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Insurance and Risk Finance 640


Insurance and Risk. Finance 640. Class 11. October 27, 2004. Types of Personal Auto Coverage ... Economic Rationale for Compulsory Auto Insurance ... – PowerPoint PPT presentation

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Title: Insurance and Risk Finance 640

Insurance and RiskFinance 640
  • Class 11
  • October 27, 2004

Types of Personal Auto Coverage
  • Third party liability
  • First party medical payments
  • In no-fault states PIP coverage for medical
    expenses and lost income
  • Uninsured and underinsured motorists
  • Physical damage

Basic Part of Personal Auto Policy
  • Part A Liability Coverage
  • Part B Medical Payments Coverage
  • Part C Uninsured Motorists Coverage
  • Part D Coverage for Damage to Your Auto
  • Part E Duties After an Accident or Loss
  • Part F General Provisions

Part A Liability Coverage
  • Insuring Agreement
  • Insurer promises to
  • Pay damages for which an insured person is
    legally liable because of an auto accident
  • Defend the Insured
  • Pay the costs of defense

Liability Coverage
  • Single limit known as a combined single limit
  • Split limits
  • Example
  • 100,000 per person for bodily injury
  • 300,000 per accident for bodily injury
  • 50,000 per accident for property damage
  • No annual aggregate limit

Liability Coverage
  • Compulsory liability
  • Most states make minimum limits mandatory
  • Financial responsibility laws
  • Penalize negligent drivers who cannot pay minimum
    damage amount
  • All states have such laws
  • Liability insurance satisfies laws

Ohios Financial Responsibility Law
  • Ohio does not require drivers or owners to buy
    car insurance.
  • Instead, you are required to have a guaranteed
    way to pay for injuries or damages that result
  • Your negligence as a driver, or
  • The negligence of anyone operating an auto that
    you may own.
  • This guarantee is known as proof of financial

Ohio Proof of Financial Responsibility
  • Insurance with minimum limits of
  • 12,500 to Bodily Injury to one person in any one
  • 25,000 Bodily Injury to two or more persons in
    any one accident
  • 7,500 Property Damage for injury to property of
    others in an accident
  • 30,000 bond issued by a surety company
  • Certificate of bond in the amount of 30,000
  • Signed by two individuals
  • Who own real estate having equity totaling at
    least 60,000
  • Certificate of the Treasurer of the State
    evidencing the deposit of 30,000 in money and

Liability Coverage
  • Who is insured and when?
  • Named insured plus
  • resident spouse
  • other family members
  • others who use the covered auto with permission
  • Covered auto is vehicle listed on the policy plus
  • newly acquired vehicles
  • temporary substitute vehicles

Liability Coverage Types of exclusions
  • Intentional injury or damage
  • Injury to an employee covered under WC
  • Using vehicle as a public or livery conveyance
  • Vehicles used in auto business
  • Vehicles with less than 4 wheels
  • Vehicles furnished or available for the insured
    or family members regular use

Liability CoverageSupplementary Payments
  • In addition to policy limits, payments for
  • Bail bond up to 250
  • Premiums on appeal and release of attachments
  • Interest on the judgment
  • Loss of earnings up to 50 day to attend a
    hearing or trial
  • Other reasonable expenses incurred at the request
    to the insurer

Medical Payments Coverage
  • In tort liability states
  • Optional
  • Limits are generally low (e.g., 1,000 - 2,500)
  • Payments regardless of fault
  • Payments not coordinated with other medical
    expense insurance
  • could collect twice

Medical Payments Coverage (cont.)
  • Insured persons are
  • Named insured and family members
  • While occupying a motor vehicle
  • When struck by a motor vehicle while walking
  • Other persons while driving a covered auto

Medical Payments Coverage
  • In no-fault states
  • Personal injury protection (PIP)
  • Often compulsory
  • Also provides limited loss of income coverage

Uninsured and Underinsured Motorists Coverage
  • Coverage if liable party has no or insufficient
  • Coverage for all damages that otherwise would
    have been paid
  • medical expenses
  • lost income
  • pain and suffering
  • Compulsory in many states
  • Applicants wishing to decline UM/UIM may be
    required to sign a waiver form.

Uninsured and Underinsured Motorists Coverage
  • Uninsured Vehicles
  • Vehicles with no applicable BI liability coverage
  • Vehicles with coverage less that the amount
    required by the states financial responsibility
    or compulsory insurance law
  • Hit and run vehicles
  • Vehicles where the bonding or insurance company
    is insolvent

Uninsured and Underinsured Motorists Coverage
  • Underinsured Motorist Coverage
  • Applies when other driver has liability insurance
    limit that is less than your actual damages

Physical Damage Coverage
  • Collision
  • Covers damage from collisions and rollovers
  • Other-than-collision (comprehensive)
  • Covers damage from
  • falling objects, explosions, glass breakage,
  • earthquake, windstorms, hail,
  • contact with an animal
  • Deductibles generally used for both

Physical Damage Coverage (cont.)
  • Payment of loss
  • Company will pay the lesser of
  • Actual cash value or,
  • The cost to repair or
  • The cost to replace
  • Less any applicable deductible.
  • Loss to a non-owned trailer is limited to 500

Auto Insurance Price Increases
Average Auto Insurance Expenditures by State
Rating Factors
  • Driver characteristics
  • Age
  • Gender
  • Marital status
  • Use of the auto
  • Number of autos
  • Other factors
  • Driving Record
  • Territory

Bodily Injury Claim Frequency
Restrictions on Rating Factors
  • Examples
  • Gender
  • Marital status
  • Use driving experience instead of age (MA)
  • Territory

  • Insurers have discretion to deny coverage in most
  • Underwriting criteria
  • Typically, lower rates are associated with more
    stringent underwriting criteria
  • Example
  • deny if potential insured drinks alcohol
  • charge lower rates than competitors who do not
    use this criteria

Government Restrictions on Underwriting
  • Some states require insurers to accept all
    applicants, I.e., no underwriting
  • Underwriting restrictions are generally related
    to rating restrictions
  • otherwise rating restrictions can be circumvented
  • Disadvantages of restrictions (see Ch. 8)
  • Prices do not reflect expected costs as closely
    distorts behavior
  • Costly to enforce

Residual Markets
  • Provide insurance at a regulated price to those
    who otherwise would find it difficult to buy
  • All states have one
  • Market shares vary widely
  • Higher market share in states with
  • more restrictions on rating and underwriting
  • more regulation of rate changes

Residual Market Share by State
Types of Residual Market Plans
  • Assigned risk plans
  • Most states
  • Applicants assigned to insurers in proportion to
    their market share
  • Insurer receives the (regulated) premium and pays

Types of Residual Market Plans
  • Reinsurance facilities
  • Each insurer sells to all applicants
  • Insurer can reinsure unwanted insureds to state
  • Deficit of reinsurer is paid
  • by all insurers in proportion to their market
  • by all policyholders (recoupment fee)

Types of Residual Market Plans
  • Joint underwriting associations
  • State hires several insurers to insure unwanted
  • Agents submit applications to these insurers
  • Deficit is paid by all insurers in proportion to
    their market share
  • State insurer (MD)
  • Deficit is paid by all insurers in proportion to
    their market share

Economic Rationale for Compulsory Auto Insurance
  • Without it, accident costs will not be borne by
    those who cause accidents
  • Uninsured do not bear the full cost of their
  • some drive even though benefits of driving
  • Uninsured do not bear the full cost of decisions
    to drive less safely
  • drive less safely than if forced to purchase
    insurance with experience rating

Criticisms of Compulsory Insurance
  • Its regressive
  • I.e., it disproportionately hurts low income
  • Forces them to buy insurance to protect other
  • Weak enforcement
  • Better to allow people to opt out by making a
    contribution to the state (VA, SC)

No-fault versus Tort Liability
  • Tort liability
  • Drivers that cause accidents can be sued for the
    losses incurred by others
  • Pure no-fault
  • Drivers pay their own costs regardless of fault
  • No law suits
  • No state has pure no-fault
  • Tort liability is restricted, not eliminated

No-fault Laws
  • Mandatory PIP coverage
  • Varies across states
  • Under 10,000 in MA, unlimited in MI
  • Limitations on suits
  • Cannot sue for losses covered by mandatory PIP
  • Cannot sue for pain and suffering unless
  • losses exceed a monetary threshold
  • losses meet verbal threshold

Arguments For and Against No-fault
  • For
  • More efficient compensation system
  • Less pain suffering compensation
  • Faster compensation
  • Lower legal costs
  • Against
  • Reduces safety
  • Not fair

Effect of No-fault on Premiums
  • Depends on
  • Limitations on tort liability
  • Level of mandatory PIP coverage

Homeowners Insurance Types of Policies
  • Multiple-line
  • 1st party property
  • 3rd party liability
  • 3rd party medical expense
  • Multiple-peril
  • Fire, windstorms, theft, etc.
  • Named peril versus open peril policies
  • Standard policy forms (HO3 form most common)

Major Coverages
  • Type of Coverage Amount of Coverage in HO3
  • A. Dwelling Chosen by policyholder
  • B. Other Structures 10 percent of dwelling
  • C. Unscheduled Personal Property 50 percent
    of dwelling coverage
  • D. Loss of Use (e.g., additional
  • living expenses if dwelling
  • cannot be occupied) 20 percent of dwelling
  • E. Personal liability 100,000 (can be
  • F. Medical payments to others 1,000 per
    person(can be increased)
  • 25,000 aggregate limit (can be

Insuring Agreements Section II
  • Personal Liability Coverage E
  • Has a single limit of 100,000 per occurrence
  • Can be increased by payment of additional premium
  • Applies to any claim or suit for damages
  • Because bodily injury or property damage
  • Caused by an insureds personal activities.

Insuring Agreements Section II (cont)
  • Medical Payments to Others Coverage F
  • Pays up to 1000 for medial bills of someone who
    is accidentally injured
  • On the premises of an insured or,
  • By the activities of an insured
  • A residence employee or,
  • By an animal owned or cared for by an insured
  • This limit can be increased

Persons Insured Homeowners Section II
  • Name Insured and Spouse
  • Resident Relatives
  • Any person under age 21 in the care of the
  • Any student enrolled in school full time, who was
    a resident of the household before moving out to
    attend school, provided the student is under the
    age of
  • 24 and your relative
  • 21 and in the care of the insured, spouse or
    resident relatives

Persons Insured Homeowners Section II(cont.)
  • Any person or organization responsible for
    covered animals or watercraft owned by an insured
  • With respect to a covered vehicle, any person
    acting in the employment of an insured

Excluded Perils
  • Intentional acts
  • Normal wear and tear
  • Changes in laws
  • Earthquakes
  • Floods
  • Nuclear accidents
  • War

Homeowners Special Limits
  • 200 on money, bank notes, bullion, coins and
  • 1500 on securities, valuable papers, stamp
  • 1500 on watercraft, including trailers and
  • 1,500 for theft of jewelry, watches, furs,
    precious and semi-precious stones
  • 2,500 for theft of firearms and related

Homeowners Special Limits (cont.)
  • 2,500 for theft of silverware, goldware,
    pewterware, etc.
  • 2,500 on property, on residence premises, used
    for business
  • 500 on property, away from residence premises,
    sued for business
  • 1,500 on certain electronic apparatus while in
    or upon a motor vehicle
  • 1,500 on certain electronic apparatus used
    primarily for business, while away from the
    residence premises and not in or upon a vehicle.

Endorsement to Section II Coverages
  • Business pursuits designed to cover certain
    occupations for legal liability arising out of
    business activities
  • Sales representatives
  • Teachers
  • Messengers
  • Collectors
  • Office employees
  • Personal Injury
  • False arrest, detention or imprisonment,
    malicious prosecution
  • Libel, slander, defamation of character
  • Invasion of privacy, wrongful eviction, wrongful

Section II Endorsements (cont.)
  • Watercraft and recreational vehicles Separate
    endorsements are needed for each
  • Watercraft endorsement Provides liability and
    medical payment coverage
  • On any inboard or outboard powered watercraft,
  • Sailing vessels 26 feet or more in length and
  • Watercraft powered by outboard motors exceeding
    25 total horsepower

Property Loss Settlement
  • Per occurrence deductible
  • Methods of valuing property
  • Like-kind replacement cost
  • Actual cash value
  • replacement cost - depreciation
  • Guaranteed replacement cost
  • Functional replacement cost

  • Premium (insured value) x rate
  • Estimation of insured value
  • square footage
  • dwelling type
  • construction grade
  • construction material
  • location
  • Factors affecting the rate
  • location
  • construction materials

Personal Umbrella Policies
  • Excess liability coverage
  • Limits 1 million
  • Applies once losses exceed limits on other
  • auto liability
  • homeowners

Coverage of Catastrophic Perils
  • Earthquake
  • Offered by most homeowners insurers
  • required in CA
  • Deductible of home value
  • Flood (NFIP)
  • Purchased through private insurers
  • Risk borne by federal government (taxpayers)
  • Some policies are subsidized
  • Moral hazard
  • Many exposed homeowners go w/o coverage

Residual Market Plans
  • Fair Plans
  • Created following urban riots in 1967-68
  • Subsidized coverage for urban property
  • CA expanded scope between 94-96
  • 28 states have plans
  • Beach and Windstorm Plans
  • Subsidized coverage for coastal property
  • 7 states have plans

Policies in Beach and Windstorm Plans
Hurricane Andrew
  • 16 billion in insured losses
  • Insurers attempted to (1) reduce exposure and (2)
    increase price
  • FL restricted both activities
  • Still many homeowners could not find coverage
  • Beach windstorm plan exposure increased
  • FL created new residual market plan in 1993 (JUA)
  • Merged beach windstorm plan with JUA in 2002
  • Created Hurricane Catastrophe Fund in 1993
  • Investment earnings not taxed

Northridge Earthquake
  • 12.5 billion in insured losses
  • Insurers attempted to (1) reduce exposure to
    earthquakes and (2) stop selling homeowners
  • CA restricted ability to cancel or fail to renew
  • Created CA Earthquake Authority (CEA)
  • Insurers could satisfy its requirement to sell
    earthquake coverage by offering a CEA policy

Government Reinsurance Arrangements
  • FL, CA, and HA have reinsurance plans
  • Proposals have been introduced for federal plan
  • Advantages
  • Preferential tax treatment of investment earnings
    on capital set aside to fund future losses
  • Governments can facilitate risk pooling over time
  • Potential disadvantages
  • Inadequate pricing
  • Raid funds for other purposes

New Capital Market Instruments
  • Examples
  • Catastrophe bonds
  • Insurer issues bonds
  • If cat occurs, insurer does not have to repay
    interest and/or principal
  • Contingent equity
  • Insurer has option to issue new stock at
    pre-arranged price if a catastrophe occurs
  • Potential advantages
  • Insurer can hold less equity capital
  • Lower tax and agency costs