Chapter 10

Learning Objectives (part 1 of 3) Identify the types of risks for which insurance coverage is appropriate Describe the basic principles of insurance and how an insurance premium is determined Describe the basic coverages of an automobile insurance policy Ascertain an optimal amount of auto coverage for the minimum premium

Learning Objectives (part 2 of 3) Describe the various forms of homeowner’s insurance Explain the consequences of buying less than full replacement value coverage Describe the appropriate coverages for owners of condos, renters, and college students

Learning Objectives (part 3 of 3) Ascertain an optimal amount of homeowner’s coverage for the minimum premium Discuss the issues associated with working with agents and representatives Check out an insurance company’s rating and complaint record Explain the role of an umbrella insurance policy

Risks for which insurance coverage appropriate Insurance should be bought to protect against catastrophic disasters, not to protect against commonplace events. Premature death & disability Major assets such as house & car Major health problems Lawsuits

Basic Principles of Insurance Loss must be fortuitous Loss must be well-defined Loss predictable in the aggregate Loss must be personal Large number of policies with similar risk exposure available Loss exposures widely distributed

How an insurance premium is determined Basic premium + loadings Basic premium based on actuarial tables that reflect likelihood of a claim Loadings include: Expenses of doing business Profit margin

Two factors to reduce a premium Deductibles Insured pays for the initial expenses out of pocket Coinsurance The insurance is only for a percentage of the claim

Basic Coverages of an Auto Insurance Policy property damage to the insured’s car physical injury to the insured and any occupants of the insured’s car legal liability for damage to the property of others legal liability for injury to others

Description of Basic Coverage Policies normally described as XXX/YYY/ZZZ (in thousands) XXX = extent of personal injury coverage per person YYY = aggregate personal injury coverage per accident ZZZ = Property damage coverage

Other Coverages in a Policy Medical Payments Underinsured/Uninsured Motorists Coverage Collision and Comprehensive Protection Towing Insurance

Extent of Coverage The wealthier you are, the more coverage needed Medical coverage offset by a health insurance policy The older the car, the less need for comprehensive

Strategy for buying auto insurance Obtain the highest liability coverages available (incremental coverage is relatively inexpensive) Agree to the highest deductibles offered A $1,000 deductible is not a catastrophic loss Breakeven period usually about 4 years for savings

Factors that determine auto insurance premiums Probability of driver having an accident Women have fewer accidents People over 25 have fewer accidents Married people have fewer accidents People with clear driver records and who had a safe driving course have fewer Features of the car Area in which a person lives

Basic Coverages of a Homeowner’s Insurance Policy property damage to the insured’s home, its contents, and related personal property physical injury to the insured’s guests legal liability for damage if the insured causes damage to the property of others legal liability if the insured causes injury to others

Forms of Homeowner’s Insurance HO-1: least coverage, 11 named perils HO-2: more coverage, 18 named perils HO-3: comprehensive coverage on home, and named peril on contents HO-5: comprehensive coverage on both home & content HO-8: special policy for older homes

Coverages of an HO-3 Policy (1 of 2) Coverage A: Covers the dwelling (defines amount of policy) Coverage B: Covers detached structures (10% of A) Coverage C: Personal property of insured (50% of A), usually based on actual cash value, and contains internal limits on special items (e.g., cash)

Coverages of an HO-3 Policy (2 of 2) Coverage D: Temporary living expenses (20% of A) Coverage E: Liability protection ($100,000 is standard amount) Coverage F: Medical expenses ($1,000 is standard amount)

Buying less than full replacement value If have at least 80% of replacement value, then no problem on “small” claims If less than 80%, then all claims will be prorated If at least 80% but less than 100%, then only problem is if claim is for more than 80%

Other types of policies HO-4: Renter’s insurance (contents and liability only, 17 names perils) HO-6: Condo insurance (also 17 named period College students: Could be covered under parent’s policies Might need to buy renter’s insurance

Strategy for buying homeowner’s insurance Set coverage A to just cover cost of rebuilding home Land and foundations are not insured Use maximum deductibles Obtain maximum liability coverage Safety features reduce cost (e.g., alarm system, deadbolt locks)

Agents vs. Representatives Agents will sell policies for multiple companies Representatives will sell for only one company Agent may be more supportive of customer in a dispute Representatives tend to have lower premiums

Selecting an insurance company Check out rating of company, to assure it is in good financial health Check on any publicly available complaint records for company & avoid those companies with high ratios of complaints per policy outstanding

Umbrella Insurance Provides back-up liability coverage Sold in increments of $1 million. Usually require a minimum liability coverage on auto & homeowner’s Best strategy is to buy an umbrella and set other liability coverages to the minimum designated (most coverage for the least $$)