Topic 15: Insurance Terms

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Topic 15 Insurance Terms

• Peril cause of loss such as fire
• Hazard increases likelihood of loss
• Physical ice on sidewalk
• Moral dishonesty
• Morale indifference to loss such as speeding
• Law of large numbers
• More units exposed to loss, greater
  predictability of loss

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Topic 15 Insurance Terms

• Adverse selection higher risk individuals will
  seek insurance
• Self-insurance business creates fund to pay own
  losses
• Risk avoidance dont drive
• Risk diversification hold harmless, shift risk
  to someone else
• Risk reduction lower chance of loss
• Take drivers training

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Topic 15 Insurance Terms

• Risk transfer buy insurance
• Principle of indemnity cant profit from loss
• Subrogation right to pursuit legal action to
  collect from third party
• Insurance interest insured stands to lose
• Life insurance required only when policy issued
• Property liability must have at start of policy
  and when loss occurs

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Topic 15 Insurance Contracts

• Contract cant be assigned
• Aleatory one person may get better deal than
  other party
• Adhesion non negotiable
• Good faith both parties must be honest
• Beneficiary can be changed unless irrevocable
  designation
• Need consent of beneficiary if want to change
• Conditions precedent, subsequent

5
Topic 16 Risk Exposures

• Personal
• Death, disability, health
• Property
• Reduction in value
• Or cost of replacement
• Liability
• Business related
• Loss of income

6
Topic 17 Property Insurance

• 80 rule required insurance
• (Amount Insured/Amount Should Have Insured x
  Loss) Deductible Insurance Payment
• Deductible subtracted last
• Amount Should Have Insured Replacement Cost x
  80
• Home
• 400,000 replacement cost
• 300,000 insurance
• 1,000 deductible
• Fire causes 20,000 damage
• Insurance reimbursement?

7
Topic 17 Property Insurance

• Homeowners Insurance
• HO 01 fire and named perils
• HO 02 broad form covers additional perils
• Personal property covered up to 50 of dwelling
  insurance
• HO 03 open perils (all risk) on dwelling broad
  form on personal property
• Most common policy
• Excludes pets, property of boarders, separately
  scheduled property
• Excludes flood, sewer backup, wet basement
• Rising water versus falling water Oakcrest

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Topic 17 Property Insurance

• Homeowners Insurance
• HO 04 renters insurance
• Broad form coverage for personal property
• HO 05 open perils for dwelling and open perils
  for personal property
• HO 06 condo insurance
• Dwelling covers interior walls
• Broad form on personal property
• HO 08 older homes
• Replacement cost gt FMV
• Insures them at a lower value

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Topic 17 Property Insurance

• Coverage A dwelling and attachments
• Coverage B structures separated from dwelling
• Garages, pools, fences
• Generally 10 of Coverage A amount
• Coverage C personal property located anywhere
• Generally 50 of Coverage A amount
• Limits on high value items jewelry, guns, etc.
• Can be increased by endorsement
• Exclusions business property, boarders property

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Topic 17 Property Insurance

• Coverage D
• Additional living expenses while home repaired
• Credit cards up to 500, no deductible
• Coverage E
• Comprehensive personal liability for
  unintentional bodily injury and property damage
  up to 100,000
• Covers damages off premises by insured, pets
• Not for insured
• Coverage F
• 1,000 per person per occurrence medical payments
• Covers damages off premises by insured, pets
• Not for insured

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Topic 17 Property Insurance

• Exclusions
• Earthquake
• Flood, rising water. (Falling water covered)
• War, nuclear accidents
• Intentional loss
• Endorsements
• Scheduled personal property
• Earthquake
• Flood
• Personal property replacement cost

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Topic 17 Property Insurance

• Miscellaneous
• No coverage if conceal material info
• Insured can cancel at any time
• Insurer must give advance notice of cancellation,
  nonrenewal
• Only one year to sue insurer

13
Topic 17 Personal Auto Policy

• Part A liability bodily injury and personal
  property caused by insureds negligence
• Also attorney fees to defend insurance
• Split limits per person/per accident/property
  damage
• 15,000/30,000/50,000
• Required? Get minimum?
• Covered individuals
• Named insured
• Spouse and family members
• Others using car with permission

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Topic 17 Personal Auto Policy

• Covered vehicles
• All vehicles listed in policy declaration
• New vehicles
• 14 days to notify
• Trailers
• Loaner cars
• Rental cars???
• Exclusions
• Intentional injury/damage
• Employees
• Motorcycles require separate coverage

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Topic 17 Personal Auto Policy

• Part B Medical Payments 1,000 per person
• Covers, no matter fault,
• Insured
• Insured family members
• Even when pedestrians hit by car
• Others in car flying turkeys
• Part D Physical Damage to Your Auto
• Collision
• Other than collision (comprehensive)
• Hitting deer not collision, covered under
  comprehensive
• Deductibles
• 250 - 1,000

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Topic 17 Personal Auto Policy

• Uninsured motorist
• Coverage applies when accident fault of
  individual with
• No insurance
• Less insurance than required by law
• Hit and and run drivers

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Topic 17 Umbrella Liability Insurance

• Required underlying policies
• Auto, home, boat, motorcycle
• Must have required amounts of coverage
• Provides additional liability coverage
• Large amount generally inexpensive

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Topic 17 Commercial Insurance

• Property
• Homeowners coverage generally provides minimal
  coverage for business property in home
• Endorsement
• Open perils or specified perils
• Actual cash value or replacement cost
• May have co-insurance (80) requirement but not
  mandatory
• Bars, restaurants, amusement parks not eligible
  for this policy

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Topic 17 Commercial Insurance

• Business income coverage
• Replaces income and covers expenses due to
  closure by covered peril fire, wind, etc.
• Crime insurance
• Police must be notified
• Liability
• Occurrence basis
• Covers claims from events during policy period
• Doesnt matter when claim filed
• Claims made
• Covers only claims made during policy period
• Will need tail coverage for claims after policy
  lapse

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Topic 17 Commercial

• Liability
• Types
• Same coverage as Personal Auto Policy
• Garage Coverage for businesses storing selling
  servicing parking vehicles
• Umbrella
• Self insure generally first 25,000
• Occurrence basis
• Professional liability
• Physicians, attorneys, etc.
• Fail to perform as promised

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Topic 17 Commercial

• Surety bonds
• Insures party will fulfill obligations
• Insured is liable to issuing company if payment
  has to be made on bond
• Directors and Officers
• Covers wrongful acts
• Workers Comp
• Provides benefits required under state law
• Payment for liability claims from employee
  injuries
• Injured on the job

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Topic 18 Health Insurance

• Hospital, surgical and physicians insurance
• Hospital room and board up to X per day
• Surgeon all or usual and customary
• Physicians only in hospital
• Not the type of health insurance you want

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Topic 18 Health Insurance

• Major medical insurance policy
• Covers most medical expenses
• Both in and outside of hospital
• High payment limit 1 million/unlimited
• Deductible
• Usually 500 to 1,000 per year
• Often per person/per family (500/1,000)
• Coinsurance
• For example, after deductible met, insured must
  pay 20 of next 5,000 of medical expenses per
  person???

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Topic 18 Health Insurance

• Major medical insurance policy
• Not covered
• Chemical addictions
• Cosmetic surgery
• Glasses
• Travel outside U.S. / Canada
• Injuries covered by workers comp
• Self-inflicted injuries

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Topic 18 Health Insurance

• Medical insurance premiums
• Self-employed
• Deducted in calculating AGI
• Employees
• Must itemize
• Medical expenses must be gt 7.5 AGI

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Topic 18 Health Insurance

• Medicare
• Part A Hospital
• Over 65
• Eligible for Social Security
• Automatically covered
• No cost

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Topic 18 Health Insurance

• Medicare
• Part B Doctors services
• Over 65
• Eligible for Social Security
• Must pay premium
• Premium increases with AGI

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Topic 18 Health Insurance

• Medicare
• Deductibles
• Part A Hospital
• 1,068 for first 60 days
• After 60 days, patient pays most of the cost
• No deductible for first 20 days at skilled
  nursing facility
• After 20 days, patient pays most of the cost

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Topic 18 Health Insurance

• Medicare
• Deductibles
• Part B Doctors services
• 135 per year
• 20 co-pay

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Topic 18 Health Insurance

• Medicare
• Part D Prescription drugs
• Anyone in Part A or B is eligible
• Annual premium 420 per year
• Covers large portion of initial costs and
  extraordinary costs but not costs in the middle
  (donut)

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Topic 18 Health Insurance

• Medigap Medicare Supplemental
• Must offer
• Part A up to one year hospitalization beyond
  Medicare coverage
• Part B pays 20 co-payment
• Can offer other benefits

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Topic 18 Health Insurance

• Medicaid provide medical care for those who
  cant afford to pay
• Administered by each state
• Must meet income/asset tests
• Five year look back rule on transfer of assets

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Topic 19 Disability Insurance

• Definition of disability
• Own occupation cant do what you normally do
• Relief pitcher disabled even if could coach
• ETE cant work at any job for which education,
  training and experience would qualify you
• Tiger Woods making cheeseburgers
• Partial disability cant work full time
• Generally 50 of total disability benefit
• Residual disability benefit if earnings decrease
  by 2/3, collect 2/3 of total disability benefit

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Topic 19 Disability Insurance

• Benefit period
• To age 65
• Period of years
• Elimination period
• One to six months
• Benefits
• Tax-free if insured paid for policy
• Employer paid for policy benefits taxable
• Up to 75 of income
• COLA riders available
• Guaranteed renewable pay premiums, policy stays
  in force
• Guaranteed insurability can increase coverage
  without showing insurability

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Topic 20 Long-Term Care Insurance

• Medicare only covers 20 days of skilled nursing
  care
• Not nursing home so Grandma can play bingo
  (custodial care)
• Can generally buy coverage up until age 84

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Topic 20 Long-Term Care Insurance

• Benefits payable if cant do more than one of
  following
• Dress, eat, bathe, toilet, walk
• Benefits are usually X per day
• May be an elimination period
• Benefits paid from one year to lifetime
• Inflation rider available
• May have waiver of premium if receiving benefits
• Must be guaranteed renewable for favorable tax
  treatment

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Topic 20 Long-Term Care Insurance

• Life insurance
• Accelerated death benefit provision and viatical
  settlements allow access to funds for long-term
  care if terminally ill
• Insurance premiums
• Self-employed
• Deducted in calculating AGI
• Not self-employed
• Must itemize
• Medical expenses must be gt 7.5 AGI
• Amount deductible limited based on age
• 3,180 for ages 61 - 70

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Topic 21 Life Insurance

• Concepts
• Mortality death rates
• Morbidity rates of disability
• Expenses greatest in early years
• Commissions
• Insurable interest
• Required at time of policy inception
• Not at the time benefits are paid

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Topic 21 Life Insurance

• Term insurance temporary
• Renewable to age 70
• Convertible to whole life
• Whole life permanent/forced savings
• Variable separate account invested based on
  policy holders allocation
• Whole life funds go into general account of
  company
• Can increase death benefits/cash value based on
  investment performance
• Universal can change
• Premiums can skip payments
• Death benefit
• Cash value separated from death benefit
• Variable universal combine features
• Survivorship second to die policy

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Topic 21 Life Insurance

• Contract provisions
• All language contained in contract
• Backdating can be done up to six months
• Owner may not be insured
• One month grace period for premium payments
• Misstate age adjust death benefit
• Loans amount borrowed subtracted from death
  benefits
• Assignment generally policies may be assigned
• Common disaster primary beneficiary must outlive
  insured by 60 90 days

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Topic 21 Life Insurance

• Contract provisions
• Incontestable insurer has two years to challenge
  validity of policy
• Exclusions suicide (one to two years) and war
• Settlement options
• Lump sum
• Annuity
• Single or joint life term certain
• Interest only

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Topic 21 Life Insurance

• Dividends
• Cash
• Accumulate
• Reduce premiums
• Buy additional coverage
• Interest credits
• Portfolio method based on insurers earnings of
  overall portfolio
• New money method based on insurers earnings on
  money invested that year

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Topic 21 Life Insurance

• Riders
• Accelerated death benefits pay benefits if
  expected to die within year in nursing home
  permanently
• Long-term care benefits rider can be added to
  life insurance policy
• Waiver of premiums if disabled
• Guaranteed insurability can buy more coverage
  without showing insurability
• Double indemnity twice policy amount if death
  accidental

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Topic 21 Life Insurance

• Nonforfeiture options
• After policy has cash surrender value,
• Can get cash within six months
• Can get a paid-up policy with a reduced face
  amount
• Can get a term policy with the same face amount

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Topic 21 Life Insurance

• Illustrations
• Projection of financial results
• Incorporate present value or just nominal values?
• Optimistic assumptions?
• Clearly label what is guaranteed?
• NAIC model does not apply to variable
  life/annuities
• Policy replacement
• Regulated by many states
• High commissions
• May make sense due to reduced mortality charges
  and in higher interest rate periods

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Topic 21 Life Insurance

• Accelerated death benefits
• Allow terminally ill insured to obtain funds
  prior to death tax-free
• Pay for custodial care
• Preferable to viatical due to discounts on
  viatical
• Viatical settlements
• Terminally ill insured transfers policy for lump
  sum payment
• Benefits tax-free to insured if
• expected to die within two years
• cant perform two activities of daily living

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Topic 22 Income Taxation of Life Insurance

• Dividends whole life policies
• Not taxable unless total dividends gt premiums
  paid on policy
• Loans whole life policies
• Not taxable
• Withdrawal of cash value
• Not taxable unless withdrawals gt basis
• If taxable, ordinary income
• Surrender
• Not taxable unless proceeds gt basis
• If taxable, ordinary income

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Topic 22 Income Taxation of Life Insurance

• Death benefit not taxable
• MECs premiums higher than necessary for
  insurance.
• Often single premium policy
• Then take cash value prior to death
• Test during first seven years of policy
• If policy is MEC,
• Death benefit is still not taxable
• Withdrawals and loans taxed as ordinary income
  with penalty if under 59 ½

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Topic 22 Income Taxation of Life Insurance

• Transfer for value
• Sell policy to someone other than related party
  (business, co-owner, family member)
• Seller not taxed if viatical settlement
• Expected to die within two years
• Buyer will be taxed on death benefits if greater
  than basis (ordinary income)
• Including premiums paid and purchase price

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Topic 22 Income Taxation of Life Insurance

• Section 1035 exchange
• Trade an existing policy for a new policy
• Good idea???
• Mortality/interest rate assumptions
• Trade an insurance policy for an annuity
• Makes IRS happy
• Can not trade an annuity for an insurance policy
• Would make the IRS sad

51
Topic 23 Business Uses of Insurance

• Buy-Sell Agreements
• Provides for the sale of business interest on
  death of owner
• Allows heirs to cash out of business
• Keeps heirs from becoming co-owners
• Keeps ownership with existing owners
• Value generally based on formula
• Valid for estate tax valuation

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Topic 23 Business Uses of Insurance

• Buy-Sell Agreements
• Cross purchase
• Owners buy policies on each other
• Number of policies?
• Older owner
• Premiums not deductible
• Entity
• Company buys policy on each owner
• Premiums not deductible

53
Topic 23 Business Uses of Insurance

• Key Person Life Insurance
• Insures life of valued employee
• Pujols
• Janitor
• Business is beneficiary
• Premiums not deductible
• Benefits tax-free

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Topic 23 Business Uses of Insurance

• Split Dollar Life Insurance
• Employer and employee share cost of premiums
• Employer pays cash value portion
• Employee pays pure life insurance cost
• If employer pays entire premium, coverage above
  50,000 taxable
• Endorsement method
• Employer owns policy
• Receives reimbursement for premiums paid
• Employee gets balance
• Employer paid premiums income to employee
• Collateral assignment method
• Employee owns policy
• Again must reimburse business for premiums paid
• Premiums treated as loans employee must pay
  interest

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Topic 24Insurance Needs Analysis

• Life insurance
• Human life approach six to ten times annual
  income
• Present value of insureds future income
• Does not consider assets, liabilities
• Financial needs determine cash needs, income
  needs, special needs and then subtract net worth

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Topic 25Insurance Policy and Company Selection

• Life insurance
• Temporary needs term
• Permanent needs whole life
• Participating pays dividends when premiums were
  too large
• Cost analysis
• Net cost method per 1,000 of coverage (total
  premiums cash value) / number of years policy
  held
• Ignores time value of money

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Topic 25Insurance Policy and Company Selection

• Life insurance
• Cost analysis
• Surrender cost index
• (future value of premiums dividends cash
  value)/fv factor for 1 for n years at i rate)
• /1,000 units of coverage
• Net payment cost index
• Same as surrender cost index but cash value is
  not subtracted

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Topic 25Insurance Policy and Company Selection

• Life insurance
• Cost analysis
• Net payment cost index same as surrender cost
  index except does not subtract cash value

59
Topic 25Insurance Policy and Company Selection

• Life insurance
• Company selection financial ratings
• Companies rated based on financial strength
• A.M. Best, SP, Moodys
• Best insurance companies only
• A rating has different meanings
• Variable products provide security of subaccounts
• Company selection underwriting
• Some companies only want certain types of risk
• State Farm Florida, b b

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Topic 25Insurance Policy and Company Selection

• Property and casualty insurance
• Policy selection
• Insure catastrophic losses
• Select deductibles based on
• Risk tolerance
• Risk capacity

61
Topic 26 Annuities

• Types
• Immediate payments begin now
• Deferred payments begin later
• Single premium one payment
• Purchase annuity with 401(k) proceeds
• Periodic premium
• Single vs. joint and survivor
• Period certain benefits continue for a minimum
  number of years
• Even if die before period ends

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Topic 26 Annuities

• Types
• Fixed periodic payment known
• Turn defined contribution plan into defined
  benefit plan
• Variable periodic payments based on investment
  performance
• Considered securities must hold Series 6 and
  insurance license to sell
• Oversold/undersold????

63
Topic 26 Annuities

• Structured settlements
• Receive periodic payments instead of lump sum
• For auto accident, medical malpractice, etc.
• Payments are tax-free if compensatory including
  pain/suffering/wrongful death/loss of goodwill
• Effectively makes interest tax-free
• Punitive, non-physical damages are taxable
• Companies buying structured settlements

64
Topic 26 Annuities

• Taxation of annuities
• Noncontributory-qualified plan
• All payments ordinary income
• Contributory-qualified plan
• Basis / total expected payments percent of each
  payment not taxed
• Remainder of payment ordinary income
• Subject to 10 penalty if not age 59 1/2
• After recover entire basis, all taxable
• If die before deferred annuity payments begin
• Refund of premiums paid generally not taxable
  since payment equals basis
• No step-up in basis for annuities

65
Topic 26 Annuities

• Taxation of annuities
• Commercial annuity
• Ordinary income and return of capital based on
  expected payments
• Corporate annuities
• Must recognize income immediately on increase in
  value of annuity no deferral

66
Topic 27 Group Term Life Insurance

• Must be nondiscriminatory
• Amount of coverage usually multiple of salary
• Cost of coverage above 50,000 is taxable
• No evidence of insurability required
• Even if leave company and convert to individual
  cash value policy

67
Topic 27 Group Permanent Insurance

• Premiums
• Deductible by employer
• Taxable to employee
• GULPs employees pay for universal life coverage
• Advantage
• Group underwriting
• Can continue as individual policy after leaving
  employment
• No evidence of insurability required
• Must convert to permanent insurance

68
Topic 27 Group Permanent Insurance

• Carve Out Insurance
• Cover top dogs only
• Employers cost deductible
• Top dogs taxed on premiums paid
• Pay bonus to top dogs so they can pay taxes on
  premiums so they wont be sad
• Employer paid death benefit
• Taxable
• Not funded by life insurance policy

69
Topic 28 Group Disability Insurance

• Can discriminate
• Long-term plans
• Similar to individual policy features
• Benefits taxable if employer pays premiums
• Employer can deduct premiums
• Integrated with other sources of disability
  income such as Social Security so dont get rich
  watching Oprah
• Disability definition cant do job qualified for
  based on training, education, experience
• If just top dogs covered, own occupation
  definition more likely
• Short-term disability
• Sick for a week continue to pay salary
• Sick for up to six months short-term disability
  policy pays benefits

70
Topic 29 Group Medical Insurance

• Types of policies
• HMOs
• Lower deductibles, co-payments
• Restricts selection of medical care providers
• PPOs
• Lower deductibles, co-payments if select
  preferred provider
• Point of service
• In network providers have lower deductibles,
  co-payments if selected

71
Topic 29 Group Medical Insurance

• Tax advantages
• Employer deducts premiums
• Employee not taxed on premiums or benefits
  received

72
Topic 29 Group Medical Insurance

• COBRA
• For businesses with more than 20 employees,
  insured can continue coverage if lost coverage
  due to
• Termination of employment (including retirement)
• Continue coverage for 18 months
• Dependent no longer covered due to
  death/divorce/Medicare eligibility/dependency
  status
• Continue coverage for 36 months
• Employee must pay cost of coverage
• Government paying in 2009 65 of cost for first
  nine months

73
Topic 29 Group Medical Insurance

• HIPAA
• Individuals losing group coverage must be offered
  coverage without pre-existing conditions
• HSAs
• Require high deductible health insurance
• Deductible of 2,300 out of pocket 11,600
• If individual contributes
• Can deduct from AGI up to 5,950 for family
  policy
• Once eligible for Medicare, cant contribute

74
Topic 29 Group Medical Insurance

• HSAs
• Earnings not taxed if used for medical expenses
• Even if after covered by Medicare
• No required distributions
• Advantage for those who want to retire early
• Can roll over funds from IRA into HSA one time up
  to annual contribution limit