13-1 Personal Finance: An Integrated Planning Approach Winger and Frasca Chapter 13 Property and Liability Insurance: Protecting Your Lifestyle Assets

13-2 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.

13-3 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

13-4 Topic Outline Fundamental Insurance Concepts Homeowners’ Insurance Automobile Insurance

13-5 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.

13-6 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

13-7 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.

13-8 Risk Management Risk 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.

13-9 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.

13-10 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.

13-11 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 Protection 80% × replacement cost of dwelling × Cost of damage at replacement cost = insurance payout

13-12 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

13-13 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.

13-14 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.

13-15 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

13-16 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

13-17 Totaling Up $100,000 Coverage

13-18 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

13-19 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

13-20 Policy Format

13-21 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

13-22 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

13-23 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

13-24 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

13-25 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

13-26 Specialized Insurance (Continued) Renters insurance  Can be purchased to cover belongings or medical bills incurred due to home accident

13-27 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

13-28 Insurance Agents Direct writers  Employee of the insurance company selling the policy Independent agent  Works on commission for two or more insurance companies

13-29 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

13-30 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?

13-31 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

13-32 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

13-33 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

13-34 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

13-35 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.

13-36 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

13-37 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?

13-38 NEXT: Chapter 14 Health Care and Disability Insurance