Group 1 Bsba FM 1a Os
Group 1 Bsba FM 1a Os
Group 1 Bsba FM 1a Os
PART 3:
INCOME AND
ASSET
PROTECTION
CHAPTER 10:
MANAGING
PROPERTY
AND
LIABILITY
GROUP MEMBERS:
I
ARACO, JULIET D. ABRANTES, CHRISTINE ABUHAN, QUEENY ACTUB, ANNA
GROUP LEADER
Learning Objectives
• Risk is the uncertainty about the outcome of a situation or event. It can involve the
possibility of results differing from expectations. There are two types of risk:
speculative risk, which can lead to gain or loss (e.g., stock market investments), and
pure risk, which involves only the potential for loss (e.g., fires, accidents, illness, theft,
covered by insurance). Risk is distinct from chance. An event with a 95% chance is
highly likely, so both uncertainty and risk are low. An event with a 0.000001% chance is
highly unlikely, so both uncertainty and risk are low. When an event has a moderate
chance (e.g., 5%), uncertainty and risk are relatively high, making insurance a wise
choice for risk reduction.
The Risk-Management Process 1 Learning Objective
Apply the risk-management process to address the risks to your property and income.
Risk
Start by pinpointing what exposes you to potential financial loss. These are known as “exposures,” and
they fall into five categories:
• Property Loss: This includes the risk of damage to your property, like a house fire.
• Liability: You might be legally responsible for others’ losses, such as in the case of causing an automobile
accident.
• Health Care Costs: Illness or injury can lead to expenses related to healthcare.
• Family Expenses: Your family could face expenses and a loss of income due to your death.
Additionally, you should identify the specific events, known as “perils,” that could lead to financial loss.
Examples of perils include fire, wind damage, theft, vehicle collisions, illness, and death.
Step 2: Evaluate Risk and Potential Losses
• Loss Frequency: Determine how often a loss might happen in a given period.
Don’t base insurance decisions solely on low loss frequency, like being young and
healthy or living in a safe area. Instead, focus on loss severity. Ask, “How much could I
potentially lose?”
For property losses, estimate the property’s value. Liability losses depend on the specific
situation. For example, if you caused an accident that permanently disabled a young
heart surgeon with three children, your liability could reach several million dollars,
covering the surgeon’s care, lost lifetime earnings, and the children’s future care and
education.
Step 3: Choose How to Handle Risk The risk of loss may be handled in five
Ways:
1.Risk Avoidance: Avoiding risk by not engaging in activities or owning items that may lead to financial loss, like choosing not to skydive
or own an airplane.
2.Risk Retention: Accepting risk consciously, sometimes by using deductibles in insurance policies, where you pay an initial portion of the
loss before insurance coverage kicks in.
3.Loss Control: Reducing the frequency and severity of losses through measures like security systems, fire alarms, and smoke detectors.
4.Risk Transfer: Transferring risk to an insurance company, which agrees to reimburse you for financial losses. This includes insuring
valuable assets or situations.
5.Risk Reduction: Reducing personal risk by obtaining insurance coverage, which shifts some or all of the risk to an insurance company,
decreasing your financial exposure.
Step 4: Implement the Risk-Management Program The fourth
step in risk management is to implement the risk-handling
methods you have chosen. For most households, this means
buying insurance to transfer and reduce risk. This involves
selecting types of policies and coverage, dollar amounts of
coverage, and sources of insurance protection.
People often wonder what types of insurance to buy and how
many dollars of coverage to choose. You should use the maximum
possible loss as a guide for the dollar amount of coverage to buy.
This way of thinking makes use of the large-loss principle which
states “insure the risks that you cannot afford and retain the risks
that you can reasonably afford.” In other words, pay for small
losses out of your own pocket and purchase as much insurance as
necessary to cover large, catastrophic losses that will ruin you
financially. The example earlier of an auto accident that injures a
heart surgeon would bring you such ruin because you would be
held responsible for those losses. Consequently, you would want
high dollar amounts of liability coverage on your auto insurance.
Step 5: Evaluate and Adjust the Program The final step in risk
management entails periodic review of your risk- management efforts.
The risks people face in their lives change continually. Therefore, no risk-
management plan should be put in place and then ignored for long periods
of time. For certain exposures, such as ownership of an automobile, an
annual review is appropriate. For areas involving life insurance, a review
should occur about once every three to five years or whenever family
structure and employment situations change. The necessary adjustments
should be implemented promptly to reflect changes over your life cycle.
Many people keep existing policies that no longer fi t their needs (too little
or too much coverage) simply because they buy once and ignore their
insurance needs for years.
üConcept! Check 10.1
UNDERSTANDING HOW
INSURANCE WORKS
INSURANCE
Is a mechanism for transferring and reducing pure
risk through which a large number of individuals
share in the financial losses suffered by members
of the group as a whole. Insurance protects each
individual in the group by replacing an uncertain-
and posibly large financial loss with a certain but
comparatively small fee. This fee, called
thepremium.
PREMIUM
Comparatively small, predictable fee with which individuals or companies can replace an
uncertain-and possibly large-financial loss.
Has four components:
✓ The individual's share of the group's losses.
✓ Insurance company reserves set aside to pay future losses.
✓ A proportional share of the expenses of administering the insurance
plan.
✓ An allowance for profit (when the plan is administered by a profit-
seeking company) Insurance premiums are usually assessed on an annual
or semiannual basis and the coverage is paid for in advance. You
generally will be charged an extra amount if you choose to make the
payments monthly.
INSURANCE POLICY
• Is the contract between the person buying
insurance (the Insured) and the insurance
company (the Insurer) It contains language
that describes the rights and responsibilities of
both parties. Most people do not take the time
to read and understand their insurance policies.
As a result, insurance remains one of the least
understood purchases people make. You can
do a much better jobs of managing your risks
if you understand the basic terms and
concepts used in the field of insurance.
HAZARDS MAKE LOSSES MORE LIKELY TO OCCUR
A hazard in any condition that increases the probability that a peril will occur. Driving under
the influence of alcohol represents an especially dangerous hazard. Three types of hazards
exist:
✓ A physical hazard is ✓ A morale hazard ✓ A moral hazard
a particular exists when a person is exists when an insured
characteristic of the indifferent to a peril. person wants a peril to
insured person or For example, a morale occur so that he or she
can collect on an
property that increases hazard exists if the insurance policy.
the chance of loss. An insured party, knowing Insurance companies
example of a physical that theft insurance often limit or deny
hazard is high blood will pay for the loss, coverage if a loss
pressure in a person becomes careless occurs as a result of a
covered by health about locking doors morale or moral hazard.
insurance. and windows.
ONLY CERTAIN LOSSES ARE
INSURABLE
•Certain minimum requirements must be met for a loss to be considered insurable-
in particular, the loss must be fortuitous, financial, and personal.
•Fortuitous losses are unexpected in terms of both their timing and their magnitude.
A loss caused by a lighting strike and fire to your home is fortuitous a loss caused by
a decline in the market value of your home is not because it is reasonable to expect
home values to rise and fall over time.
•A financial loss is any decline in the value of income or assets in the present or
future. Financial losses can be measured objectively in dollars and cents. When you
become sick, you suffer as a result of the discomfort, inconvenience, lost wages, and
medical bill. Insurance will cover only the lost wages and medical bills, however,
because these losses-but not the other can be objectively measured.
•Finally, personal losses can be directly suffered by specific individuals or
organizations rather than society as a whole.
•The PRINCIPLE IDEMNITY states that insurance will pay no more than
THE
the PRINCIPLE
actual IDEMNITY
financial loss suffered. LIMITS
For example, INSURANCE
an automobile PAYOUTS
insurance policy
will pay only the actual cash value of a stolen automobile. This principle
prevents a person from gaining financially from a loss (certainly a moral hazard).
•The principle of indemnity does not guarantee that insured losses will be
totally reimbursed. Every policy includes POLICY LIMITS which specify the
maximin dollar amounts that will be paid under the policy. These limits explain
why there is no such thing as "full coverage" insurance there is always the
potential that a loss will exceed the limits on a policy. As a result, insurance
purchasers must carefully select policy limits sufficient to cover their potential
losses.
FACTORS THAT REDUCE THE COST OF INSURANCE
Some features of insurance policies can lower your premiums without significantly reducing the
protection offered. These features include deductibles, coinsurance, hazard reduction.
A DEDUCTIBLE is an initial portion of any loss that must be paid before the insurance company will
provide coverage. For example, automobile collision insurance often includes a $200 deductible and that
means that the first $200 of loss to the car must be paid by the insured. The insurer then pays the
remainder of the loss, up to the limits of the policy. You usually have a choice of deductible amounts and
the higher the deductible the more you will save on your premium.
COINSURANCE is a method by which the insured and the insurer share proportionately in the payment
for a loss. For example, health insurance policies commonly require that the insured pay 20 percent of a
loss and the insurer pay the remaining 80 percent. Substantial premium reductions can be realized through
coinsurance, but you must be prepared to pay your share of losses. The following deductible and
coinsurance reimbursement formula can be used to determine the amount of a loss that will be
reimbursed when the policy includes a deductible and a coinsurance clause:
HAZARD REDUCTION - is action taken by the insured to reduce the probability of a loss occurring.
Insurance companies often offer reduced premiums to insureds who practice hazard and reduction for
example, to nonsmokers.
LOSS REDUCTION -is action taken by the insured to lessen the severity of loss if a peril occurs.
Smoke alarms and fire extinguishers in the home are examples of loss reduction efforts. These items will
not prevent fires, but their use may lead to less severe damage. Many insurers offer reduced premium to
policyholders who practice loss reduction.
Insurance consists of two basic elements: the reduction of risk and the sharing of losses. When you buy
insurance, you exchange the uncertainty of a potentially large financial loss for the certainty of a fixed
insurance premium, thereby reducing your risk. As Yogi Berra once said "It is tough to make predictions.
Especially about the future." But predictions are much easier for an insurance company than for an
individual. This is because risk is reduced for the insurer through the law of large numbers: As the
number of members in a group increases, predictions about the group's behavior become increasingly
more accurate. This greater accuracy decreases uncertainty and, therefore, risk.
presentation title 20XX 21
WHO SELLS INSURANCE? Two types of insurance agents exist:
Sellers of insurance, called 1. Independent insurance agents are
INSURANCE AGENTS represent independent business people who act as third-
one or more insurance companies. party links between insurers and insureds. Such
They have the power to enter into agents earn commissions from the companies
change, and cancel insurance they represent and will place each insurance
policies on behalf of these customer with the company that they believe
companies. best meets that customer's particular needs.
2. Exclusive insurance agents represent only
one insurance company for a specific type of
insurance. They are employees of the insurance
company they represent. Life insarance, for
example, is often sold through exclusive
insurance agents.
ü Concept! Check 10.2 Property Insurance
•Section I provides protection for various types of
property dam-age losses, including the following: (1)
Homeowner’s Insurance damage to the dwelling, (2) damage to other
•Combines the liability and property insurance structures on the property, (3) damage to personal
coverages needed by homeowners and renters into property and dwelling contents, and (4) expenses
a single-package policy. Four types of homeowner’s arising out of a loss of use of the dwelling (for
insurance are available for people who own houses, example, food and lodging). Additional cover-ages are
another type for the owners of condominiums, and usually provided for such items as debris removal,
one other type for those who rent housing. trees and shrubs, and fi re department service charges.
Named-perils policies cover only those losses caused
by perils that are specifically mentioned in the policy.
All-risk (or open-perils) policies cover losses caused
by all perils other than those specifically excluded by
the policy. All-risk policies provide broader coverage
because hundreds of perils can cause property losses,
but only a few would be excluded. Common
exclusions are flood and earthquake, but these can be
purchased for an additional premium if desired.
Liability Insurance
•Section II deals with liability insurance. Whenever
homeowners are negligent or otherwise fail to exercise due
caution in protecting visitors, they may potentially suffer a
liability loss. Homeowner’s general liability protection
applies when you are legally liable for the losses of another
person.
Homeowners often wish to take responsibility for the
losses of another person regardless of the legal liability.
Consider, for example, a guest’s child who suffers burns
from touching a hot barbecue grill. Homeowner’s no-fault
medical payments protection will pay for bodily injury
losses suffered by visitors regardless of who was at fault. In
the preceding example, such coverage would help pay for
the medical treatment of the visitor’s burns. Homeowner’s
no-fault property damage protection will pay for property
losses suffered by visitors to your home.
Types of Homeowner’s Insurance Policies
Six distinct types of homeowner’s insurance policies exist: HO-1 through HO-4, HO-6,
and HO-8. They are described in detail in Table 10.2 and more generally in the sections
that follow. The same terms and identifying numbers are generally used by most insurance
companies.
Basic Form (HO-1) The basic form (HO-1) is a named-perils policy that covers 11
property-damage–causing perils and provides three areas of liability-related protection: per-sonal liability, property
damage liability, and medical payments.
Broad Form (HO-2)
The broad form (HO-2) is a named-perils policy that covers 18 property-damage-causing perils and provides
protection from the three liability-related exposures
Special Form (HO-3)
The special form (HO-3) provides open-perils protection for four types of property losses: losses to the dwelling,
losses to other structures, landscaping losses, and losses generating additional living expenses.
Renter's Contents Broad Form (HO-4)
The renter's contents broad form (HO-4) is a named-perils policy that protects the insured from losses to the
contents of a dwelling rather than the dwelling itself. It covers 17 perils and provides liability protection.
Condominium Form (HO-6)
The condominium form (HO-6) is a named-perils policy protecting condominium
owners from the three principal losses they face: losses to contents and personal
property, loses due to the additional living expresses that may arise if one of the covered
peris occurs, and liability losses.
Older Home Form (HO-8)
The replacement value of an older home may be much higher than its market or actual
cash value. The older home form (HO-8) is a named-perils pol icy that provides actual-
cash-value protection on the dwelling. It does not provide that the dwell- ing be rebuilt
to the same standards of style and quality, as those standards may be prohibitively
expensive today. Instead, the policy provides that the dwelling be rebuilt to make it
serviceable.
o How Much Coverage Is Needed on Your Dwelling?
o Your first step is to determine the dwelling's replacement value. You could either use the ser vices of a
professional liability appraiser and/or consult with your insurance agent to deter-mine replacement value.
o Homeowner's insurance policies usually contain a replacement-cost requirement that stipulates that a home
must be insured for 80 percent of its replacement value (some companies require 100 percent). Thus, a home
with a replacement value of $200,000 would need to be insured for $160,000 (or perhaps $200,000), and this
amount would be the maxi- mum that the insurance company would be obligated to pay for a total loss (after
payment of the deductible by the policyholder). If you fail to meet your replacement-cost require mint, you will
not be considered fully insured and must coinsure partial lowers as well. The amount of reimbursement for
partial losses will be calculated using the replacement-cost- requirement formula:
As this calculation shows, Chris will be reimbursed for only $72,000 of his loss. His
failure to insure his house for 80 percent of its replacement cost, or $160,000 ($200,000
X 0.80), means he will be covered for only 90 percent ($144,000 $160,000) of its value,
and he must pay 10 percent of any partial loss in this case, $8000, Three out of four
homes in the United States are underinsured by an average of 35 percent.
Meeting an 80 percent replacement-cost requirement enables you to avoid coinsurance on
small losses but might still result in inadequate coverage on large losses that, though rare,
exceed the policy limit. Thus, it is wise to insure your dwelling for 100 percent of its
replacement cost. However, you will also want to increase your limits each year to keep up
with inflation in housing construction costs. To do so, you can sign up for inflation guard
protection to have your insurance company increase your coverage automatically each
year.
How Much Coverage Is Needed on Personal Property That Has
Specific Limits?
• Some types of personal property may be subject to specific
item limits. For example, the typical home- owner's insurance
policy provides maximum coverages of $200 for cash, $5000 for
personal computers, and $1000 for jewelry. This is because most
people do not have such items above these values. If your
inventory reveals a higher valuation on such items, you can
simply ask your company for extra coverage and pay the higher
premium required.
Notice that Table 10.3 lists three estimates for the value of the
con- tents of a room: the purchase price, the actual cash value,
and the replacement cost. Historically, property insurance
policies paid only the actual cash value of an item of personal
property, which represents the purchase price of the property
less depreciation. The actual-cash-value (ACV) formula is
Marianna could not replace the unit for $600. A more realistic replacement cost might be $3000.
Contents replacement-cost protection is an option sometimes available in homeowner’s
insurance policies that pays the full replacement cost of any personal property. The standard
limitation that applies to contents (50 percent of insured value of the dwelling) remains in effect
if contents replacement-cost protection is purchased. The overall limit on contents may need to
be raised, as it is easy to reach the 50 percent figure when replacement-cost valuation is used.
20XX 32
Coverage A-Liability Insurance
Liability insurance covers the insured when he or
she is held responsible for losses suffered by
others. Two types of liability can arise out of the
ownership and operation of an automobile.
Automobile bodily injury liability occurs
when a driver or car owner is held legally
responsible for bodily injury losses suffered by
other people, including pedestrian. Automobile
property damage liability occurs
The most common type of automobile insurance policy is the
family auto policy (FAP). A FAP covers the vehicle owner,
relatives living in the vehicle owner's household, and people
who have the owner's permission to drive the vehicle. In
addition, any other vehicle that the owner borrows with
permission is similarly covered for all family members.
The policy limits for FAPs are quoted as split liability limits.
usually three numbers such as 100/300/50, with each number
representing a multiple of $1000 (Figure 10.2).
In some policies, the liability limits are stated as a single
liability limit, such as $250,000. Under such policies, all
property and bodily injury liability losses resulting from an
accident would be paid until the limit is reached. These policies
are referred to as personal auto policies (PAPs). Family
members of the vehicle owner may or may not be covered
under a PAP when driving the vehicle, depending on the policy
provisions.
Figure 10.2
Automobile Liability Insurance Policy Limits
Coverage B-Medical Payments Insurance