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13-1
Personal Finance:An Integrated Planning
Approach
Winger and Frasca
Chapter 13
Property and Liability Insurance:
Protecting Your Lifestyle Assets
13-2
Introduction One of the methods for protecting wealth is the
purchase of insurance. By purchasing insurance, individuals transfer the
risk of loss to an insurer in exchange for a small payment, the insurance premium.
A home is usually one of the most valuable assets that individuals own and protecting its value can be done through the purchase of insurance.
Automobile insurance protects against property damage, medical expenses, and liability.
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Chapter Objectives
1. To review the foundations of insurance coverage
2. To understand the primary components of the homeowners’ and auto insurance packages
3. To list and explain the standard formats for homeowners’ insurance policies
4. To learn how to evaluate your auto and home insurance needs
5. To be able to find and fill any gaps in your homeowners’ and auto coverage
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Topic Outline
Fundamental Insurance Concepts Homeowners’ Insurance Automobile Insurance
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Fundamental Insurance Concepts
The first concept to understand is risk. There are two types of risk: Speculative and pure risk.
Speculative risk There is an opportunity for both gain and loss.
Pure risk There is only the opportunity of loss as the result of
accidental circumstances. One of the ways to manage pure risk is the pooling of
risk. Group members share the cost of protecting the group by paying a premium.
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Fundamental Insurance Concepts (Continued)
Adverse selection: Insurance companies try to avoid the chance that they will choose to insure many individuals who have higher than average risk.
Underwriting is the process of selecting and classifying risk exposure.
Insurable interest means that an individual has: The possibility of personally experiencing a financial loss An interest in purchasing insurance to protect against this
potential financial loss
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Fundamental Insurance Concepts (Continued)
Gambling involves wagering on a risky event in which you have no insurable interest.
Indemnification is the restoration of the financial state that existed before you incurred a loss. In the event of a loss, the insurance payment should not be
greater than the value of the loss.
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Risk ManagementRisk management involves identifying, evaluating, and
determining how to handle your risks. Risk reduction is reducing the probability of a loss
through preventive action. Risk avoidance is reducing or eliminating the risk
through behavior modification. Risk retention is accepting the risk as the least
costly and best course of action. Risk transfer is eliminating the probability of loss
through the purchase of insurance.
13-9
The Terminology of Homeowners’ Policies
Homeowners’ policies have evolved into a few standard formats. You need to understand the various terms that are part of most policies
All risks coverage: Covers all risks that are not specifically excluded in the policy
Named perils coverage: Covers only the risks that are specifically mentioned in the policy
You need to understand which coverage you have and your obligations.
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The Terminology of Homeowners’ Policies (Continued)
Replacement cost: Coverage will pay the amount needed to replace the old item with a new item with no deduction for depreciation
Actual cash value: Will pay market value, which is equal to replacement cost less depreciation
Most policies provide for replacement cost on structural damage and actual cash value on contents.
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Co-Insurance Most policies require coinsurance when the
dwelling is insured for less than 80 percent of replacement value.
Insurance companies require coinsurance because studies have discovered that underinsurance is a serious problem.
Amount of Dwelling Protection80% × replacement cost of dwelling
× Cost of damage at replacement cost
= insurance payout
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Coinsurance Example
$50,000
80% × $100,000× $10,000 = $6,250
Amount of Dwelling Protection = $50,000
Replacement cost of dwelling = $100,000
Cost of damage at replacement cost = $10,000
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Additional Policy Clauses
Inflation guard endorsement: Increases the face amount of dwelling protection to reflect
rising market prices Deductible clause:
Limits the payment to damages in excess of a given dollar loss
Mortgage clause: Insurance payments for structural damage are made to the
mortgage holder.
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Additional Policy Clauses (Continued)
Other insurance and apportionment clause: Prevents insured from collecting more than 100% of the
loss through having multiple policies Subrogation clause:
Places your right to sue for recovery after the insurer’s The insurer can only sue to recover the amount paid to the
insured. If you receive payment from your insurer, you can only sue
for any loss in excess of the insurance payment.
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Homeowners’ Coverage
Homeowners’ policies contain two sections: Property coverage and liability coverage
Property coverage The loss of the dwelling unit and personal belongings
Liability coverage Protection from the financial harm your negligence causes
others
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Elements of Property Coverage
Coverage A – Dwelling Protection Protects against structural damage to the dwelling
Coverage B – Appurtenant Structures Protects other structures such as storage sheds, garage, etc.
Coverage C – Contents Protects against the loss of unscheduled personal property
Coverage D – Loss of Use Protects against the cost of additional expenses if your
house is uninhabitable
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Totaling Up $100,000 Coverage
Dwelling $100,000
Appurtenant structures (10%) 10,000
Unscheduled property —on premises (50%) 50,000 —off premises (10%) 5,000 Additional living expenses (20%) 20,000
Total coverage $185,000
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Exclusions on Property Loss Coverage
There are some items that are not covered because they are nonpersonal in nature or they should be covered by other types of policies. Examples are: Articles in a floater Animals, birds, or fish Motorized land vehicles Aircrafts and parts Property of roomers, boarders, and tenants Business records and equipment
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Liability Coverage
Coverage E – Personal Liability Up to the policy limits it provides protection against legally
obligated expenses for bodily injury and property damage Coverage F – Medical Payments
A small amount of medical coverage to insure prompt attention to bodily injury
Allows for documentation of injury that may protect against the filing of larger claims in the future
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Policy Format
Basic Format (HO-1)Broad Form (HO-2)Special Form (HO-3)Contents Broad Form (HO-4)Comprehensive Form (HO-5)Condominium Form (HO-6)Older Home Form (HO-8)Comprehensive Endorsement Form (HO-15)
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Policy Format (Continued)
Basic format (HO-1) Provides the least coverage, insuring only the most
common perils on a named basis Broad form (HO-2)
Provides coverage for an extended list of named perils Special form (HO-3)
Most commonly purchased form and is highly recommended
All risks coverage on dwelling and named perils coverage on contents
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Policy Format (Continued)
Contents broad form (HO-4) Covers only contents and is intended for renters
Comprehensive form (HO-5) All risks coverage on dwelling and personal property More expensive than HO-3 due to coverage of all perils
Condominium form (HO-6) Covers owner’s interest in additions and improvements as
well as personal property Condominium association insures buildings and other
structures through a separate insurance policy
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Policy Format (Continued)
Older home form (HO-8) Dwelling insured at market value rather than replacement
cost Comprehensive endorsement form (HO-15)
Extends the coverage offered under HO-3 by providing all risks coverage on contents
In combination with HO-3, this provides the same coverage as HO-5
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Specialized Insurance Endorsement
Amendment extending or changing underlying coverage Floater
Coverage for scheduled property that is described in terms of type, quality, and value
Umbrella policy Extends liability limits on an underlying policy Follows the form of the underlying coverage
Earthquake insurance Must be purchased as an endorsement to your
homeowners’ policy
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Specialized Insurance (Continued)
Flood insurance Flood damage is an extended peril under homeowners’
policies so it is not covered Coverage can be purchased through federally guaranteed
insurance sold through private insurance companies Your community must participate in the National Flood
Insurance Program Home office
A small business can be covered by an endorsement A substantial business will need a separate policy
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Specialized Insurance (Continued)
Renters insurance Can be purchased to cover belongings or medical bills
incurred due to home accident
13-27
Selecting Homeowners’ Insurance
Step 1 – determine needed amount and coverage Step 2 – determine the type of needed insurance Step 3 – talk to several insurers and compare prices
Some insurers reduce premiums if you have multiple policies with them (example: both homeowners and auto)
Step 4 – check out the financial stability of the insurance company
Step 5 – after the purchase, annually review your insurance needs
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Insurance Agents
Direct writers Employee of the insurance company selling the policy
Independent agent Works on commission for two or more insurance
companies
13-29
Making Sure You Collect on a Loss
Document your property before the loss Keeps record offsite in the case of damage to your dwelling
Notify the relevant authorities and contact the insurer immediately after the loss
Evaluate your loss before you accept a settlement offer
Your insurer will share your claim information with the Comprehensive Loss Underwriting Exchange (CLUE) and it may affect your insurance risk score
13-30
Checklist for College Students
Are you covered under your parents homeowners’ policy?
Do you have adequate overall protection? Have you taken a personal inventory? Do you exceed the limits on specific classes of
property?
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Automobile Insurance Automobile insurance is meant to protect you against
three risks: Bodily harm and property damage to others Personal injury to you, your family, and guests in car Damage or loss of your car due to fire, theft, or collision
Coverage is composed of four parts: Part A – Liability Part B – Medical Payments Part C – Uninsured Motorists Part D – Damage to Your Auto
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Part A — Liability This is the most important component Split liability
Specific limits on liability coverage for a single individual, a single accident, and property damage
Example: 100/300/10 $100,000 is the maximum amount paid for bodily injury per person $300,000 is the maximum amount paid per accident $10,000 is the maximum amount paid for property damage
Single liability limit Covers all bodily and property damage incurred in a single
accident
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Parts B, C, D
Part B – Medical Payments Payments to insure prompt treatment of injuries for those
involved in the car accident Part C – Uninsured Motorists
Coverage for bodily injury caused by uninsured motorist Part D – Damage to Your Auto
Pays for the damage to your car The amount you need is determined by the value of the car
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No-Fault Insurance
Allows you to recover from your own insurer, regardless of who is at fault
It is intended to hold down the cost of insurance premiums by not determining who is at fault
It may limit your ability to sue except Verbal threshold: May sue for reimbursement if your
injuries are severe and satisfy this definition Monetary threshold: May sue if medical expenses are
greater than this amount Personal injury protection (PIP) is a mandatory
requirement in no-fault states
13-35
The Cost of Auto Insurance
The cost of auto insurance is significantly affected by the region where you live.
Also, the cost of auto insurance varies by company. The rate base is determined by your risk
classification, which considers such factors as: Personal characteristics, your driving record, where you
live, credit record, and even the kind of car you drive. Your driving record will also have a significant
impact on the cost of your insurance. High risk drivers may have to purchase insurance in the
assigned risk market.
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Typical Reasons for Insurance Discounts
Good driving record Mature driver Carpool driver Multipolicy household Nonsmoking driver Retired driver
Good student record Away-at-school driver Driver training Multicar household
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Discussion Questions
Explain pure risk. What does it mean to have an insurable interest in
something? Explain the concept of underwriting. What are some of the actions that individuals can
take to manage risk? If a homeowner has a policy that covers actual cash
value, what risks are they assuming? What are some ways to lower car insurance costs?
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NEXT:Chapter 14
Health Care and Disability Insurance