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Chapter 3: Insurance (Basics) Terminologies

3.1. Principles and Concepts 3.2. Commonly Used Insurance Terms and Definitions 3.2. Policy Structure 3.4. Common Policy Provisions 3.5. Texas Insurance Laws Regulations and General Provisions

CHAPTER 3: INSURANCE TERMS AND RELATED CONCEPTS (INSURANCE BASICS)

3.1 PRINCIPLES AND CONCEPTS

Stock companies Capital stock insurance companies are the leading type of insurer in the United States. They control almost 70% of all property and liability insurance premiums and about 50% of life insurance premiums. Stockholders own these companies and share profits and losses. Mutual companies Mutual companies have no stockholders – policyholders own the companies; have voting rights and share profits which are distributed in the form of policy dividends. In the U.S., Mutual companies control about 30% of the property and liability insurance business and 50% of the life

insurance business. County Mutual

County Mutual Insurance Companies are companies organized for the purpose of insurance on the mutual or cooperative plan against loss or damage by fire, lightning, gas explosion, theft, windstorm and hail, and for all or either of such purposes. Company Ratings

There are several organizations that rate the financial strength of insurance carriers, based on an analysis of a company’s claims experience, investment performance, management, and other factors. These organizations include A.M. Best, Standard & Poor’s, Moody’s, Duff & Phelps, and

Weiss Research. Self-Insurance

The retaining of risk. Lloyd’s of London An exchange that provides facilities for its members but does not buy or sell securities itself. Principal In the insurance business, the principal is the insurance company and the agent is a person authorized to act on the company’s behalf. Authority Express Authority- Express actual authority means an agent has been expressly told he or she may act on behalf of a principal. Implied Authority- Implied actual authority, also called “usual authority”, is authority an agent has by virtue of being reasonably necessary to carry out his express authority. Apparent Authority- Exists where the principal’s words or conduct would lead a reasonable person in the third party’s position to believe that the agent was authorized to act, even if the principal and the purported agent had never discussed such a relationship. Insurable Interest The basic rule concerning who can be insured states that before the insured can benefit from insurance, he or she must have a chance of financial loss or have a financial interest in the property. This is called an insurable interest. Loss ratio Method used to determine an insurance company’s success in covering current losses out of current premium income; determined by dividing incurred losses by earned premium. Underwriting When the application comes to the insurance company, underwriters review it for its acceptability to the company. In addition to the application, underwriters may turn to other sources of information to help them evaluate the risk.

These include:

• Inspection services • Government bureaus, such as the Bureau of Motor Vehicles • Insurance industry bureaus, such as the Automated Property Loss Underwriting System • Financial information services, such as Standard And Poor’s • Previous insurers • The company’s own claim files Rates Insurance premiums are derived from insurance rates. A rate is the price of insurance for each unit of exposure. Most state insurance laws prohibit rates which are excessive, or inadequate, or unfairly discriminatory. Types of Rates If the insurance company agrees to issue a policy, a premium must be determined. These are the basic ways in which a premium can be computed. • Judgment rating • Manual rating (Class rating) • Merit rating • Experience rating • Retrospective rating • Scheduled rating Judgment Rating- The oldest form of computing rates is called judgment rating. The premium is determined by considering the individual risk. Manual rating (class rating)- The company’s rates for a particular state or area are obtained by consulting a manual, which is usually stored on a computer. Calculating a Manual Rate

FORMULA: RATE PER UNIT X NUMBER OF UNITS = PREMIUM

EXAMPLE: AN INSURED THAT PURCHASES $60,000 OF INSURANCE AT A RATE OF $2 PER $1,000 WOULD PAY A PREMIUM OF $120 (2 X 60 = 120). Merit Rating- Typically, merit rating starts with class or manual rates, which are then modified to reflect the unique characteristics of the risks that are not reflected in the manual rate. Experience Rating- Experience rating is a form of merit rating that modifies the manual premium based on the insured’s loss experience over some period of time. Retrospective Rating- Other types of merit rating include retrospective rating, which bases the insured’s premium on losses incurred during the policy period. Scheduled Rating- Scheduled rating applies a system of debits or credits to reflect characteristics of a particular insured. Hazards A hazard is anything that increases the seriousness of a loss or the likelihood that a loss will occur due to a peril. Risk A risk is the uncertain potential for loss. Perils are things that cause losses. Hazards are catalysts that trigger or advance perils. Physical hazard Physical hazards arise from material, structural, or operational features of a risk situation. Seriously worn automobile tires would be a physical hazard. Moral hazard Moral hazards arise from a person’s habits which increase the possibility of loss. Dishonesty, such as intentionally setting a fire in order to collect the insurance, is an example of a moral hazard. Morale hazard Morale hazards arise from human carelessness or irresponsibility. Negligence 3.2 FREQUENTLY USED TERMS AND DEFINITIONS

Negligence is a failure to do what a reasonable and prudent person would do under given circumstances and it is one of the most commonly insured perils. Negligence may consist of an act or a failure to act. For negligent liability to exist, four elements must be present: • Legal duty

• Standard of care • Proximate cause • Actual loss or damage

Defenses Even when negligence is proven, legal defenses exist which could possibly eliminate or reduce a person’s legal liability.

Assumption of risk If someone understands a danger and voluntarily assumes the risk, a court may disallow recovery against a negligent party. Contributory Negligence Contributory negligence is a common law defense that denies recovery to an injured party who contributed to the loss by failing to meet standards required for self-protection. Comparative Negligence More than two-thirds of the states have adopted a less harsh version of contributory negligence known as comparative negligence . Where this is in effect, it is a statutory defense against negligence. Generally, the defense of comparative negligence reduces injury and damage awards proportionally when the plaintiff and defendant were both negligent. Intervening Cause When an independent action breaks the chain of causation and sets in motion a new chain of events, this intervening cause becomes the proximate cause and may also serve as a defense against liability. Statute of Limitations

Another defense can be found in the statutes of limitations enacted in various states. Such laws provide that certain types of lawsuits must be filed within a specified time of the occurrence to be valid under the law. Types of Damages Compensatory- Compensatory damages reimburse the injured party only for losses that were actually sustained. Punitive Damages- Intended to punish the defendant and make an example out of him or her to discourage others from behaving the same way. Absolute Liability- Absolute liability is imposed by law on those participating in certain activities that are considered especially hazardous. Strict Liability- Strict liability is most commonly applied in product claims. If a claimant can prove that a product was defective and that the defect caused the injury, the manufacturer can be held strictly liable. Vicarious Liability- There are times when a person may be held responsible for the negligent act of another person. This is called vicarious liability, or imputed liability. Cause of Loss (Perils)

* A peril is the cause of loss *

Direct loss- Direct loss means actual physical damage, destruction, or loss of property. Fire damage and stolen merchandise are examples of direct physical damage or loss.

Consequential or Indirect loss- Indirect losses are those that result from direct losses and occur as a consequence of direct loss.

Loss Valuation Actual Cash Value

Many losses are reimbursed on an actual cash value basis. Actual cash value (ACV) is usually calculated by determining the item’s replacement cost (what it would cost to buy a replacement) and subtracting an amount for depreciation. Here is what it looks like written as a formula: ACV = REPLACEMENT COST – DEPRECIATION Replacement Cost- The replacement cost for covered losses, with no allowance for depreciation.

Functional Replacement Cost- Some policies pay losses on a functional replacement cost basis, where damaged property is repaired or replaced with less expensive, but functionally equivalent materials. This method is used most frequently for losses to antique, ornate or custom construction. Market Value- Occasionally, property is insured for market value , or what it could be sold for at the time of the loss. Market value is different from ACV or replacement cost. Valued Policy- For certain hard-to-value items, the insurance company will issue a valued or agreed amount contract. Declarations The declarations section of a policy includes the identity and address of the named insured, the policy term or period, the amount of insurance or limits of liability, the policy premium, and any applicable deductibles. The declarations will also include either a property description or a schedule of coverage parts, and a list of any endorsements. Definitions Definitions define important terms used in the policy language. Some policies list definitions in a distinct section having that title. Some policies include definitions in the “Conditions” section, while others spread definitions throughout policy sections. Insuring Agreement or Clause The insuring clause or agreement describes the covered perils, or risks assumed, or nature of coverage, or makes some reference to the contractual agreement between insurer and insured. Conditions Policy conditions set provisions, rules of conduct, duties, and obligations for the parties Exclusions Exclusions may describe property, perils, hazards, or losses arising from specific causes which are not covered by the policy. Endorsements Endorsements are used to add, delete, or change any of the policy parts. Endorsements may alter the content of the declarations and insuring agreement, and they may contain conditions, 3.3 POLICY STRUCTURE

exclusions, and definitions.

AS A COMPETENT ADJUSTER, YOU MUST BE ABLE TO INTERPRET POLICY. THIS MEANS YOU MUST BE ABLE TO COMPREHEND AND RETAIN WHAT YOU READ.

3.4 COMMON POLICY PROVISIONS

Named Insured The person, persons or business actually named as the named insured in the policy declarations. Insured Anyone who may be covered by the insurance. Policy Period Every policy has a policy period which is entered in the declarations. Since coverage applies only to loss or damage that occurs during the policy period, it is important to specifically define the coverage period. Policy Territory Usually the United States, Canada and Puerto Rico. Cancellation and Non-renewal Generally, a named insured can have a policy cancelled at any time by giving written notice to the insurer. For mono-line property insurance policies, including homeowner’s insurance, an insurer must give at least 14 days’ notice of cancellation for nonpayment of premium, and at least 30 days’ notice of cancellation for any other reason. For commercial package policies, the insurer is only required to give 10 days’ notice of cancellation for any reason, and it is also required to give at least 60 days’ notice of non-renewal. For personal auto policies, an insurer must give the named insured at least 10 days’ notice of cancellation, and at least 30 days’ notice of non-renewal. Deductible The amount of a loss which the insured must absorb before the insurer begins to pay the additional loss. Pro Rata

The amount paid by each company is determined by adding the limits of all policies that cover the loss, then dividing the limit of the first policy by the total amount of insurance available. The figure that results is multiplied by the amount of the loss to determine that policy’s payment amount. Limits of Liability Each policy or coverage part will have a declarations section for listing the limits of liability. Different forms may use different wording – limit of insurance, amount of insurance, and limit of

Liability mean the same thing. Vacancy or Un-occupancy Vacant- The absence of both people and property from the premises.

Unoccupied- The absence of people. Named Insured Provisions Duties After Loss- Condition found in property-casualty policies that explain the insured’s responsibilities after a loss occurs. Assignment- Condition in insurance policies that specifies that the policy cannot be transferred to another unless the company consents to the transfer in writing. Abandonment- A condition often contained in property insurance policies that states that the insured cannot abandon damaged property to the insurer and demand to be reimbursed for its full value. Insurer Provisions Liberalization- Condition found in property insurance contracts that provides that if a law is passed that broadens coverage under a policy form or endorsement without requiring an additional premium, then all existing similar policy endorsements will be construed to contain broadened coverage. Subrogation- The transfer to the insurance company of the insured’s right to collect damages from another party. Salvage- Damaged property that can be retrieved and reconditioned then sold to reduce an insured loss.

3.5 TEXAS LAWS, REGULATIONS AND REQUIRED PROVISIONS

Commissioner of Insurance The commissioner is the department’s chief executive and administrative officer. The commissioner administers and enforces insurance the laws of Texas, and other laws granting jurisdiction or applicable to the department or the commissioner. The commissioner is appointed by the Texas governor, with the Texas Senate approval, for a two-year period. The Texas Department of Insurance The governing body for all insurance regulation in The Great State of Texas. Law and the Legal System Criminal laws- Protect public interests by governing how suspects are investigated, charged, and tried; and specify punishment. Criminal laws are statutory laws designed to punish wrongdoers. Common Law- The body of law that has developed over time through the decisions of judges. Statutory Law- The body of law developed from statutes rather than decisions of judges. Statutes- Laws enacted by legislative bodies. Hearsay- Hearsay is a person’s testimony of what he or she has heard others say but of which he or she has no personal knowledge. Claims Agents and Their Role in Insurance The Law of Large Numbers- The Law of Large Numbers helps insurers to predict the number of losses they will pay in any given time period so that they can determine what premium is required to pay for those losses. Civil laws- Protect individuals’ private rights. Sources of Law

The Principle of Indemnity and Insurable Interest

Principle of Indemnity- Explains that an insured who has suffered a loss should be restored to the same financial position as before the loss. Insurers use the loss ratio as a tool to measure their profitability.

The pure loss ratio is expressed as a percentage, as shown below:

(INCURRED LOSSES DIVIDED BY EARNED PREMIUM) X 100 = PURE LOSS RATIO

The loss ratio adds loss adjustment expenses to incurred losses:

(INCURRED LOSSES + LOSS ADJUSTMENTS EXPENSES) DIVIDED BY EARNED PREMIUM) X 100% = LOSS RATIO

Determination of Liability For first-party losses, adjusters determine the amount of damages after verifying coverage and the initial assessment. For liability claims, adjusters focus on determining liability, or establishing legal fault, along with determining damages. Tort A tort is a wrongful act or omission, other than a breach of contract, which causes harm and might lead to a civil lawsuit for damages. A person or an organization that commits a tort is

called a tort-feasor. Classes of Torts

Negligence- Negligence refers to torts that occur when a person fails to use the proper safeguards for the safety of another person on his or her property. Negligence is the most significant area of tort law for adjusters.

Strict Liability- Strict Liability (or absolute liability) often arises from ultra-hazardous operations.

Intentional Torts- Intentional torts occur when the tort-feasor purposefully harms another person through his or her actions. Contractual Liability Contractual Liability- Arises when someone’s rights are violated under the terms of a contract. Contractual Assumptions of Liability- As a condition of a business contract, a party often agrees to assume financial responsibility for liabilities imposed by law on another party. Warranties A warranty is a contractual promise that accompanies the sale of a product. Express warranties are promises made orally or in writing by the manufacturer or retailer. An implied warranty is not specifically expressed, but a purchaser could reasonably infer that the warranty exists. Adjusters encounter warranties when they are handling product liability claims.

NOTHING GIVES ONE PERSON SO MUCH ADVANTAGE OVER ANOTHER AS TO REMAIN ALWAYS COOL AND UNRUFFLED UNDER ALL CIRCUMSTANCES.

– THOMAS JEFFERSON