Wn % In addition to loss payments, insurers ancur several other types of expenses which include the cost Insurers have loss settlement expense and setting claims. They abo incur espenses to tequire new Business (sich ay advertising costs and producers’ commissions), and eneral expenses (stich as sand compurer equipment). Insurers pay premium taxes, income ayes, and various licensing and other fees. Insurers hilve expenses Weociated with investment activities, such as “The Salaries of investment department stall members. The abili C expenses and still make a reasonable profit is a measure of an insurer's w weney, that ists Tong-term financial strength. salaries, employee henctits, utilities, telephones State Insurance Regulation Insurers must be able to meet their obligations to insureds. A financially weak insurer may not have the resources necessary to mect its obligations Therefore, insurance regulators closely monitor the financial condition of insurers and take actions necessary to pi vent insurer insolvency. Every state has an insurance department that regulates the busine an that state, The insurance department regulates almost all aspe of the insurance business to some degree, but most insurance regulation deals with rates insurer solvency, and consumer protectio State insurance departments regulate insurance rates to protect consumers “Trom inadequate, excessive, or unfairly discriminatory rates, Adequate rates are necessary fo toe ough premium revenue to pay for losses ble profit. At the same time, Tegulators Believe that excessive rates are unfair to insurance consumers. Though regulators in some states trust open competition to produce lower fates for customers, many place tight caps on rates and enforce restrictions on changes to existing rates. ~ wsurers and other expenses while generating a reasons Insurance rates should reflect the insured’ loss exposures, Therefore, insureds with similar loss exposures are grouped together in a single rating class and hharged the same rate. Although other insureds may be grouped in a different rating class and charged a different rat, that rate must reflect the group's loss exposures. It would be unfair, however, ifthe different rate reflected character- isis ofthe group that had no bearing on thir loss exposures. Therefore, rates axed on such characteristics would not be permitted because they would be unfairly discriminatory. What constitutes unfair discrimination varies by st “and some states no longer allow discrimination based on such characteristics _as age and sex for certain types of insurance, su thas personal auto, Insurance regulation also deals with insurer solvency. Through solvency surveillance, insurance regulators monitor the financial condition of insuters. Such surveillance enables regulators to work with insurers that have financial difficulties to keep the insurers in business and maintain their ability to me obligations to insureds _l a ag ei pm a a ee meg pg ond ee ec,a = - ~— ~- =~ ” — - — — a ~— a ~ = — ~— - ~— “ ~ ~ ~ -_ — “ — . -_ “ ~ - - - “ : : : ‘nally, imyursnice regulation dealy with e protection. Insurance regulation protects consumers in several ways, Insurers must be licensed to write insurance policies (for most types of insurance) in-a piven state. and licensing al strenuth, In addition io Ticensing insurers, states also be license a nan Tepresentatives of insurers ice producers Such-licensing requirements apply to insur nay also apply to claim representatives and others Most states require that rers file their policy forms clepartment so that the department can approw aio monitor specific insurer practices concerning marketing, underwriting, tnd claims. In addition, state insurance departments investigate complaints ‘ygainst insurers and their Fepre Jenforce standards regarding their conduct. All of these activities help to protect consumers Benefits of Insurance Insurance provides many benefits to individuals, families, businesses, and society asa whole. These benefits include the following: * Indemnifying for the costs of covered losses * Reducing the insureds financial uncertainty * Promoting insurers’ loss control activities # Using resources efficiently * Providing support for credit tisying legal requirements * Satisfying business requirements Providing a source of investment funds * Reducing social burdens Indemnifying for Losses The primary role of insurance isto indemnify individuals families, and businesses for covered losses. To indemnify means to restore a party who has sustained a loss to the same financial position that party held before the loss.” Consider the aftermath ofa loss for those who have no insurance to recogni the value of payment for losses. If fire destroys the home ofa family with no insurance, the family members may be left without the financial resources to repair their home or to replace their belongings; they may also have no place to live, A business can incur bankruptcy as the result ofa liability judgment it cannot pay, and the employees and owners of the business are suddenly unemployed. By indemnifying insureds, insurance provides some degree of. financial security and stability for individuals, families, and businesses. Indermify Torestorea party who has sustained alos tothe same financial postion that party bed before the oss ocurtedne enueed Reducing Uncertainty Because insurance provides financial compensation when covered hoses ily reduces the uncertainty crested by many loss exposures, A ott, family’s major financial concerns, for example, often center on the possibility ofa wage earners death or the destruction oft home. If the family transters the uncertainty about she financial consequences of such losses to an insurer, the family practically eliminates these financial concerns. Insurers have e numbers greater certainty than individuals about losses, because the kaw of fan enables them to predict the number of losses that are likely to oceur and the financial effects of those losses. Promoting Loss Control Insurers often promote loss control by recommending 7 Prevent some losses from occurring or to reduce the financial that do occur, For example, individuals, families, Jes control techniques ans taking jan implement. Loss ce and Busineses can use Toss control measures such as burglar alarms, smoke alarms, and dead bolt locks to prevent or reduce property loss exposures. L control generally reduces the amount of money insurers must pay in clit control helps to improve the financial results of insurers ance costs to consumers. Thus, society benefits from activities Consequently, k and to reduce insur that prevent and reduce | Using Resources Efficiently People and businesses that face an uncertain future often set aside funds pay for future losses. Insurance makes it unnecessary to set aside a large amount of money to pay for the financial consequences of loss exposures that can be insured. Money that would otherwise be set aside to pay for possible losses can be used to improve a family’s quality of life or to contribute to the growth of a business In exchange for a relatively small premium, families and scan free ip additional funds that they would otherwise need to Tnforeseen future losses, such as the loss of a house because busines Providing Support for Credit Before making a loan, a lender wants assurance that the money will be repaid, When a lender loans money to a borrower to purchase property, the lender usually acquires a legal interest in that property. The lender often can repos sess a car or foreclose a home mortgage if the loan is not repaid. However, the lender would be less likely to make loans if it did not have some assurance of getting back its money if the car or house were destroyed or if the borrower dlied or became disabled before the loan was paid in full. anrEUREUUEUEULELEOCLEEUbt CCC tb bt tb bt tte Insurance: What sit? 1.17 Insurance facilitates loang to individuals and businesses by guarantee the Fender will ¢ the collateral for the loan (such as. house or commercial building) is destroyed or damaged by an insured event, thereby reducing the lender's uncertainty Satisfying Legal Requirements Insurance is often used or required to stares, for example, automobile owners must prove they have auto lability insurance hefore they can repister their autos. All states have laws that require ctisly’ legal requirements. In many employers to pay tor job-rel employers generally purchase workers’ c financial obligation Satisfying Business Requirements Certain basins tonic ian Breanpl Providing a Source of Investment Funds One of the greatest benefits of insurance is that it provides funds for ‘Tnvestment. Wherr insurers collect premiums, they usually do not need funds immediately to pay losses and expenses. Insurers use some of the funds to purchase stocks and bonds. Such investments provide businesses with money for projects such as new construction, research, and technology. Investment funds promote economic growth and job creation. Investment brings additional funding to insurers in the form of interest; this additional income helps to keep insurance premiums at a reasonable level for individuals and businesses, Insurers also invest in social projects, such as cultural events, education, and economic development. Reducing Social Burdens Un compensated accident victims can he a serious burden to society. Insurance ro reduce this burden by providing compensation to such injured persons. -cample, workers’ compensation insurance provides payment to injured oyees for medical expenses, lost wages, and rehabilitation, as well as benefits to survivors of employees killed by workplace accidents or diseases. Compulsory auto insurance is another example, because it provides compensation to auto accident victims who may otherwise be unable to afford proper medical care ot who may be tinable to work. Without insurance, victims of job-related injuties or auto accidents may need state welfare or the assistance of another social program.Cree ( Costs of Insurance The benefits of insurance are not cost-tree. However, the benefits of insurance outweigh the costs, and insurance is generaily considered to provide a mean ingful economic and social purpose. Among the costs of insurance are both direct and indirect costs, including the following ‘ # Premiums paid by insureds * Operating casts of insurers 2 * Opportunity costs # Increased losses © Increased lawsuits Premiums Paid by Insureds Insurers must charge premiums to have the funds cessary-to make loss “Payments, Ip fact, an insurer's total revenue (premiums and investment income) must equal or exeved the amount needed to pay for losses and GENTS OF every premium Gollar to pay for losses and twenty-five cents for other expenses. If the insurer can earn an amount equal to five percent of its premiums on its investments, it can break even. By lav, insurance premiums must not be excessive; however, insureds may believe that miums are t00 high. Realisticaliy, insurance premiums may also be considered as a cost ofiving and doing business in an indusctalized society. Operating Costs of insurers Like any business, an insurer has operating costs that must be paid to run the day-to-day operations of the company. Those costs include salaries, producers Omamissions, advertising, building experses, equipment, taxes, licensing fees, and many others, In addition, most insurers ate in business to make a profi, juSt TIRE any other business. Therefore, a reasonable amount of profit must be calculated in the cost of insurance that insureds pay. Opportunity Costs {f capital afd labor were not being used in the insurance business, they could be used elsewhere and could be making other productive contributions to society. Therefore, whatever resources the insurance industry uses in its operations represent lost opportunities in other areas—in other words, Opportunity costs. These opportunity costs are one of the costs of insurance. Increased Losses The existence of insurance may encourage losses to some extent. Although insurers have an economic incentive to provide and encourage loss c nieasures, i uirance may sometimes provide an economic incentive forve ftw’ Peer wr we weoeve ttt tt VP uwwo Ve ae a) k mite a Toss that has occurred. It is estimated that 37,500 structural tires sures to ha cones, For example, person may intentionally cause it loss OF exag and 30,500 vehicle hres in 20 fires amounted to approximately $692 million in structural damage and $132 3 were intentional, Property damage trom these million in vehicle damage. These figures do not include indirect costs, such as business interru tion, loss of use, and Femponury shelter costs, nor do they rake into consideration human suffering and luman loss exposure costs, such human loss exposure costs such as medical expenses snd funeral cos ses of arson oF suspected arson involve insurance—some property owners would ruther have the insurance money than the property son Anon is an intentionally staged accident and ic represents one form of insurance fraud. The intentional exaggeration or loss in an otherwise levitimate chaim is amore common form of insurance fraud. These exaggerations are also referred to as glaim buildup, For example, an insured may claim thar four items were [at afer aT acta tne tt the tens were meth more thon their actual value. In liability claims, claimants may exaggerate the severity of their bodily injury or property damage. Physicians, lawyers, contractors, and auto body shop operators can also he participants in claim buildup, Insurers are actively involved in the fight against insurance fraud and use various techniques to detect and investigate suspicious claims, Nevertheless, insurance fraud is a serious problem that results in billions of dollars it excess insurance payments ench year. Fraudulent claims increase costs for Toth insurers (in terms of both payment for fraudulent claims and the cost of investigating and resisting frau) and insureds (who pay increased premiums tohelp cover the cost of those who defraud insurers) Some losses may not be deliberately caused, but they may result from care- lessness on the part of an insured because insurance is available to pay for Tosses if they do occur. Routinely leaving the keys in an unlocked car is an example of such carelesness Ifthe car isstoen, the insured would safer only minimal financial consequences because the insurer will pay forthe loss. The additional losses that result from insureds’ carelessness increase the cost of insurance for everyone because insurers often pay for injuries and damage that insureds could have prevented. Increased Lawsuits 1e number of liability lawsuits has increased steadily in recent yeats. One 2son for this increase is that liability insurers often pay large sums of money ssons who have been injured. Liability insurance is intended to protect. [e who may be responsible for injury to someone else or damage to some- perty. However, some people may view liability insurance as a pool 7 aVailable to anyone who has suffered injury or damage, with little given to fault, The increase in frivolous lawsuits is an unfortunate cost snce in today's society.EL INSURANCE AS A CONTRACT An invurance polivy isa vontract between the msurer aud the insured Through insurance policies, insureds transfer the possible costs of loses to inser In tr for dhe penis pi by ine ste roi 9 py DE stace Foley AS ORE, iy promade redaes for the loses cam The TACT or insecurity thar insureds have about paying for doses that may occur, The coverage provided by insurance policies enables inlvidas, families, bE a MEAT protect their assets, vets ind minim ¢ the adverse financial effects of losses. The four basic eypes of insurance—property, liability, lif, sand health —are generally divided into two broad categories as tollows: ‘ 1. Propertyfliability insurance 2. Lifefhealth insurance Property insurance provides co verage for property and net exposures. Ieprotects an insureds assets by paying to repaiy or reph Front thi sda Tost, or desma or by replacing the net income ' iy Tos exposures, Tt provides for payment on behalf the insured for injury to others or damage to others’ property for which the insured is legally responsible. Life insurance and health insurance cover the financial consequences of personal and personnel loss exposures. Life insurance replaces the incoin _eaning potentiat tose through death and also helps to pay expenses related to an insured’ death. Health insurance protects individuals and families from fitanciat tosses Caused by sickness an : of health insurance that replaces an insureds to work because of less oF injury. Property Insurance Property insurance covers the costs of accidental losses to an insured’ property. The insured could be a family insuring its house and personal property or a business insuring its building, inventory, and equipment. When the insured experiences a loss, such as fre damage to a house, the insured deals directly with the insurer to settle the loss and receive payment. ' Many types of insurance are classified as property insurance, such as the following: * Fire and allied lines insurance * Business income insurance * Crime insurance ¢ Inland marine insurance * Ocean marine insurance 1 * Auto physical damage insurance |CULLEEGLELELELEECEETELEECELECCLETCOCLULLEE PECL eed F insurance yenerilly covers direct vot Fireand lied lines insurance insured property, suchas Buildings annT personal property, ata tied location lnsuancethat overs corTpeations deseribed in the poliey. The term “allied lines" refers to insurance die damage to arlas of ist causes of loss usually written with (allied to) fire insurance, such ats insured property. Business income insurance ot business interruption insurance Insurance tat covers the loss of ntincome or additional Insurance, expenses incurred by a business asthe result ofa covered ss to As property a business Frsiness tsa serious fe, it may have to close until reais to the hailing are inde and personal property is replaced. A resulting loss of net income occurs over time. Business income insurance pays the insured for the loss of income , Gime insurance the or additional expenses that the insured incurs because of the loss du time needed to restore the business to its pelos condition. ee en Sr Ene Du ests ress comalitlonl secutes, merchandise, and other Crime insurance covers money, securities, merchandise, and other property property fom varius causes of uy y, theft, and empk {ass such as burglary, robbery, dishanesty. Coverage for crime losses that a business may incur is usally the and employee dishonest Insurance that covers money, of loss such as provided by separate policies that insure specific types of property against specific crime losses. Crime losses that a person or family may suffer are usually ean marine insurance insured under a homeowners policy. Insurance that coves ships and —— their argo against such causes of Qcean marine insurance, one ofthe oldest forms of insurance, covers ships yey fe nin and prs and their cargo against such causes of loss as fie, lightning, and “perils of the ofteseas" easy” which include high winds, rough waters, running aground, and collision ‘with other ships or objects Inland marin insrance Inland marine insurance covers miscellaneous types of property, such as {Insurance that covers movable property, goods in domestic transit, and property used in transporta- miscellaneous types of ropry, tion and communication. Jt was originally developed to provide coverage for sichasmoabe property goods Tosses to cargo transported over land but now covers many different types of _indomestictrasit,and propery property in addition to goods in transit used in trensprtation and . communication Auto physical damage insurance covers loss o to-specifed vehicles from collision, fe, theft, or other causes. Its usualy part of a policy that also_ auto physical ‘provides auto Tiability coverage, such asa personal auto policy ora business amageinrance auto policy. Insurance that coverslass of damage te specie vhs Liability Insurance fom olson, ne, the or ater causes Because an ins ince policy is contract between the insured and the insurer, ‘0 are usually the only parties involved in a property loss. Liability ance, however, is sometimes called third-party insurance because three “Parties are involved in a liability los: the insured, the insurer, and the party who f injured or whose property is damaged by the insured. (The third party usually called the claimant.) The insurer pays the claimant om behalf of the insured ifthe insured is legally liable for the injury or damage. An insuredsence auc Auto ability insurance Insurance tha overs an insureds legal ibility arising ou ofthe ‘ownership, maintenance ous of an automobile Commercial general liability insurance Insurance that coves ability loss eposurs arising from a business organization premises and operations its products ots completed work Persona ability insurance Insurance that provides ity Coverage to individuals and families for bol ijury and property damane arising from the insured’ personal premises activities, Professional ability inserance Insurance that provides ibility coverage to professionals for crs and omisions arsng out of ther professional duties legal liability tor injury or damage is often the result of a negligent act, but there are other sources of liability ay well. Examples of lishihity insurance: include the followi # Auto liability insurance * Commercial general liability insurance © Personal liability insurance * Professional liability insurance Auto liabil y insurance covers an insureds legal liability aris the_ ownership, maintenance, oF use of un automobile, The legal costs of defending ithe mnsured against lawsuits are abo co The personal aaro policy and the business auto poliey are the most widely used auto insurance policies, These policies ean inclule coverage for oth auto Trahility and auto physical damage losses. when such defen Commercial general liability insurance covers liabiliry loss exposures _ariing from a business organization's premises and ope ‘ts product “Grits completed work. The following examples of lability clams against an appliance store illustrate the various ways that a business can be liable for the bodily injury or property damage suffered hy others: tig ‘© Premises. A customer whose finger was caught in a revolving door incurred medical expenses for treatment in a hospital emergency room * Business operations. Employees broke a water pipe while installing a dish- washer in an apartment, causing substantial water damage to property in the apartment below. # Products. A customer’ face was cut when an electric mixer sold to the customer malfunctioned and shattered a glass mixing bowl. * Completed operations. A short circuit developed in an electric stove incorrectly installed by employees and cause a fie that damaged the customer's kitchen Personal liability insurance provides liability coverage to individuals and families for bodily injury and property damage arising from the insured’s ‘personal premises or activities. As mentioned previously, in most instances, the lability arises from the insureds negligence. For example, a visitor to the insured’s home may slip and fall on the insureds icy driveway, or the insured may hit a golf ball that accidentally strikes a pedestrian in the head. This type of coverage is included in all homeowners polices. Professional liability insurance provides liability coverage to professionals for errors and omissions arising out of their professional duties. Medical malpractice insurance, which covers doctors and other healthcare providers, is probably the best known type of professional liability insurance, but similar coverage is available to other types of professionals, including insurance producers, attorneys, architects, and engineers. eeDOLELT EEUU UOUOOUob tb bbb bb bb or the Towest cost. Parents of young children may buy twenn Life Insurance One of the most severe causes of financial Loss to at family isthe prem ue death of a family member, especially the primary wage eamer. Lite insurance can greatly reduce the adverse fin: nature death by ese fi cquences fp roviding funds to replace fost income to pay uncovered mecligal expenses (when necessary) and cover the funeral costs Although there are many variations of lie insurance, the following three basic types are commonly sold: * Whole life insurance © Term insurance * Universal life insurance Whole life insurance provides lifetime (for the insured’s whole life) protes tion, accrues cash valiie, and has premiums that remain unchanged during the insured’ lifetime. Cash value is the monetary amount, considered to be «Torin of savings, that accumulates in the policy. A policyholder the cash value after a policy has been in effect for specified number of y Whole life insurance is purchased when a consumer wants lifetime protection with a level (constant) premium and a savings element Term insurance provides coverage for a specified period, such as ten or twenty years, with no cash value. A term life insurance policy is used when the con- sumer wants the maximum amount of life insurance protection available at year term insurance to provide financial security until their children are grown, Universal life insurance provides life insurance protection and a savings component. Th plcyhoKer asa eh vl account that cede ch the premiums paid, less a deduction for the cost of the insurance protection est at a specified rate. If the policyholder surrenders the policy, the cash value account may be reduced by a surrender charge to determine the surrender value paid to the policyholder. Some life insurance policies are sold directly to individuals, while other life ‘surance policies cover a group of insureds. Such group policies are usually term olicies arranged through an employer or an association. Health Insurance Health insurance i designed to protect individuals and families from financial loss caused by accidents and sickness. Like life insurance, health insurance issued on either an individual or a group basis. The various types of health insurance policies can be classified as either medical insurance or disability insurance. Medical insurance covers medical expenses that result from illness eae Whole lif insurance Lieinsurance that provides lifetime protection, accrues ash value and has premiums that remain unchanged during the insured itetime Gshvalue The monetary amount considered tobe form of savings that accuruatesin a whole fe insurance poly. Term insurance Life insurance that provides coverage fora spect perio, such ste or twenty yeas, with ‘no cash value, Universal if insurance {Insurance that provides ife insurance protection and a savings component Medical insurance Insurance that covers medical expenses that result from ness or injury.Me reen ade! Disability income insurance Atype of heath insurance that provides perndc income payments toan insured who isunabe to work because of sickness or injury or injury. Disability income insurance provides periolic income payments tan insired whens unable to work because of sickness or injury, Disability —Gisurance fy primarily income replacement insurance that pays weekly oF mnonthly Berets until the ins periaxt has claps — o work a intil a maximum SUMMARY Every individual, family, and business orgunization needs insurance. Insurance is actually four things: a risk management technique, a transfer system, a business, and a contract. retain, avoid, For loss exposures that an individual or organization cannot easi or contro, insurance is often the best available risk management technique The key elements of insurance as a transfer system are transfer and sharing, An insured transfers the potential financial consequences of loss exposures to an insurer, thereby exchanging the possibility ofa large loss for the certainty ofa much snaller periodic payment (the premium). The sharing aspect of insurance requires the insurer to pool the premiums paid by insureds into a loss fund from which covered losses are paid. Although the insurer does not expect ll insureds to experience a los, all insureds share in the cost of losses because their premiums make up the loss fund. Because of the law of large numbers, insurers can predict the number of losses that may occur and thus the amount of premium to be paid by each insured. The need for insurance exists because everyone faces exposures to loss, that is, the possibility that a loss will occur. Loss exposures can give rise to three major types of loss: property loss (including net income loss), liability loss, and personal and personnel loss. The role of insurance isto protect insureds assets from the financial consequences of lass. However, insurers prefer to provide insurance for loss exposures that are considered ideally insurable, “The insurance business provides jobs to millions of workers in the U.S. Private insurers provide most insurance, but federal and state government insurance programs also provide insurance for loss exposures that private insurers are unable or reluctant to insure Insurer operations include marketing, underwriting, claim handling, and ratemaking, as well as information processing. The states regulate many of the operations of insurers. Regulators, insureds, and others need to be assured of insurers financial stability. To protect consumers, state insurance departments regulate insurance rates, monitor insurer solvency, and protect consumers In addition to payment for loses, the insurance business offers many benefits to insureds and to society as a whole. However, there are both direct and indirect costs associated with insurance. An insurance policy, which is a contract between the insured and the insurer, states the rights and duties of each party with regard to losses. The four basi © © ©)CELEELELELELEEOCCLEEGELELCELEEETLOLG EE eC eae eee types of insurance property insurance; lability insurance, lite insurance and health insurance. Each of these types of insurance is provided through contracts hetween the insured an the insurer CHAPTER NOTES 1. Insurance Information Institute, Th Insurance Fut Book 20 (New York Insurance Information Institute, 2005), pp. 1-7, 13 2, Insurance Information Institute, The HIE Insiramee Fact Bock 2005, p. 102