Cpcu 500 Ch.8

Front 1

Insurable interest

Back 1

Insurable interest e.x. if you purchase insurance on a building that you don't own and it burns down, you are profiting from the insurance and never had anything to loose. Insurable interest requirement makes sure the insured had something at stake (concept of indemnity).

Front 2

Insurable interest pt.2

Back 2

Insurer must determine if an insurable interest in property or a life exists. Insurable interest doesn't have to be written into policy b/c it exists as a matter of law. Exists regardless of whether or not policy specifically addresses insurable interest.

Timing of insurable interest (when does it have to exist?): in life insurance, insurable interest must be satisfied at the time the policy is purchased. In property insurance, the insurable interest must exist at the time of the loss (e.x. if you own a home and sell then a fire occurs, there is no longer an insurable interest b/c you didn't have anything to lose at the time of the loss).

Front 3

Reasons for insurable interest

Back 3

Why is insurable interest a matter of law?

Insurable interest requirement exists because: supports principle of indemnity, prevents insurance use for wagering (if you could purchase insurance on any building or person, you would profit whenever something happened to them) and reduces moral hazard (if you purchase insurance on a building and then burn it down, you have nothing to loose but you would profit).

Front 4

Legal bases for insurable interest

Back 4

Insurable interest can arise from:

Ownership interest in property gives you an insurable interest (ownership of both tangible and intangible property creates an insurable interest). Just b/c there is ownership interest doesn't mean there is insurance (e.x. you can't purchase insurance on stock even though there is insurable interest).

If multiple parties own property together the titling dictates the insurable interest of each party. If property has rights of survivorship (joint tenancy with rights of survivorship) even though both parties most likely wouldn't be paid the full value, each tenant has an insurable interest in full value of the property. No rights of survivorship means insurable interest limited to owner's share (e.x. if you own 50% of the property that would be your insurable interest).

Front 5

Legal bases for insurable interest

Back 5

Legal bases for insurable interest includes:

Contractual obligations - contracts with people/property. With property a mortgage holder has property rights based on remaining balance of debt. Unsecured creditors don't have insurable interest in actual property rights but may have interest in the person that owes them the money.

Representation of another - representing party does not need to have an independent insurable interest (bailee (dry cleaner who possesses your clothes, you are the bailor, for a little while but you still own the clothes, dry cleaner would have insurable interest in your clothes while they are in possession of them), agent (interest in principles of property that are being represented) or trustee (interest in the trust property that's being managed)). If a loss occurs in any of these situations the representing party must give proceeds to the property owner.

Front 6

Legal bases for insurable interest pt.2

Back 6

Exposure to legal liability - one party can have legal responsibility for other's property (hotel owner has insurable interest in guest's property).

Factual expectancy (some states don't recognize) - party experiences an economic advantage if insured event doesn't occur or experience harm if event occurs. E.x. you get engaged and groom stole the ring from his cousin, the bride cannot own stolen property, so bride theoretically cannot have interest in that property but under factual expectancy the bride is suffering a loss if ring is reclaimed by cousin.

Front 7

Insurance to value

Back 7

Insurance to value is insurance written for an amount equal to the full value of asset insured. E.x. you own a $300k home but realize the damages you've incurred before have only been about $15k, so you only by $20k of homeowners insurance, this is discouraged by insurer b/c the premiums may not allow them to pay losses, insurers encourage insurance to value. Benefits to insurer: premiums are sufficient to cover losses and simplifies underwriting because exact values need not be determines during underwriting only when loss occurs. Benefits to insured: sufficient funds available for total loss and uncertainty is reduced even though it may be more expensive.

Front 8

Insurance to value pt.2

Back 8

Property policies typically include insurance- to-value provisions. Reduces amount payable for partial and total losses. Rewards those who have insured to value.

Insurers don't usually seek insurance to value for liability policies b/c determining maximum possible loss is impossible because severity can be unlimited.

Front 9

Coinsurance formula

Back 9

Coinsurance formula explains how amount payable is determined (homeowners). Payable = (insurable limit/ (replacement cost * 80%)) * loss sustained. If deductible, subtract.

The full amount of the loss will be covered, up to the policy limit, if coinsurance percentage is satisfied. Many homeowners policies contain an 80% coinsurance clause.

Front 10

Addressing problems

Back 10

Maintaining insurance to value limits is difficult: coinsurance requirement must be met based on value at time of loss, insurance purchaser often estimates value based on informed guess, insurable value may not be known until property is rebuilt or replaced and values change over time.

To minimize valuation issues, insured should: hire a qualified appraiser to establish replacement cost value, reappraise property every few years, review/revise policy limits periodically and consider coverage options.

Front 11

Property valuation

Back 11

All property policies state the valuation method to be used for the property: replacement cost, actual cash value (ACV), agreed value and functional value.

Front 12

Replacement cost

Back 12

Commonly used for buildings and some personal property. Current cost to repair, rebuild or purchase new property of like kind and quality. If insured has a replacement cost policy and replacement cost exceeds original purchase price, insured receives replacement cost (violates principle of indemnity). If replacement cost lower than original purchase price, replacement cost still used.

Front 13

Actual cash value

Back 13

Considers wear and tear. Supports principle of indemnity. Restores insured to pre-loss condition.

Definition of ACV often varies by jurisdiction, may be defined as: replacement cost less depreciation (based on economic (not accounting) depreciation) or market value (price for which the property can be sold on open market, may be appropriate for valuing historic buildings built with obsolete construction).

Front 14

Actual cash value pt.2

Back 14

ACV may also be defined is on a facts and circumstances type of test called the broad evidence rule - method of determining ACV based on court decisions, using factors such as: obsolescence, building's present use/profitability, alternate uses of the building, present characteristics of neighborhood, long-term plans for the community and inflationary or deflationary trends. This test looks at actual property and applies these factors to assign a cash value for it

Front 15

Loss payments

Back 15

Most replacement cost policies pay out after the insured has replaced the property (this can reduce moral hazard by reducing incentive to damage the property intentionally). Buildings are usually insured at their replacement cost (usually higher than ACV, ACV typically pays out when loss occurs, not when property is replaced).

Rates per $100 of property insurance are the same whether the property is insured for replacement cost or actual cash value. Replacement cost is often higher than ACV so you will buy more insurance but rate is the same between these two methods.

Front 16

Agreed value method

Back 16

The agreed value method is a method in which insured and insurer agree on policy limit. Agreement made when policy is written. Regardless of property value at the time of loss insurer will pay the loss based upon agreed value upfront.

Method is typically used for: commercial watercraft, antiques, paintings and objects where value is difficult to determine.

Front 17

Agreed value method pt.2

Back 17

For total loss, agreed upon value is paid. Partial losses covered on actual cash value, repair cost or replacement cost depending on the policy.

Agreed value method does not stipulate what the agreed value has to be relative to the actual value of the property.

Front 18

Functional valuation method

Back 18

Method in which the insurer is required to replace property with functional equivalent. Used when replacing property with a like kind is not practical. With real property, insurer must use common construction materials. May be appropriate when valuing historical building.

E.x. insured purchases old school building and turns it into an office building, the building burns down, this method will replace building with another office building.

Front 19

Liability claims valuation

Back 19

Liability policies are usually not specific on how the amount of a covered claim is determined.

Most policies pay lesser of: compensable amount of claim (amount of claim itself) or policy limit.

Key issue is indemnifying party who incurred the loss (claimant). Burden of proof lies with claimant. The person incurring the loss is the defendant.

Front 20

Compensable amount

Back 20

Usually determined by negotiation between the parties. Most liability claims don't go to trial. Defendant typically cannot prevent insurer from settling out of court (e.x. if you have liability insurance and you caused a loss but want to go to court and the insurer wants to settle out of court, the insurer will do what's best for them and defendant cannot prevent that).

Issue will go to trial if settlement cannot be reached by the parties. Judge has power to reduce or set aside an award given by a jury in a liability trial.

Front 21

Compensable amount pt.2

Back 21

For property damage, owner may recover: reasonable costs to repair property or cost to replace, compensation for loss of use or lost profits from inability to use.

For bodily injury claims, victim can recover: current and future medical expenses, lost wages and pain and suffering (punitive).

Front 22

Compensable amount pt.3

Back 22

When bodily injury results in a claimant's death, the claim is generally categorized as either: survival action (how much would have been recovered if the claimant had lived), wrongful death action (monetary loss to the survivors).

The category into which the claim falls affects the amount of damaged awarded.

Front 23

Policy limit

Back 23

Payment of compensable amount is capped by limits in the policy. Auto policies typically have one policy limit. Commercial general liability policies typically have multiple policy limits.

When a policy contains multiple limits, the maximum amount payable is subject to an analysis of all the limits within the policy (e.x. if you get sued for damages you caused in for $5mil but only have insurance for $1mil, that is all the insurer will pay).

Front 24

Policy limit pt.2

Back 24

In addition to damages, insurers pay defense costs and supplementary payments including court costs taxed against the insured, cost of surety bonds and interest on judgement (interest can accrue if claim isn't settled for several years).

In certain policies, defense costs and supplementary payments reduce policy limits, these policies include: directors/officers policies and pollution liability policies.

Front 25

Reasons for deductibles

Back 25

Deductibles reduce premiums. Risk financing technique. Require insured to retain portion of the loss.

Risk management professional can assist by selecting or recommending appropriate deductible. In choosing deductible, insured must balance the benefits of premium reduction with insurance protection for large losses.

Front 26

Encourage risk control

Back 26

Deductibles reduce premiums costs by encouraging risk controls. Incentive to prevent or reduce loss. If deductible is too small it will offer enough financial incentive. If deductible is too large, it defeats the purpose of risk transfer.

Deductibles are usually not effective when used with large property exposures (e.x. if building is worth $50mil a $100k ded won't significantly lower premium or insurer's loss).

Front 27

Reduce insurer costs

Back 27

Deductibles eliminate the insurer's involvement in low-dollar losses. Insuring small claims is known as dollar trading and is costly (insurer deals with administrative costs for small losses, deductible can help avoid this).

Deductibles are best in reducing insurer's expenses when used with coverages in which small, partial losses (not large loss exposure) are common (e.x. auto collision).

Front 28

Reduce insurer costs pt.2

Back 28

For most property insurance policies, the premium reduction is not proportional to the size of the deductible (e.x. if you adjust deductible by $500 that doesn't mean the premiums will be adjusted by $500). Reduction is on a sliding scale, with the premium credit increasing much more slowly than the deductible.

Premium credits encourage medium-sized deductibles.

Front 29

Deductibles

Back 29

Some liability policies use a self-insured retention instead of a deductible. With deductible, insured may not report minor incidents until situation has escalated. Insurer wants to be involved with all claims. Deductibles do not noticeably reduce premiums for liability policies b/c most liability claims are for large amounts not just small amounts so ded isn't typically effective.

Front 30

Deductibles pt.2

Back 30

Deductibles are usually not included in: commercial general liability policies, personal liability policies or auto liability policies. These policies often have self-insured retention.

Deductibles are common in: professional liability policies, directors and officers liability policies and bailee legal liability policies.

Front 31

Self-insured retentions

Back 31

Self-insured retention (SIR) vs. deductible:

Deductible - with liability policy insurer defends on a first-dollar basis, pays all covered losses, then bills insured for losses up to deductible.

SIR - insurer pays only losses exceeding SIR, and does not defend claims below SIR (insured pays their retention amount and insurer will then pay the rest). Full policy limit payable on top of SIR (SIR doesn't count against policy limit the way the ded would b/c insurer will pay full policy limit once insured has paid their SIR). SIR typically requires strict reporting to the insurance company of any claims with potential to exceed SIR.

Front 32

Noninsurance agreements

Back 32

Risk management professionals investigate all potential sources of recovery to know which policy provisions are applicable.

E.x. of noninsurance agreements (you can recovery after loss has occured w/o insurance) include: credit card protection plans, extended auto warranty and appliance service agreement.

Many homeowners policies include a provision addressing noninsurance agreements to address any overlap in coverage. If HO policy and service agreement cover a piece of property then the service agreement should pay first and the HO policy will pay any amount in excess.

Front 33

Negligent third parties

Back 33

A party who is injured has the right to recover from a negligent third party. Irrespective if the third party (whether or not they have insurance the injured party has the right to sue under tort law, if injured party has their own insurance they may collect under their policy and if policy has subrogation provision the insurer will collect from negligent driver).

Third party recovery may overlap with victim's own property insurance. Victim's own insurance usually has a subrogation provision to deal with these situations.

Front 34

Other insurance in same policy

Back 34

Some policies offer multiple coverages. Scheduled personal property endorsement attached to homeowners policy (scheduled items are covered under HO policy in general and there are also scheduled items that may be covered by an endorsement). In auto accident, coverage may be provided by medical payments, liability and uninsured motorist coverage of car owner's PAP.

Multiple coverages may have different valuation provisions or deductibles. Risk management professional wants to look to see which is best method of recovery. Insured may be able to recover more by filing under one coverage instead of another.

Front 35

Other insurance in same policy pt.2

Back 35

Coverage overlaps arise sometimes because an insured is covered by the same type of policy with two different insurer. Question arises as to which insurer will pay when loss occurs. Insurers often share the loss. E.x. you're selling a house but still own it and buy a new house, the new policy on the new home covers losses to property and the policy on the old home will cover property at a different location so property could be covered under both.

Front 36

Other insurance in dissimilar policy

Back 36

A loss is sometimes covered by more than one type of insurance or by different insurers. Valet parking services may be covered by the establishment's commercial general liability policy and commercial auto policy.

Dissimilar policies often don't include provisions that coordinate coverage with other types of policies. These overlaps in coverage are often the most difficult to resolve.