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Personal Finance:An Integrated Planning

Approach

Winger and Frasca

Chapter 13

Property and Liability Insurance:

Protecting Your Lifestyle Assets

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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.

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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

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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

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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

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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

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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