Business Education: Insurance Basics

Insurance Policy
An insurance policy is a legal agreement between the insured and the insurer in which the insurance company agrees to reimburse the insured for a certain level of loss according to policy. In exchange for premium payments, the insurance company will reimburse a percentage of the insured's loss under specified circumstances. Insurance companies use actuarial data to estimate the potential risk of loss for an insured population. It is easier to predict losses for a group of policyholders than an individual, and accurately estimating the size and number of insured losses is how insurance companies make money.

Underwriting
Through underwriting, insurance companies decide whom they will insure and at what rates. Through the underwriting process, insurance companies put together rate-classification schedules; premiums rise when the chance of loss is greater. Underwriters try to avoid adverse selection by preventing high-risk clients from getting coverage. It can be difficult for underwriters to figure out what the best classifying criteria is for potential purchasers.

Risk and Risk Avoidance
In terms of insurance, risk is the uncertainty of economic loss. When a financial interest such as health, home, car, or business is lost or damaged, financial loss occurs. Anticipating and protecting against potential risks will protect you financially. Risk avoidance, loss prevention and control, risk assumption, and insurance can help prepare for risk.
Risk avoidance is simply steering clear of situations that involve an increased level of danger. Some risk, however, is necessary. For example, if you avoid driving, your chances of being injured or killed in a car accident are reduced, but the inconvenience of not being able to drive may cause stress which can impact health. It is important to evaluate if avoiding the risk is potentially less harmful than taking the risk and its potential consequences.

Loss Prevention and Loss Control
Loss prevention lowers the likelihood that a loss will occur. For example, driving a car during good weather versus during a blizzard reduces the likelihood of being in a car accident. Loss control reduces the impact of a loss when it occurs. For example, wearing a seatbelt or having a car with airbags reduces the chance of injury or death in an accident. Both loss prevention and loss control are important to risk management programs and allow insurance companies to handle risk reasonably.

Life Insurance
Life insurance is a type of coverage people buy that pays out upon a person's death. Whole life insurance is also an investment. When the person passes away, a fixed amount is paid out. This builds cash value each year and can be borrowed against. Term life insurance does not have an investment component. People will buy it for a certain amount of time and pay a monthly premium. This can be very inexpensive for someone who is young.
There are many life insurance terms. A beneficiary is the person who receives the money upon the insured person's death. A rider changes provisions or clauses of the insurance policy. Annuities give a regular income.
Most of the time these are for life. Actuarial tables show the chances that someone will pass away before their birthday, used by life insurance companies when developing plans and pricing. Those shopping for life insurance should familiarize themselves with all the concepts prior to choosing.
There are important financial benefits of life insurance including financial protection for dependents, creditor protection, tax benefits, and savings. The most important benefit is providing for dependents upon your death. Creditor protection is important because creditors cannot claim cash benefits even if the deceased has outstanding debts and bills if the life insurance policy is set up to pay a beneficiary directly instead of through the estate. Life insurance payouts made to dependents aren't usually subject to state or federal income taxes, and sometimes dependents do not have to pay estate taxes if specific requirements are met. Finally, some life insurance policies can be used as savings vehicles.
When buying life insurance, be honest about your medical history; insurance companies can and do check into medical backgrounds. You may be asked to take a medical exam before the insurance policy will be approved.
Before taking an exam, do not drink alcohol or caffeine, smoke, or chew tobacco in the hours before the exam. Also, avoid strenuous exercise for twenty-four hours prior to the exam, which may be done in your home or office by a paramedical professional who may take blood, urine, and saliva samples to test for HIV, cholesterol, diabetes, and other health issues. If you are purchasing a large policy or are more than forty, an EKG or X-rays may be required as well as a treadmill test.

Factors That Affect the Decision Whether to Carry Life Insurance
First, an individual should consider who is counting on his income. A single person who lives alone and does not support anyone else might not need life insurance, whereas a father who is the sole support for three young children would need it much more. When the person is the breadwinner in the family or has dependents that count on him, he (or she) is much more likely to need the life insurance. If someone else would be able to get a job and provide the income, the need would be reduced. The person should consider how long others will depend on the income. Someone with very young children would need it more than someone with older children who are self-sufficient. The needs of the people depending on the income also matter. For instance, if one of the children has a disability and will incur expensive long-term medical bills, life insurance is more important. A person should also consider long term savings. Someone who has a lot of savings that can be used to support dependents will need less life insurance than someone who relies on every paycheck.

Multiple-of-Earnings Method
The multiple-of-earnings method multiplies the gross annual earnings by a certain number to estimate how much insurance coverage is needed. Though a simple method, it is not entirely accurate and only gives a rough approximation of life insurance needs. The needs analysis method looks at financial resources and obligations of the insured party and their dependents, and is far more precise and detailed. The needs analysis method determines a family's total economic need and what financial resources will be available after the insured party's death, and subtracts these resources from the financial need to determine how much life insurance is required.

Needs Analysis Method
The needs analysis method takes into account five different components for assessing a family's total economic needs. The first is how much income the dependents will need in order to live comfortably.
Looking at a family's current monthly budget for housing, utilities, food, clothing, medical/dental needs, property taxes, insurance, recreation/travel, and savings is helpful. Special needs of a dependent that is chronically ill or disabled, is attending college or has another special circumstance is the second component to consider. The third component involves extra expenses such as funeral costs or childcare costs if a surviving spouse reenters the workforce.
Liquidity is important so that payouts from the policy can be used to pay bills. Finally, it is important to figure out how much would be needed to pay outstanding bills in order to leave a family debt-free.
Financial resources not related to a life insurance policy include money from savings, investments, and Social Security survivor's benefits. Another resource may be payouts from the deceased employer's group life insurance or earned income from a surviving spouse and children.
Additionally, many families have real estate, jewelry, stocks, bonds, and other assets that could be sold. It is important to put together a complete list of these resources and their values and update this list frequently.

Term Life Insurance
Term life insurance is the simplest kind of insurance because a certain amount of insurance is purchased to cover a set period of protection. If the purchaser dies during that time period, the beneficiaries will receive everything specified in the policy. Term life insurance can be purchased for different time periods and premiums can be paid quarterly, semiannually, or annually. The two types of term insurance are a straight term policy and a decreasing term policy. A straight term policy covers a set number of years; the amount of life insurance coverage stays the same. A decreasing term policy keeps the premium the same throughout the coverage period but the amount of protection decreases over the life of the policy. This is done because the possibility of death increases with age.
The biggest advantage of term life insurance is lower initial premiums than other types of insurance, especially for younger people. Term life insurance is an affordable way to get a greater degree of protection for a specific period of time. The biggest disadvantage to term life insurance is that it only offers temporary coverage; once the policy term expires, the policy has to be renewed. Future underwriting factors can make it a challenge to qualify for insurance, but some term life policies offset this with a renewability provision which gives the policy holder the opportunity to renew without proof of insurability. There may also be a convertibility provision which allows the policy holder to convert term insurance policy to a comparable whole life policy in the future.

Whole Life Insurance
Whole life insurance provides ongoing insurance coverage for the insured's entire life. It also offers cash value, which is a small return on the investment. This cash value is obtained from investment earnings from premiums that have been paid. Savings rates on whole life policies are usually capped at a certain rate. The longer the policy is kept active, the greater the cash value.
Some of the advantages to whole life insurance are that individuals save regularly with periodic payments and there are tax breaks for these earnings. Premium payments can be budgeted over a long time, making them more affordable and eliminating the possibility of being denied life insurance at a later point in time. Premium payments contribute toward the insured's estate regardless of lifespan. However, whole life insurance does not provide yields as high as other investment types and offers less death insurance per premium dollar than term life insurance.
With a continuous premium whole life policy, also called straight life, a level premium is paid every year until death or a nonforfeiture right is claimed. The younger the purchaser, the lower the premium will be. Although premiums are reduced by purchasing a policy at a younger age, the longer coverage period can mean a higher overall payment.
Continuous premium insurance provides the highest amount of permanent death protection plus the lowest amount of savings per premium dollar, so it is a good choice for permanent life insurance.
A limited payment whole life policy provides coverage over the course of the insured's entire life, but the premium payment is for a specified period. If there are age provisions (e.g. paid up to age fifty-five or sixty-five), premiums are paid up until that age. Some insurance companies try to persuade consumers that they will save money because they do not have to pay premiums over a lifetime. However, this is not entirely true: First, the purpose of whole life insurance is permanent protection against financial loss in the event of death. It is not meant to be a savings account. Second, if the goal of the life insurance is permanent coverage, a person should buy continuous premium whole life instead of the limited payment policy.
A single premium whole life policy is purchased with a one-time cash payment at the beginning of the contract with coverage for life. Its investment components are attractive to those who want a tax-sheltered investment vehicle. Any policy interest and investment earnings are tax deferred, but there is a 10 percent early withdrawal penalty. Also, there is a capital gains tax if cash withdrawals or loans are taken against the single premium whole life policy before age 59 ½.

Insurance Company Ownership Structures Affect Premiums
Depending on how a life insurance company's ownership is structured, there can be considerable differences in insurance policy premiums.
For all intents and purposes, the policy holders of a mutual company own the company. If mutual companies are managed well, policy holders receive income or periodic dividends that reduce their premiums. Shareholders of stock companies own the company but they may or may not own policies, and they directly receive any dividends paid. Because of the difference in ownership types, the policy premiums for stock companies should be lower than those issued by mutual companies.

Universal Life Insurance
Universal life insurance is a permanent cash value insurance that combines death benefits with a tax-sheltered savings/investment account that pays interest; this interest is usually paid at a competitive money market rate. Some of the premium pays administrative fees; the remainder is added to the cash value of the policy where it earns a return rate. Although this earnings rate varies with market yields, there is a guaranteed minimum rate. As long as there is enough in the savings part to cover death protection, the policy will remain in effect. If the cash value becomes very large, insurance coverage must be increased in order for the policy to keep its favorable tax treatment.
One advantage of universal life insurance is savings, because the policy is credited at the current rate of interest. Another advantage is flexibility, because the cost of death protection is covered with an annual premium. One disadvantage is that protection levels and premiums can change. A policy holder may have to pay higher premiums down the line if early premium payments were economized. Another disadvantage is fees and charges. The first premium has a front-end load or commission, and there are fees for each annual premium, plus investment expenses and other charges.

Other Types of Life Insurance Besides Term, Whole, and Universal
Some other types of life insurance include variable, group, and special purpose. Variable life insurance means benefits are directly tied to the returns on investments made by the policy holder. Under group life insurance each eligible member of the group receives an insurance certificate for an overall, master policy for everyone in the group. Special purpose insurance can include credit life (life insurance sold along with installment loans), mortgage life (mortgage balance is paid off if the borrower dies), and industrial life insurance (policies with small face amounts, often less than $1,000).

Automobile Insurance
Automobile insurance covers drivers in the case of an occurrence that causes some sort of damage or harm. Many states force drivers to have insurance. There are many different types of policies with different coverage levels. Liability coverage provides benefits to damages suffered by other drivers. Collision coverage is for cars involved in an accident. People often have a deductible, or money they have to pay first. Premiums are the amount a driver pays monthly or regularly to maintain coverage. Comprehensive insurance also covers cars damaged without a collision such as from vandalism or weather-related events.

Personal Automobile Policy
A personal automobile policy (PAP) is a comprehensive insurance policy for automobile owners and is intended to be easily understood by a typical insurance purchaser. It has six parts, with the first four identifying the type of coverage provided: Liability coverage (Part A), medical payments coverage (Part B), uninsured motorists coverage (Part C), and coverage for damage to your vehicle (Part D). Part E explains the duties and responsibilities in the event of an accident, and Part F outlines the basic provisions of the policy, including policy coverage period and right of termination.

Liability Insurance
Liability insurance protects against financial burden in the event the insured is responsible for accidental injury or property loss to someone else. This insurance helps cover legal fees to in the event the insured is sued, although should the accident be determined to be the result of negligence caused by the insured's failure to act in a responsible manner, the insurance will not pay.

Property Insurance
Property insurance protects real and personal property against natural and manmade catastrophes such as tornadoes, fire, hail, theft, and vandalism. Property insurance lists both the property and the types of destructive acts (perils) that are covered. In order to receive property insurance, the owner needs to compile a comprehensive list of specific property to be insured. It may be necessary to include appraisals with this list. The more specific this list is, the easier it is to settle a claim. Second, a purchaser must decide on the types of perils property needs to be protected against.
Property insurance provides coverage against a wide variety of risks and includes fire insurance, earthquake insurance, home insurance, and flood insurance. Open perils is a type of property insurance that includes all causes except those exempted, whereas named perils lists the types of causes for the insurance. There are many plans with different premiums, coverage, deductibles, and exclusions. Replacement insurance will give benefits so people can replace the lost items, whereas actual cash value insurance takes off for depreciation. People should evaluate the potential risk and costs of insurance when deciding on the plan that is right for them.
Insurance companies base their premiums on the amount of risk they perceive and the potential for losses. Limit potential hazards to lower premiums. Have good lighting around your property to minimize the likelihood of someone falling, and to ward off potential thieves. Make sure that electrical wiring, stairways, carpeting and flooring are in good shape to avoid accidents. Swimming pools need to be secured with fences and locks and should be covered or drained when not in use. Keep valuables in a safe deposit box and do not keep valuables or a lot of cash at home. Take photos of insured items and keep detailed records, including appraisals.

Supplemental Property Insurance
Not all types of damage are covered by homeowner's policies, so it is important to decide if you need any type of supplemental coverage.
Some common types of supplemental coverage include flood insurance, earthquake insurance, and transportation insurance. In 1968, the federal government established a subsidized flood insurance program to work with private insurance to offer lower-cost flood insurance coverage in certain areas. Under this program, land-use controls are put in place to help reduce future flood losses.
With earthquake insurance, a 15 percent deductible on the replacement cost of a home that is destroyed or damaged by an earthquake is required. Besides car insurance, an individual may want to insure vehicles such as motorcycles, boats, RVs, mobile homes, and personal watercrafts.

Home Insurance Costs
Home insurance costs can be affected by risk factors that pose a hazard such as trampolines, swimming pools, and even certain pets. The construction materials used on a home also affects insurance costs; brick and HardiPlank homes cost less to insure than those built of wood. The age and style of the house also are figured into the costs. Finally, the location of the home affects insurance costs. Insurance premiums for all homeowners will be higher if there are a large number of claims filed from in area (e.g. high-crime level areas).

Renter's Insurance
Even if the building being rented is insured, anything that you own in that building is not. Renter's insurance covers losses due to fire, lightning, explosion, windstorms, hail, theft, civil commotion, aircraft, vehicles, smoke, vandalism, falling objects, building collapse, and the weight of water and snow. A standard policy takes care of carpets, furniture, appliances, clothing, electronic equipment, and other personal items at their value at the time of loss. Renter's insurance premiums are dependent upon location, but are generally very affordable. You can also purchase replacement cost insurance, which pays to fully replace lost items with new ones.

Health Insurance
Health insurance is very important for individuals and families to help pay for medical expenses. People typically pay a monthly fee or premium for coverage. They may have to pay a deductible, or an amount of money before the insurance company pays. Sometimes there are out-of-pocket limits or the maximum amount the consumer has to pay. There are many sources of health insurance. Many people get an employer-sponsored plan from their place of work. Others may get a private plan in the marketplace. Some may receive it from the government through Medicare or Medicaid. Still others might find it from a different source. There are many different types of plans. A PPO is a preferred provider plan, which generally gives greater benefits if an individual sees someone 'in network' as compared to 'out of network.' An HMO, a health maintenance organization, contracts physicians, hospitals, and other providers and gives benefits based on that. When choosing health insurance, people should consider current and potential healthcare concerns, the dependents who also need coverage, the premium, the coverage the plans offer, deductibles, limits, exclusions, and more. Plans vary in all these aspects.
When choosing a healthcare plan, it is important to know what the plan will cost each month and co-pays for doctors outside the plan's network. Understanding out-of-pocket limits in the case of a major illness or injury is essential. Review doctors, hospitals, services, and other medical providers covered under the plan. Know the deductibles you have to pay before insurance kicks in to help cover the costs.
Private health insurance plans are offered to both individuals and groups. These plans are either traditional indemnity plans or managed care plans. With traditional indemnity plans, healthcare services are obtained from someone other than the insurer; the insurer reimburses a portion of payments when a claim is submitted, or they pay the health service provider directly. With managed care plans, certain organizations or individual providers are contracted to provide services for a monthly fee. These plans include HMOs, PPOs, EPOs, and similar plans. It is estimated that private health insurance pays for about 35 percent of medical expenses in the United States.
About 25 percent of the U.S. population is covered under some type of government health insurance program. Medicare, administered by Social Security, is one of these programs and is paid for with social security taxes of covered workers and their employers. Medicare provides basic hospital insurance and supplementary medical insurance. Medicaid is a state-run public assistance program which provides health insurance benefits for those who are not able to afford health insurance. Worker's compensation insurance is another government health insurance plan that compensates workers who are injured on the job or become ill from work-related causes.

Disability Insurance
To estimate your disability needs, figure your take-home pay (disability benefits are usually tax-free so you'll only need to replace your take-home pay). Policies paid by employers are either partially or fully taxable. Figure out the monthly disability amount you will receive from Social Security, other government programs, company disability benefits, and group disability policy benefits and subtract your existing monthly disability benefits from it. This will give you an idea of the monthly disability benefits needed.
It is important to understand the definition of disability since policy standards differ. Ask if there are provisions for cost-of-living adjustments and guaranteed insurability options. Know both the probationary period (when the benefits kick in, usually seven to thirty days) and the waiting period (usually thirty days to one year). Determine whether the insurance is noncancelable or guarantee renewable. Finally, understand the amount and duration of benefit; group plans tend to pay a fixed gross income percentage but most individual disability income policies pay a flat monthly benefit.
Some ways to save on disability income insurance include reducing premiums by extending waiting periods, getting a policy that has benefits to age sixty-five instead of a lifetime, asking about premium discounts for prepaying, and requesting that recurring medical problems (e.g. back problems) be excluded. Get a number of price quotes since rates can vary, and check with your employer to see if disability insurance is offered as a benefit. Think about getting a small policy with a rider that allows you to buy more later on.

Long-Term Care Insurance
There are some important policy provisions to think about when purchasing long-term care insurance, including the type of care. Some policies only offer nursing home care and some only offer home health care, while others also include assisted-living, adult daycare, alternative care, and community-care; respite care for the caregiver is also a possibility. Find out if preexisiting conditions are covered. Understand how much the policies will reimburse per day as well as for how long these benefits will be covered; some coverage is only for a year while others are for the insured's lifetime. Ask about the waiting period, which is usually between ninety and 100 days. Know the requirements for eligibility and what services are covered, including skilled, intermediate, and custodial care. Check to see that there is guaranteed renewability and be wary of those that have an optional renewability. Find out the premium levels and if there is inflation protection.
Long-term care is non-hospital medical and personal care for chronic medical conditions. Determine whether the cost of premiums outweighs the cost of a potential nursing home stay. If you have a family history of disabling diseases or if you are a male, your chances of needing long-term care increases. If you have family members who will provide care, this can reduce long-term care costs. Finally, since most assets have to be depleted before
Medicaid will cover any costs, those who are older than sixty-five and have a net worth more than $100,000 and income more than $50,000 should consider purchasing long-term care.
Check long-term care policies to determine if they include Alzheimer's disease coverage as well as at least one year of home health or nursing home coverage, including intermediate custodial care. There should be a guarantee against nonrenewal or cancellation due to age or deteriorating physical or mental health, and you should have the right to return the policy within thirty days for a refund. Study the outline of coverage that explains the policy's benefits, limitations, and exclusions in great detail; this will also help comparison shop against other policies. Make sure there is not a requirement for policy holders to be hospitalized before they receive home healthcare or nursing home benefits, or a requirement that they have to receive a higher level of care first before they can receive lower care levels.
It is a good idea to buy long-term care insurance before you need it; if you are diagnosed with a serious illness, you will become uninsurable at that point. It is important to buy the coverage that you need, but not more coverage than you need. Make sure the policy has provisions for skilled, intermediate, custodial care, adult daycare centers, and assisted living facilities. If you have family caregivers or home health services, then you only need nursing home coverage. It's important to understand what the policy covers and when it pays benefits, as well as how the policy defines benefit eligibility, the amounts paid, benefit periods, and the services covered.