Commercial Insurance Notes

Commercial Insurance Notes - CAS Exam 5 Notes - Part II...

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Unformatted text preview: CAS Exam 5 Notes - Part II Contents Flitner & Trupin: Commercial Insurance . . . . . . . . . . . . . . . . . . . . . . . Chapter 1: Overview of commercial insurance . . . . . . . . . . . . . . . . . Chapter 2: Commercial property insurance, part I . . . . . . . . . . . . . . Chapter 3: Commercial property insurance, part II . . . . . . . . . . . . . . Chapter 8: Commercial general liability insurance, part I . . . . . . . . . . Chapter 9: Commercial general liability insurance, part II . . . . . . . . . . Chapter 12: Workers compensation and employers liability insurance . . . . Chapter 13: Miscellaneous coverages . . . . . . . . . . . . . . . . . . . . . . Myhr & Markham: Insurance Operations, Regulation, and Statutory Accounting Chapter 1: Overview of insurance operations . . . . . . . . . . . . . . . . . Chapter 3: Insurance marketing . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 4: Underwriting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 5: Underwriting property insurance . . . . . . . . . . . . . . . . . . Chapter 6: Underwriting liability insurance . . . . . . . . . . . . . . . . . . Chapter 9: Property claim adjusting . . . . . . . . . . . . . . . . . . . . . . Chapter 10: Liability claim adjusting . . . . . . . . . . . . . . . . . . . . . . Wiening: Foundations of Risk Management and Insurance . . . . . . . . . . . . . Chapter 1: Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 4: Insurance as a risk management technique . . . . . . . . . . . . Chapter 5: How insurance works as a business . . . . . . . . . . . . . . . . Chapter 6: Insurable risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 8: Fundamental assumptions underlying insurance . . . . . . . . . Chapter 9: Forming an insurance contract . . . . . . . . . . . . . . . . . . . Chapter 11: Reading an insurance policy . . . . . . . . . . . . . . . . . . . . Chapter 12: Common insurance policy provisions . . . . . . . . . . . . . . . Chapter 17: External factors affecting insurance contracts . . . . . . . . . . Wiening Et Al.: Personal Insurance . . . . . . . . . . . . . . . . . . . . . . . . . Chapter 1: Overview of personal insurance . . . . . . . . . . . . . . . . . . Chapter 3: Personal auto policy, part I . . . . . . . . . . . . . . . . . . . . . Chapter 4: Personal auto policy, part II . . . . . . . . . . . . . . . . . . . . Chapter 5: Homeowners insurance, section I . . . . . . . . . . . . . . . . . . Chapter 6: Homeowners insurance, section II . . . . . . . . . . . . . . . . . Chapter 12: Health and disability insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1 6 12 18 25 32 41 48 48 52 57 61 67 76 82 93 93 95 97 101 105 107 110 114 118 120 120 122 129 135 146 152 Flitner & Trupin - Chapter 1: Overview of commercial insurance Commercial insurance • Insurance that covers for-profit businesses or nonprofit organizations against the adverse financial effects of property and liability losses • Some insurers provide only commercial insurance, and some provide only personal insurance. Many insurers provide both types of insurance, but typically do so through separate personal and commercial divisions • Commercial insurance involves a far greater number of policy forms and endorsements than those used to provide personal insurance Insurance as a risk management technique • Risk management – Insurance enables a person or an organization to transfer the financial consequences of a loss to an insurer. The insurer, in turn, pays the policyholder for covered losses and distributes the costs of losses among all policyholders – Loss exposure: Any condition that presents a possibility of loss, whether or not loss actually occurs. Commercial insurance responds both to property and liability loss exposures ∗ Property loss exposure: The possibility that a person/organization will sustain a financial loss as the result of the damaging, destruction, taking, or loss of use of property in which that person/organization has a financial interest ∗ Liability loss exposure: The possibility that a person/organization will sustain a financial loss as the result of a claim being made against that person/organization by someone seeking monetary damages or some other legal remedy – The risk management process consists of the following steps 1. Identifying loss exposures 2. Analyzing loss exposures 3. Evaluating the various techniques for treating the loss exposures 4. Selecting the most effective technique or techniques 5. Implementing the selected techniques 6. Monitoring the program and making needed corrections or adjustments – Other non-insurance risk management techniques include ∗ Avoidance: Risk management technique by which an organization avoids a loss exposure by choosing not to own a particular item of property or not to engage in a particular activity ∗ Loss control: Risk management technique that prevents losses from occurring or reduces the size of losses that do occur ∗ Retention: Risk management technique by which an organization pays all or part of its own losses due to its loss exposure since retention may be less costly in the long run ∗ Non-insurance transfer: Risk management technique by which an organization obtains the promise of a second organization (other than an insurer) to pay for certain losses. Noninsurance transfers are commonly included in leases, construction contracts, and purchase agreement Lines of business • A line of business , or simply a line, is an identifiable type of insurance. The divisions used to identify lines of business depend on the purpose for which the lines are being identified (e.g. insurance regulators vs. day-to-day operations) • Commercial property insurance – As a general term, any type of commercial insurance that covers loss to property – In a narrower sense (as used here), insurance covering commercial buildings and their contents against loss caused by fire, windstorm, and other perils – Commercial property insurance provides little, if any, coverage for property while in transit or oth1 • • • • • • • • • erwise away from the insured location and omits most of crime-related perils as well as mechanical or electrical breakdown or steam boiler explosion Business income insurance – Damage to property can also result in lost income and increased expenses. Business income insurance provides organizations a way to protect against this possibility, and is often included within the commercial property line Crime insurance – Various commercial crime coverages are available to insure (i) money and securities against a wide range of perils (not limited to crime perils) and, (ii) property other than money and securities against various crime perils such as employee dishonesty, burglary, robbery, theft, and extortion Equipment breakdown insurance – Equipment breakdown insurance can be used to cover damage to property resulting from mechanical breakdown, electrical injury (other than lightning), and steam boiler explosion, as well as resulting business income losses – Aka Boiler and machinery insurance Inland and ocean marine insurance – Except in the U.S., marine insurance usually means insurance on vessels and their cargo – In the U.S., ocean marine insurance conforms to the international meaning of marine insurance – Inland marine insurance includes a wide variety of risks the were first insured in the U.S. by marine underwriters, including property in domestic transit, mobile equipment, buildings in the course of construction, property essential to transportation or communication (e.g. bridges, tunnels, radio and television towers), and many other classes of property that typically involve an element of transportation Commercial general liability insurance – CGL insurance covers the loss exposures arising from an organization’s premises and operations, its products, or its work – It also covers various other offenses that may give rise to claims or suits, such as libel, slander, false arrest, and invasion of privacy Commercial automobile insurance – Both automobile physical damage insurance and automobile liability insurance are available under a commercial automobile insurance policy – Various coverages can be added to an auto policy by endorsements, such as auto medical payments coverage and uninsured/underinsured motorists coverage – Commercial auto also encompasses specialized forms for trucking firms and auto dealers Businessowners insurance – The businessowners policy combines, in a simplified manner, most of the property and liability coverages, other than auto and WC, needed by small and medium sized business such as stores, offices, and apartment buildings – Several optional coverages can be activated by an additional premium, and a limited number of other optional coverages can be added to the policy by endorsement Farm insurance – Because many farmers live and work on their own land, they need a combination or personal and commercial insurance – The personal insurance aspect is similar to a homeowners policy. It is omitted when farm insurance is written for an agribusiness organization – The commercial insurance aspect is similar to commercial property and inland marine, covering property used in farming operations, livestock, mobile equipment and machinery, and farm structures such as barns and outbuildings – Farm insurance also covers liability arising out of personal or farming activities Workers compensation and employers liability insurance 2 • • • • • – Workers compensation and employers liability insurance provides two coverages: (i) coverage for the benefits the insured employer is obligated to pay under workers compensation laws, and (ii) coverage for employee injury claims made against the insured employer that are not covered by WC laws Excess and umbrella liability insurance – Insureds can obtain additional coverage limits (above their primary coverages) through excess liability policies – The umbrella liability policy provides excess limits above primary policy limits, but also “drops down” to cover some claims that are not covered by the insured’s primary policies Professional liability insurance – Traditionally, professional liability insurance has referred to policies covering professionals such as doctors, lawyers, and engineers against liability arising out of their rendering, or failing to render professional services – Today, such policies protect a much broader spectrum of occupations and also describe similar liability coverages such as directors and officers, fiduciary liability insurance, and employment practices liability insurance Aircraft insurance – Insureds that own or operate aircraft can obtain aircraft insurance policies that provide aircraft liability coverage, aircraft physical damage coverage, and other aircraft coverages usually not provided with commercial general liability insurance or commercial property insurance Environmental insurance – Organizations that wish to insure their pollution loss exposures and cover injury, damage or cleanup costs resulting from the release of pollutants can obtain various types of environmental insurance largely excluded under most commercial insurance policies Surety bonds – A surety bond is an agreement by one party (the surety) to answer for the failure of another (the principal) to perform as the principal has promised – Most surety bonds are provided by insurance companies, and surety bonding is regulated in the same manner as insurance – Contract surety bonds are widely used to guarantee that a contractor will complete a building project according to specifications, that the contractor will pay certain bills for labor and materials, and that the contractor’s work will be free from defects for a specified period – Commercial surety bonds are used to provide a wide range of other guarantees in any number of situations Commercial insurance policies • A commercial insurance policy can be either a monoline policy or a package policy. In practice, most organizations have a package policy that provides most or all of their needed coverages, supplemented with a couple of monoline policies from other insurers providing coverages that the package insurer either does not write or is unwilling to provide to the insured • ISO commercial package policy program – Under the rules and forms developed by ISO, a commercial policy package (CPP) includes ∗ Common policy declarations ∗ Common policy conditions ∗ Two or more coverage parts – Common policy declarations ∗ The common policy declarations (“dec” page) show · Policy number · Names of the insurance company and the producer · Name, address, and business description of the named insured · Effective date and expiration date of the policy 3 · Premium for each coverage part included in the policy · Total premium ∗ The common policy declarations page may also include a general statement, known as the “in consideration” clause in which the insurance company agrees with the named insured to provide insurance as stated in the policy in return for payment of the premium and subject to all the terms of the policy – Common policy conditions ∗ The common policy conditions are a separate form attached to the policy containing six conditions that apply to all coverage parts in the policy unless a particular coverage part states otherwise ∗ Cancellation · Only the first named insured may cancel the policy at any time by mailing or delivering written notice of cancellation to the insurance company · The insurance company can cancel the policy by mailing or delivering written notice of cancellation to the first named insured, (i) at least 10 days before the cancellation date for nonpayment of premium, or (ii) at least 30 days in advance for any other reason · The insurance company is only required to prove that the notice was mailed, not that it was received · If the cancellation results in a return premium, the refund is sent to the first named insured · In almost every state, the cancellation provision is superseded by state law (which commonly address permissible reasons for cancellation and the advance notification period) and an endorsement is added to the policy to conform with the applicable law ∗ Changes · The common policy conditions include a clause concerning changes in the policy · The policy can be changed only by a written endorsement issued by the insurance company · Such changes may be made, with the insurance company’s consent, upon the request of the first named insured only ∗ Examination of books and records · The insurance company reserves the right to examine and audit the insured’s books and records related to the policy at any time during the policy period and for up to three years after the termination of the policy · This is useful for policies issued with estimated premiums ∗ Inspections and surveys · The insurance company has the right, but not the obligation, to inspect the insured’s premises and operations at any reasonable time during the policy period · The inspections may be made by the insurer’s own personnel or by another organization acting on behalf of the insurer · The insurance company may inform the insured of the results of such inspections, and may recommend changes · The inspections and surveys provision makes it clear that the insurer (i) does not make safety inspections, (ii) does not guarantee that conditions are safe or healthful, and (iii) does not guarantee that the insured is in compliance with safety or health regulations ∗ Premiums · The first named insured is responsible for paying the premium under the policy · The insurer must pay any return premium under the policy to the first named insured ∗ Transfer of rights and duties under the policy · The insured cannot transfer any rights or duties under the policy to any other person or organization without the written consent of the insurance company 4 · The transfer of rights and duties condition also provides specifically for the automatic transfer of coverage upon the death of an individual named insured to the insured’s legal representatives, or to any person having proper temporary custody of the insured property – Coverage parts ∗ A coverage part consists of the following components · A declarations page that pertains only to that coverage part · One or more coverage forms, which contain insuring agreements, exclusions, and other policy provisions · Applicable endorsements, which modify the terms of the coverage form(s) to fit the needs of the particular insured ∗ Some coverage parts include a conditions form containing general provisions that could apply to any of the coverage forms included in the coverage part ∗ The coverage parts used in an ISO CPP correspond usually the the lines of business discussed above, including: Commercial property (including business income), commercial crime, equipment breakdown (boiler and machinery), commercial inland marine, commercial GL, commercial auto, farm ∗ Some insurers add other, non-ISO, coverage parts to their commercial package policies • Package modification factors – An important element of the commercial package policy (CPP) is the package discount the insured may receive – The premium for a CPP is determined using the same rules that would apply if each coverage part were being issued as a monoline policy. However, if both property and liability coverages are provided in the CPP, the application of package modification factors often provides a premium discount for the insured, justified by the greater efficiency of issuing a single package policy instead of several monoline policies – Package modification factor: A factor that is multiplied by the regular policy premium of any CPP that includes both property and liability coverages, resulting in a premium discount – The package modification factors reflect the type of business, the particular coverage part being rated, and other eligibility requirements. The factors vary from state to state and from insurer to insurer 5 Flitner & Trupin - Chapter 2: Commercial property insurance, part I Policies providing commercial property coverage • Commercial property insurance: Insurance that covers loss to commercial property; More narrowly, a line of insurance that covers buildings and business personal property against loss caused by a wide range of perils • Can be provided under any of the following – A businessowners policy (BOP) ∗ A businessowners policy (BOP) is a combination of property, liability and other coverages that resembles the homeowners policy used for personal insurance ∗ BOP policies are intended for smaller, less-complex businesses. Underwriting and rating are simplified and often highly automated. Most small businesses are insured under BOPs – A commercial property coverage part ∗ A commercial property coverage part offers a broader range of optional coverages to meet the needs of larger or more diverse firms, aka middle market ∗ Can be issued as part of a package policy or as a monoline policy – A policy designed for “highly protected risks” (HPR) ∗ HPR policies are designed to be issued only to organizations with superior loss protection characteristics, e.g. fire-resistant, sprinklered buildings ∗ HPR forms are typically the basis of property coverage for the largest enterprises. The coverage is broader and the terms and conditions more liberal than most commercial property coverage parts – Inland marine coverages, including output policies ∗ Firms of any size can use inland marine forms. Specialized policies such as data processing or contractors equipment floaters can be used to cover particular types of property ∗ The output policy, which has its roots in inland marine, can cover almost all of a firm’s property exposures ∗ Inland marine policies are particularly suitable for property in transit – Types of property: Real property, personal property, tangible property, intangible property. Most property insurance policies cover only tangible property (real or personal) Overview of the commercial property coverage part • Commercial property coverage part: A CPP coverage component that provides a broad range of coverages to “middle-market” or larger firms to insure buildings and business personal property • A commercial property coverage part consists of: – Commercial property declarations – One or more commercial property coverage forms – One or more causes-of-loss forms – Commercial property conditions – Any applicable endorsements • Commercial property declarations – A commercial property declarations page is a required commercial property coverage part component that provides basic information about the policyholder and the insurance provided, namely ∗ A description of the property insured ∗ The kinds and amounts of coverage provided and the covered causes of loss (basic, broad or special) ∗ A list of mortgagees, if any ∗ The deductible amount ∗ A list of the property coverage forms and endorsements attached to the policy ∗ The applicable coinsurance percentage(s) ∗ Any optional coverage 6 • Commercial property coverage forms – A commercial property coverage part component that can be any of the several commercial property forms containing an insuring agreement and related provisions – Each commercial property coverage form contains an insuring agreement, describes the property covered and not covered, sets forth the additional coverages and coverage extensions, and includes provisions and definitions that apply only to that coverage form, e.g. Building and personal property coverage form • Causes-of-loss forms – A required component of the commercial property coverage par that specifies perils covered; Choices include basic, broad, or special form – A commercial property coverage part may contain more than one causes-of-loss form, e.g. special form applying to buildings, and broad form applying to personal property as indicated in the commercial property declarations • Commercial property conditions – The commercial property conditions apply to all coverage forms included in a commercial property coverage part, unless a coverage form contains a condition to the contrary • Endorsements – Many endorsements are available to tailor commercial property coverage to meet the specialized needs of particular insureds Building and personal property (BPP) coverage form • The building and personal property coverage form (BPP) is the most commonly used commercial property coverage form. It is designed to provide coverage for physical damage to buildings and personal property used for business purposes • BPP includes nine sections: (i) Covered property, (ii) Property not covered, (iii) Additional coverages, (iv) Coverage extensions, (v) Limits of insurance, (vi) Deductible, (vii) Loss conditions, (viii) Additional conditions, and (ix) Optional coverages • Covered property – Three categories of property covered by BPP ∗ Buildings ∗ Business personal property of the insured ∗ Personal property of others in the custody of the insured – Coverage can be provided on any combination of these categories. The limit of insurance for each chosen category is on the declarations page – Building ∗ The policy covers buildings or structures listed and described in the declarations. The BPP’s definition of buildings include · Completed additions to covered buildings · Fixtures including outdoor fixtures · Permanently installed machinery and equipment Personal property owned by the insured and used to maintain or service the building or its premises ∗ In addition, if they are not otherwise insured, the building description covers additions, alterations, or repairs in progress, including materials, equipment, and supplies used in connection with such work (if they are located within 100 feet of the premises) – Business personal property of the insured ∗ “Your business personal property” covers personal property owned by the insured and used in the insured’s business in or on the described building or in the open (or in a vehicle) within 100 feet of the premises ∗ It includes furniture and fixtures, machinery and equipment, and stock (merchandise held in storage or for sale, raw materials and in-process or finished goods, including supplies used 7 in their packing or shipping). Business personal property also includes labor, materials or services furnished by the insured on personal property of others ∗ The insured’s interest in improvements and betterments (i.e. alterations or additions made to the building at the expense of a tenant who does not own the building and who cannot legally remove them) is also insured as business personal property. It is important to consider these expenditures when setting the amount of insurance purchased ∗ Business personal property also includes leased personal property for which the named insured has a contractual responsibility to procure coverage – Personal property of others ∗ This coverage protects the insured against loss or damage to the personal property of others while in the custody of the insured (e.g. dry cleaners, repair shops, . . . ) ∗ The BPP covers such property only while it is (i) in the insured’s care, custody or control, and (ii) in or on the building described in the declarations or within 100 feet of the premises • Property not covered – All three classes of covered property may be modified by this section for the following reasons: ∗ It may not be legal to insure some kinds of property (narcotics) ∗ Some property may not be subject to loss by the perils insured against (foundations of building) ∗ Some property can be insured more advantageously under other forms (automobiles) – Insurance is available for almost all of the items listed in the property not covered section. ISO manual rules permit removing the exclusion of some items, and limited coverage is provided for some items in the BPP coverage extensions. Other items can be insured by adding an endorsement to the BPP – Property otherwise insured is not totally excluded. The BPP still covers such property, but only in excess of the other insurance – Some coverage is provided for vehicles or self-propelled machines. BPP does cover: ∗ Vehicles manufactured, processed, or warehoused by the insured ∗ Vehicles other than autos held for sale by the insured ∗ Rowboats or canoes out of the water at the described premises ∗ Trailers, as provided in the coverage extension ∗ Unlicensed vehicles and vehicles operated principally on the described premises (since the exclusion applies only for vehicles licensed for use on public roads or operated principally away from the premises) • Additional coverages – Debris removal ∗ The coverage pays for the removal of debris of covered property only, and only from the result of a covered cause of loss ∗ The removal expenses are paid only if they are reported in writing within 180 days ∗ The maximum amount is 25% of the sum of the direct loss payment plus the deductible amount. An additional $10,000 limit per location is provided if (i) the direct loss plus debris removal expense exceeds the limits of insurance, or (ii) the debris removal expense exceeds the 25% limitation of direct losses. The $10,000 additional limit can be increased by endorsement ∗ The cost to clean up pollution caused by an insured peril is covered, except for pollutants from land or water – Preservation of property ∗ The preservation of property additional coverage extends the policy to protect the covered property while it is being moved and for up to 30 days at the new location ∗ This coverage is broader than the normal coverage under the policy. It protects against “any direct physical loss or damage” and is not limited to either the covered causes of loss or locations stipulated in the coverage form 8 ∗ The protection provided under this clause is subject to the limits of insurance stated in the declarations. Thus, no protection is provided if the limits of insurance are exhausted by payment for the physical loss – Fire department service charge ∗ The fire department service charge additional coverage pays up to $1,000 if the charges are assumed by contract prior to loss or are required by local ordinance ∗ This coverage limit is payable in addition to the limit of insurance and is not subject to any deductible – Pollutant cleanup and removal ∗ The pollutant cleanup and removal additional coverage provides limited coverage for the cleanup and removal of pollutants from land or water ∗ This additional coverage pays the insured’s expenses to extract pollutants from land or water at the described premises if the release, discharge, dispersal, seepage, migration or escape of the pollutants is the result of a covered cause of loss that occurs during the policy period ∗ The expenses must be reported in writing within 180 days after the loss. An aggregate limit of $10,000 per location applies to all such expenses that occur during each separate twelve-month period – Increased cost of construction ∗ The increased cost of construction additional coverage provides a small amount of insurance to cover increased cost to comply with ordinances or laws regulating the repair, rebuilding or replacement of covered buildings ∗ The amount of insurance is equal to 5% of the amount of insurance, up to $10,000. It is paid in addition to the policy limit and applies only if the replacement cost option has been selected. Higher limits can be obtained through an endorsement ∗ No coverage applies to (i) loss to any undamaged portion of the building, or (ii) the cost to demolish the undamaged portion of the structure and remove its debris • Coverage extensions – The protection provided by the coverage extensions section of the BPP coverage form applies only if at least 80% coinsurance or a value reporting period symbol is shown in the declarations – The amounts that may be paid under the coverage extensions are additional amounts of insurance and are not subject to the limits of insurance stated in the declarations – Newly acquired or constructed property ∗ The newly acquired or constructed property extension provides automatic coverage for a new building being constructed at the premises described in the declarations ∗ Automatic coverage is also provided for newly acquired buildings at other locations provided (i) the newly acquired building will be used for a purpose similar to the use of the building described in the declarations, or (ii) the newly acquired building will be used a as warehouse. The maximum coverage is $250,000 at each building ∗ If the policy covers business personal property, the extension also provides automatic coverage for: · Business personal property at any newly acquired location other than fairs, trade shows, or exhibitions · Business personal property located at newly constructed or acquired buildings at the location described in the declarations · Newly acquired business personal property at the described premises · The limit for this coverage is $100,000 at each building. The extension does not apply to personal property of others temporarily in the named insured’s possession (i) in the course of installing or performing work on the property, or (ii) in the course of the insured’s manufacturing or wholesaling activities ∗ This extension is temporary. Coverages terminates at the earliest of 9 – – – – – · The expiration date of the policy · 30 days after the acquisition of the new location or the start of construction of the new building · The date the insured notifies the insurer of the new location or new building ∗ Premium for the coverage is calculated from the date of acquisition or start of construction, regardless of when the insurer is notified Personal effects and property of others ∗ The personal effects and property of others extension provides a limited amount of coverage for personal effects while on the premises. However, personal effects are not covered for loss by theft ∗ The extension also covers property of others in the care, custody, or control of the insured. However, the limit on all property covered by this extension (personal effects and property of others) is $2,500 at each described location ∗ If the value of property of others is greater, insurance can be purchased on such property by showing a limit of insurance for personal property of others coverage, or by purchasing inland marine bailee coverage Valuable papers and records - cost of research ∗ The valuation provision of the BPP coverage form limits any payment for loss of valuable papers and records to the sum of (i) the cost of blank material for reproducing the records, and (ii) the cost of labor to transcribe or copy the records. It would not pay for the cost of research to reconstruct the information on the damaged or destroyed records ∗ The valuable papers and records - cost of research extension provides limited protection for the cost of research and reconstruction of the information contained on destroyed records. The limit is $2,500 at each described location unless a higher limit is shown in the declarations Property off-premises ∗ The property off-premises extension provides up to $10,000 coverage for covered property while it is away from the premises ∗ The extension also covers (i) property in storage at a location leased after the inception of the current policy, and (ii) property at any fair, trade show, or exhibition ∗ This extension does not apply to property in or on a vehicle or in the custody of the insured’s salesperson unless at a fair, trade show, or exhibition Outdoor property ∗ The outdoor property extension covers loss to outdoor fences, radio and TV antennas, signs not attached to buildings, and trees, shrubs, and plants ∗ The coverage for outdoor property has its own list of covered causes of loss. It covers only loss by fire, lightning, explosion, riot or civil commotion, and aircraft. Windstorm, vehicles, and vandalism are not covered ∗ The limit of coverage is $1,000, including debris removal expense, but not more than $250 may be applied to any one tree, shrub, or plant. these limits apply regardless of the types and number of items lost or damaged in one occurrence ∗ Coverage for more perils can be provided on outdoor property by adding a description and limit to the policy declarations as a separate item, or by covering the property under an inland marine form Non-owned detached trailers ∗ The non-owned detached trailers extension permits the insured to extend the business personal property coverage to trailers that (i) are used in the insured’s business, and (ii) are in the insured’s care, custody, or control ∗ In addition, the insured must have a contractual responsibility to pay for loss or damage to the trailer, and the trailer must be detached from any motor vehicle. Hitching and unhitching are not covered 10 ∗ The limit of liability is $5,000 unless a higher limit is shown in the declarations, and the coverage is excess over any other insurance covering the trailer ∗ Increased limits can be provided by adding a description and limit to the policy declarations, or by covering the property under an inland marine form 11 Flitner & Trupin - Chapter 3: Commercial property insurance, part II Causes-of-loss forms • The first insurance policies covering buildings covered loss by fire only. Lightning was added as an insured cause of loss, as well as some other perils • In the 1930s, several additional perils (windstorm, civil commotion, smoke, hail, aircraft, vehicles, explosion, and riot) were grouped into an endorsement known as “extended coverage”. This endorsement was added to fire insurance policies to provide a combination known as “fire and extended coverage” • Extended coverage was followed by “broad form” coverage which added even more perils, and “special form” coverage, which covered all perils except those specifically excluded • Fire and extended coverage has been superseded by “basic form” coverage, which includes the fire and extended coverage perils plus a few others • The extended coverage still has some importance for older mortgages, leases, and contracts. However, the basic, broad or special form is an acceptable substitute • The perils covered in a contemporary commercial property policy are specified in any of the three causes-of-loss forms – Causes of loss - Basic form – Causes of loss - Broad form – Causes of loss - Special form • The special form is by far the most widely used Causes of loss - Basic form • Causes of loss - basic form: Form that covers fire, lightning, explosion, windstorm, hail, smoke, aircraft, vehicles, riot, civil commotion, vandalism, sprinkler leakage, sinkhole collapse, and volcanic action • The causes of loss - basic form consists principally of two sections – Section A, a listing of several covered causes of loss (aka perils) which are subject to some definitions and limitations expressed within that listing – Section B, a set of exclusions that further limit the application of the covered perils • Covered causes of loss – Fire and lightning ∗ The courts have generally held that fire insurance covers only damage by “hostile fire” (i.e. fire that is not in a place where fire is intended to be: the policy would not cover damage caused by fire in a stove, but it would cover damage caused by a fire that escaped from a stove) ∗ The peril of lightning does not include artificially generated electrical current – Explosion ∗ No formal definition of explosion, but explosion of gases in a furnace (combustion explosion) is covered. However, excluded are · The rupture of pressure relief valves · The rupture of a building resulting from the expansion or swelling of its contents caused by water absorption – Windstorm or hail ∗ Covered wind or hail damage does not include damage caused by frost, cold weather, ice (other than hail), snow, or sleet, even if driven by wind ∗ Also, damage by rain, snow, sand, or dust to the interior of a building or property inside the building is not covered unless the building fist sustains exterior damage by wind, and the rain, snow, sand or dust enters through the damaged part – Smoke ∗ Covered smoke damage must be sudden and accidental ∗ There is no coverage for damage by smoke from agricultural smudging or industrial operations – Aircraft or vehicles 12 ∗ Covered damage cause by aircraft must result from actual physical contact with the aircraft or objects falling from it ∗ Spacecraft and self-propelled missiles are considered to be aircraft, but the war exclusion eliminates coverage for damage by missiles in time of war ∗ Covered vehicle damage must result from accidental physical contact with a vehicle or an object thrown by the vehicle ∗ No coverage for damage caused by vehicles owned by the insured or operated in the insured’s business – Riot or civil commotion ∗ No definition of riot and civil commotion, but in most states, a riot is defined by law as a violent public disturbance by three or more persons ∗ The policy states that riot or civil commotion includes acts by striking workers while occupying the insured premises as well as looting occurring at the time and place of a riot or civil commotion – Vandalism ∗ Covers the willful or malicious damage to or destruction of property ∗ The vandalism peril does not cover loss by theft, but damage to the building caused by the entry or exit of burglars is covered – Sprinkler leakage ∗ Covers the escape of any substance from an automatic fire protection or extinguishing system ∗ The collapse of a tank constituting a part of such a system is covered, as is the cost of repairing damage to the system if the damage results in the sprinkler leakage or if the damage is caused by freezing ∗ Also covered is the cost to tear out and replace any part of the building of structure to repair damage to the automatic sprinkler system – Sinkholes ∗ Damage to buildings or other property is covered, but the cost of filling the sinkhole is not ∗ Collapse into other underground openings, such as mineshafts, is not covered – Volcanic action ∗ Covers damage caused by lava flow, ash, dust, particulate matter, airborne volcanic blast, or airborne shock waves resulting from a volcanic eruption ∗ All eruptions occurring within any 168h period are considered a single occurrence, and thus subject to only one deductible and one policy limit ∗ The cost to remove ash, dust, or particulate matter is not covered except for the ash, dust, or particulate matter that caused loss to insured property • Exclusions – Ordinance or law ∗ Eliminates coverage for these additional consequential losses that result from the enforcement of building ordinances or laws ∗ The excluded losses can be covered by an endorsement for an additional premium – Earth movement ∗ Damage caused by earth movement (earthquake, landslide, mine subsidence) other than sinkhole collapse are not covered ∗ Damage by fire or explosion caused by earth movement is covered ∗ Earthquake coverage (also covers land shocks and movement resulting from volcanic eruption) can be added for an additional premium – Governmental action ∗ Seizure or destruction by governmental action is not covered ∗ This exclusion does not apply to the destruction of property by governmental order to stop the spread of a covered fire 13 – Nuclear hazard ∗ The basic form excludes loss caused by nuclear reaction, radiation, or radioactive contamination ∗ Loss by fire resulting from these causes is covered ∗ Some coverage for radioactive contamination can be provided by endorsement – Utility services ∗ The basic form excludes loss caused by power failure or failure of other utility service if the damage causing such failure occurs away from the described premises ∗ However, loss from a covered peril resulting from power failure is covered ∗ Coverage for off-premises service interruption caused by an insured cause of loss is available by endorsement – War and military action ∗ Eliminates coverage for loss caused by war, revolution, insurrection, or similar actions – Water ∗ Insurers exclude flood losses from commercial property forms. The water exclusion eliminates coverage for damage caused by · Flood, surface water, tides and tidal waves · Mudslide or mudflow · Backing up of sewers, drains or slumps · Underground water pressing on, or flowing or seeping through, foundations, walls, doors, windows, or other openings ∗ Damage by fire, explosion, or sprinkler leakage caused by any of the above is covered. the exclusions listed above apply whether or not the loss event results in widespread damage or affects a substantial area – Other exclusions 1. Artificially generated electric currents. However, if a fire results, the fire damage is covered 2. Rupture of water pipes unless caused by a covered cause of loss (does not apply to sprinkler leakage) 3. Leakage of water or steam from any part of an appliance or system containing water or steam (other than sprinkler system), unless caused by a covered cause of loss 4. Explosion of steam boilers, pipes, turbines or steam engines owned/leased/operated by the insured. However, if such an explosion causes a fire or a combustion explosion, the resulting damage is covered 5. Mechanical breakdown, including rupture or bursting caused by centrifugal force 6. Loss resulting from the neglect of the insured to use all reasonable means to save and preserve property at and after the time of the loss. This exclusion reinforces the insured’s duty to protect covered property after a loss 7. Some of these excluded exposures can be insured under equipment breakdown insurance Causes of loss - Broad form • Causes of loss - broad form: Form that covers basic form perils plus (i) falling objects, (ii) weight of snow, ice, or sleet, (iii) water damage, and (iv) collapse caused by certain perils (as an additional coverage) • Falling objects – The coverage for falling objects does not include damage to personal property in the open – The peril also does not cover damage inside a building unless the roof or an outside wall is first damaged by a falling object • Weight of snow, ice, or sleet – Does not cover damage to personal property in the open • Water damage – Covers loss from leakage of water or steam resulting from the breaking apart or cracking of a 14 plumbing, heating, air conditioning, or other system/appliance that is located on the described premises and contains water or steam – If the building is covered property, the form also covers the cost to tear out and replace any part of the building to repair damage to the appliance or system that leaked – The water damage peril specifically excludes 1. The cost to repair any defect that caused the loss 2. Gradual damage that occurs over 14 days or more 3. Discharge or leakage from an automatic sprinkler system 4. Discharge or leakage from a slump, including overflow because of slump pump failure 5. Discharge or leakage from roof drains, gutters, downspouts, or similar fixtures and equipment – Does not cover damage resulting from freezing unless the insured has made a reasonable effort to heat the building or drained the system and shut off the water supply • Additional coverage - Collapse – Covers loss resulting from collapse of a building or any part of a building due to ∗ Any covered cause of loss under the broad form ∗ Hidden decay, unknown to the insured ∗ Hidden insect or vermin damage, unknown to the insured ∗ Weight of people or personal property ∗ Weight of rain that collects on a roof ∗ Use of defective materials or construction methods if the collapse occurs during the course of construction (for a completed building, only the causes above are covered) – Collapse is specifically and narrowly defined as an abrupt falling down or caving in of a building or part of a building that can no longer be occupied for its intended purpose (a damaged building still standing is not covered) – The additional coverage for collapse also covers loss to property caused by the collapse of personal property inside the building if the collapse results from one of the cause listed above – Certain types of property (primarily outdoor property) are covered for collapse only if the damage results from the collapse of an insured building caused by one of the causes listed above • Glass coverage – Beginning with the 2000 revision of commercial property forms, glass that is covered property is now covered up to the policy limit (subject to the policy deductible to eliminate small losses) for all covered perils, including vandalism – ISO therefore withdrew its separate glass coverage form. Some non-ISO commercial property policies continue to place restrictions on glass coverage, and many leases require tenant to provide full glass coverage without any deductible. Separate glass coverage is available from insurers Causes of loss - Special form • Causes of loss - special form: Form that covers “risks of direct physical loss”, subject to the form’s exclusions and limitations, aka “all-risks” coverage • Advantages of the special form – Certain causes of loss that are omitted or excluded under the broad form are covered under the special form. E.g. the special form covers theft of covered property under a wide variety of circumstances not limited to looting during riot or civil commotion as with the basic/broad forms – By covering any risk of loss other than those specifically excluded, the special form covers losses that the insured might not have anticipated – The special form shifts the “burden of proof” from the insured to the insurer • Exclusions and limitations – The special form contains most of the exclusions of the basic and broad forms, including many (but not all) of the limitations expressed in the descriptions of the basic and broad covered causes of loss – Examples of broader special form coverage 15 ∗ The special form does not contain an exclusion to the vehicle peril for damage cause by vehicles owned/operated by the named insured, as in the basic/broad forms ∗ The special form covers loss caused by water that enters a covered building because of “ice dam” in the building gutters, which would be excluded under basic/broad forms – Exclusions unique to the special form ∗ Many hard to insure perils that are not covered under the basic and broad forms (because they are not named as covered causes of loss) must be specifically excluded in the special form, e.g. · Wear and tear · Rust, corrosion, fungus, decay, or deterioration · Smog · Settling, cracking, shrinking, or expansion · Infestations and waste products of insects, birds, rodents, or other animals · Damage to personal property by dampness or dryness of atmosphere, changes to extremes in temperatures, or marring or scratching ∗ However, the insurer will pay for losses caused by a “specified cause of loss” that results from the excluded peril, where “specified causes of loss” include all of the causes of loss insured under the broad form ∗ The special form also excludes loss caused by 1. Weather conditions that contribute to other excluded causes of loss (flood damage, driven by high winds is excluded) 2. Acts or decisions, including the failure to act or decide, of any person, group, organization, or governmental body (flood damage, due to local authority failure is not covered) 3. Faulty or inadequate planning, zoning, surveying, siting, design, specifications, workmanship, repair, construction, renovation, remodeling, grading, compaction, materials, or maintenance 4. If one of these excluded causes of loss results in a covered cause of loss, the insurer will pay the loss resulting from the covered cause ∗ Another exclusion unique to the special form eliminates coverage for the release, discharge, or dispersal of pollutants. However, the exclusion does not apply to any release of pollutants caused by any of the “specified causes of loss”, nor does it apply to chemicals applied to glass ∗ Loss to the following kinds of property is covered only if it is caused by “specified causes of loss” 1. Valuable papers and records 2. Animals, and then only in the event of their death 3. Fragile article if broken 4. Builder’s machinery and equipment owned/held by the insured unless on or within 100 feet of the described premises – Theft-related exclusions ∗ The special form does not contain a general exclusion of theft, and thus it covers any theft of covered property not specifically excluded ∗ The special form excludes dishonest acts of the insured or of partners, members, officers, managers, directors, or employees of the insured. Losses resulting from employee’s dishonest acts can be covered under separate crime coverage forms ∗ The special form also excludes the voluntary surrendering of property possession resulting from a fraudulent scheme or trickery. Loss of property transferred outside the described premises on the basis of unauthorized instructions is also excluded ∗ Loss by theft of construction materials not attached as part of the building is excluded unless the materials are held for sale by the named insured. Property missing without explanation or evidenced only by an inventory shortage is not covered 16 ∗ The special form imposes limits on theft for property very attractive to thieves. Such property can be insured for higher limits under separate crime or inland marine forms · $2,500 for furs and garments with fur · $2,500 for jewelry, watches, and precious metals, but the limit does not apply to jewelry or watches valued at less than $100 · $2,500 for patterns, dies, molds and forms · $250 for stamps, tickets, and letters of credit ∗ No coverage for theft of money is provided. Separate crime coverage forms can be used for covering loss of money ∗ A theft exclusion endorsement can be attached to the policy to eliminate theft coverage when the underwriter feels that the risk is unacceptable, or when the insured wants to reduce the premium • Additional coverage - collapse – The special form contains an additional coverage for collapse that is essentially the same as the additional coverage for collapse under the broad form • Additional coverage extensions – Property in transit ∗ The property in transit extension provides up to $5,000 of additional protection for a loss to the insured’s property in transit. The property must be in or on a motor vehicle owned/leased/operated by the insured and cannot be in the custody of the insured’s sales personnel. It covers only those losses that occur within the coverage territory ∗ The transit extension does not provide special-form coverage. The perils insured against are fire, lightning, explosion, windstorm, hail, riot, civil commotion, vandalism, upset or overturn of conveying vehicle, collision and theft. The coverage for theft is limited to theft of an entire bale, case, or package by forced entry into a securely locked body or compartment of the vehicle, evidenced by marks of the forced entry ∗ Inland marine or ocean marine policy may be more appropriate to cover property in transit – Cost of tearing out and replacing ∗ A clause titled water damage, other liquids, powder or molten material damage extends coverage to pay for the cost of tearing out and replacing any part of a building necessary to repair an appliance or a system from which water or another liquid escaped ∗ The extension does not pay for the repair of any defect that resulted in the leakage ∗ It will pay for repairs to fire extinguishing equipment if the damage results in the discharge of any substance from an automatic fire protection system or is directly caused by freezing 17 Flitner & Trupin - Chapter 8: Commercial general liability insurance, part I Introduction • Commercial GL insurance: Insurance that covers many of the common liability loss exposures faced by an organization, including its premises, operations, and products • Liability loss: All costs to a person/organization due to a legal claim or suit against that person/organization • CGL coverage – Costs of investigating and defending against the claim/suit – Costs of paying damage • CGL does not cover (usually) – Costs incurred by the sued organization to reduce the chance of additional, related loss in the future – Hidden costs, including time consumed in defending against a claim and the resulting adverse publicity Legal liability • Legal liability: A legally enforceable obligation of a person/organization to pay damages to another person/organization • An organization can experience a liability loss even if it is not held legally liable (due to expenses to investigate and defend against allegation of legal liability) • A liability insurance policy obligates the insurance company to defend the insured against allegations that, if true, would be covered under the policy • Most claims are settled out of court. Thus it is important for an insurer to determine whether the insured would be held legally liable • Civil and criminal law – Civil law: The branch of the law that provides a means to settle dispute between parties – Criminal law: The branch of the law that imposes penalties for wrongs against society – Insurance is not available for criminal liability since it would be against public policy and prohibited by law – Civil liability can be based on torts, contracts, or statutes • Legal liability based on torts – A tort is a civil wrong against another person other than a breach of contract. Three broad types: (i) negligence, (ii) intentional torts, and (iii) strict liability torts – Negligence: The tort of negligence is based on four elements: (i) a duty owed to another person, (ii) a breach of that duty, (iii) the occurrence of injury or damage, and (iv) a close causal connection between the negligent act and the resulting harm – Strict liability: Liability that is imposed even though the defendant acted neither negligently, nor with intent to cause harm (e.g. abnormally dangerous instrumentalities, ultrahazardous activities, and dangerously defective products) • Legal liability based on contracts – Liability based on contracts can arise out of either a breach of a contract, or an agreement to assume the liability of another party – Assumption of liability: Such a provision is often called a “hold harmless agreement” because it requires one party to hold harmless and indemnify the other party against liability arising from the activity or product subject of the contract – Not all breach of contracts are covered under CGL and contractual liability is commonly covered • Legal liability based on statutes – A statute is a written law passed by a legislative body, at either the federal or state level. Written laws at the local level are usually referred to as ordinances – Statutes and ordinances can modify the duties that persons owe to others, and be relevant in tort 18 action. A statute can also impose legal liability on certain persons/organizations regardless of whether they acted negligently, committed any tort, or assumed liability under a contract – This type of obligation is a form a strict liability based entirely on requirements imposed by statute rather than on tort law, e.g. workers compensation Sources of liability exposures • CGL insurance provides coverage primarily for liability losses arising from premises, operations, products, and completed operations, although it also covers other exposures • Premises liability exposure – Exposure to liability for injury or damage due to the ownership, occupancy, or use of premises – The standard of care imposed on an owner/occupant, landlord, or tenant is that the property be maintained as a reasonable and prudent person would maintain it • Operations liability exposure – Exposure to liability for injury or damage due to activities in addition to the occupancy of property – Exposure usually associated with manufacturers, processors, or contractors • Products liability exposure – Exposure to liability for injury or damage due to products sold or distributed by the exposed party – Product liability can be imposed on a manufacturer, seller, or distributor of products under several different legal theories, including negligence, breach of contract, and strict liability in tort • Completed operations liability exposure – Exposure to liability for injury or damage due to work completed by the exposed party – Traditionally linked with the products liability exposure • Other CGL exposures: Liability assumed under certain contracts, and liability for some intentional torts (such as libel and slander) Overview of CGL insurance • CGL insurance can be viewed as the foundation for most organization’s liability insurance programs • The most commonly used standard form is the ISO form which can be combined with CGL declarations and any applicable endorsements to form a CGL coverage part. The CGL coverage part can be either included in a commercial package policy or issued as a monoline policy • The CGL coverage form comes in two versions: (i) Occurrence form , and (ii) Claims-made form. The two forms differ only in their provisions respecting these coverage triggers • The CGL coverage form provides three separate coverages – Coverage A - Bodily injury and property damage liability – Coverage B - Personal and advertising injury liability – Coverage C - Medical payments Coverage A - Bodily injury and property damage liability • Coverage A insuring agreement – The coverage A insuring agreement consists of two distinct promises made by the insurer: (i) To pay damages on behalf of the insured, and (ii) To defend the insured against claims or suits seeking damages covered under the policy • Insurer’s duty to pay damages – The insuring agreement imposes several conditions on the insurer’s duty to pay damages. All of the following conditions must be fulfilled 1. The insured must be legally obligated to pay damages – Legal liability is a question that can be settled either in court or by the insurer’s claim investigation – The basic types of damages are: (i) special damages (for out-of-pocket costs), (ii) general damages (intangibles like pain and suffering), and (iii) punitive damages (some states do not 19 allow insurers to pay such damages) 2. The damages must result from “bodily injury” or “property damage” – CGL defines BI as “bodily injury, sickness or disease sustained by a person, including death resulting from any of these at any time” – Damages because of BI include damages for care, loss of services, or death. Damages for pain and suffering are part of BI – PD is defined as (i) physical injury to tangible property, including resulting loss of use, and (ii) loss of use of tangible property that is not physically injured – For the purpose of PD definition, electronic data is not tangible property. Coverage for loss of electronic data can be added to the CGL by endorsement 3. The policy must apply to the BI or PD – The insurer is not obligated to pay damages if any of the Coverage A exclusions applies to the claim or if the claim is not covered for any other reason 4. The BI or PD must be caused by an “occurrence” – An occurrence is defined as an accident, including continuous or repeated exposure to substantially the same general harmful conditions – Unintended results of intentional acts generally qualify as accidents 5. The occurrence must take place in the “coverage territory” – The coverage territory that applies to most claims is the United States (including its territories and possessions), Puerto Rico, and Canada – International waters and airspace are included if the injury/damage occurs in the course of travel or transportation between places included in the basic territory coverage – The coverage territory also includes the entire world with respect to (i) Goods or products made or sold by the named insured in the basic coverage territory, and (ii) Activities of a person whose home is in the basic territory but who is away for a short time while pursuing the named insured’s business 6. The BI or PD must occur during the policy period – The occurrence version of the CGL requires that the BI or PD must occur during the policy period, even if the claim is made many years later – A trigger-related provision was added in 2001 to reinforce the idea that if any insured became aware of injury or damage before the policy took effect, it would be deemed to have occurred before the policy period and would not be covered (This provision is referred to as the continuous or progressive injury provision, or the Montrose provision) – The claims-made version of the CGL requires the claims to be made during the policy period • Insurer’s duty to defend – The coverage A insuring agreement expresses the insurer’s right and duty to defend the insured against any suit seeking damages for BI or PD to which the insurance applies – The policy defines the word “suit” to include arbitration or other alternative dispute resolution proceedings, as well as formal lawsuits – The duty to defend exists even if the allegations are later proved to be groundless, false, or fraudulent. As long as one of the alleged acts or omissions is conceivably covered, the insurer is obligated to defend the insured against the entire complaint • Coverage A exclusions – CGL has 15 exclusions, some of which contain exceptions that restore coverage for certain types of claims. Many of the exclusions eliminate coverage for exposures customarily insured under other policies, or that can be insured via endorsements for additional premium. Other exclusions deal with exposures that are uninsurable – Expected or intended injury ∗ The exclusion does not apply to BI resulting in the use of reasonable force to protect persons or property 20 – Contractual liability ∗ This exclusion applies only if the liability would not have existed in the absence of the contract ∗ The exclusion does not apply to liability assumed under an “insured contract” (a contract under which liability assumed by the insured is covered in the CGL) if the BI or PD occurs after the contract or agreement is executed ∗ Insured contracts exclude: (i) contracts to indemnify a railroad for BI or PD arising from contruction/demolition operations, (ii) contracts to indemnify architects, engineers, or surveyors ∗ CGL obligates the insurer to pay reasonable attorney fees and necessary litigation expenses (in addition to the damages) assumed by the insured under an insured contract. However, such expenses paid are treated as “damages” and thus are subject to the policy limits (regular defense costs incurred in defending the insured against direct claims are paid in addition to policy limits) – Liquor liability ∗ This exclusion applies only to insureds who are in the business of manufacturing, distributing, selling, serving or furnishing alcoholic beverages ∗ It eliminates coverage if liability arises from causing or contributing to the intoxication of any person, from furnishing alcoholic beverages to a person under the legal drinking age, or otherwise violating the laws governing the sale and distribution of such beverages – Workers compensation and employers liability ∗ Exclusion d eliminates coverage for obligations of the insured under any workers compensation, disability benefits, unemployment compensation, or similar law ∗ Exclusion e eliminates coverage for BI to any employee of the insured if the injury arises out of and in the course of employment, but does not apply to liability assumed under an insured contract ∗ “Employees” include “leased workers” but not “temporary workers” , i.e. exclusion e does not apply to injuries to temporary workers – Pollution ∗ Broadly eliminates coverage for pollution liability claims related to the insured’s premises and operations. The exclusion is virtually absolute with regard to the insured’s premises, sites, or locations ∗ However, coverage is provided for: (i) BI sustained in a building and caused by smoke, fumes, vapor, or soot from the building’s heating equipment, (ii) BI or PD caused by heat, smoke, or fumes from a hostile fire, (iii) BI or PD resulting from the accidental escape of fuels, lubricants, or other operating fluids needed to perform the normal functions of mobile equipment, and (iv) BI or PD sustained in a building and caused by the release of gases, fumes, or vapors from materials brought into the building not in connection with operations from the named insured ∗ The exclusion does not apply to BI or PD resulting from pollution caused by the insured’s products or completed operations away from the insured’s premises – Aircraft, auto, and watercraft ∗ Eliminates coverage for BI or PD arising from the ownership, maintenance, use, loading or unloading of any aircraft, auto (excluding mobile equipment), or watercraft ∗ Some coverage is provided through the following exceptions: (i) watercraft while ashore on the insured’s premises, (ii) nonowned watercraft shorter than 26 feet and not being used to carry persons or property for a fee, (iii) liability assumed under and insured contract for the ownership, maintenance, or use of aircraft or watercraft (but not autos), (iv) operation of certain types of equipment attached to autos, and (v) parking an auto on or next to the insured’s premises if the auto is not owned by, rented to, or loaned to any insured (e.g. valet parking is covered) 21 – Mobile equipment ∗ The CGL form generally covers liability arising out of the ownership, maintenance, or use of mobile equipment, except for: (i) the transportation of mobile equipment by an auto that is owned, operated, rented, or borrowed by an insured, and (ii) The use of mobile equipment in a prearranged racing, speed, or demolition contest or in a stunting activity – War ∗ Excludes liability resulting from war if the liability is assumed under a contract or other type of agreement – Damage to property ∗ Eliminates coverage for damage to any of 1. Property owned, rented, or occupied by the named insured 2. Premises the named insured has sold, given away, or abandoned if the damage arises out of any part of such premises 3. Property loaned to the named insured 4. Personal property in the care, custody, or control of an insured 5. That particular part of any real property on which work is being done by the named insured, if the damage arises from the work 6. That particular part of any property that must be restored, repaired, or replaced because the named insured’s work was incorrectly performed on it ∗ Limited coverage is provided for PD (other than by fire) to premises, including contents, rented to the named insured for seven or fewer consecutive days – Insured’s products and work ∗ Damage to your product: Exclusion k eliminates coverage for any damage to the insured’s product if the damage results from a defect in any part of the product ∗ Damage to your work: Exclusion l applies to claims for PD to the insured’s completed work, except for work done by a subcontractor ∗ Damage to impaired property or property not physically injured: Exclusion m eliminates coverage if the damage arises from (i) a defect in the insured’s product or work, or (ii) failure of the insured or anyone acting on behalf of the insured to complete a contract or agreement in accordance with its terms. this exclusion also eliminates coverage for loss-of-use claims (unless it arises out of sudden and accidental damage to the insured’s product or work) ∗ recall of products, work, or impaired property: Exclusion n eliminates coverage for any loss, cost, or expense resulting from loss of use, withdrawal, recall, inspection, repair, replacement, adjustment, removal, or disposal of (i) the insured’s product, (ii) the insured’s work, or (iii) impaired property – Personal and advertising injury ∗ The final exclusion under Coverage A eliminates coverage (under coverage A only) for BI arising out of “personal and advertising injury” since they are covered under Coverage B – Fire legal liability coverage ∗ An exception to exclusions c through n of Coverage A grants coverage for fire damage to premises rented to or temporarily occupied by the named insured ∗ This coverage is subject to the “Damage to premises rented to you” limit shown in the policy declarations Coverage B - Personal and advertising injury liability • Coverage B of the CGL form insures against claims based on torts such as libel, slander, and wrongful eviction • Coverage B insuring agreement – The insurer agrees to pay those sums that the insured becomes legally obligated to pay as damages, and to defend the insured against any suit seeking such damages. Coverage B responds to claims for “personal and advertising injury” 22 – Personal and advertising injury: Injury, including consequential “bodily injury”, arising out of one or more of the following offenses ∗ False arrest, detention, or imprisonment ∗ Malicious prosecution ∗ The wrongful eviction from, wrongful entry into, or invasion of the right of private occupancy of a room, dwelling, or premises that a person occupies, committed by or on behalf of its owner, landlord or lessor ∗ Oral or written publication, in any manner, of material that slanders or libels a person or organization or disparages a person/organization’s goods, products, or services ∗ Oral or written publication, in any manner, of material that violates a person’s right of privacy ∗ The use of another’s advertising idea in your “advertisement” ∗ Infringing upon another’s copyright, trade dress or slogan in your “advertisement” – Injury has a broad meaning and can include not only physical harm or impairment but also mental anguish, mental injury, fright, shock, humiliation, and loss of reputation – To be covered, a personal and advertising injury offense must be committed within the CGL coverage territory, including worldwide coverage for offenses taking place through the internet or similar electronic means of communication – The coverage trigger for Coverage B is a covered offense committed during the policy period • Coverage B exclusions 1. Injury caused by or at the direction of the insured with the knowledge that the act would violate the rights of another person and inflict personal and advertising injury 2. Injury arising out of oral or written publication of material, if done by or at the direction of the insured with knowledge of its falsity 3. Injury arising out of publication of material whose first publication took place before the beginning of the policy period (or before the retroactive date for the claims-made form) 4. Injury arising out of a criminal act committed by or at the direction of the insured 5. Injury for which the insured has assumed liability in a contract or agreement 6. Injury arising out of a breach of contract 7. Injury arising out of the failure of goods, products, or services to conform with any statement of quality or performance made in the named insured’s advertisement 8. Injury arising out of the wrong description of the price of goods, products, or services stated in the named insured’s advertisement 9. Injury arising out of the infringement of copyright, patent, trademark, trade secret, or other intellectual property rights (exclusion does not apply to the named insured’s advertisement) 10. Injury committed by an insured whose business is any of: advertising, broadcasting, publishing, or telecasting; designing or determining the content of websites for others (this exclusion does not apply to false arrest, malicious prosecution, or wrongful eviction). Organizations engaged in the businesses listed above need to obtain special policies covering their activities 11. Injury arising out of an electronic chatroom or bulletin board that the insured hosts, owns, or controls 12. Injury arising out of the unauthorized use of another organization’s name or product in the named insured’s email address, domain name, or metatag 13. Injury arising out of the actual, alleged, or threatened discharge of pollutants at any time (no exceptions) 14. Any loss, cost, or expense arising out of (i) any request, demand, or order to test for, monitor, or clean up pollutants, or (ii) any claim or suit by or on behalf of a governmental authority for damages because of testing for, monitoring, or cleaning up pollutants Supplementary payments • The supplementary payments section of the CGL coverage form supplements the insuring agreements 23 for Coverage A and B by describing the specific items that the insurer will pay in addition to damages • The supplementary payments are payable in addition to the limits of insurance that apply to CGL coverage. However, the insurer’s obligation to pay these supplementary payments ends as soon as the applicable limit of insurance has been used up in paying damages for judgments or settlements • The supplementary payments consist of – All expenses incurred by the insured, such as fees for attorneys, witness fees, cost of police reports, ... – Up to $250 for the cost of bail bonds required because of accidents or traffic law violations involving any covered vehicle (typically mobile equipment) – The cost of bonds to release any property of the insured’s held by a plaintiff to ensure payment of any judgment that may be rendered against the insured – Reasonable expenses incurred by the insured at the insurer’s request including loss of earnings (up to $250 a day) if the insured must miss work to testify, attend court, or otherwise assist in the defense – Court costs or other costs (other than actual damages) assessed against the insured in a suit – Interest on judgment awarded against the insured, either prejudgment or postjudgment interest. However, if the insurer offers to pay the applicable limit of insurance to a third-party claimant, the insurer will not pay any prejudgment interest for the period of time after the offer is made • The contractual liability exclusion states that any defense costs paid to an indemnitee (a person/organization that the insured has agreed to hold harmless) under an insured contract are payable within policy limit. In contrast, the supplementary payments provision states that the insurer will pay an indemnity defense costs in addition to policy limits if an indemnitee and an insured are both named as parties in the same suit Coverage C - Medical payments • Medical payments coverage is not liability insurance, because it pays regardless of whether the insured is legally liable • The coverage provides a modest amount of insurance for settling minor injury cases without having to make a determination of liability, providing a means of making prompt settlements avoiding possibly larger liability claims • Coverage C insuring agreement – The insurer agrees to pay medical expenses (including by definition funeral expenses) for BI caused by an accident occurring on or next to premises that the insured owns or rents. BI caused by an accident occurring away or next to the insured’s premises is covered if the accident results from the named insured’s operations – The accident must occur in the CGL coverage territory and during the policy period – The medical expenses must be incurred and reported to the insurer within one year after the date of the accident – An injured person who wishes to receive medical payments coverage must agree to be examined by a physician designated by the insurance company • Coverage C exclusions – Any insured (other than a volunteer worker) – Anyone hired to do work for an insured or for a tenant of an insured – A person injured on that part of the named insured’s premises which the person normally occupies – A person entitled to WC benefits for the injury – A person injured while taking part in athletics – Medical payments coverage also does not apply to BI included within the products-completed operations hazard, BI excluded under Coverage A, or BI caused by war 24 Flitner & Trupin - Chapter 9: Commercial general liability insurance, part II Who is an insured ? • Many different persons or organizations may be insured under CGL, including: (i) Named insured, (ii) Employees of the named insured, and (iii) Other persons and organizations • Named insured and related parties – The named insured may be an individual, a partnership, a joint venture, a corporation, a limited liability company, or a trust – If the named insured is an individual, his spouse is also insured. However, coverage applies only to claims arising from conduct of a business owned solely by the named insured. The named insured and spouse are not covered for their nonbusiness activities – If the named insured is a partnership or joint venture, all partners and members and their spouses are insureds, but only for liability claims arising out of the conduct of the business of the partnership or joint venture – If the named insured is a limited liability company, the named company is an insured, as well as 1. The members of the company, but only with respect to the conduct of the named insured’s business 2. The managers of the company, but only with respect to their duties as managers of the named insured – If the named insured is an organization other than partnership, joint-venture or LLC, then all executive officers, directors, and stockholders are insureds, but only with respect to their liability as officers, directors, or stockholders – If the named insured is a trust, the named trust is an insured. The named insured’s trustees are also insureds, but only with respect to their duties as trustees • Employees and volunteer workers of the named insured – Employees and volunteer workers of the named insured are covered for liability claims arising from their duties as such – However, an employee or volunteer worker is not an insured for ∗ BI or personal and advertising injury to the named insured, to the named insured’s partners or members, or to a co-employee while in the course of his duties ∗ BI or personal and advertising injury arising out of the employee’s providing or failing to provide professional health care services ∗ PD to property owned, occupied, or used by any of the following: the named insured, the named insured’s employees/volunteer workers, or the named insured’s partners/members • Other persons and organizations – Real estate managers: Any person or organization acting as real estate manager for the named insured is an insured, only while serving as real estate manager for the named insured – Legal representatives: Any person having temporary custody of the named insured’s property, or being a legal representative is also an insured, but only with respect to his duties as legal representative – Mobile equipment operators: CGL insures certain additional persons for liability claims arising from operating mobile equipment registered in the name of the named insured 1. Any person while driving the named insured’s mobile equipment along a public highway with the permission of the named insured 2. Any other person or organization responsible for the conduct of the driver Coverage applies only if liability arises from operating the equipment and only if no other insurance is available to the person or organization. Coverage does not apply to BI to a co-employee of the driver, or to PD to property owned by, rented to, in the charge of, or occupied by the named insured or the employer of the driver – Newly acquired organizations ∗ If the named insured acquires or forms a new organization during the policy period, the new 25 organization qualifies as a named insured and is covered for 90 days or to the end of the policy period ∗ This provision does not extend to partnerships, joint ventures, or LLCs not named in the policy ∗ Coverage A and coverage B do not apply to BI, PD or personal and advertising injury arising out of any incident committed before the organization was acquired or formed Limits of insurance • CGL coverage is subject to the following limits of insurance: (i) General aggregate limit, (ii) Productscompleted operations aggregate limit, (iii) Personal and advertising injury limit, (iv) Each occurrence limit, (v) Damage to premises rented to you limit, and (vi) Medical expense limit. The dollar amount of each limit is shown on the CGL declarations page • Aggregate limits – An aggregate limit is the most the insurer will pay under a policy for the sum of covered claims during the policy period – When an aggregate limit is exhausted by payment of applicable claims, the insurer is no longer obligated to pay damages or defend claims subject to that aggregate limit – Aggregate limits are restored when the policy is renewed for a new policy period – The CGL contains two aggregate limits 1. The general aggregate limit is the most the insurer will pay for the sum of ∗ Damages under Coverage A except for damages included in the “products-completed operations hazard” ∗ Damages under Coverage B ∗ Medical expenses under Coverage C 2. The products-completed operations aggregate limit is the most the insurer will pay under Coverage A for damages included in the “products-completed operations hazard”, i.e. it includes all BI and PD occurring away from premises owned or rented by the named insured and arising out of the named insured’s product or work, but excludes ∗ Products that are still in the named insured’s physical possession ∗ Work that has not been completed or abandoned • Personal and advertising injury limit – The personal and advertising injury limit is the most the insurer will pay for the sum of all personal and advertising injury to one person or organization – All sums paid under this limit reduce the general aggregate limit • Each occurrence limit – The each occurrence limit is the most the insurer will pay for the sum of the following arising out of a single occurrence, regardless of the number of persons insured, the number of claims or suits brought, or the number of persons or organizations making claim 1. Damages for BI and PD under Coverage A 2. Medical expenses under Coverage C – All sums paid under this limit reduce the general aggregate limit or the products-completed operations aggregate limit, depending on the nature of the claim • Damage to premises rented to you limit – The damage to premises rented to you limit is the most the insurer will pay under Coverage A for either (i) damage by a cause other than fire to any one premises rented to the named insured, or (ii) damage by fire to any one premises rented to the named insured or temporarily occupied by the named insured with the owner’s permission – All sums paid under the damage to premises rented to you limit are subject to the each occurrence limit and also reduce the general aggregate limit • Medical expense limit – The medical expense limit is the most the insurer will pay for coverage C medical expenses 26 resulting from BI to one person – All sums paid under the medical expense limit are subject to the each occurrence limit and also reduce the general aggregate limit CGL conditions • Bankruptcy – Bankruptcy or insolvency or the insured does not relieve the insurer of any of its policy obligations • Duties in the event of occurrence, offense, claim or suit – If the insured does not perform the duties required by this condition, the insurance company may be relieved of its duty to defend and pay claims – Whenever the named insured becomes aware of an occurrence that may result in a claim, notice must be given asap. The notice (oral or written) should state 1. How, when, and where the occurrence happened 2. The names and addresses of any injured persons and any witnesses 3. The nature and location of any damage or injury resulting from the occurrence – When a claim or suit is actually brought against any insured, the named insured must 1. Record the details of the claim/suit and the date received 2. Notify the insurer in writing asap – The named insured is required to 1. Immediately forward to the insurer copies of any legal papers received in connection with the suit 2. Authorize the insurer to obtain any legal records or other documents 3. Cooperate with the insurer in the investigation, settlement, or defense against the suit 4. Assist the insurer in any action against any third party that may be liable to the insured because of the injuries or damage for which claim is made – Finally, no insured may make voluntary payment, assume any obligation, or incur any expense without the insurer’s consent. The only exception is that the insured may incur expenses for first aid at the time of the occurrence • Legal action against us – The legal action condition provides that no person or organization can bring the insurer as a defendant to any suit seeking damages from an insured – Some states permit third-party claimants to sue insurers directly, regardless of this provision – The condition also states that no person or organization can bring suit to enforce the CGL coverage unless that party has fully complied with all policy conditions • Other insurance – The other insurance condition explains how the amount the insurer is obligated to pay on a claim is determined if the insured has other insurance that also covers the claim. All applicable coverages are classified as either excess insurance or primary insurance – When CGL is excess ∗ CGL coverage is excess insurance if the other insurance is any of the following 1. Fire, extended coverage, builders risk, installation risk, or similar coverage on the named insured’s work 2. Fire insurance on premises rented to the named insured or that the named insured temporarily occupies with the owner’s permission 3. Insurance that the named insured purchases to cover its liability as a tenant for damage to premises rented to the named insured or temporarily occupied with the owner’s permission 4. Aircraft, auto, or watercraft coverage 5. Any primary insurance available to the named insured covering liability for damages arising out of premises or operations for which the named insured has been added by an endorsement as an additional insured ∗ If CGL coverage is excess, the insurer has no obligation to provide defense for any claim or 27 • • • • suit that another insurer has a duty to defend against. However, if no other insurer provides defense, the excess CGL insurer will do so, taking over the insured’s right to recover defense costs from the other insurer ∗ If a claim is covered by two or more excess insurers, they share the amount of loss in excess of all primary insurance – When CGL is primary ∗ All applicable insurance not defined as excess is considered primary and begins to pay at the first dollar of loss or when the deductible or self-insured amount is exceeded ∗ Primary insurers are obligated to provide defense for covered claims until their limits of insurance have been exhausted by the payment of settlements or judgments ∗ If two or more primary insurers cover the claim, they share the loss up to their combined limits of insurance – Methods of sharing ∗ Two methods of sharing: (i) contribution by equal shares, and (ii) contribution by limits. If all applicable policies permit contribution by equal shares, that method is used. Otherwise, contribution by limits is used ∗ Contribution by equal shares: Each insurer contributes an equal amount to the payment of the claim until the claim is fully paid or until each insurer exhausts its limit of insurance ∗ Contribution by limits: Each insurer pays that proportion of the claim that its limit bears to the total of all applicable insurance. However, no insurer will pay more than its applicable limit of insurance ∗ As a general rule, contribution by equal shares is more advantageous to the insurer with the higher limits, and contribution by limits is more advantageous to the insurer with the lower limit Premium audit – The premium audit condition requires the named insured to keep adequate records to permit correct calculation of the premium and to make such records available to the insurer on request – The named insured must promptly pay for any additional premiums resulting from the audit – If the audit shows the earned premium to be less than the original estimate, the insurer is obligated to return the excess to the named insured, subject to any policy minimum premium Representations – The representations condition states that the named insured, by accepting the policy, agrees to the following 1. The statements in the declarations are accurate and complete 2. The statements in the declarations are based on representations made by the named insured to the insurer 3. The insurer has issued the policy in reliance on the named insured’s representations Separation of insureds – The separation condition states that the insurance provided by the policy applies separately to each person insured – E.g. if one insured sues another insured, coverage is still provided for the insured who has been sued – The condition is subject to two restrictions: (i) The limits of insurance apply to all persons insured and are not increased because two or more persons are insured, and (ii) Any rights or duties specifically assigned to the first named insured are not applicable to any other insured Transfer of right of recovery against other to us – If the insured has any right to recover from any third party all or any part of a claim paid by the insurer, that right must be transferred to the insurer – The insurer’s right to subrogate arises because the insurer defends and pays damages on behalf of the insured 28 • When do we not renew – If the insurer opts not to renew the policy, it must give written notice of non-renewal to the first named insured at least thirty days before the expiration date of the policy – If the notice is mailed, proof of mailing is adequate proof of notice – Many states have adopted specific regulations that supersede this policy provision. Even if an endorsement is not attached to the policy, the regulations supersede the policy renewal provision Claims-made CGL coverage form • Claims-made trigger – In the claims-made coverage form, Coverage A and Coverage B are both subject to a claims-made coverage trigger, i.e. the first making of a claim against the insured either during the policy period or an extended reporting period provided by the policy – The claims-made form states that a claim will be deemed to have been made at the earlier of (i) when notice of the claim is received and recorded by any insured or by the insurer, or (ii) when the insurer settles the claim – The coverage form also states that notice of an occurrence is not notice of a claim • Retroactive date – An additional requirement of the claims-made form is that the injury or damage for which claim is made must have occurred on or after the policy’s retroactive date, if any, but not after the end of the policy period – The retroactive date is the date on or after which BI, PD, or a personal and advertising injury offense must occur in order to be covered – If the policy has no retroactive date, the policy covers claims first made during its policy period, regardless of when the injury occurred • Extended reporting period – An extended reporting period (aka tail) is a time period following the expiration date of a claimsmade policy. The insurer agrees to pay any claim first made during the extended reporting period if the claim is for an injury that occurred after the retroactive date and before the policy expiration date – An extended reporting period only extends the period within which claim can be made, not the period within which the injury must have occurred – The claims-made CGL form automatically includes a basic extended reporting period of five years from the policy expiration date, for no additional premium, where coverage is granted if 1. The injury occurred on or after the retroactive date, if any, and before the policy expiration date 2. The insured reported the occurrence to the insurer within sixty days after the policy expired – The claims-made CGL also permits the insured to obtain, for an additional premium, a supplemental extended reporting period, lasting indefinitely, and waiving the 60 days notice period – The supplemental tail restores the expiring policy’s aggregate limits to their original levels, but only for claims first received and recorded during the supplemental extended reporting period – The supplemental tail must be requested from the insurer in writing no later than 60 days after the policy’s expiration date, and goes into effect only when the additional premium is paid • Non-ISO claims-made forms – The ISO claims-made form has not achieved widespread acceptance – Most claims-made forms are independently developed by insurers, with differing features CGL endorsements • State endorsements – Some states have laws or regulations requiring special policy provisions – State endorsements are usually mandatory and must be attached to all policies providing coverage in the states to which they apply 29 • Exclusion endorsements – ISO provides many exclusion endorsements, all of which restrict coverage in some way – The Exclusion - Personal and advertising injury endorsement excludes Coverage B – The Exclusion - Employees and volunteer workers as insureds endorsement eliminate insured status for the named insured’s employees and volunteer workers – The Total pollution exclusion endorsement eliminates coverage for any injury, damage, or cleanup costs resulting from the actual, alleged, or threatened discharge of pollutants – The Exclusion - designated product endorsement excludes liability arising out of specified products of the insured • Classification endorsements – Many endorsements are available for adapting the CGL policy to the needs of certain classes of business organizations, either restricting or expanding coverage – E.g., the Seed merchants - coverage for erroneous delivery or mixture and resulting failure of seed to germinate endorsement, or the Exclusion - professional services - blood banks endorsements • Miscellaneous endorsements – Miscellaneous endorsements can be used to add coverages, deductibles, or insureds to a CGL policy – The Boats endorsement extend CGL coverage to any watercraft owned or used by or rented to the insured – The Deductible liability insurance endorsement enables the insured to apply deductibles to the BI and PD liability coverages – The Additional insured - vendors endorsement includes as an insured any person or organization (the vendor) specified in the endorsement – Other endorsements can be used to include such additional insureds as club members, condominium unit owners, townhouse associations, lessors of leased equipment, state or political subdivisions, users of golf carts, charitable institutions, and grantors of franchises Rating CGL coverage • The formula used to determine the premium for a CGL policy is Rate × Rate exposure = Premium • The rate depends on the nature of the insured organization and its susceptibility to liability losses. The rate exposure reflects the size of the business operations to be insured, not the type of losses to which the business is susceptible • The unit in which the rate exposure is measured is called the premium base • An insurer that writes CGL insurance develops a rate for each business classification to be insured. The classifications and their identification number, aka class code, are listed in the ISO Commercial Lines Manual (over 1000 classifications). More than one class code may apply to a given business • Two CGL rates apply for most classification 1. A premises/operations rate 2. A products/completed operations rate For organizations having little or no risk of incurring products/completed operations liability losses, only a premises/operations rate is used • Premium base – The premium base used in rating CGL coverage is also included in the classification table of the manual – Mercantile businesses are rated using a premium base of gross sales – Contracting businesses are rated on the basis of payroll – Building and premises risks (apartments and hotels) may be rated on the basis of area, gross sales, or the number of units in the building 30 – Special events (concerts, sporting events, exhibitions, . . . ) may be rated on the number of admissions to the event – Information about the organization must be gathered carefully and completely to measure rate exposure accurately – The actual premium for a CGL policy is often calculated at the end of the policy period after the rate exposure can be determined accurately • Other rating considerations – Increased limits factors are used to generate higher premiums for policies written with coverage amounts higher than the basic limits – If the insured has chosen not to buy certain coverages included automatically in the CGL form, premium credits are given for such reductions in coverage – Coverage can be written subject to a deductible, which reduces the premium – When coverage is written on a claims-made basis, the usual rates are modified by claims-made factors Miscellaneous liability coverage forms • Liquor liability coverage form – The liquor liability coverage form can be used to provide liquor liability insurance for insureds that are in the business of manufacturing, distributing, selling, serving, or furnishing alcoholic beverages and are therefore subject to the liquor liability exclusion in the CGL policy • Products/Completed operations liability coverage form – The Products/Completed operations liability coverage form can be used to provide products and completed operations coverage separately from the CGL form – This form may be used when the insured manufactures or sells a particularly hazardous product • Owners and contractors protective liability coverage form – Property owners sometimes require the contractor to provide a policy that protects them against liability for BI or PD arising out of 1. The operations of the contractor at the specified location 2. Acts or omissions of the property owner in connection with the general supervision of such operations – The Owners and contractors protective liability coverage form can be used to provide this insurance. This form automatically terminates as soon as the contractor’s work is completed or put to its intended use • Railroad protective liability coverage form – Railroad protective liability coverage is a specialized type of owners and contractors protective liability insurance – Railroads customarily require contractors working on or adjacent to railroad property to buy this coverage to protect the railroad against claims resulting from the contractor’s work • Pollution liability coverage forms – In addition to several pollution coverage endorsements, ISO coverage forms are available for insuring pollution liability arising out of designated sites and underground storage tanks • Certificate of insurance – A brief description of insurance coverage prepared by an insurer or its agent, commonly used by policyholders to provide evidence of insurance – Two problems arising from certificates of insurance for general liability insurance are (i) the requirements for notice of cancellation, and (ii) the inclusion of additional insureds 31 Flitner & Trupin - Chapter 12: Workers compensation and employers liability insurance Introduction • Workers compensation and employers liability insurance responds to two basic loss exposures faced by employers 1. The legal responsibility to pay benefits to employees as required by state WC statutes 2. The cost to defend against, and possibly pay, liability claims made against the employer on account of BI to an employee, not covered by WC laws Workers compensation statutes • Before the enactment of WC statutes, it was up to the employee to establish that the employer was at fault for the injury. The following defenses were available to employers: – The employee contributed to the accident – The employee assumed the risk of injury when he took the job – A fellow worker was responsible for the accident • WC statutes provide “no-fault” protection by removing the right of employees to sue their employers while obligating employers to compensate injured employees even if negligence is not involved • Requirements for benefits – To be covered under a WC statute, an injury or disease must arise out of and in the course of employment – The employee is covered for any work-related injury sustained while the employee is at the place of employment or traveling for the employer. Injuries occurring while the employee is on his way to or from work at a fixed location are generally not covered by the statute – Many states provide extended period of time for the discovery of slowly developing diseases • Benefits provided – The benefits prescribed by the various state WC laws generally include (i) medical benefits, (ii) disability income benefits, (iii) rehabilitation benefits, and (iv) death benefits – Medical benefits ∗ As a rule, first-dollar benefits are provided; no deductible or coinsurance provisions are imposed on the employee ∗ Depending on the state, the injured employee may have the right to select his own doctor, or may be limited to a choice from a panel designated by the employer or its insurance company – Disability income benefits ∗ Temporary partial disability: The injured worker is unable to perform some duties of a job for a definite period of time ∗ Temporary total disability: The injured worker is unable to perform any job duties for a specific period of time ∗ Permanent partial disability: The injured worker suffers an irreversible injury, but will be able to resume some job functions ∗ Permanent total disability: The injured worker will never be able to perform any job functions ∗ Income benefits are payable subject to a deductible in the form of a waiting period (3-7 days). If disability continues beyond a specified number of days, most laws provide for payments of benefits retroactive to the date of injury ∗ The benefit is payable weekly and is expressed as a % of the employee’s average weekly wage at the time of disability. Maximum and minimum weekly benefits very widely from state to state ∗ State laws require compensation for a specific number of weeks for the loss (or loss of use) of specific body parts, aka scheduled injuries. The benefits for scheduled injuries are payable without regard to actual wage loss and is in addition to any other temporary disability benefits payable 32 – Rehabilitation benefits ∗ The primary rehabilitation benefit prescribed is the payment of expenses for complete medical treatment and medical rehabilitation ∗ Vocational rehabilitation may also be required by law ∗ Most WC laws provide a maintenance allowance to injured workers during rehab, in addition to other compensation benefits. Many insurers provide rehab services extending beyond the requirements of the law ∗ Rehab can cut the cost of a WC claim by shortening the length of time that the employee is disabled. All parties benefit from rehab – Death benefits ∗ Death benefits include a flat amount for burial expenses and partial replacement of the worker’s former weekly wage • Benefit administration – Most states have a WC board or industrial commission with responsibility for administering the WC law, a few states employ the courts – To initiate a claim, the injured worker notifies the employer. The employer submits an injury report to the insurer, which then transmits the report to the administrative agency. If the claim is not contested by the employer, it is usually settled by agreement – If the claim is contested by the employer or by the insurance company, most states require a hearing by an officer of the administrative agency – Employees with pre-existing disabilities ∗ There have been several legislative responses to the problem of finding suitable employment for workers with partial yet permanent impairments ∗ Second-injury funds were established to encourage employers to hire partially impaired workers: Should additional injury occur to an already impaired worker that results in total or near total impairment, the applicable fund will pay a portion of the claim ∗ Second-injury funds are usually established by assessing both WC insurers and self-insurers in a given state ∗ The 1990 Americans with Disabilities Act (ADA) was enacted to foster equal employment opportunity for the disabled. ADA requires employers to make reasonable accommodation to enable disabled employees to perform their jobs ∗ ADA and other federal and state laws prohibit discrimination against disabled workers as long as they can do their work • Persons and employments covered – The statutes of some states exempt employers with fewer than a stipulated number of employees, and many statutes specifically exclude certain employments such as farm labor, domestic workers, and casual employees – Some employees are excluded because alternate (federal) plans are provided for them, e.g. federal government workers, maritime workers, and interstate railroad workers – Employee status ∗ An employee is a person hired to perform services for another under the direction and control of the other party, called the employer ∗ The courts have interpreted the definition of an employee broadly to provide protection to those who seek it ∗ Independent contractors: In many states, if the contractor does not provide WC insurance, the responsibility and the expenses fall on the principal (the firm that uses the contractor’s services) ∗ Temporary employees: The firm supplying the temporary employees provides WC for temporary employees; the temporary employee is an employee of the providing firm, not the firm that is using his services 33 ∗ Leased employees: Leased employees have all the outward appearance of regular employees. However, technically they are co-employees of the leasing contractor, aka Professional Employer Organization (PEO), and the client company ∗ The PEO is responsible for all payroll taxes, employee benefits, and WC coverage – Out-of-state application of laws ∗ Most state laws have extraterritorial provisions dealing with this issue. They provide that employees can receive benefits provided by the law of the state in which they are hired even if the accident occurs in another state ∗ The determination of which state’s law applies depends on the provisions of the laws. Typical considerations: · Place and nature of employment · Place where the employee was first hired · Employee’s place of residence · State in which the employer is domiciled – Federal jurisdiction ∗ The United States Longshore and Harbor WC ACT (LHWCA) provides an exclusive remedy to injured maritime workers (longshoring or shipbuilding) subject to the act ∗ Officers and crew members of vessels are not covered by the LHWCA. One of the remedies is provided by the United States Merchant Marine act of 1920, aka Jones act, allowing an injured crew member to sue the employer ∗ Admiralty law, the branch of federal law that governs most maritime matters, provides additional remedies: · A lawsuit against the employer for injury resulting from unseaworthiness of the vessel · An injured crew member’s right to “maintenance” (food and shelter) and “cure” (medical attention), regardless of whether the employer was at fault ∗ Interstate railroad workers can sue their employers for injuries resulting from employer negligence, as provided by the Federal Employers’ Liability Act – Employees in foreign countries ∗ Employees who are temporarily working outside the U.S. are generally covered by the extraterritorial provision of the WC law of the state where they regularly work, provided they have not been out of the U.S for too long ∗ In addition to time-limited coverage, WC laws in the U.S may not provide coverage for repatriation expense or endemic disease ∗ Many insurers offer foreign voluntary WC coverage ∗ In many countries, employees retain the right to sue their employers. Employers with employees in these countries need employers liability insurance with a coverage territory encompassing the foreign countries in which the employer operates • Methods for meeting the employer’s obligation – Most WC statutes require employers to demonstrate financial ability to pay any claims that may arise. Possible methods: ∗ Private insurance ∗ Insurance through assigned risk plans ∗ Insurance through state funds or employers mutual insurance companies · In about one-half of the states, state funds provide WC insurance and operate in essentially the same manner as private insurance companies, except that they accept any good faith applicant · Competitive state funds: In most jurisdictions, the fund competes with private insurers · Monopolistic state funds: Five states (ND, OH, WA, WV, WY, plus Puerto Rico and the U.S. Virgin Islands) require all WC insurance to be purchased from the state fund. 34 Other private insurers are not permitted to sell WC insurance · Employers’ mutual insurance companies: Created in a few states, to write WC insurance for any qualified employer in the state. Unlike state funds, these mutual companies are not instrumentalities of the state and they compete with private insurers ∗ Qualified “self-insurance” plans: To qualify as a self-insurer, an employer must post a surety bond with the WC administrative agency of the state to guarantee the security of benefit payments. In addition, most states require evidence of an ability to administer the benefit payments and services mandated by the law ∗ Excess insurance · An employer that qualifies for self-insurance may decide to purchase excess insurance to cover catastrophic losses. Excess WC insurance includes: 1. Aggregate excess: Aka stop loss excess, covers losses only after the insured has retained a stated amount of aggregate loss during the policy period 2. Specific excess: Covers loss due to a single occurrence only for the amount that exceeds the policy retention ∗ Pools · In some states, organizations may join with one another to form pools to provide members with WC insurance, functioning similarly to a small insurance company · The pool processes and pays WC claims on behalf of the participating entities. Frequently, claims-processing and administration are handled by an unrelated firm called a thirdparty administrator (TPA) · In most states, pools are not covered by state guarantee funds, and they generally purchase excess insurance. The workers compensation and employers liability policy • The policy contains uniform provisions even though WC benefits vary by state, because the applicable WC laws are incorporated by reference in the policy • A complete WC&EL policy consists of: (i) Information page, (ii) Policy form, and (iii) Endorsements • Information page – The information page is equivalent to the declarations page of other policies and is divided into 4 major items – Item 1: Essential information about the insured: name, mailing address, type of legal entity, and workplaces – Item 2: Coverage period, starting at 12:01 am at the address of the insured given in 1. – Item 3: Summary of the coverage provided ∗ Item 3.A: List of states where the insured has operations and the insurer is licensed to provide coverage ∗ Item 3.B: Shows the limit of liability under the employers liability coverage for BI by accident and by disease ∗ Item 3.C: Indicates that WC coverage will be extended to additional states if the insured expands operations – Item 4: Information necessary to calculate the estimated policy premium, including: ∗ Description of the classification(s) assigned to the insured business ∗ Insured’s estimated payroll for the policy period ∗ Rate applicable to each classification (per $100 of payroll) ∗ Estimated premium • Policy form – The standard WC&EL policy form includes a general section and six parts – General section ∗ Explains the nature of the policy and defines important terms ∗ States that WC laws is limited to state laws. The LHWCA and other federal laws are not 35 included ∗ “State” means any of the 50 states or DC ∗ Covered locations are defined to include all workplaces listed on the information page and all of the insured’s workplaces in states listed in Item 3.A – Part one - WC insurance ∗ The coverage provided by part one obligates the insurer to pay all compensation and other benefits required of the insured by the WC law or occupational disease law of any state listed in Item 3.A ∗ The coverage applies to BI by accident and by disease. The accident/the last exposure to disease must occur during the policy period ∗ The policy shows no dollar limit for these benefits, any applicable limits would be those found within the law itself. Part one contains no exclusions ∗ The insurer has the right and duty to defend claims covered by the policy. The insurer also agrees to pay additional costs, such as expense of investigating a claim and litigation costs ∗ The policy provides that the insured will reimburse the insurer for any penalties required under a WC laws because of: (i) willful misconduct, (ii) illegal employment, (iii) failure to comply with health and safety laws and regulations, and (iv) discrimination against employees who claim WC benefits ∗ When the insurer pays compensation or employers liability benefits on behalf of an insured, any right of recovery the insured or the injured employee may have against a third party becomes the right of the insurer ∗ Because the contract is made primarily for the benefit of employees, they have a direct right of action against the insurance company ∗ For the protection of the employee, the policy provides that the obligations of the insurance company will not be affected by the failure of the employer to comply with the policy requirements ∗ If the policy and the applicable WC law conflict, the policy will automatically conform with the law – Part two - Employers liability insurance ∗ Structured like a traditional liability policy, with an insuring agreement and exclusions ∗ EL insuring agreement · The insurer agrees to pay damages that the insured becomes legally obligated to pay because of BI to an employee (arising out of and in the course of employment), and to defend the insured against claims or suits seeking covered damages defend · Another requirement of part two is that the employment out of which the injury arises must be necessary or incidental to the insured’s work in a state or territory listed in Item 3.A of the information page · The same coverage triggers apply to EL and WC: (i) For BI by accident, the policy that is in effect when the injury occurs is the policy that applies, and (ii) For BI by disease, the policy that is in effect on the employee’s last day of last exposure to the conditions causing or aggravating the injury is the policy that applies ∗ EL exclusions · Statutory obligations: Several exclusions are aimed at eliminating coverage for claims that would be covered under various statutes: (i) Any WC, occupational disease, unemployment compensation, or disability benefits law, (ii) The Longshore and Harbor Workers Compensation Act (LHWCA), (iii) The Federal Employer’s Liability Act, and (iv) Any other federal WC or occupational disease law · Injury outside the U.S. or Canada: EL coverage does not apply to BI that occurs outside the U.S., its territories or possessions, and Canada. However, this exclusion does not apply to injury to a resident or citizen of the U.S. or Canada who is temporarily 36 outside the places listed above · Liability assumed under contract: EL coverage does not apply to liability assumed under contract, usually provided by CGL · Other exclusions: (i) Punitive damages for injury or death of any illegally employed person, (ii) BI to employees employed in violation of the law with the knowledge of the insured or any executive officers of the insured, (iii) BI intentionally caused by the insured, (iv) Damages arising out of employment practices ( e.g. harassment, discrimination, termination), (v) Fines or penalties imposed for violation of federal or state law, and (vi) Damages payable under the Migrant and Seasonal Agricultural Worker Protection Act ∗ Limits of liability · Unlike WC, EL coverage is subject to limits of liability stated in the policy. Three limits apply: 1. BI by accident limit: The most that the insurer will pay for BI resulting from any one accident, regardless of the number of employees injured 2. BI by disease - policy limit: The most that the insurer will pay for BI by disease, regardless of the number of employees who sustain disease 3. BI by disease - each employee: The most that the insurer will pay for BI by disease to any one employee · Defense costs, as well as supplementary payments similar to those covered under the CGL form, are covered in addition to the limits of liability. As in the CGL, the insurer has no duty to pay defense costs or supplementary payments after it has paid the applicable limit of insurance – Part three - Other states insurance ∗ Insurance that automatically extends coverage to the insured’s operations in any state listed in Item 3.C of the WC&EL information page ∗ The policy requires the insured to tell if he begins work in any state listed in Item 3.C of the information page ∗ If the insured has operations in a particular state on the effective date of the policy but that state is not listed in Item 3.A, the insured must notify the insurer within 30 days or else no coverage will apply for that state ∗ Insurers exclude states in which they are not licensed or in which they do not wish to provide coverage for underwriting reasons ∗ If the insured anticipates operating in a state with a monopolistic WC fund, the insured should obtain WC insurance from the appropriate state agency. However, since some WC policies from monopolistic funds do not include EL coverage, many employers buy a type of EL insurance called “Stopgap coverage” provided by private insurers – Part four - Your duties if injury occurs ∗ The insured must promptly notify the insurer of any injury, claim, or suit ∗ The insured must also cooperate with the insurer, attend hearings and trials at the request of the insurer, and help secure witnesses ∗ The insurer cannot, except at his own expense, voluntarily make any payment, assume any obligation, or incur any expenses except for immediate medical and other services at the time of injury as required by the WC law – Part five - Premium ∗ Part five explains premium determination procedures, establishing the role of insurance company manuals in determining premium and stipulating that the manuals and the premium may change during the policy period ∗ Part five also defines payroll as the premium base and stresses that it includes the remuneration of executive officers and the payroll of employees of uninsured contractors and subcontractors 37 ∗ The audit provision explains the insurer’s right to examine and audit the insured’s books and records at any time during the policy period and within three years after expiration ∗ Part five shows how the premium will be determined on cancellation of the policy ∗ The premium shown on the information page is an estimated premium which is revised upon audit – Part six - Conditions ∗ The conditions address insurer inspections, policy years, assignment, cancellation, and who represents the insured ∗ Inspections: The insurer has permission to inspect the insured workplaces and operations. However, this right does not constitute an undertaking to warrant that any workplaces, operations, machinery, or equipment inspected is safe or healthful ∗ Long-term policy: If the policy is longer than one year, each year is considered separate as far as policy provisions are concerned, and premium is computed in accordance with the manual rules and rates in effect for that year. An exception is a 3-year fixed-rate policy that would carry an endorsement modifying this provision ∗ Assignment: The WC policy cannot be assigned without the insurer’s consent. Insurers generally prefer to cancel the existing policy and issue a new policy ∗ Cancellation: States the rights of the insurer (at least 10 days notice) and the insured (can cancel at any time) to cancel the policy, subject in all cases to any requirements of the WC law ∗ Sole representative: The first named insured acts on behalf of all insureds for premium payment, refund, cancellation, and other rights and duties under the policy • Endorsements – Voluntary compensation endorsement ∗ Even when exempt persons are not entitled to WC benefits by law, benefits may be extended to them by voluntary action ∗ The “Voluntary Compensation and Employers Liability Endorsement” amends the standard WC&EL policy to include an additional coverage called “voluntary compensation” ∗ The additional coverage does not make employees subject to the WC law, but it obligates the insurance company to pay, on behalf of the insured, an amount equal to the compensation benefits that would be payable to such employees if they were subject to the WC law designated in the endorsement ∗ The voluntary compensation endorsement states that if an employee entitled to payment under the endorsement brings a suit under the common law, the coverage provided by the endorsement reverts to EL insurance. The insurer will defend the insured against the employee’s suit and pay any settlement awarded, subject to the stipulated limits of liability – LHWCA coverage endorsement ∗ Coverage can be provided by adding the U.S. Longshore and Harbor Workers’ Compensation Act Endorsement to the WC&EL policy ∗ The endorsement amends the definition of “WC law” to include the LHWCA with respect to operations in any state designated in the endorsement’s schedule Rating workers compensation insurance • Most states require insurers to belong to an approved advisory organization in order to write WC and EL insurance. The designated organization files with the supervisory authority the manuals for classification, rules, rates or loss costs, rating plans, and policy forms on behalf of its members • The National Council on Compensation Insurance (NCCI) serves as the filing agency for insurers in most states and prepares standard forms and endorsements • The exposure varies considerably according to the size of the employer’s workforce and the degree of hazard in the work performed. WC premiums reflect these two factors because premium depends on the amount of the employer’s payroll (the basis of premium) and the type of business (classification) 38 involved • Basis of premium – With only a few exceptions, the premium base for WC insurance is payroll – Payroll serves as an effective premium base because it varies directly with the exposure covered, it is easy to determine and verify from available records, and it is not readily subject to manipulation by the insured – At the inception of the policy, the insured pays an estimated premium based on an estimate of the annual payroll, and a premium auditor may examine the insured’s records at the end of the policy period (or at shorter intervals) to determine the actual payroll. Then the insurer calculates the actual earned premium – The premium cannot fall below the minimum premium shown in the manual for the governing classification • Classifications – For each employer, it is necessary to determine the basic classification that best describes the business of the employer within the state so that the employer’s exposure base and loss experience can be pooled with all similar business – Governing classification: A governing classification is one that best describes an insured’s activities. With only a few exceptions, all its employees at any one location are assigned to that classification – Standard exception classifications ∗ The payroll for certain employees is separately rated ∗ Clerical office employees and drafting employees, provided they work in an area physically separated from other operations ∗ Telecommuting clerical and drafting employees ∗ Salespersons, collectors, or messengers ∗ Drivers, chauffeurs, and their helpers ∗ The payrolls for employees in these classifications are shown separately on the policy and take the rates applying to the standard exception classification, not the rate for the governing classification – Premium adjustments ∗ Experience modification · Under an experience rating plan, the premium applicable to a particular insured is increased or decreased for a future period based on that insured’s loss experience for a period in the recent past · Rating rules provide that insureds whose WC premiums have reached certain amounts ($2,500-$5,000 a year) are subject to experience rating modification · Experience rating provides an incentive to insureds to implement loss control measures that reduce workplace accidents ∗ Retrospective rating · Under a retrospective rating plan, an insured’s premium for a given period is reduced or increased based on that insured’s loss during the same period · The insured pays an estimated premium at the beginning of the period and receives either a refund or a bill for an additional premium after the end of the period, depending on the losses during the period · Underwriters sometimes require retrospective rating plans as a condition for providing insurance for marginal accounts that may generate high losses. Conversely, insureds that expect lower than average losses may find retro rating attractive ∗ Premium discount · Many of the expenses of providing WC do not increase proportionately with increases in premium 39 ∗ ∗ ∗ ∗ ∗ · The premium discount plan provides an increasing credit for premiums in excess of a certain minimum Merit or schedule rating factors · In many states, the premium can also be modified by a merit or schedule rating factor to give the insured credit for conditions that exceed those normally expected, such as superior housekeeping, excellent employee training, and on-site medical facilities Rate deviations · In some states, insurers are permitted to apply a rate deviation factor (e.g. 10%) to the premium as calculated by the rating manual · Insurers generally reserve these credits for better risks, although competitive pressures sometimes result in average risks receiving a deviated premium Expense constant · An expense constant is a flat charge designed to cover administrative expenses, such as policy issuance and record keeping, that are common to all policies · An expense constant is applied regardless of the size of the policy premium · Not every state calls for an expense constant charge. Where they are applied, they generally amount to less than $200 per policy Deductibles · In almost all non-monopolistic states, an insured can reduce its premium by electing a deductible plan. The deductible applies to both medical and lost-time claims on a per claim basis · The credit for smaller deductible is not substantial · Large deductible plans - Plans with deductibles in the $50,000-$250,000 per claim range, greatly reduce the premium and are available in most states - Insureds electing such plans are in effect self-insuring most of their WC exposure. Large deductible plans avoid the complications of setting up a true self-insurance plan - The insurance company does all the administrative work connected with WC claims, and the insured reimburses the insurer for claim payments up to the deductible limit per occurrence - Above the deductible, the insurance coverage functions as a [per-claim stop-loss. In some cases, aggregate stop-loss protection is also included Dividend plans · For policies written on a dividend plan, the cost of insurance can be reduced by dividends declared by the insurance company · Two general types of dividend plans are available: 1. Flat-dividend plan: All eligible policies receive the same % of premium as a dividend regardless of their individual loss experience 2. Sliding-scale dividend plan: The size of the dividend varies with the insured’s own experience. The lower the insured’s loss ratio, the higher the dividend. In sliding-scale dividend plans, no dividend is paid when the loss ratio for the expiring year exceeds a certain % (45-60%) · Insurers offer dividend plans to insureds with good safety records and at least a certain minimum premium size · Dividends cannot be guaranteed. Dividends are paid after expiration of the policy and then only at the rate declared by the insurer’s board of directors 40 Flitner & Trupin - Chapter 13: Miscellaneous coverages Excess and umbrella liability insurance • Excess liability insurance and umbrella liability insurance are two similar types of coverage that organizations buy mainly to extend the limits of their CGL, commercial auto, and other “primary” liability policies • Need for excess or umbrella liability coverage – Three basic characteristics of liability insurance that are not shared by property insurance: 1. Difficulty in estimating maximum possible loss for liability exposures 2. Layering of liability coverages 3. Effect of aggregate limits – Maximum possible loss ∗ Most property loss exposures have a reasonably clear maximum possible loss (MPL), i.e. the largest loss that could be sustained in a particular occurrence or by a particular property ∗ There is no comparable way to estimate MPL for most liability exposures – Layering of coverage ∗ Most property exposures are covered entirely by one insurer. If several insurers participate on the risk, it’s usually on a pro-rata basis ∗ In contrast, high-limit liability insurance is generally arranged in two or more layers, i.e. the coverage provided by the first (or “primary” insurer) must be totally exhausted before the next layer of insurance makes any payment – Effect of aggregate limits ∗ Unlike property insurance, liability insurance is usually subject to an aggregate limit for the policy period • Insurance treatment – Large liability loss exposures can be insured with additional policies known as excess liability policies and umbrella liability policies – These policies provide limits of insurance in excess of the limits of an “underlying” primary policy – Excess or umbrella liability coverage comes into play when the amount of damages exceeds the each occurrence limit of an underlying policy or when the aggregate limit of an underlying policy has become depleted by prior claims during the policy period – Umbrella liability policies may also cover some claims not covered at all by the underlying policies • Excess liability insurance – An excess liability policy covers liability claims in excess of the limits of an underlying policy or a stated retention amount – An excess liability policy may take 3 basic forms: 1. A “following form” subject to the same terms as the underlying policy 2. A self-contained policy subject to its own terms only 3. A combination of the two types above – A following-form excess policy covers a liability loss that exceeds the underlying limits only if the loss is covered by the underlying insurance – A self-contained excess policy applies to a loss that exceeds the underlying limits only if the loss is also covered under the terms of the excess policy – Alternatively, an excess policy may combine both of the above approaches by incorporating the provisions of the underlying policy and then modifying those provisions with additional conditions or exclusions in the excess policy • Umbrella liability insurance – “Umbrella liability” is generally used to describe a type of excess insurance that is broader than ordinary excess liability policies – An umbrella liability policy provides excess coverage over several primary policies, such as CGL, AL and EL, and also provides drop-down coverage. Its distinguishing feature is coverage that is 41 – – – – – – broader in some respects than that of the underlying policies, thus providing primary coverage for certain occurrences that would not be covered by any of the underlying policies An umbrella liability policy thus performs 3 functions: 1. Provides additional limits above the each occurrence limits of the insured’s primary policies 2. Takes the place of the primary insurance when primary aggregate limits are reduced or exhausted 3. Covers some claims that are not covered by the insured’s primary policies, subject to a retention Drop-down coverage ∗ The latter two functions - providing primary coverage when either the underlying aggregate limits are exhausted or the underlying policy simply does not cover the type of loss - are often referred to as drop-down coverage ∗ When a claim covered by the umbrella policy is not covered at all by any primary policy, the drop-down coverage is subject to a retention, aka self-insured retention (SIR) ∗ In many policies, especially for small businesses, the retention does not apply to defense costs. Coverage for these costs is provided in full, often referred to as “first-dollar defense coverage” ∗ The retention does not apply when the umbrella is (i) paying in excess of a claim covered by the primary policy, or (ii) dropping down to pay a claim because the primary policy’s aggregate limit has been exhausted Required underlying limits ∗ Each insurer writing umbrella liability policies has its own requirements for the types and amounts of underlying insurance that the insured must have ∗ The umbrella limits apply in full in excess of each of the underlying coverages ∗ If the umbrella policy includes a SIR for coverages provided on exposures not covered in the primary policies, the coverage limit would apply above (“on-top”) the SIR Aggregate umbrella limits ∗ Most umbrella policies contain aggregate limits that operate like the aggregate limits in the primary insurance ∗ In some cases, the aggregate limit applies to all claims under the umbrella ∗ In other cases, the aggregate limit applies only to coverages that are subject to an aggregate limit in the underlying policy Broad insuring agreement ∗ Many umbrella policies contain one comprehensive insuring agreement instead of several specific ones. A common approach is for the insurer to promise to pay the amount in excess of the underlying limit that the insured becomes legally obligated to pay as damages for BI, PD, personal or advertising injury arising out of an occurrence to which the policy applies, subject to the umbrella policy’s limit ∗ The definitions of BI, PD, personal and advertising injury in an umbrella policy may differ from those in the underlying policies ∗ Some umbrella policies use two insuring agreements, often referred to as “A” and “B”. Insuring agreement A is an excess coverage applying over the underlying policies. Insuring agreement B applies to occurrences for which coverage is available under the umbrella but not in the underlying policies Occurrence and claims-made coverage triggers ∗ Umbrella policies are usually occurrence forms. However, the underlying primary policies sometimes include both occurrence and claims-made coverages ∗ Gaps in coverage can occur when the umbrella or excess policy has a different coverage trigger than the underlying coverage. To avoid this problem, some insurers provide both occurrence and claims-made triggers in their umbrella policies. These policies provide that the trigger for the umbrella coverage is the same as that used for the underlying coverage 42 – Exclusions ∗ Umbrella policies contain exclusions that restrict the broad coverage granted by the insuring agreement ∗ Much of the broadened coverage provided by umbrella policies is achieved by using exclusions in the umbrella policy that have narrower application than the exclusions of the underlying policies – Conditions ∗ The principal differences between the general conditions of primary liability policies and umbrella policies concern maintenance of underlying insurance and the coverage territory ∗ Maintenance of underlying insurance · The maintenance of underlying insurance condition obligates the insured of an umbrella liability policy to maintain all required underlying coverages in full force and effect during the policy period, except to the extent that their aggregate limits become reduced by payment of claims · The insured further agrees to notify the insurer promptly if any underlying policy is changed or replaced by a policy issued by another insurer ∗ Failure to maintain underlying limits · If the underlying insurance is not maintained, the umbrella policy will apply as though the underlying insurance had been maintained · The umbrella policy will not drop down to pay claims that would have been covered by the required underlying policy ∗ Concurrent inception and expiration · Umbrella and excess policies should have the same inception and expiration dates as the underlying policies, i.e. be concurrent · If the policy periods of the primary and umbrella policies cannot be made concurrent, the insured’s agent or broker should ask the umbrella insurer to endorse its policy to permit impairment of the aggregate limit in the underlying policy ∗ Coverage territory · Most umbrella policies provide worldwide coverage, in contrast with the more limited coverage territories ordinarily found in primary policies · However, some umbrella policies require that suit be brought in the U.S. or Canada Professional liability insurance • “Professional liability insurance” is now available for more occupations than just those traditionally classified as professions, the common thread being liability for the failure to use the degree of skill expected of a person in the particular field • PL insurance is now also used to describe coverages such as directors and officers liability, employment practices liability, and other coverages not included in CGL or commercial auto policies • Because of the broadening of the term “professional liability” these exposures are also known as “malpractice” or “errors and omissions” • Professional liability insurance for specific occupations – In most cases, only a few insurers that specialize in a particular type of PL insurance write that type of insurance – Most PL insurance is written on forms independently developed by individual insurers as opposed to standard forms • Differences between professional liability and CGL policies – Claims-made trigger ∗ Many PL coverages develop “long-tail” claims. Consequently, insurers prefer to use claimsmade PL policies in order to avoid liability for late reported claims under policies that expires years before the claim is eventually submitted ∗ In contrast to CGL, the claims-made provisions found in independently developed PL policies 43 sometimes do not contain any automatic extended reporting period. Any extended reporting period must usually be specifically requested and paid for, and few (if any) PL policies offer an unlimited extended reporting period (1-3 years is usual) – Consent to settle ∗ In contrast to CGL, because professional or business reputations may be at stake in claims under PL policies, the insured frequently is given the right to participate in the decision to settle a claim ∗ The policy may provide that the insurer cannot settle a claim without the insured’s consent. If the insured does not consent to settlement, the insurance company, at its expense, must then continue to defend the insured and pay any judgment that the court may award ∗ More typically, PL policies provide that if the insured does not agree to a proposed settlement, the insured must take over the defense and pay any further defense expenses as well as the amount of any judgment or settlement that exceeds the amount for which the insurer could have settled the claim (“hammer clause”) ∗ To lessen the harshness of this provision, some policies provide that the insured and the insurer will share additional defense and settlement costs that ensue when an insured refuses to consent to a settlement – Selection of defense counsel ∗ Under a CGL policy, the insurer selects and pays the attorneys that defend the insured against claims that would be covered by the policy ∗ Some PL policies give the insured the right to select counsel, usually subject to the insurer’s approval of the qualifications of the attorney selected by the insured Deductibles ∗ Most small to mid-size accounts have CGL coverage with no deductible ∗ PL insurance is usually subject to a deductible. Most PL insurers have mandatory minimum deductibles for their various classes of PL business, with higher deductibles as an option • Physicians professional liability – Example of medical errors that can result in liability: (i) Failure to properly diagnose a disease, resulting in more serious illness, disability or even death, (ii) Improper performance of a surgical procedure, causing injury to a patient, (iii) Failure to warn a patient of the hazards involved in a course of treatment, (iv) Leaving a surgical instrument or other foreign object in a patient following surgery – Physicians can also be held liable for administrative errors or omissions connected with their medical practice – The insuring agreement in a typical physicians PL policy covers damages resulting from “providing or withholding professional services” by the insured or anyone else for whose acts the insured is legally responsible – The insuring agreement also covers liability arising out of the insured’s service on a formal accreditation board – The damages that the insurer will pay are not restricted to those for BI or PD. Damages for libel, slander, defamation, invasion of privacy, and similar offenses are generally covered by PL policies unless specifically excluded • Insurance agents and brokers E&O liability – Errors and omissions for which insurance agents or brokers have been held liable: (i) Failure to properly advise the client regarding his insurance needs, (ii) Failure to obtain insurance for a client in a timely manner after agreeing to do so, (iii) Failure to renew a policy at expiration without giving prior notice to the client, and (iv) Failure to properly advise the client regarding appropriate limits – Insurance producers can also become liable to the insurance companies they represent (e.g. over binding authority) 44 – A typical policy agrees “to pay on behalf of the insured all sums that the insured becomes legally obligated to pay as damages . . . arising out of any negligent act, error or omission . . . in the conduct of the insured’s business – A policy exclusion makes it clear that the policy does not cover damages for direct BI or direct damage to tangible property. The policy may, however, pay damages indirectly related to either BI or PD • Other exclusions – Most policies exclude contractual liability, punitive damages, and the insured’s dishonest, criminal, or malicious acts – PL policies for some professions contain specialized exclusions, e.g. PL policies for lawyers and accountants may exclude liability arising from practice before the SEC • Conflicts and overlaps with the CGL policy – The standard recommendation for avoiding disputes as to whether the CGL or the PL policy covers a loss, is to obtain PL insurance and CGL coverage from the same insurer – When coverage has been placed with separate insurers, any claim with a possible overlap in coverage should be reported to both insurers • Directors and officers liability insurance – The individuals who serve as the directors and officers of a corporation can be sued, as individuals, for breach of their corporate duties. Corporations usually agree to indemnify their directors and officers for the costs resulting from suits against them – The D&O liability exposure affects both the individual directors and officers and the corporation itself. Many corporations protect themselves and their directors and officers against this exposure by purchasing D&O liability insurance – There is no standard form for D&O liability insurance. Each insurer develops its own policy – Claimants can include stockholder, employees, competitors, customers, and regulators – Insuring agreement ∗ A D&O policy ordinarily contains two insuring agreements 1. The first agreement covers the directors and officers of the insured corporation for their personal liability as directors and officers that results from a wrongful act, i.e. any breach of duty, neglect, error, misstatement, misleading statement, omission, or other act done or wrongfully attempted 2. The second insuring agreement, often referred to as company reimbursement coverage, covers the sums that the insured corporation is required or permitted by law to pay to the directors and officers as indemnification for suits alleging wrongful acts by directors and officers ∗ D&O insurance is written on a claims-made basis. The availability and terms of extended reporting periods vary among policies but generally are not as liberal as those of the ISO claims-made CGL policy – Exclusions ∗ Virtually all D&O policies exclude BI and damage to tangible property. D&O policies ordinarily exclude liability for pollution and nuclear hazards as well ∗ Other exclusions: (i) Libel or slander, (ii) Gaining any personal profit to which one was not legally entitled, (iii) Failure to effect or maintain adequate insurance for the corporation, (iv) Certain violations of the Securities Exchange Act, (v) Acts of deliberate dishonesty, and (vi) Liability under the Employee Retirement Income Security Act (ERISA) – Other provisions ∗ The costs of defending against D&O suits are notoriously high. These costs are typically subject to policy limits instead of being payable in addition to policy limits as in standard CGL policies ∗ Deductibles 45 · D&O policies are usually subject to both a flat deductible amount and a specified percentage of participation by the insured in all losses exceeding the retention · A higher deductible often applies to the company reimbursement coverage than to the insuring agreement that covers the directors and officers directly ∗ Entity coverage · Many insurers offer the option to include the corporation as an insured. This option is referred to as entity coverage. Because the corporation is often named as a defendant in a lawsuit alleging wrongful acts by the directors and officers, entity coverage can be a worthwhile extension of the D&O policy · However, there are disadvantages for the directors and officers: They will have to share the limits of liability with the corporation and, because of potential conflicts of interest, separate legal counsel may be required for the corporation, which would increase defense costs and reduce the limits available to pay claims · There is also a danger that the entire policy may be attached by the bankruptcy trustee in the event of a corporate bankruptcy, leaving the directors and officers with no protection at all – D&O coverage for smaller corporations and nonprofits ∗ Policies written for smaller entities are similar to D&O policies written for large corporations except that they are more frequently written to include the organization as an insured • Employment practice liability insurance – Employment practices liability (EPL) insurance covers an organization, its directors, and officers, and its employees against claims alleging damages because of wrongful employment practices, such as sexual harassment, wrongful termination, and unlawful discrimination – Most EPL policies are written by insurers using their own independently developed forms – Definitions of wrongful employment practices vary from policy to policy but generally include: (i) Sexual harassment, (ii) Wrongful termination and wrongful failure to hire, promote, or grant tenure, (iii) Wrongful demotion, reassignment, or discipline, (iv) Unlawful discrimination against someone in a legally protected class, (v) Invasion of privacy, (vi) Defamation, and (vii) Intentional infliction of emotional distress – Typical exclusions eliminate coverage for claims arising from labor disputes and collective bargaining; reorganization, downsizing, or closure operations; Violations of federal laws that establish fiduciary responsibilities for employers to their employers; And claims arising from the bankruptcy, insolvency, receivership, or liquidation of the employer – EPL policies are usually written on a claims-made basis. Extended reporting periods of from one to three years are usually provided with an additional premium required to activate them – In addition to damages paid for judgments or settlements, the cost of defense is covered, but it is often paid within (not in addition to) the limit of insurance – The definition of insured in an EPL policy usually includes the corporation, its directors and officers, its employees, and in most policies, its former employees – Almost all policies require a minimum deductible and many insurers that write EPL coverage for smaller firms provide risk management assistance – A coverage variation for smaller enterprises, particularly nonprofit and governmental organizations, is the combination of EPL coverage and D&O coverage in a single policy • Employee benefits liability and fiduciary liability insurance – Employee benefits include health, life, and nonoccupational disability insurance; Privately sponsored retirement plans; 401(k) plans; Educational assistance plans; A nd others – Two type of insurance - employee benefits liability insurance and fiduciary liability insurance are the principal means of covering the liability exposures arising out of employee benefit plans – Employee benefits liability insurance ∗ Employee benefits liability insurance covers an employer (and, in some policies, its employ- 46 ees acting on its behalf) against liability claims alleging improper advice or other errors or omissions in the administration of the employer’s benefit plans ∗ The coverage is usually provided in an endorsement to the employer’s CGL policy ∗ Examples of administrative errors: (i) Providing negligent advice on the selection of employee benefit programs, (ii) Failing to enroll an employee in the employer’s group health insurance program, (iii) Improperly calculating a retiree’s pension benefits ∗ Employee benefits liability insurance is often written on an occurrence basis – Fiduciary liability insurance ∗ ERISA imposes specific duties on all employee benefit plan fiduciaries. ERISA defines as a fiduciary practically anyone whose role in employee benefits involves discretionary control or judgment in the design, administration, funding, or management of a benefit plan ∗ A fiduciary who causes a loss to the plan by breaching the statutory duties can be held personally liable for the full amount of the loss. Moreover, the employer of the fiduciary can become vicariously liable for the loss ∗ In addition to facing claims for errors or omissions in carrying out their administrative duties, fiduciaries can be sued if they breach fiduciary duties involving discretionary judgment, e.g. investing funds accumulated for an employee retirement income plan ∗ Employee benefits liability insurance does not cover liability for such discretionary judgment. Fiduciary liability insurance covers the exposure ∗ Fiduciary liability policies also usually include coverage for administrative errors in the same manner as employee benefits liability coverage. However, many fiduciary liability polices do not include the corporation as an insured: Coverage is restricted to the individual fiduciaries themselves 47 Myhr & Markham - Chapter 1: Overview of insurance operations The insurance mechanism • The costs associated with risk can discourage business growth, investment in research and development, or expansion into new technologies and industries. From a customer standpoint, uncertainty over the financial consequences of a loss can affect spending levels • Insurance: A risk management technique that transfers some or all the potential financial consequences (liability) for certain loss exposures from the insured to the insurer Risk management process • Steps in the risk management process 1. Identify loss exposures 2. Analyze loss exposures 3. Examine the feasibility of risk management techniques 4. Select the most appropriate techniques 5. Implement the risk management techniques 6. Monitor results and make changes as needed • The law of large numbers is the foundation for ratemaking and pricing insurance products • Not all loss exposures can be insured. Coverage for some loss exposures may not be available, or the cost may not be affordable. However, risk can also be transferred contractually to a third party • Alternative risk financing techniques: Self-insurance programs, captives, risk retention programs Classifications and types of insurers • U.S. P&C insurers can be classified in four ways: (i) Legal form of ownership, (ii) Place of incorporation, (iii) Licensing status, and (iv) Marketing systems used • An insurer may be further classified by what types of insurance it writes or its specialty • Form of ownership – Proprietary insurers ∗ Proprietary insurers are formed for the purpose of earning a profit for their owners. E.g. stock insurance companies, Lloyd’s, and insurance exchanges ∗ Stock insurance companies: Most prevalent type of proprietary insurer in the U.S. Owned by their stockholders, who elect a board of directors to oversee the company’s operations, which in turns appoints officers who make the day-to-day decisions ∗ Lloyds: Consists of Lloyd’s of London and American Lloyd’s organizations. Lloyd’s of London is not an insurance company, but a marketplace such as a stock exchange. All of the insurance written at Lloyd’s is written by or on behalf of individual members and backed by his personal fortune. The liability of each member is limited to the amount that member agrees to write. Individual members are not liable for the obligations assumed by any other member. Each member belongs to one or more of over 50 syndicates, with the day-to-day management delegated to the syndicate manager. Lloyd’s provides coverage for many unusual or difficult loss exposures ∗ Insurance exchanges: An insurance exchange is a proprietary insurer similar to Lloyd’s because it acts as an insurance marketplace. Members can be individuals, partnerships, or corporations and they have limited liability. Members belong to syndicates and delegate day-to-day operations to the syndicate manager. The only existing exchange is INEX – Cooperative insurers ∗ Cooperative insurers are formed to provide insurance at a minimum cost to policyholders, who own the insurer ∗ Cooperative insurers include: (i) Mutual insurance companies, (ii) Reciprocal exchanges, (iii) Fraternal organizations, and (iv) Other cooperatives ∗ Mutual insurance companies: Mutuals are corporations owned by their policyholders and formed to provide low-cost insurance to those policyholders. The policyholders elect a 48 board of directors that appoints officers to manage the company. Some profit is retained to increase surplus, and excess profit is usually returned to policyholders as dividends. Most mutuals are advance premium mutuals. Some mutuals retain the right to assess policyholders for additional premiums if more funds are needed ∗ Reciprocal exchanges: Reciprocal exchanges are formed to provide insurance at a lower cost to members and are owned by their members. The liability is transferred to the other members of the exchange. A reciprocal is managed by an attorney-in-fact. A reciprocal is a nonprofit organization, but the attorney-in-fact can be formed for profit ∗ Fraternal organizations: Fraternal organizations resemble mutual companies, but they combine a lodge or social function with their insurance function. They write primarily life and health insurance ∗ Other cooperative insurers: Cooperative insurers include captive insurers, risk retention groups, and purchasing groups. Captive insurers can take several forms, but, regardless, they are formed to insure the loss exposures of the captive’s owners. Legislation has also allowed risk retention groups and purchasing groups to form. These cooperatives can be stock companies, mutuals, or reciprocal exchanges. They are usually organized so that a limited group or type of insured is eligible to purchase insurance from them – Other insurers ∗ Pools · A pool consists of several insurers, not otherwise related, that join together to insure loss exposures that individual insurers are unwilling to insure. These loss exposures present the potential for losses that either occur too frequently or are too severe (catastrophic) · Additionally, the pools buy reinsurance from nonmembers to increase their capacity · Pools can be formed either voluntarily or to meet statutory requirements. They operate either as a syndicate or through reinsurance · A syndicate pool issues a joint policy to the insured, listing all pool members and specifying the part of the insurance for which each member is responsible. Under such policies, the insured has a contractual relationship with each pool member and can sue any or all of them directly if a disagreement arises · Under a reinsurance pool, one member of the pool issues the policy to the insured, and the other pool members reinsure an agreed proportion of the policy’s insured loss exposures. The insured has a contractual relationship only with the member that issued the policy · Many pools are required by law. Virtually all states require some kind of pooling arrangement to provide auto liability insurance for drivers who cannot obtain such insurance in the standard market. Similar pools are required for WC coverage in most states · Fair Access to Insurance Requirements (FAIR) plans are required by law in 28 states providing property insurance to qualified property owners ∗ Government insurers · Numerous states have government insurance operations. 1/3 of the states have insurance funds providing WC insurance for some/all employers in the state. Most funds compete with private insurers. Several others are, by law, the only source of WC in their states · The U.S. federal government has many insurance operations: Social security, the national Flood Insurance Program (NFIP). Federal insurance programs also include deposit insurance for banks and other financial institutions, crop insurance, and crime insurance – Place of incorporation ∗ Domestic insurer · Insurance is regulated at the state level. Therefore, a domestic insurer is incorporated within a specific state or, if not incorporated, is formed under the laws of that state · Reciprocal exchanges are the only unincorporated insurers permitted in most states. Insurance exchanges and Lloyd’s organizations are permitted in only a few states 49 ∗ Foreign insurer: A domestic insurer that is licensed to do business in states other than its domiciled state ∗ Alien insurer: An alien insurer is incorporated or formed in another country – Licensing status ∗ Licensed (admitted) insurer: An insurer authorized by the state insurance department to transact business within a particular state ∗ Unlicensed (nonadmitted) insurer: An insurer not authorized by the state insurance department to transact business in the insured’s state ∗ Producers for primary insurance (except excess and surplus line producers) are licensed to place business only with admitted insurers ∗ Excess and surplus lines producers are licensed to place business with nonadmitted insurers, but only after admitted insurers have decline to write it ∗ Licensing status is also important for reinsurance purpose – Marketing systems ∗ A fourth classification of insurers is by marketing system, i.e. the system used to deliver insurance products to the marketplace. The three types of marketing systems are · Independent agencies and brokerages · Direct writers · Exclusive writers Insurance functions • Three core functions: (i) Marketing, (ii) Underwriting, and (iii) Claims • Nine additional functions supporting the core functions: Loss control, Reinsurance, Actuarial, Investments, Information technology, Premium audit, Human resources, Legal services, Accounting • Marketing – Marketing involves determining what products or services customers want and need and delivering them to those customers – A successful marketing program includes 1. Market research to determine the needs of potential buyers and segment markets 2. Advertising/public relations programs to inform customers about the insurer’s products/services 3. Training programs to prepare the sales force to meet the public’s needs 4. Setting production goals and strategies for achieving them 5. Motivating and managing producers • Underwriting – The underwriting department’s responsibility is to determine whether the applications received meet the guidelines established by the insurer – The goal of the underwriting department is to write a profitable book of business • Claims – The claim function is responsible for providing prompt and professional loss adjustment services – Claim professionals act in a public relations role for the insurer – The claim function supports marketing by promptly and fairly paying claims, which promotes policy renewal and referrals for new business – The purpose of the loss adjusting process is to achieve a fair, equitable settlement based on the circumstances of the loss. Too high loss settlements increase the cost of insurance for everybody. Too low loss settlements deprive the policyholder of the full benefits of the insurance policy • Loss control: The primary responsibility of an insurer’s loss control department is to prevent losses if possible and to minimize any losses that do occur • Reinsurance: Reinsurance transfers to the reinsurer some or all of the potential financial consequences of certain loss exposures covered by the policies of another insurer – The first type of reinsurance department establishes and negotiates reinsurance programs with reinsurers or reinsurance intermediaries 50 • • • • – The second type of reinsurance department provides reinsurance for other primary insurers Actuarial: The actuarial function supplies all of the information required to calculate insurance rates, develop rating plans, and estimate loss reserves Investments: The investment function is key in any insurance operation because of the nature of the risk transfer mechanism. Insurers invest premium and loss reserve funds to provide cash flow to pay for future losses Information technology: Provides the infrastructure supporting all of the insurer’s internal/external communications and many of the rating, statistical, claim payment, and other automated functions Other functions: Premium audit, human resources, legal services, and accounting Interdependence among functions • Marketing and underwriting – While the underwriting department decides which insurance applications to accept, those applications are generated based on marketing activities – Need clear communication between these departments to ensure that acceptability guidelines are clearly understood and that the insurer’s products/services are viable in the marketplace – Marketing provides feedback on the products and services which can help underwriters with product development • Underwriting and loss control – Underwriters need the loss control department help to inspect premises or survey loss exposures – In providing continuing loss control services to existing policyholders, the loss control department may also obtain information that is important to the underwriting process • Loss control and marketing – Some insurers features their loss control activities as a selling point in their advertising • Claim and other departments – The claim department interacts with the underwriting, marketing, and loss control department – Claim department convey important underwriting information that arises during claim adjusting – The claim department generates loss-history information on policyholders that both underwriting and marketing can use – When it denies a claim, marketing and underwriting may need to review advertising and/or coverages offered – Claim Dept. may discover aspects of the policyholder’s operations that need loss control attention • Actuarial and other departments – The actuarial department interacts primarily with underwriting and marketing – It determines most of the insurance rates and rating plans used by the u/w department, and it prepares the statistical information used to evaluate the u/w department’s performance – In determining rates and rating plans, the actuarial department must also consider the views of the marketing department about the acceptability of the rates in the marketplace – The actuarial dept. must maintain contact with the claim dept. because the case reserves established by the claim dept. are an important element in establishing statement reserves • Information technology and other departments – The IT department interacts with all of the other insurer functions and facilitates exchanges of information among them all 51 Myhr & Markham - Chapter 3: Insurance marketing Introduction • A marketing system is the framework that directs and facilitates the design, development, sale, and support of a product or service • A distribution channel is the method used to sell that product or service to the ultimate consumer • Possible marketing systems: retail outlet, wholesale outlet, direct sales force • Distribution channels: direct mail, telemarketing, media advertising, or internet access Unique characteristics of insurance marketing • Legal status of agents – An agent is a person or firm authorized to represent another person or firm in the performance of some function. The person/firm an agent represents is called the principal – Within the insurance industry, the term “agent” is sometimes reserved for independent contractors who represent insurers. The term “broker is reserved for independent contractors who represent (prospective) policyholders in their dealings with insurers – A producer is a person who sells insurance to customers – The powers an agent possesses are limited to those powers conferred by the principal. Agency law recognizes two primary types of authority in agent-principal relationships ∗ Actual authority: Authority (express or implied) conferred by the principal on an agent under an agency contract ∗ Apparent authority: Authority that arises from a third party’s reasonable belief based on appearances created by a principal that an agent has authority to act on behalf of that principal • Duties producers owe to customers 1. To provide the agreed-on policies 2. To place the agreed-on policies with a solvent insurer Overview of insurance product marketing • The marketing plan – Before introducing a new insurance product/service, the insurer completes a comprehensive marketing plan, identifying the product/service to be promoted, the customers to be targeted, and detailing the resources and strategies used to create, price, promote and sell the product – A marketing plan for a typical insurance product may include 1. Product proposal and sales goals 2. Situational analysis : including analyses of the competition, critical factors to succeed, resources, technology, and training requirements, and an assessment of the existing legal and regulatory environment. A SWOT (Strengths, Weaknesses, Opportunities, Threats) analysis 3. Marketing goals : proposed target market, sales projections, and measures of success 4. Marketing strategies : how the product will be developed, priced, promoted and sold – Marketing plans are also essential for existing products and services. They provide roadmaps necessary to profitability and effectively acquaint sellers with potential buyers Traditional marketing systems for insurance • P&C insurers market their products and services to customers through traditional marketing systems, alternative distribution channels or some combination of both. The three traditional marketing systems are 1. Independent agency and brokerage system 2. Exclusive agency system 3. Direct writer system • The principal characteristics that distinguish one traditional marketing system from another are – Contractual relationship between the producer and insurer – Ownership of policy expirations 52 – Compensation methods • Insurers select a marketing system based on organizational structure, business and marketing plans, growth goals, technological capabilities, staffing, and other resources necessary to support the selected system(s) • Independent agency and brokerage marketing system – Independent agents and brokers ∗ Producers (agents and brokers) are independent contractors, not employees of the insurers, and are free to represent as many insurers as they want ∗ Independent producers own the policy expirations, as clearly stated in the agency contract. The expirations constitute the largest and most marketable asset of an insurance agency ∗ Compensation is typically in two forms 1. A flat percent commission on all business submitted 2. A contingent or profit-sharing commission earned by meeting volume and/or profit goals and/or loss ratio ∗ Independent producers may provide risk management advice to their customers, help them to select insurance coverages needed, assist them in establishing and managing self-insurance programs, implementing loss control measures, and determining alternatives or supplements to insurance ∗ The independent agency and brokerage system is flexible and able to meet the needs of many different insurance customers – National and regional brokers ∗ These firms meet the needs of large commercial customers who demand sophisticated technical knowledge and comprehensive servicing ∗ They can also meet the need for insurance program business for (group of) customers who require a particular type of coverage for multiple locations, e.g. attorneys, daycare centers ∗ National and regional brokers are equipped to provide their customers with risk management services and loss control, actuarial, and claim administration services that are typically supported by offices in multiple states ∗ The brokers receive negotiated fees for the services they provide, or fees in addition to commissions, subject to state regulation – Independent agent networks ∗ They consist of independent agencies and brokerages that join together to gain advantages normally available only to large national and regional brokers ∗ By combining individual agency forces, an agent network can offer many benefits to its agent members: (i) Obtaining access to an increased number of insurers, (ii) Combining premium volume to meet insurer requirements for profit sharing, (iii) Generating additional sales income, (iv) Receiving preferred agency contracts, (v) Facilitating agency succession planning, (vi) Providing expertise in risk management services, (vii) Offering expertise in financial planning services, (viii) Enabling resource sharing and expense reduction, and (ix) Increasing market share – Managing general agents (MGAs) ∗ MGAs serve as intermediaries between insurers and the producers who sell insurance directly to the customer, similar to wholesalers. An MGA operates as an independent business firm that performs, on behalf of insurers, some or all of the the services and functions usually performed by an insurer’s branch office ∗ MGAs can represent a single/multiple insurer(s). The advantage to an insurer of operating through an MGA is the low fixed cost ∗ The MGA is compensated by a commission override on business its subagents sell. The MGA may also receive a contingent commission based on the profitability or the volume of business it writes 53 ∗ MGAs develop expertise in particular markets and design insurance programs in collaboration with the insurers they represent ∗ Full-service MGAs can provide an array of benefits to their subagents and brokers, including claim administration, information management, loss control and risk management services, underwriting and marketing services, policy issuance, and premium collection ∗ Insurers must supervise the MGAs that represent them, and most states regulate the MGAs activities and contracts – Excess and surplus lines brokers ∗ Excess and surplus lines (E&S) brokers place business with insurers not licensed in the state in which the insurance transaction occurs, because coverage is not available through standardmarket insurers. In some states, brokers must provide letters from the insurers rejecting the coverage ∗ When a producer wants to sell excess and surplus lines insurance, he must go through an excess and surplus lines broker rather than contacting the insurer directly ∗ Using an E&S broker has two advantages 1. E&S brokers have access to insurers that have the capacity to provide the needed insurance. A producer rejected by standard insurers may contact an E&S broker if (a) An unusual or a unique loss exposure (b) A customer who requires high limits of insurance (c) A customer who requires unusually broad or specialized coverage (d) Loss exposures requiring a tailored insurance program 2. The producer can use an E&S broker to place coverage on an unfavorable loss exposure ∗ E&S brokers work with their producers to ensure that (i) coverage is placed only with eligible nonadmitted insurers, (ii) the customer’s unique or unusual requirements can be met by the prospective E&S insurer, and (iii) the financial security of the E&S insurer is properly evaluated ∗ State guaranty funds, which provide claim-payment protection to insureds in the event of insurer default, are not available to E&S policyholders ∗ Among the various regulatory responsibilities of E&S brokers are: (i) Document maintenance, (ii) Bonding (the E&S broker must maintain a surety bond), (iii) Diligent effort or search, (iv) Notice to insured (disclaimer about the lack of guaranty fund protection), (v) Report filing and tax collection, and (vi) P&C licensing, in addition to a surplus lines license • Exclusive agency marketing system – The exclusive agency marketing system uses independent contractors called exclusive agents (or captive agents) who are not employees of insurers – Exclusive agents are restricted by contract to representing a single insurer, although some exclusive agency companies allow their agents to place business with other insurers if the exclusive agency company does not offer the product or the service needed – Exclusive agents typically do not have ownership of expirations. However, some insurers do grant limited ownership of expirations to their agents – Exclusive agents are compensated by commissions. During initial training, some of them may receive a salary, a guaranteed minimum income, or income from a drawing account – The exclusive agency system commonly pays one commission rate for new business and another, lower rate for renewal business. For exclusive agents, the focus is on new-business production – The exclusive agency company handles many administrative functions for the exclusive agent, including policy issuance, premium collection, and claim processing Direct writer marketing system • The direct writer marketing system uses sales agents (aka sales representatives) who are employees of the insurers they represent • The direct writer producer sells insurance for his employer at office locations provided by the direct 54 writer company • Direct writer producers do not have any ownership of expirations • Producers in the direct writer system may be compensated by salary, by commission, or by both salary and a portion of the commission generated • Direct writer agents are largely relieved of administrative functions by their employers Functions of producers • Prospecting – Virtually all producers prospect. Prospecting involves locating persons, businesses, and other entities that may be interested in purchasing the insurance products and services offered by the producer’s principals – Methods: (i) Referrals from present clients, (ii) Referrals from strategic partners (banks, real estate brokers, . . . ), (iii) Advertising (media and direct mail), (iv) Websites, (v) Telephone sollicitations, and (vi) cold canvass (aka cold calling) • Risk management review – The principal method of determining a prospect’s insurance needs • Sales – One of the most important activities of the producer because it is essential to sustaining the livelihood of the agency or brokerage – Commission on business sold is the principal source of income for producers, and the ownership of policy expirations applicable to the business sold is the principal asset of an insurance agency – Steps: (i) contacting the prospective client, (ii) determining the prospect’s needs, (iii) preparing and presenting a proposal, and (iv) closing the sale • Policy issuance – Some producers maintain a supply of an insurer’s pre-printed policies and forms in their offices and issue them as needed to their customers – Other producers use their own agency management systems to generate computer-issued policies on site – More common is insurer’s practice of assembling policies at the producer’s request and either mailing them directly to policyholders or sending them to the producer for delivery • Premium collection – Agency bill: A payment procedure in which a producer sends premium bills to the insured, collects the premium, and sends the premium to the insurer, less any applicable commission – For business that is agency billed, the three widely used methods of transmitting premiums to the insurer are 1. The item basis ∗ The premium (less commission) is forwarded to the insurer when the producer collects it or when it becomes due ∗ The producer is usually not required to pay the insurer until the premium has been collected 2. The statement basis ∗ The insurer sends a statement to the producer showing the premiums that are due. The producer is obligated to pay the premiums indicated as due or to show that the statement is in error ∗ The producer must pay the insurer when the premium is due, even if the policyholder has not paid the producer 3. The account current basis ∗ The producer periodically (monthly) prepares a statement showing the premiums due to the insurer, after deducting appropriate commissions, and transmits that amount to the insurer ∗ The producer must pay the insurer when the premium is due, even if the policyholder 55 has not paid the producer – Premiums are usually not due to the insurer until 30 or 45 days after the policy effective date. This delay also permits the producer to invest the premiums collected until they are due to the insurer, which may be a significant part of the producer’s remuneration – Direct bill: A payment procedure in which an insurer sends premium bills to the insured, collects the premium, and sends any commission payable on the premium collected to the producer, usually on a monthly basis – Agency billing is more commonly used with large commercial accounts. For small commercial accounts, and the majority of personal insurance, the direct bill process is used • Customer service – Most producers are involved to some degree in customer service, which may differentiate them in the marketplace – Services: endorsement request, coverage quotes, billing inquiries, field underwriting, facilitate contacts between policyholders and insurer personnel • Claim handling – Producers are likely to be involved in handling claims filed by their policyholders, because they are the policyholder’s principal contact with the insurer – Many producers are authorized by their insurers to adjust some types of claims, mostly limited to small first-party property claims – A few large agencies or brokerages with skilled claim personnel may be authorized to settle large, more complex claims – Claim handling by qualified producers offers two major advantages 1. Quicker service to policyholders 2. Lower loss adjustment expenses to the insurer • Consulting – Many producers offer consulting services (for insureds or prospects) , for which they are paid on a fee basis – Laws in some states prohibit agents from receiving both commission and a fee from the same client. Fees are billed separately from any insurance premiums due, whereas commissions are included in the premium totals billed 56 Myhr & Markham - Chapter 4: Underwriting Introduction • Underwriting is the process of determining what loss exposures will be insured, for what amount of insurance, at what price, and under what conditions. Underwriters determine underwriting criteria and apply them to the loss exposures of applicants • Underwriting authority varies considerably by insurer and by type of insurance. Specialty insurers usually centralize underwriting authority. At the other extreme, some insurers decentralize underwriting authority which they grant to specific producers or MGAs • Purpose of underwriting – The purpose of underwriting is to develop and maintain a profitable book of business for the insurer. A book of business is all of the policies that an insurer has in force or some subgroup of those policies – For underwriting to achieve its purpose, insurers must minimize the effects of adverse selection (a situation that occurs because people with the greatest probability of loss are the ones most likely to purchase insurance) – Underwriters minimize the effects of adverse selection by carefully selecting the applicants whose loss exposures they are willing to insure The underwriting process • To make an underwriting decision, underwriters go through the following six steps: (i) evaluating loss exposures, (ii) Determining underwriting alternatives, (iii) Selecting an underwriting alternative, (iv) Determining the appropriate premium, (v) Implementing the underwriting decision, and (vi) Monitoring the loss exposures • Evaluating loss exposures – Underwriters weigh the need for information against the cost to obtain it – Underwriters identify four hazard categories 1. Physical hazards: A tangible condition of property, persons, or operations that increases the frequency or severity of losses 2. Moral hazard: A condition that increases the likelihood that a person will intentionally cause or exaggerate a loss 3. Attitudinal hazard: A condition of carelessness or indifference that increases the frequency or severity of loss 4. Legal hazard: A condition of the legal environment that increases loss frequency or severity – The principal sources of underwriting information are ∗ Producers - they know the applicant ∗ Applications - provides general information ∗ Inspection reports - physical condition, safety record, management ∗ Government records - e.g. Motor vehicle records (MVRs) ∗ Financial rating services - e.g. surety bond underwriting ∗ Loss data - frequency, severity, credibility ∗ Field marketing personnel - local, specific information ∗ Premium auditors - actual loss exposures ∗ Claim files - firsthand view of the insured/insured locations ∗ Production records - indicate quality of the applicant • Determining underwriting alternatives – The three underwriting alternatives are 1. Accept the submission as is 2. Reject the submission 3. Make a counteroffer to accept the submission subject to modifications – Four major types of modifications are: (i) Require loss control measures, (ii) Change insur57 ance rates, rating plans, or policy limits, (iii) Amend policy terms and conditions, and (iv) Use facultative reinsurance – Require loss control measures ∗ Some loss control measures are inexpensive and simple to implement, while others require considerable capital investment ∗ Underwriters should make sound recommendations accompanied by well-reasoned and convincing explanations – Change insurance rates, rating plans, or policy limits ∗ A submission that is not acceptable at standard rates may be desirable if the underwriter can charge a different rate, use a different rating plan, or provide a different limit ∗ Pricing plays a key role in underwriting judgment-based insurance such as inland and ocean marine and GL loss exposures subject to “A-rating” ∗ Several rating plans are available for commercial applicants, including experience rating, schedule rating, and retrospective rating · Experience rating: uses the policyholder’s past experience to develop a premium modification factor to adjust the manual rate. Experience rating has a formal methodology that must be applied without discrimination to all submissions that meet experiencerating eligibility requirements · Schedule rating: awards debits/credits to a submission based on specific categories such as the care and condition of the premises and the training and selection of employees. Credits and debits vary by insurer, and are limited by insurance statute. Insurance statutes require that insurers apply schedule rating plans to all eligible submissions without discrimination and that adequate documentation be kept on file to justify the pricing decision · Retrospective rating: is an individual experience modification program that uses the current period as the experience period to develop the experience modification factor. At the end of the policy period, the actual loss experience for that same period is determined and a final premium is calculated, subject to minimum and maximum ∗ Changing policy limits (which usually reflect reinsurance limitations or availability and possible catastrophic loss) is an option for the underwriter. If high policy limits are requested, the u/w may suggest lower limits within the insurer’ underwriting guide ∗ For property insurance, the u/w must be alert for overinsurance that could indicate a moral hazard – Amend policy terms and conditions ∗ An unacceptable submission may become acceptable by modifying the policy to exclude certain causes of loss, add or increase a deductible, or make another coverage change ∗ The underwriter’s flexibility varies by type of insurance, if policies have been approved by state regulators, coverage modifications are seldom possible ∗ When the requested coverage cannot be provided, the u/w may suggest alternative coverage – Use facultative reinsurance ∗ If the applicant is in a class of business that is not covered by the underwriter’s reinsurance treaty, or if the amount of insurance exceeds net treaty capability, the u/w may be able to transfer a portion of the liability for the applicant’s loss exposure to a facultative reinsurer ∗ An alternative to purchasing facultative reinsurance is to ask the producer to divide the insurance among several insurers, aka “agency reinsurance” • Selecting an underwriting alternative – The following factors also need to be considered before selecting an underwriting alternative: (i) Amount of underwriting authority required, (ii) Presence of supporting business, (iii) Mix of business, (iv) Producer relationships, and (v) Regulatory restrictions – Underwriting authority: Before accepting an application, an u/w must determine whether he 58 has the necessary underwriting authority, otherwise the submission must be referred to a higher underwriting authority (time consuming) – Supporting business: A submission that is marginal by itself may be acceptable if the other insurance components of the applicant’s account - the supporting business - are desirable, i.e. constitute above-average business – Mix of business: When underwriting an individual application, the u/w must consider whether accepting the application supports the insurer’s goals for mix of business – Producer relationships: Some producers often pressure underwriters to accept a marginal submission as an accommodation. The long-term goals of producers and underwriters are growth and profit, and mutual accommodation and willingness to see the other’s viewpoint are essential to building a satisfactory working relationship – Regulatory restrictions: State regulations restrict underwriters’ ability to accept or renew business, often limiting reasons for cancellation or non-renewal, or limiting the time within which an underwriter can decline a submission or provide notice of refusal to renew • Determining the appropriate premium – Underwriters must ensure that each loss exposure is properly classified so that it is properly rated. Misclassification can produce adverse results, including insufficient premium to cover losses and expenses, inability to sell policies because prices are higher then competitors’ prices, and charges that the insurer has violated regulations prohibiting unfair trade practices – The appropriate premium must be not only high enough to enable the insurer to continue to write profitable business, but also low enough to compete with other insurers – For most types of personal insurance, WC, and some other commercial insurance, proper classification automatically determines the appropriate projected loss costs – Personal insurers typically have subsidiary companies for insureds with loss exposures that fall into the preferred-risk, standard-risk, and high-risk categories. Underwriters can place each applicant with the subsidiary considered most appropriate • Implementing the underwriting decision – Three steps are involved 1. Communicating the decision - Give clear reasons for rejection/modifications 2. Putting coverage into effect - Issue a binder, policy worksheet and/or certificate of insurance 3. Recording information for accounting, statistical and monitoring purposes • Monitoring loss exposures – Underwriters must be alert to changes in insured’s loss exposures – Monitoring existing policies may be done through: (i) policy changes, (ii) notice of loss, (iii) loss control and premium audit reports – Underwriters must also monitor books of business (loss ratios, premium volumes) – Classes with poor or deteriorating loss experience can be identified and corrected through rate increases, coverage restrictions, or more stringent selection standards – Monitoring territorial underwriting results can help the insurer target areas for future agency appointments in profitable regions – Underwriting results can also be monitored by the producer – Underwriting decisions and underwriting results are not always related. Over the long-run, however, the better the quality of the underwriting decisions, the better the results Types of underwriters • Insurers distinguish between line underwriters and staff underwriters – Line underwriters are responsible for implementing the steps in the underwriting process. They are generally located in insurers’ branch or regional offices – Staff underwriters assist underwriting management with making and implementing underwriting policy. They are located in an insurer’s home office • Line underwriters 59 – Assist with determining appropriate coverage ∗ Verify policies issued ∗ Draft manuscript policies and endorsements ∗ Discuss loss exposure with the producer – Provide service to producers and policyholders ∗ Prepare premium quotations, assist producer with proposals ∗ Process cancellations, endorsements, certificates, renewals • Staff underwriters – Researching the market ∗ Effect of adding or deleting entire types of business ∗ Effect of expanding into/retiring from additional states ∗ Optimal product mix ∗ Premium volume goals – Researching and developing coverages – Evaluating underwriting experience ∗ Trend analysis ∗ Communicate changes in the underwriting guidelines – Reviewing and revising rating plans ∗ Respond to changes in loss experience, competition and inflation – Formulating underwriting policy ∗ Influenced by senior management ∗ Subject to constant review and periodic change, considering: (i) financial capacity, (ii) Regulation, (iii) Personnel and physical resources, and (iv) Reinsurance – Developing underwriting guides ∗ Communicate the insurer’s underwriting policy to line underwriters and others by developing underwriting guides and related bulletins ∗ Uniform and consistent underwriting decisions ∗ Distinguish routine from non routine decisions – Conducting underwriting audits ∗ An underwriting audit is a management control tool used to determine whether line underwriters are properly implementing underwriting policy ∗ The audit focuses on: proper documentation, adherence to procedure, classification, rating practices, and conformity of decisions to the underwriting guide ∗ Monitor underwriting activity by analyzing statistical results by type of insurance – Assisting with education and training 60 Myhr & Markham - Chapter 5: Underwriting property insurance Underwriting fire insurance • Fire insurance focuses on physical hazards, although moral and attitudinal hazards are important. Property underwriters analyze four areas (“COPE”): (i) Construction, (ii) Occupancy, (iii) Protection, and (iv) External loss exposures • Construction – The construction of the covered building is a primary underwriting consideration – Construction classes ∗ ISO uses six classes. Ratings consider 1. The vertical load-bearing members that support the building’s weight 2. The materials used in the roof and floors which spread the weight across vertical loadbearing members ∗ Class 6 - Fire-resistive construction: Construction that incorporates load-bearing members which can withstand fire damage for at least two hours ∗ Class 5 - Modified fire-resistive construction: Construction that has load bearing walls and columns of masonry or reinforced concrete construction with a fire resistance rating of one to two hours ∗ Class 4 - Masonry noncombustible construction: Masonry construction or construction that includes exterior walls of fire-resistive construction with a fire-resistance rating of not less than one hour ∗ Class 3 - Noncombustible construction: Construction that has exterior walls, roof and floor constructed of and supported by metal or other noncombustible (but not fire-resistive) material ∗ Class 2 - Joisted masonry construction: Construction that has load-bearing exterior walls made of brick, adobe, concrete, gypsum, stone, with at least a one hour fire-resistance rating, and with floors and roofs made of combustible material ∗ Class 1 - Frame construction: Construction that has load-bearing components made of wood or other combustible materials – Construction materials ∗ Underwriters must consider several interior finish characteristics, including their ability to spread fire, the fuel provided for a fire, and the smoke and noxious gases emitted while burning ∗ The fuel load (aka fire load) indicates the expected maximum amount of combustible material in a given area of a building, including both structural elements and contents ∗ Insulation is another construction material that can be problematic ∗ Underwriters should also consider the construction materials used in roofing – Additional construction characteristics ∗ Building’s age · A different building code may have been in effect when the building was constructed · Complying with the current building code may increase repair costs · Obsolescence of heating, cooling, electrical and fire protection · Different intended occupancy, concealed spaces due to remodeling, unprotected openings in firestops due to alterations ∗ Building’s height: Restricts the capability of fire services to fight fires from outside ∗ Building’s fire divisions: Horizontal and vertical fire divisions, such as firewalls, parapets, firestops, and fender walls ∗ Building’s openings: The most common cause of unprotected openings are oversight and poor loss control, fire doors must protect openings in firewalls ∗ Building’s construction code · Local ordinances or state statutes that regulate the construction of buildings within a municipality, county, or state 61 · ISO has developed the Building Code Effectiveness Grading Schedule (BCEGS), from 1 (excellent) to 10 • Occupancy – A building’s occupancy affects property loss frequency and severity. Most occupancies are subject to common hazards and special hazards – Occupancy categories 1. Habitational ∗ Includes apartments, hotels, motels and nursing homes ∗ Detecting or controlling hazards can be difficult ∗ Often affected by fluctuations in the economy 2. Office: Low-hazard category 3. Institutional ∗ Schools, churches, hospitals, and property owned by government entities, prisons, police and fire stations ∗ Risk retention groups, municipal pools, and other alternative risk-transfer programs are commonly used to insure public entities ∗ To avoid adverse selection, an u/w need to determine why institutional property is being submitted for a traditional insurance program 4. Mercantile: A small fire can produce a large loss in this category 5. Service organization: e.g. dry-cleaners, auto service stations 6. Manufacturing operations – Characteristics of contents ∗ The loss potential of a particular occupancy can be evaluated by examining the content’s ignition sources, combustibility, and damageability ∗ Potential ignition sources · Friendly fires that escape containment · Friction that generates enough heat to ignite nearby combustible material · Electricity that produces sparks or heat that can ignite exposed combustibles · Exothermic chemical reactions that produce heat sufficient to cause ignition ∗ Combustibility · Highly combustible materials: (i) Light combustible material such as plywood, shingles, paper, cotton and other fibers, (ii) Combustible dusts, (iii) Flammable liquids, (iv) Combustible gases (H2 ), (v) Materials subject to spontaneous combustion, and (vi) Explosive materials, acids and oxidizing agents · The insured’s management practices in controlling its hazards can make a significant difference in the acceptability of the account ∗ Damageability · Major u/w consideration when determining the probable maximum fire loss to contents · Small and quickly extinguishable fire can cause a severe loss to highly damageable contents like expensive clothing, furniture or electronic equipment – Occupancy hazards ∗ The physical hazards that any occupancy presents can be classified into two categories: (i) Common hazards, and (ii) special hazards ∗ Common hazards · Hazards existing in almost every class of business occupancy · Four broad sources of common hazard: (i) Housekeeping practices (uncollected litter, improper storage, improper disposal), (ii) Heating equipment, (iii) Electrical equipment, and (iv) Smoking (for which management’s policy and enforcement are important in controlling this hazard) ∗ Special hazards 62 · Special hazards of the class: Hazards that increase the likely frequency or severity of loss but that are typical for the type of occupancy, e.g. cooking in a restaurant · Special hazards of the risk: Hazards that are created by the activities of a particular business and that are not typical of other businesses with which it would be classed · Special hazards of the risk are neither contemplated by the underwriter nor considered in standard rates for that class. Identifying special hazards of the risk requires a physical inspection of the insured’s business • Protection – Fire protection is of two types 1. Public or municipal protection provided by towns and cities 2. Private protection provided by the property owner or occupant – Public protection ∗ Public fire protection is defined as fire protection equipment and services made available through governmental authority to all properties within a defined area ∗ AAIS fire protection classifications · Protected: Building is within 1000 feet of a fire hydrant and within five road miles of a responding fire department · Partially protected: More than 1000 feet away from a fire hydrant, but within five road miles of a responding fire department · unprotected: Neither protected nor partially protected ∗ ISO independently evaluates public fire protection a publishes a Public Protection Classification (PPC) for each community which is an integral part of the rating process ∗ The PPC system rates the quality of a public fire service from 1 (excellent) to 10, measuring the adequacy of the equipment available to the public fire service, the water supply, and response time. Classes 1 through 8 apply to properties in protected communities. Class 9 applies to properties too far from a water supply, and class 10 applies to property without public fire protection available ∗ A given property may have a public protection class inferior to the community as a whole because 1. The property may present a loss exposure to fires that are more challenging than the fire services is equipped to handle 2. The fire service may lack year-round access to the property – Private protection ∗ Private protection systems consist of (i) prevention, (ii) detection, and (iii) suppression measures ∗ Prevention · One can control heat sources and separate fuel and heat. Also, one can control arson to prevent fires · Heat sources can sometimes be reduced or eliminated · Flammable or combustible material can be kept away from fixed-location heat sources ∗ Detection · Major detection systems include (i) a guard service with a clock system, (ii) a private patrol service, (iii) smoke and heat detectors (connected to an alarm), (iv) an automatic local alarm (sounds an alarm inside or outside the building), and (v) a central station alarm (a private detection service that monitors the systems) or remote station system (directly signals the local police and fire stations) ∗ Suppression · Private fire suppression methods fall into four categories: (i) portable extinguishers, (ii) standpipes and hoses, (iii) automatic sprinklers systems (including automatic, wet-pipe, dry-pipe, pre-action, and deluge sprinkler systems), and (iv) private fire brigades (which 63 should be evaluated in the same way as public fire departments) • External loss exposures – External loss exposures are outside the area owned or controlled by the insured. Single-occupancy and multiple-occupancy loss exposures present different underwriting challenges – Single-occupancy loss exposures ∗ A single-occupancy loss exposure exists when the property being underwritten is entirely owned or controlled by the policyholder. The external loss exposures come from adjoining properties ∗ Often little can be done from a loss control standpoint to reduce external loss exposures ∗ Exposing buildings: An exposing building is one that significantly increases the possibility of a fire in the insured building ∗ Other loss exposures: Lumberyards, gasoline storage tanks, brush, or woodlands – Multiple occupancy loss exposures ∗ Persons other than the policyholder own or control portions of the fire division that contains the insured property ∗ Underwriters should consider the occupancy class of the other occupants ∗ Another factor is the amount of protection available against fire originating in exposing occupancies Underwriting property values • The insurance buyer requests a limit of insurance to provide adequate protection. Property underwriters confirm the adequacy of the policy limits • The most common property valuation methods are replacement cost and actual cash value. Actual cash value is sometimes defined as replacement cost minus depreciation, but other factors are also often considered • Property is insured to value when the amount of insurance on that property approximates the policyholder’s insurable interest in the property’s insurable value • Insurance policies include coinsurance clauses and other insurance-to-value provisions to encourage purchasing insurance to value • Insurable value, which is based on the valuation provision in the insurance policy, is different from market value (price the property could command in a free market) or book value (acquisition costs of the property and accounting depreciation) • The insurer also benefits when underwriters encourage insurance to value because it promotes – Higher limits (hence higher premiums) of property insurance – An adequately insured book of business – Competitive status for the insurer • Underwriters must consider the effects of inflation. They should reassess the values exposed to loss at policy renewal, and adjust the limits accordingly Underwriting property causes of loss • Fire – Underwriters use the COPE - construction, occupancy, protection, and external exposure - model – Measures of loss severity: (i) amount subject, and (ii) probable maximum loss – Amount subject: Represents a worst-case scenario, i.e. the total value exposed to loss at any one location from any one event (the insurer’s amount subject can be different from the insured’s amount subject) – Probable maximum loss (PML): An estimate of the largest likely loss (subjective estimate, based on experience and judgment) • Lightning – Almost always paired with fire coverage – Lightning can and does cause insured damage independently of fire 64 • • • • • • – Loss control measures available: External/internal surge protectors, lightning rods Explosion – Combustion explosions: Prevention techniques: Limit the amount of fuel in the atmosphere, and restrict the supply of oxygen that reaches the fuel. Venting minimizes explosion damage – Pressure explosion: Equipment breakdown insurance covers explosions of steam boilers and piping, while commercial property forms insure against explosions of other pressure vessels. Homeowners forms protect against both Windstorm – Virtually included among the covered causes of loss in all personal and commercial property insurance – Windstorm is a difficult cause of loss to underwrite because it is hard to limit the consequences of any windstorm that may occur – Windstorm coverage is available in most parts of the U.S., offering a good geographic spread of risk. Adverse selection is rarely a problem, because property owners with little loss exposure purchase windstorm coverage as part of a package. Reinsurance is frequently used to mitigate the effects of catastrophic windstorm losses – Windstorm is a more serious consideration for personal rather than commercial insurance underwriters. Buildings that adhere to sound codes avoid or sustain only minimal damages. Enforcing building codes is essential in coastal areas – Underwriters must do more than evaluate individual submissions. Managing a book of business is essential. Insurers must be highly aware of their aggregate loss exposures from a single storm – To manage its aggregate windstorm loss exposure, an insurer has to restrict the number of loss exposures it writes in a given geographic area. An insurer can elect to restrict its writings by establishing a target expressed as a desirable market share, policy count, or total insured value Hail – Large damages to growing crops, aluminum siding, and roofing materials – Property underwriters need to be aware of the areas where hailstorms are relatively common – Property underwriters sometimes limit their writing in areas often hit Vandalism and malicious mischief – Vandalism can occur anywhere, but is most common in urban areas with many children and young adults – Vacant or unoccupied property tends to attract vandals. Hence, many policies limit or exclude coverage on vacant property – Little underwriting attention because vandalism produces relatively small and infrequent losses – Computer hacking and other cyber attacks may qualify as vandalism Water damage – Losses caused by accidental discharge, overflow, leakage of water or steam from plumbing, heating, and cooling systems are the most commonly covered losses – Water damage caused by flood is usually excluded because of its catastrophic nature – Although water damage occurs frequently, most claims are relatively minor Flood – Most private insurance policies covering buildings and other fixed-location real property exclude coverage for flood losses. However, other types of policies, especially personal property, such as personal auto and inland marine, typically do cover the flood cause of loss – Underwriters must recognize when covered property is in a location susceptible to flooding of any type. Six types of flood are common: (i) Riverine floods, (ii) Tidal floods, (iii) Wind floods, (iv) Rising water levels downstream causing a backwater flood, (v) Ice jams flooding upstream/downstream areas, and (vi) Accidental floods (dam breaking) – Through the National Flood Insurance Program (NFIP), the federal government is the largest flood insurance underwriter in the U.S. 65 • Earthquake – Underwriters must limit their total earthquake loss exposures within each seismic region to protect against a catastrophic loss – Earthquake underwriting considerations include 1. Areas of earthquake activity 2. Soil conditions 3. Building design and construction • Collapse • Other causes of loss: (i) Riot and civil commotion, (ii) Sprinkler leakage, (iii) Sinkhole collapse, (iv) Mine subsidence, (v) Volcanic action, (vi) Terrorism, (vii) Weight of ice, snow, or sleet, and (viii) Theft 66 Myhr & Markham - Chapter 6: Underwriting liability insurance Sources of legal liability • Legal liability – U.S. law is based on common law (decision of courts), state and federal statutes (written laws enacted by legislative bodies), and contract law (civil law dealing with contracts) – The law recognize two classes of wrongful acts 1. Criminal acts - Crimes against others, which are also offenses against society 2. Civil acts - Civil wrongs violate the rights of individuals by tort or by breach of contract – Liability insurance covers losses resulting from BI or PD to others for which the insured is legally liable and to which coverage applies – Liability insurance covers three sources of legal liability: (i) Torts (tort liability), (ii) Contracts (contractual liability), and (iii) Statutes that impose liability without regard to fault (statutory liability) • Torts – A tort is a wrongful act (other than a breach of contract) for which a civil lawsuit can provide a remedy. Torts can be intentional or negligent, they can also be based on absolute or vicarious liability – Negligence ∗ Negligence is the failure to exercise the degree of care that a reasonably prudent person would exercise to avoid harming others ∗ Four elements are required to bring a civil suit for negligence 1. Legal duty owed to the plaintiff to use due care 2. Failure to conform to the standard of care required in the situation, creating an unreasonable risk of harm 3. Causal connection between the negligent act and the BI or PD 4. Bodily injury or property damage ∗ Courts have recognized three classes of persons whose rights the law protects while they are on the premises of another party, with the highest degree of care owed to an invitee, and the lowest, to a trespasser 1. An invitee - Person who enters a premises for the financial benefit of the owner/occupant, e.g. a customer 2. A licensee - Person who enters a premises with the owner/occupant’s permission, e.g. a social guest 3. A trespasser - Person who enters a premises without the owner/occupant’s consent, e.g. a burglar – Intentional torts ∗ In contrast to negligence, intentional torts generally involve a wrongful act or omission intended to cause harm ∗ E.g., assault and battery, unlawful detention (false imprisonment, false arrest), defamation (libel, slander), invasion of the right of privacy, and copyright violations – Strict liability ∗ Tort liability can be imposed when the defendant acted either negligently nor with intent to cause harm. This type of liability is commonly referred to as strict liability, or absolute liability (liability imposed without regard to fault) ∗ E.g., abnormally dangerous instrumentalities, ultrahazardous activities, sale of dangerously defective products – Vicarious liability ∗ Vicarious liability: liability arising when one party is held liable for the actions of another party ∗ Relationships that can lead to vicarious liability include: principal-agent, employer-employee, 67 parent-child, partnership, or contractual relationship ∗ Closely related to vicarious liability is the concept of negligent entrustment, i.e. claims against the person who negligently entrusts property to another. However, such claims are based on negligence, not vicarious liability – Damages ∗ Damages are money the law entitles the plaintiff to recover for bodily injury, personal injury, or property damage ∗ Court-awarded money damages are usually categorized as compensatory or punitive · Compensatory damages compensate the injured party for the harm caused by the defendant’s wrongful acts · Punitive damages punish defendants whose conduct is willful or grossly negligent ∗ Liability insurance always covers compensatory damages, but adheres to applicable state and federal law on punitive damages • Statutes – Statutes can impose legal liability on certain persons regardless of whether they committed a tort or assumed contractual liability, e.g. the WC system for U.S. statutory liability • Contracts – Legal liability based on contracts can arise out of either (i) a breach of contract, or (ii) an agreement to assume another party’s liability – Hold-harmless or indemnity agreements are contractual provisions whereby one party agrees to assume the liability of another party for damages in situations in which the first party would not otherwise be liable Underwriting commercial general liability • CGL insurance provides coverage for loss exposures in five liability categories: (i) Premises and operations liability, (ii) Personal and advertising injury liability, (iii) Premises medical payments liability, (iv) Contractual liability, and (v) Products and completed operations liability • Premises and operations loss exposures – Premises liability loss exposures arise from the ownership or possession of real property (the premises) – Operations liability loss exposures arise from a policyholder’s business activities conducted away from its own premises and from uncompleted work – Liability underwriters tend to evaluate a business’s loss exposures in terms of its “premises risks” (e.g. for a retail store) or “operations risks” (e.g. for a building contractor). Generally, businesses with substantial premises loss exposures have minimal operations loss exposures, and conversely – Various factors increase premises liability loss exposures: level of customer traffic, location, legal status of persons likely to be on the premises – Because BI claims tend to produce larger losses, BI loss exposures are a primary underwriting concern. However, the potential for property damage losses cannot be ignored. Property damage losses include claims not only for the value of the damaged property but also for the loss of its use – Physical hazards fall into three categories: (i) Common hazards, (ii) Special hazards of the class, and (iii) Special hazards of the risks – To properly evaluate the physical hazards of premises loss exposures, underwriters consider the entire premises (inside and outside) as well as the physical hazards that can cause property damage (e.g. pollution ) – The hazards related to operations loss exposures vary more than those related to premises loss exposures. In addition, operations-type risks generally have a greater potential for property damage losses than do premises-type risks – Contractors and subcontractors ∗ A policyholder could be held liable for the negligent acts of contractors or subcontractors 68 • • • • hired to perform work ∗ Generally, a property owner who hires an independent contractor is not liable under common law for the independent contractor’s negligent acts. However, in some cases, the courts have held that an independent contractor is a de facto employee ∗ The law also holds the insured vicariously liable for duties that cannot be delegated to others ∗ When rating business operations other than a contractor, no special classification or rating rule exist for subcontractors, because the potential exposure is minimal ∗ When the policyholder is a contractor, the underwriter must determine whether subcontractors carry adequate insurance, e.g. requiring certificates of insurance from the subcontractors, or rely on the policyholder’s reputation in hiring competent subcontractors Personal advertising injury loss exposures – Personal injury loss exposures include the policyholder’s legal liability arising out of libel, slander, false arrest, wrongful eviction, invasion of the right of privacy, and infringement of copyright, trade dress, or slogan – The coverage provided under CGL (coverage B) excludes personal injury and advertising injury committed by an insured whose business is advertising, broadcasting, publishing, or telecasting Premises medical payments loss exposures – Medical payments (Coverage C in the CGL) provides coverage for medical expenses of persons other than the insured who are injured on the policyholder’s premises or because of his operations – Medical payments does not require the policyholder to be legally liable to pay for them, hence the limits are much lower than BI or PD ($5,000-$10,000 per person) – Medical payments for CGL is a third party coverage. It is a first party coverage for the PAP Contractual liability loss exposures – CGL policies usually cover any liability the insured assumes under a contract related to the business – Hold-harmless agreements ∗ A contractual provision that obligates the indemnitor to assume the indemnitee’s legal liability ∗ Statutes in most states limit using hold-harmless agreement ∗ When evaluating this loss exposure, an underwriter must rely on the insured’s reputation and past practices Products and completed operations loss exposures – Sources of products liability ∗ Breach of warranty: Source of liability based on laws that protect consumers who purchase products that do not perform as expected ∗ Negligence: Applies to a broad range of persons who have no contractual relationship with the seller. The most common charge of negligence in PL suits is failure to give adequate warning ∗ Strict liability: Imposes liability on any person who produces an unreasonably dangerous product. It is the most common basis for PL suits – Product loss exposures ∗ Underwriting generally focuses on the product itself, determining the inherent hazards of the product being the first and most important step ∗ The applicant’s business, the limits of liability, and the business’s size and scope are other important factors ∗ Other factors include: representations or promises made to the consumer, safety instructions in the manual, product’s packaging, easy to read instructions, loss/quality control in the product design and production phases, product recall procedures, position of the policyholder in the distribution channel, and product’s ultimate consumer – Completed operations loss exposures 69 ∗ Completed operations loss exposures include construction, service, repair, and maintenance activities ∗ Completed operations loss exposures vary by class of business ∗ The underwriter must determine the likelihood and severity of potential losses by evaluating the applicant’s business Underwriting professional liability insurance • Today, the term “professional liability” is also used to encompass insurance not limited to professions but purchased widely by all types of organizations, e.g. directors and officers liability insurance, fiduciary liability insurance, and employment practices liability insurance • Professional liability loss exposures – The loss exposures covered by professional liability insurance include mistakes, errors and omissions in rendering professional services, or wrongful acts – Professional liability insurance is usually written by insurers who specialize in that type of insurance • Occurrence versus claims-made coverage – Many PL policies provide claims-made coverage because: (i) PL losses tend to be large and infrequent, and claims are often filed and settled many years after the occurrence, and (ii) It is difficult to determine whether the PL insurance has been underwritten and priced correctly until after many years after the premium has been collected • Settlement conditions: Most PL insurers insist on the right to settle out of court without the policyholder’s consent • Defense costs: Can be paid in addition to policy limits, or included within policy limits • Deductibles and self-insured retentions (SIRs): Large SIRs are common with PL insurance, providing a strong incentive for the insured to prevent losses • Other factors – Social and business trends that affect a particular type of professional liability insurance (e.g. accounting scandals) – Uncertainty in the labor market and its consequences on employment practices liability claims – Declining profitability for certain types of professional liability insurance ∗ Physician’s medical specialty for medical profession liability ∗ Lawyers’ specialty area for lawyers’ PL Underwriting personal liability insurance • Personal liability insurance is part of every homeowners policy, and applies to the premises where the applicant maintains a residence and to the non-business activities of the policyholder and household members • Residence premises loss exposures – This loss exposure can be increased by an attractive nuisance hazard, i.e. a potentially harmful object or structure that may entice children onto the premises – A significant underwriting factor is the policyholder’s attitude about maintaining the premises – Residence liability losses are infrequent but can be severe. The expense factor of the low premium does not permit extensive investigation and inspection of the premises – Hence, highly unpredictable losses must be underwritten based on little information. However, some insurers have developed supplementary forms to capture additional information • Personal activity loss exposure: Personal liability insurance extends coverage to all activities not specifically excluded and does not limit coverage to personal activities at the residence premises • Other underwriting factors: Factors not directly related to the premises or the applicant’s activities include: (i) occupation, (ii) claim history (The Comprehensive Loss Underwriting Exchange - CLUE - provides useful information), and (iii) credit scores (highly controversial, sometimes prohibited) Underwriting auto insurance 70 • The regulatory environment – Underwriting discretion is especially limited in personal auto insurance. Regulators have developed: (i) Financial responsibility laws, (ii) Compulsory auto liability insurance laws, (iii) Shared market mechanisms, (iv) Mandatory uninsured motorists coverage, (v) No-fault auto laws, and (vi) Restrictions on cancellations and non-renewals – Financial responsibility laws ∗ Require a motor vehicle’s owner or operator to show proof of financial responsibility in one of three instances: 1. After an auto accident causing BI or PD greater than a specified amount 2. After conviction for serious offenses, such as reckless driving, DUI, or leaving the scene of an accident 3. After failure to pay a final judgment arising from an auto accident ∗ Require that insurance remain in effect until a notice of termination is filed with the DMV ∗ Extend insurance coverage to all vehicles owned by the insured, whether or not listed in the policy – Compulsory auto liability insurance laws ∗ Require the registered owners of all motor vehicles to have insurance with at least the minimum legal limits, which vary by state ∗ Motorists must be able to produce evidence of current insurance when requested by law enforcement officers ∗ May also require insurers to notify the DMV when a policy has been canceled and to provide continuous coverage until the cancellation notice has been effected properly – Residual market mechanisms ∗ Every state has developed a residual market mechanism to underwrite the insurance needs of drivers who cannot obtain liability insurance in the voluntary market ∗ Four types of residual market mechanisms: (i) Automobile insurance plans, (ii) Joint underwriting associations, (iii) Reinsurance facilities, and (iv) State funds ∗ Automobile insurance plan (AIP) · Aka assigned risk plan, assigns drivers to insurers that are plan members · Each insurer is usually required to accept assignments based on its share of the voluntary market in the state · The AIP requires that applicants be rejected by the voluntary market before they can apply · Underwriters have no control over the drivers they eventually must underwrite ∗ Joint underwriting associations (JUAs) · JUAs operate as insurers. They appoint servicing insurers to handle all insurer functions · State law usually requires all insurers that write auto coverage in the state to participate in a JUA · JUA profits and losses are distributed among insurers based on their voluntary market share ∗ Reinsurance facilities · States with reinsurance facilities require all voluntary insurers to be servicing insurers of the residual market · If an applicant is considered a high-risk driver, the underwriter can assign the driver’s premiums and losses to the reinsurance facility · The profits or losses on those policies are shared evenly among all insurers · One advantage is that drivers are not aware that they have been placed in the residual market ∗ State funds · Operating funds for the Maryland Automobile Insurance Fund (MAIF) are received from 71 the insurance premiums written with MAIF · MAIF receives no state funding, and the state of Maryland is not responsible for any debts or obligations of the fund – Mandatory uninsured motorists coverage ∗ Compulsory auto liability insurance has not been successful in keeping uninsured drivers off the roads ∗ Some states require all drivers to have uninsured motorists coverage, which compensates the policyholder for medical expenses and loss of income (and in some states, property damage) arising out of the use of an uninsured motor vehicle ∗ This coverage is activated when the owner of an uninsured motor vehicle is at fault in an accident with the policyholder, or when the policyholder is the victim of a hit-and-run driver – No-fault auto insurance laws ∗ Many states have no-fault insurance laws, requiring both first-party no-fault insurance and third-party auto liability insurance ∗ Many no-fault laws restrict an injured party’s right to sue ∗ A typical no-fault law requires first-party medical coverage and loss of earnings coverage for auto accident victims in all cases ∗ Many states also provide survivors’ and funeral benefits as well as payment for replacement services required by the injured party – Restrictions on cancellations and nonrenewals ∗ Most states have enacted laws that restrict the reasons for which insurers can cancel or nonrenew auto policies, usually applying to both personal and commercial policies ∗ In some states, statutes specify the acceptable reasons to cancel or nonrenew. In others, the insurance department establishes the restrictions ∗ Laws also specify the time period required for insurers to notify policyholders (∼ 30-60 days before cancellation/expiration date) ∗ Cancellation and nonrenewal restrictions have important underwriting implications: hard to cancel a bad risk, review pending renewal well in advance – Insurance requirements for commercial autos ∗ The Motor Carrier Act of 1980 requires certain commercial motor vehicles to meet financial responsibility requirements ∗ Motor carriers meeting the financial responsibility requirements through insurance must get their commercial auto insurance policy endorsed ∗ The MCS-90 endorsement imposes additional responsibilities on the insurer: the insurer is responsible for insured-owned vehicles not listed in the policy, and for trucking routes not described in the application ∗ The insurer must give motor carriers 35 days cancellation notice, and 30 days notice to the DoT • Personal auto loss exposures – Major underwriting factors considered in most private passenger auto underwriting guides include • Age of operator • Age/Type of auto • Auto use • Driving record • Territory • Gender/Marital status • Occupation • Personal characteristics • Driver physical condition • Safety equipment • Commercial auto loss exposures – Similar to personal auto – Factors relating to the vehicle (trucks, tractors, and trailers) 1. Vehicle weight and type 2. Vehicle use ∗ The ISO Commercial Lines Manual (CLM) classifies trucks and tractor-trailers into (i) 72 service, (ii) retail and (iii) commercial use ∗ Service use: Vehicles used to transport personnel or material to job sites. They receive the lowest rate ∗ Retail use: Vehicles used for deliveries and pick-up. They receive the highest rate (unfamiliar route, tight schedules) ∗ Commercial use: Any vehicle not in the two previous categories ∗ The CLM also provides classifications for public use vehicles (taxis, van pools, school buses) 3. Radius of vehicle operation 4. Special industry classifications ∗ Seven major classifications: Truckers, food delivery, specialized delivery, waste disposal, farmers, dump and transit mix trucks and trailers, contractors, not otherwise specified • Commercial auto loss control – Loss control reports: The report confirms and supplements information listed on the application, such as the type, scope, and efficiency of operations or the physical condition of vehicles – Safety programs ∗ Essential elements of a good fleet safety program: Driver selection, driver training and motivation, equipment control, accident reporting and review, periodic evaluation of drivers and vehicles, program enforcement and reinforcement, management support of the program ∗ Periodic on the road evaluations are a positive underwriting factor, but these evaluations must be followed up with corrective action Underwriting workers’ compensation insurance • Introduction – WC insurance protects employers against statutory liability losses, incurred under WC statutes. Benefits include death benefits, disability income, medical expense, and rehabilitation expense. WC benefits are compulsory in all states except New Jersey, South Carolina, and Texas – Employer’s liability insurance covers employers for their legal liability to an employee for BI arising out of and in the course of employment that is not covered under the WC law – WC benefits vary by state. WC laws are specifically incorporated into the policy contract by policy reference. Therefore, an u/w must read the applicable statutes to interpret the policy – WC insurance loss experience is closely related to changing economic, regulatory, and political environments, which often vary by state • Underwriting guidelines – Some insurers use the experience rating modification as an index of the account’s desirability within its class – It does not matter who provides coverage because experience modifications are calculated by the applicable state’s WC rating organization – Experience rating provides a financial incentive for effective loss control, and an accurate method to capture statistics about an applicant • Underwriting considerations – Line underwriters use the insurer’s guidelines to evaluate individual accounts. The primary factors are on-premises and off-premises hazards ∗ On-Premises hazards: Housekeeping, maintenance, and specific hazards present due to the type of machines, equipment, materials, and processes used in operations ∗ Off-premises hazards: Three elements: (i) the duration of travel, (ii) the mode of transportation, and (iii) the hazards at remote job sites – Other factors also demand special attention: management’s attitude about safety, the number of temporary and seasonal workers, subcontractors the insured engages, and the potential for cumulative trauma disorders or occupational disease ∗ Management attitude and capability 73 · The u/w considers the willingness and ability of management to minimize hazards and reduce losses · Insufficient financial resources can be detrimental to safety programs · Employee morale and claim consciousness often reflect management attitude toward WC and industrial safety, and the degree of managerial skill ∗ Temporary and seasonal workers · Employers use vendors or professional employer organizations (PEOs) to provide employees. For WC coverage, this practice raises the question of who employs these workers · Some state regulators and legislators have permitted master policies to be issued for all workers of a PEO, other states have prohibited them · NCCI has developed several endorsements for use with WC policies to clarify whether coverage applies to leased workers, non-leased workers, or both ∗ Subcontractors · Most WC laws hold a contractor responsible for WC benefits to employees of its uninsured subcontractors · The u/w must ascertain whether a subcontractor loss exposure exists. The policyholder may have to pay a rate based on the additional subcontractor payroll ∗ Cumulative trauma disorders · Cumulative trauma disorders, aka repetitive strain injuries (RSI) are now recognized by most states as compensable injuries · The major difficulty associated with determining compensability for these injuries is distinguishing between normal aging conditions and those that are truly job related · Determining financial responsibility is a related concern ∗ Occupational disease · The definition varies by state but an occupational disease is generally one resulting from causes the worker faces on the job and to which the general public is not exposed · E.g. silicosis, asbestosis, radiation, tuberculosis, pneumoconiosis · It is more difficult to predict the frequency and severity of occupational diseases than of work-related accidents · Hazard analysis includes monitoring the work environment for the presence of industrial poisons and chemical compounds • Occupational Safety and Health Act – The Occupational Safety and Health Act (the Act) of 1970 sets safety standards for employers and imposes penalties for violations – The Act created the Occupational Safety and Health Administration (OSHA) to enforce those standards. The Department of Labor enforces the Act – Safety inspectors may enter working premises. the employer has 15 working days to contest a citation, and violations are punishable by a $10,000 fine. A second conviction imposes double penalties – OSHA standards can help control cumulative trauma disorders, e.g. OSHA success in the red meat industry – All employers subject to the Act are required to keep occupational injury records for employees – OSHA safety inspections and logs are a source of underwriting information • Maritime occupations – Maritime loss exposures are those related to occupations involving work on vessels while at sea or in close proximity to bodies of water, e.g. docks, piers, or terminals – Some employee injury claims come within federal rather than state jurisdictions. Federal laws entitle certain group of workers to compensation for work-related injuries regardless of fault. This is similar to state’s WC laws, except that the schedule of benefits and administrative procedures are established by federal laws. Consequently, applicable rates for insurance coverage differ 74 – The principal federal laws are the United States Longshore and Harbor Workers’ (USL&HW) Compensation Act and the Merchant Marine Act (Jones Act) – Underwriters must always be alert to the existence of potential maritime loss exposures • Residual market - WC – When employers are unable to obtain WC coverage in the voluntary market, they seek to meet their statutory requirements in the residual market – Residual markets vary by state and include state funds, joint underwriting associations (JUAs), or assigned risk plans. Twenty states have either a monopolistic state fund or a competitive state fund – The Workers Compensation Insurance Plan (WCIP) is an assigned risk program that distributes applicants among all insurers in the state based on the % of their participation in the voluntary market. NCCI administers the WCIP on behalf of regulatory authorities in 20 states – NCCI also administers the National Workers Compensation Reinsurance Pool (NWCRP, or National Pool), which reinsures most of the business written in the state pools 75 Myhr & Markham - Chapter 9: Property claim adjusting Claim adjusting • The insurer fulfills its contractual promise to the policyholder through the claim settlement process. Adjusters screen request for payment to distinguish valid from invalid claims. Valid claims are assessed to determine their value and then are paid • The adjuster is responsible for the reputation of the insurer, being one of the only contact between the policyholder and the insurer • Internally, adjusters must provide information to several departments, including marketing, underwriting and actuarial • When a claim goes to trial, the adjuster must manage the defense counsel and communicate to plaintiff’s counsel the insurer’s settlement philosophy • The structure of an insurer’s claim organization is typically described in terms of its geographic or physical organization and its management/settlement authority • Claim offices are usually located close to policyholders so that service can be provided easily. Often, when claims occur outside the insurer’s normal geographic scope, independent adjusters are employed • A distinguishing feature of a claim organization is that higher levels of settlement authority are assigned to individuals based on their responsible use of the claim authority already granted. Experience, knowledge, and the confidence of management are all factors considered in extending settlement authority • Independent adjusters also provide expertise for complex or unusual claims. Many insurers employ independent adjusters as a normal part of their business rather than expanding their own staffs • The claim adjusting process can be described in terms of investigation, evaluation, negotiation, and settlement of coverage, liability, and damage issues Property claim adjusting process • Who has an insurable interest? Who is insured? – An insurable interest in property is a prerequisite to asserting a claim under an insurance policy. This u/w requirement is supported by language in the policy that limits all claim payments to the extent of the insured’s insurable interest – Interests in property ∗ Generally, anyone who would be financially harmed by the destruction of property has an insurable interest in that property (e.g. ownership) ∗ Under joint ownership, two or more owners each have a complete, indivisible interest in the property ∗ Joint ownership between husband and wife is known as tenancy by entireties ∗ Ownership in common involves two or more owners, each with an identifiable fractional financial interest in the property (e.g. partners) ∗ Lessees of property have an interest in the use of the property for the life of the lease ∗ Custodians of property, such as bailees, warehouse employees, and carriers, have an interest in the property to the extent of their fees and for their legal liability for the property safe return to its owner ∗ Security interests can exist in almost any property.The secured party is generally a creditor of the property owner. Security interests are created by contractual agreement or by law and are not usually evident – Policy requirements for an insurable interest ∗ Insurance policies simply limit payment on any claim to the extent of the insured’s interest ∗ Allowing the insured to collect more than its insurable interest in the property would provide a great incentive for the insured to deliberately destroy the property ∗ Identifying all insurable interests in the property enables the adjuster to treat every party fairly without compromising the insurer’s rights and it helps identify other coverage on the 76 same property – Coverage by other insurance ∗ Landlords and tenants · An adjuster need to review the lease to determine the interests of either a landlord or a tenant · Two-part analysis: (i) What are the parties’ respective interests in the property under lease, and (ii) What rights does each party have under the applicable insurance policy in question · To recover under an insurance policy, a party must have both the right to do so under the policy and an insurable interest in some property covered by the policy ∗ Bailors and bailees · The respective interests of the bailor-bailee in the property are determined by contract, or by the law · Adjusters handling claims for owners of property damaged while in a bailee’s possession usually rely on the bailee’s insurer to handle the claim · Should the bailee’s insurer deny liability, the owner’s insurer must handle the claim · Subrogation claims against the bailee might be waived or otherwise affected by the agreement between the owner and the bailee ∗ Mortgagors and mortgagees · Mortgage agreements usually require the owner to name the mortgagee on the owner’s insurance policy · Insurance policies grant rights to mortgagees that are separate and distinct from the owner’s rights, so adjusters may have to protect a mortgagee even when the owner’s coverage under the property is void · In most cases, the mortgagee’s interest is protected when claim settlement proceeds are used to repair the property. The adjuster should include the mortgagee’s name on any claim settlement check – Identification of insureds ∗ Generally, only the “first named insured”, “named insured”, or spouse of the named insured is entitled to make a claim ∗ In the event of the named insured’s death, an adjuster can settle claims with the named insured’s legal representative ∗ Loss payees are parties, such as owners of leased office equipment, who do not have any rights greater than or independent of the policyholder, but the loss payee’s name must be included on any claim settlement check ∗ Adjusters must deal with the right party. For cases in which the insurer can deny coverage to the first named insured or to the named insured’s spouse, the adjuster must check the policy for the rights the other insureds might have • What property is insured? Where is it insured? When is it insured? – Policy provisions about what property is covered, where it is covered, and when it is covered are straightforward and usually do not cause disagreement between the insured and the adjuster – Real/personal property ∗ Real and personal property may be valued differently, may have different limits of coverage and coinsurance requirements, so they must be distinguished ∗ Adjusters can determine whether fixtures (i.e. personal property that has become attached to and part of real property) by answering the three questions: 1. How permanently attached to the real property is the fixture? 2. Is the fixture well adapted to the real property? 3. What was the intent of the owner? ∗ The ISO HO-3 loss settlement provision requires that carpets, awnings, appliances, and 77 outdoor antennae be valued as personal property, regardless of whether they might actually be fixtures – Property not covered ∗ All claim denials should be in writing ∗ Failure to provide a reasonable explanation for a claim denial with references to the policy and the facts of the claim violates the Unfair Claims Settlement Practices Act – Additional coverages ∗ Adjusters should reach agreement about an expense before it is incurred ∗ The adjuster’s authorization of an expense under the additional coverages is contractually binding on the insurer, even if the expense in question is not covered – Policy period ∗ Adjusters must verify that the loss occurred during the policy period • Against what causes of loss does the insurance protect? – Most property insurance policies provide coverage only for direct physical loss. Adjusters must, therefore, recognize indirect or nonphysical types of losses – Even when loss of use is covered, direct physical loss to property is required to trigger such coverage and to measure its duration – Nonphysical losses include loss of value to property not caused by physical damage or destruction, such as obsolescence, loss of market, investment loss and financial fraud. E.g., for loss of market, if the inventory has not suffered a physical loss, its diminished value is not covered – Cause of loss and exclusions ∗ Some causes of loss are difficult to verify: · Water damage: Gradual seepage and floods are usually not covered, but may be combined with covered losses. The adjuster must separate damages by cause of loss · Collapse: Decay and insect and vermin damage are covered causes of collapse only if hidden. Defective construction is a covered cause of collapse only if the collapse occurs during construction · Theft: The adjuster’s most difficult task is to verify the loss and its amount. A claim cannot be denied simply because the insured fails to provide receipts · Vandalism: Adjusters investigating unexplained damage to property cannot pay for such damage under the coverage for vandalism unless evidence of intentional or malicious wrongdoing exists ∗ Some cause of loss have troublesome exclusions: · Gradual causes of loss: Property that suffers from wear and tear, rust, decay, deterioration, latent defect or rot (all excluded causes of loss) may suffer a subsequent loss that is covered and the adjuster must separate property that suffered the gradual damage from that which did not · Ordinance or law: Adjuster handling claims with additional costs due to ordinance or law must identify and segregate those additional costs when they are not covered · Faulty design, construction, or material: Usually not covered, and must be segregated by the adjuster (to initiate subrogation) if they lead to a covered cause of loss · Intentional acts of the insured: Not always easy to identify and prove, e.g. to prove arson, an adjuster must prove: (i) an incendiary fire, (ii) a motive on the insured’s part, and (iii) opportunity on the insured’s part • What is the dollar amount of loss? – Replacement cost ∗ Replacement cost is the cost to replace property with identical property or with property of like kind and quality at the time of loss ∗ Determining replacement cost is easier than determining actual cash value ∗ Once the property has been fully identified and described, the adjuster must determine the 78 – – – – – cost to replace it at the time of loss, i.e. the amount at which the policyholder can buy the item of personal property (not the original cost) ∗ If the exact type of property damaged is no longer available, the adjuster can make settlement based on property of like kind or quality ∗ Insurers have the option of replacing property rather than paying money to settle claims ∗ Determining replacement cost for building damage requires construction estimates based on: (i) Specifications, (ii) Materials, (iii) Labor, (iv) Overhead, and (v) Contractors’ profit ∗ Adjusters must negotiate estimates in good faith and use only contractors who provide legitimate estimates and good workmanship ∗ Whenever losses are settled on a replacement cost basis, determining the insured’s compliance with insurance to value requirements must also be done on a replacement cost basis ∗ Insurance policies generally do not permit replacement cost settlements until the property has been repaired or replaced. If the insured needs funds to pay a contractor before repair or replacement is complete, the adjuster will either (i) release to the insured an actual cash value settlement, with the balance paid upon complete repair or replacement, or (ii) parcel out a replacement cost settlement as repair or replacement is gradually accomplished Actual cash value ∗ Actual cash value (ACV) is usually defined as replacement cost minus depreciation ∗ Depreciation represents loss of value. When physical wear and tear is the chief cause of depreciation, adjusters usually apply straight-line depreciation ∗ Aside from physical wear and tear, obsolescence is the main cause of depreciation ∗ Other definitions of actual cash value · Application of the “replacement cost minus depreciation” definition requires an ascertainable figure for replacement cost which does not always exist (e.g. antiques) · The definition does not allow only for deductions from the replacement cost, certain property (e.g. collectibles) appreciates in value · Some courts have defined actual cash value to mean fair market value. Adjusters should not apply market valuation unless a well-functioning secondary market exists · Other courts have required adjusters to consider all pertinent factors, including physical wear and tear, obsolescence, market value, and any other relevant factors. This approach is known as the “broad evidence rule” Deductibles ∗ When a coinsurance penalty reduces the recoverable amount of loss, the insured benefits by having the deductible applied first ∗ Adjusters should use the approach of applying the deductible first unless the policy explicitly states otherwise, e.g. the commercial building and personal property (BPP) form Stated values and agreed amounts ∗ Some coverages provided on personal articles floaters are on a stated amount basis. The stated amount is determined by appraising the policyholder’s property or by reviewing a sales receipt. The insured is entitled to no more than the least amount of (i) the property’s actual cash value, (ii) the cost to repair or replace, or (iii) the applicable amount of insurance ∗ Fine arts and valuable papers are usually insured on an agreed amount basis. The insurer agrees to restore the property to its condition before the loss or to pay the amount agreed upon at the time the policy was written Repair or replace option ∗ Claims are generally settled with money. Occasionally, adjusters prefer to settle claims by repairing or replacing the property, when it is significantly less expensive to do so ∗ Insurers can also settle the claim with money based on the insurer’s cost to replace the item Appraisal clause ∗ The appraisal clause found in every property insurance policy is used solely to settle disputes 79 over the value of the property or the amount of loss ∗ The possibility of an appraisal procedure in which an impartial umpire settles the dispute gives both sides an incentive to negotiate in good faith • What are the insured’s duties after a loss? – An insured is not entitled to loss payment unless his duties have been performed. This requirement protects the adjuster from a critical review in a subsequent claim audit. Making the policyholder follow legitimate claim settlement procedures also helps uncover fraudulent claims or misrepresentations – Provide prompt notice ∗ A telephone call suffices, and this requirement is rarely an issue ∗ In case of loss by theft, the insured is required to notify the police (helps discouraging fraudulent claims) – Protect property ∗ The insured is required to protect the property from further loss by making emergency repairs and by implementing emergency safeguards ∗ Such measures are a reimbursable part of the loss (subject to policy limits) as long as they are “reasonable” and “necessary” ∗ The insured usually seeks pre-approval from the adjuster – Assist with the loss adjustment process ∗ Inventory all damaged property and, under certain policies, all undamaged property as well ∗ Show the damaged property to the adjuster ∗ Allow books and other records to be inspected ∗ Cooperate, as required in some policies (BPP) – Provide proof of loss ∗ A proof of loss is a written, signed, and sworn-to statement by the insured about the loss ∗ In a proof of loss, the insured is typically required to specify the time, place, and cause of loss; The interests in the property; Any other insurance on the property; And detailed estimates, inventories, bills, and other documentation that prove the loss ∗ Once a proof of loss has been submitted, the adjuster must respond promptly. Rejecting a proof of loss must be done in writing and should state specific reasons for the rejection ∗ Many insurers routinely waive the proof of loss. To be most effective, the proof of loss should be required early in the adjustment process – Submit to examination under oath ∗ An examination under oath is a statement given by a person who has sworn to tell the truth before a court officer ∗ Insurers rarely require an examination under oath, but when they do, they usually suspect policyholder fraud ∗ The examination under oath is a policy condition that the insured must fulfill, if required by the insured – Public adjusters ∗ Sometimes a policyholder can engage a public adjuster to assist with a claim. In such cases, the public adjuster handles all of the insured’s duties following the loss ∗ The insurer’s adjusters are required to handle claims with whomever policyholders designate to represent them • What procedures must be followed to settle the claim? – Regardless of how a claim is investigated, it involves 1. Determining the cause of loss 2. Determining the amount of loss 3. Documenting the cause and amount of the loss – When they receive a new claim, adjusters either do: 80 ∗ Accept the policyholder’s word and settle the claim accordingly ∗ Employ experts to investigate the claim or refer it to a SIU ∗ Personally investigate the claim – Experts may be consulted to determine the cause of loss, and other experts used to determine the value of a loss – Avoiding waiver and estoppel ∗ Waiver: The voluntary and intentional relinquishment of a right, expressed explicitly or implied by conduct ∗ Estoppel: The principle that prevents the insurer from asserting a right that it has already waived. Estoppel can result from a waiver, but can also be based on thoughtless, unintentional action on which the other party relies ∗ An adjuster’s words an actions can cause waiver and estoppel of the insurer’s right, especially by continuing to adjust a claim after a coverage problem has been discovered. A court can consider such a behavior a waiver, or the policyholder may rely on such behavior leading to estoppel ∗ Adjusters avoid the problems of waiver and estoppel with nonwaiver agreements, or with reservation of rights letters. In each of these documents, the insurer clearly indicates that nothing it does (through the adjuster) in handling the claim is intended as a waiver of any of the insurer’s right ∗ The general nonwaiver agreement is used whenever little is known about the loss and the adjuster wants to investigate without compromising the insurer’s rights ∗ A reservation of rights letter has the same content as a nonwaiver agreement. It is sent (certified mail) to the policyholder as a letter, usually when the policyholder refuses to sign a nonwaiver. Assuming that proof of receipt by the policyholder can be shown, a reservation of rights letter is as effective as a nonwaiver agreement ∗ The claim payment constitutes a waiver and the insurer is estopped from raising the coverage issues again – Determining salvage value and subrogation rights ∗ Claim adjusters can minimize the insurer’s losses by salvage and subrogation activities ∗ Claim adjusters do not reduce the amount of a loss settlement because of the value of “expected” salvage. Instead, if salvage value is apparent, insurers usually pay full value to the insured and handle the salvage themselves ∗ Ordinarily, adjusters and insurers do not directly market salvage, they use professional salvage companies ∗ An insurer may have subrogation rights when a party other than the policyholder is responsible for causing the loss. When an insurer pays an insured for a loss under a policy, the insurer is substituted (subrogated) for the insured and obtains the insured’s rights against any responsible party ∗ If the responsible party has liability insurance and the two insurers cannot agree on a settlement amount, a subrogation claim is likely to be handled through the nationwide arbitration system operated by “Arbitration Forums, Inc.” · Although this agreement applies only to claims between signatory parties and amounts below $100,000, the agreement keeps many claims out of court · Settlements under this agreement are fair and far less expensive than court settlements ∗ When an insurer obtains an amount through subrogation efforts, it must first pay the attorney fees and other expenses of subrogation and then reimburse the insured for any deductible or any other amount of loss not covered. The insurer receives what is left 81 Myhr & Markham - Chapter 10: Liability claim adjusting Introduction • Liability claim adjusting differs so significantly from property claim adjusting that most insurer claim operations are organized separately into either property or liability coverage units • Once coverage has been established, resolving liability claims depends more on determining legal liability and damages than on an insurance policy’s terms • In liability claims, the insured is not the person with the claim. The party with a liability claim against the insured is the claimant, aka third party. The insurer has no contract with, and the liability adjuster has no contractual obligations to, the claimant • Although liability claims for PD exist, they represent a relatively minor % of the total dollars paid on all liability claims. Negotiation plays a greater role in settling BI claims than it does in settling PD claims Liability claim adjusting process • Four steps: (i) Determining coverage, (ii) Determining legal liability, (iii) Determining damages, and (iv) Negotiating and settling the claim • Rarely are coverage, legal liability, and damages determined quickly and easily. They require investigation and documentation, which consume most of an adjuster’s time • Determining coverage – The essential coverage clause of most liability insurance policies is simple. Usually, any type of BI or PD for which the insured is allegedly liable is covered, unless it is specifically excluded – When determining coverage, adjusters are primarily concerned with the possible application of exclusions – Claimant’s allegations ∗ The claimants allegations determine coverage, even if those allegations are disputed and even if they are eventually proved untrue ∗ Protection against false, unproved, and unprovable claims is a crucial part of the protection provided by liability insurance policies – Coverage problems ∗ Adjusters face difficulty whenever coverage for a claimant’s allegations is doubtful, e.g. when some aspects of a claim are covered and others are not, and when coverage for the entire claim is questionable ∗ If part of a claim is clearly not covered: · The adjuster must explain (in writing) to the insured why not, with reference to specific policy provisions · The adjuster must explain that the insurer will continue handling the claim but that the insured may have to contribute to an eventual settlement or judgment · However, because most liability claims are settled without clearly specifying the basis of liability or the elements of damages, the insurer usually pays the entire settlement ∗ When coverage for the entire claim is doubtful: · The adjuster must explain to the insured in writing why, and must explain what the adjuster will do · After issuing a letter advising the insured of a coverage problem and reserving the insurer’s rights, the adjuster must promptly investigate and make a coverage determination · If coverage is found to apply, the insured is informed. If coverage does not apply, a prompt letter of denial is forwarded to the insured ∗ Insurers can resolve coverage questions through declaratory judgment actions in court. However, this procedure is very expensive in legal bills and lengthy ∗ Whenever coverage does not apply to a claim, the insured should receive a written explanation, and a copy should go to the producer. if a lawsuit has been filed, the insured must be 82 – – – – told exactly how much time he has to file a response with the court Bodily injury and property damage ∗ Liability insurance policies usually apply only to claims for BI or PD, the most likely exception being the personal injury coverage of the CGL ∗ Money damages are an appropriate remedy for both BI and PD and are normally included in the relief sought in a lawsuit ∗ Lawsuits that seek only injunctions, and not money damages, are generally not for BI or PD. They could be covered though if such suits concern ongoing BI and seek an injunction to stop further injury, or if they seek an injunction for interference with use of property (loss of use of property is included under PD) ∗ Lawsuits alleging breach of contract resulting only in financial harm or lawsuits alleging financial fraud are more clearly not covered. Likewise, regulatory fines or minor criminal fines are not PD damage and are not covered ∗ Claims for emotional injury only, without physical BI present more difficult coverage issues. Generally, if the court cases of the applicable jurisdiction allow a tort claim based on emotional injury only, then an emotional injury would constitute BI for coverage purposes Intentional acts ∗ Liability insurance policies generally exclude coverage for the insured’s intentional acts. This is an important exclusion because claimants often allege that the insured acted intentionally. However, this is a difficult exclusion since 3 questions arise 1. Did the insured intend the result of his action or merely intend to commit the action without contemplating the injurious outcome? 2. Can intentional acts be excluded when the claimant also alleges negligence or strict liability on the insured’s part? 3. Is the insured liable for the intentional acts of an agent, if the insured is vicariously liable? ∗ Adjusters cannot rely on the intentional act exclusion unless they are familiar with the law in their state regarding its meaning. In some states, an assault may not be excluded as an intentional act unless the insured intended the resulting harm ∗ The distinction between intending the act and intending the harm has been at the center of numerous suits by insureds seeking coverage under their homeowners liability insurance for acts of sexual molestation (most of which have now a specific exclusion) ∗ Applying the intentional act exclusion is difficult when the claimant also alleges negligence or strict liability on the insured’s part. Upon settlement, no distinction is made between which parts of the settlement are for which allegations ∗ A case is settled as a whole, and coverage issues cannot be resolved in a settlement. The same problem exists even when a case is litigated to a verdict, which is most often expressed as a single sum of money and does not resolve any coverage issues Contractual obligations ∗ Generally, liability insurance does not guarantee that insureds will perform their contractual agreements. However, adjusters cannot deny coverage for all claims based on breach of contract, and contractual obligations are frequently involved in covered claims ∗ The consequences of a breach of contract may be covered even if the breach itself is not ∗ Certain contractual obligations may be directly insured by liability policies, e.g. CGL covers contractual liability assumed in a lease and contractual liability assumed for another’s torts for BI or PD ∗ Claims of contractual breach may be combined with claims of negligence or strict liability (e.g. products or professional liability) Property under the insured’s control ∗ Insured’s often submit claims for property damage to another’s property that has been damaged while in the insured’s care, custody, control, or while the insured was working on it. 83 Such property damage is clearly excluded from coverage by the typical liability insurance policy ∗ Adjusters can identify care, custody, or control situations with minimal investigations, and usually direct the insured to the first-party coverage that deals with these situations ∗ PD to the insured’s product itself, to the insured’s work itself, or to property that the insured has sold or given away is likewise excluded from typical liability policies • Determining legal liability – Proper investigation is essential in determining legal liability and is one of the core skills of claim adjusting – Many legal principles are relevant to claim adjusting, including (i) tort liability, (ii) criminal liability, (iii) contractual liability, (iv) statutory liability, and (v) vicarious liability – Investigation ∗ The adjuster must gather all the additional facts after a claim’s initial report ∗ When a claimant’s account of an accident is committed to a statement, it cannot be easily changed later. An adjuster should also obtain the insured’s account of the accident ∗ Taking statements from witnesses is standard practice with liability claims. However, as long as a witness is available to testify, a statement given out of court cannot be used as evidence, except for impeachment ∗ Adjusters also collect evidence in other forms, such as police reports, photographs and diagrams of accident scenes, and products or objects involved in claims. Evidence should be collected promptly to preserve the accident scene before changes occur ∗ Obtaining all of the relevant evidence is the most important aspect of any investigation. In addition, adjusters should be constantly evaluating the credibility of evidence as it is received ∗ For witnesses to be completely credible, they must: (i) Have had an opportunity to observe the facts, (ii) Remember those facts accurately, (iii) Have the ability to communicate those facts, and (iv) Have no motive to distort the facts – Tort liability ∗ A tort is a civil wrong not arising out of a breach of contract ∗ Negligence is the usual basis of tort liability . A cause of action in negligence requires (i) a legal duty owed to the claimant, (ii) a breach of that duty that causes harm, (iii) a causal connection between the breach and the harm, and (iv) actual BI or PD on the claimant’s part ∗ It is not enough for the BI of a person to be “caused by” another for compensation to result. Proximate (or legal) cause, i.e. an event that sets in motion an uninterrupted chain of events contributing to a loss, must also exist. This legal concept requires that an unbroken chain of events must link the “cause” and the injurious “event” ∗ Intervening negligence could eliminate proximate cause between the original negligence and the injurious outcome ∗ Tort liability can also be based on behavior other than negligence. Intentional torts include: assault, battery, false arrest, false imprisonment, theft, defamation, trespass, and fraud ∗ Tort can also be based on strict liability (or “absolute liability”), which is liability that exists regardless of whether the insured was negligent. Absolute liability is generally imposed for activities such as operating aircraft, storing explosives, or having wild animals on premises ∗ An adjuster investigating tort liability must know all of the elements of the tort(s) so that tort liability can be recognized – Criminal liability ∗ criminals are legally liable in civil courts to their victims ∗ An adjuster handling a claim filed against a convicted criminal must often concede liability, but not necessarily coverage – Contractual liability 84 ∗ A party who breaches a contract is legally liable to the other party to the contract ∗ In cases of alleged breach of contract, the adjuster must thoroughly review the entire applicable policy. The adjuster must investigate the insured’s behavior to determine whether it constitutes a breach of contract. Finally, the adjuster must investigate all potential contractual defenses ∗ In cases of contractual hold-harmless agreements and assumptions of liability, the adjuster must scrutinize the contract to determine whether it applies to the situation in question. Courts interpret such contracts narrowly – Statutory liability ∗ Should a statute violation cause BI or PD, the policyholder’s liability coverage may apply ∗ An adjuster handling a case involving an alleged statute violation must determine what the statute requires, what the policyholder did, and whether any insurance policy exclusion applies – Vicarious liability ∗ Frequently, adjusters must investigate the possibility of vicarious liability, which is liability imposed on a party because of that party’s relationship to a wrongdoer ∗ For adjusters, the most important issue regarding vicarious liability is the scope of employment or agency. An employer is liable for the acts of its employees only while they are acting within the scope of their employment ∗ The adjuster handling such situations often faces difficulty because the employer may overstate the extent to which it made its rules and prohibitions known to the employee – Defenses to liability claims ∗ The most useful defenses are: (i) absence of negligence, (ii) comparative or contributory negligence, (iii) assumption of risk, and (iv) statute of limitations ∗ Absence of negligence · Absence of negligence is not so much a defense as it is a failure to prove the claimant’s case. Nevertheless, adjusters should consider absence of negligence as a possible defense · Many accidents occur through no one’s fault ∗ Comparative or contributory negligence · Comparative or contributory negligence exists whenever a claimant’s own fault contributes to causing his BI. Such negligence is common · Under comparative negligence laws, the claimant’s recovery is reduced in proportion to the claimant’s share of fault · Under some comparative negligence laws, claimant fault in excess of 50% completely bars the claimant from recovery. However, in “pure” comparative negligence states, a claimant can be 99% at fault and still recover 1% of the damages · In the few states that recognize contributory negligence, any fault on the claimant’s part completely bars the claimant from recovery ∗ Assumption of risk · The assumption of risk defense applies whenever a claimant knows a risk and voluntarily assumes it anyway · For the defense to be valid, the claimant’s behavior must be both knowing and voluntary ∗ Statute of limitations · Each state has statutory time limitations (from 2 to 15 years) on the right to file lawsuits. The amount of time varies by state and by the type of legal claim · Failure to file a lawsuit within the allotted time waives any obligation on the tortfeasor’s part so that an expired statute of limitations can serve as an absolute defense • Determining damages – Adjusters must determine and document damages before settling a claim – Adjusters usually rely on outside experts for damage information, such as doctors for BI; apprais- 85 ers, contractors, or repairers for PD; and accountants or economists for financial factors – Damages in BI liability claims are usually proved with medical reports and bills, hospital records, and employer information. So, settling a BI claim often does not occur until treatment has concluded or until a clear prognosis and course of future treatment are known – Damages in PD claims are proved with repair estimates or with actual bills for repair and rental – Bodily injury claims ∗ The claimant has the burden of proving the damages. Nevertheless, the adjuster must investigate the nature and value of damage ∗ Damages can be classified as either special damages or general damages. Special damages are established for losses that can be quantified, such as loss of earnings. General damages are for intangible losses, such as pain and suffering. These damages are highly subjective, but they are the largest and most important element of damages in BI claims ∗ To estimate general damages, some adjusters multiply (all or medical only) special damages. The multiple-of-specials approach to general damages is often criticized as inappropriate in most cases. It has no logical basis nor any official recognition in case law. Nevertheless, it is widely practiced by both claimants’ attorneys and adjusters ∗ Expenses for medical treatment · Medical expenses must be related to the BI, necessary to heal the BI, and reasonable in amount. With a solid case for unnecessary and/or excessively expensive treatment, an insurer can avoid payment · Because adjusters lack the experience and expertise necessary to evaluate the necessity and frequency of medical treatment, insurers have begun to employ utilization review services. Adjusters may also audit medical bills · In many states, the defendant must pay the medical expense, even if it has been covered by another source of insurance, such as health insurance. This is know as the collateral source rule (a tort law that prevents the tortfeasor - defendant - from deducting from the amount owed to the victim - plaintiff - any goods, services, or money the victim received from other “collateral” sources as a result of a tort ∗ Loss of earnings · Any amount that a claimant would have earned during a disability period is recoverable. Lost wages are established by verifying the extent and period of disability and the claimant’s earnings · The adjuster must usually rely on a physician’s written report to evaluate a claimant’s disability or ask for an independent medical exam · Earnings are verified easily for a claimant who receives a salary or who works regular hours for wages. Earnings of self-employed claimants and claimants who own their own businesses are more difficult to verify ∗ Pain and suffering · Pain and suffering: Intangible injuries, including inconvenience and anxiety as well as pain and suffering associated with a physical injury · Pain and suffering is an intangible factor in every BI case and is usually the largest component of damages. The amount awarded depends on the medical expense amount, the disability’s length, the severity and nature of BI, the locale where the lawsuit is tried, the attorney’s respective skills at creating sympathy and favorable impressions, and many other factors · Proper evaluation requires a good deal of experience, but even experienced claim adjusters are well aware of how inaccurate they could be in a given case ∗ Permanency/disfigurement · Permanent BI injuries and scars are evaluated similarly to pain and suffering - unscientifically 86 ∗ Loss of consortium · Loss of consortium is an element of damages that generally belongs only to the injured’s party spouse. Some states permit payment to other family members such as a parent or grandparent. Other states limit consortium payments to the spouse · Consortium traditionally consist of sex, society, and services · This element of damages is also difficult to evaluate, and sometimes it is estimated as a percentage of the underlying injury damages ∗ Future damages · Any of the previous elements of damages that can be expected to continue into the future should be included in a settlement or jury verdict · With serious BI, future damages can exceed the damages incurred · Any future damages that can be specified in amount should be discounted to their present value ∗ Survival and wrongful death · The term “survival and wrongful death” refers to both the action and the damages · Survival actions are legal causes of action that existed for the deceased before his death · Wrongful death action belongs to the deceased’s survivors. This action is designed to compensate survivors for the loss of the deceased and arises only upon death · Most deaths involve eligible beneficiaries because most states allow spouses, parents, or children to recover. Financial dependence allows for the largest recoveries · Some states provide for a loss-to-the-estate measure of damages to the eligible beneficiaries. Under this measure, the deceased’s future cost of maintenance is subtracted from future earnings to determine a net contributions figure, or an estimate of the deceased’s estate. Under loss-to-the-estate measures of damages, the future damages should be discounted to their present values – Property damage claims ∗ Determining damages in third-party PD liability cases is easier than in first-party PD claims since the adjuster does not need to worry about deductibles, special sublimits, coinsurance, or damages caused by both covered and noncovered causes ∗ In third-party claims, the law allows a deduction for depreciation from replacement cost ∗ One important difference between first-party and third-party PD claims is that the property owner’s own negligence is irrelevant in first-party claims, but it can be a major factor in settling third-party claims · In contributory negligence states, the owner’s fault is a complete bar to recovery · In comparative negligence states, the owner’s fault reduces the recovery ∗ A PD claimant is in a relatively weaker bargaining position with the adjuster than a BI claimant because of the smaller or more definite value of PD claims and the expense of litigating them. Some restrictions on adjusters address this situation: · Claim managers strongly discourage having a PD claim go to lawsuit · The Unfair Claims Settlement Practices Act, a version of which is in effect in most states, requires adjusters to attempt settlement when liability is reasonably clear and forbids stalling on one claim settlement to influence another’s settlement ∗ Many PD liability claims first appear as subrogation claims from other insurers. Should the adjusters for the respective insurers be unable to negotiate a settlement, the claim can be resolved by intercompany arbitration · The Property Subrogation Arbitration Agreement covers most first-party subrogation claims · The Nationwide Inter-Company Arbitration Agreement covers APD claim subrogation · The arbitrators in these claims decide issues of both liability and damages, and their decision cannot be appealed. The vast majority of U.S. insurers subscribe to these agree- 87 ments • Negotiating and settling claims – Everything an adjuster does on a claim should be directed toward settlement. The vats majority of liability claims are settled without going to lawsuit. The vast majority of claims that do go to lawsuit are settled before trial – Settling liability claims is the most valuable service liability claim adjusters perform for insureds, claimants, insurers, and society – Duty to settle ∗ Liability insurance policies usually give insurers the right to settle claims, but they do not impose a duty to settle because insurers might want to litigate a claim. The threat that a claim may be litigated helps keep many dubious claims from ever being asserted ∗ The insurer, rather than the insured, controls the defense and claim settlement. If a verdict exceeds the insured’s policy limit, however, the insured has to pay excess ∗ A legal obligation to settle arises when the value of a liability claim approaches or clearly exceeds the insured’s policy limit ∗ If a court thinks that an insurer unreasonably rejected settlement, it would probably hold the insurer responsible for the damages exceeding policy limits. This is one type of bad faith claim against the insurer, i.e a claim that implies or involves actual or constructive fraud, a design to mislead or deceive another, or a neglect or refusal to fulfill some good-faith duty or some contractual good-faith obligation – Pressures to negotiate ∗ Both sides to a claim are pressured to negotiate by the possibility of an undesirable outcome at trial ∗ Claimants typically settle for less than they could reasonably expect from a trial because: (i) they are far less able than insurers to risk an adverse result, and (ii) their attorneys make much more money for their time by settling claims than by trying them ∗ Claimants and insurers have very different emotional investments and therefore approach settlement differently ∗ Plaintiff and defense attorneys face similar professional pressures: It is almost always in their client’s best interests to settle. Yet to develop their professional skills and gain credibility, they need trial experience. Trying cases, however, is enormously stressful. Juries are unpredictable, clients can be unforgiving, and professional reputations can be made or destroyed by a single case ∗ Adjusters are also highly motivated to limit and control legal expenses. Both claim department management and corporate management monitor legal expenses closely. Adjusters are reprimanded for allowing claims to go to trial unnecessarily and for failing to pursue settlement throughout the course of litigation – Negotiation strategies ∗ In a typical claim settlement, negotiations begin with a demand by the claimant’s attorney for a specific sum of money. The opening demand is usually a high evaluation of the claim ∗ Usually, however, the adjuster responds to the attorney’s demand with a settlement offer that is a lower evaluation of the claim ∗ If they believe they can settle, they continue to negotiate until they agree on a specific settlement amount. With an unrepresented claimant, the adjuster is much more likely to make the first settlement offer ∗ Neither adjusters nor attorneys consider willingness to negotiate a weakness. good negotiators can take strong positions and encourage the other side to continue the process ∗ Properly preparing for and intelligently evaluating a claim are essential prerequisites to good negotiating. Proper preparation consists of the adjuster’s investigation and documentation of liability and damages. The adjuster determines both a good first offer and a probable range 88 of settlement ∗ Every adjuster can settle claims without consultation up to a specified dollar limit. Beyond that limit, the adjuster must obtain settlement authority from higher-level claim personnel. Request for settlement authority are usually presented in writing and summarize the facts, the liability details, the BI, and the special damages ∗ The adjuster must also be sure that a credible defense attorney is involved should the claim already be in lawsuit. Finally, communicating some flexibility in one’s position is important ∗ Most adjusters and attorneys negotiate cooperatively and constructively – Settlement techniques ∗ Most claims are settled using a general release, in which the claimant releases the insured of all liability for the claim and the insurer agrees to pay the claimant the agreed settlement amount . Specialized releases address particular situations, such as those involving joint tortfeasors and minors ∗ For claims by married individuals, the claimant’s spouse should also be a party to the release to dispose of his consortium claim. For claims in which a lawsuit has been filed, the settlement must include the lawsuit’s dismissal by the claimant (by filing a simple notice in the court records stating that the claim has been settled ∗ Liability claims are usually settled with a lump-sum payment ∗ Structured settlement · An agreement in settlement of a lawsuit involving specific payments made over a period of time · Structured settlements are usually made on high-value claims. They are especially useful when the claimant is likely to experience regular damages into the future · Structured settlements are attractive to insurers because they enable them to offer more dollars in the total settlement at a lower present cost than with a lump-sum payment ∗ Advanced payments · A payment made to a claimant following a loss to cover the immediate expenses resulting from that loss · Many insurers use advance payments to discourage the claimants from hiring attorneys · Payments are paid without receiving a release in return, but the claimant must sign a receipt acknowledging payments and that the advance payments count toward final settlement ∗ Walk-away settlement · A settlement that involves lump-sum payments made by insurers to settle claims and that does not require a release from the claimant · These settlements are most appropriate for small claims · Walk-away settlements promote excellent public relations, enhance assertive claim handling, and encourage claimants to refrain from bringing suit · In claims in which the claimant does sue, the insurer is entitled to credit for what it has paid • Litigation – All liability claim adjusters should be familiar with litigation. Insurers have both the right and the duty to defend the policyholder. Adjusters must understand and properly handle this right and duty – Lawsuit procedures are governed by civil procedure, i.e. the rules by which courts conduct civil trials. Civil trials concern the judicial resolution of claims by one individual or group against another – Because attorneys fees are a major expense for liability insurers, adjusters implement a variety of controls designed to minimize legal expenses – Adjusters must simultaneously ensure the insured’s proper defense, develop strategy, direct lit- 89 igation, and manage legal expenses. Properly handling litigation is one of the most challenging tasks in claim adjusting and one of the most important of any insurance activities – Role of courts in resolving claims ∗ The courts play an essential role in settling claims. Courts provide an incentive to negotiate ∗ However, courts are not fast, inexpensive or predictable ∗ The adverse psychological effects of litigation tend to mount as time progresses, a circumstance that increases incentives to settle. Following pretrial activities, many parties conclude that they prefer a settlement for a definite amount ∗ The values that attorneys and adjusters place on claims are derived from actual results of claims litigated to conclusion. Although only a small percentage of claims are decided by courts verdicts, those verdicts influence the price of all claims – Duty to defend ∗ The duty to defend is a valuable aspect of liability insurance ∗ A type of lawsuit that is difficult to settle involves claims of multiple codefendants, all of whom insist they have no liability and refuse to settle ∗ The insurer’s duty to defend is especially important in frivolous, fraudulent, or meritless claims. When insurers defend frivolous lawsuits to a verdict, they spend far more on defense than on claim indemnification. When insurers settle frivolous lawsuits, they usually do so because settling saves a greater amount of legal expenses ∗ The insurer’s duty to defend is also its right. The insurer can select the defense attorney, and the insured is then obligated to cooperate with that chosen attorney ∗ The insurer can unilaterally decide to settle or to continue a claim’s defense. Although the defense attorney is professionally obligated to serve the insured’s interests above all, the insurer pays the defense attorney and therefore dictates all defense decisions ∗ Defense attorneys hired to defend the insured should never be used to advise the insurer on coverage issues in the same case ∗ Generally, an insurer must defend an entire claim whenever a plaintiff’s allegations for any part of the claim are covered ∗ When two defense attorneys are involved, the insurer’s attorney has the right to control the case as long as the insurer’s money is at stake – Civil procedure ∗ Court cases proceed according to rules of civil procedure. The five stages of a lawsuit are (i) pleadings, (ii) discovery, (iii) motions, (iv) trial, and (v) appeal ∗ Pleadings · The pleadings are papers filed with the court clerk in which each side give its account · A lawsuit is initiated with either a summons, i.e. a simple notice to the defendant that a lawsuit has been filed, or a complaint, i.e. a listing of allegations in which the plaintiff establishes his case · All jurisdictions require that a complaint notify the defendant of the nature of the case · Within a specified time (20-30 days), the defendant must file an answer, i.e. a response to each of the plaintiff’s allegations. As part of the answer, the defendant can also raise affirmative defenses · The defendant can join additional defendants by filing a cross-complaint against other parties who might ultimately be found responsible for the cause of action being brought against the defendant. Additional defendants must file an answer to the cross-complaint · The initial pleadings that join a party to a lawsuit, whether a summons, complaint, or cross-complaint, are served on the party by a court officer. Thereafter, court rules usually allow papers to be served by private parties or by mail ∗ Discovery · Discovery is the formal process by which each party obtains the evidence and information 90 known to the other parties · Discovery can be by (i) written interrogatories, (ii) by deposition (recorded by a court reporter), (iii) by requests for documents (when documentary evidence is at issue), or (iv) by requests for admission (written statements that the receiving party must either accept or dispute) · Because depositions are the most expensive and time-consuming form of discovery, most attorneys prefer to use the other forms of discovery first to narrow the issues. Nevertheless, depositions are usually essential to preparing a case · Discovery may also include a right of inspection, or a right of independent medical examination ∗ Motions · A motion is a formal request to the court for a decision or ruling · Motions can be made at any point from suit initiation to appeal. They can be narrow and specific, or comprehensive · E.g., a motion for summary judgment, in which the moving party asks the court to decide the case in its favor, usually after only pleadings or discovery has been completed and before trial ∗ Trial · Barring summary judgment or settlement, a case goes to trial · Either a judge or a jury decides which party’s case is more persuasive and renders a verdict accordingly ∗ Appeal · An appeal is a request to a higher court to overturn the trial decision · Following a verdict, the losing party can file an appeal · Only alleged errors of law, not issues of fact can be argued on appeal. Therefore, most trial verdicts are not appealed. the trial marks the end of most claims – Legal expense control ∗ Defending liability lawsuits is tremendously expensive. Adjusters are responsible for implementing and enforcing strategies to control legal expenses ∗ Many claim departments require adjusters to preapprove all depositions or motions ∗ Most claim department use only certain preapproved law firms to defend liability claims. They require law firms to submit budgets for each case or to quote a fixed price for the entire case ∗ Claim departments usually require monthly or quarterly bills on active cases. Adjusters or specialized legal auditing firms can check lawyer’s detailed bills against the actual file and the attorney’s original time sheets to verify charges ∗ Ultimately, the best control of legal expenses is complete avoidance of the legal process – Alternative dispute resolution ∗ Alternative dispute resolution (ADR) refers to any number of forums for settling claims outside the traditional court system. The most common ADR forums are : (i) negotiation, (ii) mediation, (iii) arbitration, (iv) appraisals, (v) mini-trails, and (vi) pretrial settlement conferences ∗ Negotiation · Negotiation is the primary ADR forum for resolving claims outside litigation · Claim supervisors and managers should monitor the negotiation process to ensure that it is working properly ∗ Mediation · When direct negotiations fail, the parties can use mediation as an ADR forum · Mediation can be considered negotiation with a referee, called a mediator · The mediator listens to each side present its case, identifies the weaknesses in the argu- 91 ∗ ∗ ∗ ∗ ments or in the evidence presented, proposes alternative solutions, and helps improve the relationship between the parties · The mediator does not normally decide the case for the parties but instead assists them in reaching a mutually agreeable settlement Arbitration · In arbitration, the parties present their cases to a disinterested third party (the arbitrator) who acts as a judge in weighting the facts presented and making a decision based on the evidence · Arbitration’s advantage is that a decision is made. The arbitrator’s decision provides the “winner” with leverage in future negotiations · Arbitration can be binding or non-binding · Arbitration Forums, Inc. is one well known national organization that insurers use to resolve intercompany disputes Appraisal · An appraisal is a method of resolving disputes between insurers and their insureds · The appraisal provision resolves disputes over the amount owed on a covered loss, but it does not determine whether coverage exists Mini-trial · A mini-trial or summary jury trial is an ADR forum that closely resembles the traditional legal system in that representatives (usually attorneys) present an abbreviated version of their case to a panel that acts as a jury · The jury’s decision can be binding or non-binding · Critics argue that little cist saving is achieved. The main advantage is that the litigants do not have to wait months or years to have their cases heard Pretrial settlement conference · A pretrial settlement conference is a meeting of the judge and the parties’ lawyers in a judge’s conference chamber two or three weeks before the trial to narrow the issues to be tried, to stipulate the issues and evidence to be presented at trial, and to help settle the case · A pretrial settlement conference is also an ADR forum that almost all states now require · The conferences are sanctioned by the court and are normally conducted by the judge who is presiding over the case. Lawsuits have already been filed for these cases · The purpose of the pretrial settlement conference is to force litigants to make one last effort to resolve the claim in lieu of going to trial 92 Wiening: Foundations of Risk Management and Insurance Wiening - Chapter 1: Risk Introduction • Risk management helps persons and organizations to realize the opportunities, and avert the threats, associated with risk – In the safety and insurance fields, risk management focuses on loss prevention and mitigation – In finance, risk management focuses on asset and liability risks in an organization’s balance sheet and on such issues as currency and stock market fluctuations that represent opportunity for gain as well as potential for loss • Insurance is one important technique for dealing with some risks – Risk managers can view insurance as a risk transfer technique to finance their organization’s insurable risks – Economists may view insurance as a social device to distribute risks among large numbers of individuals or enterprises – Investors may view insurance organizations as a (un-)favorable investment opportunity in the financial services sector – Insurance regulators define insurance to clarify which activities they are authorized to regulate Risk and related concepts • Elements of risk 1. An uncertain outcome 2. The possibility of a loss • Uncertainty – Uncertainty appears to be the same as indeterminate outcome – To some degree, uncertainty represents a state of mind, based on opinion or emotion, rather than objective risk • Possibility – Possibility means something could happen – Possibility either exists, or it does not exists • Probability – Probability is the proportion of times that events will occur in the long run – Unlike possibility, probability is measurable and can be expressed as a number between zero and one – Understanding the probability of various outcomes is a key step in such important matters as prioritizing where risk management attention should be focused, as well as determining what risks can be insured • Loss exposure – A loss exposure is any condition or situation that presents the possibility of a loss, whether or not an actual loss occurs – Evaluating a loss exposure: Loss exposures are projected into four dimensions: 1. Loss frequency: The number of losses within a specified time period 2. Loss severity: The amount, in dollars, of a loss for a specific occurrence 3. Total dollar losses: The total dollar amount of losses for all occurrences during a specific time period 4. Timing: When losses occur and when loss payments are made After estimating the four dimensions of a loss exposure, credibility, i.e. how reliably the frequency, severity, total dollar losses, and timing of a loss can be projected, should be considered. The greater the credibility, the better the decisions will be about handling loss exposures – Types of loss exposures 93 ∗ Property loss exposures: The possibility that a person or an organization will sustain a loss due to the damaging, destruction, taking, or loss of use of property in which that entity has a financial interest ∗ Property losses can be referred to by focusing on the type of property (building loss, personal property loss), the type of peril (fire loss, theft loss), the type of consequences (business income loss, additional living expense loss) or the type of policy (homeowners loss, auto loss) ∗ Liability loss exposure: The possibility that a person or an organization will sustain a loss due to a claim alleging legal responsibility for injury or damage suffered by another party ∗ Liability losses can be referred to by focusing on the type of insurance that covers the loss (products liability loss, professional liability loss, workers compensation loss) ∗ Personal or human loss exposure: The possibility that an individual or a family will sustain a loss due to a family member’s illness, disability, death, or unemployment ∗ Personnel loss exposure: The possibility that an organization will sustain a loss due to a key employee’s disability, death, retirement or resignation ∗ Exposures to loss of goodwill: An intangible asset that reflects the value that reputation and patronage add to an organization. Goodwill is also important to individuals. Many property and liability insurance policies provide coverages to prevent a loss of goodwill, e.g. bailees customers insurance, personal property of others coverages ∗ Exposures to loss resulting from failure to perform: E.g. a contractor’s failure to complete a construction project as scheduled ∗ Missed opportunities: E.g. an organization that delays a decision to modify its product in response to changes in market demand Perils and hazards • Perils – Peril: A cause of loss, such as fire, windstorm, explosion or theft – In practice, “peril” usually refers to a cause of property loss – The causes of liability losses are categorized according to ∗ The legal basis of liability: common law, statutes, contracts ∗ The activity leading to a claim for damages: owning, operating, distributing products, providing services • Hazards – Hazard: A condition that increases the frequency or severity of a loss. When hazards increase, losses become more likely – Insurers identify four hazard categories ∗ Moral hazard: A condition that increases the likelihood that a person will intentionally cause or exaggerate a loss ∗ Attitudinal hazard: A condition of carelessness or indifference that increases the frequency or severity of a loss ∗ Physical hazard: A condition of property, persons, or operations that increases the frequency or severity of loss · Common hazards: Hazard sources encountered in almost every class of property · Special hazard: Hazards considered unique to an individual property ∗ Legal hazard: A condition of the legal environment that increases the frequency or severity of a loss – Hazards have a compounding effect 94 Wiening - Chapter 4: Insurance as a risk management technique Pooling • Pooling is a fundamental risk management concept. Pooling arrangements reduce risk without transferring it • Pool: An association of persons or organizations that combines their resources to economically finance recovery from accidental losses • Pooling arrangements with uncorrelated losses – Pooling arrangements reduce risks when the pooled losses are independent, or uncorrelated – The pooling arrangement does not change accident frequency or severity, but it changes the probability distribution of accident costs facing each person – The pooling arrangement does not change either person’s expected cost, but it makes the actual cost more consistent and less variable (it reduces the variance), therefore reducing each individual’s risk or uncertainty – Pooling makes the amount that each person must pay for accident losses less risky (more predictable), because pooling reduces the variability of the average loss for all the participants. As even more participants are added, the probability of extreme outcomes goes down, and the probability distribution becomes more and more bell-shaped – Risk can be substantially reduced for all participants. Although pooling arrangements do not prevent losses or transfer risk, they do reduce the amount of risk borne by each participant • Pooling arrangements with correlated losses – The essential point that pooling arrangements reduce risk for each participant continues to hold provided losses are not perfectly positively correlated – However, the magnitude of risk reduction is lower when losses are positively correlated than when they are independent. When losses are positively correlated, the distribution of losses has a greater variability (higher standard deviation) so that losses are less predictable – Correlation in losses has important implications for risk management and insurance. E.g. most insurance policies exclude coverage for losses resulting from war or nuclear reaction because losses resulting from either event are strongly positively correlated Insurance compared with pooling • Pooling is a mechanism for sharing costs; it is not a mechanism for transferring risks. Insurance, although it is based on loss-sharing principles, is a risk-transferring technique. Insurance provides stronger guarantees that sufficient funds will be available in the event of a loss than does a pooling arrangement • Operating a pool – Operating a pooling mechanism generally creates additional costs such as ∗ Marketing ∗ Underwriting ∗ Claim administration ∗ Administrative and information systems expenses – In exchange for the added expense of operating the pool, the member receives reduced risk due to the reduced variation in losses over time – Pools generally have policymaking boards composed of representatives elected or appointed by their member agencies – Day-to-day operations are usually conducted by a third-party administrator (TPA) – The pool services vary, but often include procuring excess insurance or reinsurance, funding to pay for accidental losses, claim handling, loss control and safety consulting, legal defense, actuarial studies, investment of funds, general risk management advice, property appraisals, medical costcontainment programs, wellness programs, and pre-employment physical programs – Pools are almost always initially capitalized through contributions made by members. Many pools 95 may return excess funds as dividends to their members • Key differences between pooling and insurance – Although an insurance company fundamentally resembles a formal pooling mechanism, they are distinct in two important ways 1. An insurance company transfers the risk from the insured to the insurer in exchange for premiums, rather than simply serving as a conduit for passing along its costs to other insurance buyers 2. The insurer introduces additional financial resources, which enables the insurer to provide a stronger guarantee that sufficient funds will be available in the event of a loss, further reducing risk – The insurer’s additional resources are derived from three principal sources 1. Initial capital: The minimum amount of initial capitalization is required by law in the state where the insurance company is chartered. This startup fund may be provided by stockholders who expect a return on their investment or by policyholders who want to establish an insurance company that will provide a market for their particular insurance needs 2. Insurance premiums: Each premium should be sufficient to cover that policyholder’s fair share of claims and expenses, and to provide a profit for the insurer 3. Retained earnings: Retained earnings are derived from premiums in excess of amounts used to pay claims and expenses, and from earnings on invested money. The money available for investment includes the initial capital and the “float” on any premiums that have not yet been spent to pay claims or expenses – Pooling versus insurance ∗ With pooling, losses are shared among all pool members, thereby reducing the financial risks of a member’s individual loss ∗ With insurance, risks and losses are transferred to an insurer – Insurance buyers transfer risks they are unwilling to retain to insurers. Through reinsurance, primary insurers pool or transfer risks, thus staying within capacity constraints and helping to ensure their solvency. Reinsurance helps to reduce risk for insurers that accept risks transferred by insurance buyers 96 Wiening - Chapter 5: How insurance works as a business Economic view of insurance • The insurance system operates efficiently when responding to the fundamental economic law of supply and demand • Insurance promotes efficiency when it increases value for the insured by reducing the cost of risk while simultaneously enabling the insurer to earn a profit • Equilibrium price: The price at which the quantity supplied equals the quantity demanded in a free market that is operating without constraints Supply and demand in insurance • Supply – From a limited perspective, it seems that insurance companies would want to sell just as much insurance as they can. More business should mean more profits, as well as greater diversification through a wider spread of risks that improves predictability. Moreover, insurers who sell more insurance than they can handle are able to control the amount of risk they retain by transferring some of the risk to reinsurers – However, overall, the supply of insurance is limited by (i) the amount of risk the insurer is willing to accept in exchange for the premium it receives, and (ii) the insurer’s capacity to assume new business – Amount of risk versus premium ∗ The supply of insurance depends on insurance company perceptions of likely risk and profit. Insurance companies may not be willing to accept business for which they do not expect a reasonable profit or that involves unpredictable levels of risk that cannot be properly priced ∗ The opportunity for reasonable profit may also be limited by the premiums the insurer can charge. Premium levels are often affected not only by price controls imposed by regulators, but also by competition – Capacity to assume new business ∗ Capacity: The amount of insurance an insurer, or the entire insurance industry is able to write ∗ Financial capacity: Insurance regulators pay close attention to an insurer’s premium-tosurplus ratio, aka capacity ratio. Capacity constraints limit an insurer’s ability to grow rapidly, because a rapid increase in new business tends to increase an insurer’s obligations more rapidly than it increases surplus ∗ Physical and human resources: An insurer should not write business unless it has the physical and human capacity to handle that business ∗ Reinsurance: A primary insurer’s capacity is limited partly by its ability to reinsure some of its risks ∗ Marketing strategy: Each insurer must decide what business it wants to be in, where it will specialize, and how it will invest its resources • Demand – Size of the overall insurance market ∗ The following factors contribute to the decline of the annual growth rate of the P&C market: (i) Saturation of the market demand for insurable products such as autos, houses, and life insurance, (ii) decline in the average annual growth rate of the population, (iii) decline in inflation, and (iv) competitive market conditions caused by capacity, which has restrained price increases ∗ The growth of alternative risk financing tools is another factor limiting the demand for traditional property-liability insurance – Insurance mandates ∗ Another factor affecting the demand for insurance is insurance mandates. Often, insurance 97 – – – – is not optional, or going without insurance is not a feasible option ∗ E.g. states impose financial responsibility requirements on auto owners or operators, most employers are required to provide WC benefits prescribed by law ∗ When it is not required by law, insurance is often required by contract, e.g. mortgagee/creditors requiring property insurance Attitude toward risk ∗ The demand for insurance is also strongly influenced by the insurance buyer’s attitude toward risk ∗ Insurers attempt to increase the demand for insurance by advertising and public education programs that make people aware of their risks that insurance can handle Financial status ∗ Only individuals or businesses whose income exceeds a certain minimum level are likely to purchase insurance. The higher an individual’s income and asset level are, the more likely he is to purchase insurance, and the more protecting assets becomes important ∗ The demand for some forms of insurance diminishes for very wealthy individuals and for organizations with substantial assets, when they have financial resources sufficient to handle losses as current expenses or use various form of retention Price of insurance ∗ Another factor affecting demand for insurance is price ∗ One way insurers try to increase demand for their own products and overcome price concerns is to distinguish products from those of competitors, or by introducing new insurance products ∗ Recently, large commercial insurance buyers have increasingly turned to the alternative risk transfer market Tax incentives ∗ Tax incentives affect demand by encouraging people to purchase certain types of insurance in which the premium is tax deductible, e.g. employer provided group life and health insurance ∗ For an individual or a family, casualty losses can be income-tax-deductible in some cases, but property-liability insurance premiums are not. The tax deduction helps subsidize the cost of uninsured losses and may lead to forgo the purchase of property insurance, or to purchase insurance with a high deductible ∗ For a business, casualty losses are tax-deductible at the time they are paid, not during the year when they are incurred. Alternatively, insurance premiums are tax-deductible as a business expense when they are paid. In many cases, the annual cost of insurance is much more consistent from year to year than the amounts that would otherwise be paid as retained losses, making it a powerful argument for insurance when earnings stability is a risk management objective Competition • Competition also affects the economics of the insurance business. The degree of competition is related to: • Number of competing insurers – Competition usually increases as the number of competitors increases – Insurance is highly competitive, several thousands different insurance companies write business in the U.S. – It is easy to enter the market. The 1999 Gramm-Leach-Bliley act removed some of the barriers that previously kept banks and other financial services organizations from competing with traditional insurers – The internet also made it easy for insurance organizations to develop a widespread virtual presence without establishing a traditional marketing force • Substitutes for insurance – Competition is affected by the availability of substitutes 98 – Various loss-financing alternatives to insurance do exist, and they become increasingly appealing as the cost of insurance increases – A simple substitute involves self-insurance, which becomes possible when wealth accumulates for an individual or a business • Knowledge of the market – Another aspect of competition is consumer knowledge of the market – Insurance companies have benefited, to some extent, from the fact that it was not practical or convenient for a typical insurance purchaser to make insurance shopping a major research project because of the cost of both time and effort to obtain information – The internet dramatically changed the amount of price information available to insurance buyers and the speed with which that information can be obtained. The availability of this market information will inevitably make insurance marketing more competitive – Consumer access not only to pricing information but also to insurer financial ratings and consumer satisfaction surveys has improved – Observers expect internet sales of insurance to grow substantially over the next several years Insurance pricing • The insurance premium for each policy should be set at a level that reflects the loss exposures covered by that policy, with an allowance for the insurer’s expenses, profits and contingencies, and, perhaps, an adjustment for investment income. Insurers refers to this as a premium that is commensurate with the exposure • Three general pricing issues: adverse selection, actuarial versus social equity, and timing • Adverse selection – Adverse selection: The process by which people with the greatest probability of loss are those most likely to purchase insurance – Information is especially important in assessing the price in any transaction. Information is important in both risk identification and risk analysis – Significant ethical, social and legal issues exist with respect to the information insurers need to develop appropriate insurance prices – However, if too much information is kept private, the insurance buyer would know more than the insurance company about the risks involved in their transaction. Such a situation would discourage insurers from supplying insurance • Actuarial equity versus social equity – Actuarial equity: The development of insurance rates based on the actuarially calculated costs associated with the loss exposures that will be transferred to the insurer – Social equity: The development of insurance rates based on an insured’s ability to pay; Not allowing insurers to alter premiums because of factors outside an insured’s control, e.g. gender – Fair discrimination, which charges an equitable premium to each insured, is an essential element of insurance pricing. However, equity has a different meaning for different people, and opinions vary as to whether insurance pricing should achieve actuarial equity or social equity – Actuarial equity has been the traditional test applied by regulators to distinguish between fair and unfair discrimination, but a trend in recent years has been to consider social equity as well – Social equity involves two concepts 1. Insurers should relate the amount each person should pay for insurance to ability to pay rather than to the person’s loss exposure or expense factor 2. Insurers should not increase a person’s insurance premium because of criteria that are beyond that individual’s control – To help achieve social equity, legislators and the public have identified certain insurance rate variables that are socially unacceptable: race, religion and national origin, and in some jurisdictions, gender – When regulatory constraints distort actuarial equity, with the effect that some groups are under99 charged for their insurance, insurers need to overcharge other groups to break even • Timing – Another issue in insurance pricing is timing – For some kinds of losses, especially large losses arising from liability exposures, a substantial delay (often lasting for years) can occur among the date when an event occurs, the date when the loss is discovered, and the date when the loss is paid – During this period, the insurer invests the premium paid for the coverage and generates investment income. This investment income offsets the cost of the insurer’s expected losses, and this is often reflected in insurer’s pricing 100 Wiening - Chapter 6: Insurable risks Insurable risks for privately owned insurers • Private insurance companies insure some, but not all, loss exposures, which ideally have certain characteristics. The government may provide an insurance program for losses that posses to few of the ideal characteristics • A commercially insurable loss exposure ideally possesses the following six characteristics 1. Loss exposure involves pure, not speculative, risk – One purpose of insurance is to make the insured financially whole after a loss – This purpose may be defeated if a loss exposure involved a speculative risk (which offers the possibility of a gain as well as a loss), and the insured gained as a result of that risk 2. Loss exposure is subject to accidental loss from the insured’s standpoint – If the insured has some control over whether or when a loss occurs, the insurer is at a disadvantage because the insured may have an incentive to cause a loss – If losses are not accidental, the insurer cannot calculate an appropriate premium. There needs to be reasonable uncertainty about the probability or timing of a loss 3. Loss exposure is subject to losses that are definite in time and that are measurable – Writing an insurance policy would be extremely difficult if the happening time, location or amount of a loss cannot be precised – If losses cannot be measured, they cannot be projected and it would be impossible to establish a premium 4. Loss exposure is one of a large number of similar, but independent, exposures – The loss exposure must be common enough for the insurer to pool a large number of them – This also gives better accuracy in projections and premium calculations 5. Loss exposure is not subject to a loss that would simultaneously affect many other similar loss exposures; loss would not be catastrophic – The insurance mechanism would not operate economically if a large number of insureds all incur losses at the same time – An insurer can manage catastrophic exposures by limiting the amount of exposures within a geographic area and by purchasing reinsurance 6. Loss exposure is economically feasible to insure – Loss exposures involving high frequency and low severity are not economically feasible to insure because of the expense of providing the insurance – It also does not make sense to insure a loss exposure for a loss that is almost certain to occur Constraints on insurability • State laws regulate the kinds of insurance that can be written in each state and prescribe the minimum capital and surplus. Some financial requirements are so high that an insurer may forgo writing a line of business • State insurance departments also regulates forms and rates, sometimes making it unattractive for an insurer to offer specific coverages • Regulatory approval is often a slow process that constraints insurer’s ability to provide new products and services • Other internal and external obstacles to writing certain type of insurance – Personnel: The insurer needs to have the right staff to enter certain lines of business – Reinsurance: The insurer’s ability to write a new line of business may depend on whether it can obtain reinsurance for large or catastrophic losses – Financing and capacity: To write more insurance at an acceptable premium-to-surplus ratio, may require the insurer to seek more funds from its stockholders, issue surplus notes or generate more surplus from operations, none of which it may be able or willing to do – Custom and tradition: Most insurers hesitate to pioneer in areas that other insurers have not 101 successfully tested – New business: A new line of insurance, in which losses are indeterminable, may lead to variable underwriting results that are difficult to price and that may unnecessarily expose the insurer’s assets to loss Characteristics of fire losses and insurability • Loss exposure involves pure, not speculative, risk – Except for an obsolete run-down building at a prime location where the land may be worth more without the building, fire risk is almost always a pure risk, making attractive for the insurer • Loss exposure is subject to accidental loss from the insured’s standpoint – Arson committed by the insured (arson-for-profit) must be distinguished from arson committed by others – An insurer can project aggregate accidental fire losses with reasonable confidence based on past experience although the possibility of riot or civil commotion remains a concern for property underwriters in some urban areas – While fires generally meet the criteria of being accidental, the fact that they can be deliberately set detracts from being considered an ideal risk • Loss exposure is subject to losses that are definite in time and that are measurable – Loss timing becomes critical only if the loss occurs near the expiration date of the policy – It is necessary to specify before a loss occurs whether the insured loss will be the amount of dollars necessary to repair or replace with like kind and quality, or whether the insured loss will be depreciated actual cash value – Some insurance provides coverage for additional living expenses, fair rental value, or other financial losses resulting from a building that cannot be used. These losses are more difficult to measure • Loss exposure is one of a large number of similar, but independent, exposures – Fire insurance can be written on many similar, but independent, dwellings. Although all homes are different, they can be grouped into classes facing essentially the same loss potential. Therefore, fire loss exposures are ideally suited to insurability because a large number of similar yet independent exposure units are available for pooling • Loss exposure is not subject to a loss that would simultaneously affect many other similar loss exposures; loss would not be catastrophic – Unless they are close to one another, each insured dwelling presents an independent loss exposure to fire. An insurer writing fire insurance on several geographically separated buildings would generally have a good, diversified spread of risks – Reinsurance can effectively mitigate large-loss exposures such as large multiple-occupancy buildings, congested urban areas or rural areas subject to forest and brush fires • Loss exposure is economically feasible to insure – Dwelling fires tend to be low-frequency, high-severity (from the insured’s perspective) events that insureds could not usually recover from financially without insurance – Aggregate fire losses generate credible statistical information on which fire insurance rates can be based – Dwelling fire insurance can generally be priced at a marketable level that is very attractive to buyers wanting to protect their home investments • Conclusions – Fire insurance on dwellings meets most of the ideal requirements of commercial insurability – Insurers still must identify buildings with higher-than-normal hazards, guard against arson-forprofit, avoid excessive concentration of loss exposure, ensure adequate diversification of exposures, and carefully establish the insurable value of property subject to loss – If insurance is not readily available through private insurers, then it may be available through a Fair Access to Insurance Requirements (FAIR) plan ∗ FAIR plan: An insurance pool, through which private insurers collectively address an unmet 102 need for property insurance on urban properties, especially those susceptible to loss by riot or civil commotion ∗ FAIR plans make basic property insurance available to property owners who are otherwise unable to obtain insurance because of their property’s location or any other reason ∗ FAIR plans are currently available in more than half of the U.S. states. They are not meant to replace normal channels of insurance Characteristics of windstorm losses and insurability • Loss exposure involves pure, not speculative, risk – Except in unusual circumstances, windstorm damage to a building presents only the possibility of a loss, but no possibility of a gain. So, like fire, windstorm is almost always a pure risk and well suited for insurance • Loss exposure is subject to accidental loss from the insured’s standpoint – Windstorm exposure clearly satisfies the requirement that losses be accidental from the standpoint of the insured – Insureds, however, can fail to take proper preventive measures, claim that a windstorm caused a loss that it did not, or claim that damage was more extensive than it actually was – Windstorm frequency cannot be controlled. However, loss severity from windstorm can be reduced through building design and other preventive measures • Loss exposure is subject to losses that are definite in time and that are measurable – The date and time of a windstorm can be documented with weather reports. However, sometimes, distinguishing between covered windstorm damage and not-covered flood damage is difficult because a storm may produce both perils – Valuation of a windstorm can be complicated. When damages are widespread, the surge in demand for construction contractors, equipment and supplies can substantially increase repair costs, presenting special challenges • Loss exposure is one of a large number of similar, but independent, exposures – Like fire, windstorm can be written on many similar buildings. Forecasters have been most successful in projecting how many hurricane-force storms will strike nationally each year, not where they will strike – Diversification requires a geographical spread of risks, as well as a large number of exposure units • Loss exposure is not subject to a loss that would simultaneously affect many other similar loss exposures; loss would not be catastrophic – Different buildings in the same geographic area are not independently exposed to windstorm loss. Unlike fire, a single windstorm is likely to damage many buildings. Reinsurance can help mitigate an insurer’s risk of large losses from windstorm • Loss exposure is economically feasible to insure – The catastrophic nature of some windstorms - notably hurricanes - makes windstorm insurance difficult to underwrite, especially for insurers with a high volume of business in a limited geographic area – Appropriate rating is complicated by the fact that premium and loss calculations are performed in one-year periods, while weather cycles are much longer • Conclusions – Windstorm does not meet the ideal characteristics of an insurable loss exposure as effectively as does fire insurance – In coastal areas or other areas exposed to severe windstorm losses, private insurers are often unable to write windstorm insurance – Industry-sponsored FAIR plans or beach and windstorm plans operate to fill the gap ∗ Beach and windstorm plan: An insurance pool operated by property insurers in several Atlantic and Gulf Coast states to ensure that property insurance is available, in specified areas, for damage due to hurricanes and other windstorms 103 ∗ In all cases, property insurers are required to share in plan losses according to their share of state property insurance premiums ∗ A disadvantage of these programs is that insurance availability tends to encourage construction in coastal areas Characteristics of flood losses and insurability • Flood damage to property at fixed locations was traditionally considered uninsurable, even for property that was readily insured against fire and windstorm losses. On the other hand, flood insurance is readily available for autos and other personal property that can easily be moved out of harm’s way • Loss exposure involves pure, not speculative, risk – Except in unusual circumstances, flood damage presents only the possibility of loss, but no possibility of gain – The flood exposure does involve pure risks of loss to flooded buildings, and on this characteristic, flood is insurable • Loss exposure is subject to accidental loss from the insured’s standpoint – Most floods are caused by unusually severe, random weather conditions that result in excessive rainfall. timing might be seasonal but otherwise unpredictable – Some floods are caused by controllable factors (bursting of a dam, releasing flooding waters) – Although uncertainty exists about whether a flood will occur at a particular location/year, in many areas the long-term probability of flood can be forecasted. Some property, located within a 10-year, 20-year or 100-year flood plain, is almost certainly exposed to loss • Loss exposure is subject to losses that are definite in time and that are measurable – Determining when and where a flood loss has occurred is usually straightforward – However, determining whether damage was caused by a windstorm, flood, or water driven by the wind may be necessary, especially when windstorm and flood insurance are written under different policies, or when one of the perils is not covered – Another issue arises when a given loss can be attributed to more than one occurrence of a particular peril, such as a fire in an already flooded area • Loss exposure is one of a large number of similar, but independent, exposures – Flood insurance can be written on many similar buildings. Buildings of similar construction at different locations can face substantially different exposures depending on their altitude and proximity to water • Loss exposure is not subject to a loss that would simultaneously affect many other similar loss exposures; loss would not be catastrophic – Flood risks are not well diversified. Serious floods tend to affect all properties within a widespread area and are often catastrophic, making the loss exposure less than ideal for insurance • Loss exposure is economically feasible to insure – The catastrophic nature of some floods, combined with the fact that an eventual flood is virtually certain at many locations, generally makes offering flood insurance difficult for private insurers – Adverse selection due to property owners in flood zones being more likely to want flood insurance – Private insurers would need to conduct costly risk assessment programs or engineering studies to evaluate the probability of flooding for each applicant, leading to an expensive premium that most people would be unwilling to pay • Conclusions – Buildings and most personal property in flood zones are difficult to insure privately because the exposures are not independent, which poses the risk of catastrophic loss – Premiums in flood zones would be too high for most insureds to pay without government assistance – Flood insurance is now readily available under a government insurance program – The federal government has also devoted engineering resources to evaluating flood zones, and these evaluations have facilitated underwriting flood insurance by private insurers 104 Wiening - Chapter 8: Fundamental assumptions underlying insurance 1. Insurance requires good faith • Generally, the insurance mechanism is highly vulnerable to abuses such as misrepresentation or opportunism. These abuses can be prevented if all parties exercise good faith in the transaction • Good faith: Principle imposing a standard of honesty on the parties to an insurance contract • Good faith requires that a person applying for insurance make a full and fair disclosure of the risk to the insurer and its agent • If an insured conceals or misrepresents a material fact or commits fraud, at any time, the insurance contract can be voided • The insurer must fulfill its promises as outlined in the contract. This good faith must also carry through to claim handling, in which insurers are obligated to investigate and pay claims promptly. Insurers who act in “bad faith” may face serious penalties under the law 2. The policy drafter should not receive an unfair advantage • Contract of adhesion: Any contract in which one party must either accept the agreement as written by the other party or reject it • The typical insurance policy is a contract of adhesion. Courts have ruled that any ambiguities or uncertainties in an insurance contract of adhesion are to be construed against the party who drafted the agreement • If a policy’s interpretation creates ambiguities/uncertainties, the policy is interpreted in favor of the insured who played no role in drafting the policy, and against the insurer • No matter who drafts the policy, that party should not receive an unfair advantage in setting the terms of the contract 3. The goal of insurance is to indemnify • Indemnify: The act of making someone, who has suffered a loss, whole • Indemnity: The compensation an insured receives after a loss to make the insured whole • Contract of indemnity: A contract under which the insured is entitled to payment only if he has suffered a covered loss and only up to the extent of the financial loss actually suffered • Valued policy: Policy that pre-establishes a $ amount the insurer will pay for an insured loss • Insurance is a contract of indemnity when the amount the insurer pays is no more than the full amount of the insured’s loss • Some insurance policies are valued policies (e.g. life insurance), not contracts of indemnity because the amount payable by the insurer for a total loss is the policy limit which is not necessarily related to the loss’s financial value 4. Insurance should not overindemnify • Principle of indemnity: The principle that insurance policies should provide a benefit no greater than the loss suffered by an insured • The potential for overindemnification can create a moral hazard for some insureds. A moral hazard exists when an insured considers intentionally causing a loss or exaggerating a loss to benefit financially from the loss • Insurers can reduce moral hazards (and overindemnification) by clearly defining the extent of a covered loss in the policy provisions and by carefully setting policy limits 5. Insureds should not be indemnified more than once per loss • Ideally, one insurance policy, or one portion of a policy, standing alone, should cover a given loss. Duplicate sources of recovery (receiving payments from many policies) could result in the insured’s overindemnification • However, people can be insured under more than one policy when they carry multiple policies (e.g. auto and health insurance) or can receive payment from a collateral source • Collateral source rule: A tort law rule that prevents the tortfeasor (defendant) from deducting from the amount owed to the victim any goods, services, or money the victim received from other “collateral”sources (e.g. insurance benefits) as a result of the tort 105 6. 7. 8. 9. • Although only one source of recovery per loss has been identified as a fundamental principle of insurance, some strongly believe that duplicate recovery can be appropriate in some cases Parties to be insured should face potential loss • Parties to be insured should face potential loss, i.e. to have legally enforceable insurance coverage, a person must possess an insurable interest in the subject of the insurance and should face the possibility of financial harm resulting from the kind of losses covered by the insurance • Insurable interest: Any interest a person has in property subject of insurance, e.g. damage to the property would cause the insured a financial loss or another tangible deprivation • If the relationship between the person and the property, life or event in question exposes the person to possible financial loss, and is not unduly remote, insurable interest exists Insurance is intended for fortuitous future losses • Fortuitous losses are losses that happen accidentally or unexpectedly, with reasonable uncertainty about the probability or timing of loss. To provide coverage for a loss, the courts generally require that losses be fortuitous • However, many losses happen fortuitously but are not covered by an insurance policy • To maintain an equitable loss distribution among insureds, u/w must avoid adverse selection by precluding coverage for these types of losses. Insurers must carefully specify what is an insured event, what circumstances will trigger coverage, and when the policy goes into force/terminates • In some cases, an insurer may be willing to apply coverage to known losses or losses in progress (e.g. claims-made policies for liability insurance) • While the fundamental assumption is that insurance is intended for fortuitous future losses, the actual practice of insurance makes many exceptions to that principle Insureds should not profit from their own wrongdoing • It would be against public policy to permit an insurance contract to indemnify a person against loss caused by his or her own willful wrongdoing. most insurance policies contain carefully worded provisions that exclude coverage for intentional injuries. In addition, the courts permit an insurer to deny coverage that allows a party to profit by intentionally causing an insured loss • Detecting and proving fraud can be a challenge, one reason why underwriters generally prefer to avoid coverage presenting a moral hazard Insurance should equitably distribute risk costs • The cost of each insured’s policy should be commensurate with the risks it presents to the insurer • Insurance achieves an equitable distribution of risk costs in various ways, including: – Rating plans projecting expected loss costs and expenses for each insurance policy so that they can charge premiums commensurate with the insured’s loss exposure as well as with the insurer’s projected expenses – Coinsurance in property insurance provides an incentive for people to avoid a penalty by purchasing amounts of insurance that reflect their exposure to loss – Subrogation, through which loss costs are allocated to the party most responsible for the loss • Other forces can affect the ability to achieve actuarial equity, including: – Insurance regulators which must approve many of the rates charged by insurance companies. Such rate approval can sometimes affect the free-market economic forces intended to match insurance premiums with insured exposures – Social equity which tends to redistribute wealth (e.g. good drivers subsidize the cost of insurance for bad drivers) – No-fault insurance: With no-fault laws, the costs of auto-related injuries are assigned to the insurer of the party who is injured, not the at-fault party. Although this results in an inequitable distribution of loss costs, it can also eliminate the substantial expenses otherwise involved in determining which party was at fault 106 Wiening - Chapter 9: Forming an insurance contract Contracts Elements of any contract 1. Offer and acceptance – The first element of a contract is offer and acceptance. Agreement is reached when one party makes a specific offer and the other party makes specific and genuine acceptance – The offeror must express, by word or conduct, an intent to enter into a contract. The terms of the contract must be sufficiently definite, and the offer must be communicated to the offeree – An offeree can either accept the offer, reject it or make a counteroffer which would cancel the original offer and constitute a new offer – Acceptance must be made by the party to whom the offer was made, it must be consistent with the offer, and it must be communicated to the offeror by appropriate word or act 2. Consideration – Consideration: Something of value given by each party to the contract – The consideration necessary to make a contract legally enforceable may be paying money, giving a promise in return, performing an act, or relinquishing a right to do what one is legally entitled to do 3. Competent parties – The parties to any contract must be considered legally capable of entering into an agreement for the contract to be legally enforceable – A contract may be voidable if any contracting party was not legally competent at the time of the agreement 4. Legal purpose – Any contract must serve a legal purpose. A contract is illegal when forming the contract or performing the agreement constitutes a crime or a tort 5. Legal form – Contracts generally need not be in writing in order to be valid – Only agreements that are within the so-called Statute of Frauds, or other statutes requiring written form, fail to be enforceable unless in writing • Enforcement of a contract – If a valid, enforceable contract is breached by any party, the other party may seek a remedy through the legal system. Two common remedies are 1. Payment of damages: Pay money damages for having breached the contract 2. Specific performance: A court may order a party to perform its duties as specified in the contract – However, a contract can be unenforceable if it is void, voidable or canceled – Void contract: A void contract never had any legal existence, even though one or more parties may have considered it a contract, because some key element of a contract is missing – Voidable contract: A voidable contract legally exists, but its existence is tenuous because it can legally be rejected (made void) at the option of one or both of the parties – Canceled contract: A canceled contract is a legally enforceable contract that is no longer in effect. To cancel a contract, a party to the contract must first acknowledge that it is a legally valid contract and then terminate it according to its own contractual terms Insurance contracts • Offer and acceptance – An applicant who submits a completed application to the insurance company makes the actual offer, or is the offeror. If the insurance company (the offeree) issues a quote and the applicant pays the corresponding premium, a policy is issued. The policy issuance constitutes acceptance and thus consummates the agreement 107 • • • • • – The contract is considered communicated when the acceptance is mailed, not when it is received, i.e. it is accepted when the policyholder mails the premium Consideration – The insurer’s consideration is its promise to make payment upon an insured event’s occurrence – The insured’s consideration is its payment of the premium or its promise to pay the premium – If the insured fails to make the initial premium payment when it is due, the insurer can cancel the policy for non-payment of premium. this is considered a flat cancellation ∗ In practice, it is generally not feasible to cancel a policy flat if an insured event has occurred ∗ Delayed payments are common. Permitting insurers to deny every claim arising before the insured has a chance to pay the initial premium would be against public policy Competent parties – People may be able to void policies if they can show that they were under the influence of medicine that clouded their judgment when the policy was purchased – The parties who must be competent typically include the insurance company (their legal authority to do business in a state), the agent (states impose basic competency standards) - if any -, and the insured (competency issues could be sanity, minority, or intoxication) Legal purpose – The examples below illustrate how certain insurance coverages for some types of losses could be against public policy and lack legal purpose ∗ Liability insurance for punitive damages ∗ Homeowners insurance coverage for child molestation or spousal abuse ∗ Property insurance coverage on illegal goods ∗ Property insurance coverage in the absence of an insurable interest Legal form – In the absence of statutory prohibitions, insurance contracts need not be in writing to be valid – Typically, oral contracts, known as binders, are documented after the call in the form of written contracts that clarify the terms of the agreement – The courts generally enforce oral contracts of insurance, provided that they are specific enough to show the parties’ mutual assent on key matters Unenforceable insurance contracts – If an insurance agreement is unenforceable, then no legal remedies are available – Insurers have several possible methods for getting out of insurance contracts, e.g. ∗ The insurer can void the contract based on lack of consideration if the premium payment bounced ∗ The insurer could have the policy made void based on a material misrepresentation ∗ The insurer could enforce the contract provisions by denying coverage based on a breach of policy conditions ∗ The insurer could send a cancellation notice after inspection of the property Genuine assent • Genuine assent is the parties’ intent to enter into a contract expressed by their actions and/or words • Genuine assent can be found lacking under circumstances involving the following: 1. Fraud • Courts consider six elements when evaluating allegations of fraud. The first five elements must be present to rescind a contract on the basis of fraud. The sixth element must also be necessary to obtain damages. The six elements of fraud are (a) False representation (b) Knowingly made (c) Intent to influence or deceive (d) Material fact (e) Reasonable reliance 108 2. 3. 4. 5. (f) Detriment Concealment or misrepresentation • Concealment: An intentional failure to disclose a material fact • Misrepresentation: A false statement of a material fact • Material fact: A fact that would have influenced whether the insurer would accept the insurance application or on what terms the insurer would accept it • Concealment and/or misrepresentation is inconsistent with mutual confidence and good faith. It is determined by looking at material facts Mistake • While some mistakes do not affect the rights of the parties to a contract, others make the agreement voidable or unenforceable • When a mistake occurs in an insurance transaction, the courts sometimes interpret the policy to determine how or whether coverage applies Duress • Duress is the wrongful use of force to obtain assent to an agreement. If the person was deprived of free will in entering the agreement, the court may void the contract • Economic pressure alone, even if significant, is not usually considered duress Undue influence • Undue influence prevents a person from exercising his own free will in making a contract because another person in a dominating position unduly influences or controls the decision • Most legal cases involving undue influence concern gifts, wills, or the selection of insurance beneficiaries • For undue influence to occur, the following situations must be present – A confidential relationship must exist between the parties – One party must exercise some control and influence over the other – An element of helplessness or dependence must be involved • Mental infirmity may form the basis for a claim of undue influence • The law assumes undue influence whenever the dominated person receives inadequate benefit from a contract made with the person who is dominating 109 Wiening - Chapter 11: Reading an insurance policy Physical construction of insurance contracts • Definitions – Insurance contract: Generally means policy. The term contract emphasizes the insurance agreement legal nature – Line of insurance: “line” is loosely used to refer to different types of insurance – Monoline policy: A policy that covers a single line (or part of) of insurance – Package policy: A policy that covers more than one line of insurance – Form: One of the major documents within an insurance policy – Endorsement: A document that modifies one or more policy forms. In life and health insurance, the term “rider” is used instead – Coverage part: One or more forms that together provide coverage for a line of insurance • Self-contained versus modular policies – A self-contained policy is a single, complete-by-itself document containing all the agreements between the applicant and the insurer – A self-contained policy is appropriate for insuring loss exposures that are similar among insureds – A modular policy is a mix-and-match set of components, designed around one basic policy component (such as a “policy jacket”, aka “common conditions form”) – The modular approach is commonly used in commercial insurance. An advantage of the modular approach is that a single policy can include several types of insurance, resulting in a commercial package policy – Advantages of modular policies ∗ Carefully designed and coordinated provisions in the various form minimized the possibility of gaps and overlaps that may exist when several monoline policies are used ∗ Consistent terminology, definitions, and policy language make coverage interpretation easier ∗ Fewer forms are required to meet a wide range of needs ∗ Underwriting is simplified because much of the same basic information that must be analyzed applies to all lines of insurance ∗ Adverse selection problems can be reduced when the same insurer provides several types of insurance for the same insured ∗ Insurers often give a package discount • Preprinted policies – Preprinted policies are ready-made, off-the-shelf policies, developed for use with many different insureds – An insurer may adopt standard policies, also used by other insurers, or develop its own nonstandard policies (aka “company-specific form”) – ISO and the American Association of Insurances Services (AAIS) have developed standard insurance forms that are usually accompanied by a portfolio of coordinated endorsements that reflect necessary state variations or customize coverage – Many insurance companies have developed nonstandard insurance forms where policy wording and content can vary from the provisions used by other insurers or insurance advisory organizations and which contain coverage enhancements not found in standard policies • Manuscript policies – Manuscript policies are custom contracts developed for one specific insured, to meet a unique coverage need – A manuscript policy wording is generally developed through negotiation between the insurer and the insured • Related documents – Several other documents can become part of the policy, either by being physically attached or by being referred to within the policy. These include completed application for insurance, 110 endorsements, insurer’s bylaws, terms of relevant statutes, . . . – An endorsement (aka “policy change”, “addition”, “amendment”, or “codicil”) is a provision that adds to, deletes, replaces, or modifies another document in the insurance policy. Two general rules of interpretation apply: 1. An endorsement takes precedence over any conflicting terms in the policy to which it is attached 2. A handwritten endorsement supersedes a typewritten one – Policies providing WC insurance or auto no-fault insurance are among those that typically provide benefit specified by state statute, which are usually incorporated by reference – Other documents sometimes included are: References to rules and rate manuals, statutory or regulatory constraints, premium notes, inspection reports, specification sheets or operating manuals relating to safety equipment or procedures Insurance policy content • Every property-liability insurance policy provision can be placed into the following six categories 1. Declarations • Declarations (aka ”information page”) refers to the portion of the policy containing information that was declared by the insured on the insurance application, along with the insurance company’s declaration about what coverage it provides • The declarations typically include: policy number, policy inception and expiration dates, name of the insurance company, name of the insurance agent, name of the insured(s), mailing address of the insured, physical address and description of the covered property or operations, numbers and edition dates of all attached forms and endorsements, dollar amounts of applicable policy limits and deductibles, names of persons or organizations whose additional interests are covered, premium 2. Definitions • Defines terms used throughout the entire policy or form • Undefined words and phrases are interpreted according to their usual meaning (either ordinary, technical or legal). Consideration is also given to the local, cultural, and trade-usage meanings of words, if applicable 3. Insuring agreements • An insuring agreement is any insurance policy statement indicating, under specific circumstances, that the insurer will make a loss payment or provide a service • A policy can have more than one insuring agreement (e.g. if many coverages are included in the policy, each coverage will be based on an insuring agreement) • Introductory insuring agreement: The insuring agreements that introduce a coverage section broadly state what the insurer agrees to do under the contract, subject to clarification elsewhere in the policy. The full scope of coverage cannot be determined without examining the rest of the policy, because the insurer’s obligations are invariably clarified or modified by other policy provisions • Comprehensive versus limited in scope – Insuring agreements can be divided into two broad categories (a) Comprehensive or all-purpose insuring agreements, which describe extremely broad, unrestricted coverage that applies to virtually all causes of loss or situations. This broad coverage is both clarified and narrowed by exclusions, definitions, and other policy provisions (b) Limited or single-purpose insuring agreements, which restrict coverage to certain causes of loss or situations. Exclusions, definitions, and other policy provisions serve to clarify, narrow and sometimes broaden the coverage – For property insurance, insuring agreements fall into two categories (a) Named-perils, specified-perils, or specified-causes-of-loss coverage 111 i. Basic form coverage: provides protection against a list of named causes of loss ii. Broad-form coverage: provides protection against the named causes of loss in the basic form and additional named causes of loss (b) Special-form coverage ∗ Provides protection against causes of loss that the form does not specifically exclude. This comprehensive approach invariably covers broad-form causes of loss as well as additional causes of loss that are not otherwise listed in the broad or basic forms • Insuring agreements for extended, additional, and supplemental coverages – Many insurance companies include supplemental, more-or-less secondary, coverages along with the main coverage in the insuring agreement – A coverage extension extends a portion of a basic policy coverage to apply to a type of property or loss that would not be otherwise covered – Additional coverage adds a type of coverage not otherwise provided – Supplementary payments clarify the extent of coverage for certain expenses • Other provisions functioning as insuring agreements – Other policy provisions that grant or restore coverage otherwise excluded, and therefore serve as insuring agreements, might appear within a definition, as an exception to an exclusion, or elsewhere in the policy 4. Exclusions • Exclusions have been defined as policy provisions that state what the insurer does not intend to cover, it clarifies the coverages granted by the insurer. Exclusions serve seven purposes (a) Eliminate coverage for uninsurable loss exposures • Common exclusions of uninsurable exposures involve losses due to war, intentional acts of the insured or other non-accidental events, nuclear radiation, earthquake, flood-damage to fixed-location property, normal wear and tear, and “inherent vice” (e.g. iron rusts, wood rots, or rubber deteriorates • Each of those excluded exposures fails to sufficiently possess at least one of the ideal characteristics of an insurable loss exposure (b) Assist in managing moral hazards • Exclusions can help manage moral hazards to the extent that they eliminate coverage for the insured’s intentional acts that are essentially uninsurable • Other conditions and miscellaneous provisions make it difficult to exaggerate losses successfully (c) Assist in managing attitudinal hazards • Some exclusions assist in managing attitudinal hazards by making the insured bear the losses that result from their own carelessness (d) Reduce likelihood of coverage duplications • It is usually unnecessary and wasteful if two insurance policies provide coverage for the same loss • E.g. personal liability policies usually exclude losses arising from business activities, and commercial property typically excludes autos (e) Eliminate coverage not needed by the typical insured • E.g. typical auto and homeowners policies exclude use of the family auto as a taxicab for hire, or renting portions of the family home for storage of others • Insurers are not always permitted to exclude coverage for exposures not faced by the typical purchaser. E.g. state regulators would be very unlikely to approve a policy exclusion such as excluding auto liability coverage for drunk drivers, because it would eliminate a source of recovery for the innocent victims (f) Eliminate coverages requiring special treatment • Exclusions are used to eliminate coverages requiring special rating, underwriting, loss control, 112 or reinsurance treatment substantially different from what is normally applied to the contract • E.g. many standard policies covering valuable personal property exclude coverage for losses occurring while the property is on exhibition, and general liability policies usually exclude the professional liability exposure (g) Assist in keeping premiums reasonable • All exclusions, to some extent, serve in keeping premiums at a level that a sufficiently large number of insurance buyers will consider reasonable, a goal that is shared by insurers, regulators and consumers • E.g. Road assistance and flat tire assistance exclusions from personal auto policies 5. Conditions • A policy condition is any provision that qualifies an otherwise enforceable promise of the insurer. If the insured does not comply with the conditions, the insurer may be released from any obligation to perform some of all of its otherwise enforceable promises • E.g. insured’s obligation to pay premiums, report losses promptly, provide appropriate documentation for losses, cooperate with the insurer in any legal proceedings, and refrain from jeopardizing an insurer’s rights to recover from responsible third parties under subrogation actions 6. Miscellaneous provision • Some policy provisions do not strictly qualify as declarations, definitions, insuring agreements, exclusions or conditions. They may deal with the relationship between the insured and the insurer, or help establish working procedures for implementing the policy, but they do not have the force of conditions. If they are not followed, normally the insurer must still fulfill its contractual promises • E.g. a valuation provision that sets standards for measuring losses under the policy, the insured’s right to vote in the election of the board of directors of a mutual 113 Wiening - Chapter 12: Common insurance policy provisions Definitions • Provision: Any statement in an insurance policy • Condition: An insurance policy provision that qualifies an otherwise enforceable promise of the insurer or the insured • Clause: A particular article, stipulation, or provision in a formal document Creating an enforceable contract • Enforceable contracts have five key elements: offer and acceptance, consideration, competent parties, legal purpose, and legal form. Provisions in nearly all insurance policies reinforce two of those elements: 1. The insured’s consideration is reinforced by payment of premium provisions 2. Genuine assent to the offer and acceptance is reinforced by concealment, misrepresentation , or fraud provisions • Payment of premium provision – The payment of premium provision is a policy provision that indicates the insurer’s agreement to provide insurance coverage in exchange for the insured’s payment of premium – Some policies include additional provisions relating to premium calculation – Some provisions may also indicate who is responsible for handling premiums and renewal options • Concealment, misrepresentation, or fraud provision – A policy provision that voids coverage if the insured is guilty of concealment, misrepresentation or fraud – Even without a specific contractual provision, the insured’s concealment, misrepresentation or fraud can provide sufficient grounds for the insurer to avoid an insurance contract Insured parties • Insured party: Person, corporation, partnership or other entity contractually entitled to a loss payment or other benefits according to the insurance policy’s terms • All insured parties have contractual rights in an insurance contract, but some have more rights than others • Insured parties identified by name – An insurance policy’s declarations can specifically name (i) named insureds, and (ii) loss payees and mortgagees, who, typically, are secured creditors – Named insured: The person, corporation, partnership or other entity named as such in a policy’s declaration page – The order in which named insureds are listed in the policy declarations can be important. The first named insured is typically responsible for premium payment and is the only insured who can cancel the policy, receive notice of cancellation, make policy changes with the insurer’s consent, receive claims and occurrence data from the insurer, and receive returned premiums – “You” means the named insured, and any other person qualifying as a named insured. “An insured” includes, in addition, any other person that qualifies as an insured under the policy – Loss payee: A loss payee might be entitled to some payment for losses covered by the policy. However, a loss payee is neither an insured nor a named insured. Loss payees can include secured creditors, and their interests in personal property can be protected by a loss payable clause – Loss payable clause: A policy clause that protects the creditor’s interest in personal property pledged as a collateral for a loan. The typical loss payable clause promises only to make sure the loss payee participates in claims proceeds. Some loss payable clauses extend additional rights to the loss payee (e.g. entitlement to receive advance notice of cancellation, protection even when the loss results from the named insured’s fraudulent acts or omissions – Mortgagee: The rights of a mortgagee, who has an interest in real property, are somewhat stronger than those of a typical loss payee. The mortgage clause protects the mortgagee’s interest and is viewed as a separate contract between the insurer and the mortgagee. The mortgagee’s 114 • • • • rights under the policy cannot be impaired by an act or omission of the debtor, even if the insured ∗ Fails to report important changes ∗ Fails to pay premium when due ∗ Fails to submit a proof of loss as required by the policy The mortgagee is also entitled to receive advance notice of cancellation or nonrenewal Insured parties identified by relationship – Most property and liability policies cover as an “insured” one or more parties identified only by their relationship to the named insured. Some insured parties are members of a class, while others receive protection as legal substitutes for the named insured – Members of a class ∗ The most obvious class is spouse. The spouse possesses the same rights and privileges as the named insured whose name appears in the declarations ∗ Various parties may qualify for status as an insured because they belong to some class such as: Family members, household residents, employees, officers and directors, other classifications stated in the policy based on personal or business relationships with the named insured – Legal substitutes for the named insured ∗ A legal substitute for the named insured can also become an insured under the named insured’s policy, including: ∗ Legal representatives, e.g. executor or administrator ∗ Personal representatives, e.g. a son who has been granted power of attorney ∗ Heirs and assigns, i.e. parties who will inherit the named insured’s property ∗ these representatives do not literally qualify as separate insureds. rather, they are acceptable legal substitutes for the named insured Additional insureds – Additional insured endorsement: An endorsement that adds coverage for one or more persons or organizations to the named insured’s policy – Examples to illustrate the range of options for additional insureds: (i) Club members, (ii) Engineers, Architects, or surveyors, and (iii) Owners, lessees or contractors Multiple insured parties or covered locations – Insurance policies must address the questions as to how actions by one insured may affect coverage for other insureds, or how conditions at one location may affect coverage at another location – Separation of interests: A policy provision that clarifies the extent to which coverage might apply separately to more than one insured party – Concealment, misrepresentation, or fraud by only one insured: The treatment of this issue is not consistent among insurers, and examining the coverage forms that apply to the situation is necessary – Actions of parties beyond the insured’s control: Usually, coverage is not affected by actions of people whom the named insured cannot control – Breach of condition at only one location: Most insurance policies resolve this issue by stating that the breach of a policy condition at one location does not affect coverage for a loss at another location Parties not insured – Most insurance policies explicitly preclude coverage for bailees or assignees. Some also address the situation in which a consolidation or merger changes the identity of parties having an insurable interest in covered property or activities – No benefit to bailee provision ∗ Bailee: A party having possession of another’s personal property and a duty either to return it to the owner or to deliver or dispose of it as agreed. Gratuitous bailment owes a somewhat lesser degree of care than bailee for hire ∗ A bailee for hire is not legally responsible for all damage to property in its custody, but only 115 for damage caused by the bailee’s negligence ∗ No benefit to bailee provision: A provision of many property insurance policies stating that the insurer provides coverage for the property owner but not the bailee. Usually, · Subject to other policy terms, an insured does have protection for loss to property in the custody of a bailee for hire · The bailee (and the bailee’s own insurer) cannot benefit from this coverage, thus preserving the insurer’s subrogation rights – Assignment provision ∗ Assignment: A transfer of a contract right from one party (the assignor) to another (the assignee) ∗ Assignment provision: A provision contained in most property and liability insurance policies that prohibits one insured from transferring ownership of an insurance policy to another party without the insurer’s consent ∗ Exceptions to the widespread assignment provision involve, e.g., ocean going cargo or property insurance for a trust – Consolidation-merger provision ∗ A provision that clarifies whether, or to what extent, coverage automatically applies to employees or property acquired through a business consolidation, merger, or acquisition Policy period and territory • An insurance policy must specify when something must happen to trigger coverage (provisions relating to the policy period) and where (provisions relating to the policy territory) • Policy period provisions – Policy period: The time frame, beginning with the inception date, during which insurance coverage applies – Although one-year policies are typical with property-liability insurance, other time periods are also common – Some property insurance policies depart from the general rule just described and terminate coverage when the exposure ceases to exist, e.g. a builders risks policy which expires when construction is completed, or a crop-hail insurance policy ending when the crop is harvested – To clarify whether coverage is effective on the first or last day of the policy, the precise time when coverage begins and ends must be specified – Policy period provisions also address when something must happen to trigger coverage. The single word “commencing” can be important when a loss occurs close to the time when the policy begins or expires, e.g. for a fire that overlaps with the policy expiration date, or an insurer could be obligated to pay business income for losses for many months after a business income policy expires, as long as the loss-producing event began during the policy period • Territory provisions – In any given policy, the coverage territory provisions help identify broad geographical borders beyond which coverage does not apply. Other policy provisions can be much more restrictive (e.g. real property covered only at the address specified, or long-haul trucking exposures covered only within a described radius of operations) – State variations may proved to be very important, especially for WC and auto insurance which are subject to specific state’s mandatory insurance laws – An insurance policy provision is not enforceable if it conflicts with the applicable law of the state. Some policies contain an explicit conformity with statute provision addressing that point, and indicating that if a conflict exists between a state statute and the insurance policy, the statute applies – A policy may contain a provision stating, in effect, that the policy provides the coverage required by the law of the state where the accident occurs 116 Subrogation and salvage • After an insurer has paid a property loss to an insured, or has paid a liability loss on an insured’s behalf, the insurer sometimes may recover all or part of its payment through the processes of subrogation and salvage • Subrogation and salvage activities within the claim department enable insurers to recover a portion of the money paid out in satisfying claims. By reducing the insurer’s overall loss ratio, subrogation and salvage activities reduce the premiums the insurer needs to charge • Subrogation – Subrogation: The process by which an insurer recovers payment from a negligent third party who caused a property or liability loss that the insurer has paid to, or on behalf of, an insured – Whenever somebody’s property is damaged through another person’s fault, the property owner has a legal right to recover from the responsible party or from his insurer, but no double recovery is allowed – The subrogation provisions clarify how these situations are handled, by transferring to the insurer who has paid a loss any of the insured’s rights of recovery for that loss – In short, the insured recovers for the loss under its own property insurance and the property insurer then takes over any rights of recovery against a responsible third party – Similarly for liability losses, after paying a third-party claim, the insurers takes over any rights of recovery previously possessed by the insured and may seek to recover damages from another responsible party – Assignment and subrogation combined ∗ The assignment provision prohibits assignment of policy ownership without the insurer’s consent ∗ The subrogation provision provides that an insured may waive its rights of recovery before a loss occur ∗ After a loss occurs, the insured may legally assign its right of recovery, including its rights to collect from the insurer, to any other party ∗ After an insurer has paid a loss for the insured, the subrogation provision requires that the insured must assign rights of recovery to the insurer • Salvage – Salvage: The process through which an insurer takes possession of damaged property, for which it has paid a total loss, and recovers a portion of the loss payment by selling the damage property. Damage property itself can also be called salvage – Recovered property provision: Clarifies how the insurer and the insured will handle property that is recovered after a claim for its loss has been paid – Most often, the insured determines whether to take back recovered property, but the insured does not keep both the property and the claim money 117 Wiening - Chapter 17: External factors affecting insurance contracts Procedures to resolve coverage disputes • Insurance policies describe the insurer’s duties in the event of a loss, but they do not explicitly state an insurer’s four available options 1. The insurer may accept the claim or defend the insured against the suit 2. The insurer may disclaim any obligation under the policy and deny coverage risking to be found ultimately to have breached its contractual duties 3. The insurer may issue a reservation of rights letter or a nonwaiver agreement if a question about liability and/or coverage arises, i.e. the insurer agrees to investigate the claim (or to provide a defense for liability claims), but reserves its rights to disclaim coverage later 4. The insurer may seek a declaratory judgment, i.e. the insurer asks the court to declare the parties rights • Insurer denies coverage – When denying a claim, an insurer faces the possibility of a suit from either the insured or a third-party claimant – Suit by an insured ∗ A suit can result in a judgment requiring the insurer to pay not only the original claim, but also punitive damages ∗ “Suit” provisions usually require that the insured first comply with other policy provisions. ∗ Property insurance policies usually stipulate that the legal action must be initiated within a specified time after the date of loss ∗ Liability policies do not carry time limitations but prohibit the filing of any suit against the insurer until the insured’s obligation is determined by final judgment or settlement, which can involve a long delay – Suit by third-party claimant ∗ A third-party claimant has no contractual relationship with the insurance company of the party who injured the claimant, and as such, usually has no basis on which to sue the insurer ∗ However, a few jurisdictions have enacted direct action statutes that permit third-party claimants to sue an insurer directly • Preserving the insurer’s rights – Insurers use reservation of rights letters and nonwaiver agreements to preserve their ability to disclaim coverage if the facts reveal that there should be no coverage under the policy – Reservation of rights letter ∗ A letter signed and issued by an insurer to indicate that it is handling a claim with the understanding that it might later deny coverage when more information is available. It has two purposes 1. To protect the insurer’s right to deny coverage later, if warranted, without facing the accusation that its earlier actions waived that right 2. To inform the insured that a coverage problem may exist and give the insured an opportunity to protect the insured’s interests ∗ To prevent bad-faith actions, the insurer should send a specific and concise reservation of rights letter to the insured immediately on identifying a potential problem – Nonwaiver agreement ∗ An agreement indicating that the insurer does not waive its rights to later deny coverage which becomes effective when signed by both parties to the agreement Legal doctrines • Contract of adhesion – Insurance policies are contracts of adhesion. Ambiguities in a contract of adhesion are interpreted in favor of the party that did not draft the contract, usually the insured 118 • • • • • – Standard insurance policies are sometimes constructed to take advantage of the doctrine of adhesion. If an insurance contract can be interpreted in two different ways and the insurer is satisfied with either interpretation, no expansion of the contract is necessary to make it more precise – In many states, whether ambiguities in a case are interpreted against the insurer depends on (i) who drafted the policy provision, and (ii) the insured’s level of sophistication in insurance matters – To determine whether an insured falls within the “sophisticated insured” rule, courts consider factors like: Size of the insurance organization, insured’s employment of a professional risk manager, involvement of counsel on insured’s behalf, insured’s retention of a sophisticated insurance broker, use of a manuscript policy, and relative bargaining power of the parties Reasonable expectations doctrine – A doctrine that interprets an insurance policy as providing the protection that the insured might reasonably have expected, even though that expectation is not clearly expressed in or supported by the policy – The reasonable expectations doctrine is sometimes applied to renewal policies that contain a change without any oral or written explanation about the change Unconscionable advantage principle – A principle that prevents an insurer from taking unfair advantage of an insured – Generally, the courts have sided with the insured in cases in which the insured is trying to preserve the contract but finds some provision objectionable, difficult, or almost impossible to fulfill Substantial performance doctrine – A doctrine that allows the insured, under some circumstances, to meet policy conditions through something short of literal performance – The substantial performance doctrine applies to insureds who have attempted honestly and faithfully to perform their contractual duties. The insured must be able to demonstrate no willful omission or departure from the contract Waiver and estoppel – Waiver and estoppel are closely related legal doctrines under which an insurer might provide benefits not specified in the insurance contract – Waiver: The intentional or voluntary relinquishment of a known right, e.g. acceptance of a late renewal premium payment – Estoppel: A legal principle that prevents a party from enforcing a present claimed position because it is inconsistent with that party’s past conduct Fortuity – Even without a specific exclusion, the concept of fortuity would preclude property coverage against loss resulting from ordinary wear and tear, inherent vice, or defect – Known-loss or loss-in-progress situations are closely related to the issue of fortuity. Traditionally, insurers did not need to cite an explicit policy exclusion to successfully deny coverage where the policyholder had purchased insurance knowing of an ongoing situation likely to result in a loss 119 Wiening Et Al.- Chapter 1: Overview of personal insurance Introduction Personal insurance is insurance that covers the financial consequences of losses to individuals and families caused by death, illness, injury, disability, and unemployment as well as liability and property losses Loss exposures of individuals and families • Loss exposure: Any condition presenting the possibility of a financial loss, whether or not loss occurs • Property loss exposures consist of three elements: – Property exposed to loss ∗ Real property: Land as well as buildings and other structures attached to the land or embedded in it (including common areas shared with ownership rights) ∗ Personal property: Tangible or intangible property that is not real property. The main categories of personal property are: (i) Dwelling contents (generally insured as a group), (ii) High-value personal property (usually require a more specific type of insurance), (iii) Property with unusual or intrinsic value (which need to be established when insurance is purchased), (iv) Business personal property (additional insurance coverage may be necessary), and (v) motor vehicles, trailers, watercraft and aircraft (separately insured) ∗ To keep the cost of personal insurance reasonable, personal insurance policies are designed to cover the loss exposures of the average person or family. Additional premium is usually required to cover valuable or unusual items – Causes of loss affecting property – Financial consequences of property losses ∗ Reduction in value of property ∗ Increased expenses ∗ Lost income • Liability loss exposures, consider two elements: – Possibility of a claim for money damages ∗ A liability loss exposure involves the possibility that one party, claiming injury/damage, brings a claim for money damages against another party allegedly at fault ∗ Claims for liability damages are governed by civil law. The most common types of claims involve tort liability, contractual liability, and statutory liability ∗ Tort liability: An individual may face a claim for tort damages (Tort: A wrongful act, other than a crime or breach of contract), based on any of the following: · Negligence: The most common cause of liability losses. There are four legal elements of negligence: A duty to act, a breach of that duty, the occurrence of an injury or damage, and the breach of duty is the direct cause of the injury or damage · Intentional torts: Libel, slander, assault, battery, trespass, nuisance · Absolute liability: Legal liability that arises from inherently dangerous activities, regardless of the degree of care used. it does not require proof of negligence ∗ Contractual liability: liability assumed under a contract or agreement, e.g. lease ∗ Statutory liability: Liability imposed by a specific statute or law, e.g. automobile accidents – Financial consequences of liability losses 1. Cost of investigation and defense 2. Money damages awarded if the defense is not successful ∗ many liability claims are settled before they reach court because it is usually less expensive ∗ Liability loss exposures put all of an individual’s financial resources (including potential future income) at risk of loss. The amount of damages ordered by the court is based on the loss the injured party suffers, not on the financial resources of the party at fault Personal risk management • Risk management: The process of making and carrying out decisions that will decrease the adverse 120 • • • • • • • effects of potential losses Risk management involves the following steps – Identifying loss exposures – Analyzing loss exposures – Examining possible risk management techniques to be used – Choosing the appropriate techniques – Implementing the chosen techniques in a risk management plan – Monitoring and revising the plan, as needed Personal risk management: The risk management process applied to the loss exposures of individuals or families Individuals and families are likely to consider insurance as the only way to handle their loss exposures, and to expect insurance to take care of all their exposures for them. They are not likely to identify all their exposures, study alternative risk management techniques, and select and implement other techniques. They are even less likely to monitor and revise their decisions Some customers expect a personal insurance agent to serve as their risk manager. However, customers should make their own coverage decisions. Insurance personnel can become involved in errors and omissions (E&O: Negligent acts committed by a person while conducting insurance business that give rise to legal liability for damages. Can also involve a failure to act that creates legal liability) Insurance as a risk management technique: Insurance is only one of many risk management techniques. It should not be expected to cover all types of losses, other risk management techniques are appropriate for treating many loss exposures Other techniques to treat loss exposures – Loss control: Risk management technique to reduce the frequency or severity of losses, one of the most important and overlooked personal risk management technique. Controlling loss exposures involves both loss prevention (control loss frequency) and loss reduction (control loss severity) – Avoidance: Risk management technique by which an individual or family avoids a loss exposure by choosing not to own a particular item of property or not to engage in a particular activity – Noninsurance transfer: A risk management technique that transfers loss exposures from one party to another party that is not an insurer, e.g. transfer property and liability exposure through the terms of a lease – Retention: A risk management technique that draws on the financial resources of an individual/family to pay for part or all of the consequences of a particular loss exposure. Retention can intentional (e.g. higher deductibles) or unintentional (e.g. not purchasing certain coverages) How a personal risk management program works – Analyze/identify the loss exposures faced, e.g. make a home inventory, analyze driving patterns and personal activities, list unusual hazards or activities facing a liability claim – Purchase insurance for some of the exposures, and see what remaining exposures are not covered – Employ loss prevention measures, e.g. car inspection – Implement loss reduction measures, e.g. purchase fire extinguishers – Avoid some risks, e.g. flood exposure with a house on the lake – Examine leases and other document to check for noninsurance transfers – Retain some of the risk of loss by raising deductibles on some insurance policies Types of personal insurance policies • Personal insurance policies are often standardized and are usually written as a package policy (policy that covers two or more lines of insurance, e.g., homeowners policy or the personal auto policy), combining property and liability coverages • Other types of policies beside the personal auto policy (PAP) and the homeowners policy: Dwelling policy, mobilehome insurance, farm insurance, flood insurance, FAIR plans, beachfront and windstorm plans, inland marine insurance, watercraft insurance, umbrella policies, life insurance, health insurance including Medicare, disability income insurance 121 Wiening Et Al.- Chapter 3: Personal auto policy, part I Overview of the personal auto policy • The PAP is designed to insure private passenger autos (cars, vans, suv designed primarily for use on public roads) as well as pickup trucks and full-size vans subject to restrictions. The PAP can also be used, if allowed by the state and the insurer, to cover motorcycles, golf carts, snowmobiles, motorhomes and other vehicles by adding an endorsement to the policy • Summary of coverages – The PAP consist of a declaration page, an agreement and definitions page, and six separate parts – Part A - Liability coverage: provides coverage that protects the insured against a claim for bodily injury or property damage arising out of the operation of an auto – Part B - Medical payments coverage: provides coverage for medical expenses incurred by an insured because of bodily injury caused by an auto accident – Part C - Uninsured motorists coverage: provides protection if an insured is injured by an uninsured motorist, a hit-and-run driver, or a driver whose insurer is insolvent – Part D - Coverage for damage to your auto: provides coverage for physical damage to a covered auto and to certain nonowned autos (physical damage coverage) – Part E - Duties after an accident or loss: outlines the duties required of an insured after an accident or a loss – Part F - General provisions: contains general provisions, such as cancellation and termination of the policy and the policy period and territory • Declarations – Declarations page: A required component of an insurance policy providing information about the insured, a description of the insured autos, a schedule of coverages, and other important details – Elements of the declaration page - Insurance company - Named insured - Policy period - Description of insured autos - Schedule of coverages - Applicable endorsements - Lienholder - Garaged Location - Rating information - Signature • Agreement and definitions – Agreement: A brief general statement serves as an introduction to the policy and states that the insurer’s obligations are subject to all the terms of the policy and depend on the payment of premium by the insured – Definitions ∗ You and your: refer to the named insured (also includes spouse if residing in the same household) ∗ We, us and our: refer to the insurance company ∗ Owned includes leased: A leased vehicle is deemed to be an owned auto if it is leased under a written agreement for a continuous period of at least six months ∗ Bodily injury: Bodily harm, sickness or disease, including death ∗ Business: includes a trade, a profession or an occupation ∗ Family member: A person related to the named insured or spouse by blood, marriage, or adoption and resides in the named insured’s household (includes foster child) ∗ Occupying: Occupying is defined as in, upon, getting in, on, out or off, used in connection with parts B and C ∗ Property damage: Physical injury to or destruction of tangible property, including loss of use of tangible property ∗ Trailer: A vehicle designed to be pulled by a private passenger auto, pickup or van ∗ Your covered auto: Your covered auto includes four classes of vehicles: (i) Any vehicle shown in the declarations, (ii) A trailer owned by the insured, (iii) A temporary substitute auto or trailer (for part D physical damage, it is treated as a nonowned auto), and (iv) A 122 newly acquired auto ∗ Newly acquired auto: An eligible private passenger vehicle that becomes owned during the policy period. It automatically receives coverage equal to the broadest coverage indicated for any vehicle shown in the declarations (except for physical damages) · An additional auto is automatically covered for fourteen days · A replacement auto is covered for the remainder of the policy · An insured who does not carry collision coverage receives automatic physical damage coverage on a newly acquired auto for four days, subject to a $500 deductible · An insured who does carry collision coverage receives automatic coverage on a newly acquired auto for fourteen days Part A - Liability coverage • The liability coverage of the PAP provides protection against an insured’s legal liability arising out of the ownership or operation of an auto • Insuring agreement – In the liability coverage insuring agreement, the insurer agrees to pay damages for bodily injury (BI) or property damage (PD) for which an insured is legally responsible because of an auto accident – Definitions ∗ Damages: Monetary award that one party is required to pay to another who has suffered loss or injury for which the first party is legally responsible ∗ Compensatory damages: Damages, including both special damages and general damages, that are intended to compensate a victim for harm actually suffered ∗ Special damages: Compensatory damages allowed for specific out-of-pocket expenses, e.g. doctor and hospital bills ∗ General damages: Compensatory damages awarded for losses, such as pain and suffering, that do not have a specific economic loss ∗ Punitive damages: Damages awarded by a court to punish wrongdoers. Some states do not permit insurers to award payment for punitive damages ∗ Split limits: The maximum amount a PAP insurer will pay for the insured’s liability for BI per person, BI per accident, and PD per accident ∗ Single limit: Maximum amount an insurer will pay for the insured’s liability for both BI and PD per accident ∗ Prejudgment interest: Interest on damages that accrues between the time the accident or suit occurs and when a judgment is rendered indicating that the insured is responsible for damages. It is subject to the policy limit of liability ∗ Structured settlement: Periodic and guaranteed payments made for damages over a specified time period – Damages may include both compensatory damages (special damages and general damages) and punitive damages – The policy limits applicable to this coverage can be expressed either as split limits or as a single limit. Most policies are written with split limits. A single liability limit endorsement modifies the liability coverage of the PAP to provide coverage on a single-limit basis – The damages covered also include any prejudgment interest awarded against the insured. Prejudgment interest is considered to be part of the award for damages and is subject to the policy limit of liability – Damages are usually paid in a lump sum. However, a structured settlement may be used when a large BI claim is involved – The insurer also agrees to defend the insured and pay all legal defense costs, even if the combined figure exceeds the policy limits. However, the insurer’s duty to settle or defend the claim ends when the limit of liability has been exhausted by the payment of judgments or settlements 123 • Insured persons: four categories are insured for liability coverage under the PAP – The named insured and any family member – Any person using a covered auto – Any person or organization, but only for legal liability arising out of an insured person’s use of a covered auto on behalf of that person or organization – Any person or organization legally responsible for the named insured’s or a family member’s use of any auto or trailer (other than a covered auto or an auto owned by that person or organization) • Supplementary payments – The following supplementary payments may be paid in addition to the liability limits and other defense costs – Cost of bail bonds (up to $250, only if BI or PD damages result) – Premiums on appeal bonds and bonds to release attachments – Interest accruing after a judgment, aka postjudgment interest (interest in damages that accrues after a judgment has been rendered and before the damages are paid) – Loss of earnings because of attendance at trials, up to $200 a day – Other reasonable expenses incurred at the insurer’s request • Liability coverage exclusions – The insuring agreement of Part A describes broad coverage that is narrowed by exclusions, including: – Intentional injury – Property owned or transported – Property rented to, used by, or in the care of the insured: This exclusion does not apply to a residence or private garage – Bodily injury to an employee of an insured: BI excluded if the employee is injured during the course of employment, unless WC benefits are not required/available – Public or livery conveyance: The exclusion does not apply to share-the-expense car pools – Garage business: Liability insurance does not apply to any insured while employed or engaged in the business of selling, repairing, servicing, storing or parking vehicles. these loss exposures should be covered by a commercial policy – Other business use: Commercial vehicles and trucks used in a business should be covered under business auto policies – Using a vehicle without reasonable belief of being entitled to do so: This exclusion does not apply when another family member uses the owned auto of a named insured – Nuclear energy liability losses – Vehicles that have fewer than four wheels or are designed primarily for off-road use – Other vehicles owned by the named insured or available for the named insured’s regular use – Vehicles owned by or available for regular use of any family member – Racing • Limit of liability – Coverage is most commonly provided on a split-limits basis. Three dollar limits are stated ∗ The first limit applies to BI to each person ∗ The second limit applies to BI to all persons in each accident ∗ The third limit applies to all PD in each accident – The PAP states that the limits of liability for the policy will not be increased regardless of the number of injured persons, claims made, vehicles or premiums shown, or vehicles involved in an auto accident – The limit of liability provision specifically states that no one is entitled to receive duplicate payments for the same elements of loss under Part A - Liability coverage, Part B - medical payments coverage, Part C - Uninsured motorists coverage, or any underinsured motorists coverage provided 124 by the policy • Out-of-state coverage – Definition: A provision that automatically provides any higher limits and types of coverage required by the state in which an auto accident occurs, if such accident occurs in a state other than the one in which the covered auto is principally garaged – E.g. a driver who is not required to have “no-fault” personal injury protection (PIP) coverage in his home state would have PIP coverage when driving in a state that requires it • Compliance with financial responsibility laws – The PAP will automatically comply with financial responsibility laws, e.g. higher minimum limits requirements • Other insurance – Part A of the PAP has a provision that addresses situations in which more than one auto policy covers a liability claim. When the insured has other applicable liability insurance on an owned vehicle, the insurer pays only its pro-rata share of the loss, which is the proportion that its limit of liability bears to the total of all applicable limits – If other liability insurance is available on a nonowned vehicle, the PAP coverage is excess over any other collectible insurance Part B - Medical payments coverage • Medical payments coverage is an option that can be added to the PAP. Under this coverage, the insurer pays medical expenses up to a specified limit for certain people who are injured in an auto accident. The limit is typically between $1,000 and $10,000 per person and applies separately to each insured person who is injured in any one auto accident • Insuring agreement – The insurer will pay reasonable and necessary medical and funeral expenses incurred by an insured because of BI caused by an accident. The insurer will pay only those expenses incurred for services rendered within three years from the date of the accident – Medical payments coverage applies without regard to fault • Insured persons – Two groups of persons are considered insured persons for medical payments coverage: (i) the named insured and family members, and (ii) any other person while occupying a covered auto – The named insured and family members are covered for their medical expenses if they are injured while occupying (in, upon, getting in, on, out or off) a motor vehicle, or are injured as pedestrians when struck by a motor vehicle designed for use mainly on public roads – Any other person while occupying a covered auto is also insured. However, if the name insured is operating a nonowned vehicle, passengers in the car (other than family members) are not covered under the name insured medical payments coverage. Passengers in the nonowned vehicle should seek protection under their own policies or under the medical payments coverage that applies to the nonowned vehicle • Medical payments exclusions – Motorized vehicles with fewer than four wheels – Public or livery conveyance: the exclusion does not apply to share-the-expenses car pools – Vehicles used as a residence or premises – Injury during the course of employment, granted that WC benefits are required/available – Other vehicles owned by the named insured or available for the named insured’s regular use, in order to exclude medical payments coverage on an owned or regularly used vehicle that is not described in the policy and for which no premium is paid – Vehicles owned by or available for regular use of any family member, however, the exclusion does not apply to the named insured and spouse – Occupying a vehicle without reasonable belief of being entitled to do so, however, for insurance purposes, it is assumed that one family member has permission to use another family 125 member’s car – Vehicles used in the business of an insured, this exclusion applies only to commercial vehicles, not to private passenger auto, pickup, van or a trailer – BI from nuclear weapons or war, excluding also insurrection, rebellion or revolution – Nuclear radiation exclusion – Racing • Limit of liability – The limit of insurance for medical payments coverage is stated in the declarations. this limit, typically between $1,000 and $10,000 is the maximum amount that will be paid to each injured person in a single accident, regardless of the number of injured persons, claims made, vehicles or premiums shown, or vehicles involved in the auto accident – In addition, the limit of liability provision specifically states that no one is entitled to receive duplicate payments for the same elements of loss under Part B - Medical payments coverage, Part A - Liability coverage, Part C - Uninsured motorists coverage, or any underinsured motorists coverage • Other insurance – If other auto medical payments insurance should apply, the insurer would pay its pro rata share based on the proportion that its limit of liability bears to the total of applicable limits – With respect to a nonowned vehicle, however, medical payments coverage under a PAP is excess over any other collectible auto insurance that provides payment for medical or funeral expenses Part C - Uninsured motorists coverage • Uninsured motorists (UM) coverage is designed to compensate an insured for BI caused by an uninsured motorist, a hit-and-run driver, or a driver whose insurer is insolvent • Insuring agreement – The insurer agrees to pay compensatory damages that the insured person is legally entitled to recover from the owner or operator of an uninsured motor vehicle because of BI caused by an accident – Such compensatory damages could include medical expenses, rehabilitation expenses, lost wages, and other losses resulting from the insured’s BI. Only compensatory damages are covered, punitive damages are specifically excluded – UM coverage applies only if the uninsured motorist is legally responsible for the accident. Although a covered person is not required to sue the uninsured driver, that driver’s legal liability must be established – In some states, UM coverage for property damage claims is also included, subject to a deductible such as $200 or $300 • Insured persons – Three groups of persons are considered insureds under the uninsured motorists coverage 1. The named insured and family members, covered if injured by an uninsured motor vehicle while occupying a covered auto or nonowned auto, or as pedestrians 2. Any other person occupying a covered auto, thus passengers in the insured’s car have coverage for BI caused by an uninsured motorist 3. Any person legally entitled to recover damages because of bodily injury to a person described in 1. and 2., e.g. a surviving spouse could collect damages under the uninsured motorist coverage • Uninsured motor vehicles – The uninsured motorist coverage specifies the types of vehicles that are considered uninsured motor vehicle. An uninsured vehicle is a land motor vehicle or trailer of any type meeting any of the following criteria ∗ No BI liability insurance or bond applies to the vehicle at the time of the accident ∗ A BI liability policy is in force, but the limit is less than than the minimum amount required 126 by the financial responsibility law in the state where the named insured’s covered auto is principally garaged ∗ The vehicle is a hit-and-run vehicle, whose operator or owner cannot be identified, that hits (i) the named insured or any family member, (ii) a vehicle that the named insured or a family member is occupying, or (iii) the named insured’s covered auto ∗ A BI liability policy or bond applies at the time of the accident, but the insurance or bonding company (i) denies coverage, or (ii) is or becomes insolvent – Certain vehicles, however, are not considered to be uninsured motor vehicles, such as ∗ Vehicles owned or furnished or available for the regular use of the named insured or any family member ∗ Vehicles owned or operated by a self-insured under any applicable motor vehicle law, except a self-insured that is or becomes insolvent ∗ Vehicles owned by a governmental unit or agency ∗ Vehicles operated on rails or crawler treads ∗ Vehicles designed mainly for use off public roads (while not on public roads) ∗ Vehicles located for use as a residence or premises • Uninsured motorists exclusions – No uninsured motorists coverage on vehicle, the UM coverage must be specified in the policy – Primary coverage under another policy – Claim settled without insurer’s consent – Covered auto used as public livery or conveyance, except for car-pools – Vehicle used without reasonable belief of being entitled to do so – Cannot benefit WC insurer – Punitive damages not paid • Limit of liability – The minimum amount of uninsured motorists coverage available under the PAP is the amount required by the financial responsibility or compulsory insurance law of the state in which the named insured’s covered auto is principally garaged. Higher limits can be purchased for additional premium – The limit of liability for uninsured motorists coverage is shown in the declarations. UM coverage is normally written on a split-limits basis, but single-limit coverage is available by endorsement – The limits shown are the most that will be paid regardless of the number of insured persons, claims made, vehicles or premiums shown, or vehicles involved in the accident – The UM section specifically states that no person will receive duplicate payments for any loss under Part A - Liability coverage, Part B - Medical payments coverage, Part C - Uninsured motorists coverage, or under any underinsured motorists coverage provided by the policy • Other insurance – If other applicable uninsured motorists insurance is available under one or more policies, the following provisions apply to the payment for damages: ∗ The total amount paid will be no more than the highest limit of any of the policies ∗ Coverage for an accident involving a vehicle the named insured does not own is provided on an excess basis over any collectible insurance providing coverage on a primary basis ∗ When the named insured’s policy and the other policies provide coverage on a primary basis, each policy will contribute proportionally to the insured’s recovery. Each insurer’s share is equal to proportion its UM limits bears to the total amount available under all applicable coverages provided on a primary basis ∗ When the named insured’s policy and the other policies provide coverage on an excess basis, each policy contributes proportionally to the insured’s recovery, based on the excess limits each policy provides 127 • Arbitration – Arbitration is the process for settling disputes between the insured and the insurer concerning whether or for what amount uninsured motorists coverage applies – If the insurer and the insured cannot agree on whether the insured is entitled to recover damages under uninsured motorists coverage, or on the amount of the damages, the dispute can be settled by arbitration. However, both the insurer and the insured must agree to arbitration – Each party selects an arbitrator, and the two arbitrators select a third arbitrator (if they cannot agree within thirty days, either party can request that the selection be made by a judge of court having jurisdiction). Each party pays the expenses it incurs, and share the expenses of the third administrator – A decision agreed to by two of the three arbitrators is binding as to (i) whether the insured is legally entitled to recover damages, and (ii) the amount of damages (if it does not exceed the minimum limit for BI specified by the state’s financial responsibility law, otherwise, either party can demand the right to a trial within sixty days) 128 Wiening Et Al.- Chapter 4: Personal auto policy, part II Part D - Coverage for damage to your auto • Part D of the PAP provides physical damage coverage for damage to or theft of a covered auto. It is a type of property insurance including both collision coverage and “other-than-collision” coverage. Coverage under part D also applies to nonowned autos used by an insured, including temporary substitute vehicles • Insuring agreement – The insurer promises to pay for any direct and accidental loss to a covered auto or a nonowned auto, including its equipment, minus the deductible shown on the declarations page. Three coverage alternatives are usually available ∗ No physical damage coverage ∗ Other-than-collision coverage ∗ Both collision and other-than-collision coverage – If the insured purchases both collision and other-than-collision (OTC), the premiums are shown separately on the declarations page. Additional physical damages coverages (e.g. towing and labor costs coverage) can be added by endorsements – Many motorists purchase only OTC because collision insurance is more expensive and OTC often has a lower deductible • Collision loss – Collision: The upset of a covered auto or a nonowned auto or its impact with another vehicle or object – Examples of collision losses covered under part D: an auto collides with another vehicle, an auto smashes into a tree, a driver loses control of an auto and overturns, an owner parks an auto which gets dented during the absence of the owner, a person opens a car door in a parking lot and the door gets damaged – Collision losses are paid regardless of fault – If two or more autos, for which the same policy provides collision coverage, are damaged in the same collision, only one deductible applies (the larger deductible applies if they are different) • Other-than-collision loss (OTC) – OTC coverage: Coverage for auto physical damage losses that are not caused by collision and that are not specifically excluded by the policy. Sometimes referred to as “comprehensive” coverage – Examples of OTC losses: missiles or falling objects, fire, theft or larceny, explosion or earthquake, windstorm, hail water or flood, malicious mischief or vandalism, riot or civil commotion, contact with a bird or other animal, breakage of glass – Colliding with a bird or an animal is not a collision loss. If glass breakage is caused by a collision, the insured can elect to have the glass breakage considered as part of the collision loss (hence, only one deductible has to be satisfied) • Physical damage coverage for nonowned autos – The part D coverages also apply to a nonowned auto, however, the coverage would be in excess over any physical damage coverage the owner has on his car – Coverages also apply for a rented or borrowed auto, unless the vehicle is made available for an insured’s regular use – The definition of nonowned auto also includes any auto or trailer that is being used as a temporary substitute for a covered auto or trailer that is out of normal use because of its breakdown, repair, servicing, loss or destruction – If there is a loss to a nonowned auto, the PAP provides the broadest coverage applicable to any covered auto shown in the declarations • Deductibles – A flat deductible of some amount specified in the policy declarations applies to each covered collision loss. A separate deductible (usually lower than the collision deductible) applies to other129 than-collision losses – Deductibles require the insured to share covered losses with the insurer. Deductibles are used for part D to: ∗ Reduce small claims ∗ Hold down premiums ∗ Encourage the insured to be careful in protecting his car against damage or theft • Transportation expenses – Part D provides an additional coverage known as transportation expenses which provides reimbursement of up $20 per day (up to $600) for temporary travel expenses for each covered loss – When the loss involves a nonowned auto and an insured is legally responsible to the owner of that auto for the owner’s transportation expenses, the insured’s PAP will pay (up to $20 a day). Similarly for a renter’s loss of income – If the insured has purchased only OTC coverage, the PAP provides transportation expenses coverage in the event of any OTC loss – The PAP states that the transportation expenses coverage is provided without application of a deductible. It is however subject to a waiting period, a 48-hours waiting period applies to theft losses, and a 24-hours waiting period applies to loss by other perils – For theft, transportation expenses coverage ends when the stolen auto is returned to use (or the insurer pays for the auto), including the auto repair time if needed, minus the two days deductible – For other than theft cause of loss, transportation expenses coverage is in effect during the period necessary to repair the car, subject to the one day deductible • Exclusions – Public or livery conveyance – Wear and tear, freezing, mechanical or electrical breakdown, and tire damage, in order to exclude regular maintenance expenses. This exclusion does not apply if the damage results from a theft – Radioactive contamination or war – Electronic equipment designed for the reproduction of sound, if they are not permanently installed, and up to some limits for custom equipment – Equipment designed for the reception and transmission of audio, visual or data signals, except for a permanently installed phone powered by the auto electrical system – Media and accessories – Government destruction or confiscation, however, this exclusion does not apply to the interests of any loss payees such as banks or other lending institutions – Camper body or trailer not shown in the declarations, however, the exclusion does not apply to a nonowned trailer, or a trailer acquired during the policy period if the insurer is asked to cover it within fourteen days – Nonowned auto used without a reasonable belief of permission – Radar and laser detection equipment, because they promote unsafe driving – Customizing equipment, including but not limited to: special carpeting or insulation, furniture or bars, height-extending roofs, custom murals, paintings or decal. However, for a pickup, the exclusion does not apply to a cap, cover or bedliner – Nonowned auto used in the auto business, since the business of selling, repairing, servicing, storing or parking vehicles constitutes a commercial loss exposure which should be insured by the repair shop – Racing – Rental vehicles: If the rental agreement includes a collision damage waiver or if applicable state law precludes the rental company from recovering from the insured for the loss, the PAP will not pay • Limit of liability 130 • • • • – The insurer’s limit of liability for a physical damage loss to a covered auto is the lower of (i) the actual cash value of the damaged or stolen property, or (ii) the amount necessary to repair or replace the property with other property of like kind and quality. In determining the cash value, an adjustment is made for depreciation and physical condition of the damaged property – The coverage for damage to your auto endorsement can be used to establish the car’s insurable value when the policy is written, e.g. for antique cars – The insurer’s maximum obligation for sound reproduction equipment installed in locations not used by the original manufacturer is limited to $1,000 – The maximum amount paid for a physical damage loss to a nonowned trailer is $500 – Betterment: If a repair or replacement results in better than like kind or quality, the insurer will not pay for the betterment – Diminution in value ∗ Diminution in value: Actual or perceived loss in market or resale value resulting from a direct and accidental loss ∗ ISO has filed a clarifying endorsement in many states noting that coverage for diminution in value is specifically excluded Payment of loss – The insurer has the option of paying for the loss in money or repairing or replacing the damaged or stolen property – If the insurer returns a stolen auto, the insurer pays the cost of returning the stolen car or its equipment to the insured and also pays for any damage resulting from the theft – However, the insurer has the right to keep all or part of the stolen property and pay the insured an agreed or appraised value – If the insurer pays for the loss, that payment will include the applicable sale tax for the damaged or stolen property No benefit to bailee – Bailee: Person or business that has in its care, custody, or control, property belonging to another – The no benefit to bailee provision states that the policy will not benefit, either directly or indirectly, any bailee. The named insured receives recovery, but the insurer preserves its right to recover from the bailee if negligent Other sources of recovery – If other sources of recovery also cover a loss, the PAP insurer pays only its share of the loss. Its share is the proportion that its limit of liability bears to the total applicable limits – Any physical damage insurance provided by the PAP for a nonowned auto is excess over any other collectible source of recovery, which include coverage provided by the owner of the nonowned auto, any other applicable physical damage insurance, and any other source of recovery that applies to the loss Appraisal – Appraisal: A provision that describes how the insured and the insurer will settle dispute about the amount of loss – Each party selects a competent appraiser, and the two appraisers select an umpire. A decision by any two of the three is binding – Procedurally, the appraisal process resembles the arbitration process described under UM coverage. Each party pays its chosen appraiser and shares equally the expenses of the appraisal and the umpire Part E - Duties after an accident or loss • Part E of the PAP outlines a number of duties the insured must perform after an accident or a loss. the insurer has no obligation to provide coverage unless the insured fully complies with these duties. Additional duties are imposed if the insured is seeking protection under Part C - Uninsured motorists coverage or Part D - Coverage for damage to your auto 131 • General duties – Prompt notice: The insurer should be notified promptly of how, when, and where the accident or loss occurred. The notice should also include the names and addresses of any injured persons and witnesses – Cooperation with the insurer, in the investigation, settlement, or defense of any claim or suit – Submission of legal papers to the insurer – Physical examination, at the insurer’s expense – Examination under oath, if required by the insurer – Authorization of medical records – Proof of loss, i.e. a written statement giving the pertinent facts of the claim • Additional duties for uninsured motorists coverage 1. Notify police: The person seeking benefits under Part C - UM coverage must notify the police if a hit-and-run driver is involved (to reduce fraudulent claims) 2. Submit legal papers: If the person seeking coverage sues the uninsured motorist, a copy of the legal papers must be sent to the insurance company • Additional duties for physical damage coverage 1. Prevent further loss: The person seeking coverage must take reasonable steps after a loss to protect a covered auto or nonowned auto and its equipment from further loss. the insurer will pay the reasonable expenses incurred to protect the vehicle from further damage 2. Notify police: If a covered auto is stolen, the person seeking coverage must promptly notify police of the theft, which significantly increases the possibility of recovering the stolen vehicle 3. Permit inspection and appraisal (for small losses, the insurer may waive its right to inspect) Part F - General provisions • Bankruptcy of insured – The insurer is not relieved of any obligations under the policy if the insured declares bankruptcy or becomes insolvent • Changes in the policy – The terms of the policy cannot be changed except by an endorsement issued by the insurer – If the change requires a premium adjustment, the adjustment is made in accordance with the manual rules of the insurer – Changes during the policy term that can result in a premium increase or decrease include changes in: ∗ The number, type, or use of insured vehicles ∗ The operators of insured vehicles ∗ The place of principal garaging of insured vehicles ∗ The coverage, deductibles, or limits of liability – Another portion of the changes provision, aka liberalization clause, automatically provides broadened coverage under some conditions. However, this provision does not apply to changes that include both broadenings and restrictions • Fraud – No coverage exists for any insured who makes fraudulent statements or engages in fraudulent conduct in connection with any accident or loss for which a claim is made • Legal action against the insurer – The PAP states that no legal action can be brought against the insurer until the insured has fully complied with all of the policy terms – In addition, under Part A - Liability coverage, no legal action can be brought against the insurer unless the insurer agrees in writing that the insured has an obligation to pay damages or the amount of the insurer’s obligation has been finally determined by a judgment after trial • Insurer’s right to recover payment – Subrogation: Insurer’s right to recover payment from a negligent third party. When an insurer 132 pays an insured for a loss, the insurer takes over the insured’s right to collect damages from the other party responsible for the loss. The insurer has the right to subrogate against the party directly responsible for the loss – The subrogation clause does not apply to physical damages coverages in regard to any person who is using a covered auto with a reasonable belief that he is entitled to do so – If a person receives a loss payment from an insurer and also recovers damages from another party, that person is required to hold the proceeds of the second recovery in trust for the insurer, and to reimburse the insurer to the extent of the insurer’s loss payment • Policy period and territory – The PAP applies only to accidents and losses that occur during the policy period (usually six months or a year) and within the policy territory – The policy territory includes the United States, U.S. territories and possessions, Puerto Rico, and Canada. the policy also applies to a covered auto while being transported among ports of the U.S., Puerto Rico, or Canada – The insured can purchase the limited Mexico coverage endorsement to extend PAP coverage to an insured who is involved in an accident in Mexico within twenty-five miles of the U.S. border on a trip of ten days or fewer. this endorsement does not eliminate the need to purchase primary liability coverage from a Mexican insurer • Termination – The PAP contains a provision that applies to termination of the policy by either the insured or insurer. the termination provision consists of four parts: (i) cancellation, (ii) nonrenewal, (iii) automatic termination, and (iv) other termination provisions – All states have laws that restrict the insurer’s right to cancel or nonrenew an auto policy, differing from the termination provision in the PAP. Changes mandated by state laws are usually incorporated into the policy by means of a state endorsement that must be attached to all auto policies in the state. State law supersedes the policy provisions – Cancellation ∗ The named insured normally can cancel anytime during the policy period by returning the policy to the insurer or by giving advance written notice of the date the cancellation is to become effective ∗ The insurer has more limited cancellation rights. If the policy has been in force for fewer than 60 days and is not a renewal or continuation policy, the insurer can cancel by mailing a cancellation notice to the insured ∗ If the cancellation is for nonpayment of premium, the insurer must give the named insured at least 10 days notice; In all other cases, at least 20 days’ notice must be given ∗ After the policy has been in force for 60 days, or if it is a renewal or continuation policy, the insurer can cancel the policy for only one of three reasons 1. The premium has not been paid 2. The driver’s license of an insured has been suspended or revoked during the policy period 3. The policy has been obtained by a material misrepresentation – Nonrenewal ∗ If the insurer decides not to renew, the named insured must be given at least 20 days’ notice before the end of the policy period ∗ The times when the insurer can nonrenew vary with the length of the policy period ∗ Policy period ¡ 6m: Right to nonrenew every 6 months, beginning six months after the policy’s original effective date ∗ 6m ¡ policy period ¡ 1y: Right to nonrenew at the end of the policy period ∗ Policy period ¿ 1y: Right to nonrenew at each anniversary of the policy;s original effective date – Automatic termination 133 ∗ Under the automatic termination provision, if the insurer offers to renew the policy but the named insured does not accept the insurer’s offer to renew, the policy automatically terminates at the end of the current policy period ∗ Failure to pay the renewal premium means that the named insured has not accepted the insurer’s offer to renew the policy ∗ If the named insured obtains other insurance on a covered auto, the PAP coverage on that auto automatically terminates on the effective date of the other insurance, even if the original insurer is not notified – Other termination provisions 1. The insurer may choose to deliver the cancellation notice rather than mail it. However, proof of mailing of any cancellation notice is considered sufficient proof of notice 2. If the policy is canceled, the named insured may be entitled to a premium refund, computed according to the insurer’s manual rules 3. The effective date of cancellation stated in the cancellation notice becomes the end of the policy period • Transfer of insured’s interest in the policy – The “transfer of your interest in this policy” provision limits assignment (i.e. the transfer of a policy from the named insured to another party) of the policy by an insured – The insurer’s written consent is required – However, if the named insured dies, the coverage is automatically continued to the end of the policy period for both the surviving spouse, if a resident of the same household at the time of death, and the legal representative of the deceased person • Two or more auto policies – If two or more auto policies issued to the named insured by the same insurer apply to the same accident, the insurer’s maximum limit of liability is the highest applicable limit of liability under any one policy 134 Wiening Et Al.- Chapter 5: Homeowners insurance, section I Introduction • Before the 1950s, owners of private residences had to purchase separate policies to cover their various needs. During the 50s, standard homeowners policies were developed to cover most types of private residences and personal property, as well as to provide liability insurance for owners of such property • In the 1970s, the need grew for insurance contracts containing simplified language. In 1976, ISO introduced a simplified homeowners policy series although not adopted throughout the states. The 1984 edition of the ISO homeowners policy using simplified policy language was approved in all states except Texas, and was revised in 1991 • In 1994, ISO introduced multistate revisions in the form of endorsements. The “Homeowners 2000” policy program, subject of this chapter, incorporates these multistate revisions, broadens many coverages of the 1991 form, and restricts other The homeowners 3 special form (HO-3) • The HO-3 policy is designed for the owner-occupants of a one- to four- family dwelling used as the residence of the named insured. The policy is not intended for owners who do not occupy the dwelling • Other eligible persons: (i) purchaser of a dwelling under a long-term installment contract without legal title to the property, (ii) a dwelling under construction if the named insured is the intended owner-occupant, (iii) occupants with a wide estate arrangement, and (iv) a trust when it is the sole owner of the dwelling and the trustee, grantor or beneficiary reside on the premises • Structure of the HO-3 policy – The policy is divided into two major sections ∗ Section I - Property coverages specifies the property covered, the perils for which property is covered, and the exclusions and conditions that affect property coverage and losses ∗ Section II - Liability coverages provides information regarding liability coverages, exclusions and conditions – The policy begins with segments that establish the policy insuring agreement and the definitions of words used in the policy. The policy ends with conditions that apply to both property and liability coverage sections – Modifying endorsements ∗ The HO-3 meets most, but not all, needs of many individuals and families. Endorsements can be used to alter the policy language to add, delete, or modify the coverage – Declaration page ∗ The declarations page provides essential information about the insured, the property covered, and the limits of coverage provided ∗ The declarations page answers the following questions: who is the policyholder, where is the policyholder residence, what are the coverage limits, what is the premium, what is the section I deductible, what is the effective date of the policy, what forms and endorsements apply to the policy, and who is the mortgage holder ? – Agreement ∗ The “agreement” (insuring agreement) , the first sentence in the policy form reads: “We will provide the insurance described in this policy in return for the premium and compliance with all applicable provisions of this policy” ∗ The insurer agrees to provide coverage, and the policyholder agrees to pay the premium and comply with the policy conditions – Definitions ∗ Any ambiguities in an insurance policy are construed against the party that wrote the contract, i.e. in this case, any ambiguity is interpreted in favor of the insured ∗ The terms “you”and “your” are defined in the HO-3 as referring to the “named insured” shown in the declarations and the spouse if a resident of the same household. The terms 135 “we”, “us”, and “our” refer to the insurer ∗ “Named insureds” and other “insureds” · The named insured has somewhat more protection than other insureds · The definition of “insured” encompasses not only a named insured, but also other insureds, including: · Relatives who are residents of the named insured’s household · Other persons under the age of 21 in the care of a named insured or resident relative · A full-time student who lives away from home but resided in the household before leaving to attend school, provided the student is either a relative under the age of 24 or someone in the care of the named insured or a resident relative under the age of 21 · When the policy refers to “an insured”, it means “one or more insureds” ∗ “Residence premises” and “insured location” · “Residence premises” does not include as many places as “insured location” · Residence premises includes only the location shown as “residence premises” in the declarations and means: (i) The one- to four-family dwelling where the named insured resides in at least one of the units, (ii) That part of any other building (such as an apartment building) where the named insured resides, and (iii) Other structures and grounds at that location · Insured location includes the “residence premises” and also: (i) An unlisted residence acquired by the named insured during the policy period, (ii) A nonowned premises where any insured is temporarily residing (e.g. hotel room), (iii) Vacant land, other than farm land, owned by or rented to any insured, (iv) An insured’s land on which a one- to fourfamily residence is being constructed, (v) Individual or family cemetery plots, and (vi) Any part of a premises occasionally rented to an insured for nonbusiness use (e.g. hall rented for a wedding) – Deductible ∗ Following the definitions, the policy begins with a statement that the insurer will pay only property losses covered under Section I that exceed the deductible amount shown in the declarations ∗ The standard deductible is $250, but the insured can choose a higher deductible for a lower premium ∗ The most used deductible amounts are $250 and $500. they apply to all perils insured against under Section I of the policy ∗ Many insurers in catastrophe-prone areas also use special higher deductible amounts that apply to specified perils ∗ The deductible is subtracted once from the total of all loss payable under Section I - Property coverages caused by a single loss event. The insurer does not pay more than the applicable policy limits • Section I - Property coverage – Section I is divided into the following property coverages: Coverage A - Dwelling, Coverage B - Other structures, Coverage C - Personal property, Coverage D - Loss of use, and Additional coverages – Collectively, these coverages describe property and expenses the HO-3 would cover – Coverage A - Dwelling ∗ Coverage A applies to the dwelling on the “residence premises” listed on the declarations page ∗ Coverage A also applies to structures attached to the dwelling (e.g. garage, deck) as well as to materials and supplies that are located on or next to the covered dwelling that are used to construct or repair the dwelling ∗ The land at the residence premises is specifically excluded from property coverage and its 136 value should not be included when determining the amount of insurance to purchase ∗ When buying insurance, a homeowner should determine the Coverage A limit based on the cost to replace/rebuild the dwelling – Coverage B - Other structures ∗ Other structures refer to structures on the residence premises, other than the dwelling building, that are not attached to the dwelling (e.g. fence, swimming pool, detached garage) ∗ Coverage for other structures is automatically provided under the HO-3 with a limit that is 10% of the limit of Coverage A, limit collectively applied to all “other structures” at the residence premises, but in addition to the Coverage A limit ∗ The other structures - increased limits endorsement provides higher limits for specified other structures ∗ Coverage B has three important exclusions. No coverage is provided for other structures: · Rented to anyone who is not a resident of the dwelling, unless it is rented as a garage · From which any “business” is conducted, business being defined as full-time, part-time, or occasional trade, profession or occupation or any other activity engaged in for money or compensation, except for volunteer activities or home daycare services involving no compensation beyond payment of expenses. Also excepted are business activities in which any insured received more than $2,000 in total compensation for the twelve months before the inception date of the policy · Used to store “business” property, unless the business property is solely owned by an insured or a tenant of the dwelling and provided it does not include gaseous or liquid fuel (except for fuel in the tank of a vehicle or craft parked or stored in the structure) – Coverage C - Personal property ∗ Coverage C applies to the policyholder’s personal property anywhere in the world, including items that the policyholder owns or uses, e.g. Coverage C provides coverage for property that is borrowed ∗ Coverage C provides coverage for personal property owned by others while it is on the residence premises ∗ Coverage C also provides coverage for personal property owned by a guest or residence employee while the property is in any residence occupied by the insured ∗ the standard limit for Coverage C is 50% of the coverage A limit and applies in addition to the Coverage A limit. The Coverage C limit can be increased simply by changing the amount appearing on the declarations page, no endorsement is required but an additional premium is charged ∗ Only 10% of the limit for Coverage C, or $1,000 (whichever is greater) is provided for property usually located at a residence (the full amount of Coverage C would be available for property in a self-storage warehouse) other than the residence listed on the declarations page. This 10% (or $1,000) limitation does not apply to personal property that is moved from the residence premises because the house is being repaired. An increased limit on personal property in other residences endorsement is available ∗ An insured who is moving from one principal residence to another has the full limit of Coverage C available at both locations for thirty days ∗ Special sublimits · The following limits can be modified with the Coverage C increased special limits of liability endorsement · $200 on money and precious metals, including cash, bank notes, coins, medal, scrip (used as a fund raiser, sold to donors for a % of the redeemable value, the difference being donated by a retailer), stored value card (prepaid phone card), smart card, silver, gold and platinum · $1,500 on securities, documents, records and stamps, regardless of the medium, e.g. per- 137 sonal records on computer. This limit also includes the cost to research and replace the lost information · $1,500 on watercraft, of all types, including their trailers, equipment, and motors · $1,500 on trailers, other than those used with watercraft · $1,500 for theft of jewelry and fur, the limit being not applicable to other perils (e.g. fire) · $2,500 for theft of firearms and related items · $2,500 for theft of silverware, goldware, platinumware and pewterware. The scheduled personal property endorsement is available to increase limits · $2,500 for property on the residence premises used primarily for any business purpose, regardless of who owns the property. The increased limits on business property endorsement and the home business coverage endorsement are available · $500 for property away from the residence premises used for business purposes · $1,500 for electronic apparatus and accessories equipped to be operated by power from a motor vehicle, while in or upon a motor vehicle · $1,500 for electronic apparatus equipped to be operated by power from a motor vehicle, used primarily for business while away from the residence premises but not in or upon a motor vehicle ∗ Property not covered · Articles insured elsewhere, in this or other insurance · Animals, birds, or fish · Motor vehicles, including equipment, parts and electronic equipment operating solely from the vehicle’s electrical system. An exception is made for vehicles that are not required to be registered for use on public roads or motor vehicles used solely to service an insured’s residence or designed to assist the handicapped · Aircraft, excepted model and hobby aircraft · Hovercraft, i.e. self-propelled motorized ground effect vehicles · Property of roomers or boarders unrelated to an insured · Property in an apartment rented to others · Property rented or held for rental to others off the residence premises · Business data, stored either on paper or electronically. However, coverage is provided for the cost of blank recording, storage media and computer software · Credit card or electronic fund transfer card · Water or steam, e.g. the refill of a swimming pool is not covered – Coverage D - Loss of use ∗ Coverage D applies only if the damage is the result of a loss that is covered under Section I of the policy, e.g. loss of use due to flooding would not be covered ∗ Coverage D is automatically provided at a limit that is 30% of the Coverage A limit, and applies in addition to the Coverage A limit. The coverage D limit can be increased simply by changing the amount appearing on the declarations page, no endorsement is necessary ∗ Three coverages are grouped under Coverage D · Additional living expense, covering only the necessary and increased expenses caused by the temporary relocation, i.e. only the difference between the insured’s normal living expenses and the higher relocation expenses. Payment is made for the shortest time required to repair the dwelling or to permanently relocate the household · Fair rental value, i.e. the lost rental value minus expenses that do not continue, until the repairs are made. Fair rental value coverage applies even to units not currently rented to a tenant as long as the units is “held for rental” · Loss of use due to civil authority, as long as the threat to the property comes from a peril insured against by the HO-3 (e.g. flood threat would be excluded). Coverage D will 138 reimburse the policyholder both additional living expenses and fair rental value for no more than two weeks – Additional coverages ∗ Debris removal: The cost of debris removal is included within the Coverage A, B or C limit. If the debris removal cost plus the damage to the property exceeds the applicable limit, the additional coverage for debris removal provides an additional 5% of the limit. This coverage also pays for reasonable expenses (up to $1,000) for removal from the residence premises of (i) the insured’s trees felled by windstorm, hail, or the weight of ice, snow or sleet, or (ii) a neighbor’s trees felled by a Coverage C peril. The tree must either damage a structure, block a driveway, or block an handicapped access ramp and no more than $500 is paid for the removal of any one tree ∗ Reasonable repairs, reimbursing the policyholder for the reasonable cost of measures taken to protect the property from further damage ∗ Trees, shrubs, and other plants, covered for the perils of fire, lightning, explosion, riot, civil commotion, aircraft, vehicles (not owned or operated by a resident), vandalism or theft. Weather-related losses are not covered, and the coverage is limited to 5% of the Coverage A limit and not more than $500 for any one tree, plant or shrub ∗ Fire department service charge, up to $500 ∗ Property removed when attempting to save some contents from an endangered home is covered for thirty days, for any peril ∗ Credit card, electronic fund transfer card or access device, forgery, and counterfeit money, up to $500 for (i) legal obligations because of the theft or unauthorized use of the insured’s credit card, (ii) loss resulting from the theft or unauthorized use of a fund transfer card or access device, (iii) loss caused by forgery or alteration of a check, and (iv) loss through acceptance of counterfeit U.S. or Canadian money. However, no coverage is provided for losses arising out of business use or the dishonesty of an insured. A credit card, EFT or access device, forgery and counterfeit money coverage endorsement is available ∗ Loss assessment, up to $1,000 of the insured’s share of a loss assessment made by a corporation or association of property owners if the loss is a result of a peril insured against Coverage A and the damaged property is of a type insured under this policy. A loss assessment coverage endorsement is available ∗ Collapse, only when caused by certain specific perils: Named perils insured against in Coverage C, hidden decay unknown to the insured, hidden insect or vermin damage unknown the the insured, weight of contents - equipment - animals or people, weight of rain on a roof, use of defective building material or construction methods if collapse occurs during construction ∗ Glass or safety glazing material, unless the dwelling has been vacant for more than sixty days before the loss ∗ Landlord’s furnishing, up to $2,500 per apartment for loss by the same perils applicable to other property under Coverage C, except for theft. A landlord’s furnishing endorsement is available ∗ Ordinance or law, provides an additional 10% of the Coverage A limit to pay for: · The added cost of construction, demolition, remodeling, renovation, or repair due to damage as a result of a covered peril · The demolition, reconstruction, remodeling, removal or replacement of the undamaged part of a covered building or other structure when the entire building must be rebuilt, following damage to another part of the building · The remodeling, removal, or replacement of the undamaged part of a covered building or other structure when it’s necessary to complete the work being done to the damaged area · Related debris removal expenses 139 · Specifically excluded are losses in value to the building and costs associated with pollutants ∗ Graves markers, up to $5,000 for loss caused by the Coverage C perils – General comments on additional coverages ∗ Most of these additional coverages are given special treatment because they do not fit neatly into Coverage A, B, C or D groups. Others address items that have been excluded from the full coverage otherwise available under Coverage C ∗ Some additional coverages create additional coverage limits, but others do not ∗ Some additional coverages are subject to the deductible, but others are not ∗ Some additional coverages are available only after a covered loss has occurred, but others are independent of any other covered loss Section I - Perils insured against • Section I - Perils insured against has the following divisions – Coverage A - Dwelling and Coverage B - Other structures – Coverage C - Personal property • Perils insured against for Coverages A and B: direct physical loss – This section begins with: “We insure against direct physical loss to property described in Coverages A and B”. The approach to describing the perils insured against for Coverages A and B is known as special-form coverage, i.e. coverage for any direct physical loss to property unless the loss is caused by a peril specifically excluded by the policy, aka “all-risks” or open perils coverage – Next, a list of excluded perils is provided. If a peril is not listed within these exclusions, it is covered • Perils excluded for Coverages A and B – Perils listed in the Section I exclusions – Collapse, although collapse that results from another cause is provided under a Section I additional coverage – freezing of a plumbing, heating, air conditioning or sprinkler system, or a household appliance – Freezing, thawing, pressure or weight of water or ice – Theft of construction material are excluded until the dwelling is finished and occupied – Vandalism and malicious mischief to vacant dwellings, vacant (unfurnished and no occupants) for more than sixty consecutive days – Mold, fungus, or wet rot, unless it is hidden and results from an accidental leak of water or steam from a plumbing, heating, or air conditioning system or household appliance or from a storm drain or water, steam or sewer pipes off the residence premises – Natural deterioration, specifically excluding wear and tear, marring, deterioration, mechanical breakdown, latent defect, or inherent vice – Smoke from agricultural smudging or industrial operations – Pollutants, whether solid, liquid, gaseous or thermal, except if the pollutants are released or escape as the result of any of the perils insured under coverage C – Settling of the dwelling – Animals, the HO-3 excludes damages to and caused by animals that an insured owns or keeps, or caused by birds, vermin, rodents, or insects – Exception to excluded perils - water damage coverage ∗ The HO-3 covers water damage to buildings or other structures that results from an accidental discharge or overflow of water or steam, coming from a plumbing, heating, air conditioning, or sprinkler system, from a household appliance on the residence premises, or from a storm drain or water , steam, or sewer pipe off the residence premises ∗ Coverage is provided for damage caused by the water and also for the cost of tearing out and replacing any part of the building or other structure necessary to make repairs. However, the 140 loss to the damaged system or appliance is not covered – Ensuing losses covered: Ensuing losses (loss caused by a peril that occurs after or as a result of an initial peril, e.g. fire damage following an earthquake) not specifically excluded by the HO-3 are covered. E.g. settling of foundations is excluded, but if a settling foundation causes a water pipe to break, the ensuing water damage would be covered • Perils insured against for coverage C – Under Coverage C, only named perils (perils listed and described in the policy, aka specified perils or specified causes of loss) are covered – The homeowners 5 - Comprehensive form closely resembles the HO-3 but changes the coverage for Coverage C from named perils to “special-form coverage” – Fire or lightning – Windstorm or hail covers damage to personal property caused by rain, snow, sleet, sand or dust only if wind or hail first damages the building and causes an opening. Coverage of windstorm and hail damage to watercraft, trailers, furnishing and equipments is provided only while these items are inside a fully enclosed building – Explosion, including gunshot or rifle shot – Riot or civil commotion – Aircraft – Vehicles, covering damage to personal property in the back seat of a car involved in an auto accident – Smoke, excluding loss caused by smoke from agricultural smudging or industrial operations – Vandalism or malicious mischief – Theft applies if the circumstantial evidence is strong enough to establish that theft is the cause of loss. Also includes “mysterious disappearance”. However, the following types of theft are excluded ∗ Theft committed by an insured ∗ Theft from a building under construction and theft of construction materials ∗ Theft from that part of the insured premises rented to someone other than another insured ∗ Theft from another residence the insured owns, unless the insured is temporarily living there ∗ Theft of property belonging to an insured who is a student at a residence away from home, if the student has not been there for more than sixty days ∗ Theft is excluded for watercraft, including its furnishing and equipment, away from the residence premises ∗ Theft of trailers and campers is excluded – Falling objects, provided the falling object penetrated the building first – Weight of ice, snow or sleet, applying only to property contained in a building – Accidental discharge or overflow of water or steam – Sudden and accidental tearing apart, cracking, burning or bulging – Freezing – Sudden and accidental damage from artificially generated electrical current, excluding loss to transistors, electronic components or circuitry of appliances, computers or home entertainment equipment. A special computer coverage endorsement changes the named perils coverage to “special coverage” for electronic hardware and equipment, software and media – Volcanic eruption, excluding earthquake or tremors Section I - Exclusions • Some perils are excluded for both buildings and personal property covered under Section I. The list of these exclusions begins: “We do not insure for loss caused directly or indirectly by any of the following. Such loss is excluded regardless of any other cause or event contributing concurrently or in any sequence to the loss. These exclusions apply whether or not the loss event results in widespread damage or affects a substantial area” 141 • Special-form property insurance policies tend to make it clear that loss involving flood, earthquake, war, and nuclear reaction are excluded even if another prior cause can also be identified • Perils excluded under Section I – Ordinance or law, other than the coverage provided in the additional coverage section – Earth movement However, damage caused by ensuing fire or explosion is covered, and theft is not excluded. An earthquake endorsement can be added to cover the earthquake peril – Water damage However, ensuing losses from fire, explosion or theft resulting from water damage are covered – Power failure due to a problem away from the residence premises – Neglect However, the insurer agrees to pay the cost of reasonable repairs under an additional coverage – War, including the discharge of nuclear weapons are excluded – Nuclear hazard, i.e. any nuclear reaction, radiation or contamination – Intentional loss committed by an insured – Governmental action, i.e. destruction, confiscation, or seizure by order of any governmental or public authority. This exclusion does not preclude coverage for governmental action taken to prevent the spread of fire – The next three exclusions apply only to Coverage A - Dwelling and Coverage B - Other structures. Any ensuing loss is covered as long as the policy does not preclude coverage for that ensuing loss – Weather conditions are excluded perils if they contribute to any of the previously excluded perils, e.g. mudslide – Acts or decisions of other people, organizations, or governmental bodies that cause property damage due to an excluded peril are not covered – Faulty workmanship damage from faulty planning, zoning, surveying, design specifications, workmanship, construction, renovation, materials and maintenance are excluded if the ensuing loss is excluded Section I - Conditions • The section I - Conditions of the policy describe the conditions applying to Section I that both the insured and the insurer must meet. It also explains how property will be valued in the event of a loss • Insurable interest and limit of liability – This Section I condition limits the maximum payment for any single loss to the applicable limits shown on the declarations page, regardless of the number of insureds who might have an insurable interest in the property. This condition further limits loss payment to any insured to the extent of that insured’s insurable interest in the property at the time of loss • Your duties after loss – “In case of a loss to covered property, we have no duty to provide coverage under this policy if the failure to comply with the following duties is prejudicial to us. These duties must be performed either by you, or your representative, or by an “insured” seeking coverage, if not you” – Give prompt notice – Notify the police, if a loss is by theft – Notify the credit card, EFT, or access device company – Protect the property from further damage – Cooperate with the insurer – Prepare an inventory, including the quantity, description, value and amount of the loss. Bills, receipts, and related documents must be attached – Verify the loss which includes showing the damaged property, allowing the insurer to make copies of records and documents, and submit to an examination under oath – Sign a sworn proof of loss, within sixty days of the insurer’s request. This is a form provided by the insurer that establishes the time and cause of loss, the insured’s insurable interest in the property, other insurance that might cover the loss, the inventory of the damaged personal 142 property, information supporting additional living expenses, and information regarding a credit card, fund transfer card, or access device loss • Loss settlement – This portion of the Section I - Conditions establishes how the amount that will be paid for property after a loss will be determined. There are two settlement methods: (i) one method for Coverage C - Personal property items and other miscellaneous items, and (ii) another method for Coverages A and B – Coverage C and miscellaneous items ∗ Such losses are settled at the lesser of (i) Actual cash value (ACV) at the time of the loss, and (ii) The amount required to repair or replace the items ∗ The personal property replacement cost endorsement changes the loss settlement basis for Coverage C and miscellaneous items to replacement cost instead of ACV – Coverages A and B ∗ The amount payable for a building loss may be one of three amounts: (i) The replacement cost, (ii) The actual cash value, and (iii) an amount that falls between these two numbers. it all depends on how the limit of insurance compares to the replacement cost value of the damage building at the time of the loss ∗ The methods for determining the loss settlement for a building are as follows: · If the limit of insurance is 80% or more of the replacement cost: The insurer pays for the replacement cost of the damage up to the limit of coverage · If the limit of insurance is less than 80% of the replacement cost: The insurer pays the greater of (i) the ACV of the damage, or (ii) the proportion of the cost to repair or replace the damage that the limit of insurance bears to 80% of the replacement cost Loss payment = MAX ACV, Limit of insurance × Replacement cost of loss 80% Replacement cost ∗ Except for small losses (under $2,500) the insurer will not pay more than the actual cash value until repairs are completed. An insured who has not decided whether to rebuild can initially seek loss settlement on an ACV basis and has up to 180 days to notify the insurer that he intends to complete the repairs and make settlement on a replacement cost basis ∗ If the building is rebuilt on different premises, the insurer will pay no more than it would if the building were repaired or replaced at the original premises ∗ Regardless of the method used to determine the loss settlement amount, the limit of coverage shown on the declarations page is the maximum amount that will be paid for any loss ∗ The additional limits of liability for Coverages A, B, C and D endorsement increases the Coverage A limit to equal the current replacement cost of the dwelling if that amount exceeds the limit appearing on the declarations page. the limits of liability for Coverages B, C and D will be increased by the same percentage applied to Coverage A • Loss to a pair or set – Items that are more valuable in pairs or sets are settled according to a special policy provision. The insurer can elect to ∗ Replace the missing item and restore the pair or set to its original value ∗ Pay the difference between the ACV of the pair or set and the ACV of the remaining items from the pair or set • Appraisal – Appraisal: A procedure, prescribed by a provision in a property insurance policy, for the insured and the insurer to settle disputes regarding the value of a covered loss – The insurer and the policyholder each choose an appraiser to prepare an estimate of the value of the loss. Each party pays for its own appraiser – If the estimates differ, the two appraisers submit their differences to an umpire, i.e. an impartial 143 • • • • • • • • • • • individual who resolves the difference and whose costs are shared by the insured and the insurer. An agreement by any two of the three will set the amount of loss Other insurance and service agreement – If two or more insurance policies cover the same loss, this condition explains that the loss will be shared proportionally by all policies – An insured home or item of personal property may also be covered by some type of service plan, property restoration plan, home warranty, or service warranty agreement. The homeowners policy makes it clear that homeowners insurance coverage applies as excess over any amounts payable under any such agreement Suit against us – An insured may not bring legal action against the insurance company unless all policy provisions have been complied with – Any legal action must be started within two years of the loss Our option – The insurer reserves the right to repair or replace damaged property with similar property. Repairing or replacing property is the insurer’s option Loss payment – The insurer will adjust all losses with the policyholder or spouse. A loss is payable sixty days after the insurer receives a proof of loss and either (i) the insurer and the policyholder have reached an agreement, or (ii) a court judgment or an appraisal award has been entered – Some states require a different time period Abandonment of property – If the insured abandons the property after it is damaged or destroyed, the insurer is not obligated to take over responsibility for it, or to accept the property Mortgage clause – This condition establishes the following rights of the mortgagee listed on the declarations page – If a loss occurs to property covered by Coverages A or B, the loss will be payable jointly to the mortgagee and the policyholder. Typically, the mortgagee relies on this right to ensure that the policyholder uses the money to repair the property – A mortgagee has rights that are independent of the policyholder’s rights. if the insurer denies the policyholder’s loss, the mortgagee retains the right to collect from the insurer its insurable interest in the property – If the insurer cancels or nonrenews the policy, the insurer must mail notice to the mortgagee (in addition to notice sent to the insured) at least ten days before the cancellation or nonrenewal No benefit to bailee – A bailee who holds the property of an insured is responsible for the care of that property. the bailee cannot avoid responsibility for a damage because the insured has coverage under the homeowners policy Nuclear hazard clause: Excluded nuclear hazards encompass nay resulting radiation, contamination, explosion or smoke. A direct loss by fire resulting from the nuclear hazard is covered Recovered property: If property is recovered, the policyholder has the option of taking the property and returning the claim payment or keeping the claim payment and allowing the insurer to take over the property Volcanic eruption period: All volcanic eruptions that occur within a 72h period are considered to be one volcanic eruption. If multiple eruptions occur within that period, only one coverage limit and one deductible apply Policy period: Coverage applies only to losses that occur during the policy period Concealment or fraud: No insured is covered under this policy if any insured conceals or misrepresents any material information, engages in fraudulent conduct, or makes false statements relating to the insurance. this condition applies whether the conduct occurred before or after a loss 144 • Loss payable clause: The insurer agrees to include the named loss payee when a claim is paid involving that property. Normally, this means that a claim draft would be payable to both the named insured and the loss payee. the loss payee is also entitled to notification if th policy is canceled or nonrenewed 145 Wiening Et Al.- Chapter 6: Homeowners insurance, section II Section II coverages • Section II - Liability coverages consists of two principal coverages, plus a few additional coverages – Coverage E - Personal liability – Coverage F - Medical payments to others – Section II - Additional coverages provides four miscellaneous liability related coverages • Difference Section I vs. Section II – Section I includes first party (the insured) insurance that provides coverage for loss to property owned or used by an insured. Section II provides third party (someone not party to the insurance contract who may assert a claim against a first party) coverages. Damages for claims covered under Section II are not payable to an insured, they are paid on behalf of an insured – A deductible applies to most of the Section I coverages, but no deductible applies to Section II – Section I contains detailed descriptions of covered property and perils. Section II contains much less details, broadly describing personal liability and medical payments to others coverages and then clarifying coverage through exclusions • Coverage E - personal liability – All homeowners policies automatically include Coverage E - personal liability for a basic limit generally set at $100,000 per occurrence. This limit can be increased by showing the higher limit on the declarations page, no endorsement necessary – Personal liability coverage is provided if a claim is made or a suit is brought against an insured because of bodily injury (BI: bodily harm, sickness, or disease, including required care, loss of services and death that result) or property damage (PD: physical injury to, destruction of, or loss of use of tangible property) – The personal injury endorsement adds a definition for “personal injury” and modifies the liability coverage of the homeowners policy to include not only BI and PD but also “personal injuries”, such as libel, slander, malicious prosecution, wrongful eviction and violating a person’s right of privacy – The definition of “insured” is broader for Section II - Liability than it is for Section I - Property. The following are included as insureds for Section II coverages ∗ The named insured and spouse if resident of the same household. They are identified as you in the policy ∗ Residents of the household who are relatives of the named insured or spouse ∗ Residents of the household who are under 21 and in the care of the named insured or resident relatives ∗ A full-time student who resided in the household before moving out to attend school (either under 21 and in the care of the named insured or resident relatives, or under 24 and a relative of the named insured) ∗ Any person or organization legally responsible for animals or watercraft that are covered by the policy and owned by a person defined in the first three bullets above, e.g. the neighbor who walks the dog ∗ Anyone employed by a person defined in the first three bulleted items, with respect to any motor vehicle covered by the policy ∗ Other persons using any vehicle covered by the policy on an insured location, with the consent of the named insured, are insured for liability coverage – Events that trigger liability coverage ∗ This coverage, which applies anywhere in the world, covers BI and PD arising from the insured’s activities or premises. In most instances, such liability arises from the insured’s negligence – Defense cost coverage ∗ In addition to paying up to the limit of liability, the insurer pays defense costs if an insured 146 is presented with a lawsuit that involves a claim that is covered under the policy ∗ This defense cost coverage is provided even if the suit is groundless, false, or fraudulent ∗ The insurer retains the right to investigate and settle any claim in a way that the insurer decides is appropriate ∗ The insurer cannot simply offer to pay the policy limit and abandon the insured. The insurer is required to defend the insured against damages resulting from an occurrence until a settlement or judgment is reached. However, once the insurer has paid a judgment or settlement that exhausts the total limit of Coverage E - Personal liability, the insurer is not required to provide a further defense • Coverage F - Medical payments to others – Medical payments to others covers the necessary medical expenses incurred by others (third party, not an insured) within three years of the injury – It is different from the PAP where medical payments coverage protects the insured, family members and other passengers of the insured automobile – The medical payment to others coverage overlaps with the BI liability coverage, however, liability coverage applies only when an insured is legally responsible for damages. Claims for medical payments are often paid when the insured feels a moral obligation to another person, although the insured is not negligent and has no legal responsibility. In other cases, a small BI claims can be paid as medical payments to keep matters simple – Coverage F - medical payments to others is automatically included in all homeowners policies for a limit generally set at $1,000 per person for a single accident. This limit can be increased for an additional premium and is shown on the declarations page – Coverage F applies to people injured in the following situations ∗ A person is on an “insured location” with the permission of an insured ∗ A person off the insured location is injured because of conditions on the insured location ∗ A person off the insured location is injured by an insured’s activities ∗ A person off the insured location is injured by a residence employee of the insured during the course of employment ∗ A person off the insured location is injured by an animal owned by or in the care of an insured – Coverage F applies to insured “residence employees”, but not to other employees ∗ Residence employees include domestic workers whose duties include maintaining or using the household premises or performing domestic or household services, i.e. duties related to the insured’s residence ∗ Employee is an employee of an insured who is not a residence employee – Insured locations: Eight locations are included in this definition Exclusions • Section II - Liability coverages begins with a complex set of exclusions for losses arising out of motor vehicles, watercraft, aircraft, and hovercraft, as well as exceptions to the exclusions. With respect to all these vehicles or craft, there is no coverage for BI, PD or medical claims arising out of – The ownership, maintenance, occupancy, operation, use, loading, and unloading of a motor vehicle or craft by any person unless it appears in a specific exception to the exclusions – Negligent entrustment, by an insured, of an excluded motor vehicle or craft – An insured’s failure to supervise, or negligently supervising, a person – An insured’s “vicarious liability” for the actions of a child or minor • Motor vehicles – As defined, a motor vehicle is a self-propelled vehicle, including an attached trailer. Most excluded motor vehicle exposures can be insured under a PAP – Coverage does not apply to motor vehicles that ∗ Must, by law, be registered for use on public roads or property ∗ Are involved in an organized race 147 ∗ Are rented to others ∗ Are used to carry persons or cargo for a charge ∗ Are used for any business purpose, except for motorized golf carts used on a golf course – Unless the vehicle is excluded under one of the preceding categories, it may be covered under one of the exceptions to the motor vehicle exclusion, e.g. ∗ Motor vehicle in dead storage on an insured location ∗ Motor vehicle used solely to service an insured’s residence ∗ Motor vehicle designed for assisting handicapped people ∗ Motorized vehicle designed for recreational use off public roads and not owned by an insured ∗ Motorized vehicle designed for recreational use off public roads an downed by an insured on an insured location ∗ Motorized golf cart, slower than 25 mph, owned by an insured and used to play golf on a golf course, or legally used within a private residential association ∗ Trailer not towed by, hitched to, or carried on a motor vehicle – The low power recreational “motor vehicles” endorsement and snowmobile endorsement can be attached to a homeowners policy to provide liability coverage for some motorized vehicles when used off the insured premises • Watercraft – In general, small, low-powered watercraft, or watercraft the insured uses but does not own, are included for section II coverage – Watercraft not covered by the homeowners policy can be insured by a watercraft policy. The watercraft endorsement provides Coverages E and F for scheduled watercraft – Coverage does not apply to watercraft that ∗ Are involved in an organized race, excluding sailboats and predicted log cruises ∗ Are rented to others ∗ Are used to carry persons or cargo for a charge ∗ Are used for any business purpose – Unless the craft is excluded under one of the preceding categories, it may be covered under one of the watercraft exclusion, e.g. ∗ Watercraft that are stored ∗ Sailboats shorter than 26 feet ∗ Sailboats longer than 26 feet not owned by or rented to an insured ∗ Inboard or inboard-outdrive watercraft with engines of 50 horsepower or less that are not owned by an insured ∗ Inboard or inboard-outdrive watercraft with engines of more than 50 horsepower that are not owned by or rented to an insured ∗ Watercraft with one or more outboard engines totaling less than 25 horsepower ∗ Watercraft with one or more outboard engines totaling more than 25 horsepower that are not owned by an insured ∗ Watercraft with outboard engines of more than 25 horsepower owned by an insured if acquired during the policy period. If the insured acquires such watercraft before the policy period, they are covered only if the insured declares them at the policy inception or reports the intention to insure them within 45 days of acquiring them • Aircraft and hovercraft – The homeowners policy flatly excludes all aircraft liability, except for model airplanes or hobby aircraft – Hovercraft liability is flatly excluded • Other exclusions applying to both Coverage E - Personal liability and Coverage F Medical payments to others – Expected or intended injury or damage 148 – – – – – – ∗ An occurrence (accident that results in BI or PD, including continuous or repeated exposure to the same general harmful conditions) must be accidental to be covered ∗ The exclusion in the homeowners policy makes it clear that intentional acts are not covered, even if the results of the act are more serious than was intended ∗ However, coverage is not precluded in cases of self-defense, involving reasonable force to protect either people or property Business ∗ The business exclusion is designed to preclude coverage for BI or PD arising out of the business activities of any insured, but to provide coverage for occasional or part-time activities such as delivering newspapers, maintaining lawns, washing cars, or babysitting ∗ No coverage is granted for BI or PD relating to a business operated from the residence premises or another insured location ∗ Business is broadly defined to include full-time, part-time, or occasional trade, profession, or occupation, or any other activity engaged in for money or other compensation except: · Activities for which the insured received less than $2,000 during the year preceding the policy period · Volunteer activities · Home daycare services not involving compensation, but possibly involving an exchange of services · Home daycare services rendered to a relative ∗ Unless otherwise excluded, coverage is available for an “insured” under the age of 21 involved in a part-time or occasional, self-employed business with no employees ∗ Renting property to others qualifies as a business. However, three exceptions to this exclusion are · Rental of an insured location on an occasional basis is a covered exposure if the location is used only as a residence · Rental of part of an insured location as a residence is a covered exposure as long as the occupying family takes no more than two roomers or boarders in a single family unit · Rental of part of an insured location is a covered exposure if it is used only as an office or a school, studio, or private garage ∗ Several endorsements are available to provide limited liability coverage for certain business activities of the insured · The permitted incidental occupancies - residence premises endorsement extends Section I and II coverages for a business on the residence premises · The home business insurance coverage endorsement provides even broader coverages · The business pursuit endorsement provides Section II coverage engaged in, but not owned or controlled by the insured · The home day care endorsement extends Section II coverages to a day care business in the home · The additional residence rented to others endorsement extends Section II coverages to an additional residence of the insured that is rented to one to four families For each of the preceding situations, Section II coverage applies to the insured but not to the tenants of the insured Professional services: Coverages E and F exclude coverage for the insured’s rendering or failure to render professional services. This exposure should be addressed by a professional liability policy Locations that are not insured locations: A loss that arises out of premises that are not an insured location is not covered War: Section II excludes any loss that results from war Communicable disease: Section II excludes any loss that arises from the transmission of a communicable disease by an insured 149 – Sexual molestation, corporal punishment, physical or mental abuse are not covered under Section II – Controlled substances: Section II excludes any loss resulting from the use, sale, manufacture, delivery transfer or possession of controlled substances as defined by the FDA. However, coverage is provided for the legitimate use of prescription drugs by a person following the orders of a licensed physician Exclusions applying only to Coverage E - Personal liability • Loss assessment – Coverage E excludes coverage for liability assessments charged to the policyholder by a homeowners’ association or a community of property owners – However, a Section II - Additional coverage provides $1,000 in coverage for this exposure, with an endorsement available to increase the $1,000 limit • Liability assumed under contract – Coverage E does not apply to liability an insured assumes under any contract or agreement – However, coverage is provided for two types of written contracts as long as the exposures do not involve coverage excluded elsewhere in the policy ∗ Contracts relating to the ownership, maintenance, or use of an insured location ∗ Liability of others assumed by the named insured before an accident occurs • Damage to the insured’s property – Liability coverage excludes damage to property owned by an insured, to preclude insured-versusinsured claims – In addition, an insured cannot collect payment under Section II - Liability coverage for damage to his own property, even if the property repairs serve to prevent a liability claim – Coverage E is intended to be a third-party coverage. Insureds can collect payment under Section I of the homeowners policy for damage to their own property that is covered under Section I • Property in the insured’s care – Coverage E does not apply to damage to property that is rented to, occupied by, or in the care of an insured – An exception to this exclusion applies to property damage caused by fire, smoke, or explosion • Bodily injury to persons eligible for WC benefits – Coverage E excludes coverage for bodily injury to any person who is eligible to receive or who is provided benefits by an insured under a state WC law, nonoccupational disability law, or occupational disease law • Nuclear liability: BI or PD liability is excluded in order to limit the insurance industry’s overall liability for nuclear occurrences • Bodily injury to an insured: the named insured, resident relatives, and other residents under the age of 21 in the insured’s care cannot collect damages under Coverage E for their own bodily injury, even if the injury is caused by another insured Exclusions applying only to Coverage F - Medical payments to others • Residence employee off premises – Coverage F excludes bodily injury to a residence employee if an injury occurs off the insured’s location and the injury does not arise out of the employee’s work – Therefore Coverage F would apply if ∗ The residence employee is away from the insured location, but is working ∗ The residence employee is on the insured location (whether working or not) • Bodily injury eligible for WC benefits – Any person eligible to receive payment under any WC law, nonoccupational disability law, or occupational disease law will not receive compensation for BI under Coverage F. this exclusion applies whether or not the benefits are to be provided by an insured 150 • Nuclear reaction – Coverage F excludes bodily injury from any nuclear reaction, nuclear radiation, or radioactive contamination, regardless of the cause • Injury to residents – Bodily injury to any person who regularly resides at the insured location (other than a residence employee) is excluded under Coverage F - Medical payments to others 151 Wiening Et Al.- Chapter 12: Health and disability insurance Providers of private health insurance • Private insurers sell both individual and group medical expense coverages. However, most individuals and families are insured under some type of group health insurance plan. Individual coverages are relatively unimportant in terms of the total amount of health insurance. Group insurance premiums now account for more than 90% of the total premiums paid for health insurance • Commercial insurers – Private life and health insurers and some P&C insurers sell individual and group health insurance coverages. Most of the business is written by fewer than 100 insurers, and half of it comes from about 30 insurers – Commercial insurers also sponsor various managed care plans, including Health Maintenance Organizations (HMO) and Preferred Provider Organizations (PPO) • Blue Cross and Blue Shield plans – Blue Cross and Blue Shield plans are typically nonprofit plans that cover hospital expenses, physician and surgeon fees, and related medical expenses – The “Blues” also offer major medical insurance, the various plans providing individual, family and group coverages – Service benefits rather than cash benefits are typically provided, with payment made directly to the hospital instead of the insured – Blue Cross and Blue Shield plans also sponsor managed care plans, including HMOs and PPOs. Most plans today include both Blue Cross and Blue Shield coverages • Self-insured plans – Many employers self-insure part or all of the health insurance benefits provided to their employees – Employers that self-insure typically purchase stop-loss insurance to cover excess losses – In addition, employers that self-insure often enters into contract with third-party administrators (TPA) to manage the plans – Self-insurance has several advantages to employers. Health insurance costs might be reduced or might increase less rapidly because of the savings in state premium taxes, commissions and the insurer’s profit. Cash flows may be improved since the employer earns interest on the money until the claims are paid. Finally, self-insured plans are usually exempt from state laws that require insured plans to offer certain mandated benefits Basic medical expense coverages • Basic medical expense coverages include hospital expense insurance, surgical expense insurance, physician’s visits insurance, and coverage for additional medical services • Hospital expense insurance – Hospital expense insurance pays for covered medical expenses while the patient is in the hospital, e.g. daily room-and-board benefits, benefits for miscellaneous services, and supplies provided during the hospital stay – Two methods are commonly used to pay the daily room-and-board charge: (i) An indemnity plan pays the actual daily charge up to some maximum dollar limit for a specified number of days, e.g. $500 daily for 120 days, or (ii) A second type of plan provides service benefits, paying up to the full cost of a semi-private room for up to a specified number of days, typically from 31 to 365 – Hospital expense insurance typically includes ancillary charges , e.g. drugs, laboratory fees, operating room, X-rays • Surgical expense insurance – Surgical expense insurance covers part or all of a physician’s fee for a surgical operation – Different methods are used to reimbursed surgeons: Some older plans use a schedule approach where a maximum dollar amount is specified for each procedure – The majority of surgical expense plans reimburse physician on the basis of their usual, reasonable, 152 and customary (URC) charges – Many insurers consider a fee to be reasonable if it does not exceed the ninetieth percentile for the same medical procedure performed by other physicians in the same geographic area – The patient must pay that portion of the fee in excess of the maximum allowed unless the physician accepts the amount allowed by the insurer • Physicians’ visits insurance – Insurance that covers nonsurgical care provided by an attending physician other than a surgeon – The coverage usually applies when the patient is in the hospital, but some plans also cover office and home visits • Additional benefits – Outpatient surgery when surgery is performed in a hospital or an office but the patient recovers at home – Preadmission testing when diagnostic tests are given as an outpatient before admission to the hospital – Diagnostic X-ray and laboratory expenses – Home healthcare services by health professionals – Extended-care facility services – Hospice care Major medical insurance • Major medical insurance: Insurance that covers medical expenses resulting from illness or injury that are not covered by a basic medical expense plan • The purpose of major medical insurance is to prevent the insured from being financially ruined by a catastrophic illness or injury • Types of major medical plans – Supplemental plan: covers medical expenses that exceeds the limits of the underlying basic medical expense policy, and sometimes covers certain medical expenses not covered by the basic policy – Comprehensive plan: combines basic medical expense coverages and major medical insurance into one policy • Basic characteristics – Broad coverage – High lifetime limits – Deductible ∗ To eliminate small claims and hold down premiums ∗ Calendar year deductible: Deductible an insured must meet only once during the calendar year, applying separately to each family member unless there is a family deductible provision ∗ Most plan with a calendar year deductible also have a deductible carry-over provision where expenses incurred during the last three months can be carried over to satisfy next year deductible, if the deductible has not been met for the current year ∗ Most major medical plans contain a common accident provision stating that if two family members are injured in the same accident, the deductible for only one insured will apply ∗ A corridor deductible is commonly used to integrate a basic medical expense plan with a supplemental major medical plan, applying to medical expenses not paid or covered by the basic plan. It is the amount an insured must pay under a supplemental major medical plan after the insured’s medical expenses exceed the limits of the underlying basic medical expense plan – Coinsurance provision ∗ A medical insurance provision that requires the insured to pay part of the covered medical expenses in excess of the deductible, in order to hold down premiums and reduce overuse of the plan benefits ∗ Major medical plans typically have a stop-loss provision that limits the amount the insured 153 must pay. All covered expenses in excess of the stop-loss limit are reimbursed at a rate of 100% for the rest of the calendar year – Exclusions and internal limits ∗ Although major medical plans provide broad coverage, they contain several exclusions, including eyeglasses and hearing aids, elective cosmetic surgery, experimental surgery, expenses covered by a WC law, expenses in excess of usual and customary charges, and services furnished by governmental agencies unless the patient has an obligation to pay ∗ To control costs, major medical plans also contain internal limits, which are maximum amounts payable for certain covered medical services Important group health insurance provisions • Group health policies do not have standard provisions and coverages vary widely. However, certain important provisions apply to most group health insurance policies and some are mandated by law • Preexisting conditions – A health insurance provision that excludes coverage for any preexisting medical condition for a limited period after an insured enters the plan – The purposes of this clause are to reduce adverse selection against the insurer and to hold down the employer’s costs – In 1996, Congress enacted the Health Insurance Portability and Accountability Act, which restricts the right of employers and insurers to exclude or limit coverage for preexisting conditions – The major provisions of the law dealing with preexisting conditions are ∗ Employer-sponsored group health insurance plans are prohibited from excluding or limiting coverage for a preexisting condition for more than twelve months (eighteen months for late enrollees). A preexisting condition is defined as a medical condition diagnosed or treated during the six months before the enrollment date, and cannot be applied to pregnancy, newly born children or adopted children ∗ Once the twelve month period expires, no new preexisting condition period may ever be imposed on workers who maintain continuous coverage, with no more than a sixty-three day gap, even if they change jobs or health plans ∗ Employers and insurers must give credit for previous coverage of fewer than twelve months with respect to any preexisting condition exclusion under a new health plan ∗ Discrimination against employees and dependents, as well as charging higher premiums, based on health status is prohibited. Health status is broadly defined to include medical condition, claim experience, receipt of healthcare, medical history, genetic information, evidence of insurability, and disability ∗ The legislation guarantees the availability of health insurance coverage for small employers. Insurers and HMOs are prohibited from denying coverage to employers that employ between two and fifty employees ∗ However, portability does not mean that workers can take their present health insurance coverage with them when they leave their current jobs. Instead, it means that when workers change jobs, the new employer or health plan must give them credit for prior , continuous health insurance coverage ∗ The law establishes only federal minimum standards for preexisting conditions and portability. States are free to adopt shorter preexisting condition periods • Continuation of group health insurance – Terminated employees and covered dependents can retain their group health insurance for a limited period by electing to remain in the employer’s plan under the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) – The COBRA law applies to employers of twenty or more employees. Qualifying events include termination of employment for any reason (except gross misconduct), death of the employee, divorce or legal separation, and attainment of a maximum age by dependent children 154 – For termination, the employee can remain in the plan for up to 18 months, and up to 36 months for other reasons. Insureds who elect to remain in the group plan can be required to pay up to 102 percent of the group rate – The HIPAA guarantees the availability of individual health insurance to eligible individuals who meet the following criteria: (i) they have had employment-based health insurance for at least eighteen months, (ii) they are ineligible for COBRA or have exhausted their COBRA coverage, and (iii) they are ineligible for coverage under any other employment-based health plan • Coordination of benefits provision – To prevent overinsurance and duplication of benefits, group medical expense plans typically contain a coordination-of-benefits provision, indicating the order of payment when an insured is covered under two or more group health insurance plans and limiting the insured’s total recovery under all applicable policies to 100% of covered expenses – The major rules for the coordination-of-benefits provision, developed by the National Association of Insurance Commissioners (NAIC) are ∗ The plan covering the employee is primary, the other plan pays second ∗ If the claimant is a dependent child whose parents are not divorced or separated, the plan of the parent whose birthday occurs first during the year is primary, the other plan pays second ∗ For a dependent child whose parents are divorced, and for whom one parent is responsible for health insurance, that parent’s plan is primary and the other plan pays second ∗ If no court decree requires a parent to provide health insurance, the plan of the parent who has custody and has not remarried is primary ∗ If the parent who has custody of a dependent child has remarried, that parent’s plan is primary. The stepparent’s plan pays second, and the plan of the parent without custody pays third ∗ If none of the preceding rules applies, the plan that has covered the claimant for the longest period of time will pay its benefit first Dental insurance • Dental insurance covers normal dental care and damage to teeth in an accident. Most insureds are covered under group plans. The coverage also encourages insureds to regularly see a dentist, who can detect or prevent serious dental problems • Types of group dental plans – Two major types 1. Schedule plan in which covered dental services are listed in a schedule and a specific dollar amount is paid for each service. Most schedule plans do not have deductibles or coinsurance, however, the benefits paid are usually lower than the usual reasonable and customary charges of dentists 2. A nonscheduled dental plan is the most common type. Most dental services are covered, and dentists are reimbursed on the basis of their URC charges subject to any limitations on benefits stated in the plan. Nonscheduled plans usually have an annual deductible and a coinsurance provision. However, diagnostic and preventive services may be exempt of the deductible/coinsurance. Expensive services may be reimbursed at a lower percentage • Cost controls 1. Dental insurance plans have provisions to help control costs, including – In addition to deductibles and coinsurance, annual maximum limits on benefits may be imposed – New employees may have to meet a waiting period before certain dental expenses become covered (orthodontia) – To deal with adverse selection, employees desiring coverage after their eligibility period expires may have to meet a waiting period – Certain dental expenses are excluded, such as cosmetic dental work, lost dentures and ex155 penses covered by WC – Most plans contain a predetermination-of-benefits provision for costly procedures Long-term care insurance • Long-term care is an insurance that pays for extended medical care or custodial care received in a nursing home, hospital, or home • The Medicare program does not cover long-term care in a nursing facility, only skilled nursing care up to 100 days. Custodial care is excluded altogether. In addition, most aged patients in nursing homes do not initially qualify for long-term care under the Medicaid program which is a welfare program with stringent eligibility requirements • Benefits provided – Purchaser of LTC insurance typically have choices of a daily benefit paid over a maximum period of time, or for the insured’s lifetime. Some plans allow purchasers to select maximum lifetime benefits – The policies typically cover skilled nursing home care (24h/day), intermediate nursing care, and custodial care – Many policies also cover home healthcare services • Elimination period – Most LTC plans are sold with an elimination period (the initial time period in a health insurance or disability income policy during which benefits are not paid) that functions like a “time deductible” – Elimination periods can substantially reduce the annual premium and range from 0 to 365 days • Eligibility for benefits – All LTC policies have “gatekeeper” provisions that determine whether the insured is eligible for benefits under the policy – A common type of gatekeeper provision requires that the insured be unable to perform a certain number of activities of daily living (ADLs: eating, bathing, walking, dressing) • Protection against inflation – Protection against inflation is usually available as an optional benefit – Some plans allow insureds to purchase additional amounts of insurance with no evidence of insurability – Other plans provide for an automatic benefit increase in which the daily benefit is increased by a specified percentage for a numbers of years • Guaranteed renewability: Most individual LTC policies sold are guaranteed renewable. However, premiums can be increased for the underwriting class in which the insured is placed • Cost: LTC insurance is expensive, especially if the policy is purchased by older individuals Managed care plans • Managed care plans are medical insurance plans that provide coverage for cost-effective medical services provided to plan members. They differ substantially from traditional group health insurance plans • These plans generally limit the choice of physicians and other healthcare providers, monitor the quality of medical care provided and emphasize preventive care and healthy lifestyles for plan members • Different types of managed care plans exist, including (i) Health maintenance organizations, (ii) Preferred provider organizations, (iii) Exclusive provider organizations, and (iv) Point-of-service plans • Health maintenance organization – A health maintenance organization (HMO) is a managed care plan that provides a wide range of comprehensive healthcare services to a specific group for a fixed, prepaid fee. – Most services are covered in full with few maximum limits on individual services. Office visits to HMO physicians are covered in full, or a nominal fee is charged for each visit – Members’ choice of healthcare providers is usually restricted to those in the HMO network. Coverage of medical care received outside the HMO geographic area is usually limited to emergency medical treatment 156 • • • • • – Plan members pay a fixed, prepaid premium for the services provided, most of them not subject to deductibles or coinsurance. Many HMOs impose copayment charges for certain services – HMOs emphasize cost control ∗ Physicians may be paid a salary and an incentive bonus based on plan experience ∗ HMOs enter into contracts with specialists and other healthcare providers which agree to a negotiated fee ∗ Patients often need a referral from a PCP to see a specialist ∗ HMOs monitor network physicians, who may also be required to get approval before performing certain treatments Preferred provider organization – A preferred provide organization (PPO) is a plan that contracts with healthcare providers to provide medical services to plan members at discounted fees – To encourage plan members to receive treatment from preferred providers, deductibles and coinsurance charges are reduced or eliminated – Plan members are not required to receive treatment from a preferred provider but have a financial incentive to do so because their out-of-pocket cost will be less Exclusive provider organization – An exclusive provider organization (EPO), unlike a PPO, is a managed care plan that does not pay for medical care received outside the network of preferred providers Point-of-service plan – A point-of-service (POS) plan is a managed care plan that combines the characteristics of an HMO and a PPO – The POS plan has a network of preferred providers. If the insured receive care in the network, he pays little or nothing out of pocket – If care is received outside the network, the care is covered, but the patient must pay substantially higher coinsurance charges and a deductible Advantages of managed care plans – Healthcare costs can be held down because these plans emphasize cost controls – Plan members often pay little or no out-of-pocket costs for covered medical services – Managed care plans provide many loss-prevention services, such as routine physical examinations, Pap smears, immunizations, well-child care and eye examinations – Managed care plans generally have lower hospital and surgical utilization rates, and employees do not have to file claim forms Disadvantages of managed care plans – One major criticism of managed care plans is that the emphasis on cost control may reduce the quality of care provided to some patients, e.g. PCP are slow in referring sick patients to specialists, certain diagnostic tests may not be prescribed and some patients who should be hospitalized are not – Managed care plans often provide a financial incentive, such as a bonus to network physicians, to hold down costs. Critics argue that physicians have a conflict of interest between providing high quality medical care to patients and holding down costs – HMO physicians are not free to treat patients without restrictions, prescription drugs may be limited to drugs on a approved list. As a result, many plan physicians believe that an outside third party is now compromising the traditional doctor-patient relationship Disability income insurance • Disability income (DI) insurance makes periodic income payments to an insured who is unable to work because of sickness or injury • DI insurance is available from several sources: (i) Individual DI insurance, (ii) Group DI insurance, and (iii) Social security DI benefits • Individual disability income insurance 157 – An individual DI insurance policy pays monthly cash benefits to an insured who becomes totally disabled from sickness or injury – Limit on amount of DI ∗ Most insurers limit the amount of DI to no more than 60 to 80% of the worker’s earnings for several reasons: ∗ Often, the worker will have no taxes or fewer taxes to pay on DI benefits ∗ The insured may be tempted to malinger if benefits are too high ∗ High DI may encourage postponing the return to work – Definition of total disability ∗ The meaning varies among insurers. The most liberal definition is: Total disability means that the insured is unable to perform the major duties of his own occupation ∗ A less liberal definition is: Total disability means that the insured is unable to perform the duties of any gainful occupation for which he is reasonably suited by education, training and experience ∗ Many policies use a dual definition combining the two preceding definitions. For an initial time period, total disability is defined in term’s of the insured’s own occupation. After the initial period expires, the less liberal definition would apply ∗ A definition of presumptive disability may also appear in the policy. Total disability is presumed to exist if the insured loses the sight of both eyes or the use of both hands, both feet, or one hand and one foot – Residual disability ∗ Many plans have a residual disability benefit or make it available as an additional benefit. A residual disability benefit means a pro rata benefit is paid when a disabled person returns to work but has a reduction in earned income ∗ The insured must experience an earnings reduction of at least 20 or 25% before a pro rata benefit is paid. If the loss of earnings exceeds 75 or 80%, many plans will pay the full monthly disability benefit – Elimination period ∗ DI policies typically have an elimination period during which DI benefits are not paid ∗ A ninety-day elimination period is common – Benefit period ∗ The policyowner has a choice of benefit period, the period of time that disability benefits are payable after the elimination period has been satisfied ∗ Most disabilities are of short duration – Renewability of the policy ∗ The renewability provisions in an individual DI policy refer to the length of time the DI policy can remain in force. The most important renewability provisions are · Guaranteed renewable policy (the most common type): A policy that cannot be canceled after it has been issued, and the insurer guarantees renewal to some stated age, but retains the right to increase premiums for the underwriting class in which the insurer is placed · Noncancelable policy: Policy that cannot be canceled or non-renewed until some stated age, typically 65. In addition, the premiums are guaranteed and cannot be increased until that time · Conditionally renewable policy: Policy that guarantees renewal to a specified time, provided the insured meets certain qualifications, such as full-time employment. Premiums can be increased – Waiver of premium ∗ DI policies typically contain a waiver-of-premium provision, stating that if the insured is totally disabled for ninety days, premiums due after the initial ninety-day period will be 158 waived as long as the insured remains disabled ∗ There is also a refund of the premiums paid during the initial ninety-day period – Optional disability income benefits ∗ Social Security offset rider: To prevent overinsurance, the amount of DI insurance may be reduced by Social Security disability benefits. The Social Security offset rider pays an additional amount of DI benefits if the insured is denied Social Security benefits ∗ Cost of living rider: Under this costly rider, the disability benefits are periodically increased based on the CPI ∗ Guaranteed insurability rider: Under this rider, the insured has the right to purchase additional amounts of disability income coverage with no evidence of insurability • Group disability income insurance – Many employers have DI insurance plans that pay weekly or monthly cash benefits to disabled workers, either through short-term plans or long-term plans – Short-term plans ∗ Short-term plans pay DI benefits to eligible workers for short periods, typically from thirteen weeks to two years. The benefit amount is usually a specified percentage of weekly earnings up to some maximum limit, such as 50 or 70% of earnings but not to exceed a stated amount ∗ Short-term plans typically have a short elimination period that ranges from one to seven days for sickness. However, accidents are covered from the first day of disability. The elimination period holds down cost and reduces absenteeism and malingering ∗ Most short-term plans cover only nonoccupational disabilities that occur off the job; WC pays benefits for job-related disabilities. Workers are considered totally disabled if they are unable to perform every duty of their regular occupation. Partial disabilities are not covered – Long-term plans ∗ Many employers also have long-term disability plans that pay disability benefits for longer periods than short-term plans, typically from two years to age 65. However, for disabilities occurring after age 65, the benefits are paid for a limited duration ∗ Most long-term plans cover both occupational and nonoccupational disability, with a dual definition of disability commonly used ∗ Maximum monthly benefits are usually limited to 50 to 70% of the workers normal earnings up to some monthly maximum. The monthly maximum benefits are substantially higher than those in short-term plans ∗ The disabled worker must satisfy an elimination period of three to six months before benefits are paid. In addition, if the disabled worker is receiving Social Security disability benefits or WC benefits, the monthly benefit is reduced to prevent overinsurance and malingering ∗ Certain supplemental benefits may also be available, such as · Pension accrual benefit · Cost of living adjustment · Monthly survivor income benefit to an eligible spouse or children for a limited period • Social Security disability income benefits – Social Security DI benefits are available under strict eligibility requirements – Eligibility requirements 1. The disabled worker must earn a certain number of credits, also called quarters of coverage, for work in a covered employment ∗ For 2002, a worker earns one credit for each $870 of covered earnings, up to four credits annually ∗ The number of credits needed to qualify depends on the worker’s age when he becomes disabled 2. The worker must satisfy a five full calendar months waiting period 3. The disability must meet the stated rigid definition: “The worker must have a physical or 159 mental condition that prevents him from doing any substantial gainful work, and the condition must be expected to last at least twelve months or result in death”. Monthly earnings of $780 are considered substantial, but special rules apply to blind people – Benefits ∗ A monthly benefit is paid to qualifying disabled beneficiaries ∗ Benefits can also be paid to unmarried children under 18, unmarried children who became disabled before age 22, a spouse caring for a child under 16 (or a child who became disabled before 22), a spouse age 62 or older 160 ...
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This note was uploaded on 02/29/2012 for the course BUSINESS 100 taught by Professor Allprofessor during the Spring '12 term at Virginia College.

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