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Flashcards in Insurance Deck (54)
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What is Risk?


A condition where there is a possibility of loss (a situation where exposure to loss exists). At least two outcomes and one of those is undesirable.

  • Starting a business
  • Buying real estate

Insurable Risk is not Subjective, but rather objective (condition of the real world)

Degree of risk may or may not be measurable. (However remember that the loss must be measurable and definite: time, place, form and monetarily measurable for it to be an insurable risk)

Types (not all insurable):

  1. Financial (loss of money vs. Non-Financial (Pain and Suffering)
  2. Static (non-economy) vs. Dynamic (economic - inflation, business cycle)
  3. Fundamental (large group - recession, earthquake) vs. Particular (individual or small group)
  4. Pure Risk vs. Speculative
    1. Pure = may be insurable
      1. Personal, Property, Liability, Failure of others (breach)
    2. Speculative = not insurable


What is Peril?


The cause of a loss, the event insured against:

  • Fire
  • Windstorm
  • Theft
  • Flood
  • illness
  • etc.



What is a Hazard?

What are the three types?

A condition that may create or increase the chance of loss arising from a peril.

  • Owning a home on an earthquake fault
  • Owning a home by a river

Physical Hazard: physical characteristics of the person or property that increase the chance of loss (e.g. oily rags left near a furnace or high blood pressure)

Moral Hazard: the chance of loss from dishonesty (e.g. person intentionally causes a loss or overstates the amount of the loss when a peril occurs)

Morale Hazard =  Extra Careless: Indifference to loss (due to the existence of insurance), which creates carelessness and increases the chance of loss (e.g. failure to lock car doors)


What are the Elements of Insurance?

What is Adverse Selection?

  • Large number of homogeneous exposure units
  • Loss must be definite and measurable
  • Must be fortuitous or accidental
  • Must not be catastrophic (for the insurance company)

Adverse Selection?

  1. the likelihood that people with the highest risk of loss are also most likely to purchase insurance
  2. High-risk persons seeking insurance coverage at standard rates
  3. Common:
    1. insurance policies with premiums that increase with age


What are the Methods to Avoid/Reduce Loss?


  • Avoidance: Do not drive, Do not purchase a home but rent. Most Extreme. May not be practical
  • Diversification: Duplication of assets or activities at different locations
  • Risk Sharing: entity using a corporation/limited partnership form/hold harmless agreement
  • Transference: INSURANCE
  • Retention: Voluntary - Recognizes that the risks exist and assume losses (deductible, coinsurance, self-insurance - large corporations)
  • Risk Reduction: Sprinkler system, safety programs, alarm system, hand rails



Methods that may be used to potentially lower insurance premiums?

  1. Increase Deductible (P&C or Health)
  2. Increase elimination period (Disability or LTC)
  3. Install an Alarm (Property)
  4. Improve Health and diet (Life and Health)
  5. Avoid Tobacco (Life and Health)
  6. Choose safer occupation (disability)
  7. Reduce # of years of coverage (LTC or Disability



What is Insurable Interest?


  • Property and Casualty: At inception and at time of claim
  • Life: At inception, but need not be at time of claim



What are the types of Social Insurance?


What are the types of Public Insurance?


What are the types of Private Insurance?


  1. Social Security
  2. Medicare
  3. Workers Compensation
  4. Medicaid


  1. FDIC
  2. PBGC
  3. SIPC


  1. Life
  2. Health
  3. Disability
  4. LTC
  5. Property
  6. Liability


What are the Parts of the Insurance Contract?


  • Declarations Page: Factual Statements that identify the specific person, property or activity being insured.
  • Definitions: Explanation of key policy terms
  • Insuring Agreements: Spells out the basic promise of the insurance company
  • Conditions: Spells out in detail the duties and rights of both parties.
  • Exclusions: Circumstances when the insurer will NOT pay.



What are the 5 elements of an insurance contract?

Five Elements:

  1. Offer and acceptance
  2. Consideration
  3. Legal Object
  4. Legal Capacity
  5. Legal Form

Offer and Acceptance:

  1. Generally offer is a person applying for insurance (contract of adhesion) through application
  2. Submission of completed insurance application + payment = binding contract if the application would pass standard underwriting requirements


  1. Most insurance - promise to pay is sufficient
  2. Life insurance - premium must be received 

Legal Object:

  1. must be legal purpose; can't have insurance to cover interruption of illegal business purpose

Legal Capacity

  1. minors and incompetents not sufficient; voidable by such party.

Legal Form

  1. state law; must be filed and approved by state regulatory before sales can proceed


What are the Standards of Care?


  • Negligence:
    • failure to act in a way that a reasonably prudent person would have acted under the circumstances
  • Attractive Nuisances:
    • Swimming pool, vacant lot
  • Negligence per se: no need to prove negligence
    • violation of a statute is a common example
  • Strict Liability: no need to prove negligence
    • Extraordinarily Dangerous Activities - blasting
    • Product Liability - defective product
    • Workers Comp - injured on job
  • Vicarious Liability: Respondeat superior (principal's liability for their agents).


What are Defenses?


  • Assumption of Risk (skiiing, car racing)
  • Contributory (jay walking, being drunk)
  • Comparative (A is 20% negligent, B is 80%)
  • Last Clear Chance (Rear end someone when you could have avoided it by swerving, braking in time) - an exception to contributory negligence: Driver 1's negligence caused the accident, Drive 2 had last clear chance to avoid the accident and failed to do so. Driver 1 can recover injuries despite his own contributory negligence



What are two methods of Calculating Life Insurance needs?


Evaluating a person's need for capital resources upon death. Lack of life insurance on either spouse is a weakness in a case study

  • Capital Retention Approach: Uses interest only, so the original capital is still left at the end of the period 
    • It does NOT consider inflation.
  • Human Value Method
    • projects income of the individual uses the discount rate to net present value of the life
    • Cash flows can be adjusted downward for taxes
  • Financial Needs Analysis Method
    • analyzes the needs of survivors and dependents.
    • Calculated two ways:
      • Annuity Approach - death benefit and the interest consumed by investors
      • Purchasing Power Preservation Model: death benefit not consumed
        • part of the interest is consumed and the rest of interest is used to preserve the purchasing power of the death benefit



What are the most comprehensive Insurance Rating Service/Category services

public information alone?


Public information and Interview?


  • A.M. Best: A++ to F (Public information and interviews with management)
  • Standard & Poor: AAA to CCC (only upon request)
  • Moody's: may assign ratings on the basis of public information alone.
  • Fitch: uses public information and management interviews; public information alone may be used



What are Sections of a Homeowner's Policy and what do they cover?


Section I (Coverage: A B C D)

  • A - Dwelling and Attached Structures
    • includes materials and supplies intended for use in construction
    • Land is excluded
    • Partial Loss:
      • 80%: replacement cost basis provided the amount of insurance coverage is 80% of the replacement cost of the building (90% for commercial)
      • Under 80%: Higher of Actual Cash Value OR % of the replacement cost of the partial loss the insurance company represents as a co-insurer
    • Partial Loss Example:
      • House replacement cost (excluding land): $350,000
        • Insurance Coverage = $210,000
        • Flood Damage = $200,000
      • 80% = $240,000
      • 60% = $210,000 / $350,000
      • Replacement Coverage = 210,000 / $240,000 = 87.5% Coverage
    • NOTE - Won't pay out higher than face amount (i.e. if you get 80% above, then $240,000 is max. Always recommend full coverage)
  • B - Other structures, separate from dwelling (detached garage, fences, sheds)
    • Generally, 10% of the amount of insurance on the dwelling applies as insurance on detached structures
    • For Example, the home is insured for $150,000, the detached structures are insured for $15,000
    • Exclusions:
      • Land
      • Structures used for business purpose
      • does not apply to structure rented to someone who is not a tenant of the dwelling, except for a private garage if it's used as a private garage.
  • C - Contents and Personal Property
    • Personal property, either owned or used by the insured, is covered; this coverage extends worldwide!
    • 50% of the dwelling
    • May be reduced to 40% if the personal property doesn't equate to 50% of value of the dwelling. May not be reduced below 40% for HO-1, HO-2, HO-3, HO-5
    • Exclusions
      • separately insured property (jewelry, furs, boats)
      • animals, birds fishes
      • motor vehicles, cars, motorcycles, golf carts, snowmobiles
      • aircrafts
      • property of tenants not related to insured
      • property in a unit that is rented or held for rental (refrigerator, stove, furniture)
      • property held for rentals (bikes and motor scooters)
      • Business data such as papers, software, drawings
      • Credit Cards / ATM Cards
    • Limitations
      • $200 cash, currency, bank coins, bullions
      • $500 property for things used for business purposes
      • $1,500 securities, manuscripts, personal records, stamp collections, 
  • D - Loss of Use
    • ​20% of the amount of insurance on the dwelling for H0-2, HO-3, HO-5 policies (HO-1 and HO-8 policies are limited to 10%)
      • Additional living expenses
      • Fair rental value
      • Prohibited Use


Section II

  • E - Liaiblity
  • F - Medical Payments



What property is excluded under Personal Property Coverage?


  • Animals, Birds, or Fish
  • Motorized Land Vehicles and Aircraft
  • Property of roomers, boarders or other tenants
  • Property contained in an apartment regularly rented or held of rental to others by the insured (unless specifically endorsed)



What are the Basic Form Perils Covered?


The policy lists perils covered:

  • Windstorm
  • Hail
  • Aircraft
  • Riot
  • Vandalism
  • Vehicles
  • Explosion
  • Smoke
  • Fire
  • Lightning
  • Theft

Study Hint: Remember: WHARVVES/FLT



What are the Broad Form Perils Covered?


  • Rupture of a System
  • Artificially Generated Electricity
  • Falling Objects
  • Freezing of Plumbing

Study Hint: Remember Basic plus RAFF



Homeowner's Policy Exclusions include:


  • Earthquake
  • Flood
  • Neglect
  • Intentional Loss
  • Ordinance/Law
  • Power Failure
  • War
  • Nuclear Hazard

Note: Sinkhole is a covered peril for the exam



What is the formula for Replacement Cost Coverage?


  • Replacement Cost x Coinsurance Percentage = Insurance Required
  • Insurance Carried ÷ Insurance Required x Loss - Deductible = Amount Paid by Insurance



What are the requirements for a vehicle to be eligible for:

  • Insurance Services Office (ISO)
  • Personal Auto Policy (PAP)


  • Be owned by an individual or by a husband and wife living in the same household
  • Be private passenger auto
  • Not be used as public or livery conveyance
  • Not be rented to others



What are the Parts of an Auto Insurance Policy?

What do they cover?


  • Part A - Liability to third parties
  • Part B - Medical payments
  • Part C - Uninsured/Underinsured motorists
  • Part D - Damage to the covered auto



What is classified as a "Covered Auto" under an

Auto Insurance policy?


  • Any vehicle shown on the declarations page
  • Any of the following which you acquire during the policy period:
    • Private Passenger Auto
    • Pickup Truck
    • Panel Truck or Van

NO coverage for any of these used in a business (need a commercial policy for that)

  • Any trailer you own listed on the declarations page
  • Any auto or trailer you do not own while used as a temporary substitute for any vehicle decribed herein which is out of normal use because of a breakdown, repair, servicing, loss or destruction



Who are the Persons Insured under medical payments

coverage of the PAP?


  • The named insured and any family member who suffers bodily injury caused by accident while occupying covered vehicle
  • The named insured and family members who if, while a pedestrian, are struck by any motor vehicle designed for use on public roads or by a trailer
  • Other persons while an occupant of the insured's auto (passengers)



What is Uninsured Motorist Coverage (UM)?


This agreement promises to pay the amount an injured insured could have collected from the uninsured dirver if such driver had carried auto liability insurance. The term "covered person" as used under the uninsured motorist coverage of the PAP includes the following:

  • The named insured and any family member
  • Any other person occupying the insured's covered auto
  • Any person, for damages that person is entitled to recover because of injury to a person described above

Note: UM is liability protection, NOT medical payments



What are the perils covered under the "Other Than Collision" Provision of an Auto Policy?


  • Glass Breakage

Loss caused by:

  • Falling Objects
  • Fire
  • Theft
  • Explosion
  • Earthquake
  • Windstorm
  • Hail
  • Water
  • Flood
  • Riot or Civil Commotion
  • Contact with Birds or Animals


What are the benefits of an Umbrella Liability Insurance?


  • Nearly always a correct answer since it is smart coverage
  • Provides liability coverage (BI/PD) for catasptrophic claims
  • Requires policy owner to carry certain underlying coverage of specified amounts
  • Professional acts are specficially EXCLUDED!  



What are the two types Professional Liaiblity Insurance and who/what does it cover?


  • Malpractice - Bodily Injury (doctors, dentists)
  • Errors and Omissions (E&O) - Monetary damages (financial advisors, lawyers, accountants, insurance agents)



What does Worker's Compensation cover?


  • Unlimited Medical Expenses
  • Diasbility Income (TAX FREE)
  • Death Benefits
  • Rehabilitation (Medical and Vocational)
  • Absolute Liability



Medicare does NOT cover...


  • Routine foot care, glasses, hearing aids, and dental
  • Emergency Care outside the US (some exceptions for Canada, Mexico and Caribbean)



Explain the limitations of Medicare's Long Term Care coverage.


Benefits are Limited: Pays all of the first 20 days of SKILLED care and everything over a specified amount per day for the next 80 days of SKILLED care (100 day max)

The Limited Benefit is Subject to Substantial Restrictions: Pays for SKILLED care only:

  • Admission to a nursing home must follow within 20 days of the hospital stay of three days or more
  • The patient's condition must be expected to improve



Compare HMO vs PPO



  • Provider paid monthly fee regardless of services rendered (Capitation)
  • Out of Network care not covered at all


  • Provider paid for actual services rendered
  • Out of network partially covered, usually 70%



What are the COBRA coverage requirements and

Qualifying Events?


  • Must have 20 Full/Part-Time Employees.
  • The option to buy Continuation. 

Coverage must be offered to: (Qualifying Event?)

  • Terminated employees/dependents up to 18 mo.
  • Voluntary or involuntary termination, change from FT to PT
  • Spouses and other dependents up to 36 mo.
  • Employee's death, divorce, legal separation, or eligibility for Medicare Children of Employees up to 36 mo.
  • Loss of dependent status (marriage)
  • Reaching dependency age limit specified by plan



What is a Health Savings Account (HSA) and

what are its benefits?


  • Used in conjunction with High Deductible Health Plan (HDHP)
  • Distributions are tax free if used for health care
  • Contributions not spent are carried forward and portable
  • Unused assets become property of named bene on death
  • Distributions for non-medical are ordinary income plus 20% penalty if under 65



What are the Definitions of Disability?


Social Security Disability?


Own Occupation

  1. The best definition for the insured and most expensive
  2. Inability to engage in one's own occupation

Modified any occupation

  1. Inability to engage in any reasonable occupation for which one might be suited by education, experience, or training, or for which one could easily become qualified
  2. ineligible for benefits if you work another job. You can still receive benefits if you can take another job, just not if you actually do take the job.

  3. The difference between this type of provision and any-occupation coverage is that under any-occupation coverage you are ineligible for benefits even if you don’t take a job that you can work.

Split Definition -

  1. To years own occupation, then modified own occupation

Any Occupation (Social Security definition)

  • Inability to engage in any occupation

Social Security Disability

  1. Mental or physical impairment that prevents the worker from engaging in any substantial gainful employment; for Social Security, the disability must have lasted for 5 months and be expected to last a total of at least 12 months or result in the death of the worker.


What are the policy elements of disability policy?

Policy Elements:

  1. Definition of Disability
  2. Elimination Period
  3. Benefit Amount or Percentage
  4. Benefit Term
  5. Coverage (perils insured against)


What are the Policy Continuation Provisions for Disability Income?


  • Noncancellable "Noncan": Continuous term policy guaranteeing the insured's right to maintain the policy at the stated premium
  • Guaranteed Renewable: Continuous right to maintain the policy, but the insurer may increase the premium by class of insureds 



Taxation of Premiums and Benefits for Disability Policies


Taxation of Premiums and Benefits:

The individual owns the contract and pays the premium:

  • Premiums are not deductible
  • Benefits are tax free to the employee

The employee owns the contract and the employer pays the entire premium under a bonus arrangement like section 162 disability insurance:

  • Premiums are deductible by the employer as a bonus
  • Benefits are tax free to the employee.

The employee owns the contract and the employer pays the entire premium under a salary continuation plan (group plan).

  • Premiums are deductible by the employer
  • Benefits are taxable to the employee



Permanent Life Insurance (Low Risk Tolerance)


  • Insurance company controls the investment return
  • Assets part of the general account
  • Whole Life
  • Universal Life



Permanent Life Insurance (High Risk Tolerance)


  • Client controls the investment return
  • Assets part of a separate account
  • Variable Life
  • Variable Universal Life



What are the Dividend Options on Life Insurance?


  • Cash
  • Reduce Premium
  • Accumulate with Interest
  • Paid up Additions
  • One-year Term/5th Dividend

Remember: CRAPO



What are the Nonforfeiture Options of Life Insurance?


  • Cash
  • Extended Term
  • Paid Up
  • Reduced Amount



What are the Life Insurance Settlement Options?


  • Cash
  • Pure Life/Single Life
  • Refund
  • Period Certain
  • Specified Income/Period
  • Interest Only
  • Joint and Survivor



What is a Modified Endowment Contract (MEC)?


  • Entered into after June 21, 1988
  • Fails to meet the "7-Pay Test" (for the exam, includes ALL single premium policies)
  • Distributions/Withdrawals are taxed LIFO (Interest First)
  • Distributions under 59½ are also subject to 10% federal penalty tax (if not disabled)
  • Death Benefit is still tax-free



What are the MEC Grandfather Life Insurance rules?


  • If death benefit increases by $150k or less and the insured has guaranteed insurability (no proof of insurability), the policy will NOT lose its grandfathered (non-MEC) status.
  • If the policy increases by ANY amount and the insured must prove insurability, the policy MAY lose its grandfathered (non MEC) status.



When are the proceeds in a Life Insurance policy taxable

due to Transfer for Value?


If an interest in a life insurance policy is transferred for valuable consideration (not a gift), the proceeds in the excess of the consideration paid for the policy, combined with any premiums paid by the owner, are taxable as ordinary income (like a viatical).

The main exceptions to this rule are:

  • A sale or transfer to the insured
  • A sale or transfer to a partner or partnership in which the insured is a partner
  • A corporation in which the insured is a shareholder or officer
  • Divorce  



What are the 1035 Tax Free Exchange Rules?


  • Life → Life (OK)
  • Life → Annuity (OK)
  • Annuity → Annuity (OK)
  • Annuity → Life (NO NO NO!)



Buy Sell Stock Redemption


Cross Purchase


Stock Redemption:

  • No Step up in Basis


  • Step up in Basis



Split Dollar Insurance Endorsement Method


Collateral Assignment Method


Endorsement Method:

  • Employer is the owner
  • Employee is not a shareowner

Collateral Assignment Method:

  • Employee is owner
  • Employee is a Shareholder
  • Employee assigns the policy



Explain Annuity Taxation


Periodic Payouts:

  • Basis / Payout  = Tax-free

Lump Sum Payouts:

  • LIFO (Interest First Rule)
  • Ordinary income plus 10% penalty if under 59½



What are the characteristics of a

Flexible Spending Account (FSA)?


  • Must be used by March 15th or forfeited to the company (use it or LOSE it)
  • Medical Only
  • Dependent Care must be used by 12/31
  • Not subject to income tax, FICA or FUTA
  • Health FSA may not be used to reimburse employee premiums paid for other health plans (such as MSA, HSA and LTC)
  • Expenses for LTC services can NOT be reimbursed under a health FSA, but other medical expenses can be reimbursed.



What are the major Tax Free Fringe Benefits?


  • Health Care Premiums
  • Insurance Premiums on non-discriminatory group life policy up to $50k
  • Company car for working conditions only
  • Employer-provided transit passes ($265/mo. cap) or parking ($265/mo. cap)
  • Occasional overtime meal money, cab fare, theater or sporting event tickets
  • Discounts on services limited to 20% of selling price charged to customers



When are Fringe Benefits taxable?


  • Health Insurance Premiums paid for self-employed, partners, and more than 2% owners of an S-Corp are Taxable Income.
  • 100% is deductible as an adjustment to income on the FRONT of the 1040.
  • This can include all types of health insurance programs.



Long-Term Care Chronically Ill

To receive benefits from a long-term care insurance policy, the insured must be chronically ill. 

Chronically ill is defined as being unable to perform, without substantial assistance, two of six activities of daily living (ADLs) for at least 90 days.

The ADLs include:

  1. eating,
  2. bathing,
  3. dressing,
  4. transferring from bed to chair,
  5. using the toilet, and
  6. continence (i.e., the ability to control one's bowel and bladder).


Substantial services are required to protect the individual because of substantial cognitive impairment