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3 Property & Casualty

Chapter One

General Insurance

LEARNING OBJECTIVES

Upon the completion of this chapter, you will be able to:

1. Recognize definitions of general insurance and insurance law terminology2. Identify basic insurance concepts and principles3. Identify the characteristics of insurers4. Recognize the role of insurance producers5. Recall the elements of legal contracts and interpretations affecting contracts6. Define Insurable interest

OVERVIEWThis chapter is designed to acquaint the student with the fundamentals of the insurance industry as a whole as well as foundational concepts that constitute the basis of insurance regardless of their state licensing.

1.1 The World of InsuranceOne of the largest and most diverse sectors of the insurance industry consists of companies, agencies, producers, consumers, and organizations that provide information and support to the private firms and persons who buy and sell insurance.

Private Firms and Persons1. Insurers (Insurance companies or Carriers) manufacture and sell insurance coverage by way of

insurance policies or contracts.2. Insurance Agencies are independent organizations that recruit, contract with, and support sales

agents and producers.3. Insurance Agents or Producers are licensed individuals representing an insurance company when

transacting insurance.4. An Insured is the person or entity that buys insurance for protection from loss of life, health,

property or liability.

Trade and Regulatory Associations1. The National Association of Insurance Commissioners (NAIC) consists of all State and territorial

insurance commissioners or regulators.a. The NAIC provides resources, research, legislative and regulatory recommendations and

interpretations for state insurance regulators.b. The association promotes uniformity among states. Members may accept or reject

recommendations.c. The NAIC has no legal authority to enact or enforce insurance laws.

2. Federal Insurance Office (FIO) – The Federal Insurance Office was established by the Dodd-Frank Wall Street Reform and Consumer Protection Act. This office monitors the insurance industry and identifies issues and gaps in the state regulation of insurers. It also monitors access to affordable insurance by traditionally underserved communities and consumers, minorities, and low- and moderate-income persons. The FIO is not a regulator or supervisor. Insurance is primarily regulated by the individual States.

3. Insurance producer and company trade associations also exist to provide education, support, networking and lobbying for insurance companies and producers.

4Property & Casualty

Insurance Regulation at the State LevelThe insurance industry is regulated primarily at the state level. The legislative branch writes and passes state insurance laws, or statutes, to protect the insuring public. The judicial branch is responsible for interpreting and determining the constitutionality of the statutes. The role of a state’s executive branch is to enforce the existing statutes that have been put in place. The Commissioner, Director, or Superintendent of Insurance is typically appointed by the Governor, and the Commissioner has the power to issue rules and regulations to help enforce these statutes.

Insurance Regulation at the Federal LevelThe McCarran-Ferguson Act of 1945 determined that the federal government can not regulate insurance in areas over which states have the authority to do so. Congress created federal agencies to provide regulatory oversight impacting insurance practices. Government insurers step in (as a last resort) when private insurers are unable to provide protection relative to the catastrophic nature or unpredictability of a risk.

Private versus Government InsurersMost insurance is written through private insurers. However, there are instances where governmental-based insurers step in to offer an insurance alternative when private insurers are unable to provide protection. This usually relates to the catastrophic nature of the risk, capacity to handle the risk, and lack of desire to engage in a line of insurance where experience to evaluate necessary premium intake to offset potential loss is lacking. Examples of government insurance are:

1. Federal social insurance programs (Social Security, Medicare, Medicaid).2. Federal Crop Insurance.3. Government Crime Insurance.4. Federal Flood Insurance.

1.2 Types of Insurers – Insurance Companies or Carriers

Stock Insurance Company1. A stock company is owned by stockholders or shareholders.2. Directors and officers direct the company operations and are elected by stockholders.3. Stockholders receive taxable corporate dividends as a return of profit when declared by the Directors.4. Dividends are not guaranteed.5. Traditionally stock insurers issue Non-Participating policies.

Mutual Insurance Company1. A mutual company is owned by policyholders (who may be referred to as members).2. A Board of Trustees or Directors directs the company operations and is elected by policyholders.3. Policyholders receive non-taxable dividends as a return of unused premium when declared by the

directors.4 Dividends are not guaranteed.5. Traditionally, mutual insurers issue Participating policies.

Reciprocal Insurance Company1. A group-owned insurer whose main activity is risk sharing.2. A reciprocal insurer is unincorporated, and is formed by individuals, firms, and business

corporations that exchange insurance on one another. Each member is known as a subscriber.3. Each subscriber assumes a part of the risk of all other subscribers. If premiums collected are

insufficient to pay losses, an assessment of additional premium can be made.4. The exchange of insurance is affected through an Attorney-In-Fact.

General Insurance – chapter One


Lloyds of London1. Lloyds of London is not an insurance company, but consists of groups of underwriters called

Syndicates, each of which specializes in insuring a particular type of risk.2. Lloyds provides a meeting place and clerical services for syndicate members who actually transact

the business of insurance.3. Members are individually liable for each risk they assume.4. Coverage provided is underwritten by a syndicate manager such as an attorney-in-fact or individual

proprietor.

Fraternal Benefit Societies1. Fraternal benefit societies are primarily social organizations that engage in charitable and benevolent

activities that provide life and health insurance to their members.2. Membership typically consists of members of a given faith, lodge, order, or society.3. They are usually organized on a non-profit basis.

Risk Retention Groups (RRG)1. A group-owned insurer that primarily assumes and spreads the liability related risks of its members.2. Licensed in at least one state and may insure members of the group in other states.3. Owned by its policyholders.4. Group must be made up of a large number of homogeneous or similar units.5. Membership is limited to risks with similar liability exposures such as theme parks, go cart tracks,

or water slides.6. Must have sufficient liquid assets to meet loss obligations.7. Each member assumes a portion of the risks insured.

Self InsurerTo self-insure means to assume the financial risk one’s self. This is generally an option only for large companies who may even reinsure for risks above certain maximum limits.

1. A ______________ insurance company is owned by its policyholders.a. Stockb. Reciprocalc. Fraternal Benefits Societyd. Mutual

1.3 Fundamentals of Insurers

Residual Markets1. A private coverage source of last resort for businesses and individuals who have been rejected by

voluntary market insurers.2. A Joint Underwriting Association or Joint Reinsurance Pool requires insurers writing specific

coverage lines in a given state to assume the profits/losses accruing their share of the total voluntary market premiums written in that state.

3. Risk Sharing Plan – Insurers agree to apportion among themselves those risks that are unable to obtain insurance through normal channels.

4. Coverage is typically written as Workers’ Compensation, personal auto liability or property insurance on real property.



Reinsurance Companies (Risk Sharing)1. An insurance company that assumes all or a portion of a risk from a primary or ceding insurance company.2. Reinsurance transfers risk among insurance companies.3. The insurer requesting reinsurance is the primary or ceding company.4. The Insurer sharing in the risk is the reinsurance company.5. Consumer inquiries must originate with the ceding company, which then obtains reinsurance.6. Types of Reinsurance:

a. Treaty Agreements – Reinsurance agreement that covers all risks contained in the subject line(s) of business automatically.

b. Facultative Agreements – Reinsurance agreement that allows ceding and reinsurance companies the opportunity to negotiate coverage for individual risks.

Financial Rating Services1. Independent financial rating services evaluate and rate the financial stability of insurance companies.2. These companies assign rating codes to show financial strength or weakness of each company rated.3. The ratings are available to the public.4. Producers are responsible for placing business with insurers that are financially sound.5. Examples of rating services include: A.M. Best Company, Standard &Poor’s, Moody’s Investment

Services, Weiss Insurance Rating, and Duff and Phelps Credit Rating.

2. If an insurance company wants to transfer all or part of the risk it has accepted, it would buy which of the following types of insurance?a. Residualb. Reinsurancec. Reciprocald. Insurer

1.4 Insurer Domicile and Admittance1. Domicile refers to the jurisdiction (i.e., state or country) where an insurer is formed or incorporated.

Domestic Insurer Foreign Insurer Alien InsurerAn insurer organized under the laws of this state, whether or not it is admitted to do business in this state.

An insurer not organized under the laws of this state, but in one of the other states or jurisdictions within the United States, whether or not it is admitted to do business in the state or jurisdiction.

An insurer organized under the laws of any jurisdiction outside of the United States, whether or not it is admitted to do business in this state.

Exam Tip #1: A compAny cAn only be domiciled in 1 stAte. they Are foreign in the 49 other stAtes And Alien in Any other country.

Exam Tip #2: domicile hAs nothing to do with being licensed in A stAte—thAt is being Authorized or Admitted.

Exam Tip #3: Know the difference between domicile of insurers vs. Admitted /Authorized

2. Admitted vs. Non-admitted – Refers to whether or not an insurer is approved or authorized to write business in this State.a. The domicile does not impact whether an insurer may be admitted to do business in this State.b. An Admitted (Authorized) insurer is authorized by this State’s Commissioner of Insurance to

do business in this State. It has received a Certificate of Authority to do business in this State.



c. A Non-admitted (Non-authorized) insurer has either applied for authorization to do business in this state and was declined or they have not applied. They are not authorized to transact insurance in this state.

d. Surplus and Excess lines insurance can be placed through non-admitted carriers.3. Surplus Lines Insurance finds coverage when insurance cannot be obtained from admitted insurers.

a. May not be utilized solely to receive lower cost coverage than would be available from an admitted carrier.

b. Each State regulates the procurement of Surplus Lines insurance in its State.c. Non-admitted business must be transacted through a Surplus Lines Brokers or Producers.

3. Which of the following is an insurance company that is organized under the laws of another state within the United States?a. Domesticb. Alienc. Foreignd. Authorized

1.5 Insurer Management and Distribution

Management1. Executives – Oversee the operation of the business.2. Actuarial Department – Gather and interpret statistical information used in rate making. An actuary

determines the probability of loss and sets premium rates.3. Underwriting Department – Responsible for the selection of risks (persons and property to insure)

and rating that determines actual policy premium.4. Marketing/Sales Department – Responsible for advertising and selling.5. Claims Department – Assists the policyholder in the event of a loss.

Insurance Company Financial Structure1. The Department or Division of Insurance regulates all insurers doing business in this state. Its major

concern is providing protection against the insolvency of an insurer.2. The Department or Division regulates the organization and ownership, capital and surplus

requirements, reserves, accounting, investments, annual statements, rehabilitation of impaired insurers, and the liquidation of insurers when necessary.

3. The Department’s or Division’s main goal is the protection of the general public through the use of the following reports and regulations:a. Investments – Insurance regulations require that all investments be approved by the insurer’s

Board of Directors. Most investments are required to be invested in something that is fairly stable.

b. Annual Statement – Every insurer authorized to transact business in this state must file a financial report with the Department or Division annually. The financial report must be detailed so the Department or Division might see anything of financial concern.

c. Examination of Insurers – The Department or Division conducts examinations on every insurer in this state. The examination may be as often as the Department or Division deems necessary.

d. Rehabilitation and Liquidation – Regardless of the regulations and controls, a few insurers find themselves in financial difficulty. When this happens, the Department or Division will step in and attempt to help the insurer become solvent again. Only as a last resort are insurers declared insolvent and the liquidation process started.



Distribution Models1. Exclusive or Captive Agency System – Deals with the insured through an exclusive or captive agent.

a. Agent represents solely one company or group of companies having common ownership.b. Insurer retains ownership rights to the business written by the agent.c. The agent is an employee or a commissioned independent contractor.d. Insurer may or may not provide office and agency support services.

2. Direct Writing Systema. Producer or Agent is an employee of the insurer.b. Insurer owns the accounts.c. The agent may be paid a salary, salary plus bonus, or commission.

3. Independent Agencya. An agent or agency that enters into agency agreements with more than one insurer. It may

represent an unlimited number of insurers.b. Agency retains ownership of the business written.c. An independent contractor that is paid a commission and covers the cost of agency operations.

4. Career Agency System – Agents are recruited, trained and supervised by either a managing employee or General Agent who is contracted with the insurance company.

5. Personal Producing General Agenta. Does not recruit career agents.b. Sells insurance for carriers it is contracted with and maintains its own office and staff.

6. Direct Mail or Direct Response Companya. Sells insurance policies directly to the public with licensed employees or contractors.b. A marketing system utilizing direct mail, newspapers, magazines, radio, television, internet,

web sites, call centers and vending machines.7. Mass Marketing

a. Mass marketing is used to target a specific type of insurance to a large group of individuals, such as the American Association of Retired People (AARP).

b. Insurer reduces marketing and underwriting expenses.

4. Which insurance company department accepts the insurance risk?a. Executiveb. Actuarialc. Claimsd. Underwriting

1.6 Insurance Agents and Producers1. Law of Agency

a. A relationship between two or more parties where one party (the agent or producer) acts on behalf of the other party, known as the principal or insurer.

b. The agent or producer binds the actions and words of the principal.2. Insurer (principal)

a. Insurer is the source of authority from which the producer must abide.b. Insurer is responsible for all acts of a producer, when producer is acting within the scope of its

authority.c. Producer may be personally liable when his/her actions exceed the authority of the agency’s

contract.



3. Producer (agent)a. A person or agency appointed by an insurance company to represent it and to present policies on

its behalf.b. A producer possesses three types of authority:

1) Express – Authority that is written into the producer’s agency contract. An example would be the producers binding authority if written in the contract.

2) Implied – Authority the public assumes the producer has. An example would be the business activities of providing quotes, completing applications and accepting premiums on behalf of the insurer.

3) Apparent – Authority created when the producer exceeds the authority expressed in the agency contract. This occurs when the insurer does nothing to counter the public impression that such authority exists. An example would be the producer’s acceptance of premiums on a lapsed policy.

c. Producer’s Responsibilities to the Insurer:1) Fiduciary duty to the insurer in all respects, especially when handling premium funds.2) Must keep premium funds in a trust account separate from other funds and forward to

insurer promptly.3) Must report any material facts that may affect underwriting.4) Responsible for soliciting, negotiating, selling, and cancelling the insurance policies with

the insurer.5) Duty to only recommend the purchase of suitable policies.

d. Producer’s Responsibilities to Insurance Applicant or Insured:1) Forward premiums to insurer on a timely basis.2) Seek and gain knowledge of the applicant’s insurance needs.3) Review and evaluate the applicant’s current insurance coverage, limits and risks.4) Serve the best interests of the applicant or insured, although producers represent the insurer.5) Recommend coverage that best protects the insured from possible loss and NOT the most

profitable coverage from the perspective of the producer.4. Broker

a. A licensed individual who negotiates insurance contracts with insurers, on behalf of the applicant.

b. Represents the applicant or insured’s interests, not the insurer, and thus does not have legal authority to bind the insurer.

c. A broker’s license is not applicable in all states.

Exam Tip: A broKer AlwAys represents the insured. An Agent AlwAys represents the insurer.

5. Which of the following individuals represents the insurance company when selling an insurance policy?a. Producerb. Brokerc. Adjusterd. Insurer



6. Which of the following types of authority does the public assume an agent has when quoting insurance?a. Authorizedb. Expressc. Impliedd. Apparent

7. A producer has each of the following responsibilities to the Insurer, except:a. A fiduciary dutyb. Forwarding premiums to the insurer on a timely basisc. Reporting material facts that may affect underwritingd. A duty to recommend only high rate policies

1.7 Federal Regulations

Fair Credit Reporting Act (15 USC 1681–1681d)1. Protects consumer privacy.

a. Ensures data collected is confidential, accurate, relevant and used for a proper and specific purpose.

b. Protects the public from overly intrusive information collection practices.2. When an application is taken, it must inform the applicant a credit report (from consumer reporting

agency) will be obtained. The purpose of this is to determine the financial and moral status of an applicant (for variety of purposes such as employment screening, insurance underwriting or loan approvals).

3. Applicant has the right to review the report.a. Applicant challenge – Credit reporting agency must reinvestigate within 6 months, if applicant

challenges accuracy.b. Inaccuracies – Agency must forward to applicant inaccurate information given out within

previous 2 years.c. Disallowed information – Report must not include lawsuits over 7 years old or bankruptcies

over 14 years old.4. Insurer obligations

a. Insurer is not responsible for correcting inaccuracies on any reports.b. If an applicant is denied coverage because of inaccurate information they are entitled to certain

rights.

Exam Tip: Know thAt the fcrA does All of the following:

• provides finAnciAl And morAl stAtus of A client

• gives A person recourse if denied due to the credit report being inAccurAte

• protects consumers right to privAcy

• the insured cAnnot require the insurer to issue the policy if the report is corrected

• the ApplicAnt must be given disclosure At the time of ApplicAtion

Financial Anti-Terrorism Act (USA Patriot Act)Imposes record keeping and government reporting requirements on banks, financial institutions and non-financial businesses for specific financial transactions and customer financial records (a part of the Bank Secrecy Act).



Fraud and False Statements (Fraudulent Insurance Act)1. Fraud always involves a false statement and deceit; it can be either a criminal or civil crime. Federal

laws prohibit the commission of fraud.2. In 2001, the NAIC adopted model legislation for the prevention and enforcement of insurance fraud.

Subsequently, each of the states enacted its own Fraudulent Insurance Act.3. A fraudulent act involves a misstatement of material fact by a person who knows or believes that

statement to be false. The statement is made to another person who relies on its accuracy to make a decision or to act and is subsequently harmed by relying on the deliberately false statement.

4. State fraudulent insurance acts do not modify the privacy of any individual; they protect producers, brokers, and insurers in the event fraudulent information is provided by consumers.

5. Insurance applications and claim forms must contain a disclosure about how false statements and fraud will be treated by the insurer. A sample warning is, “Any person who knowingly presents false or fraudulent information on an insurance application or claim for the payment of a loss is guilty of a crime and may be subject to fines and confinement in state prison.”

McCarran-Ferguson Act (Deals with the Fraud Act)1. Public Law 15/McCarran-Ferguson Act established the federal government’s right to regulate the

industry.2. Federal law does apply to situations involving Fraud and False Statements made in the insurance

transaction, which might lead to jeopardizing the financial soundness of an insurance company.3. This act makes it a federal offense and penalties can include fine, imprisonment, or both.

Merchant Marine Act of 1920 (the Jones Act)Because Workers’ Compensation laws do not apply to seamen, the Jones Act allows insured seamen to make claims for injuries suffered during the course of employment. It also regulates maritime commerce in U.S. waters, transportation of cargo, and the rights of seamen.

Motor Carrier Regulatory and Modernization Act (the Motor Carrier Act of 1980)Deregulated the trucking industry by prohibiting any entity from interfering with a motor carrier’s right to set its own rates. Motor carriers and private motor carriers that transport property are required to establish evidence of financial responsibility in the form of insurance, a bond, a guarantee, or qualification as a self-insurer.

Gramm-Leach-Bliley Act (GLBA, a.k.a. the Financial Services Modernization Act of 1999)1. Repealed parts of the Glass-Steagall Act of 1933 to allow the merger of banks, securities

companies, and insurance companies. It also established the Financial Privacy Rule and Safeguards Rule for the protection of consumers’ privacy.

2. The Financial Privacy rule requires “financial institutions,” which include insurers, to provide each consumer with a privacy notice at the time the consumer relationship is established and annually thereafter.

3. The privacy notice must explain:a. The information collected about the consumer.b. Where that information is shared.c. How that information is used.d. How that information is protected.

4. The notice must also identify the consumer’s right to opt out of the information being shared with unaffiliated parties pursuant to the provisions of the Fair Credit Reporting Act.



5. Should the financial institutions privacy policy change at any point in time, the consumer must be notified again for acceptance.

6. Each time the privacy notice is re-established, the consumer has the right to opt out again.

Terrorism Risk Insurance Act and its Extensions of 2005 and 20071. Terrorism Risk Insurance Act of 2002 (TRIA) – Enacted in direct response to the terrorist attacks

New York City and Washington, D.C. on September 11, 2001. Congress provided temporary financial compensation to insured parties during its crisis of recovery from the terrorist attacks.

2. TRIA was intended to respond to the chaos the 9/11 terrorist attacks caused in the insurance industry as well as to assure that commercial property and liability insurance would continue to be able to provide coverage for the peril of terrorism.

3. TRIA was a temporary program that allowed the federal government to share in terrorism losses with private insurers in the event a certified act of terrorism took place.

4. TRIA expired on December 31, 2005 and was extended for two years, with changes, under the Terrorism Risk Insurance Extension Act of 2005 (TRIEA). It was extended with changes a second time, in 2007, under the Terrorism Risk Insurance Program Reauthorization Act of 2007 (TRIPRA) and is scheduled to expire on December 31, 2014.

5. Protects consumers by addressing market disruptions and ensuring the continued widespread availability and affordability of property and casualty insurance for terrorism risk.

6. The Act provides for a Terrorism Insurance Program established in the Department of the Treasury. The Secretary of the Treasury administers the Program. “Act of Terrorism” is defined as any act certified by the Secretary of Treasury, in cooperation with the Secretary of State and Attorney General.

7. Only commercial property and casualty insurance is covered by the Program; personal lines insurance and life and health insurance are not covered.

8. No payment may be made by the Secretary under the Program with respect to an insured loss that is covered by an insurer, unless:a. The person that suffers the insured loss, or a person acting on behalf of that person, files a claim

with the insurer.b. The insurer provides clear and conspicuous disclosure to the policyholder of the premium

charged for insured losses covered by the Program and the Federal share of compensation for insured losses under the Program.

c. The insurer processes the claim for the insured loss in accordance with appropriate business practices, and any reasonable procedures that the Secretary may prescribe.

d. The insurer submits to the Secretary, in accordance with such reasonable procedures as the Secretary may establish.

9. An insurer must make coverage for insured losses that do not differ materially from the terms, amounts, and other coverage limitations applicable to losses arising from events other than acts of terrorism.

10. The Secretary shall not make any payment for any portion of the amount of such losses that exceeds $100 billion (cap on annual liability) and no insurer that has met its insurer deductible shall be liable for the payment of any portion of that amount that exceeds $100 billion.

11. The insurer deductible is 20% of all covered losses.12. The insurance marketplace aggregate retention amount (the maximum losses the insurance industry

must sustain before federal co-payments are available) is the lesser of $27.5 billion and the aggregate amount, for all insurers, of insured losses during such period.

13. The insurance companies share of losses in excess of the deductible (amounts paid or losses exceeding insurer’s deductible) is 15%, while the federal government is responsible for 85%.



Violent Crime Control and Law Enforcement Act of 1994 (18 USC 1033, 1034)The largest crime bill in U.S. history expands funding to federal agencies such as the FBI, DEA, and INS and includes provisions that address (among other topics) domestic abuse and firearms, gang crimes, immigration, registration of sexually violent offenders, victims of crime, and fraud.

1. The Act made it a felony for a person to engage in the business of insurance after being convicted of a state or federal felony crime involving dishonesty or breach of trust.a. Violations include willfully embezzling money, knowingly making false entries in any book,

report or statement of the business, threatening or impeding proper administration of the law in any proceeding involving the business of insurance.

b. Dishonesty – Deceit, misrepresentation, untruthfulness, falsification.c. Breach of Trust – Based on fiduciary relationship of parties and the wrongful acts violating the

relationship.2. Penalties – Fines and possible prison time.3. Insurance license applicants and producers:

a. Applicants who have been convicted of a felony must apply for Consent to Work in the business of insurance—prior to applying for an insurance license.

b. Producers must apply for consent in their resident state.c. Officers and employees must apply for consent in the state where their home office is located.d. Prohibited persons (convicted felons) must apply for consent in order to discover if they are

permitted or prohibited from the insurance business.e. Reciprocity – If consent is granted by any state, other states must allow the applicant to work in

their states as well.f. Consent Withdrawal – If conditions of consent are not continually met, the consent may be

withdrawn.

8. A federal regulation called the ______________ protects consumer privacy.a. Consolidated Omnibus Budget Reconciliation Actb. Fraudulent Insurance Actc. Privacy Protection Actd. Fair Credit Reporting Act

1.8 Risk Management

Insurance (The Principle of Insurance)The principle of insurance is defined as spreading out the result of a financial loss created by an individual’s death or property damage, so the cost for each individual is small. Insurance is the substitution of a small certain expense for a large uncertain loss. It also transfers the risk, protects against uncertainty, shares the loss, and reduces anxiety.

Exam Tip: Know thAt insurAnce:

1. trAnsfers the risK

2. protects AgAinst uncertAinty

3. shAres the loss

4. reduces Anxiety



1. Riska. A condition where the chance, likelihood, probability or potential for a loss exists.b. Uncertainty concerning a loss.

2. Managementa. The determination of what types of protection are required to meet an insured’s needs.b. A survey of the insured’s operations, health, assets and exposures that could give rise to losses.c. Assessment of potential loss frequency and severity.d. Physical inspections, applications or medical exams used for underwriting help to manage a risk.

3. Types of Risk:a. Speculative Risk

Situations where there is a chance for loss, gain, or neither loss nor gain to occur. An example of speculative risk is gambling. Speculative risk cannot be insured.

b. Pure Risk1) Situations where there is no chance for gain; the only outcome is for nothing to occur or for

a loss to occur.2) Pure risk can be insured. Examples include:

a) The possibility of damage to property caused by a fire or other natural disaster.b) The possibility of financial loss as a result of death.

4. Loss – Reduction, decrease, or disappearance of value. The basis of a claim for damages under the terms of an insurance policy.

5. Peril – The cause of a loss.6. Hazard – A specific condition that increases the probability, likelihood, or severity of a loss from a peril.7. Three Types of Hazard

Physical Hazard Moral Hazard Morale HazardA physical condition that increases the probability of loss; use, condition, or occupancy of property. Example: Flammable material stored near a furnace.

Dishonest tendencies that increase the probability of a loss; certain characteristics and behaviors of people. Example: An insured burns down his/her own house to collect the insurance payout.

Attitude that increases the probability of a loss. Example: Indifference or carelessness of leaving one’s house or vehicle unlocked.

8. Loss Exposure – The condition of being at risk for a loss. Purely by existing, property and people are at risk for loss.

9. Adverse Selectiona. An imbalance created when risks that are more prone to losses than the average (standard) risk

are the only risks seeking insurance within a specific marketplace. For example, only those living in earthquake-prone areas seek to buy earthquake insurance.

b. High-risk exposures tend to seek or continue insurance at a higher participation rate than the average risk exposures do.



10. Managing Riska. Analyzing exposures that create risk and designing programs to minimize the possibility of a loss.b. Ways of managing risk:

S Sharing • Investments of a large number of people may be pooled by use of a corporation or partnership.

T Transfer• Transferring the risk from one party to another, such as from a

consumer to an insurance company.• Transfer the uncertainty of loss via a contract.

A Avoidance

• Elimination of the risk.• Avoid the activity that gives rise to the chance of loss.• After potential areas of hazards have been identified, it may be found

that some exposure to risk can be eliminated, but it is impossible to avoid all risk.

R Reduction

• Minimizing the chance of loss, but not preventing the risk. For example, sprinkler systems, burglar alarms, pollution controls and safety guards on machinery.

• Pooling or spreading the risk among a large number of persons or entities.

R Retention

• Assume the responsibility for loss.• Self insure the entire loss or a portion of the loss. Choosing deductibles

is a method of risk retention.• It might be economically practical for an insured to not insure each

exposure to loss and instead insure only those risks that threaten financial stability security.

11. Insurable risks must include:a. Large number of homogeneous units or groups with the same perils.

1) Law of Large Numbers – As the number of units in a group increases, the more likely it is to predict a particular outcome.

2) Auto insurance losses are the easiest type of insurance loss to predict precisely because the number of units insured is so great.

b. The chance of loss must be calculable. A statistical expectation of loss is used by insurers to calculate premiums.

c. The loss must be measurable (definite and verifiable in terms of amount, cause, place and time).d. The premiums must be affordable.e. From the perspective of the insured, the loss must be accidental in nature.f. Catastrophic perils are not covered; examples include war, nuclear hazard and illegal operations.

9. Dishonest tendencies that increase the probability of loss are what types of hazard?a. Physicalb. Moralc. Emotionald. Legal

10. Each of the following must be included in an insurable risk, except:a. Calculable chance of lossb. Excluded catastrophic perilsc. Large group with dissimilar membersd. Accidental losses



1.9 Insurance Concepts1. The Insurance Contract

a. A legal contract purchased to indemnify the insured against a loss, damage or liability arising from an unexpected event.

b. The exchange of a relatively small and definite expense for the risk of loss that, if it occurs, may be large or small.

c. A contract designed to transfer risk from the insured to the insurer.2. Principal of Indemnity

a. Insured is restored to the same financial or economic condition that existed prior to the loss.b. Insured should not profit from an insurance transaction.

3. Insurability – The ability of an applicant to meet an insurer’s underwriting requirements.4. Underwriting – The process of selecting, classifying, and rating a risk for the purpose of issuing

insurance coverage.5. Insurable Events – Any event, past or present, that may cause loss or, damage or create legal

liability on the part of an insured.6. Insurable Interest

a. All Policies1) Insurable interest must exist in every enforceable insurance contract. Depending upon the

contract, it must exist at the time of application or at the time of loss.2) Requires the potential for an insured to suffer financial or economic hardship in the event of

a loss.b. Life & Health policies

1) Insurable interest must exist at the time of application, but not at time of loss.2) Coverage is determined based on the possibility of an economic or financial loss due to an

accident, sickness, or death of the insured.3) The amount of insurance that may be purchased varies based on the type of coverage.

In some cases, no coverage limit apply.c. Property

1) Insurable interest must exist at the time of the loss.2) Property ownership (or mortgage or lien) is evidence of insurable interest.

d. Casualty1) Insurable interest must exist at the time of the loss.2) Insurable interest usually results from property or contract rights and potential legal liability.

11. Which principle of insurance restores the insured to the same economic condition that existed before the loss?a. Indemnityb. Insurabilityc. Adhesiond. Underwriting



1.10 Contracts

General Terms

Term DefinitionContract Law Pertains to the formation and enforcement of contracts.

Tort Law Torts are civil wrongs; they’re not crimes or breaches of contract. They result in injuries or harm that constitute the basis of a claim by a third party.

Contract of Utmost Good Faith

Both parties bargain in good faith when forming and entering into the contract. The two parties rely upon the statements and promises of the other and assume no attempt to conceal or deceive has been made.

Estoppel

Prevents the denial of a fact, if the fact was admitted to be true previously.

Example: An attorney might use estoppel against an agent or an insurance company that has allowed something in the past, but is now denying the same scenario a second time. For instance, a client had a policy lapse and the agent accepted a past due premium payment and pushed it through the home office without a reinstatement application. Some time later, the same client tries to submit a past due premium after the same policy lapsed again, expecting the same outcome of a reinstated policy. The agent does not allow it this time. The client suffers a loss and the insurer denies claim because the policy is lapsed. The attorney could argue in a court of law that since the agent and the company allowed the client to previously reinstate the policy by paying premium, they must do so again.

Hold Harmless Agreement

A contractual agreement that transfers the liability of one party to another party; it is used by landlords, contractors, and others as a way to avoid or reduce risk.

Parole Evidence Rule

A written contract may not be altered without the written consent of both parties.

Waiver Voluntary surrender of a known right, claim or privilege

Four Elements of a Legal Contract1. Competent Parties

a. All parties to a contract; Insurer and Insured must have legal capacity to enter into a contract.b. Those without legal capacity include:

1) Minors – The insurer may be held responsible for its obligations, however, in most cases a minor cannot enter into a contract. Exceptions do exist, such as for the purchase of auto insurance.

2) The mentally incompetent or incapacitated.3) Persons under influence of drugs or alcohol.

2. Legal Purposea. All parties to a contract must enter it for a legal purpose; public policy cannot be violated by a

legal contract.b. All parties to a contract must enter it in good faith.

3. Agreement – One party must make and communicate an offer to the other party and the second party must accept that offer.a. Offer – The offer for entering an insurance contract is the application submitted by the

applicant.b. Acceptance – The acceptance of an insurance contract takes place when the insurance company

agrees to issue insurance. A counteroffer by the insurance company is not acceptance until the applicant accepts the counteroffer.



4. Considerationa. Something of value is exchanged; the exchange of an act for a promise.b. The consideration made by the applicant is the premium payment.c. The consideration made by the insurer is its promise to pay for covered losses.

Insurance Contracts: Characteristics, Definitions and InterpretationsContract of Adhesion – One party writes the contract, without input from the other party. One party (insurer) prepares the contract and presents it to the other party (applicant) on a “take-it-or-leave-it” basis, without negotiation. Any doubt or ambiguity found in the document is construed in favor of the party that did not write it (insured).

Aleatory Contract – The exchange of value is unequal. Insured’s premium payment is less than the potential benefit to be received in the event of a loss. The insurer’s payment in the event of a loss may be much greater, or much less (e.g., $0 in the event a loss doesn’t occur), than the insured’s premium payment.

Valued Contract – A contract that pays a stated amount in the event of a loss. (Most insurance policies are NOT valued contracts unless they are endorsed).

Indemnity Contract – An agreement to pay on behalf of another party under specified circumstances, such as when a loss occurs.

Applicant – The party submitting an application for insurance.

Application – A document submitted by an applicant to an insurer that provides information needed for the insurer to underwrite a risk; becomes part of the insurance contract. Most applications require statements on the application to be true to the best knowledge and belief of the applicant.

Endorsement – A policy form that broadens and restricts —or alters or adds to the provisions of a property and casualty insurance contract.

Personal Contract – Owner cannot transfer or assign ownership of an insurance policy (property and casualty) to another person.

Non-Personal Contract – Owner may transfer or assign ownership of a life or health insurance policy to another person.

Assignment – Policy owners may not assign or transfer their rights under an insurance contract without the written consent of the insurer.

Issue Age – Insured’s original age on the policy issue date.

Attained Age – Insured’s age at any point in time at issuance, renewal or conversion.

Effective Date – The date when insurance coverage begins.

Lapse Date – The date when insurance coverage ends; if not cancelled prior, policy will terminate by end of grace period if premium is not paid.

Unilateral Contract – Only one party is legally bound to the contractual obligations after the premium is paid to the insurer. Only the insurer makes a promise of future performance, and only the insurer can be charged with breach of contract.

Conditional Contract – Both parties must perform certain duties and follow rules of conduct to make the contract enforceable. The insurer must pay claims if the insured has complied with all the policy’s terms and conditions.



Reasonable Expectations Doctrine – What a reasonable and prudent policy owner would expect; the reasonable expectations of policyowners are honored by the Courts although the strict terms of the policy may not support these expectations.

Representations – Statements made by the applicant on the application that are believed to be true to the best of the knowledge and belief of the applicant; may be withdrawn prior to policy issuance.

Misrepresentations – A false statement contained in the application; usually does not void coverage or the policy. If material to the issuance of coverage, meaning the insurer would not have issued coverage had the misrepresentation not been made, coverage does not apply. In some cases, a material misrepresentation may void the policy.

Concealment – The willful hiding or obscuring of material facts pertinent to the issuance of insurance (or a claim). Concealment results in denial of coverage and may void the policy.

Warranties – Statements in the application or stipulations in the policy that are guaranteed true in all respects. If warranties are later discovered untrue or breached (past, present or future), coverage (and sometimes the contract) is voided.

Fraud – Intentional deception of the truth in order to induce another to part with something of value or to surrender a legal right. Contains 5 elements:

• False statement, made intentionally and that pertains to a material fact.• Disregard for the victim.• Victim believes the false statement.• Victim makes a decision and/or acts based on the belief in, or reliance upon, the false statement.• The victim’s decision and/or action results in harm.

Void Contract – An agreement without legal effect because it was made illegally or it was declared void by the courts because it doesn’t contain all the elements of a legal contract.

Voidable Contract – A valid contract that for reasons satisfactory to a court, may be set aside by one of the parties. An example is an insurer may void or revoke coverage for misrepresentation or fraud.

12. Each of the following is an element of a legal contract, except:a. Considerationb. Legal Purposec. Agreementd. Indemnity

13. A warranty is defined as which of the following?a. Intentional misrepresentation on the applicationb. Statement in the application that is guaranteed to be truec. A false statement in the applicationd. What a reasonable and prudent buyer can expect

1.11 Insurer Underwriting

Underwriter1. The underwriter’s primary responsibility is the selection of risks to be insured. The

underwriter also determines the classification, and premium rate if a risk is accepted by the insurer.

2. Underwriting protects the insurer against adverse selection and risks that are more likely than average to suffer losses.



3. Goal is to select risks that fall into the normal range of expected losses.4. Field underwriter is the producer.5. Line and staff underwriters are employed by the insurer.

Underwriting Factors1. Nature of the risk.2. Hazards that are present.3. Claims history.4. Other factors that depend upon the type of risk being insured.

Premium Assumptions1. Must charge an adequate premium for the risk based on the same factors used in evaluating the risk.2. Premium rates are considered inadequate when they do not cover projected losses and expenses.3. Rates must not be excessive or unfairly discriminatory.4. Rate – The dollar amount charged for a particular unit of insurance, such as $5 per $1,000 of insurance.5. Premium – The total cost for the amount of insurance purchased.

$50,000 of coverage = $5 rate x 50 (per $1,000 of insurance) for a $250 premium.

Rating Types/Methods1. Class Rating – A rate charged to a group of policyholders who have similar exposures and experience.

a. A Class Rate system is the most common approach and is the key element in premium calculation.

b. Class rates apply to all members of a large group of similar risks.c. When class rates are printed in a rate manual, they are sometimes referred to as manual rates

2. Experience Rating – A rate based on the policyholder’s actual loss history when compared to the loss history of similar risks.

3. Individual Rating – A rate used for a policyholder because a large enough pool of similar risks is not available to any other type of rate. Primarily used for commercial any specialty risks because of the number of unique variables involved.

4. “A” Rating or Judgment Rating – An individual rate that doesn’t use loss history as a component and that is derived largely from the underwriter’s evaluation and best judgment the risk poses to the insurer.Exam Tip: this is the only method where the underwriter rAtes the policy. in All other rAting methods, ActuAries determine the rAtes.

5. Loss Cost Rating – A rating organization provides insurers with the portion of a rate that does not include provisions for expenses or profit.a. The expense and profit components to develop the final rate must be added by individual

insurers based upon their projections.b. Loss cost rating is used on risks for which the insurer may not have enough data to develop the

rate, other than for expenses and profit.6. Manual Rating – The use of rates contained in a manual published by the insurer or those of the

rating organization of which it is a member.7. Merit Rating – The use of rates that rewards a policyholder that takes measures to decrease the

probability of loss by the implementation of safety programs, loss control programs, etc.8. Retrospective Rating – The use of rates that adjust the policy premium to reflect the current loss

experience of the policyholder. Premium adjustments are subject to minimums and maximums.9. Schedule Rating – A method of rating property and liability risks by using charges and credits to

modify a class rate based on the nature of the particular risk being rated.



Rate Approval1. File and Use – Rates must be filed with the state insurance regulatory authority (Department of

Insurance) and may be used as soon as they are filed.2. Prior Approval – Insurers cannot use rates until approved by the Department of Insurance, or until a

specific time period has expired after the filing.3. Mandatory Rates – Some states require that mandatory rates be used for certain lines of insurance.4. Open Competition – A state relies on competition between insurers to produce fair and adequate

rates.5. Loss Reserves – The net premiums plus interest reflects possible future contract obligations. An

accounting measurement of an insurer’s future obligation to its policyholders.a. Case Reserve Method – A loss reserve established for each claim, when reported.b. Average Value Method – A loss reserve established based on average settlements of particular

claim types.c. Loss Ratio Method – A loss reserve formula based upon the expected losses for a particular

class or line.d. Tabular Method – A loss reserve based upon the estimated length of an insured’s or claimant’s

life or expected disability.6. Financial Ratios

a. Loss Ratio – Determined by dividing Paid Losses + Loss Reserves by Total Earned Premiums.b. Expense Ratio – Determined by dividing an insurer’s Total Operating Expenses by Written

Premiums.c. Combined Ratio – Sum of the loss ratio and expense ratio.

7. Underwriting Measurementa. Premiums can only be established by the insurance company after balancing all accounting from

the past.b. This is where the loss ratio and the expense ratio play an intricate part of this process.

Example: If the loss ratio is 50%, then the company is paying out in claim loss $.50 on every $1.00 that it receives in premiums. If the expense ratio is 30%, then $.30 of every dollar that it receives is used to cover operating expenses. The two combined is equal to 80%, which means that for every dollar coming in, the insurance company is experiencing a 20% underwriting profit.

Exam Tip: Know this formulA:

prEmium CalCulaTion

when computing insurAnce premiums, you multiply the units of exposure times the rAte. the purpose of the premium cAlculAtion is to bring in enough premium dollArs to cover clAims And expenses.

Example: If the rate is $2.25 per square foot, then the annual premium for a 10,000 square foot building would be $22,500.

14. Each of the following is a factor considered by an underwriter, except:a. Hazardsb. Marital statusc. Claims historyd. Outside factors



15. Which of the following calculations equals a company’s loss ratio?a. All losses + expensesb. Paid losses + loss reserves ÷ total earned premiumc. Losses + total operating expenses ÷ total written premiumd. Paid losses + paid expenses ÷ total earned premium

chapter One — lIGhtnInG Facts

1. The State Commissioner, Supervisor, or Director of Insurance is the chief insurance regulator who protects the insuring population by regulating all insurers and insurance professionals doing business in the State. 1.1

2. A stock insurance company issues non-participating policies and is owned by stockholders who received taxable corporate dividends as a return of profit. 1.2

3. A mutual insurance company issues participating policies and is owned by the policyholders who receive non-taxable dividends as a return of unused premium. 1.2

4. Reinsurance is the transfer of risk between insurance companies. The reinsurer assumes some or all of the risk of the ceding, or primary, insurance company. 1.3

5. Domicile refers to the state in which an insurer incorporated. A domestic insurer is organized under the laws of the resident state; a foreign insurer is organized under the laws of another state within the United States; and an alien insurer is organized under the laws of a country outside the U.S. 1.4

6. An admitted insurer is authorized to do insurance business in the state and is issued a Certificate of Authority by the state’s Department of Insurance. 1.4

7. The underwriting department of an insurance company is responsible for the selection of risks to insure and determines the rate to be charged. 1.5

8. An agent/producer can be the employee of an insurance company that owns the agent’s book of business, or an independent agent that enters into agency agreements with more than one insurance company. Independent agent retains ownership of their books of business. 1.5

9. The Law of Agency is a three-party relationship where a Principal authorizes an Agent to act on its behalf to create a legal relationship with a Third Party. 1.6

10. Express authority is written into the producer’s agency contract; implied authority is that which the public assumes the agent possesses; and apparent authority is created when the agent exceeds express authority and the insurer does not respond. 1.6

11. The Fair Credit Reporting Act (FCRA) protects consumer privacy by ensuring that any data collected by an insurer remains confidential, and is accurate, relevant, and used for a proper and specific purpose. 1.7

12. A risk is the uncertainty of a loss. 1.813. A peril is the cause of loss. 1.814. A hazard increases the probability of a loss. The 3 types of hazards are physical, moral, and a

morale. 1.815. The principle of indemnity does not allow the insured to profit from a loss; instead, it restores the

insured to the same financial or economic condition that existed prior to the loss. 1.916. Insurable interest in property and casualty insurance must exist at the time of the loss. 1.917. The insurance contract is one of adhesion; one party (the insurer) prepares the contract and presents it

to the second party (the insured), who must accept it on a “take-it-or-leave-it” basis. 1.1018. The underwriting factors used to determine premium include the nature of the risk, hazards, claims

history, and other factors that vary depending upon the risk. 1.11 Lightning Facts available in “audio” MP3 format. Visit our website.


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