial to the insured. When a fraud exclusion is contingent upon final adjudication, the insurer must pay all claims, including those for defense costs, until a court rules that the insured committed fraud and does not have its ruling overturned on appeal. In other words, this kind of fraud exclusion allows someone who has been accused of fraud to have defense costs covered until the end of a case. Another common conduct exclusion in D & O policies prevents the insured from receiving insurance benefits if a court rules that the person has profited illegally through misdeeds. This exclusion closes a loophole that would otherwise allow a financial criminal to suffer no losses when there is a courtordered disgorgement of funds. A disgorgement of funds occurs when someone surrenders ill-gotten gains and returns them to wronged parties. This exclusion is often an issue when a case involves backdating of stock or insider trading. Insured vs. Insured Exclusion In an effort to prevent policyholders from using their insurance coverage as an instrument of fraud, many liability contracts contain an insured vs. insured exclusion. This exclusion lets the insurance company deny claims when the opposing parties Real Estate Institute 110

117 LIMITING YOUR PROFESSIONAL RISKS in a lawsuit are covered by the same policy. This exclusion is most commonly an issue for directors and officers (who will not have coverage if they are sued by their own companies), but it occasionally applies to non-corporate professionals, too. A medical malpractice policy that covers a doctor and his nurse, for instance, might not provide benefits to the doctor if he performs a medical procedure on the nurse and is sued for negligence. The insured vs. insured exclusion can be broader than its name suggests. It may exclude coverage when a legal battle is waged between a person who is covered by a policy and a relative of someone who is covered by that same policy. Regardless of any familial relationship between them, a wannabe plaintiff cannot work around the insured vs. insured exclusion by asking or encouraging a third party to sue an insured. A suit by a shareholder against a director or officer, for example, will not be covered by a D & O insurer, unless the shareholder takes legal action independently, rather than in connection with the corporation or some other covered entity. For clarity s sake, companies may want to learn how their D & O coverage would be affected if the company ever fails and is taken over by a regulatory body. Would the regulator then be thought of as the company by the insurer and be treated as an insured under the policy? If so, would the company s directors and officers be covered if the regulator sued them? Side A-only coverage, which is reserved for individual directors and officers, sometimes has a modified insured vs. insured exclusion, letting the insurer deny claims when directors and officers are sued by their own companies but allowing coverage for suits between two or more individual insureds. Investigations When a company or an individual faces a civil suit that relates to his or her job duties, internal and regulatory investigations are often not far behind. A shareholder suit against a director or officer might prompt a board of directors to form a committee to investigate the merits of the legal claim, and entities such as the SEC might weigh in on the matter. In similar fashion, a malpractice suit against a doctor might lead to a situation in which the physician must defend himself or herself to a state medical board in order to keep a license in force. Coverage in these situations is far from uniform across the liability insurance community. An individual or company that is in the market for liability insurance might find that some policies will not cover claims arising out of self-initiated investigations or informal investigations conducted by regulatory bodies. Older D & O policies, including those that were issued near the passage of the Sarbanes-Oxley Act, excluded coverage of some specific SEC-related claims while covering policyholders in other kinds of securities disputes. When they exist, exclusions that pertain to regulatory actions can apply to fines, penalties, punitive damages or seemingly any other kind of demand for money. Pollution Exclusions Several liability policies specifically exclude coverage for pollution claims. This exclusion can create a big insurance gap for design professionals who may have worked with leadbased paint or are linked to an asbestos problem. Corporate executives are also affected by this exclusion when their companies produce products that harm the environment or perform services that create pollution. In many cases, this gap can be eliminated through the purchase of an environmental insurance policy, which can cover the cost of cleanups and the consequences of hazardous spills. Many companies, however, do not buy this coverage and fail to realize that even a securities claim, which would normally be covered by a D & O policy, can be denied if there is a significant connection between shareholders losses and a pollution problem. The cases National Union Fire Insurance Co. v. U.S. Liquids, Inc. and Owens Corning v. National Union Fire Insurance Co. exemplify different courts interpretations of pollution exclusions. National Union v. U.S. Liquids U.S. Liquids was a waste disposal company that, at some point, had acquired City Environmental Inc., a Detroit-based business that was dumping waste illegally into the city s sewer system and was being accused of other environmental violations. The eventual closure of a City Environmental plant by the Environmental Protection Agency led to a criminal investigation of U.S. Liquids, a six-day suspension of trading for company stock and a nearly $10.75 decline in the value of the company s securities. Shareholder and derivative suits against U.S. Liquids collectively charged that the company had violated fiduciary duties, falsified environmental test results and inflated its earnings by charging people for disposal services that were never completed. From the company s point of view, its legal problems were not about pollution; rather, they centered on fiduciary responsibilities, omissions and misrepresentations. It was therefore assumed that the company s D & O insurer would at least pick up defense costs related to the suits. Though the insurer agreed that U.S. Liquids claims were indeed securities claims, it still invoked the policy s pollution exclusion, which applied to any loss in connection with a claim alleging, arising out of, based upon, attributable to, or in any way involving directly or indirectly the actual, alleged or threatened discharge, dispersal, release or escape of pollutants; or any direction or request to test for, monitor, clean up, remove, contain, treat detoxify or neutralize pollutants, included but not limited to a Claim alleging damage to the Company or its securities holders. The company s policy also said pollutants include (but are not limited to) any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste. To the United States District Court for the Southern District of Texas, the pollution exclusion was broad and clear, and the company s problems with misrepresentations and pollution were not mutually exclusive. The court sided with the insurer, ruling that the carrier had neither a duty to defend U.S. Liquids claims nor a duty to indemnify the company for its losses. That decision did not sit well with lawyers for U.S. Liquids, who claimed that such a ruling could effectively void all security coverage under the policy, since dealing with pollutants was an essential part of the company s business. The court, however, refuted that interpretation of its ruling, saying that its decision would still leave enough room for the policy to cover securities claims if they were connected to self-dealing, tax evasion or embezzlement. Owens Corning v. National Union A court that heard the Owens Corning case arrived at a different conclusion. Problems at Owens Corning had resulted in shareholders filing a class action suit against the company, alleging that the company had withheld information about its exposure to asbestos risks and misjudged the effect a major asbestos claim would have on the organization s finances. Assorted misrepresentations, according to shareholders, had artificially inflated the company s stock. The class action case was settled, and the company indemnified its directors and officers for their losses. But when the company tried to collect from its D & O insurer, the carrier denied claims on multiple occasions, citing a policy exclusion. Policy language left the company uninsured for any claim arising out of or related to asbestos or asbestos related injury or damage; or any alleged act, error, omission or duty involving asbestos its use, exposure presence existence, detection, removal, elimination or avoidance Following a temporary victory for the insurer via another court, the United States Court of Appeals for the Sixth Circuit ruled that it was the company s alleged misrepresentations that had inflated its stock, and not the asbestos. The central issue in the case, from the court s perspective, was not asbestos. Instead, Real Estate Institute 111

118 LIMITING YOUR PROFESSIONAL RISKS it was the manner in which the company had represented its financial health to the plaintiffs. In contrast to the court in U.S. Liquids, the Owens Corning court reasoned that allowing the insurer to deny the claim based on an asbestos exclusion could potentially leave the company uninsured against all kinds of shareholder suits, since it made its money by selling asbestos products. Pollution Claims Cultural changes and current events make insurers use of pollution exclusions something to keep an eye on. Scientists, politicians, news outlets and the general public have heaped tremendous amounts of attention on the issue of global warming in recent years, and it may be just a matter of time before many companies are pulled into court due to their alleged roles in climate change. Yet even within the large faction that does not doubt climate change is a real problem, there is a debate as to whether greenhouse gas (a main culprit in climate change) is technically a pollutant in the traditional sense of the word. With that in mind, it will be interesting to see how liability insurers respond. Will they be able to deny global warming claims through their preexisting pollution exclusions, or will they add specific language to the policies in order to protect themselves? At this point, one may even predict that the industry will respond to global warming in much of the same way that some insurers responded to terrorism in 21 st century: by working around policy exclusions and creating a product that meets clients modern needs. Foreign Claims Business is more international than ever before, with U.S. companies commonly conducting business with clients and peers in other countries, and with American corporations expanding their reach by opening offices all over the globe. This globalization presents both obvious and sometimes overlooked challenges to directors, officers and various professionals. Among the less obvious complications is the effect international business can have on a person s liability insurance. If an individual or company has a D & O policy or an errors and omissions policy, the coverage may only extend to domestic claims and not to international disputes. So the insured may not be able to access any insurance benefits from a U.S. carrier if a lawsuit is filed outside of the United States. If a policy does not specifically exclude international claims, the insured should still keep in mind that a U.S.-based company with overseas offices may need to comply with foreign insurance laws. D & O benefits, for instance, may not be available to directors and officers who are stationed overseas unless the company has purchased coverage from an overseas carrier. D & O insurance contracts that cover companies and individuals beyond U.S. borders may need to be written in foreign languages, which may create a problem if something is lost in translation. Finally, it is worth mentioning that some countries put limits on a company s ability to indemnify its directors, officers and other employees for legal expenses. Years ago in the United Kingdom, for example, indemnification was not allowed if a case was settled out of court. Other Exclusions Other exclusions have received less attention from the people who sell insurance and the people who write about the industry. Admittedly, some of the lesser-known exclusions are only applicable to specific kinds of clients. However, since producers are likely to encounter a broad variety of professionals in need of liability protection, it is important for them to at least be aware that these various exclusions exist. A D & O policy, errors and omissions policy or malpractice policy may or may not cover the following: Punitive damages Taxes Privacy breaches Discrimination claims Cases in which a company is sued for not having bought adequate insurance Cases in which an insurance producer inappropriately gave clients tax advice Cases in which an insurance producer participated in bid-rigging, rebating or wet-ink transactions Cases in which insurance producers failed to disclose the duties they owe and do not owe to clients as agents or brokers Cases in which directors and officers are accused of violating the Employee Retirement Income Security Act Cases in which medical professionals gave free advice or provided free services and are accused of malpractice Policy Rescissions and Severability In addition to having the right to deny a specific claim, a liability insurer reserves the right to rescind, or revoke, an entire liability policy under certain circumstances. Grounds for rescission are few, making this total cancellation of coverage relatively rare. An insurance company may rescind a professional liability policy when the policyholder fails to pay the required premiums on time or when it is determined that the filled-out application for the insurance contained untruths. The insurer s ability to cancel coverage in these situations probably seems reasonable enough to most people. Insurance companies do not want to give coverage away for nothing, and they do not want to be misled about the nature of the risks that they undertake. Still, the insurer s right to rescission is not as clean-cut as it may seem, particularly when it comes to untrue statements on an insurance application. When an insurance company wishes to rescind a policy due to an applicant s misrepresentations, the burden of proof is on the insurance company. In other words, the applicant is considered innocent until proven guilty and remains covered until the insurer can conclusively show that misrepresentations occurred. An insurer may not be able to rescind a policy, regardless of a misrepresentation, if the insurer should have reasonably known about the misrepresentation when it was made or if the misrepresentation did not influence the way the insurer offered coverage to the applicant. When an insurer is successful in rescinding a policy, it typically must give affected policyholders a refund of their premiums. Directors and officers should be made to understand that their application for liability insurance comprises far more than a basic questionnaire. For rescission purposes, an application can include an insurer s own forms as well as any recent documents that have been filed with a regulator. For publicly held companies, this means that an error, omission or misrepresentation in filings with the SEC can lead to the rescission of a company s D & O insurance. When a liability policy insures only one person, the insured needs only to pay for coverage and remain honest with the carrier in order to avoid rescission. But when multiple insureds are involved, rescission can become a real concern for directors, officers and assorted professionals. Suppose one executive is given the task of securing D & O insurance for several people and misrepresents facts on an application without telling anyone about it. Would that one person s misrepresentations give the insurer the right to cancel everyone s coverage? It all might depend on whether the policy contains a severability clause. A severability clause requires an insurance company to separate an innocent insured from a guilty insured and lets innocent people maintain their coverage regardless of another person s misrepresentations Real Estate Institute 112

119 LIMITING YOUR PROFESSIONAL RISKS For a long time, D & O policies did not allow for severability, and even now, severability clauses can be narrow in scope. In addition to rescinding coverage from the people who sign an application, an insurance company may revoke coverage for anyone who knew or should have known about misrepresentations. Conclusion Considering all the liability risks that exist for professionals, a nervous observer may wonder why anyone would dare become a director, officer, doctor, lawyer or insurance agent. But that way of thinking is often impractical and unreasonable. After all, modern society would perhaps not function smoothly without the expertise and services of trained professionals. The public s dependence on skilled doctors, lawyers, builders and the rest means that there may always be enough emotional and material awards attached to these professions to attract an assortment of willing and qualified candidates. Apprehensive men and women who long for a professional career but shy away from one for fear of a legal dispute should realize that competence and care are not a person s only shield in battles against liability. With the help of a knowledgeable insurance producer, they may be able to obtain a liability insurance policy that offers the necessary protection Real Estate Institute 113

120 LIMITING YOUR PROFESSIONAL RISKS Below is the Final Examination for this course. Turn to page 122 to enroll and submit your exam(s). You may also enroll and complete this course online: Your certificate will be issued upon successful completion of the course. FINAL EXAM 1. Seemingly all of the justifications people give for either committing or tolerating fraud are linked to the insurance industry's poor. A. financial condition B. training methods C. public image D. federal regulation 2. Insurers can play fair by keeping policy proportional to the amount of risks that the policies absorb. A. issues B. prices C. size D. language 3. Even among their peers, insurance producers have noted somewhat approaches to fighting fraud. A. unpopular B. soft C. better D. different 4. For a long time, insurance fraud was thought of as something an individual committed or with a few close confidants. A. quickly B. often C. alone D. quietly 5. To guard against, producers should take note of doctors and lawyers who seem to be involved in an unusually large number of accident cases. A. high rates B. reduced commissions C. double collections D. fraud rings EXAM CONTINUES ON NEXT PAGE Real Estate Institute 114

121 LIMITING YOUR PROFESSIONAL RISKS 6. The most indefensible forms of medical insurance fraud are those that cheat as well as insurers. A. nurses B. perpetrators C. themselves D. patients 7. Claims departments and investigative teams can sometimes spot medical insurance fraud merely by looking at a situation and applying some to it. A. legal angle B. common sense C. special clause D. unknown evidence 8. Accidents involving witnesses are obvious causes for concern. A. no B. less than five C. many D. related 9. The more intricate life insurance fraud schemes in the United States tend to involve relatively policies from several companies. A. large B. important C. small D. meaningless 10. Insurance professionals know that something is only if it has financial value to the applicant. A. insurable B. memorable C. usable D. remarketable 11. In recent years, insurers have had to deal with more than they might have ever imagined. A. catastrophes B. producers C. innocent victims D. indefensible claims 12. On the human side, many insurers personally employ or enlist the services of a Special Unit (SIU). A. Incentive B. Informants C. Incarceration D. Investigative EXAM CONTINUES ON NEXT PAGE Real Estate Institute 115

122 LIMITING YOUR PROFESSIONAL RISKS 13. Many agents like the traditional commission system because it is what they know and because it compensates them quickly for their labors. A. first-year B. last-year C. furthermost D. levelized 14. In some ways, the commission system is like an annuity, giving the agent a dependable, small income each year. A. first-year B. shared C. levelized D. compatible 15. Though a rarity in the insurance business, a few companies discourage most kinds of and instead pay their employees primarily on a salary basis. A. employee benefits B. customer service C. credits D. sales bonuses 16. Many people within the insurance industry believe sellers of policies should disclose the commissions they earn, either during the sales presentation or upon the request. A. buyer's B. seller's C. company's D. department's 17. For centuries, in the United States kept banks out of what were believed to be risky businesses so that depositors' funds were not put in danger. A. securities commission B. legislation C. insurance companies D. insurance producers 18. The section of the GLBA regarding approval of loans and credit seemed to ignore the fact that few banks would approve a loan if applicants didn't already have in place. A. back-up plans B. good credit C. insurance D. down payment funds EXAM CONTINUES ON NEXT PAGE Real Estate Institute 116

123 LIMITING YOUR PROFESSIONAL RISKS 19. Protecting information held by financial institutions is at the heart of the GLBA's privacy provisions. A. consumer B. insurers' C. producers' D. public 20. In response to privacy requirements in the GLBA, the FTC adopted the in May of A. Secrecy Act B. Privacy Act C. Protection Rule D. Safeguards Rule 21. Derivative actions arise when file a suit on a company's behalf. A. directors B. employees C. shareholders D. outsiders 22. The business judgment rule is a commonly cited legal concept that attempts to fairly address the fact that a company's decision makers are infallible. A. always B. not C. usually D. commonly 23. A can be sued if he or she was poorly trained in a policy's features and exclusions and misrepresented those features and exclusions to insureds. A. producer B. customer C. consumer D. doctor 24. Professional liability insurance is often secured for individuals by their. A. employees B. insurer C. company D. attorney 25. Unlike insurance for workers compensation and personal automobiles, liability insurance for directors and officers has standard form. A. one B. a long C. a short D. no EXAM CONTINUES ON NEXT PAGE Real Estate Institute 117

124 LIMITING YOUR PROFESSIONAL RISKS 26. Many professionals buy policies from multiple carriers and construct high " " of coverage. A. groups B. combinations C. towers D. bridges 27. Based on the way they handle claims, insurance contracts can be deemed either " -made policies" or "occurrence policies." A. payments B. claims C. years D. days 28. As helpful as D & O policies, errors and omissions policies and malpractice policies can be for clients, they do tend to contain many. A. exclusions B. additions C. contradictory terms D. fees 29. When a company or an individual faces a that relates to his or her job duties, internal and regulatory investigations are often not far behind. A. financial problem B. civil suit C. challenging situation D. embarrassing moment 30. When a liability policy insures only one person, the insured needs only to pay for coverage and remain honest with the carrier in order to avoid. A. claims B. rescission C. liability D. higher premiums END OF EXAM Turn to page 122 to enroll and submit your exam(s) Real Estate Institute 118

125 Notes

126 Notes

127 Notes

128 INSTRUCTIONS FOR OPEN-BOOK EXAMINATION To receive continuing education credit for one or both of the courses in this book, you must complete the corresponding exam for each course. To submit your exam: ONLINE: Visit our website: MAIL or FAX: 1. The answer sheet for both exams is on the next page. A duplicate copy is on the back cover of the book. 2. Remove the answer sheet from the book. 3. The exam questions appear at the end of each course. 4. Complete the answer sheet and return it to the REAL ESTATE INSTITUTE Real Estate Institute 122

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