Insurance and Risk Finance 640

1
Insurance and RiskFinance 640

• Class 11
• October 27, 2004

2
Types of Personal Auto Coverage

• Third party liability
• First party medical payments
• In no-fault states PIP coverage for medical
  expenses and lost income
• Uninsured and underinsured motorists
• Physical damage

3
Basic Part of Personal Auto Policy

• Part A Liability Coverage
• Part B Medical Payments Coverage
• Part C Uninsured Motorists Coverage
• Part D Coverage for Damage to Your Auto
• Part E Duties After an Accident or Loss
• Part F General Provisions

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Part A Liability Coverage

• Insuring Agreement
• Insurer promises to
• Pay damages for which an insured person is
  legally liable because of an auto accident
• Defend the Insured
• Pay the costs of defense

5
Liability Coverage

• Single limit known as a combined single limit
  
• Split limits
• Example
• 100,000 per person for bodily injury
• 300,000 per accident for bodily injury
• 50,000 per accident for property damage
• No annual aggregate limit

6
Liability Coverage

• Compulsory liability
• Most states make minimum limits mandatory
• Financial responsibility laws
• Penalize negligent drivers who cannot pay minimum
  damage amount
• All states have such laws
• Liability insurance satisfies laws

7
Ohios Financial Responsibility Law

• Ohio does not require drivers or owners to buy
  car insurance.
• Instead, you are required to have a guaranteed
  way to pay for injuries or damages that result
  from
• Your negligence as a driver, or
• The negligence of anyone operating an auto that
  you may own.
• This guarantee is known as proof of financial
  responsibility.

8
Ohio Proof of Financial Responsibility

• Insurance with minimum limits of
• 12,500 to Bodily Injury to one person in any one
  accident
• 25,000 Bodily Injury to two or more persons in
  any one accident
• 7,500 Property Damage for injury to property of
  others in an accident
• 30,000 bond issued by a surety company
• Certificate of bond in the amount of 30,000
• Signed by two individuals
• Who own real estate having equity totaling at
  least 60,000
• Certificate of the Treasurer of the State
  evidencing the deposit of 30,000 in money and
  securities.

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Liability Coverage

• Who is insured and when?
• Named insured plus
• resident spouse
• other family members
• others who use the covered auto with permission
• Covered auto is vehicle listed on the policy plus
• newly acquired vehicles
• temporary substitute vehicles

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Liability Coverage Types of exclusions

• Intentional injury or damage
• Injury to an employee covered under WC
• Using vehicle as a public or livery conveyance
• Vehicles used in auto business
• Vehicles with less than 4 wheels
• Vehicles furnished or available for the insured
  or family members regular use

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Liability CoverageSupplementary Payments

• In addition to policy limits, payments for
• Bail bond up to 250
• Premiums on appeal and release of attachments
  bonds
• Interest on the judgment
• Loss of earnings up to 50 day to attend a
  hearing or trial
• Other reasonable expenses incurred at the request
  to the insurer

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Medical Payments Coverage

• In tort liability states
• Optional
• Limits are generally low (e.g., 1,000 - 2,500)
• Payments regardless of fault
• Payments not coordinated with other medical
  expense insurance
• could collect twice

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Medical Payments Coverage (cont.)

• Insured persons are
• Named insured and family members
• While occupying a motor vehicle
• When struck by a motor vehicle while walking
• Other persons while driving a covered auto

14
Medical Payments Coverage

• In no-fault states
• Personal injury protection (PIP)
• Often compulsory
• Also provides limited loss of income coverage

15
Uninsured and Underinsured Motorists Coverage

• Coverage if liable party has no or insufficient
  coverage
• Coverage for all damages that otherwise would
  have been paid
• medical expenses
• lost income
• pain and suffering
• Compulsory in many states
• Applicants wishing to decline UM/UIM may be
  required to sign a waiver form.

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Uninsured and Underinsured Motorists Coverage
(cont.)

• Uninsured Vehicles
• Vehicles with no applicable BI liability coverage
• Vehicles with coverage less that the amount
  required by the states financial responsibility
  or compulsory insurance law
• Hit and run vehicles
• Vehicles where the bonding or insurance company
  is insolvent

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Uninsured and Underinsured Motorists Coverage
(cont.)

• Underinsured Motorist Coverage
• Applies when other driver has liability insurance
  limit that is less than your actual damages

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Physical Damage Coverage

• Collision
• Covers damage from collisions and rollovers
• Other-than-collision (comprehensive)
• Covers damage from
• falling objects, explosions, glass breakage,
• earthquake, windstorms, hail,
• contact with an animal
• Deductibles generally used for both

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Physical Damage Coverage (cont.)

• Payment of loss
• Company will pay the lesser of
• Actual cash value or,
• The cost to repair or
• The cost to replace
• Less any applicable deductible.
• Loss to a non-owned trailer is limited to 500

20
Auto Insurance Price Increases
21
Average Auto Insurance Expenditures by State
22
Rating Factors

• Driver characteristics
• Age
• Gender
• Marital status
• Use of the auto
• Number of autos
• Other factors
• Driving Record
• Territory

23
Bodily Injury Claim Frequency
24
Restrictions on Rating Factors

• Examples
• Gender
• Marital status
• Use driving experience instead of age (MA)
• Territory

25
Underwriting

• Insurers have discretion to deny coverage in most
  states
• Underwriting criteria
• Typically, lower rates are associated with more
  stringent underwriting criteria
• Example
• deny if potential insured drinks alcohol
• charge lower rates than competitors who do not
  use this criteria

26
Government Restrictions on Underwriting

• Some states require insurers to accept all
  applicants, I.e., no underwriting
• Underwriting restrictions are generally related
  to rating restrictions
• otherwise rating restrictions can be circumvented
• Disadvantages of restrictions (see Ch. 8)
• Prices do not reflect expected costs as closely
  distorts behavior
• Costly to enforce

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Residual Markets

• Provide insurance at a regulated price to those
  who otherwise would find it difficult to buy
  insurance
• All states have one
• Market shares vary widely
• Higher market share in states with
• more restrictions on rating and underwriting
• more regulation of rate changes

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Residual Market Share by State
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Types of Residual Market Plans

• Assigned risk plans
• Most states
• Applicants assigned to insurers in proportion to
  their market share
• Insurer receives the (regulated) premium and pays
  claims

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Types of Residual Market Plans

• Reinsurance facilities
• Each insurer sells to all applicants
• Insurer can reinsure unwanted insureds to state
  reinsurer
• Deficit of reinsurer is paid
• by all insurers in proportion to their market
  share
• by all policyholders (recoupment fee)

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Types of Residual Market Plans

• Joint underwriting associations
• State hires several insurers to insure unwanted
  policyholders
• Agents submit applications to these insurers
• Deficit is paid by all insurers in proportion to
  their market share
• State insurer (MD)
• Deficit is paid by all insurers in proportion to
  their market share

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Economic Rationale for Compulsory Auto Insurance

• Without it, accident costs will not be borne by
  those who cause accidents
• Uninsured do not bear the full cost of their
  driving
• some drive even though benefits of driving
  
• Uninsured do not bear the full cost of decisions
  to drive less safely
• drive less safely than if forced to purchase
  insurance with experience rating

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Criticisms of Compulsory Insurance

• Its regressive
• I.e., it disproportionately hurts low income
  people
• Forces them to buy insurance to protect other
  people
• Weak enforcement
• Better to allow people to opt out by making a
  contribution to the state (VA, SC)

34
No-fault versus Tort Liability

• Tort liability
• Drivers that cause accidents can be sued for the
  losses incurred by others
• Pure no-fault
• Drivers pay their own costs regardless of fault
• No law suits
• No state has pure no-fault
• Tort liability is restricted, not eliminated

35
No-fault Laws

• Mandatory PIP coverage
• Varies across states
• Under 10,000 in MA, unlimited in MI
• Limitations on suits
• Cannot sue for losses covered by mandatory PIP
• Cannot sue for pain and suffering unless
• losses exceed a monetary threshold
• losses meet verbal threshold

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Arguments For and Against No-fault

• For
• More efficient compensation system
• Less pain suffering compensation
• Faster compensation
• Lower legal costs
• Against
• Reduces safety
• Not fair

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Effect of No-fault on Premiums

• Depends on
• Limitations on tort liability
• Level of mandatory PIP coverage

38
Homeowners Insurance Types of Policies

• Multiple-line
• 1st party property
• 3rd party liability
• 3rd party medical expense
• Multiple-peril
• Fire, windstorms, theft, etc.
• Named peril versus open peril policies
• Standard policy forms (HO3 form most common)

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Major Coverages

• Type of Coverage Amount of Coverage in HO3
  Policy
• A. Dwelling Chosen by policyholder
• B. Other Structures 10 percent of dwelling
  coverage
• C. Unscheduled Personal Property 50 percent
  of dwelling coverage
• D. Loss of Use (e.g., additional
• living expenses if dwelling
• cannot be occupied) 20 percent of dwelling
  coverage
• E. Personal liability 100,000 (can be
  increased)
• F. Medical payments to others 1,000 per
  person(can be increased)
• 25,000 aggregate limit (can be
  increased)

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Insuring Agreements Section II

• Personal Liability Coverage E
• Has a single limit of 100,000 per occurrence
• Can be increased by payment of additional premium
• Applies to any claim or suit for damages
• Because bodily injury or property damage
• Caused by an insureds personal activities.

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Insuring Agreements Section II (cont)

• Medical Payments to Others Coverage F
• Pays up to 1000 for medial bills of someone who
  is accidentally injured
• On the premises of an insured or,
• By the activities of an insured
• A residence employee or,
• By an animal owned or cared for by an insured
• This limit can be increased

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Persons Insured Homeowners Section II

• Name Insured and Spouse
• Resident Relatives
• Any person under age 21 in the care of the
  insured
• Any student enrolled in school full time, who was
  a resident of the household before moving out to
  attend school, provided the student is under the
  age of
• 24 and your relative
• 21 and in the care of the insured, spouse or
  resident relatives

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Persons Insured Homeowners Section II(cont.)

• Any person or organization responsible for
  covered animals or watercraft owned by an insured
• With respect to a covered vehicle, any person
  acting in the employment of an insured

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Excluded Perils

• Intentional acts
• Normal wear and tear
• Changes in laws
• Earthquakes
• Floods
• Nuclear accidents
• War

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Homeowners Special Limits

• 200 on money, bank notes, bullion, coins and
  medals
• 1500 on securities, valuable papers, stamp
  collections
• 1500 on watercraft, including trailers and
  equipment
• 1,500 for theft of jewelry, watches, furs,
  precious and semi-precious stones
• 2,500 for theft of firearms and related
  equipment

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Homeowners Special Limits (cont.)

• 2,500 for theft of silverware, goldware,
  pewterware, etc.
• 2,500 on property, on residence premises, used
  for business
• 500 on property, away from residence premises,
  sued for business
• 1,500 on certain electronic apparatus while in
  or upon a motor vehicle
• 1,500 on certain electronic apparatus used
  primarily for business, while away from the
  residence premises and not in or upon a vehicle.

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Endorsement to Section II Coverages

• Business pursuits designed to cover certain
  occupations for legal liability arising out of
  business activities
• Sales representatives
• Teachers
• Messengers
• Collectors
• Office employees
• Personal Injury
• False arrest, detention or imprisonment,
  malicious prosecution
• Libel, slander, defamation of character
• Invasion of privacy, wrongful eviction, wrongful
  entry

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Section II Endorsements (cont.)

• Watercraft and recreational vehicles Separate
  endorsements are needed for each
• Watercraft endorsement Provides liability and
  medical payment coverage
• On any inboard or outboard powered watercraft,
• Sailing vessels 26 feet or more in length and
• Watercraft powered by outboard motors exceeding
  25 total horsepower

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Property Loss Settlement

• Per occurrence deductible
• Methods of valuing property
• Like-kind replacement cost
• Actual cash value
• replacement cost - depreciation
• Guaranteed replacement cost
• Functional replacement cost

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Pricing

• Premium (insured value) x rate
• Estimation of insured value
• square footage
• dwelling type
• construction grade
• construction material
• location
• Factors affecting the rate
• location
• construction materials

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Personal Umbrella Policies

• Excess liability coverage
• Limits 1 million
• Applies once losses exceed limits on other
  policies
• auto liability
• homeowners

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Coverage of Catastrophic Perils

• Earthquake
• Offered by most homeowners insurers
• required in CA
• Deductible of home value
• Flood (NFIP)
• Purchased through private insurers
• Risk borne by federal government (taxpayers)
• Some policies are subsidized
• Moral hazard
• Many exposed homeowners go w/o coverage

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Residual Market Plans

• Fair Plans
• Created following urban riots in 1967-68
• Subsidized coverage for urban property
• CA expanded scope between 94-96
• 28 states have plans
• Beach and Windstorm Plans
• Subsidized coverage for coastal property
• 7 states have plans

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Policies in Beach and Windstorm Plans
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Hurricane Andrew

• 16 billion in insured losses
• Insurers attempted to (1) reduce exposure and (2)
  increase price
• FL restricted both activities
• Still many homeowners could not find coverage
• Beach windstorm plan exposure increased
• FL created new residual market plan in 1993 (JUA)
• Merged beach windstorm plan with JUA in 2002
• Created Hurricane Catastrophe Fund in 1993
• Investment earnings not taxed

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Northridge Earthquake

• 12.5 billion in insured losses
• Insurers attempted to (1) reduce exposure to
  earthquakes and (2) stop selling homeowners
  coverage
• CA restricted ability to cancel or fail to renew
  coverage
• Created CA Earthquake Authority (CEA)
• Insurers could satisfy its requirement to sell
  earthquake coverage by offering a CEA policy

57
Government Reinsurance Arrangements

• FL, CA, and HA have reinsurance plans
• Proposals have been introduced for federal plan
• Advantages
• Preferential tax treatment of investment earnings
  on capital set aside to fund future losses
• Governments can facilitate risk pooling over time
• Potential disadvantages
• Inadequate pricing
• Raid funds for other purposes

58
New Capital Market Instruments

• Examples
• Catastrophe bonds
• Insurer issues bonds
• If cat occurs, insurer does not have to repay
  interest and/or principal
• Contingent equity
• Insurer has option to issue new stock at
  pre-arranged price if a catastrophe occurs
• Potential advantages
• Insurer can hold less equity capital
• Lower tax and agency costs