PRINCIPLES OF INSURANCE

215 Pages·2004·0.54 MB·English

PRINCIPLES OF INSURANCE

LESSON 1A INSURANCE BASICS

This lesson focuses on the following topics:

•WHAT IS INSURANCE?
•BASIC INSURANCE DEFINITIONS

WHAT IS INSURANCE?

An insurance policy is a legally binding contract between an insurance company and the

person who buys the policy, commonly called the "insured" or the "policyholder."

In exchange for payment of a specified sum of money, called the "premium," the

insurance company agrees to pay the "beneficiary" (or for some benefits, the "owner")

of the policy a fixed or otherwise determinable amount of money, if circumstances that

are set out in the policy, occur.

Another way of looking at insurance is to consider that it is a group of people getting

together and paying on a regular basis into a 'pooled' account. If any of them need to

claim off the insurance because of some personal calamity, the money is there to

enable this to happen. In that way, insurance serves as a risk transfer mechanism by

which people or businesses can shift some of their uncertainties or risks to the

insurance companies. The insurance companies charge a fee, known as a premium, for

accepting these risks, and in return, agree to pay for the financial losses that the

policyholder may suffer.

BASIC INSURANCE DEFINITIONS

Some of the basic insurance definitions are discussed here:

Application – The first questionnaire an insurance applicant fills out when he applies

for insurance. This form will ask for information about the applicant and the subject to

be insured (i.e., the applicant’s car, houses, personal property, etc.).

Cancellation – The termination of insurance coverage during the policy period. This is

further divided into three types of cancellations:

i.
Flat Cancellation – The cancellation of a policy as of its effective date,

without any premium charge.

ii.
Pro-rata Cancellation – When the policy is terminated at midterm by the

insurance company, the earned premium is calculated only for the period for

which the coverage was provided. For example: An annual policy with a

premium of $1,000 is canceled after 40 days of coverage at the company’s

election. The earned premium would be calculated as follows:

Earned Premium = 40/365 days x $1,000

Earned Premium = .110 x $1,000

Earned Premium = $110

iii.
Short-rate Cancellation – When the policy is terminated prior to the

expiration date at the policyholder’s request, then the earned premiums

charged would be more than the pro-rata earned premium. Generally, the

return premium would be approximately 90 percent of the pro-rata return

premium. However, the company may also establish its own short-rate

schedule.

Decline – This refers to a situation when the company refuses to accept the request for

insurance coverage.

Effective Date – This is the date on which the insurance policy begins.

Expiration Date – This is the date on which the insurance policy ends.

Insurance Agent – A person authorized by, and acting on behalf of the insurer, to

transact all classes of insurance that the insurance company is licensed to sell.

*** QUIZ NO 1 ***

LESSON 1B INSURANCE BASICS

This lesson focuses on the following topics:

•WHO NEEDS INSURANCE?
•TYPES OF INSURANCE

INSURANCE AGENT?

Insurance is everyone’s need. Anyone who owns something or desires personal

protection needs insurance. From individuals to businesses, insurance is a way to

protect all of us from financial loss, disaster, and bad investment.

Everyone should buy insurance based on his/her unique personal needs. The market

offers a wide range of insurance products, including property, liability, health, disability,

crisis, savings, income protection and investment, to match the changing needs of

people or businesses at different stages of their lives.

Certain insurance contracts are also made compulsory by legislation. For example,

Oregon law states that tavern and liquor establishments must carry $300,000 of liquor

liability insurance or maintain a bond not less than $300,000 with a corporate surety

authorized to conduct business in Oregon. Many states require employers to purchase

workers’ compensation to protect employees injured on the job.

TYPES OF INSURANCE

There are many types of insurance. Here we will discuss the most common types of

insurance. Each type of insurance protects the insured from a different type of financial

loss.

Life Insurance – In this type of insurance, the company provides money to the

insured’s beneficiary when the insured dies.

Health Insurance – This type of insurance covers medical and hospitalization bills of

the policyholder.

Long-term Care Insurance – This type of insurance covers the person’s expenses

relating to nursing and hospitalization for the elderly.

Disability Insurance – This type of insurance provides income in case the insured

becomes disabled and is unable to work.

Personal Property Insurance – This type of insurance covers the property against

damages.

Home Owner's Insurance – This type of insurance covers damages to the insured’s

house.

Automobile Insurance – This type of insurance covers the insured’s car and

passengers against damages.

Other types of Insurance – There are also some other types of insurances related to

the Business, Disaster, Travel, etc.

INSURANCE AGENT

The insurance agent is an individual who sells and services insurance policies. There

are generally two classifications of agents:

1. Independent Agent

An independent agent represents at least two insurance companies, and

services clients by searching the market for the most advantageous price for the

most coverage. The agent's commission is a percentage of each premium paid

and includes a fee for servicing the insured's policy.

2. Captive or Exclusive Agent

This type of agent represents only one company, and sells only its policies. This

agent is paid on a commission basis in much the same manner as the

independent agent.

*** QUIZ NO 2 ***

LESSON 1C INSURANCE BASICS

This lesson focuses on the following topics:

•WHAT DOES AN INSURANCE AGENT DO?
•RESPONSIBILITIES OF AN INSURANCE AGENT
•SUMMARY

What Does an Insurance Agent Do?

The agent system for the distribution of insurance has worked pretty well over the years,

with agents marketing the products of the insurer and, at the same time, educating the

consumers on how to limit risks and make better choices regarding their insurance

needs. As insurance costs have increased dramatically in the last decade, agents have

achieved a key role in planning cost saving measures for individuals as well as small

businesses.

Responsibilities of an Insurance Agent

The insurance agent needs to:

•
Work with clients to evaluate their need for protection

•
Educate the client by explaining the various plans available and by providing

appropriate cost indexes

•
Make specific recommendations that suit the client's objectives and budget

•
Encourage the client to act in a timely fashion to assure that the proper coverages

are in place when they are needed. The agent also sees to it that accurate and

complete information is provided to the insurer to make sure that the client gets the

very best premium available.

•
Keep in contact with the client, and periodically review or update their coverage. The

agent should suggest appropriate changes, and counsel clients on ways to reduce

cost. Often they will need to assist their client in reviewing the need for legal and tax

compliance, and recommend other professional assistance when necessary.

•
Assist with claims, answer questions and serve as the mediator in helping their

clients deal with insurance companies.

•
Assist business owners in communicating their benefit packages to their employees,

often assisting the employee in seeing how the benefits coordinate with their

personal financial programs as well as those provided by government entities.

SUMMARY

In this lesson, we touched on the basics of insurance. We discussed some definitions of

insurance and the insurance policy. We learned about the application process for the

insurance policy, the cancellation processes at different stages during the policy, and

some important dates which need to be taken into consideration by the insurer. We also

discussed different types of insurance which mainly include Life, Health, Long-term,

Personal property, Disability and Automobile. At the end of the lesson, we discussed the

major responsibilities of the insurance agent, and the important role a good relationship

between the client and the company plays.

*** QUIZ NO 3 ***

LESSON 2A LIFE INSURANCE BASICS

This lesson focuses on the following topics:

•WHAT IS A LIFE INSURANCE POLICY?
•REASONS FOR PURCHASING LIFE POLICIES
•LIFE INSURANCE: AN ASSET
•ESTIMATING LIFE NSURANCE NEED
•

WHAT IS A LIFE INSURANCE POLICY?

In a life insurance policy, the most common event is the death of the person who is

insured—in which case the payment is made to the beneficiary. Depending on the type

of policy, it sometimes may be the insured person attaining a certain age, or the owner

requesting to surrender the policy for its cash value, or to take that cash value out in the

form of monthly payments for a set number of years of the insured's life.

REASONS FOR PURCHASING LIFE POLICIES

People purchase life insurance for many reasons. Some of them are discussed here:

• Family protection – To provide financial security to surviving family members upon

the death of the insured.

• Insurance to cover a particular need – Such as paying off a mortgage or

consumer debt upon the insured’s death.

• Business insurance – To compensate a company on the death of a key employee

or to provide a surviving partner the resources to buy out the deceased partner’s

share of the business.

• To provide funds – To pay estate taxes or other final obligations necessary to settle

a deceased person’s estate.

LIFE INSURANCE: AN ASSET

A reasonable way to approach life insurance is to think of it as an asset rather than a

necessary expenditure. In fact, life insurance is akin to investment in property. Some of

the advantages of buying life insurance are listed below:

• It is a very secure asset

• The policy owner need not worry about closely managing it

• It is purchasable in any affordable amount

• It provides a reasonable rate of return

• Proceeds are payable immediately

• The policy owner can choose his/her method of premium payment

ESTIMATING LIFE INSURANCE NEED

There are several simple methods used to estimate an applicant’s life insurance need.

Next we will review these methods along with examples.

The most basic rule of thumb is the Income Rule, which states that the insured’s

insurance need would be equal to 6 or 8 times his/her gross annual income.

Example: Allie is earning a gross annual income of $60,000. She should have between

$360,000 (6 x $60,000) and $480,000 (8 x $60,000) in life insurance coverage.

The Income Plus Expenses Rule states that the insured’s insurance needs to be

equal to 5 times his/her gross annual income plus the total of any mortgage, personal

debt, final expenses, and special funding needs (i.e., college, university etc.).

Example: Assume that Fredrick earns a gross annual income of $60,000 and has

expenses that total $160,000. His insurance need would be equal to $460,000 ($60,000

x 5 + $160,000).

*** QUIZ NO 4 ***

LESSON 2B LIFE INSURANCE BASICS

This lesson focuses on the following topics:

• ESTIMATING LIFE INSURANCE NEED

o PREMIUMS AS PERCENTAGE OF INCOME
-Family Needs Approach
-Income Replacement
-Estate Preservation and Liquidity Needs
• THE APPLICATION PROCESS

o INTRODUCTION
o PARTIES INVOLVED IN THE APPLICATION PROCESS

Premiums as Percentage of Income

Using the Premiums as Percentage of Income rule, a minimum of six percent of the

insured’s gross income (as the primary income earner) should be spent on life

insurance premiums. Add an additional one percent for each dependent. Once the

applicant determines the percentage of the income that should be spent on life

insurance premiums, the agent may advise purchasing as much life insurance as the

applicant can get for that premium amount.

There are other more comprehensive methods used to calculate life insurance need.

Overall, these methods are more detailed than rules of thumb and provide a more

complete view of insurance needs. These methods are:

• The Family Needs Approach
• Income Replacement
• Estate Preservation and Liquidity Needs

The Family Needs Approach requires the applicant to purchase enough life insurance

to allow his/her family to meet its various expenses in the event of the applicant’s death.

Under the family needs approach, the applicant divides his/her family's needs into two

main categories:

1. Immediate Needs at Death (Cash Needs)

2. Ongoing Needs (Net Income Needs)

Once the applicant determines the total amount of his/her family's needs, he/she may

purchase enough life insurance to cover that amount.

The Income Replacement calculation is based on the theory that the purpose of life

insurance is to replace the loss of the applicant’s income when he/she dies. Under this

approach, the amount of life insurance the applicant should purchase is based on the

value of the income that he/she can expect to earn during his/her lifetime, taking into

account such factors as inflation and anticipated salary increases.

The Estate Preservation And Liquidity Needs approach attempts to calculate the

amount of life insurance needed upon the applicant’s death for items such as taxes,

expenses, fees, and debts, while preserving the value of his/her estate. This method

takes into consideration the amount of life insurance needed to maintain the current

value of his/her estate for his/her family, while providing the cash needed to cover death

expenses and taxes.

THE APPLICATION PROCESS

Introduction

First things first—to get insured, one needs to get an application from the insurance

company. The applicant then fills out the form, signs it, and returns it for consideration.

It is often required that the applicant be physically present in front of the agent while the

questions are being filled out on the application. The information provided in the

application form gives the underwriters of the insurance company a basis for

determining if they will issue a policy.

Parties involved in an Insurance Application

There are three parties relevant to an insurance application, namely:

The Proposed Insured – This is the person whose life is being insured by the

life insurance policy.

The Applicant – This is the person applying to the insurance company for life

insurance and may or may not be the proposed insured.

The Policy Owner – This is the person that usually pays the premiums and the

person who retains all rights to any values or options contained in the policy.

*** QUIZ NO 5 ***

LESSON 2C LIFE INSURANCE BASICS

This lesson focuses on the following topics:

•MINOR APPLICATIONS
•CORRECTING THE APPLICATION
•CONDITIONAL RECEIPT
•REPRESENTATIONS/WARRANTIES

FRAUD/CONCEALMENTMinor Applications

As a rule, minors - mostly persons of age less than 18 - are not allowed to enter

contracts. However, life insurance allows an exception: A person is a minor only until

age 15.

In case the proposed insured is not yet 15 years of age, one of the following persons

will have to sign the application on behalf of that child:

• His/her mother or father.

• A court-appointed guardian.

Correcting the Application

To change any information on the form, the proposed insured must initial any and all

changes on that application. Extra care must be taken when filling out the application

forms, since the insurance company can cancel or rescind the entire contract from the

date of issue, if the error is discovered after the issuance of a policy. Of course, this

must take place before the incontestability clause of the contract takes effect.

Conditional Receipt

The receipt located at the bottom of the application is called a conditional receipt. The

agent is advised to collect the first full premium from the applicant at the time of

application, and to use this receipt. Being conditional, it states in very clear terms that

the policy acceptance is subject to the approval of the carrier. It also acknowledges

payment of the first full premium.