Please answer the following 3 questions and use the chapter reading attached as references. Please cite sources in APA format. 1. Why is it important to review existing policies

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DETERMINING INSURANCE NEEDS

CHAPTER 4

INTRODUCTION

Insurance is a risk-transfer device. By contract, one party (the insurer) agrees to indemnify another party for the financial consequences of a loss. Through the purchase of insurance, the financial consequences (the risks) of a loss are transferred to another party (the insurer).

After assessing risk exposures (see ), risk managers must then decide whatChapter 3 types of insurance and amount of coverage the organization needs to protect itself from liability for the maximum exposures. For example, Businesses own real property, either for their own use or to lease to others; have liabilities arising out of custody of property belonging to others; have liability exposures to others arising from premises, operations, and products; and encounter a host of other situations in which loss might cause the business to suffer financially.

In this chapter it is that (specifically bodily injury and property damage)exposure to loss that is used to define the word . However, the word risk is also used by insurancerisk professionals to include any of the following:

• the property insured;

• the person insured;

• the perils being insured against; or

• Any hazards that may increase the chance of loss from a peril.

This chapter examines the process for estimating insurance needs from the perspective of both business and personal insurance needs. Whether acting as a professional risk manager for a corporation or simply assessing the insurance needs for one’s own family, the fundamental question is the same: How much risk should be retained—knowing that any losses from retained risk will be paid for directly—and how much should be transferred to an insurer through an insurance policy, knowing that the premiums for that policy will be spent regardless of losses that may (or may not) be incurred?

ADVANTAGES OF USING INSURANCE FOR RISK TRANSFER

There are a number of advantages to using insurance as a risk transfer mechanism.

C o p y r i g h t 2 0 1 6 . T h e N a t i o n a l U n d e r w r i t e r C o m p a n y .

A l l r i g h t s r e s e r v e d . M a y n o t b e r e p r o d u c e d i n a n y f o r m w i t h o u t p e r m i s s i o n f r o m t h e p u b l i s h e r , e x c e p t f a i r u s e s p e r m i t t e d u n d e r U . S . o r a p p l i c a b l e c o p y r i g h t l a w .

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They include the following:

• Insurance presents the risk manager with the opportunity to incur a known, up-front cost (the premium) in exchange for the insurer’s taking on the large, possibly catastrophic unknown (the potential for a large loss).

• Securing an insurance policy may satisfy a contractual requirement. If a retail business leases a building, the lease will probably require that the lessee carry insurance that will cover any damage done to the building. The vast majority of all types of contracts include insurance requirements.

• Banks and other financial institutions usually require that insurance be purchased to protect their interest in the buildings on which they hold mortgages. Loans on other types of property, such as cars, furnishings, and equipment, often are conditional on evidence that insurance on the items is in place.

• Most insurance policies provide that the insurance company adjust and pay claims on behalf of the insured business. This takes a burden off company managers, who are not experts in claim-management procedures.

• Insurance may be used to satisfy certain statutory or regulatory requirements. For example, state laws in all but Texas require that insurance be purchased to cover workers compensation exposures, unless the business is a qualified workers compensation self-insurer.

DISADVANTAGES OF USING INSURANCE FOR RISK TRANSFER

The following are some of the disadvantages to using insurance as a risk transfer mechanism:

• Spending money for insurance means that the insured has that much less to invest elsewhere—whether in new plant and equipment, new personnel, new training methods, or the acquisition of other businesses. If the risk manager can measure that loss, perhaps a trade-off can be made between less insurance and an aggressive investment policy.

• Even the broadest of insurance policies may not cover every loss. Some business owners and executives may be under the false impression that all claims will be covered by their insurance policies, but that is not possible. As noted previously, the selection of a good intermediary will help ease this situation.

• The way in which most intermediaries are compensated—through commission on the insurance they sell—has given rise to concern among some risk managers. An alternative is to compensate the intermediary on a fee basis, which can be difficult to negotiate or calculate.

• Despite the advent of simplified insurance policies, with language that is designed to be more easily understood, insurance policies are difficult to read and understand. It is easy to assume coverage is broader and more complete than it actually is.

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ESTIMATING BUSNIESS INSURANCE NEEDS

Step One: Beginning the Process

Ideally, a risk exposure survey will show most of a company’s potential loss exposures, as described in . The risk manager should review the survey, each aspect of theChapter 3 company’s lines of business, and well-known industry hazards to generate a detailed checklist. When the checklist is complete, the risk manager can use it to create a comprehensive insurance package specific to the company’s needs.

is a guide to help risk managers ascertain their companies’ needs. It is notFigure 4.1 comprehensive, but it will give risk managers a place to begin. When compiling the checklist of insurance needs, the risk manager should consider which categories are relevant to the business.

When the analysis is reasonably complete, the risk manager should solicit proposals for insurance coverage, providing the results as a basis for the proposal. In some cases, risk managers interview and solicit insurance proposals from various . Anintermediaries intermediary is an individual or company that is licensed to sell insurance, such as an independent agent, a retail broker, or a surplus lines agent. Another name for intermediary is or .producer broker

Risk managers should select the producer they believe would deliver the best insurance coverage, providing that producer with a letter. The broker-of-record letterbroker-of-record appoints that producer as the corporation’s representative to all insurance carriers, and it permits the producer to approach the market for insurance coverage and pricing options on behalf of the client.

In general, insurance companies provide only one quotation for each piece of business that is submitted to them. If a broker does not present an organization’s complete insurance needs for a package price, the insurer may quote higher premiums than a bundled price. In some instances, because coverage is not sought as a package, the broker may obtain separate policies from different insurers, also resulting in higher premiums.

Step Two: Choosing an Intermediary

Proposals may be solicited from several different types of insurance intermediaries. Because individuals that sell insurance must be licensed in the state in which the prospective insured is located, the intermediary must be licensed in that state. In most states, all these intermediaries are now referred to and licensed as . Recall from producers

that there are different types of producers.Chapter 2

Figure 4.1

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Independent Agents

An represent one or more insurers in a given state, and are typicallyindependent agent compensated by commissions that insurance companies pay.

Independent agents are said to of the policies they write. When theown the expirations policy expires, an independent agent may offer the renewal to any insurance company he represents, and he has the right to sell those policy rights to anyone else. If either the insurance company or the independent agent for any reason terminates the agency agreement, the customers remain with the agent. He may then place them with any other company he represents.

It is the insurer that creates the agency relationship through the contract with the independent agent. The independent agent’s first duty and loyalty must be to the insurer that appointed him. The agency contract spells out the agent’s rights and responsibilities. One of an agent’s important rights is the right to bind the insurer to an insured. When the agent tells a customer that a risk is covered, the risk is covered. Among the agent’s responsibilities are: loyalty to the principal; truthfulness in dealings with the insurer; and accurate accounting of any funds that belong to the insurer.

The advantage of working with an independent agent is that with the availability of several markets, the agent should be able to find a good match for the customer—both in terms of coverage and price.

Exclusive Agents

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An represents only one insurance company. Unlike the independentexclusive agent agent, the exclusive agent may or may not own policy expirations, depending on the company. Either party may terminate the arrangement at any time.

Exclusive agents usually are compensated by commissions that their company pays.

Employee and Direct Writing Agents

Employee agents are licensed as insurance agents (producers), but they are employees of the insurer. They do not own their expirations and are usually employed at will by the insurer.

A direct-writing agent is an employee agent, but only does business over the telephone or Internet. Employee agents and direct writers usually are compensated with salary.

Brokers

Recall from that a is considered an agent of the insured—not theChapter 2 broker insurance company—and has permission to place coverage with certain insurers. However, in general, there is no agency contract between the insurer and the broker and a broker typically does not have binding authority. When a customer goes to a broker, the broker will try to place the customer with one of the companies with whom he has a relationship. However, the broker may not bind coverage for that customer without the express permission of the insurer.

There may or may not be a formal service agreement between the broker and the insured business. In many cases, a business that uses a broker for insurance and risk management services will issue a broker-of-record letter to that broker to establish the relationship. In others, a service agreement or contract may be executed. In lieu of commission, many brokers negotiate a service fee with the insured businesses they represent. This agreement outlines the level of service the broker has agreed to provide and the fee amount the business will pay for that service.

In larger commercial settings, brokers have the advantage of finding the best match for the applicant, without being tied to any company or system.

Surplus Lines Brokers

A is a specialized insurance producer who has relationships with surplus lines broker (see ). Nonadmitted insurers are not subject to rate andnonadmitted insurers Chapter 2

form regulation by the various states, and an insured cannot approach a surplus lines broker directly. Rather, a licensed intermediary must approach the surplus lines broker. Surplus lines brokers are usually compensated by insurance company commissions.

The advantage of working with a surplus lines broker is that they can quickly adapt their forms and underwriting to accommodate a risk without regulatory approval. Also, some business are engaged in activities that are unique or risk enough that they may be required to shop in the surplus lines market to find coverage (see “Frequently Asked Questions” below).

The biggest disadvantage is that the insured’s premium is not protected by a state’s

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guaranty fund, so claims may not be paid in the event that the nonadmitted company becomes insolvent. Any business considering surplus lines coverage should thoroughly investigate the company’s financial rating. (See Appendix A for a discussion about how insurance companies are rated).

Step Three: Binders of Insurance

After selecting an intermediary’s proposal, the risk manager should receive binders of insurance that reference the insurance coverage that is in place. The binders take the place of the insurance policies until they are issued.

The binders contain information similar to the declarations page of a policy:

1. Name and address of the insured, insurer, and intermediary

2. Forms that apply

3. Effective and expiration dates

4. Binder premium

5. The exposures covered, such as general liability, auto liability, and property

6. Limits of insurance that have been bound

Typically binders are issued for a period of thirty days. If the risk manager has not received the policy within that thirty-day period, a new binder should be issued. Many claims have been adjusted and settled based on the information that is contained in the binder. It is important that they accurately represent the coverage and are renewed if they expire.

Step Four: Reviewing Policies

The insurance policy is a contract that spells out the terms and conditions of coverage. Any discrepancies between the proposal, binder, and insurance policy will be controlled by the insurance policy. Any questions or discrepancies should be referred to the intermediary as soon as possible, before problems develop. The intermediary should act as an advocate for the insured in resolving any discrepancies. See , Selecting Insurers andChapter 6 Policies, for a more detailed discussion of insurers and policies.

The insurance departments in most states do review policy language and approve or disapprove wording. Most insureds have little or no input into the language of the policies that they purchase.

Thus, an insurance policy is a —the insurer has drafted the contractcontract of adhesion and the insured must adhere to it. Although this may not seem advantageous to the insured, it is important to remember that, because of this, courts typically interpret insurance policies in the light most favorable to the insured. If the insurer was not clear about the intent, the benefit of the doubt must be given to the insured. Coverage grants will be interpreted broadly and exclusions narrowly. Also, any undefined words will be given their ordinary meaning.

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Risk managers should review insurance policies as soon as they receive them. It is incumbent upon the insured to make sure that the policy as delivered by the insurer matches the proposal sent to the underwriter for coverage. Are all the requested coverages in place? Does the policy insure the right property? Does the policy provide coverage for all appropriate perils? Are there gaps in coverage or are there overlapping coverages? Any problem identified should be dealt with quickly, preferably before a claim arises.

State Minimum Standards

States have established minimum coverage requirements that insurance policies must meet. These requirements involve such items as minimum notices of cancellation and nonrenewal, allowable exclusions, and policy terms.

States set minimum standards because of the public policy aspect of the insurance transaction. The importance of the insurance contract to the general welfare of the public-at-large requires that insurance transactions meet a high standard of review. In addition to the adhesion contract aspects of the insurance policy, there are also other differences between the insurance policy and other contracts. One of the most important differences is that breach of a contract in a usual business situation does not allow the breached party to recover punitive damages awards. However, the issue of bad faith in insurance transactions has developed at law such that insureds that can prove breach of an insurance contract by an insurer can, in some circumstances, sue for and recover punitive damages or bad faith dealing awards.

Monoline vs. Package Policies

The insured may be presented with either a monoline or package policy:

• A covers only one line of insurance, such as a property policymonoline policy covering building and contents.

• A —on the other hand—covers more than one line, and oftenpackage policy combines property, general liability, auto, and excess liability coverage forms.

For instance, the Businessowners Package Policy (BOP) covers the building(s), other structures, and personal property of the insured. The liability section covers damages the insured may have to pay because of its liability to someone else for bodily injury or property damage. Auto and business income coverage can also be provided through the package.

In general, an insurance policy is made up of an insuring agreement that describes the property or liability risk covered, a definitions section, exclusions, and policy conditions. Any applicable endorsements are also attached to the policy. Each section should be reviewed with the agent or broker delivering the policy to see that it matches the specifications. The risk manager should become familiar with the policy exclusions, particularly as it is this section of the form that is frequently misunderstood and troublesome.

Use of Deductibles

One way to keep the premium down is through the use of higher . Adeductibles deductible is the amount for which the insured is responsible on any property loss before

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the insurance pays. If the property deductible is $50,000 and the loss is $1 million, the insured would pay $50,000 and the insurer, $950,000.

A functions in a similar way. The specific wording of deductibleself-insured retention and self-insured retention language should be reviewed to determine exactly how they would work.

A higher deductible shows the insurer that the insured is willing to share in a greater portion of any loss, and the insurer rewards this willingness with a reduced rate. However, the insured must be certain that in case of a loss, it can quickly and easily come up with the amount of the deductible. The important thing is how much premium is being saved for choosing the higher deductible. With a $100,000 deductible, risk managers need to see how much credit they are getting for taking on the exposure to that extra $50,000. In some cases, insurers may insist that an insured assume a higher deductible or it will decline to write the business.

The typical deductible is a or , which means thatflat deductible straight dollar deductible a dollar amount applies to any loss. Flat deductibles usually apply on a “per claim” basis, which means that the deductible is subtracted from each claim, even when more than one claim arises from one accident or occurrence. However, some flat deductibles apply on a “per occurrence basis”, which means that only one deductible applies to all claims that arise from the same accident or occurrence—an important distinction for risk managers to be aware of.

. ABC Restaurants selects a $10,000 per claim deductible for itsExample general liability program. Unfortunately, one of its restaurants offers a Mother’s Day buffet that includes salmonella-tainted tuna salad. On Mother’s Day, 291 people are victims of food poisoning. Since the restaurant has a per claim deductible, the restaurant must pay the first $10,000 of each of the 291 individual claimants’ negligence claim.

Conversely, ABC selects a $10,000 per occurrence deductible. If the same situation occurred, the restaurant probably would have to pay only one $10,000 deductible.

Another type of deductible is a , which is a percentage of the limitpercentage deductible of liability for covered property. Some policies combine flat and percentage deductibles. For instance, a policy may be written with a $10,000 deductible, but that does not apply to a loss from an earthquake. In that case, the deductible for earthquake damage can range from 2 to 25 percent of the limit.

DETERMINING PERSONAL INSURANCE NEEDS

The process of determining the insurance needs for an individual or family is similar to the process that is used for businesses, though the needs themselves are often simpler. Individuals need not concern themselves with binders of insurance, but they do need to

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analyze their risks, select an intermediary (or decide to purchase coverage directly from an insurer), and review their current coverage.

Analyzing Individual and Family Risk

Like businesses, individuals should begin the process by analyzing which types of risks they face. In most cases, these risks will involve a risk of loss to property, a risk of liability, or health-related risks.

The type of property that needs to be covered will determine the type of policy that should be purchased to protect against its loss:

• Most types of personal property are protected by a homeowners policy (see ) or equivalent policies for condo owners or rental unit tenants (see Chapter 12 ).Chapter 13

• Vehicles, which generally include most types of self-powered conveyances, are typically covered by a personal auto or recreational vehicle policy (see ).Chapter 11 More specialized vehicles such as aircraft and large boats may require their own policies from specialized insurers.

• Property that is used in a business may be covered under commercial policy (see ), but is often not if it is owned by an individual, rather than a businessChapter 23

entity. In those situations, both personal and commercial lines offer riders and other add-ons that may be used to cover property that may not be protected otherwise (see ).Chapter 31

For individuals, liability can arise from either ownership of property or actions taken by the insured. For most people, a homeowners policy provides ample coverage for any types of liability that may occur. For more coverage, or coverage that addresses particular needs, individuals may want to consider a personal umbrella policy that can provide an extra layer of protection (see ).Chapter 13

Finally, health problems carry two kinds of risk. The first is the cost of treatment, which can be insured against by purchasing health insurance (see ) and long-termChapter 19 care insurance (see ). The second health-related risk is that a medical conditionChapter 21 may impair an individual’s ability to work and earn income. Obviously this risk varies depending on one’s unique financial circumstances, both those who are in their prime working years can protect against such a loss of income by purchasing short-and long-term disability insurance (see ).Chapter 17

Selecting an Agent

The different types of insurance producers described above and in areChapter 2 available to individuals as well as businesses, though individual rarely have needs that require a broker or purchases form the surplus lines markets. In addition, individuals who are also employees may be able to obtain various types of coverage through their employers or a professional association, and business owners may find that insurers are willing to offer competitive premiums on personal lines in order to retain the business as commercial line policyholder. In general, it pays for individuals to routinely review their

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insurance needs and to shop around for policies or (bundles of policies) that make the most sense given their specific needs.

Health, disability, and long-term care insurance are frequently available through an employer, and self-employed individuals may enjoy certain tax advantages when purchasing insurance for health-related risks. Individuals who are not purchasing coverage through the workplace can also take advantage of coverage offered directly from insurers or through an intermediary.

Reviewing Coverage

Individuals should review their insurance coverage regularly. During these reviews, it is important to make sure that the coverage they have still matches the risks to which they are exposed. Several common problems that can arise when insurance coverage is neglected include:

• . Most homeowners policies contain coinsuranceUnderinsurance of one’s home clauses (see “Coinsurance Requirements” in ) that significantly restrictChapter 12 coverage if the amount of coverage falls below a certain percentage of the home’s value. If a home’s value has increased over several years without a corresponding increase in coverage levels, the homeowner could find that the coverage provide in the event of a loss is not nearly enough to make the needed repairs.

• . Individuals makeCoverage that hasn’t kept up with the insured’s financial life decisions about how much coverage is needed based in large part on their own financial circumstances. If those circumstances change—for better or for worse—an adjustment in insurance coverage may be warranted. This adjustment may mean purchasing more coverage or it may mean purchasing less.

. When Rita got her first “real job” after college seven years ago, sheExample 1 purchased a long-term disability policy that paid 60 percent of her income for two years after a ninety-day waiting period. Since then Rita has married, had one child, and she remains the primary breadwinner for her household. After reviewing the disability coverage, she and her spouse decide to upgrade to a policy that has a shorter waiting period and a longer length of coverage.

. Jeff has a job that requires frequent travel by car, and has had theExample 2 same personal auto coverage since he was in his early twenties. When he first bought the coverage, money was tight and he knew that he didn’t want to have the risk of a large deductible if his car was ever damaged, so he purchased a policy with relatively low coverage amounts and a low deductible. Ten years later Jeff now has a much higher income and significant investments. When he reviewed his personal auto coverage, he elected to increase both the coverage amount—to protect his assets—and deductible—to reduce his premiums—significantly.

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• . Any policy that allows benefits to be received by a thirdOutdated beneficiaries party should be reviewed to make sure that those third parties are still appropriate. This can include children, (ex-) spouses, and lenders.

• Insurance that was purchased for property that is no longer owned, or is used . If a type of insurance was purchased because the insured used thedifferently

property a certain way or had a particular type of property, coverage should be changed if that condition no longer applies. For instance, if an insurer was chosen because it offered good rates on a bundle of policies that included coverage for a boat, and the insured no longer owns the boat, it may be beneficial to shop for a different carrier. Similarly, a homeowner who no longer rents out part of her home may need different (and perhaps less expensive) coverage.

Finally, policyholders should use their regular insurance reviews to make sure that (1) current inventories of insured property are up to date so that they can be provided to the insurer in the event of a loss (see “Duties After a Loss” in ), and (2) importantChapter 12 insurance documents, including full copies of all policies, are stored somewhere that will be protected in the event of an emergency. Traditionally, this has meant using a physically secure form of storage such as a fire-proof box or safe deposit box at a bank. However, more technically inclined policyholders often use online “cloud” services to store electronic copies of these documents that can be viewed and printed from anywhere. Regardless of the strategy employed, policyholders should know where those documents are.

WHERE CAN I FIND OUT MORE?

1. Many insurers that specialize in particular industries or groups may have developed checklists. Coverage applications, which ask many of the questions that are necessary to determine what exposures need to be addressed, are another valuable source.

2. RIMS, the risk management society™, .www.rims.org

3. The Council of Insurance Agents and Brokers (CIAB), .www.ciab.com

4. Independent Insurance Agents and Brokers of America (IIABA) www ..independentagent.com

5. The National Association of Professional Insurance Agents, .www.pianet.com

6. The FC&S Bulletins. Cincinnati: The National Underwriter Company. www ..nationalunderwriter.com/fcs-online.html

FREQUENTLY ASKED QUESTIONS

– What if a business’s exposures are unique and very hazardous?Question

– In this case, the surplus lines market may be the only place to find coverage. TheAnswer surplus lines company that does insure this business will not have the advantage of a

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