Insurance Principles Explained

Intro to Insurance

• Insurance is the transfer of risk from a person or business to an insurer as per the terms of a contract.
• Insurance is a contract to indemnify against loss, damage, or liability from a contingent or uncertain event.
• Indemnity aims to restore an individual to their pre-loss condition, preventing gain.

Risks

• Risk is the possibility of loss.
• Speculative risk involves the possibility of loss or gain and is not covered by insurance.
• Pure risk involves only the chance of loss and is insurable.
• Risk retention means the individual is responsible for the worst-case scenario.

Criteria for Pure Risks

• Calculable: The risk can be predicted based on statistics.
• Affordable: The premium is within the insured's budget.
• Non-Catastrophic: The risk is not detrimental to the insurer (e.g., war).
• Homogeneous: The risks are similar in nature.
• Accidental: The risk cannot be intentional.
• Measurable: The risk is definable in numerical or dollar amounts.

Insurable Interests

• Necessary for fire or liability insurance.
• Proof of insurable interest is required at the date of application and time of loss.
• Expectant/Contingent interest cannot be insured because there is no ownership.

Parties

• Insurer: The entity covering the costs.
• Insured: The entity receiving the policy.
• First Party: The insured.
• Second Party: The insurer.

Adverse Selection

• Occurs when the insurer takes on an insured with a higher-than-average chance of loss.
• Avoided by Underwriting: The process of collecting information to determine coverage eligibility.

Insurance Concepts

• Property Insurance: Protects the insured's belongings.
• Casualty Insurance: Protects others due to the insured's negligence.
• Property/Fire insurance: Covers the insured's things.
• Liability insurance: Covers damages to others due to the insured's negligence, protecting against lawsuits.

Reinsurance

• Reinsurance: An insurance company's insurance, transferring risk to a reinsurer.
• Cedent insurer: The company transferring risk.
• Reinsurer: The company assuming the risk.
• Facultative reinsurance: The reinsurer considers each risk before the cedent transfers it.
• Treaty Reinsurance: Assumes all of a certain risk from the cedent company.

Types of Insurers

• Stock insurers: Corporations owned by stockholders, issuing non-participating policies; dividends are taxable.
• Mutual Insurers: Owned by policyholders, issuing participating policies; dividends are not taxable and are a refund of premium.
• Fraternal Benefit Societies: Member-only, non-profit organizations offering insurance as a benefit; policies are called "certificates".
• Reciprocal Insurers: Unincorporated groups insuring each other's losses; subscribers pay premiums and are assessed if a loss occurs.
• Lloyd’s Association: Covers unique risks through syndicates, where members pool money to cover percentages of claims.
• Risk Retention Groups (RRG’s): Liability insurance for similar businesses that pool resources together.
• Risk Purchasing Groups: Groups of businesses in the same industry negotiating discounts on insurance premiums.
• Self Insurers: Businesses or individuals that retain risk and pay their own claims.

Classification of Insurers

• Private: Insurance offered by private companies, such as auto, homeowners, life, and health insurance.
• Government: Federal or state-provided insurance covering war risks, nuclear energy, flood, crop, unemployment, and workers' compensation.

Insurance Company Location

• Domestic: The state where a company is incorporated.
• Foreign: A company incorporated in another state or U.S. territory.
• Alien: An insurer based in another country other than the U.S.

Authorized vs Unauthorized Insurers

• Certificate of Authority: A license required to sell insurance in a state.
• Authorized/Admitted: Companies that have received their certificate of authority.
• Unauthorized/Non-admitted/Non-approved: Companies without a certificate of authority, able to sell surplus lines insurance.

Surplus Lines Insurers

• Sells insurance for risks deemed too high by traditional insurers.
• Governed by the state, with non-admitted/unauthorized insurers.
• Cannot customize policies or charge cheaper rates.

Financial Rating of Insurers

• Evaluation of an insurance company's financial strength based on factors like reserves, loss experience, and management.

Insurance Marketing or Distribution Systems

• Agency System: Agents represent the insurer and brokers represent the insured.
• Independent Insurance Agents: Sell products from multiple companies and own policy renewals.
• Captive (exclusive) Agents: Represent only one company, with the insurer owning policy renewals.
• General Agents/General Managing Agents: Supervise other agents and earn commissions on their business.
• Direct-writing Companies: Products are sold by employees.
• Direct Response Marketing: Policies are sold directly to consumers without an agent.

Law of Agency

• Agency: Relationship where an authorized individual acts on behalf of another.
• Agent: The individual authorized to act on another’s behalf.
• Principal: The person or company granting authorization.
• Law of Agency: Legal relationship between an insurer (principal) and an agent, where contracts made by the agent are contracts of the principal.

Authority

• Authority: The legal power granted to the agent.
• Express Authority: Stated explicitly in a written agency agreement.
• Implied Authority: Not written but implied for the agent to conduct business.
• Apparent Authority: The authority believed by others to be within reason for an agent to perform.

Responsibility to the Applicants/Insureds

• Agents are fiduciaries, entrusted with financial responsibility.
• Fiduciary: An individual in a position of financial trust.
• Agents must promptly send premiums to the insurer.
• Commingling: Illegally mixing personal funds with the insured's or insurer’s funds.
• Suitability Considerations: Making appropriate purchase recommendations based on a client's needs and circumstances.

Elements of a Legal Contract

• Consideration: Money and statements made on an application.
• Legal Purpose: Transfer of a risk that doesn’t violate the law.
• Offer (insured): Proposal made by the insured.
• Counteroffer (insurer): The insurer issues the policy at a higher premium or with restrictions.
• Acceptance: Agreement between both parties, unconditional and unqualified.
• Competent Parties: Parties with the legal capacity to make a contract.

Distinct Characteristics of Insurance Contracts

• Adhesion: Policies written by the insurer, with the insured adhering to the terms.
• Aleatory: Contracts of unequal value for the parties.
• Utmost Good Faith and Reasonable Expectation: Honesty expected from both parties.
• Unilateral: Only the insurer is bound to perform.
• Personal: Contracts between the insurer and insured, usually non-transferable.
• Conditional: Require certain conditions to be fulfilled.
• Indemnity: Meant to reestablish the insured to their pre-loss financial state.

Representations, Misrepresentations, Warranties, Concealment, and Fraud

• Representations: Statements believed to be true at the time of application.
• Misrepresentation: False information that does not determine the policy's viability.
• Material misrepresentation: False information affecting the insurer’s decision.
• Warranty: Promises made by the insured, relied on by the insurer.
• Concealment: Failure to disclose material facts.
• Fraud: Intentional act to deceive and collect more on a claim.

Waiver and Estoppel

• Waiver: Intentional and voluntary giving up of a right usually by the insurer.
• Estoppel: Forbidding the waived right to be used against the insured.

Property vs Casualty Insurance

• Property Insurance: Protection on belongings from perils.
• Casualty Insurance: Liability insurance and protection for your negligent acts.

Main Policy Structure (DICEE)

• Declarations: Information of the insured, property description, deductibles, and term.
• Insuring Agreement: Covered perils or risks assumed by the insurer with the agreement between both parties.
• Conditions: Policy provisions, rules of conduct, and obligations required for coverage.
• Endorsements: Modifications to the original policy.
• Exclusions: Perils, property, or losses not covered by the policy.

Additional Sections

• Definitions: Clarifies terms used.
• Additional/Supplementary Coverage: Payment for additional expenses not normally covered.

Insureds Definitions

• Named Insured: Person or entity named in the declaration.
• First-named Insured: Person listed first on the declarations page for partners in a business.
• Insureds: Other persons covered by definition, such as relatives.
• Additional Insured: Individual or business added in the endorsement section.

Policy Period and Territory

• Policy Period: Duration of the policy.
• Policy Territory: Location where the loss must occur.

Cancellation and Nonrenewal

• Cancellation: Stopping a policy before the expiration date.
• Outcomes of a cancellation:
  • If Insurer Cancels: Requires advance notice, and the entire unearned/unused premium is returned on a prorated basis.
  • If Insured Cancels: No need for advanced notice and, insurer is entitled to retain a larger percentage of the unearned premium, with surcharge or penalty for early cancellation, applied on a short-rated basis.
• Flat Cancellation: When a policy is cancelled on the effective date.
• Non-renewal process: Occurs at the expiration date, with advanced notice required.

Deductible

• Deductible: Amount paid out of pocket before the insurer pays.
• Purpose: To prevent small claims and overuse of insurance.
• Higher Deductible, lower the premiums.

Other Insurance

• Other Insurance: Condition where multiple policies cover the same loss or claim.
• Non-concurrency: Policies cover the same property but provide different coverage.
• Primary Insurance: Policy that attaches immediately upon loss.
• Excess Coverage: Only pays after the primary policy has paid its limit.

Explore core insurance concepts: indemnity, risk types, risk retention, and 'Accidental' criteria. Understand adverse selection and unearned premium handling. Test your knowledge of insurance principles.