AINS Study Guide: Insurance Concepts & Policies PDF

Why Do We Have Insurance? 1 Educational Objective 1 Explain how the components of insurance work, including the benefits of insurance. Key Points: The concepts of risk, transfer, and pooling form the bas...

Why Do We Have Insurance? 1 Educational Objective 1 Explain how the components of insurance work, including the benefits of insurance. Key Points: The concepts of risk, transfer, and pooling form the basis of insurance, which allows people and businesses to transfer the risk of financial consequences from loss exposures to an insurer. A. What Is Insurance? To fully understand how insurance functions, you first need to understand the concepts of risk, transfer, and pooling. 1. Risk a. Risk is uncertainty about outcomes, and it can be negative or positive. b. While risk management is concerned with both positive and negative risks, insurance alleviates the uncertainty associated with negative financial consequences. 2. Transferring Transferring is the act of transferring the financial consequences of unanticipated events to an insurer. 3. Pooling With pooling, all insureds share the costs of each other’s losses. Insurers combine all of the premiums collected from customers into a fund that is used to pay losses as they occur. This helps keep premiums affordable and helps the insurer cover large losses when they occur. B. The Benefits of Insurance It’s important to remember that insurance benefits not only those whose losses it pays but also society as a whole by: 1. Paying for losses 2. Managing cash flow 3. Complying with legal requirements 4. Promoting risk control activities 1.1 Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 1.2 Increasing Your Insurance IQ—AINS 101 Review Questions 1-1. What three concepts are pertinent to understanding insurance? 1-2. If Katherine has an insurance policy that covers property damage to her bicycle shop, how does that affect her budget? 1-3. Who benefits from insurance? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  Why Do We Have Insurance? 1.3 Educational Objective 2 Distinguish among the common types of personal and commercial insurance. Key Points: Distinguish among the common types of personal and commercial insurance. A. What Is Personal Insurance? 1. Property insurance protects an insured’s assets by covering the cost of repairing or replacing property that is damaged, lost, or destroyed. It can also cover related lost income or extra expenses. 2. Liability insurance provides payments for injury to others or damage to others’ property for which the insured is legally responsible. It also covers the cost to defend the insured against related lawsuits. 3. Although not the focus of this content, life insurance replaces the income-earning potential lost through death. It also helps to pay expenses related to an insured’s death. 4. Health insurance protects individuals and families from financial losses caused by sickness and accidents. B. Personal Property-Casualty Insurance 1. Homeowners—Provides protection when people’s homes and/ or belongings are damaged or stolen and liability coverage for situations such as the family dog biting a guest. 2. Personal auto—If the insured is at fault in an accident, provides coverage for bodily injury to another person or damage to another person’s auto. Also provides coverage for damage to the insured auto (not wear and tear). Typically legally required. 3. Personal umbrella—Provides additional protection for people with a high potential for large liability losses. C. What Is Commercial Insurance? 1. Many businesses purchase a commercial package policy or a businessowners policy, both of which provide business owners with property, crime, and liability coverages. 2. Common types of commercial property-casualty insurance: a. Commercial property—Covers damage to buildings or their contents that results from fire, vandalism, and other causes of loss. b. Commercial crime—Protects against losses from theft of business property and money, including employee theft. c. Commercial general liability—Protects a business against its legal liability to others for bodily injury and property damage. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 1.4 Increasing Your Insurance IQ—AINS 101 d. Commercial auto—Covers liability for bodily injury and property damage caused by the use of the business’s autos and also damage to the business’s own autos when they are in an accident. e. Workers compensation—Covers legally required benefits that businesses are required to pay to their employees for job- related injuries and illnesses. f. Commercial umbrella—Provides additional liability limits beyond those provided by other commercial policies, protecting a business in the event of a large liability loss. Review Questions 2-1. What type of insurance would an insured purchase to protect a new sports car? 2-2. A fire destroys Sarah’s restaurant. What type of insurance would cover the damages to the restaurant? 2-3. Someone broke into Mike’s house while he was away on vacation. The robber stole his expensive guitar. What type of insurance would cover the loss? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  Why Do We Have Insurance? 1.5 Educational Objective 3 Compare the various types of private insurers and examples of government-run insurance programs. Key Points: In the United States, insurance is typically provided by private insurers; however, certain loss exposures are covered by government insurance programs. A. Common Private Insurers 1. Many of the largest property-casualty insurers in the U.S. are stock insurers. Stock insurers’ objective is to earn a profit, and they attract stockholders by the expectation of investment returns. 2. Mutual insurers include some large national insurers and many regional insurers. To share profits, mutual insurers pay dividends to policyholders as a return of a portion of premiums paid. 3. Surplus lines insurers provide insurance coverages unavailable in the standard market. 4. Reinsurance allows a primary insurer to transfer some loss exposures to another insurer, the reinsurer. It can help a small insurer provide insurance for large accounts. B. Are There More? Other types of private insurers include reciprocal insurance exchanges, in which each member is both an insured and an insurer; Lloyd’s, which is an insurance and reinsurance marketplace (a little bit like a stock exchange); and captive insurers, which are formed to cover the loss exposures of specific organizations. C. Government Insurance 1. When private insurers are unable or unwilling to satisfy legitimate insurance needs, government programs can. 2. If a government requires a type of insurance, such as a state’s requiring workers compensation insurance, then it must ensure that the insurance is available at a reasonable price. 3. Providing convenience to insureds, by reducing either the time or the resources needed to obtain insurance coverage, adds to the efficiency of the market. 4. The government may participate in insurance to accomplish social goals and reduce risk to society. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 1.6 Increasing Your Insurance IQ—AINS 101 Review Questions 3-1. Christopher works for a private insurer that provides insurance coverages unavailable in the standard market. What kind of insurer does Christopher work for? 3-2. Under what circumstances would the government participate in insurance? 3-3. What are some examples of federal government insurance plans? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  Why Do We Have Insurance? 1.7 Educational Objective 4 Classify the various types of risks faced by people and organizations. Key Points: Risk can be classified as pure risk or speculative risk. A. Pure Versus Speculative Risk 1. Pure and speculative risks must often be managed differently, and insurance is just one of many risk management techniques. 2. Pure risk, such as the risk of fire, can usually be managed by purchasing insurance. The speculative risk might be managed by maintaining the property to enhance its resale value. B. Risk Quadrants 1. Hazard risk Arises from property, liability, or personnel loss exposures 2. Operational risk Arises from people, processes, systems, or controls 3. Financial risk Arises from the effect of market forces on financial assets or liabilities 4. Strategic risk Arises from trends in the economy and society C. Emerging Technologies 1. As risk management technology has become more accessible, people and businesses are investing more in preventing losses entirely rather than relying on insurance to pay for losses after they occur. 2. Artificial intelligence enables computers to perform tasks that require critical thinking, such as making decisions. It allows robots to work alongside humans and cars to operate without human drivers. 3. Sensors detect and measure objects or conditions continuously to warn of problems or malfunctions. Smart sensors may trigger a response to an issue, which helps reduce losses. 4. Computer vision helps a machine recognize an object and respond to it as a human would. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 1.8 Increasing Your Insurance IQ—AINS 101 Review Questions 4-1. Into what two categories can risk be classified? 4-2. What are the four quadrants of risk? 4-3. Which quadrant of risk arises from trends in the economy and society? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  Why Do We Have Insurance? 1.9 Answers to Assignment 1 Questions NOTE: These answers are provided to give students a basic understanding of acceptable types of responses. They often are not the only valid answers and are not intended to provide an exhaustive response to the questions. Educational Objective 1 1-1. To fully understand how insurance functions, you first need to understand the concepts of risk, transfer, and pooling. 1-2. She has to budget for the insurance premium, but not for the full cost of rebuilding her shop. 1-3. Insurance benefits not only those whose losses it pays, but also society as a whole. Educational Objective 2 2-1. An insured could protect a new sports car by purchasing personal auto insurance. 2-2. Property insurance would protect Sarah’s assets by covering the cost of repairing or replacing property that is damaged, lost, or destroyed. 2-3. Homeowners insurance would provide protection against damage to or theft of Mike’s home and/or belongings. Educational Objective 3 3-1. Christopher works for a surplus lines insurer. 3-2. When private insurers are unable or unwilling to satisfy legitimate insurance needs, government programs can. 3-3. Common examples of federal government insurance plans include the National Flood Insurance Program and the Terrorism Risk Insurance Program. Educational Objective 4 4-1. Risk can be classified as pure risk or speculative risk. 4-2. The four quadrants of risk are hazard, operational, financial, and strategic. 4-3. Strategic risk arises from trends in the economy and society. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. How Do Insurers Succeed? 2 Educational Objective 1 Explain why insurance operations are regulated. Key Points: Each U.S state government regulates the insurance business in its own state. The principles of insurance regulation underlie every insurer function. The insurance industry is regulated primarily for three reasons: A. To Protect Consumers Insurance regulation protects consumers by: 1. Verifying that insurance policies, which can be hard to understand, truly benefit the customer 2. Requiring insurers to pay legitimate claims and honestly represent the benefits of a policy 3. Guaranteeing that insurance is available and accessible to everyone who needs it B. To Maintain Insurer Solvency Regulators enact and enforce rules that encourage insurers to maintain and enhance their financial position. They do this for several reasons: 1. To guarantee that insurers have enough cash on hand to pay for future claims made on all the policies they issue, even the ones for which they long ago collected the premium 2. To ensure that a catastrophe that affects lots of policyholders at once doesn’t deplete insurers’ resources and make them unable to pay claims 3. To prevent an insurer from recklessly investing its profits or engaging in fraudulent activities that could jeopardize its reserves C. To Prevent Destructive Competition 1. Preventing destructive competition helps insurers maintain their financial health and protects consumers. 2. Regulation seeks to keep insurers from pricing policies too low for two main reasons: a. Not charging enough premium could leave the insurer without enough cash on hand to pay covered claims. b. Charging low rates could be an attempt to drive competitors out of business. 2.1 Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 2.2 Increasing Your Insurance IQ—AINS 101 Review Questions 1-1. Can you name the three reasons why insurance is regulated? 1-2. A series of intense wildfires are devastating the West Coast. Which objective of insurance regulation is therefore in jeopardy? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  How Do Insurers Succeed? 2.3 Educational Objective 2 Interpret an insurer’s profitability given its financial statements. Key Points: Interpret an insurer’s profitability given its financial statements. A. Understanding Financial Statements In many ways, an insurer is just like any other business: It has to manage its assets, liabilities, revenue, and expenses to stay profitable. B. An Insurer’s Income Statement Insurers prepare income statements to show their total revenue, expenses, and net income for a time period, such as a year. 1. An insurer’s revenue comes primarily from the premiums paid by policyholders. 2. An insurer’s expenses include losses from claims, the cost associated with paying those claims, and the cost associated with underwriting. 3. The income statement includes calculation of the insurer’s net income from underwriting, as well as its net income from investments. 4. You calculate the insurer’s bottom line, or its net income before taxes, by adding its net underwriting gain or loss and its net investment income. C. The Importance of Earned Premiums 1. An insurer calculates its written premiums by totaling the premiums charged on all policies written with effective dates of January 1 through December 31. 2. Earned premiums are the portion of the written premiums that apply to the part of the policy period that has already occurred. 3. The remaining portion of written premiums applies to the policy period that has not yet occurred. So it’s called unearned premiums, which is coverage yet to be provided. D. An Insurer’s Balance Sheet 1. The balance sheet is designed to give you a snapshot of the insurer’s financial position at a specific point in time. It includes the insurer’s assets such as cash, liabilities, and surplus. 2. Admitted assets are items that insurers can easily turn into cash, such as stocks, bonds, and real estate. 3. Nonadmitted assessments are types of property that insurers can’t easily convert to cash. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 2.4 Increasing Your Insurance IQ—AINS 101 4. Liabilities represent the insurer’s responsibility to pay policyholders’ claims. 5. The policyholders’ surplus represents the difference between the value of the company’s assets, minus its liabilities. Review Questions 2-1. When reviewing the balance sheet, which item gives the best indication of an insurer’s overall economic health? 2-2. What does an insurer’s income statement show? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  How Do Insurers Succeed? 2.5 Educational Objective 3 Illustrate how the combined ratio works and why it’s important. Key Points: The combined ratio provides a snapshot of the insurer’s income from its underwriting operations (earned premium), the costs of generating income (expenses), and the costs of upholding the insurance contract (loss payments and the expenses associated with the losses). A. Measuring Underwriting Results Underwriting results are a key indicator of insurer profitability, and the most common financial measure of underwriting results over a specific period of time is the combined ratio. B. Determining an Insurer’s Profitability Being able to quickly gauge an insurer’s level of profitability comes in handy in a variety of situations, such as: 1. Analyzing your own insurer’s financial statements over several quarters or even several years to see how they’re trending over time 2. Comparing the performances of multiple insurers to get an accurate picture of how the industry is doing as a whole 3. Making calculations to see the potential effects of changing underwriting strategies or expanding into new lines of business C. The Combined Ratio 1. The combined ratio is used to indicate whether an insurer is making an underwriting loss or gain. Two components form this ratio: a. The loss ratio measures how much of each premium dollar the insurer uses to pay losses and loss adjustment expenses. b. The expense ratio indicates how much of each premium dollar is used to pay the insurer’s expenses, such as employee wages, marketing costs, and so forth. 2. Adding these two ratios together will yield the combined ratio. D. What Indicates Profitability? A combined ratio of less than 100 means that the insurer is making a profit from underwriting insurance. A combined ratio of more than 100 means the insurer is not making an underwriting profit. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 2.6 Increasing Your Insurance IQ—AINS 101 Review Questions 3-1. Mary would like to understand the profitability of the Underwriting Department she works for. If the combined ratio is $0.97, what profit was achieved for each premium dollar the insurer earned? 3-2. Identify the two ratios that make up the combined ratio. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  How Do Insurers Succeed? 2.7 Educational Objective 4 Distinguish among the main types of insurer marketing distribution channels. Key Points: Distinguish among the main types of insurer marketing distribution channels. A. How Is Insurance Marketed? 1. An insurer markets its products to customers based on their needs and preferences. 2. There are unique aspects to the insurance marketplace, such as who is allowed to sell policies for certain insurers. 3. Insurance is commonly marketed and sold through: a. Independent agents and brokers b. Exclusive agencies c. Direct writers d. Distribution channels B. Who Are Independent Agents and Brokers? 1. Both agents and brokers sell insurance products to individuals and businesses and provide policy services. However, the broker represents the customer, while the agent represents one or more insurers. 2. Because they are not legal representatives of the insurer, brokers usually can’t commit an insurer to write a policy—unlike agents, who generally can. Independent agents and brokers are not employees of an insurer and are usually free to work with as many insurers as they want. 3. Independent agents and brokers own their expiration lists—which are lists that contain policyholder information and policy expiration dates. C. What Is an Exclusive Agency? 1. An exclusive agency is contracted to sell insurance for one insurer or group of insurers. The agents are not employees of the insurer, but they cannot sell policies from another insurer because a contract prohibits them from doing so. 2. Unlike independent agents, exclusive agents do not own policy expiration lists; the insurer does. This means that if the agent decides to contract with another insurer, he or she cannot take the policyholders along. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 2.8 Increasing Your Insurance IQ—AINS 101 D. What Is a Direct Writer System? The key to a direct writer marketing system is that the insurer is using its own employees as producers. These agents are similar to exclusive agents because they are restricted to representing only one insurer, which owns the expiration lists. E. Insurance Distribution Channels As technology changes customer expectations, insurance is increasingly sold in ways other than through a producer: 1. Digital—Apps and websites 2. Call centers—Customer service representatives or chatbots 3. Direct response—Social media, email blasts, website ads, and direct mail 4. Group marketing—Marketing to members of the same personal or professional group 5. Financial institutions—Marketing through banks and financial services Review Questions 4-1. Describe how insurance is marketed? 4-2. Regarding how they sell insurance, what do agents and brokers have in common, and what is different about them? 4-3. What would be the ideal way for an insurer to market its products if trying to sell auto insurance to young drivers? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  How Do Insurers Succeed? 2.9 Answers to Assignment 2 Questions NOTE: These answers are provided to give students a basic understanding of acceptable types of responses. They often are not the only valid answers and are not intended to provide an exhaustive response to the questions. Educational Objective 1 1-1. The insurance industry is regulated primarily for three reasons: To protect consumers To maintain insurer solvency To prevent destructive competition 1-2. If a natural disaster were affecting a particular geographic area, maintaining insurer solvency would be in jeopardy. One of the reasons regulators enact and enforce rules that encourage insurers to maintain and enhance their financial position is to ensure that a catastrophe that affects lots of policyholders at once doesn’t deplete insurers’ resources, thereby preventing insurers from paying claims. Educational Objective 2 2-1. The best indication of an insurer’s overall economic health, as shown on the balance sheet, is its policyholders’ surplus, which shows how much cash an insurer has on hand for emergencies, unexpected losses, and expansion of its business. 2-2. An insurer’s income statement shows its revenues, expenses, and net income for a particular period of time. Educational Objective 3 3-1. A combined ratio of less than 100 indicates a profit—in this case, the Underwriting Department gains a $0.03 profit for every premium dollar earned. For every $1.00 in premium, the insurer pays $0.97 for losses and expenses. 3-2. The combined ratio is the sum of the loss ratio, which measures how much of each premium dollar the insurer uses to pay losses and loss adjustment expenses, and the expense ratio, which indicates how much of each premium dollar is used to pay the insurer’s expenses, such as employee wages, marketing costs, and so forth. Educational Objective 4 4-1. Insurance is marketed through independent agents and brokers, exclusive agencies, direct writers, and distribution channels. 4-2. Both agents and brokers sell insurance products to individuals and businesses and provide policy services. The broker represents the customer, while the agent represents one or more insurers. 4-3. An insurer trying to sell auto insurance to young drivers would probably advertise heavily online. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. How Does Underwriting Work? 3 Educational Objective 1 Explain why underwriting is essential and how collaboration with other departments benefits insurers and insureds. Key Points: The purpose of underwriting is to develop and maintain a growing, profitable book of business. A. What Is Underwriting? 1. Everything an insurer does—from issuing policies, collecting premiums, handling claims, auditing accounts, and marketing—is related to or affected by underwriting decisions. 2. Underwriting is the process of evaluating risks, selecting who can be insured, pricing that insurance coverage, determining policy terms and conditions, and monitoring those decisions. 3. The primary purpose of underwriting is to help an insurer develop and maintain a growing, profitable book of business. B. Primary Underwriting Activities To help an insurer develop and maintain a growing, profitable book of business, underwriters perform these key activities: 1. Minimize adverse selection Adverse selection generates unprofitable business by allowing an individual or a business with a high probability of loss to obtain insurance at a lower cost than the insurer would normally charge for that risk because the insurer wasn’t fully aware of the actual risk involved. Underwriters minimize adverse selection and unprofitable business by carefully selecting applicants with loss exposures they are willing to insure, charging appropriate premiums, and monitoring applications and books of business for unusual patterns of policy growth or losses. 2. Ensure adequate policyholders’ surplus Underwriters ensure adequate policyholders’ surplus by following underwriting guidelines, effectively evaluating and selecting loss exposures, and charging adequate premiums. 3. Enforce underwriting guidelines Underwriting guidelines, or guides, specify the attributes of an account that underwriters should look for before offering coverage. They also include the levels of underwriting authority 3.1 Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 3.2 Increasing Your Insurance IQ—AINS 101 given to various underwriters, as well as to agents and brokers. Underwriting managers are responsible for making sure the insurer’s underwriting guidelines are adhered to. C. Collaboration Between Underwriting and Other Departments 1. Cooperation between underwriters and the representatives of other insurer functions improves the quality of information available to underwriters and, ultimately, improves the services they provide to insurers and insureds. 2. Risk control professionals and premium auditors in particular provide underwriters with valuable information that enables them to make better underwriting decisions. D. Valuable Risk Control and Auditing Information Types of valuable information risk control professionals and auditors provide to underwriters: 1. Field inspection reports on the premises and operations of new insurance applicants and existing insureds renewing their policies 2. Descriptions of operations that can help classify loss exposures 3. Technical information on the fire and health hazards of new building materials and production processes 4. Loss control measures that could help an applicant meet underwriting guidelines 5. New loss exposures at an insured’s premises 6. Changes in an insured’s commercial operations Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  How Does Underwriting Work? 3.3 Review Questions 1-1. Brian is an underwriter. If he wants to help an insurer develop and maintain a growing, profitable book of business, what key activities should he preform? 1-2. Mary has been approved for a life insurance policy with a low premium because on her application she falsely stated that she does not indulge in dangerous activities such as sky-diving, illegal street racing, and free solo rock climbing. What is this an example of? 1-3. When are underwriters most effective? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 3.4 Increasing Your Insurance IQ—AINS 101 Educational Objective 2 Distinguish among the activities of different types of underwriters. Key Points: An insurer typically employs two complementary groups of underwriters. A. The Two Types of Underwriters Insurers typically employ two distinct types of underwriters. Each fills a role that is critically important to helping an insurer develop and maintain a profitable book of business. 1. The first group works primarily in the field by interacting directly with producers and applicants. These are commonly referred to as field underwriters, although some insurers call them line underwriters. 2. The second group works primarily in the insurer’s corporate office and helps establish and maintain the insurer’s overarching underwriting policy. These are corporate (or staff) underwriters. B. What Do Field Underwriters Do? Underwriters working in the field, sometimes referred to as line underwriters, perform the following activities: 1. Select insureds. The most important thing field underwriters do is select new and renewal accounts that meet the insurer’s underwriting guidelines. 2. Ensure accurate classification and pricing. Field underwriters are responsible for ensuring accurate account classification so each account can be priced properly. 3. Recommend or provide coverage. Field underwriters work with producers to recommend or provide applicants with appropriate coverage. 4. Manage a book of business. This involves evaluating the quality and profitability of all the business written for a group of policies. 5. Support producers and insureds. This can involve presenting policy quotations, processing policy endorsements, helping to explain coverages, and making coverage recommendations. 6. Support marketing objectives. Since field underwriters work closely with producers and insureds, they can help educate the Marketing Department on what types of accounts are most profitable for the insurer. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  How Does Underwriting Work? 3.5 C. What Do Corporate Underwriters Do? Underwriters at the corporate level, sometimes referred to as staff underwriters, perform the following activities: 1. Research the market. Insurers must continually research fundamental issues, such as the potential markets they want to target. Corporate underwriters assist with this effort by evaluating things like the effect of adding or deleting entire lines of business or expanding into new geographic areas. 2. Formulate underwriting policy. Formulating the policy is a collaborative effort between corporate underwriters and others, and the results are communicated through underwriting guidelines. 3. Revise underwriting guidelines. Corporate underwriters revise underwriting guidelines so that they reflect any changes in the underwriting policy. 4. Develop coverage forms. Corporate underwriters collaborate with the insurer’s actuarial and legal departments to develop new coverage forms and modify existing forms to meet customer needs. 5. Review rates. Rates are reviewed by underwriters and updated regularly to respond to changes in loss experience, regulatory developments, and competition. 6. Educate and train. Corporate underwriters are typically responsible for determining and fulfilling the training needs of field underwriters. 7. Arrange reinsurance. Corporate underwriters determine reinsurance needs and select reinsurers. 8. Assist with complex accounts. When complex or unique issues arise with an account, corporate underwriters consult with other underwriters to resolve these issues. 9. Conduct underwriting audits. Corporate underwriters review files to check whether individual underwriters are following the insurer’s underwriting guidelines. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 3.6 Increasing Your Insurance IQ—AINS 101 Review Questions 2-1. What two complementary groups of underwriters does an insurer typically employ? 2-2. Which group of underwriters would be best suited to select new and renewal accounts that meet the insurer’s underwriting guidelines? 2-3. Which group of underwriters would be best suited to help formulate an underwriting policy? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  How Does Underwriting Work? 3.7 Educational Objective 3 Summarize the steps in the underwriting process. Key Points: To make accurate decisions about which individuals and businesses to insure, underwriters follow a series of steps that make up the underwriting process. A. Evaluate the application In the first step of the underwriting process, underwriters try to understand the risk associated with each applicant. Underwriters may use information from the application, inspection reports, past claims, financial documents, audit reports, telematics, predictive models, and catastrophe models to complete this evaluation. B. Develop underwriting alternatives After evaluating an application, an underwriter may accept or reject it as is. Or the underwriter could develop underwriting alternatives by modifying the application and making a counteroffer to the applicant. C. Select an underwriting alternative An underwriter must evaluate each underwriting alternative carefully and select the best one under the circumstances. In some cases, the underwriter has no choice but to reject the application. Underwriters must make sure that each loss exposure is accurately classified so that the account is accurately rated. For most types of personal insurance and some types of commercial insurance, a loss exposure’s classification automatically determines the premium. D. Implement the underwriting decision After evaluating an application, making any appropriate modifications, and determining a premium, the underwriter must implement the final decision. E. Monitor the underwriting decision Underwriters must monitor their decisions to make sure that the desired results are achieved. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 3.8 Increasing Your Insurance IQ—AINS 101 Review Questions 3-1. What does the first step of the underwriting process involve? 3-2. Name the tasks that must be completed to implement an underwriting decision? 3-3. Camron is an underwriter who reviewed an application and determined that modifications must be made before Camron can accept the application. What are some modifications she might require? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  How Does Underwriting Work? 3.9 Educational Objective 4 Given the insurance rate and exposure units for a particular insurance policy, calculate the policy premium. Key Points: Insurance premiums are calculated by multiplying the insurance rate by the number of exposure units. The insurance rate is the unit price for coverage. A. Factors Needed to Calculate a Policy Premium 1. One of the main activities underwriters perform is determining the premium for a policy. This is commonly called rating. 2. The premium is calculated by multiplying the insurance rate (think of this as the unit price) by the number of exposure units. 3. Other factors may affect the final premium, such as whether optional coverages are purchased. B. Insurance Rate and Exposure Units 1. What is an insurance rate? a. An insurance rate is the unit price for insurance coverage. b. Typically, an insurer’s rating manual has a separate rate for each rating classification it uses. c. A rate manual is a resource for classifying accounts and developing premiums for given types of insurance. d. Manual rates are usually intended to represent the average risk in a class. e. There are hundreds of classifications of commercial business operations. f. Underwriters determine the appropriate classification for a commercial operation by evaluating the individual characteristics of its business operation. 2. What is an exposure unit? a. The fundamental measures of the loss exposures used in insurance rating are referred to as exposure units. b. An exposure unit is a unit of measure used to determine an insurance policy premium. C. Collaborating With Premium Auditors Premium auditors help underwriters in these ways: 1. Ensuring accurate classification of exposures—Although underwriters must establish the classifications when the policy is issued, the information submitted is occasionally incomplete or inaccurate. A premium audit conducted at the end of the policy period can reveal any necessary classification changes. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 3.10 Increasing Your Insurance IQ—AINS 101 2. Comparing anticipated loss exposures with actual loss exposures— An audit helps an insurer assess a commercial operation and verify that the loss exposures were calculated accurately. 3. Identifying new exposures—A change in operations may create a new exposure, and the insured may not communicate such a change to the insurer. Premium auditing identifies new exposures and their proper classifications. 4. Assessing an account’s desirability—Premium auditors visit the insured’s premises, meet with management, review business records, and observe the employees and operations. These activities provide valuable insights for underwriting. 5. Identifying physical, moral, and morale hazards—Auditors can identify a variety of hazards. Physical hazards include construction, hazardous materials, and poor safety or hygiene practices. Moral hazards include questionable business practices or a failing business. Morale hazards include indifference to properly maintaining property or poor financial recordkeeping. Any of these should be promptly communicated to underwriting. D. Other Factors That Can Affect the Premium 1. Underwriters may deviate from a manual rate for a particular rating classification to reflect differences between the insured’s actual risk and the average risk in that classification. 2. Factors that can affect the final premium: a. Increasing policy limits b. Purchasing optional coverages c. Good-student discounts d. Installing fire-protection systems e. Positive loss experience in the recent past f. The care and condition of the premises g. An insured’s employees receiving specific training Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  How Does Underwriting Work? 3.11 Review Questions 4-1. Kevin is an underwriter in training. How would you describe an exposure unit to Kevin? 4-2. How are insurance premiums calculated? 4-3. Name three factors that can affect the final premium: Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 3.12 Increasing Your Insurance IQ—AINS 101 Answers to Assignment 3 Questions NOTE: These answers are provided to give students a basic understanding of acceptable types of responses. They often are not the only valid answers and are not intended to provide an exhaustive response to the questions. Educational Objective 1 1-1. Brian should help the insurer minimize adverse selection, ensure adequate policyholders’ surplus, and enforce underwriting guidelines. 1-2. This is an example of adverse selection. 1-3. Underwriters are most effective when they’re collaborating with other departments. Educational Objective 2 2-1. The first group (field underwriters) works primarily in the field with producers and applicants, and the second group (corporate underwriters) typically works in the insurer’s corporate office and helps establish the insurer’s overarching underwriting policy. 2-2. The most important thing field underwriters do is select new and renewal accounts that meet the insurer’s underwriting guidelines. 2-3. Formulating the policy is a collaborative effort between corporate underwriters and others, and the results are communicated through underwriting guidelines. Educational Objective 3 3-1. The first step involves evaluating the insurance application, also referred to as the submission, to understand the risk associated with the applicant. 3-2. To implement an underwriting decision, the underwriter must communicate it to the producer (agent or broker), issue the required documents, and record information about the applicant and policy. 3-3. Before accepting this application, Camron may require the applicant to implement risk controls, she may raise the premium, and she may adjust the policy terms and conditions. Educational Objective 4 4-1. An exposure unit is a unit of measure (for example, area, gross receipts, payroll, value insured) used to determine an insurance policy premium. 4-2. Insurance premiums are calculated by multiplying the insurance rate by the number of exposure units. 4-3. Any of the following factors can affect the final premium: Increasing policy limits Purchasing optional coverages Good-student discounts Installing fire-protection systems Positive loss experience in the recent past The care and condition of the premises An insured’s employees receiving specific training Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. How Do Insurers Handle Claims? 4 Educational Objective 1 Explain how claims professionals collaborate with each other and other departments to meet insurers’ goals. Key Points: Claims professionals collaborate with each other and other departments to meet insurers’ goals. A. Important Terms 1. A claim is a request by a person or business seeking compensation from an insurer for a loss that may be covered by an insurance policy. 2. A claimant is the party who makes the claim. 3. A claims representative is the person responsible for investigating, evaluating, and settling claims. B. The Claims Department Hierarchy 1. A claims manager directs and supervises some activities. These may include setting goals for closing claims, developing the professional skills of staff, and establishing claims procedures for the department. 2. Because claims departments may be divided into line-of-business units or by geographic locations, claims supervisors assist claims managers. The supervisors review claim files to make sure they’re being handled correctly and consistently and help determine strategies around business and staff development. 3. Claims representatives, meanwhile, handle the claims themselves. There are three types of claims reps: a. Telephone claims representatives, who investigate and evaluate claims based on telephone interviews and correspondence. b. Field claims representatives work outside of the office, generally handling claims that require the scene of the loss to be investigated and holding in-person meetings with insureds, claimants, lawyers, and any other people involved with the claim. c. Specialized claims representatives are usually found in larger organizations, where they develop a particular set of skills and specialize in either one line of business, such as auto or homeowners, or in a particular state, where they develop expertise in that state’s laws and regulations. 4.1 Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 4.2 Increasing Your Insurance IQ—AINS 101 C. Interdepartmental Cooperation No department in an insurance organization can exist on its own, and collaboration is integral to an efficient claims department. D. How Departments Help One Another 1. Risk Control Department a. The Risk Control Department needs claims experience information to direct resources and efforts to crucial areas of an insured’s operation. b. The Claims Department relies on risk control for data that can support the loss adjusting process. c. The Risk Control Department can provide standards, technical advice, laboratory analyses, and other assistance to the Claims Department when investigating and settling claims. 2. Premium Auditing a. Claims information can benefit an auditor by verifying employment classifications. b. Premium auditors can provide inventory values, contractors’ equipment lists, and other facts that are important to the claims function. 3. Underwriting a. Claims personnel help underwriters by ensuring that claims are paid fairly and according to the policy. b. Proper, consistent, and efficient claims handling enables underwriters to evaluate, select, and appropriately price loss exposures. 4. Marketing a. The Claims Department provides the Marketing Department with information about customer satisfaction, timeliness of settlements, and other variables that help market insurance products. b. Marketing personnel recognize that the other services the insurer performs for the insured are forgotten quickly if the insurer fails to perform well after a loss occurs. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  How Do Insurers Handle Claims? 4.3 Review Questions 1-1. Crystal was late for work and ran a red light, accidentally rear-ending Martin. Both were uninjured and exchanged insurance information. Martin then called Crystal’s insurer and reported his damages to Shawn. In this scenario, who is the claims representative and who is the claimant? 1-2. Kyle would like to become a field claims representative. How would you describe the related duties to him? 1-3. Jill is responsible for the professional development of claims personnel. What role does she play in the Claims Department? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 4.4 Increasing Your Insurance IQ—AINS 101 Educational Objective 2 Summarize the steps in the claims handling process. Key Points: Although the claims handling process, sometimes referred to as loss adjusting, may vary from organization to organization, it generally follows six steps: A. Acknowledging a Claim After a loss is reported, the insurer creates a claim file and notifies the insured that it has done so. Then a claims manager assigns a claims representative to the claim. B. Identifying the Policy Once a claims representative has received the claim file, the rep searches the organization’s database for the corresponding policy. C. Contacting the Insured Step 3 in the process is to contact the insured or the insured’s representative. D. Investigating and Documenting the Claim This effort might include examining the scene of the accident; investigating any medical claims, including bodily injuries; and speaking with outside experts. E. Determining Cause of Loss and Loss Amount After gathering all the facts, the claims representative determines the cause of loss and whether it’s covered by the policy. If it is, the rep calculates the amount of the loss based on documented valuation figures and any policy deductibles that apply. F. Concluding the Claim The claims representative prepares a loss statement and settles the claim with the applicable policyholder, claimant, or representative. Claims that aren’t covered by the policy are denied, and denial documentation is included in the file. Either way, the rep completes and files closing reports to properly document the claim.Review Questions Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  How Do Insurers Handle Claims? 4.5 2-1. Mary is a claims representative. Ken, an insured, drove his car into a pond on his property. What is the first step in the claims handling process that Mary should take? 2-2. Mary has just searched the organization’s database for the corresponding policy. She determines that the loss occurred during Ken’s policy period and that coverages in the policy apply to the loss and then calculates an appropriate loss reserve. What is the next step she should complete? 2-3. What must Mary do immediately before concluding the claim? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 4.6 Increasing Your Insurance IQ—AINS 101 Educational Objective 3 Explain how claims representatives handle the unique components of property claims. Key Points: Although the claims under different lines of insurance share some characteristics, such as verifying coverage and determining the amount of loss, they also have unique aspects. A. Unique Concerns When Verifying Coverage A claims representative should ask four questions when processing a property insurance claim. 1. Does the insured have an insurable interest in the property? Insurable interest means that a person has an interest in the item being insured and would suffer a financial loss if the property were damaged. 2. The next question is whether the damaged property is covered by the policy. Most property insurance policies exclude losses to certain types of property. 3. The third question concerns whether the cause of loss is covered by the policy. 4. The final question is whether any additional coverages, endorsements, or coverage limitations apply. In many insurance policies, additional coverages and limitations modify the basic coverage provided. B. Valuation Methods Three methods can be used to determine the value of the property that was damaged in a loss: the actual cash value, replacement cost basis, and agreed value methods. 1. The actual cash value method factors depreciation, which is a reduction in value due to physical wear and tear, into the replacement cost. 2. The replacement cost basis method does not consider depreciation, but focuses on initial cost paid for an item. 3. The agreed value method is used to insure property that is difficult to value, such as fine arts, antiques, and collections. C. Subrogation and Salvage Rights Two factors that can affect an insurer’s cost for a property claim are subrogation and salvage rights. 1. Subrogation is a process through which an insurer can recover from another party an amount it paid as a loss. This becomes possible if that other party caused the loss or insured the party who caused it. 2. Salvage rights allow the insurer to take possession of the insured property for which it has paid a total loss. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  How Do Insurers Handle Claims? 4.7 D. Special Considerations for Property Catastrophe Claims 1. Insurers that cover several properties exposed to windstorms, floods, and wildfires should be prepared to handle the large number of losses associated with a catastrophic event. 2. Effective catastrophe response requires careful preparation and detailed contingency plans that are regularly maintained and updated. These plans should account for power loss, transportation interruptions, and material scarcity. Review Questions 3-1. A claims representative should ask four questions when processing a property insurance claim. Can you name them? 3-2. What valuation method involves reimbursing the insured for the cost of replacing the property, minus depreciation? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 4.8 Increasing Your Insurance IQ—AINS 101 Educational Objective 4 Explain how claims representatives handle the key aspects of liability claims. Key Points: The overall arc of the liability claims handling process is very similar to property claims handling in that the claims representative verifies coverage, determines the cause of loss and the amount of damages, and concludes the claim. However, liability claims handling is often more complex for three main reasons. A. Key Differences Throughout the Process 1. When verifying whether coverage applies to a liability claim, the key difference from a property claim is that the claims representative must determine whether the insured is legally responsible for the loss. 2. Determining legal responsibility may lead to a more in-depth investigation of the claim, including witness interviews and site inspections to help recreate the events that lead to the loss. 3. If coverage applies, insurers often prefer to settle claims outside of court due to the time, expense, and uncertainty involved in a lawsuit. 4. Before an attempt to settle a claim is made, the insurer needs to have an idea of what the damages are or could be. B. Types of Damages in Liability Claims Lawsuits There are two main types of damages awarded in a liability suit: compensatory and punitive. 1. Compensatory damages are awarded to reimburse a victim for harm experienced. They include special damages and general damages. a. Special damages cover specific losses, such as medical expenses or lost wages. b. General damages are compensatory damages awarded for losses that do not have a specific economic value, such as pain and suffering; disfigurement; and so forth. Because these losses do not involve measurable expenses, estimating their dollar value requires considerable expertise. 2. Courts issue the other main type of damages, punitive, to punish defendants for reckless, malicious, or deceitful acts—and to deter others from following their example. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  How Do Insurers Handle Claims? 4.9 C. Concluding the Claim 1. A large percentage of liability cases are negotiated out of court. Even if a case is scheduled to go to court, the claims negotiations usually continue. 2. This requires a great deal of skill, patience, and understanding on the part of the claims representative. Review Questions 4-1. What are the two types of damages awarded in legal liability cases? 4-2. When verifying whether coverage applies to a liability claim, what is the key difference from a property claim? 4-3. When Mariah was making a smoothie with her new electric blender, the handle broke, slashing her with glass. She wound up needing several stitches on her right hand, which caused her to miss a week of work. It turned out that the defect was something the manufacturer knew about but decided would be too expensive to redesign. What types of damages could Mariah receive if she sued the manufacturer? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 4.10 Increasing Your Insurance IQ—AINS 101 Answers to Assignment 4 Questions NOTE: These answers are provided to give students a basic understanding of acceptable types of responses. They often are not the only valid answers and are not intended to provide an exhaustive response to the questions. Educational Objective 1 1-1. In the scenario presented, Shawn is the claims representative, and Martin is the claimant. 1-2. This is what you could tell Kyle: Field claims representatives work outside of the office, generally handling claims that require the scene of the loss to be investigated and holding in-person meetings with insureds, claimants, lawyers, and any other people involved with the claim. 1-3. Jill is a claims manager. Educational Objective 2 2-1. Mary should start by acknowledging Ken’s claim. 2-2. Because Mary has completed Step 2, identifying the policy, she should now move on to Step 3, contacting the insured. 2-3. Before moving to the final step, concluding the claim, Mary must determine the cause of loss and loss amount, Step 5 in the six-step claims handling process. Educational Objective 3 3-1. The four questions claims representatives should ask are: Does the insured have an insurable interest in the property? Is the damaged property covered by the policy? Is the cause of loss covered by the policy? Do any additional coverages, endorsements, or coverage limitations apply? 3-2. The actual cash value method reimburses the insured for the cost of replacing the property, minus depreciation. Educational Objective 4 4-1. The two main types of damages awarded in liability suits are compensatory and punitive. Compensatory damages reimburse a victim for actual harm, and punitive damages are awarded to punish a defendant and deter others from following their example. 4-2. When verifying whether coverage applies to a liability claim, the key difference from a property claim is that the claims representative must determine whether the insured is legally responsible for the loss. 4-3. The types of damages Mariah could receive if she sued the manufacturer include general damages for the pain she suffered, special damages to cover the cost of receiving stitches, and punitive damages because the manufacturer knew about the defect but chose not to correct it. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. How Do Insurers Reach Customers? 5 Educational Objective 1 Distinguish among the various roles of insurance producers. Key Points: Producers are the people customers most closely associate with the insurer’s promise to compensate them for a loss, making them the most important connection between insurers and the public. A. Why Are Producer Sales So Important? 1. Sales are essential for the success of the agency, brokerage, or insurer for which the producer is employed, and sales are also essential for the producer’s personal success, as most of his or her income results from commissions. After speaking with a prospective customer and assessing the prospect’s needs, a producer will prepare a proposal for coverage and close the sale. 2. Sales are the byproduct of the producer’s relationship with the customer—the stronger the relationship, the more likely it is to continue, thus creating the possibility of future sales. B. How Risk Management Reviews Build Producer/Customer Relationships 1. Producers help customers address their risk management concerns. a. For an individual or a family, the risk management review may be relatively simple—producers interview people or ask them to fill out questionnaires about their property and activities. b. For businesses, producers devote significant time to analyzing property, products, services, employees, and liabilities to determine appropriate risk management strategies. 2. A review of previous losses, or a “loss run,” can guide the producer. Loss runs include, at a minimum, lists of losses and their total cost. C. How Interacting With Customers Helps Producers Build Relationships 1. Understanding customers and providing personalized advice and coverage options are other important ways that producers build strong relationships. Some basic ways they achieve this on a day- to-day basis include: a. Responding to billing inquiries b. Reviewing accounts 5.1 Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 5.2 Increasing Your Insurance IQ—AINS 101 c. Answering questions about coverage d. Corresponding with premium auditors and risk control representatives e. Collecting premiums 2. A producer is typically the first representative of an insurer that the policyholder comes into contact with. So, a policyholder may naturally contact the producer when dealing with a claim. Ultimately, a policyholder needs to be transferred to the insurer’s Claims Department; however, the producer can give valuable initial advice on how to handle a damage or injury situation. Review Questions 1-1. Matthew wants to become a producer. What are three activities a producer performs (whether he or she works for an agency, a brokerage, or an insurer)? 1-2. Matthew asks you what is considered the most important function a producer can perform. What would you tell him? 1-3. Which producer function can help lay the groundwork for sales while also strengthening the producer/customer relationship? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  How Do Insurers Reach Customers? 5.3 Educational Objective 2 Illustrate how customer service interactions benefit insurance customers and organizations. Key Points: Customer service representatives (or CSRs) are a crucial part of an insurer’s relationship with its customers. A. The Many Roles of a CSR In addition to selling products, CSRs can: 1. Respond to general inquiries 2. Handle claim reporting 3. Answer billing inquiries 4. Process policy endorsements 5. Review and explain quotes to customers 6. Explain coverage B. Why Is Building Customer Loyalty Important? 1. Excellent service builds strong relationships and customer loyalty. This is important in insurance because profitability is directly linked to customer retention. 2. Superior service creates sales opportunities and attracts new customers to the organization. Satisfied customers tell their friends and provide leads and referrals that CSRs and producers can use to generate new business. The resulting reputation for excellent service can attract new customers. Review Question 2-1. Name three ways a CSR can add value, in addition to selling products. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 5.4 Increasing Your Insurance IQ—AINS 101 Educational Objective 3 Illustrate how producers serve as risk consultants to their clients. Key Points: As part of their ongoing relationship with commercial clients, producers never stop looking for risk management techniques that might produce even better results for them. They also try to keep an eye on changes to their loss exposures, as the combination of insurance and other risk management techniques they use may prove to be ineffective or become obsolete as new loss exposures develop or as existing loss exposures change or are eliminated. There are lots of ways that producers tackle this task, but one effective method that many use in one form or another is to break it into a step-by-step process. A. Step 1: Establish Standards of Acceptable Performance 1. The first step of the risk consultation process is to work with the client to establish the standards of acceptable performance. There are lots of ways to measure how well a program is working, but the best ones measure its results and the activities that produced them. 2. Results-based standards focus on the goals of the program, no matter how much effort is required to achieve them. 3. Although results standards are important, activity standards that focus on the quality and quantity of risk management activities— such as the installation of new safety equipment—rather than on outcomes are also necessary to obtain a complete picture of the success or failure of a risk management program. B. Step 2: Compare Actual Results With the Standards The second step of the risk consulting process involves taking the standards developed in Step 1 and combining them in a way that allows actual results to be compared with the goals. C. Step 3: Correct Substandard Performance or Revise Standards 1. The next—and most important—step in this process is to correct substandard performance or revise standards. 2. One situation in which a producer’s risk management expertise is vital is when a risk management program’s performance is substandard. A producer can appraise the situation and figure out whether loss exposures have changed since the program was implemented, or maybe more of the company’s employees need to buy into the risk management plan. 3. It’s also possible that the chosen techniques just aren’t working. Or if the risk management techniques are not the problem, the standards may be. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  How Do Insurers Reach Customers? 5.5 D. Step 4: Evaluate Substantially Exceeded Standards 1. Risk management goals should be attainable, but they should also pose a challenge. 2. One standard that is used to measure the performance of an organization’s entire risk management program, not just its premium costs, is cost of risk. 3. Cost of risk, or total cost of risk (TCOR), is the total cost of all aspects of the organization that relate to managing risk, such as the cost of retained losses, insurance premiums, and resources devoted to risk management. Review Questions 3-1. Can you name the steps of the risk consultation process in the correct order? 3-2. Courtney runs a delivery service and chose to install rear-view cameras in all work vehicles. What standard has Courtney focused on? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 5.6 Increasing Your Insurance IQ—AINS 101 Answers to Assignment 5 Questions NOTE: These answers are provided to give students a basic understanding of acceptable types of responses. They often are not the only valid answers and are not intended to provide an exhaustive response to the questions. Educational Objective 1 1-1. Producers perform some or all of the following activities: Sales Risk management review Policy issuance Premium collection Customer service Claims handling 1-2. Sales is the most important function a producer can perform. 1-3. The risk management review can help lay the groundwork for sales while also strengthening the producer/customer relationship. Educational Objective 2 2-1. In addition to selling products, CSRs can add value in any of the following ways: Respond to general inquiries Handle claim reporting Answer billing inquiries Process policy endorsements Review and explain quotes to customers Explain coverage Educational Objective 3 3-1. The steps in the risk consultation process are: Establish standards of acceptable performance. Compare actual results with these standards. Correct substandard performance or revise standards. Evaluate substantially exceeded standards. 3-2. Installing rear-view cameras in all work vehicles is an example of an activity-based risk management ­standard. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. What Goes Into an Insurance Policy? 6 Educational Objective 1 Identify the six characteristics of an ideally insurable loss exposure. Key Points: Insurers consider some kinds of loss to be entirely uninsurable. To understand why insurers don’t cover certain loss exposures, you must understand the six key traits of ideally insurable loss exposures. A. Pure Risk 1. The first characteristic of an ideally insurable loss exposure is that it should be associated with pure risk, not speculative risk. 2. Pure risk entails a chance of loss or no loss, but no chance of gain. 3. A speculative risk presents the possibility of loss, no loss, or gain. Insurance is not designed to finance speculative risks. A purpose of insurance is to cover the insured for a loss, not to enable the insured to profit. B. Fortuitous 1. The second characteristic of an ideally insurable loss exposure is that the loss associated with the exposure should be fortuitous from the insured’s standpoint. 2. For a loss to be fortuitous, the insured cannot have control over whether or when a loss will occur. If the insured has control, the insured might have an incentive to cause a loss. C. Definite and Measurable The third characteristic of an ideally insurable loss exposure is that it is definite and measurable. D. Fourth and Fifth Characteristics 1. The fourth characteristic is a loss exposure that is one of a large number of similar exposure units. 2. The fifth characteristic of an ideally insurable loss exposure is that it is independent and not catastrophic. a. Independent means that a loss suffered by one insured does not affect any other insured or group of insureds. b. A catastrophic loss is severe; it involves numerous exposure units suffering the same type of loss simultaneously, with significant financial consequences for the insurer. If a large number of insureds who are covered for the same type of loss 6.1 Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 6.2 Increasing Your Insurance IQ—AINS 101 were to incur losses simultaneously, the insurance mechanism would not operate economically and losses to the insurer could be catastrophic. E. Affordable The final characteristic of an ideally insurable loss exposure is affordability. The insurer should be able to charge an economically feasible premium—one that the insured can afford to pay. Insurers seek to cover only loss exposures that are economically feasible to insure. Because of this constraint, loss exposures involving only small losses, as well as those involving a high probability of loss, are generally considered uninsurable. Review Questions 1-1. Mark wants to invest in the stock market. What kind of risk would he be taking? 1-2. Samantha and her manager review the six characteristics of an ideally insurable loss exposure. Samantha determines that the exposure of flood possesses only three of the six characteristics: pure risk, fortuitous losses, and definite and measurable. How did Samantha determine that flood exposure is a pure risk? 1-3. Samantha and her manger also came to the determination that the exposure of a hurricane possesses fortuitous losses. How did they arrive at this determination? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  What Goes Into an Insurance Policy? 6.3 Educational Objective 2 Recognize the distinguishing characteristics of insurance policies. Key Points: Although all the rules of contract law apply to insurance policies, certain special characteristics distinguish insurance policies from other contracts. A. What Makes Insurance Policies Unique? 1. All insurance policies are contracts. But not all contracts are insurance policies. This unique subset of contracts has the same essential elements that all contracts have, but, because of the specialized function it serves of transferring risk from an insured to an insurer, it also has certain special characteristics. B. Contract of Indemnity 1. The purpose of insurance is to restore a party who has had a loss to the same financial position that party held before the loss occurred. This is known as indemnifying the party for its loss. Most property and liability insurance policies are contracts of indemnity. 2. A contract of indemnity doesn’t always pay the full amount to restore an insured who has suffered a covered loss to the same financial position, but the amount the insurer pays is directly related to the amount of the insured’s loss. 3. According to the principle of indemnity, the insured should not profit from a covered loss. Insurance policies contain various provisions to clarify that the insured cannot collect more than the amount of the loss. C. Utmost Good Faith Because insurance involves a promise, it requires that the insurer and insured be ethical in their dealings with each other. This means an insurance policy is a contract of utmost good faith. D. Fortuitous Events and the Exchange of Unequal Amounts Insurance contracts involve an exchange of unequal amounts. E. Conditional Contract of Adhesion 1. Because the insurer determines the exact wording of the policy, the insured has little choice but to take it or leave it. 2. An insurance policy also is a conditional contract because the parties have to perform only under certain conditions. Whether the insurer pays a claim depends on whether a covered loss has occurred, and the insured must fulfill certain duties before a claim is paid. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 6.4 Increasing Your Insurance IQ—AINS 101 F. Nontransferable 1. Once an insurance policy is in effect, an insured cannot freely transfer the policy to another party because the insurer would then be legally bound to a contract with a party it may not wish to insure. 2. Most insurance policies contain a provision that requires the insurer’s written permission before an insured can transfer a policy to another party. Review Questions 2-1. What principle prevents an insured from profiting from owning an insurance policy? 2-2. Name three of the six distinguishing characteristics of insurance policies. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  What Goes Into an Insurance Policy? 6.5 Educational Objective 3 Identify the methods for structuring insurance policies Key Points: The heart of every insurance coverage is the insurer’s promise to pay for covered losses in exchange for a periodic payment. An insurance policy formalizes this agreement. It also serves as a road map to everything important about the coverage, from what’s covered and for how much to situations where coverage doesn’t apply and everything in between. A. Policy Forms 1. Most policies are issued on preprinted forms, but insurers develop specific policies called manuscript forms when needed for particular customers. 2. Policies are also either self-contained (made up of one document) or modular (made up of several different documents). B. Preprinted and Manuscript Forms 1. Most insurers use standard preprinted forms. They’re usually developed by advisory organizations, such as Insurance Services Office, Inc.—or ISO— and the American Association of Insurance Services. 2. When preprinted forms aren’t sufficient for a particular insured or small group of insureds, the insurer or the insured’s broker may draft a special customized form called a manuscript form to meet the customer’s needs. C. Self-Contained and Modular Policies 1. If a client needs a type of coverage common to a large number of insureds, the insurer may choose to offer a self-contained policy. 2. However, if a customer needs a variety of coverages that may not be common to a large number of insureds, the insurer may offer a modular policy. D. What Other Documents Can a Policy Contain? 1. The insurer keeps the application as part of the policy to preserve what the insured stated. 2. A policy may also include endorsements, which modify the basic policy form. 3. Insurer’s bylaws describe the insurer’s rules regarding its ownership and operations. 4. Insurers sometimes incorporate statutes into policies by referring to them, so some policies contain relevant statutory terms. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 6.6 Increasing Your Insurance IQ—AINS 101 Review Questions 3-1. What type of insurance form is most widely used? 3-2. A self-employed tattoo artist wants to make sure she’s covered in case a client sues her. What policy type would her agent suggest? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  What Goes Into an Insurance Policy? 6.7 Educational Objective 4 Explain how each category of provisions helps clarify the insurance policy. Key Points: Every insurance policy is a collection of policy provisions. These provisions state what is and is not covered by the policy, what types of loss the policy covers, what key words within the policy mean, how much the insurer will pay in the event of a covered loss, and what duties both the insurer and the insured have under the policy. A. Breaking Down the Provisions Every insurance policy includes five main provisions: 1. Declarations 2. Definitions 3. Insuring agreement 4. Policy conditions 5. Policy exclusions B. The Declarations, Definitions, and Insuring Agreement Three provisions—the declarations, the definitions, and the insuring agreement—form the core of every insurance policy. 1. The declarations are usually the first page of an insurance policy. They personalize a policy by outlining who or what is covered and where and when coverage applies. 2. The definitions section defines policy terms. It’s usually located near either the beginning or the end of the policy. This helps people understand the policy and reduces confusion over what the policy does and does not cover. 3. The insuring agreement states the insurer’s promises to the insured. A policy that provides more than one coverage can have more than one insuring agreement. C. Conditions and Exclusions 1. An insurer doesn’t have to fulfill its promise to pay for covered losses if the insured doesn’t adhere to the rules laid out in the policy’s conditions section. Some of those conditions include: a. Paying premiums b. Reporting losses promptly c. Cooperating with the insurer Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 6.8 Increasing Your Insurance IQ—AINS 101 2. Exclusions state what the policy will not cover. Insurers use exclusions for specific reasons, including: a. To eliminate coverage for uninsurable loss exposures b. To discourage the insured from intentionally causing a loss c. To reduce duplicate coverage d. To eliminate unnecessary coverage e. To eliminate coverages that need special treatment D. Property Policy Provisions 1. The big differences between property and liability policies are found in their insuring agreements. 2. A property insurance policy compensates an insured who suffers a financial loss because property has been lost, stolen, damaged, or destroyed. 3. The policy must identify which property loss exposures are covered. That means the types and locations of property, causes of loss, and financial consequences that are covered. 4. Property policies must also indicate which parties are covered and how much an insurer will pay in the event of a loss. E. Liability Policy Provisions 1. The insuring agreements of most liability policies make essentially the same promise: to pay damages for bodily injury or property damage for which an insured becomes legally liable and to which the coverage applies. 2. The insurer also promises to pay related defense costs. To clarify the intent of the insuring agreement, which is usually a relatively brief statement, the provisions of a liability insurance policy must address the covered activities, covered types of injury and damage, excluded loss exposures, covered costs, covered time period, covered parties, and amounts of recovery. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.  What Goes Into an Insurance Policy? 6.9 Review Questions 4-1. What three provisions form the core of every insurance policy? 4-2. When would a property insurance policy compensate an insured who suffers a financial loss? 4-3. What promise do the insuring agreements of most liability policies make? Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved. 6.10 Increasing Your Insurance IQ—AINS 101 Answers to Assignment 6 Questions NOTE: These answers are provided to give students a basic understanding of acceptable types of responses. They often are not the only valid answers and are not intended to provide an exhaustive response to the questions. Educational Objective 1 1-1. Investing in the stock market is an example of speculative risk because it presents the possibility of loss, no loss, or gain. 1-2. The exposure is a pure loss because a loss that occurs as a result of a flood does not result in financial gain for the insured; thus, there is either a loss or no loss. 1-3. Hurricanes are fortuitous because the insured does not have control over whether and when a hurricane loss will occur. Educational Objective 2 2-1. Indemnity is the principle that prevents an insured from profiting from owning an insurance policy. 2-2. An insurance policy has all these characteristics: Contract of indemnity Contract of utmost good faith Contract involving fortuitous events and the exchange of unequal amounts Contract of adhesion Conditional contract Nontransferable contract Educational Objective 3 3-1. Preprinted forms are most widely used. 3-2. An agent would suggest a manuscript policy because her coverage needs are likely not common to a large number of insureds. Educational Objective 4 4-1. The declarations, definitions, and insuring agreement form the core of every insurance policy. 4-2. A property insurance policy compensates an insured who suffers a financial loss because property has been lost, stolen, damaged, or destroyed. 4-3. The insuring agreements of most liability policies make essentially the same promise: to pay damages for bodily injury or property damage for which an insured becomes legally liable and to which the coverage applies. Copyright © American Institute For Chartered Property Casualty Underwriters. All rights reserved.