Planning Your Financial Future, 4eby: Boone, Kurtz & Hearth

Property and Liability Insurance

Chapter 9

2

Introduction

Insurance may be the least understood of all areas of personal financial planning

90% of Americans make fundamental mistakes when buying insurance Buy wrong types and wrong amounts Rarely review their coverage even

though needs change over time

3

Understanding Risk

Risk – uncertainty of injury or loss Speculative: possibility exists for gain

as well as loss (gambling or investing Uninsurable

Pure: threat of loss without possibility of gain Insurable

4

Ways of Dealing with Risk

Avoid risk—don’t do things that can lead to negative consequences

Reduce risk—buy smoke detectors, don’t smoke, etc.

Assume risk—save money should the worst happen, such as your house catching fire

Transfer risk—buy an insurance policy A contract in which the insurance company

agrees to pay an individual or firm compensation for losses (for a fee, or premium)

5

The Characteristics of an Insurable Risk

Must be common to a large number of people That which is not predictable for the individual is predictable

for the group (if the group is large enough) An insurable interest must be present

Policyholder must demonstrate that s/he stands to suffer a financial loss

For instance, you can’t purchase a life insurance policy on a stranger

The loss should be fortuitous (unexpected) The loss must be definite (definable in monetary

terms) Risk should be spread over a wide geographical area

To avoid excessive exposure to catastrophic losses

6

Major Categories of Insurance

Property and liability insurance Property: covers physical damage to or

destruction of property Liability: protects against financial

losses to others for acts for which you were responsible

Exists for automobiles, homeowners, and personal liability

7

Major Categories of Insurance

Health and disability insurance Cover potential financial losses due to sickness or

accident Disability insurance provides payments when

insured is unable to work due to illness or injury Over 72% of Americans have this type of insurance

Life insurance Protects people against financial losses that occur

with premature death Over 75% of Americans have this type of insurance

8

Property and Liability Insurance

Automobile insurance About ten million auto accidents yearly A minimum amount of insurance is required in

most statesHomeowners insurance

Protects your home from perils Fire, windstorm, burglary Most do not cover damage from floods or earthquakes

Mortgage lenders require homeowners’ insurance Even if you don’t own home, you should have

renters’ insurance

9

Basic Elements of Insurance

Insurance premium How much you pay

Insurance company uses these premiums to pay operating expenses and current claims, while remainder is invested to pay future claims

Insurance policy Contains all provisions of policy

Amount/type of insurance Beneficiaries Restrictions

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Basic Elements of Insurance

Insurance agent Receives a sales commission Exclusive agents

Represent only one insurance company Independent agents

Operate independent businesses and represent multiple companies

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Basic Elements of Insurance

Insurance companies Can be either:

Stockholder owned and run like any other company

Mutual associations Technically owned by policyholders and may

receive premium rebates in form of dividends No evidence that this type of policy costs

any less than a comparable policy from stockholder owned company

12

Determining Your Individual Insurance Needs

Need to know what to insure, how much insurance to buy, how long you need it and how to choose right policy Life insurance – not everybody needs it Health insurance – everybody should have it

Many people buy health insurance through employers HMO: lower out-of-pocket expenses but fewer choices

Disability insurance – experts think many people are underinsured in this area Suggest a policy that pays 60–70% of salary

13

Determining Your Individual Insurance Needs

Homeowners insurance Best is policy that offers full replacement

Auto insurance As a minimum, you need liability If your car is old, you may not want collision and

comprehensive coverage—may not be worth itPersonal liability

Is it likely someone will sue you and you’ll lose a substantial amount of assets? If not, additional personal liability probably not

necessary

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Figure 9.4: Classifying the Risks You Face & How You Should Handle Them

Source: Based on data from IntelliChoice and the Insurance Information Institute.

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Buying an Insurance Policy

Insure against large financial losses, not small ones

Buy insurance with broad coverage, not narrow policies

Shop aroundConsider buying insurance from

companies that sell directly to consumersBuy insurance only from financially

strong companies

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Resolving Disputes with Insurance Companies

Start with the agent who sold you the policy

Next, contact company directlyNext, contact your state’s insurance

commissionerKeep copies of important

documents

17

Personal Liability Insurance

Liability is the financial responsibility one person has to another—may result from negligence

Negligence is the failure to exercise due care to protect others from harm (even if unintentional)

Reasonable (or due) care is the action any responsible person would take in a similar position

Strict liability Person can be held financially responsible for an action even if

s/he was not directly at fault Example: Your dog (although you made provisions to restrain it)

escapes and eats the neighbor’s chickens Vicarious liability

If someone for whom you are responsible destroys another’s property, you are held liable

Example: Your child breaks the neighbor’s window

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Personal Liability Insurance

A legally liable person can be held financially responsible for property damage, medical expenses, lost wages, and pain and suffering Can be VERY expensive Liability insurance is designed to

protect a person from financial risks associated with legal liability

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Personal Liability Insurance

Liability portion of homeowners and auto insurance policies Insurance company agrees to pay for personal

injuries or property losses that occur to nonmembers of insured’s household at the insured’s home (and things that pets might do to others and their property)

Insurance company agrees to pay medical and repair bills on injured party/car if you are involved in an accident at which you are at fault

20

Personal Liability Insurance

Umbrella liability policy If you desire excess personal liability

protection in amounts of 1, 2, 5+ million Provides more protection in areas not covered by

homeowners and auto insurance False arrest, invasion of privacy, defamation of

character High deductibles

If you have substantial assets, probably need umbrella policy

May need one also if involved in something that tends to increase your personal liability

21

Homeowners Insurance

What a homeowners policy covers Damage to the house

Based on replacement cost Must be caused by a peril

Damage to other structures Damage to trees and shrubs

Up to a specified limit Personal property losses

Usually up to half the value of house Limits to certain items

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Homeowners Insurance

What a homeowner policy covers (cont’d) Additional living expenses

If a house becomes unlivable due to covered perils, policy pays for temporary living expenses

Liability Most policies offer at least $50,000, with more

protection available for additional premium

23

How Much Coverage Should You Have?

Mortgage loans require that you carry insurance equal to at least 80% of the current replacement value of structure If you don’t, you might not get

reimbursed for the full amount of loss

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How Much Coverage Should You Have?

Experts recommend that you buy guaranteed full replacement cost coverage Will pay the entire cost to repair or replace the

structure, regardless of original cost of home, improvement, or covered personal property

Especially important if rising housing prices exist in your area

Many insurers began phasing out guaranteed replacement cost coverage in late 1990s Replaced with extended replacement coverage

Pays only maximum amount stated on policy plus another 20 to 25%

25

The Deductible

What you pay before insurance kicks in Standard is $250 Charged on a per-claim basis

Higher the deductible, lower the premiums

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Renters and Condominium Policies

Covers only the personal property for those who rent or own cooperative apartment

Can be purchased on a named-peril or all-perils basis

2/3 of all renters do not carry insurance

Cost is typically quite low

27

Supplementing the Homeowners Policy

Endorsements Amendments that increase the standard

coverages Example: inflation protection

Why would you want this? If your policy covers only the actual cash value of house/personal property

Floater policies Designed to protect valuable personal property,

but each item must be ‘scheduled’ Completely described to insurer’s satisfaction Often a professional appraisal is required

28

Supplementing the Homeowners Policy

Floods and earthquakes are excluded from standard homeowners policies, but can be purchased separately

Flood insurance Offered through insurance companies but provided by federal

government Not available to everyone in flood-prone areas

Community must participate in National Flood Insurance Program Earthquake insurance

Expensive (can be $1,000+ annually) Terrorism coverage

Since 9/11/01, many insurance companies have begun to exclude terrorism

Can be purchased for an additional premium

29

Filing a Claim

Can only collect for personal property you can prove you lost If everything you had in your home was

lost, could you provide insurance company with a list of everything and how much it was worth? If you can provide receipts, that’s great, but you

can videotape, photograph, etc. Record items on a personal software package,

and store a copy off-premises

30

Filing a Claim

Notify police if you experience theft Get copies of police report

Telephone insurance agent May have to follow up with written statement

Take action (if necessary) to prevent further damage to house, etc.

Develop list of damaged, destroyed items Submit receipts for additional living expenses to agent Provide information to claims adjuster Review settlement steps in your policy If you are dissatisfied with settlement offer, meet with agent

and adjuster Still dissatisfied? Meet with insurer’s consumer affairs office or

state insurance commissioner

31

Automobile Insurance

Americans pay about three times more a year in auto insurance than homeowners insurance

Each year over 30 million accidents occur, resulting in $100 billion in loss

Specific needs vary from driver to driver

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Types of Coverage

Liability insurance Bodily injury

Covers the insured if his car injures or kills someone

Anyone driving the insured’s car (with permission) is protected

Property damage If insured’s car damages another car or property Doesn’t pay for damage to insured’s car

Collision insurance does this

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Liability Insurance

Most policies look something like this 50/100/10 (represents 1,000s of dollars)

$50,000 is the max will pay for death/injury to one person in any one accident

$100,000 is the max amount for two or more people for a single accident

$10,000 is the max for property damage coverageMost states require a minimum amount of

liability insuranceExperts recommend more than the minimum

required If a judgment is made against you for greater than

your insurance, you’ll be expected to pay it

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Medical Payment Insurance

Pays for reasonable medical expenses up to max amount

May duplicate coverage under your health insurance If you have adequate health insurance, you may wish to

lower the amount of medical payment insurance you have Covers auto accident-related medical expenses for

You Your family Additional passengers All family members while riding in someone else’s car All family members if struck by a car while walking

35

Uninsured/Underinsured-Motorist Insurance

Handles injuries to insured and family members caused by an uninsured (or underinsured) motorist or hit-and-run driver

About 13% of accidents are caused by uninsured motorists

Some states require coverageRelatively inexpensive (about $40/year)

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Collision Insurance

For an at-fault accident, collision pays for repairs to your car (or if car is totaled, pays for depreciated value of vehicle)

Not a compulsory insurance But lender may insist on it

Not necessary if car is quite old and not very valuable

37

Comprehensive Physical Damage Insurance

Covers damage occurring from something other than collision

Not a compulsory insuranceExact cost depends on dangers car is

exposed to in an area Likelihood of perils, car thefts, etc.

38

Auto Insurance Premiums

Average American pays about $700 per vehicle, but in some cities it’s about $1,500 a year

Exactly how much you pay depends on different factors Type of vehicle + attributes Your age, gender Where you live Driving record, etc.

39

Auto Insurance Premiums

Amount and type of coverage Ask to see a breakdown of your premium

What portion of premium is going to pay for what Place of residence

City dwellers pay more Personal characteristics

Age more than any other personal factor affects likelihood of having an accident

33% of drivers under age of 25 have accidents Women generally have fewer accidents than men Young married people have fewer accidents than

young single people

40

Auto Insurance Premiums

Automobile usage How often, and how far do you drive?

Business travel—higher rates Pleasure vehicle—lower rates

Driving record Any accidents, violations recently If your driving record is really bad, you may not be

able to get ‘regular’ coverage Be placed in the assigned risk pool

Type of car driven Expensive Desired by thieves

41

Making the Right Auto Insurance Decision

As your life changes, your needs change Review your coverage regularly

If you have ‘enough’ money, you may want to consider larger deductibles

It’s probably a good idea to have uninsured motorist coverage even if it’s not required

Have a sufficient amount of liability coverage The more wealth you have, the more you have to lose

Shop aroundDrive safely