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Insurance Concepts
Iām a firm believer of starting with a good foundation before launching into intermediate courses. So although this book is designed for advanced claims adjusters in the 5th to 10th year or so of their careers, in the first few chapters, Iām going to cover the definitions, rules, steps, and methods adjusters should already know. Besides, it never hurts to have a refresher.
Insurance is a practice in which one party (the insured) transfers the risk of a loss (pays a premium) to another party (the insurer).
Insurers have accountants who review prior losses to determine the likelihood of the same event occurring in the same place. This is part of how premiums are set. This is also why the owner of a home located on a flood plain cannot obtain insurance from a standard carrier and would have to buy flood coverage from the National Flood Insurance Program. A property insurer would find the risk of a flood unacceptable since the possibility of the home flooding (due to being on a flood plain) is high. Alternatively, if an insured had a house on the top of a mountain, a standard property insurer would likely offer flood coverage, although it would probably be a waste of money from the standpoint of the insured, as chances of flooding would be low.
Insurance books of business, or classes, are underwritten first as a group, and then individually. For example, auto insurance underwriters/accountants review types of accidents, locations of these accidents, the people involved in said accidents, and the varying amount of damage incurred to arrive at a base premium. Then they review the specifics of individual seeking the policy. If the prospective insured is a better than average driver, his premium might be lower than his neighbor; if he is a worse driver, his premium would likely be higher.
The Affordable Care Act, the national healthcare coverage passed under President Obamaās tenure, generated considerable discussion, both pro and con. The Act penalizes people who failed to obtain healthcare insurance. Many laypeople and members of Congress believed the Act would mean paying for othersā insurance, expressing that they did not believe this was the purpose of insurance.
This, literally, is how insurance works. You not only pay for your risk, but you also pay for your neighborās possibility of loss as well. Likewise, you effectively transfer the possibility of your risk to someone else.
Because liability insurance on automobiles is mandatory for everyone, the premium for the transfer of risk is (usually) affordable. If you drive in a rural area, where there are fewer cars, your premium will likely be lower. If you drive in an urban area where there are many opportunities for an accident, your premium will tend to be higher.
Most insureds would be unable to afford to self-insure against the possibility of their own car accidents. The amount of money the insured would need to hold aside for payment/liquidity would be based on the frequency of the type of claim and the maximum value of a claim. Most auto claims are small property damage and bodily injury claims; however, if there were serious injuries to the other party in the auto accident, such as permanent paralysis, or even death, payment of this kind of claim would likely be more than one individual could sustain. This is why everyoneās premiums are pooled together, enabling the insured to āpayā for the lossāeven though the insurance carrier is really the one writing the check.
What it comes down to is you are using both yours and your neighborās premiums to pay for your car accident. And when the neighbor has an accident, he is doing the same, because both your premiums and his premiums go into a āpotā that is reserved to pay such claims.
Insurers can get into trouble if they underwrite too heavily in a single area. For example, say the mythical carrier Gulf Coast of America insures only residential homes located within five miles of the Gulf Coast. Now a hurricane comes along, creating damage along the Louisiana coast. All premiums pitch in so that all insureds are covered. Then, two months later, Houston is hit by an even more severe hurricane. More premiums pitch in. By the time a hurricane hits Florida, on the far side of Gulf Coast of Americaās 400-mile coverage area, all the premiums would already have been paid out, and the insurer would go bankrupt. In real life, Montana pays for damage due to Houston hurricanes, while Arkansas helps cover California wildfires, and Illinois pitches in for Oklahomaās tornadoes.
There are ways for both the carriers and the insureds to avoid biting off more than they can chew.
Risk Management
Both insureds and insurers alike can simply avoid a risk or loss exposure: insureds do so by choosing not own the item (or live in the place) which causes the risk; an insurer can do so by issuing an exclusion for the risk or refusing to underwrite the risk.
The insurer can lower its risk of large payments for accidents by offering larger deductibles or large retention agreements with the insured. A retention agreement is when the insured agrees to retain a specific amount of the loss. This is commonly called āself-insuranceā or āself-insured retention.ā
Often the insured will enter into agreements with others who will agree to pay for and to protect the insured from a loss. These are called noninsurance transfers or indemnity agreements. As a side note, the person or organization who is paying or protecting the insured from a loss will usually its own insurance policy and it will be that carrier who handles the claim. So, although this is called a ānoninsurance transfer,ā a is carrier involved and insurance is available.
What Insurance Covers
An insurance policy is a contract between the insured and insurer. The specifics of what is and is not covered will be discussed in later chapters. The contract must contain an insurable interest for the policy to be applicable for a loss.
Insurable interest is any legal or monetary relationship one person has with the property that is insured. The insured will have an insurable interest in her home; the mortgage holder or lienholder will also have an insurable interest since it lent the insured money to buy the residence and wants to be sure said residence is protected.
Insurance policies cover risks. Risks, also known as hazards or perils, are conditions that increase the possibility a loss will occur. There are three types of risks:
ā¢Physical hazard is a feature of an item which will cause or increase the opportunity for a loss. An example of a physical hazard would be locating a log cabin in the Western United States, because such a cabin would be kindling for the wildfires that tend to burn often throughout these states.
ā¢Moral hazard is the risk that a loss will increase in frequency or severity of damages based on the actions of the insured. An example of a moral hazard would be when the insured places dried brush close to the log cabin and neglects to remove dead trees from the property which could increase the frequency or severity of a fire.
ā¢Morale hazard is the risk that a loss will increase in frequency or severity of damages based on the attitude of the insured. A morale hazard is very similar to the moral hazard, but in this instance, the insured knows there is an increased possibility of fire, but he does nothing to decrease the risk because he āhas insuranceā which will pay for any damages.
Insurance Regulation
Insurance is regulated at the state level through the McCarran-Fergu-son Act of 1945, which declared that states should regulate the business of insurance and confirmed that the continued regulation of insurers by the states was in the publicās best interest.
The Financial Modernization Act of 1999, also called Gramm-Leach-Bliley, established a broad network to allow relationships among banks, securities firms, and insurers. It also affirmed that states should control the business of insurance. The main reason for insurer regulation is to protect laypeople (insureds and claimants). State regulation is geared toward several key functions, including insurer licensing, agent licensing, adjuster licensing, policy review and approval, market conduct, financial regulation, and complaint reviews.
An insurerās failure in regulatory compliance may cause suspension or revocation of its license in that particular state. The states also have the ability to assess fines for these violations.
This book specifically focuses on claims; therefore, it will not discuss regulation relating to other aspects of the insurance marketplace. However, most states require insurance adjusters to pass a test to receive a license to practice the adjustment of claims. This information can be found on each stateās department of insurance website.
The National Association of Insurance Commissioners (NAIC) published model unfair claims practice acts which most states have adopted. Every adjuster must be aware of his stateās Unfair Claims Practices Act and what constitutes unfair acts while adjusting claims in order to avoid bad faith. The NAIC also serves as an advisory board and a place for all the states to discuss issues in order to present a (somewhat) uniformed supervision of insurer...