Introduction to Insurance

•  Method of sharing risks
•  Definition of Insurance
•  Three forms of economic death
•  Ways in which to respond to a risk
•  Risk, peril and hazard
•  Law of Large Numbers
•  Insurance and Gambling
•  Company definitions
•  Dividends
•  Type of hazards
•  Company makes money

 

Purpose of Life and Health Insurance 

• Risk – Sharing a loss

Five ways to respond to a risk:

1. Avoid
2. Retain
3. Reduce
4. Share
5. Transfer

 

• Insurance – Transfer of a Risk

• Insurance is designed for pure risks not speculative risks such as gambling.

• Peril – cause of a loss such as death, accidents, and/or illness.

• Hazard – increase the chance of a loss.

 

Three types of hazards:

1. Physical  (high blood pressure)
2. Moral  (intentional loss)
3. Morale – not caring about what can happen if loss occurs

 

The Law of Large Numbers – grouping large numbers of similar risks to give companies the statistical probability of claims.

Stock Company – owned by shareholders.  Dividends that are owned by the stockholders are the return of investments and are taxable. These companies issue non-participating polices.

Mutual Company – organized by the policyholders.  The dividends that are paid to the policyholders are the return of unneeded premium. These are not taxable and are not guaranteed.  These companies issue participating polices.

Fraternal – clubs is which one of the benefits of the memberships is insurance for that club member.  It works like a mutual insurance policy.

Self-Insurers – individual or employer retains the entire risk.

Private or Government Insurance

Reinsurance – sharing of a risk, which is too large for one company to accept in whole.  Part of the premium is paid to another company who accepts the excess risks.

Insurance companies are organized in three areas.

1. Domestic- home state
2. Foreign- out of state but still in the USA or its territories
3. Alien- out of the USA

Insurance companies must be authorized or admitted to do business in a state.

Legal tractions by unauthorized or non-admitted insurance companies are called surplus lines companies.

 

Contract Law

 

Contract– an agreement between two or more parties.

Doctrine of Utmost Good Faith –  demands that all parties to the contract want the agreement to work.

Doctrine of Reasonable Expectations – the parties have the right to get what they reasonable expect.

Elements of a contract:

Agreement – Offer and Agreement

• Offer

• Acceptance

• Consideration

• Competent parties

• Legal Purpose

A contract is not valid without all elements.  Without the contract, there is no coverage.

 

Offer – A statement that is complete enough to be accepted entirely.

Acceptance –  Image of the offer or no changes.

The Offer and Acceptance form the agreement.

• An application without the premium is an invitation

• An application with the premium is an offer

The insurance company accepts the offer when the policy is issued as applied for and delivered.

Consideration  – exchange of value (polices and premium)

• Insurance company’s promise is its consideration
• Applicant’s premium and the statements in the application are their consideration.

Statements must be true to the best of the applicant’s truth

• Two meanings of the word “Truth”
  • Representations – true to the applicant’s best knowledge an d belief (subjective)
  • Warranties – absolutely true (objective)
  • Two meanings of the word “Untrue”
    • Misrepresentation – a lie (overt)
    • Concealment – failure to state an important or material fact (covert)

• To affect coverage the misstatement must be
  • Material and Intentional

Competent Parties – requires that the applicant is sane, sober, of sound mind and not under duress.

• Minors are not legally competent and must have a parent or legal guardian sign the application.

Legal Purpose – Legal intent requires two things in Life Insurance

• Insurable interest

• Consent

Insurable interest requires that the application be in a position to lose if the insured dies.  Usually this is a financial or economic loss.

Only the applicant needs insurable interest at the time of application.

The insured’s signature on the application is the required evidence of consent.

A Counter Offer is not required to form a contract. It voids all that came before it and becomes the offer if it is accepted.

To make an offer is also not required to form a contract.

Coverage takes effect – Application without premium or invitation…Company issues and delivers the policy (offer)…the premium is paid (acceptance).  Coverage begins when the premium is paid.

Application with premium (offer)… The company issues and delivers the policy (acceptance). Coverage begins when the policy is physically delivered.

A Continued Statement of Good Health, signed by the applicant, is like a supplement to the application and is a part of the delivery process.

Interim Insuring agreements – Bridges that speed up coverage.  They can only be used with prepaid applications.

• Conditional Receipts – Coverage began on a later date (pending medical exam)

• Interim Term Receipts – Coverage begins with conditions attached

• Acceptance Form of Receipt – Coverage begins when the application is accepted (delivery of policy is not required)

Type of Insurance Contracts

• Personal – insurable interest

• Conditional – promise comes with strings attached

• Unilateral – company makes an enforceable promise. One promissory

• Contracts of Adhesion – ambiguities are always a decided in favor of the insured. One author

• Aleatory – unequal consideration

Waiver – giving up legal right.

Estoppel – a party is stopped from using a waived right.

If a policy is issued based upon an incomplete application, the company waives the right to answers.

Producers has three rights of authority

• Expressed – In writing

• Implied – logically expected to do

• Apparent – public reasonably believes that the authority exists

 

Underwriting Basics

 

Underwriting – Process of selecting and classifying risks

Mortality – risk of death

Morbidity – risk of sickness or accident

The Application is the primary Source of Underwriting Information

• Part I: General Information
• Part II:  Medical History

Other sources:

• Producer’s report

• Inter-company data (MIB)

• Physician’s Report

• Medical Exam and Lab Test

• Investigative Consumer Report

• Credit Report

Companies share medical information through the Medical information Bureau (MIB).

The consumer has the right to see the MIB information. The information would be submitted to the insured’s doctor.

 

The Fair Credit Reporting Act governs both credit and inspection reports.

The Act is a federal statute that requires that the applicant:

• Is notified that a report will be requested

• Consent with the applicant’s signature

• Has the right to challenge the validity of the report

• Has the right to include their side of the story in the report

• Has the right to have incorrect data updated

Under the Information Act, information can  only be retained for seven years or ten years concerning bankruptcy.

 

Underwriting Factors:

• Age

• Gender

• Tobacco Use

• Weight and Build

• Physical Condition

• Personal and Family Health History

• Occupation and Hobbies

 

HIV/AID can be used in underwriting. However, once the policy is issued, HIV/AIDS losses can not be excluded from coverage.

 

Preferred Risk – Better than average risk

Substandard Risks – Insureds who are rated with high-risk policies

Declined Risks – Uninsurable risk

Adverse Selection – Proof of insurability is often used to reduce the impact of the tendency for poor risks to buy insurance.

Exclusions – Losses that are not covered.

• Risk + Expense – Interest = Gross Premium
• Risk – Interest = Net Premium

Premium Mode is the frequency of premium payment.  The more frequently the premium is paid, the higher the cost.

Independent Rating Services

Companies that rate the financial soundness of Insurance Companies include A M Best, Moody’s Investors Service, Standard, and Poor’s Insurance Rating Services.

 

Life Insurance and Annuities

There are three ways of marketing Life Insurance – Industrial, Group and Ordinary.

Ordinary contracts run the gamut from those that offer Death Benefit only (Term).

To those that offer Cash Value only  (Annuities).

There are three types of Ordinary Life Insurance Policies

1. Term – Pure insurance protection for death benefit. The death benefit is for a stated period. The cost of Term goes up with age at renewal.  The premium is based on attained age.  Attained age is age at the time that the policy is purchased or renewed.

•   Level Term has overpayment in the early years to cover underpayment in the later years of the policy.  Term insurance provides the most death benefit for the lowest premium dollar amount.  Level Term has the same death benefit throughout the term of the policy
• Decreasing Term has a benefit that goes down throughout the term of the policy.  Decreasing Term has a benefit that goes down throughout the policy term such as mortgage protection insurance
• An Increasing Term Policy has a death benefit that goes up throughout the policy term
• Annually Renewable Term (ART) allows the policyholder to renew the policy without providing proof of insurability.  The premium increases because of the insured’s age
• Convertible Term allows the policyholder to covert from Term to permanent insurance without providing proof of insurability. The new premium will be based on the new attained age and the new form of insurance
• Policies mature when the face amount is paid out.  Term polices mature if the insured dies during the term; if the policyholder outlives the term, the policy expires

 

Tax Fact:  There is no income tax impact to a beneficiary on a death benefit.

2. Whole Life or Permanent Life – offers both death benefits and cash value growth.  The emphasis is on death benefit. The policy will only pay either the death benefit or cash value but not both.

Whole Life Polices feature:

• Coverage to age 100

• Fixed Premium

Cash Value grows at a guaranteed fixed rate.  Cash value equals death benefit at age 100.

Tax Facts:  The growth of cash value is sheltered from tax as long as the money is left with the company.  If the cash value is taken out  the policyholder is taxed on the growth as ordinary income the year it is taken out.

Whole Life polices mature in one of two ways

• Death on the way to age 100 and there is no income tax impact

• Insured reaches the age of 100

Whole Life policies can be purchased as

• Single Premium

• Limited Pay

• Continuous Premium – premium is paid to age 100

Limited – Pay may be expressed by the length of the payment period such as a 20-year pay life or the age at which the policy is paid up such as Life Paid at 60.

The shorter the payment period the less the total cost and the faster the growth of cash value.

 

3.      Endowment – have both a Death Benefit and the growth of Cash Value.  The emphasis is on cash accumulation.

The Endowment pays insured if you live and pays if you die.

Tax Facts: The Tax Reform Act of 1984 states that to keep the tax benefits of life insurance the policy can not grow cash value so fast that the cash value equals the face amount before the insured’s 95^th birthday.  This killed the traditional Endowment. The Technical and Miscellaneous Revenue Act (TAMRA) of 1988 created the modified Endowment Contract (MEC).

An MEC is any life policy that grows cash value faster than n a Seven-Pay Whole Life.

Any loan or withdrawal from the cash value of an MEC is:

• Considered interest first

• Subject to a 10% penalty if the insured is less than 59 ½ years of age.

A “major change” in the MEC includes increase in death benefit.

4. Annuities – all cash value and no death benefit.

 Life insurance designed to create an estate; Annuities are designed to methodically liquidate an estate.

Annuities have two lives (phases, periods)

• Accumulation Period (Pay –in)

• Income or Annuity Period (pay-out)

Changes may only be made during the Accumulation Period.

If the Annuity owner dies or terminates the contract, during the Accumulation period the annuity, owner or beneficiary is entitled to the higher of the cash value or premium paid minus lawful surrender charges. The person receiving the payout during the Annuity Period is the annuitant.

Tax Fact:  Growth is taxed at the annuitant’s normal rate, plus 10% penalty fees if the annuitant is less than 59 ½ years of age at withdrawal.

Three choices when the contract matures:

• Take the money

• Annuity Certain (definite start/definite stop)

• Life Annuity – pays for life and is the most common.

Life Annuity with Period Certain – pays for life but at a minimum for a guaranteed period.

Refund Life Annuity – pays for life, but refunds any principle balance remaining at the death of the annuitant.

Joint and Survivor Life annuities, and their variations, pay as long as either one lives.

Benefits are guaranteed in a Conventional Fixed Dollar Annuity. The benefits are not guaranteed in a Variable Annuity.

Common Uses of Annuities

• Life Income

• Cash Accumulation

• Group Retirement

How much Life Insurance is enough?

Human Life Value Approach – money coming in – what would the breadwinner have earned?

Financial Needs Approach – money going out – what does the family need absent the breadwinner?

This is an optional quiz you may take to review the content of this unit.

Your answers are not submitted for credit. Only the final test of this course is submitted for credit.

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