CH-9-10 Insuring Your Health – PFIN Personal Finance : Book Guide

This Document Contains Chapters 9 to 10 Chapter 9 Insuring Your Health Chapter Outline Learning Goals I. The Importance of Health Insurance Coverage II. Health Insurance Plans A. Private Health Insurance Plans 1. Traditional Indemnity (Fee-for-Service) Plans 2. Managed Care Plans a. Health Maintenance Organizations (HMO) b. Preferred Provider Organization (PPO) c. Other Managed Care Plans 3. Blue Cross/Blue Shield Plans B. Government Health Insurance Plans 1. Medicare a. Basic Hospital Insurance (Part A) b. Supplementary Medical Insurance (SMI or Part B) c. Medicare Advantage Plans d. Prescription Drug Coverage (Part D) 2. Medicaid 3. Workers' Compensation Insurance 4. Affordable Health Care Act of 2010 III. Health Insurance Decisions A. Evaluate Your Health Care Cost Risk B. Determine Available Coverage and Resources C. Choose a Health Insurance Plan IV. Medical Expense Coverage and Policy Provisions A. Types of Medical Expense Coverage 1. Hospitalization 2. Surgical Expenses 3. Physician Expenses 4. Major Medical Insurance 5. Comprehensive Major Medical Insurance 6. Dental Services B. Policy Provisions of Medical Expense Plans 1. Terms of Payment a. Deductibles b. Participation (Co-insurance) c. Internal Limits d. Major Medical Policy: An Example e. Coordination of Benefits 2. Terms of Coverage a. Persons and Places Covered b. Cancellation c. Preexisting Conditions d. Pregnancy and Abortion e. Mental Illness f. Rehabilitation Coverage g. Continuation of Group Coverage (COBRA) C. Cost Containment Provisions for Medical Expense Plans V. Long-Term Care Insurance A. Do You Need Long-Term Care Insurance? B. Long-Term Care Insurance Provisions and Costs C. How to Buy Long-Term Care Insurance VI. Disability Income Insurance A. Estimating Your Disability Insurance Needs B. Disability Income Insurance Provisions and Costs 1. Definition of Disability 2. Benefit Amount and Duration 3. Probationary Period 4. Waiting Period 5. Renewability 6. Other Provisions Major Topics A sound personal financial plan includes adequate protection against the potentially devastating financial consequences associated with a serious illness or accident. Provisions must be made to meet doctor and hospital bills as well as to replace income lost during periods of extended illness and recuperation. Health care insurance provides a way to meet such costs. It is a vital component of an effective financial plan, because without adequate health care insurance everything that one has accomplished, as well as the likelihood of goal achievement, could quickly be wiped out. Health care insurance is therefore an essential component of financial plans. The major topics covered in this chapter include: 1. The effect of rising health care delivery costs on the need for adequate health care insurance and the importance of including health insurance as a fundamental component of a strong personal financial plan. 2. Types and sources of health care coverage available for covering medical and hospitalization expenses, including indemnity and managed care plans, such as health maintenance organizations, individual practice associations, and preferred provider organizations. 3. The providers of health care coverage, ranging from the federal government's new health care plan and the Social Security program, to group health insurance policies and individual health coverage options. 4. Review of the most important health insurance policy provisions as they relate to terms of payment and terms of coverage. 5. Cost containment provisions commonly found in health insurance plans. 6. Long-term care insurance, including policy provisions and costs. 7. The importance of disability insurance to replace lost wages during periods of extended illness. Key Concepts Recognizing and meeting the need for adequate health care protection is fundamental to effective personal financial planning. Because health care costs are rising faster than the costs of most other consumer products and services, insuring one's health is both necessary and difficult. It is therefore important to be acquainted with the major concepts of health insurance. The following phrases represent the key concepts stressed in this chapter. 1. The need for health care insurance coverage 2. Indemnity (fee-for-service) plans 3. Managed care plans, including HMOs, IPAs, and PPOs 4. Blue Cross/Blue Shield plans 5. Group health insurance 6. Social Security, Medicare, Medicaid and disability income coverages 7. Workers' compensation insurance 8. Types of coverage: hospital insurance, surgical insurance, and physicians expense insurance 9. Major medical insurance and comprehensive major medical insurance 10. Dental insurance 11. Policy provisions for payment, coverage (including COBRA provisions), and cost containment 12. Long-term care insurance 13. Disability income insurance 14. Managed care network 15. Deductibles 16. Co-insurance 17. Coordination of benefits provision 18. Preexisting condition clause 19. Health Insurance Portability and Accountability Act (HIPPA) 20. Cost-of-living adjustment (COLA) and Guaranteed Insurability Option (GIO) 21. Medicare Advantage Plans (Plan C) 22. The Patient Protection and Affordable Care Act and the Reconciliation Act of 2010 (ACA) Financial Planning Exercises The following are solutions to problems at the end of the PFIN 4 textbook chapter. 1.. Answers will vary. Students should discuss the following factors: • Quality of network, physicians, hospitals, and services • Freedom of choice and its importance • Ability to see out-of-network providers • Coverages required • Personal health considerations • Cost considerations The type of plan the student selects should be appropriate given the individual's analysis. Steps that reduce health care costs include: • Good health practices, such as proper nutrition, exercise, etc. • Avoidance of unnecessary risks • Self-insurance for a portion of health care costs (through a higher deductible) Answers may address the limitations of policies that cover only a certain type of accident, illness, or financial need where major gaps in coverage will often occur and a need for a comprehensive insurance program if the coverage is not overlapping. A focus on policy provisions such as terms of payment, terms of coverage, risk avoidance, and loss prevention is warranted. Discussion about policy cost containment can include preadmission certification, continued stay review, second surgical opinions, waiver of co-insurance, and limitation of insurer’s responsibility, as well as an individual’s participation in cost containment through prevention and risk assumption measures (such as enrollment in wellness programs, choosing healthy lifestyles, opting for larger out of pocket deductibles, and asking questions and assessing cost/benefit decisions prior to opting for expensive procedures). 2. Students should submit Worksheet 9.1 for each of the three policies. Answers will vary, depending upon the Internet information that they gather. Service Policy #1 Policy #2 Policy #3 Hospital care Surgery (inpatient and outpatient) Office visits to your doctor Maternity care Well-baby care Immunizations Mammograms Medical tests, x-rays Mental health care Dental care, braces and cleaning Vision care, eyeglasses and exams Prescription drugs Home health care Nursing home care Services you need that are excluded Choice of doctors Location of doctors and hospitals Ease of getting an appointment Minimal paperwork Waiting period for coverage 6. Pros of long-term care insurance include: protection of assets should a covered family member need lengthy nursing home care and the security of arranging in advance for coverage for lengthy nursing home care. The disadvantages are: 1) the high cost of this coverage; 2) by the time a person needs this coverage, inflation and rising health care costs may have rendered the benefits inadequate; and 3) if the covered person never needs these services, the premiums paid may be lost. Student assessment of their family's needs will differ, but they should consider if there is a history of debilitating disease in their family, if a family member currently has a health problem, who would be available to care for their family members, and if they can afford the premiums. 7. a. Worksheet 9.2 for Ryan Harris: DISABILITY BENEFIT NEEDS Name(s) : Ryan Harris 1. Estimate current monthly take-home pay $ 3,800 2. Estimate existing monthly disability benefits: a. Social security benefits $______ b. Other government benefits ______ c. Company benefits ______ d. Group disability policy benefits 2,250 3. Total existing monthly disability benefits (2a + 2b + 2c + 2d) $ 2,250 4. Estimated monthly disability benefits needed ([1] – [3]) $ 1,500 b. Ryan needs to supplement his employer's disability insurance with an individual policy. The minimum he currently needs is $1,500 per month, and he will need $3,800 per month once his employer's plan coverage ends. He should decide how long his own assets would cover immediate needs so that he can choose a policy with a longer waiting period. Own-occupation coverage is more expensive than any-occupation, but the cost would be lessened if he purchases one with a 6-month waiting period which would kick in when his employer’s plan is exhausted. If Ryan feels he cannot afford own-occupation coverage, he should evaluate what other occupations he would consider if he were disabled. A noncancellable policy is preferable because the premiums will not go up, but a guaranteed renewable policy would be more affordable. Other factors to assess include the length of the waiting period, the age at which benefits expire, and the availability of residual benefits if he is able to work part-time. Answers to Concept Check Questions The following are solutions to “Concept Check Questions” found on the student website, CourseMate for PFIN 4, at www.cengagebrain.com. You can find the questions on the instructor site as well. 9-1. Health insurance protects your financial future against potential economic loss due to illness or injury. With the high cost of health care today, a serious illness could wipe out a family's savings, and a disability could severely lower their standard of living. 9-2. In general, the costs of health care have been increasing at a rate that exceeds the rise in the consumer price index (CPI). Probably, the chief cause of rapidly rising health care costs stems from the increased demand for health care services resulting from the aging U.S. population. In turn, this increased demand has been stimulated by the government's Medicare and Medicaid programs, as well as the rapid growth in the broad base of private health care plans. Also, the acquisition of expensive new health care equipment and facilities by hospitals and clinics has pushed costs upward. A poor distribution of demand for and supply of health care facilities and services resulting in an inefficient allocation of health care resources also contributes to today's high cost of health care. 9-3. The primary health insurance providers are private insurers, including Blue Cross/Blue Shield, group insurance plans, and managed care organizations, and government programs like Medicare, Medicaid, and workers' compensation. 9-4. Group health care insurance consists of health care contracts that are written between a group (usually an employer, union, credit union, college or university, or other organization) and an insurance company. The coverages of each specific plan are subject to negotiation between the group and the insurer. With the exception of disability coverage, most health care coverages are available through group health insurance plans. In most group plans, the employer will pay all or part of the premiums. Unlike group plans, individual health insurance coverages provide protection directly to the policyholders and/or their families. While under a group plan the individual is entitled only to the benefits that are available in the master plan, individuals with individual health insurance coverages can tailor the coverage to their needs. 9-5. With traditional indemnity (fee-for-service) plans, the insurer is separate from the health care provider. The insurer pays the provider or reimburses the patient. There are no limitations on the doctors and hospitals an insured can choose. These plans generally have an annual deductible, after which the insured is reimbursed for a percentage (usually 80%) of usual, customary, and reasonable charges. Managed care plans combine the insurer and the provider, with the insured paying fixed monthly payments to that organization. Members receive medical services from a designated provider group. Managed care providers stress cost controls and preventive health care. Co-payments are low, and most services are covered by the monthly fee. 9-6. HMOs attempt to reduce the costs of health care to families and individuals through more efficient utilization of resources and by practicing "preventive medicine." Health maintenance organizations (HMOs) consist of hospitals, physicians, and other health care personnel who have joined together in a central facility to provide necessary health services to its subscribers. Most HMOs provide physical exams and sponsor pro-health activities in an effort to keep their members healthier. Members are charged a monthly fee based upon the number of persons in the family. The fee entitles them to receive preventive and corrective health care services. Members may also have to pay a $5 to $20 fee each time they use an outpatient service or need a prescribed drug. Members may have little choice of their physician and may not be able to get medical care outside of a given geographic location except in the case of emergencies. An individual practice association (IPA) is often considered to be little more than a variation on a standard HMO because the financial and service arrangements are similar, with only the physical facility being different. As a member of an IPA, one would prepay monthly and be entitled to the health care services offered. However, the services are not provided from a central facility. Instead physicians operate out of their own offices and from community hospitals that provide services to IPA members as well as others. A preferred provider organization (PPO) has characteristics of both an HMO and an insurance plan and can be administered by an insurance company or a provider group. A PPO offers comprehensive health care services to its subscribers within a network of physicians and hospitals who have agreed to accept a negotiated fee schedule. In addition, it provides insurance coverage for medical services not provided by the PPO network. 9-7. Blue Cross/Blue Shield plans are not insurance policies, but rather prepaid hospital expense plans. Blue Cross contracts with hospitals, who in exchange for a specified fee or payment, agree to provide specified hospital services to members of groups protected by Blue Cross. Similarly, Blue Shield plans are contracts providing for surgical and medical services. These plans serve as intermediaries between groups who want these services and physicians who contractually agree to provide them. Until 1994, Blue Cross/Blue Shield organizations were nonprofit. Since that time, the 38 independent local member companies operate as for-profit corporations. They compete for business with private insurance companies. Their income is used to lower premiums and/or expand coverage. 9-8. The formal name for what is commonly referred to as Social Security is old-age, survivor's, disability, and health insurance (OASDHI). Health care benefits are provided under two separate programs: Medicare and disability income. Medicare is a health care plan designed primarily to help persons over age 65 meet their health care costs. It also covers a number of persons under age 65 who are current recipients of monthly Social Security disability benefits. The two primary components of Medicare are: (1) basic hospital insurance covering the first 90 days of illness, with deductibles varying according to the number of days of hospitalization, and (2) supplementary medical insurance, a voluntary coverage that reimburses 80% of approved charges after the $100 deductible is met. Under the basic hospital insurance coverage of Medicare (commonly called Part A), inpatient hospital services are included for the first 90 days of illness. A deductible is applied during the first 60 days of illness. Co-insurance provisions, applicable to days 61–90 of the hospital stay, can further reduce benefits. Medicare also covers all or part of the cost of up to 100 days in post-hospital extended-care facilities. Medicare contributes not only to hospital room and board, but also to all hospital inpatient services, limited stays in extended-care facilities, and some post-hospital services such as therapy, rehabilitation, and home health care. Supplementary Medical Insurance (SMI) is Medicare's voluntary supplemental plan (commonly called Part B) providing payment for (1) physicians' and surgeons' services provided at home or in a health care facility; (2) home health service (visits by a registered nurse); (3) medical and health services such as X-rays, diagnostics, laboratory tests, rental of necessary durable medical equipment, prosthetic devices, and ambulance trips; and (4) limited psychiatric care. It is financed by charging premiums ($66.60 per month in 2004) to those people who elect to participate in the plan. Anyone age 65 or over is eligible to participate in this program. The program has deductibles, coinsurance, and internal limits. For up-to-date information on changes in the Medicare program, pull up their Web site at www.medicare.gov. Medicaid is a state-run public assistance program that provides health insurance benefits to those of low economic means. Each state has its own regulations regarding eligibility and services covered. The states primarily fund their own Medicaid programs, although the federal government also contributes to funding. 9-9. Worker's compensation insurance statutes have been enacted in every state and by the federal government to provide compensation to workers for job-related illnesses or injuries. In most cases, compensation provides benefits covering medical expenses, rehabilitation, disability income, and scheduled lump-sum amounts for death and certain injuries, such as dismemberment. Employees receive worker's compensation coverage regardless of whether they have other health care insurance or not. Several important benefits are lump-sum payments and second-injury funds. Lump-sum payments are lump sum amounts normally paid to employees who suffer dismemberment in work-related accidents or to their beneficiaries in the case of death. A schedule of lump-sum payment benefits for various injuries is normally provided for the insured. Second-injury funds are established as part of the worker's compensation statutes in order to relieve employers of the additional worker's compensation premium burden they might incur if an already handicapped worker sustained further injury on the job. These funds protect the employer from developing an adverse claims experience (that would result in increased premiums) merely because they hired an already partially handicapped worker. 9-10. The key provisions of ACA (usually called the Affordable Health Care Act) include: • The individual mandate, which required all Americans to have or buy health insurance by 2014 or pay a penalty. • The coverage of young adults or children of those insured by insurance companies, up to the age 26. • The coverage of individuals with pre-existing health conditions without limiting or setting unrealistically high insurance rates. • Health care insurance exchanges, which provide a marketplace for individuals and businesses for more transparency in the comparison of policy features and premiums. • Small firm coverage, whereby a law requires small firms with more than 50 full-time employees to provide health insurance coverage or pay extensive fines. The Affordable Care Act requires students to have a level of coverage that exceeds the plans historically offered by most colleges. Consequently, premiums are rising by several hundred dollars a year to around $2,000 per student. Indeed, some colleges are dropping student health-insurance plans due to their higher costs. If a student is not covered under a parent’s health care plan, he/she must consider an individual health insurance plan. If a parent’s policy is relied on, be careful if the college is in another state. Make sure that your plan's network of preferred doctors and hospitals extends there. If not, the highest level of coverage may not be available. For some family plans, out-of-state coverage is limited, so a high-deductible student health plan might be the way to go, because it makes sense for students to return home for all routine care and prescriptions. The Affordable Care Act may make some student health plans more appealing. It prohibits all plans from having “lifetime coverage limits” that could limit maximum coverage in the case of a serious illness or accident. The new law also prohibits insurers from excluding students under 19 for pre-existing conditions. Thus, answers about how the ACA affects students can include some or all of the following: (1) the ability to extend coverage under a parent’s health care policy for students under 26; (2) the potential to have less take-home pay due to the higher Medicare taxes proposed; (3) the ability for some students with pre-existing medical conditions to get better health care policies; (4) health care coverage for all students that do not currently have health care insurance, or face the prospect of a fine. 9-11. Four methods for controlling the risks associated with healthcare expenses include: 1. Risk avoidance—trying to avoid exposure to a particular risk so that loss will not occur. Not driving a car would be a way to avoid having an auto accident. 2. Loss prevention—taking preventive measure to try to keep a loss from occurring. Not driving over the speed limit and never driving after drinking would be examples of loss prevention. 3. Loss control—taking measures to control the amount of loss in case it actually occurs. Wearing a seat belt when riding in an auto helps keep your head from going through the windshield or you being thrown out of the car should an accident occur. 4. Risk assumption—you pay for the loss yourself. It is not economically feasible to insure against every small loss, so you simply pay out of pocket for the loss or do without. You back into a light post and knock out your taillight. The amount of loss is less than your deductible on your auto insurance, so you pay for the taillight yourself. Not fixing it is not a good option in this instance, as your car would not pass inspection, or you might get a ticket. 9-12. Employees should consider numerous factors in evaluating their employer-sponsored health insurance plan. If their employer offers a flexible-benefit plan, the employee must decide which benefits to choose for the amount of money allotted by the employer toward benefits. If the employee needs more coverage, he or she must decide whether to purchase the extra from the employer's plan or from another source. If the employer offers a medical reimbursement account to which the employer contributes, the employee can decide whether to use that money or allow it to build up against some unknown future expenses. If the employee's spouse also receives benefits from his or her employer, then the couple must decide how to best coordinate the coverages of the two plans. If the employee loses his or her job, then he or she must decide whether to continue health insurance coverage through COBRA or not. 9-13. Several sources of health insurance are available to supplement employer-sponsored health insurance plans. These include private insurance companies as well as Blue Cross/Blue Shield. Some amount of healthcare coverage is available on homeowner's and automobile insurance policies, but the coverage is limited and applies only in certain circumstances. Several government programs are available, such as Medicare for those 65 or older, Medicaid for those of low economic means, medical care for military or retired military personnel, and public health programs to treat communicable diseases, handicapped children, and mental health disorders. 9-14. Student answers will vary depending on their current needs and situations. 9-15. Hospitalization insurance policies offer reimbursement plans which generally pay for (1) a portion of the per day hospital room (semi-private) and board charges. This typically includes floor nursing and other routine services. These policies also cover (2) ancillary expenses, such as the use of the operating room, laboratory tests, X-ray examinations, and medicine received by the patient while hospitalized. Surgical expense insurance provides coverage for the cost of surgery in or out of the hospital. Payment is based on either service benefits, which pay expenses that are considered "reasonable and customary" for that procedure, or on a schedule of benefits that prescribes the maximum amount the insurer pays for listed surgical procedures. Usually, surgical expense coverage is quite extensive and will pay for almost any type of surgery that is required to maintain the health of the insured. Surgical expense coverage is typically sold in conjunction with a hospital insurance policy either as an integral part of that policy or as a rider. 9-16. Major medical coverage is designed to finance medical costs of a more catastrophic nature and provides benefits for nearly all types of medical expenses resulting from either illnesses or accidents. The amounts that can be collected under this coverage are relatively large. Major medical coverage is typically written with provisions to limit payments, including deductibles, participation or coinsurance, and internal limits. Most policies now cap the insured's out-of-pocket payment through deductibles and coinsurance; after a certain dollar amount is paid by the insured, the company pays 100% of covered costs. Someone who must purchase insurance as an individual on a limited budget needs this protection the most. A comprehensive major medical insurance plan combines the basic hospital, surgical, and physician’s expense coverages with major medical protection to form a single policy and is usually the most desirable type of coverage to have. Usually the deductible is low, often $100 to $500. There may be no coinsurance feature. Comprehensive major medical is frequently written as a group policy, although individual policies are available. 9-17. a. Deductibles, which require the insured to pay the first so many dollars, are typically relatively large, usually ranging from $500 to $1,000 per illness or accident. Some plans have annual deductibles or else specify the initial amount of the cost of each illness or accident for which the insured is responsible. The insurance policy will reimburse only amounts above the deductible. A greater deductible usually results in less being paid by the health care plan for any particular illness or accident, but it usually results in lower premium payments by the insured as well. The deductible reduces the insurer's administrative costs and the frequency of small claims. b. Coinsurance, or participation, provisions stipulate that the company will pay only some portion, normally 80 or 90%, of the amount of the covered loss in excess of the deductible. The insured participates by "coinsuring" or paying the remainder. It is used to discourage feigning illness or unnecessary medical expenses. c. Sometimes individuals are covered under several health care policies—for example, both spouses work and each is provided with family health coverage. Because health insurance policies are not contracts of indemnity, it may be possible for the insured individuals to collect multiple payments for the same illness or accident. However, many health care policies will have a coordination of benefits provision (also called "nonduplication procedure" or “other insurance”) which reduces multiple benefit payments. The insurance companies involved will coordinate their payments so that the reimbursement amount is not greater than the actual charges incurred. The presence of these clauses should help to lower policy premiums as well as prevent “moral hazard,” the temptation to file a claim or even injure oneself in order to profit. 9-18. When employees voluntarily or involuntarily (except in the case of gross misconduct) leave their jobs and therefore give up membership in the insurance group, they can lose their health insurance. In 1986, Congress passed the Consolidated Omnibus Budget Reconciliation Act (COBRA) to allow employees to elect to continue coverage for themselves and eligible family members through the group for up to 18 months. Exercising the COBRA conversion involves timely payment of premiums by the former employee (up to 102% of the company cost) to the former employer. Retirees and their families are also eligible. Most states provide for conversion of the group coverage to an individual policy without evidence of insurability. 9-19. Typical cost containment provisions include the following: • Pre-admission certification: Insurance company must approve scheduled hospitalization and an estimated length of stay. • Continued stay review: Insurer must approve extensions of hospital stay beyond the number of days set in pre-admission certification. • Second surgical opinion: Many group policies require second opinions on specific nonemergency procedures to confirm the surgical need and, in their absence, may reduce the surgical benefits paid. • Waiver of coinsurance: Provides waiver of co-payment and/or deductible (pays 100%) for certain cost-saving procedures, such as outpatient surgery and use of generic pharmaceuticals. • Limitation of Insurer's Responsibility: Many policies limit the amount of costs the insurer must pay to those considered "reasonable and usual." This provision sometimes limits the type and place of medical care for which the insurer will pay. Requiring a second surgical opinion reduces the number of unnecessary nonelective and/or elective surgeries, thereby holding down the insurer's costs. Many conditions can now be treated without surgery or with surgery that is not so invasive and requires less hospital and recovery time for the patient. This provision obviously benefits patients as well in that they are not subjected to the trauma and recovery from unnecessary surgery as well as possibly wages lost due to not being able to work. 9-20. Most regular health care policies do not cover the cost of long-term care. As more of the population lives longer, there is a greater likelihood that many people will at some point in their lives be unable to care for themselves for an extended time period. Long-term care insurance covers the cost of medical, personal, and social services provided at home, in a community program such as an adult day-care center, or in a nursing home for those who require long-term care as a result of a catastrophic illness such as Alzheimer's disease, heart disease, and stroke. This care can be very expensive, and it is therefore important to consider adding long-term care coverage when developing financial plans. 9-21. a. Type of care: Policies will cover care in either a nursing home or in the home of the insured, or both. Obviously, a better policy will cover both situations. b. Eligibility requirements: These are used to determine whether a person qualifies for payment and use "gatekeeper provisions" that may vary considerably. Some policies pay if a physician orders long-term care; others base their determination on the number of activities of daily living (ADLs) the insured cannot perform. c. Services covered: Policies may differ in the levels of care that they will cover (skilled, intermediate, or custodial care). The broader the coverage, the better, because even custodial care at a nursing home can be very expensive over a long period of time. Other long-term care policy provisions include: • Daily benefits—sets a daily maximum for reimbursement. • Benefit duration—how long the benefits will be paid; ranges from one year to the insured's lifetime. • Waiting period—period after eligibility begins during which no benefit payments are made; the longer the waiting period, the lower the premium. • Renewability—guaranteed renewability assures continued coverage as long as premiums are paid; an optional renewability provision means that the insurer can terminate coverage and should obviously be avoided. • Preexisting conditions—excludes coverage for conditions that exist when the policy is issued, usually for 6 to 12 months. • Inflation protection—provides for increased coverage to keep up with inflation; an additional premium is charged for this rider. • Premium levels—the age of the individual when the policy is initiated determines the premium; premiums go up dramatically with age. 9-22. Before spending money for long-term care insurance for yourself or an elderly relative, you must consider such factors as whether there are significant assets to protect, your ability to pay the expensive premiums, likelihood that you will become disabled due to advanced age or family history of disease, and availability of family members to provide care. If you decide to purchase a long-term care policy, you should do so while you are healthy and middle aged because once you have a serious disease or become “older,” you either aren't eligible for a policy or the premiums will be exorbitant. Before you buy a policy, it's important to find the right types of coverage for your needs and to understand what the policy covers and when benefits start. Good long-term care policies include several levels of care. 9-23. Disability income insurance provides a family with weekly or monthly payments to replace income when the insured person is unable to work as a result of a covered illness, injury, or disease. Some companies also offer disability income protection for an unemployed spouse. Such insurance helps pay for the services that the spouse would normally provide. Waiting period provisions require that the insured wait a specified length of time after inception of the disability before the payment begins. Its purpose is to omit coverage for frequent small losses that are very expensive to administer. A family can save a substantial amount in premiums by purchasing a policy that has a relatively long waiting period. Insured individuals can generally trade off increased waiting periods for an increased duration of benefits. This is advisable since the primary need is generally for prolonged long-term disability coverage. However, families must make sure to provide for themselves an adequate cushion account or some means to see them through this period. 9-24. Disability or nondisability of an insured is defined in various ways. The more restrictive and less desirable definition states that individuals are disabled if they no longer have the capacity to undertake employment for which they are reasonably suited based on their education, training, or experience. Under this any occupation definition, a person who could pursue a related or different career and still be gainfully employed would not qualify for benefits. Hence, a family’s standard of living could decline considerably. More liberal policies classify insured individuals as disabled if they simply cannot pursue at least one primary duty of the occupation for which they have been trained, called the own occupation definition. This is a much more desirable and usually a more expensive coverage, but the family’s standard of living will not suffer nearly as much. An insured who suffers a presumptive disability—dismemberment, total loss of eyesight or hearing—is considered totally disabled, and no employment test applies. 9-25 The benefit duration determines whether the disability coverage will be for a specific time period or for a lifetime. The choice depends on whether or not the insured has good pension benefits that start at age 65 so that disability coverage would no longer be necessary. Solutions to Online Bonus Financial Planning Exercises The following are solutions to “Bonus Personal Financial Planning Exercises” found on the student website, CourseMate for PFIN 4, at www.cengagebrain.com. You can find these questions on the instructor site as well. 1. The Blakes have many things to consider in choosing their health insurance. If they select the indemnity plan, they will be able to choose the best doctors and hospitals available for their son's future surgeries. However, this plan will cost them $85 more per month in premiums, or $1,020 per year. Additionally, each family member will have a $500 deductible, potentially another $2,000 out of pocket for them. Then after the deductible is met, the Blakes will still have to pay 20% of the covered costs. While that may not sound like much, 20% on a $100,000 operation is $20,000, and it's quite possible that their son's expenses may go even higher. Some indemnity policies require only 3 family members to meet their deductibles (the 4th and subsequent family members would not have to meet their deductibles) before coverage kicks in, and some indemnity plans also have a stoploss provision which limits the family's total out-of-pocket amount. The Blakes should definitely check to see if this plan has these provisions. The group HMO would definitely be cheaper for the Blakes. Not only are the monthly premiums less, but also there are no deductibles to meet, just $20 co-pays for doctor visits and prescription drugs. The tradeoff would be their lack of ability to choose the doctors and hospitals to treat their son. They should thoroughly research the quality of the doctors and hospitals available through the HMO as well as the HMO's reputation for servicing its clients. Will the HMO be easily convinced to go out of their network to find a specialist if they do not currently one have that would meet the Blakes’needs? If the HMO does have the appropriate specialists, are they of the highest caliber? If the Blakes’are not pleased with their findings concerning the HMO, they should go with the indemnity plan if they possibly can. It could literally mean the difference between life and death for their son. Concerning other options open to the Blakes, Ken probably makes too much money for their family to qualify for any public assistance programs for their son's surgeries and treatment. However, they should still check to see what is available in their state. Also, they should see if there are any nonprofit organizations that would help with some of the cost of their son's care. Finally, they should research other insurance companies, both for full coverage and for a supplemental policy to help defray some of the costs. It's likely that other insurance will not be as cost effective as their employer's, but they won't know their options unless they check. Solutions to Critical Thinking Cases The following are solutions to “Critical Thinking Cases” found on the student website, CourseMate for PFIN 4, at www.cengagebrain.com. You can find these questions on the instructor site as well. 9.1 Evaluating Zach’s Health Care Coverage 1. The $3,000 deductible feature means that the insurance will not cover the first $3,000 of eligible expenses for the year (or possibly for each illness or accident in which Zach is involved, depending on the policy terms). The 80% coinsurance clause indicates that the insurer will pay only 80% of the amount of covered losses in excess of the deductible. The internal limit of $180 per day on hospital room and board indicates that the maximum the insurer will pay for hospital room and board is $180 per day. The internal limit of $1,500 on surgical fees indicates that the insurer will pay no more than $1,500 for such expenses. Because Zach’s medical expenses exceed $3,000, it appears that his policy will pay 80% of the costs above this amount. However, Zach’s hospital room and board charges exceed the $180 per day internal limit, so this constraint will increase the portion of the costs that he must pay. The same is true for the surgical fee, because his policy's internal limit for a maximum surgical fee reimbursement is $1,500. 2. The total expenses of the accident, as well as the division of these expenses between the insurer and Zach, are shown on the table below. Looking at this table, we can see that the total expenses of the accident were $20,900. Of this amount, Zach will recover $12,620 (about 60%) from the insurance company and will have to pay the remaining $8,280— 40%—out of his own pocket. 80% Limit Internal Excess Expense Item Total (where appl.) Limit Charges Surgeon $ 2,500 $ 2,000 $ 1,500 $ 500 Physician 1,000 Hospital room, board (Charged $250 x 60 days; limit $180 x 60 days) 15,000 12,000 10,800 1,200 Nursing 1,200 Anesthetics 600 Wheelchair 100 Ambulance 150 Drugs 350 Subtotal $ 20,900 1,700 Deductible – 3,000 After Deductible $ 17,900 Zach’s 20% (of above amount) – 3,580 Excess Charges – 1,700 Insurance Company Pays: Zach Pays: $ 12,620 Deductible 3,000 20% coinsurance 3,580 Excess charges 1,700 Total $8,280 3. Zach would have had additional protection had he purchased a policy with any or all of the following: a smaller, or no, deductible; a larger, or no, coinsurance clause; and higher, or no, internal limits. However, in order to get these less restrictive coverages Zach would have to pay higher premiums, and as he is self-employed, he would have to bear this entire cost himself. In most cases, the additional premiums required to increase these "short-term" coverages are not justified. People are better off devoting more money toward meeting prolonged types of illnesses and disabilities. However, Zach should look at his personal financial situation to find the right level of deductible for him; $3,000 is probably too high, and he could probably shop around for less restrictive internal limits. In addition to his major medical coverage, Zach should have some type of disability income insurance—particularly given the risk of his occupation. Such coverage would allow him to receive weekly or monthly income payments to replace the income he will not receive when he is unable to work as a result of a covered illness or accident. Since Zach has already been unable to work for two months and will likely be unable to work for another few months while recuperating at home, some form of disability income insurance is probably needed. In addition to Social Security benefits, which do not begin until a worker has been totally disabled for five months, and worker's compensation, if he is eligible, some type of long-term disability income coverage is needed. Since the really catastrophic events for which disability insurance is most important require long-term coverage, he would probably be better off purchasing a disability income policy with a longer waiting period and longer duration of benefits. In summary, Zach should evaluate his disability income coverage and fill in any gaps that may exist, particularly in the area of long-term disability income insurance. 4. Zach’s major medical insurance coverage seems inadequate. Based on Zach’s recent accident, he must pay about 40% of major medical costs. Zach should increase his major medical coverage. However, to get more attractive deductibles, coinsurance, and internal limits, he would have to pay additional premiums. The amount of increased coverage to be purchased should be analyzed from a needs approach and in view of a cost/benefit ratio. Furthermore, the amount of coverage purchased would have to be evaluated in light of Zach’s financial situation. In the area of disability income insurance Zach’s coverage is minimal. He may be eligible for Social Security benefits and may also qualify for certain worker's compensation benefits. However, he should probably purchase additional long-term disability income coverage in order to provide for adequate income replacement in the event of a prolonged or permanent disability—especially in view of his somewhat hazardous occupation of window washing. Better short-term disability coverage with a 60- or 90-day waiting period and a relatively long duration of benefits would also be useful. Such coverage would probably have been beneficial in light of Zach’s current injuries (for which he had been hospitalized sixty days and will probably be unable to work for a few additional months). The amount of coverage Zach ultimately buys will, of course, depend upon his available financial resources. However, Zach does need to analyze his health insurance plan(s) and increase his coverage appropriately. 9.2 Roberto and Juanita Get a Handle on Their Disability Needs 1. The amount of additional disability income insurance needed by Roberto in order to protect his family in the event he becomes completely disabled is calculated in a format similar to Worksheet 9.2 on the following page. These calculations are based upon the following four assumptions (1) Roberto and Juanita need 90% of their combined takehome pay in order to meet their bills and provide for a variety of necessity items; (2) if Roberto becomes completely disabled, Juanita will continue to work at her part-time job; (3) Roberto’s average monthly take home pay for the most recent year was $2,300; and (4) Roberto’s group health insurance policy provides coverage for his entire family. Estimate of Roberto’s Disability Income Insurance Needs: Income Requirement Roberto’s current take-home pay $2,300 Juanita’s current take-home pay 700 Total Income $3,000 (1) Monthly Income Need (90% of Total Take-Home Pay) $2,700 Existing Disability Sources Juanita’s take-home pay $ 700 Company disability benefit (20% x $2,300) 460 Social Security payment 700 (2) Monthly Income if Roberto is Totally Disabled $1,860 Roberto’s Disability Income Insurance Need [(1) – (2)] $ 840 Based upon these calculations, it appears that Roberto needs an additional $840 of monthly disability income insurance coverage in order to provide his family with a subsistence level of income. 2. The question can be answered either "No" or "Yes," depending upon what assumptions are made with respect to Roberto’s ability to work. Two situations, of course, could exist: (1) Roberto can continue to work when Juanita is totally disabled; and (2) both Roberto and Juanita are totally disabled. In the first case they would not necessarily need any disability income insurance for Juanita since their monthly income need of $2,700 (calculated in question 1) could be met from Roberto’s $2,300 take-home pay and Juanita’s $400 monthly Social Security benefit. If both Roberto and Juanita become totally disabled, they would need some disability income coverage on Juanita. In the question 1 calculations, Juanita was expected to provide $700 monthly. Clearly some alternate source for these funds must be arranged. Because Social Security disability income benefits for Juanita will provide $400, they need an additional $300 of disability income, which could be provided by either increasing Roberto’s monthly disability insurance need by $300 to $1,140 or by purchasing $300 of disability income insurance for Juanita. Either would provide adequate disability income insurance coverage should they both become totally disabled, but it might be cheaper to increase his policy benefit rather than get an additional policy on her. The ultimate decision should be based upon a cost analysis of these alternatives, choosing the one with the lower cost. 3. First of all, Roberto should make sure that his group health insurance coverage is adequate to cover the medical costs associated with the total disability of both Juanita and him, as well as their young son. The family is mostly dependent on Roberto’s ability to work, so increasing his coverage is very important. However, it may not be cost effective to obtain a policy on Juanita, and as it is unlikely that they both will be disabled at the same time; a better alternative might be to start a regular saving/investing program instead of paying premiums for Juanita. This would also serve as their cushion to see them through the waiting period before Roberto’s disability benefits begin, should he ever become disabled. Chapter 10 Protecting Your Property Chapter Outline Learning Goals I. Basic Principles of Property Insurance A. Types of Exposure 1. Exposure to Property Loss a. Property Inventory b. Identifying Perils 2. Liability Exposures B. Principle of Indemnity 1. Actual Cash Value versus Replacement Cost 2. Subrogation 3. Other Insurance C. Co-Insurance II. Homeowner's Insurance A. Perils Covered 1. Section I Perils 2. Section II Perils B. Factors Affecting Home Insurance Costs C. Property Covered D. Personal Property Floater (PPF) E. Renter's Insurance: Don't Move In Without It F. Coverage: What Type, Who, and Where? 1. Types of Losses Covered a. Section I Coverage b. Section II Coverage 2. Persons Covered 3. Locations Covered G. Limitations on Payment 1. Replacement Cost 2. Policy Limits 3. Deductibles H. Homeowner's Insurance Premiums III. Automobile Insurance A. Types of Auto Insurance Coverage 1. Part A: Liability Coverage a. Policy Limits b. Persons Insured 2. Part B: Medical Payments Coverage a. Policy Limits b. Persons Insured 3. Part C: Uninsured Motorists Coverage a. Policy Limits b. Persons Insured c. Underinsured Motorists Coverage 4. Part D: Coverage for Physical Damage to a Vehicle a. Collision Insurance b. Comprehensive Automobile Insurance B. No-Fault Automobile Insurance C. Automobile Insurance Premiums 1. Factors Affecting Premiums 2. Driving Down the Cost of Auto Insurance D. Financial Responsibility Laws IV. Other Property and Liability Insurance A. Supplemental Property Insurance Coverage B. Personal Liability Umbrella Policy V. Buying Insurance and Settling Claims A. Property and Liability Insurance Agents B. Property and Liability Insurance Companies C. Settling Property and Liability Claims 1. First Steps Following an Accident 2. Steps in Claims Settlement 3. Claims Adjustment Major Topics As long as you own valuable assets, you need a way to protect yourself financially should those assets be destroyed or be subject to a lawsuit or financial claim. Property insurance is available to protect these assets from damage and therefore to protect your financial goals from being displaced should property damage occur. Also available is liability insurance, which protects you from the consequences of potentially negligent acts that can cause financial ruin. The major topics covered in this chapter include: 1. Property and liability insurance is designed to protect against the loss of real and personal property that occurs because of various perils or your own negligence. 2. Homeowner's insurance includes two types of coverages: one on property and the second for personal liability and medical payments. 3. Losses that are covered by homeowner's insurance are paid out on an actual cash value basis, after considering deductibles and policy limits, with the exception of the house and garage, which are usually treated on a replacement basis. 4. There are many aspects to automobile coverage, including personal liability, property damage to your car and property or that of another, and medical payments. 5. There are many other kinds of property and liability insurance available besides homeowners and automobile insurance. 6. As with the purchase of any asset or service, you must evaluate your loss exposure to determine how much insurance you need. It is important to find a good insurance company and insurance agent to help in evaluating various coverages and in making claims. Key Concepts Few people generally understand what they are receiving when they buy insurance. What is even worse, those who do buy insurance often do not know if they are adequately covered. This chapter is designed to introduce the principles of property and liability insurance so that the student understands the types of coverages available and how to determine the necessary amount of insurance. The following phrases represent the key concepts stressed in this chapter. 1. Exposure to losses and liabilities 2. Negligence 3. Perils and insurable exposure 4. Principle of Indemnity, Co-insurance, and Right of Subrogation 5. Homeowner's insurance, including property damage and personal liability coverage 6. Renters insurance 7. Insurance policy limits and deductibles 8. Personal Automobile policy (PAP), including liability, medical, uninsured motorist, underinsured motorist, and property damage coverage 9. Other types of property and liability insurance, including flood and earthquake insurance, personal liability umbrella insurance, and insurance on other forms of transportation 10. Selecting an insurance agent and insurance company 11. Property inventory 12. Comprehensive Insurance Policies versus Named Peril Policies 13. Personal property floater (PPF) 14. Replacement cost 15. Financial responsibility laws 16. Captive agent versus an independent agent 17. Claims adjustor 18. No-fault automobile insurance Financial Planning Exercises The following are solutions to the problems at the end of the PFIN 4 textbook chapter. 1. No, a 90% co-insurance clause on a homeowner’s policy would not be better than an 80% clause unless the homeowner could only obtain a policy with a 90% co-insurance clause. A 90% co-insurance clause would require Jeannie to buy at least enough insurance to equal 90% of the replacement value of his property. If she had less coverage than that, then Jeannie would be required to pay a proportional share of the loss. If she had at least that amount of coverage, then she would be reimbursed for covered losses (after meeting her deductible) dollar for dollar up to the amount of the policy limits. With an 80% co- insurance clause, she could get by with purchasing a little less insurance and still receive full coverage in the event of loss. 2. a. With an 80% co-insurance requirement, the minimum insurance policy the Evans can have on their home and still be covered is $280,000 ($350,000 x .80). Their policy is for $310,000, so they have adequate coverage. b. Total Schedule C coverage is 50% of Schedule A ($310,000), or $155,000. However, internal policy limits apply. See "Policy Limits.". Television: $600 value/8 year life = $75/year depreciation. Current value = $450. Payment Item Value per Schedule C Limit TV $ 600 $ 450 Jewelry 1,850 1,000 Silverware 3,000 2,500 $5,450 $3,950 Eligible amount $3,950 Less: Deductible – 500 Actual payment $3,450 c. If the Evans had increased their internal policy limits or purchased personal property floater insurance, they would have received more for their jewelry and silverware. If they had purchased replacement-cost coverage, they would have been reimbursed for the replacement cost of their television versus the depreciated value. 3. The Parkers should have renter's insurance to protect their personal belongings against physical damage from water, fire, theft, etc. The cost of renter's policies is reasonable and also provides liability coverage, which is very important. The couple should inventory their possessions and meet with several knowledgeable casualty insurance agents to discuss appropriate property and liability coverage amounts. Then they should purchase the lowest cost policy that meets their needs. 4. Assuming the company reimburses actual cash value, the most they would pay would be the difference between the $35,000 replacement price and the accumulated depreciation. Since five years of the assets' 15-year useful lives have expired, one third of the replacement value would be lost to depreciation (thus 1/3 of $35,000 = $11,550). By subtracting that in depreciation from the $35,000 replacement value, an actual cash value of $23,450 results. This amount, less any deductible, would be paid to Lizzie. 5. a. The damage to Raman’s vehicle will be covered under the collision portion of his auto insurance and is subject to the $500 deductible. The full amount of the damage to the other car will be covered under the property damage liability portion of his policy as the damage is less than his $25,000 limit. Total paid by the insurance company: $3,785 + $1,850 = $5,635. b. The injuries to the other two people will be covered under the bodily injury liability portion of his auto policy and is subject to the limit of $25,000 per person and $50,000 total. Therefore, he will have to pay the additional $5,000 to each of the two injured persons. c. This would fall under the collision portion, and since the claim is below the $500 deductible, the insurance company pays nothing. Answers to Concept Check Questions The following are solutions to “Concept Check Questions” found on the student website, CourseMate for PFIN 4, at www.cengagebrain.com. You can find the questions on the instructor site as well. 10-1. The fundamental concepts related to property and liability insurance concern the types of exposure, the principle of indemnity, and co-insurance. The two basic types of exposures are the physical loss of property and the liability one might have as the result of alleged negligent actions. The principle of indemnity deals with restoring the insured person’s economic loss, but in an amount not to exceed his or her economic loss. Most property and liability contracts are based on this principle. Co-insurance is a provision commonly found in property insurance contracts that requires policyholders to buy insurance in an amount equal to a specified percentage of the value of their property; failure to do so implies that the policyholder will be responsible for part of the loss—or, in effect, becomes the co-insurer. 10-2. The principle of indemnity means the insured should be restored in whole or in part for a given economic loss. Restoration usually takes the form of a monetary payment for the loss, but occasionally the insurance company will instead repair or replace the damaged or destroyed property. At the same time, the principle of indemnity prohibits insured persons from being compensated by their insurance company for an amount exceeding the amount of economic loss. Most property and liability insurance contracts are contracts of indemnity. Concepts related to this principle are implemented in property and liability insurance: (1) actual cash value, (2) subrogation, and (3) other insurance. Actual cash value is defined as the replacement cost less depreciation. Some insurers guarantee replacement cost without taking depreciation into account if the proper type and amount of insurance has been purchased. Subrogation is the right given to an insurance company (after they pay a claim for a loss) to request reimbursement from the person who caused the loss or that person's insurance company. An "other insurance" clause prohibits insured persons from insuring their property with two or more insurance companies and then collecting in full for a loss from all companies. A pro rata scheme is usually established for dealing with such situations. 10-3. The right of subrogation allows the insurance company, once it has paid a claim for a client's loss, to request reimbursement from either fthe person who caused the loss or that person's insurance company. A person who is not at fault in an incident of loss but collects from his or her insurer must subrogate to the insurer the right to collect from the at-fault person or insurer. If a victim collected the full amount from both parties, he or she would be better off after the loss than before. This is a violation of the principle of indemnity. Through subrogation, insurers attempt to lower insurance costs by reducing the net amount they must pay out to satisfy claims. 10-4. The co-insurance feature requires policyholders to buy insurance in an amount equal to a specified percentage of the replacement value of their property. If the co-insurance requirement is not met, the maximum compensation allowable for total or partial loss may be based on a specified percentage of that loss and not on the policy limits. The policyholder, then, becomes the "co-insurer" and must bear part of the loss. 10-5. The perils against which most properties are insured under various homeowners' policies are usually assigned to one of two sections in the policy contract. Section I perils relate to the house, attached structures, and personal property. These include: fire; lightning; windstorm; hail; explosion; riots; damage by vehicle; smoke damage; vandalism; theft; glass breakage; damage by falling objects; weight of ice, snow, and sleet; collapse of building; accidental damage to or from heating or plumbing systems; freezing; and damage by electrical equipment. Section II perils relate to personal liabilities of the insured and medical payments to others. While policies offer protection against nearly any source of liability resulting from negligence, they do not insure against potential liability perils such as libel, slander, defamation of character, and contractual or intentional wrongdoing. 10-6. Under Section I, the homeowner's policy offers protection for the house, detached structures, and the personal property of the homeowners and their families. In addition, coverage for certain types of losses also apply to the lawn, trees, plants, and shrubs. Structures on the premises used for business purposes (except incidentally) are excluded from coverage, as are animals (pets or otherwise) and motorized vehicles not used in the maintenance of the property. For many expensive and easy to steal items, such as cash, jewelry, furs, cameras, guns, etc., there are specified limits which are quite low. It may be necessary to add a personal property floater (PPF) to provide the level of coverage needed. a. African parrot—not covered (animals are excluded). b. Motorbike—not covered (you’re expected to have coverage on the bike already). c. Avon cosmetics for sale—not covered (considered business inventory). d. Tupperware for home use—covered, but only the amount which exceeds your deductible (it’s your personal property). 10-7. a. A policyholder can suffer three different types of property-related losses when misfortune occurs. The types of losses covered by a homeowner's insurance contract usually include a direct loss of property, an indirect loss through the loss of use of damaged property, and any extra expenses that result from direct and indirect losses. b. Persons covered include those named in the policy, as well as members of their family who are residents of the household, and in many cases, guests of the insured. c. Locations. Most homeowner's policies offer coverage worldwide for personal property. The exception is property left at a second home—obviously you’re supposed to have that home insured also. 10-8. Replacement-cost coverage provides the insured with an amount necessary to repair, rebuild, or replace an asset at today's prices. The homeowner's policy is one of the few types of property insurance that provides replacement-cost coverage. Under this type of coverage, the insurer will repair or replace damaged items without taking any deduction for depreciation. Actual cash value coverage only reimburses on the depreciated value of an insured item. The actual cash value is found by subtracting an appropriate amount of depreciation from the property's replacement value. Since the actual cash value is always less than (or equal to) the replacement value, replacement-cost coverage is the preferred type of coverage and usually adds very little additional cost to the annual premium. 10-9. Deductibles place constraints on what an insurance company must pay on small losses. They help reduce insurance premiums by doing away with the frequent small loss claims that are proportionately more expensive to administer. The standard deductible in most states is $250 on the physical damage protection found in Section I of the homeowner's policy. However, deductibles of $500 or $1,000 are available on an optional basis. In general, higher deductibles result in lower premiums on a given policy. Deductibles do not apply to either the liability or medical payments coverage since insuring companies want to be notified of all claims, no matter how trivial. If companies did not set this policy, the insurer might be notified too late to properly investigate and prepare an adequate defense for a resulting lawsuit. 10-10. The major coverages available under the personal auto policy (PAP) are: 1) Liability policy provisions which pay on the insured's behalf sums he or she has become obligated to pay because of accidental damages caused to another and to defend the insured against another who is seeking compensation arising out of a covered occurrence. 2) Medical payments insurance which provides payment to eligible insured individuals of an amount no greater than the policy limits for all reasonable and necessary medical expenses incurred within three years after an auto accident. 3) Uninsured motorist coverage which compensates the insured for damages caused by an uninsured or underinsured motorist. 4) Coverage for damage to your vehicle which includes: Collision insurance which pays for collision damage to an insured automobile regardless of fault and comprehensive insurance which provides for protection against damage to an insured automobile caused by any peril (with few exceptions) other than collision. a. Automobile medical payments insurance provides payment to a covered person up to the policy limit for medical expenses incurred within 3 years of an auto accident. It also covers injuries sustained as a pedestrian or bicycle rider in a traffic accident. It pays on an excess basis when you are injured as a passenger in someone else’s vehicle. If you have medical expenses greater than the limits of the owner’s coverage, your policy will pay the excess amount up to the medical payments limit. b. Uninsured motorists coverage applies to the named insured,, their family members, and others occupying their covered auto where they are accident victims negligently injured by uninsured or hit-and-run motorists. In many states, this coverage is for bodily injury only and not for property damage. 10-11. a. Automobile Collision Insurance is a first party property damage coverage that pays for collision damage to an insured automobile regardless of who is at fault. The amount payable is the actual cash value of the loss (i.e., depreciated value) in excess of a stated deductible. The stated deductible may be as low as $50 and as high as $500 to $1,000. A collision occurs when you are driving your car and collide with anything, such as a tree or fence, not just with another auto. Most likely, your insurance coverage also protects you against collision when driving a rented vehicle. b. Automobile Comprehensive Insurance provides protection against loss to an insured automobile caused by any peril (with few exceptions) other than collision. This coverage includes, but is not limited to, damage caused by fire, theft, glass breakage, falling objects, malicious mischief, vandalism, riot, and earthquake. It ordinarily has a $50 to $100 deductible, and the maximum compensation provided is the actual cash value of the automobile. Theft of your property inside your auto is usually not covered by your auto insurance but may well be covered under your homeowner’s policy. 10-12. No-fault auto insurance is based upon the belief that the liability system should be replaced by a system that reimburses without regard to negligence. Under pure no-fault insurance, the driver, passenger, and injured pedestrians are reimbursed by the insurer of the car for economic losses stemming from bodily injury. The insurer does not have to provide coverage for claims made for losses caused to other motorists. Each insured party is compensated by his or her own company regardless of which party is at fault. The main argument in favor of no-fault suggests that the existing liability insurance does a poor job of compensating victims of automobile accidents for their losses. Proponents also suggest that it will reduce the number of lawsuits and will reduce auto insurance costs. Those against no-fault suggest that is has already proven to be more expensive than the existing liability system. Also, based upon existing data, it appears that the right to sue for damages has not been materially thwarted by states enacting no-fault legislation. 10-13. A number of factors influence the availability and cost of auto insurance. The factors that are important include: Rating Territory. Since accidents are more likely to occur in some geographic areas than others, higher rates are applied where the probability of claims is greatest. Use of automobile. Both the number of miles driven and whether or not the car is used for business purposes affect cost. Personal Characteristics of Driver. Age, sex, and the marital status of insureds affect the auto insurance premium assessed. Type of automobile. Automobiles are classified with respect to performance. If an automobile is not classified as standard performance, higher rates are usually charged. Driving Record. The driving records of the insured and those that live with them play an important part in the determination of premiums. A poor driving record will increase a given driver's premiums or affect the type of insurance plan the driver is offered. Those who have been refused regular coverage may be assigned to an automobile insurance plan, a plan for high-risk drivers which features less coverage for a much higher premium. Discounts. Some auto insurers give discounts to individuals for special reasons, such as demonstrated safe driving, driver's education, etc. Discounts can knock 5 to 50% off annual premiums. Deductibles. As a rule, the greater the deductible, the less costly the insurance coverage—using a high ($1,000) deductible on your comprehensive and collision insurance can result in premium savings of as much as 45–50%. 10-14. Financial responsibility laws attempt to force motorists to be financially responsible for the damages they become legally obligated to pay as a result of automobile accidents. Two basic types of laws compel motorists to assume financial responsibility. The first variety is one in which all automobile owners in a given state are required to show evidence that they have liability insurance coverage prior to obtaining registration for their motor vehicles. In the second type of financial responsibility legislation, motorists do not have to show their insurance coverage until after they are involved in an accident. If they then fail to demonstrate compliance with the law, their registration and/or driver's license is suspended. This latter type of law has been criticized on the basis that it allows negligent motorists to have one "free" accident. Even though the motorists who are not financially responsible lose their driving privileges, the losses to their victims may remain uncompensated. 10-15. a. Earthquake Insurance—This is a type of homeowner's insurance that provides financial protection from earthquake damage. Although this form of insurance is fairly inexpensive to purchase, policies typically carry a 15% deductible on the replacement- cost coverage of the home, meaning homeowners will have to bear significant out-ofpocket costs before they are able to collect on the policy. b. Flood Insurance—This type of coverage provides protection against the financial consequences of flood damage. This insurance is subsidized by the federal government and is sold in cooperation with private insurance agents to homeowners living in floodprone areas. c. Other Forms of Transportation Insurance—Insurance coverage is available for other forms of transportation in addition to automobiles. Mobile home insurance provides homeowners with coverage similar to that for conventional homes. However, due to total losses occurring more frequently on mobile homes than on more permanent structures, rates per $100 of protection are typically higher for mobile homes. Recreational vehicle insurance is available for a variety of vehicles, including all-terrain vehicles, antique autos, minibikes, and camping vehicles. While full coverage is generally available, some restrictions may apply and rates can vary substantially. Boat insurance may be provided to some extent through the owner's homeowner's policy. However, a boat and motor endorsement may need to be added to the policy in order to attain sufficient coverage, or the owner may need to purchase a specially designed boat-owner's policy. 10-16. A personal liability umbrella policy might be a wise purchase for persons with moderate to high levels of income and net worth who are viable targets for liability claims. An umbrella policy would cover legal judgments in excess of the amount of liability covered by a homeowner's or auto policy. Other persons who might need umbrella insurance would include those who rent out their home or have house sitters or unbonded hired help, such as gardeners and babysitters, and people who have clients visit in their home office. The homeowner would be responsible for any injuries incurred while such individuals are on the premises or in their employ, or for any injuries their workers might cause to other people. 10-17. A captive agent represents only one insurance company and is more or less an employee of that company. Independent agents, however, typically represent between two and 10 different property insurance companies. You should find an agent who is knowledgeable and willing to take the time to go over your total property and liability exposures and develop a sound and affordable insurance program. In property insurance, agents who meet various experience and educational requirements and pass a series of written examinations qualify for either the Chartered Property and Casualty Underwriter (CPCU) or Certified Insurance Counselor (CIC) designations. These agents are known to have demonstrated above average knowledge and experience in their field. With respect to the insurance company itself, it is a good idea to pay particular attention to the company's financial soundness, claims settlement practices, and geographic extent of operations. Friends and acquaintances can often provide insight into its claims settlement policy. 10-18. After an accident, you should record the names, addresses, and phone numbers of all witnesses, drivers, occupants, and injured parties, along with the license numbers of the automobiles involved, the license number of the drivers, their auto insurance policy number, and the name, address, and phone number of their insurance company. Try to sketch how the accident occurred on paper, and take pictures if you have a camera. Notify law enforcement officers as well as your insurance company representative of the accident. Don't admit liability at the scene of an accident or discuss it with anyone other than the police and your insurer. The typical insurance claim settlement process involves four steps: 1. Giving notice to the company that a loss (or potential for loss) has occurred. Timely notice is extremely important. 2. Investigation of the claim. To properly investigate a claim, insurance company personnel may have to talk with witnesses or law enforcement officers, gather physical evidence to tell whether the claimed loss is covered by the policy, and check to make sure the date of the loss fell within the policy period. 3. Providing proof of loss. This step usually requires the claimant to give a sworn statement, show medical bills, provide an inventory and certified value of lost property, provide an employer’s statement of lost wages, and, if possible, provide physical evidence of damage. 4. Payment by insurer of either the requested amount, a lesser amount, or nothing on the basis that the company has no legal responsibility under the terms of the policy. In the case of a disputed claim, most policies provide for claim arbitration. The claims adjustor may work for the insurance company, work as an independent adjustor, or work for an adjustment bureau. Primarily, the adjustor is looking out for the interests of the company. He or she must diligently question and investigate, and at the same time offer service to minimize settlement delays and financial hardship. In the situation where an individual must file a claim against another's insurance company, a question of fault arises, and the adjustor will only be concerned with the economic interest of the insurer and its policyholders. As the claimant is not a customer of the insurer, the adjustor will generally be unconcerned with keeping the claimant satisfied. In this situation, the claimant may have to seek the service of a public adjustor or attorney to settle the claim. These services will generally be costly but will be well worth it, particularly when the claimant is not being treated fairly by the insurance company's adjustor. Solutions to Critical Thinking Cases The following are solutions to “Critical Thinking Cases” found on the student website, CourseMate for PFIN 4, at www.cengagebrain.com. You can find these questions on the instructor site as well. 10.1 The Salazars’ Homeowner's Insurance Decision 1. All homeowner’s policies include two sections: Section I which covers their property, and Section II which provides liability and medical payments. Section II is the same for all forms; only Section I differs. Section I coverage of the various forms is described below: In most parts of the country, there are 5 standard forms of homeowner’s policies: HO-2 —Homeowner’s 2 Broad Form HO-3 —Homeowner’s 3 Special Form HO-4 —Homeowner’s 4 Contents Broad Form (renter’s insurance) HO-6 —Homeowner’s 6 Unit-Owner’s Form (condo owner’s insurance) HO-8 —Homeowner’s 8 Modified Coverage Form (older homes) [HO-1 was the basic form which covered damage by fire, lightening, windstorm, hail, explosion, riots, aircraft, vehicles, smoke, vandalism, theft, and glass breakage. It applied to the house, detached structures, and other personal property and is being phased out nationally.] HO-2 is the broad form. In addition to the risks covered by HO-1, it covers falling objects—weight of ice, snow, and sleet, collapse of building, accidental damage to or from heating or plumbing systems, freezing, and damage by electrical equipment. This coverage applies to the house, detached structures, and other personal property. HO-3 is the special form. It covers all risks on personal property, except glass breakage, and all risks, except those specifically excluded, on buildings. By far, most homeowner’s policies now written are of this type and would be the best choice for the Salazars. Whereas HO-1 and HO-2 covered specific perils, HO-3 covers by exclusion. That is, it covers everything except certain named perils. This “open-peril” coverage is superior to Forms 1 and 2, and some of the losses excluded under Form 3 can be insured by an endorsement or under a separate policy. Often Form 3 is used with the Homeowner’s Special Personal Property Coverage Endorsement, Form HO-15, which provides openperils coverage on the contents. HO-8 is a modified coverage policy for older homes. It is used for houses with market values well below their replacement cost. As the Salazars are purchasing a new home, this is not a suitable choice. 2. The perils against which the house, detached structures, and personal property should be insured should certainly include all of those listed as being covered by the HO-2 form, particularly given the climate of the Houston area. The great thing about the HO-3 form is that it also includes the out-of-the-ordinary, as yet unthought-of perils (except for those specifically excluded) which invariably occur. 3. The types of loss protection provided by the HO-2 and HO-3 coverages on the house and detached structures were enumerated in the answer to question 1 of this problem. Under both forms (HO-2 and HO-3), the coverage also applies to house contents, unlisted personal property, and personal property off the premises. The amount of coverage is set equal to 50% of the policy value for house contents and unlisted personal property and 10% of the policy value (but not less than $1,000) on personal property off premises. One important fact should be highlighted: The coverage on the house and detached structure is based upon replacement cost. Coverage on the house contents, unlisted personal property, and personal property off premises are typically based upon actual cash value. Note that recently many insurers began offering, for a slight premium increase, replacement-cost coverage on contents. These homeowner's policies may also specify internal limits for certain types of properties. For example, a $200 limit applies to money bank notes, bullion, silver, and coins and medals; a $1,000 limit applies to securities, manuscripts, evidences of debt, passports, tickets, and stamps; a $1,000 limit applies for loss by theft of jewelry, watches, furs, and precious and semiprecious stones; and a $2,000 limit applies to the loss of firearms by theft. The standard liability limit (coverage E) is $100,000, and the medical payments portion (coverage F) normally has a limit of $1,000 per person. Other expense coverages often included are claim expenses, such as court costs and attorney fees, first aid expenses such as ambulance costs, and damage to the property of others up to $500 per occurrence. 4. The Salazars should go with the HO-3 policy and shop for rates with reputable insurance companies. They should definitely get replacement-cost coverage and should also consider riders or endorsements for any special items in their home which may have limited coverage under the homeowner’s policy. Joaquin and Pilar should be sure to consider co-insurance clauses and obtain sufficient coverage to comply with this requirement. Also, they should make sure that adjustments are made periodically so that the amount of their insurance coverage increases as the value of their home increases. If they fail to do this, they may find that they would not have replacement-cost coverage. 10.2 Auto Insurance for Seth Morris 1. a. Basic Automobile Liability Insurance. Under this coverage, the insurer agrees: (1) to pay on the insured's behalf all sums for which the insured becomes legally obligated to pay because of accidental damages he or she caused another; and (2) to settle the claim or defend the insured against another who is seeking compensation arising out of a covered occurrence, up to policy limits only. b. Uninsured Motorist Coverage meets the needs of "innocent" accident victims injured by uninsured or hit-and-run motorists. Under this coverage, an insured is legally entitled to collect an amount equal to the sum that could have been collected from the negligent motorist's liability insurance, if such coverage had been available. c. Automobile Medical Payments Insurance provides for payment to eligible insured individuals of an amount no greater than the policy limits for all reasonable and necessary medical expenses incurred within three years after an automobile accident. It even provides for duplicate loss reimbursement even though other sources of recovery, such as accident or health insurance, also make payment. d. Automobile Collision Insurance provides property damage coverage that pays for collision damage to an insured automobile, regardless of fault. This coverage is written without outside limits, and the amount of insurance payable is the actual cash value of the loss (depreciated value) in excess of a stated deductible. e. Comprehensive Automobile Insurance provides protection against loss to an insured automobile caused by any peril (with few exceptions) other than collision. This coverage provides broad protection and includes, but is not limited to, damage caused by fire, theft, glass breakage, falling objects, malicious mischief, vandalism, riot, and earthquake. 2. Yes. The various limits available for each type of coverage are listed below: a. Basic Automobile Liability Insurance. Typically, this policy provides for different policy limits, depending on whether the damage is bodily injury or property damage. Limits are placed on both of these types of damages. Common terms are stated as $10,000/$20,000/$10,000. The first two amounts pertain to the maximum amounts for bodily injury to others: the first number is the maximum allowable per person, and the second number is the total maximum allowable per accident, no matter how many people are injured. The third number is the per accident amount of property damage liability protection. b. Uninsured Motorist Coverage. This coverage typically provides basic limits of $10,000/$20,000. This means that in the event the insured is involved in an accident with an uninsured motorist the maximum liability coverage per person injured in an accident is $10,000, and total liability per accident is $20,000. In many states, this part does not cover your property which has been damaged. c. Automobile Medical Payments Insurance usually provides per person limits of $1,000, $2,000, $3,000, $5,000, or $10,000. Most families are advised to buy the $5,000 or $10,000 limit because, even if they have other adequate heath insurance coverage available, they cannot be certain that their passengers are equally well protected. d. Automobile Collision Insurance. This part covers the damage to your auto when you collide with anything, regardless of fault. There are no outside limits. The amount of insurance payable is the actual cash value of the loss in excess of a stated deductible, which is typically $50, $100, or $250. e. Comprehensive Automobile Insurance. This part covers the damage to your auto against most insurable perils, other than collision, regardless of fault. Again, the amount of insurance payable is the actual cash value less any applicable deductible, which is most commonly $50 or $100. Theft of personal property kept or left in the insured automobile is not covered under this policy. Such losses may be covered by the offpremises coverage of the homeowner's policy. 3. a. Basic Automobile Liability Insurance. The persons covered under this coverage are the named insured and family residents of his or her household with respect to an owned automobile. Also protected are any other persons who use the automobile with the permission of the named insured owner as long as they stay within the scope of such permission. Coverage is also afforded to persons or organizations on whose behalf the automobile of the named insured owner is being driven. Coverage is also extended to the named insured while operating other nonowned automobiles and to his or her household relatives while they are operating any nonowned private passenger automobile or trailer. b. Uninsured Motorists Coverage. This coverage is applicable and/or offered to the named insured, his or her household relatives, and any other person driving the insured vehicle within the scope of permission. It is effective when those covered are "innocent" accident victims negligently injured by uninsured or hit-and-run motorists. c. Automobile Medical Payments Insurance. Coverage under an automobile medical payments insurance policy applies to a named insured and household relatives while occupying either an owned or an unowned automobile (with permission) or if struck by an automobile or trailer of any type. Auto insurance contracts also sometimes cover any other person occupying an unowned private passenger automobile that is being operated by a named insured or a covered relative. d. Automobile Collision Insurance. This coverage protects against loss to an insured automobile caused by collision. Due to the types of losses covered, the specification of persons covered is usually not necessary. This is a comprehensive property damage coverage, not a human loss coverage. e. Comprehensive Automobile Insurance. This coverage protects against loss to an insured automobile caused by any peril (with few exceptions) other than collision. Due to the types of losses covered, the specification of persons covered is usually not necessary. This is a comprehensive property damage coverage, not a human loss coverage. 4. Mr. Morris’ policy should, at a minimum, contain provisions for liability, uninsured motorists, and medical payments protection. In many states, minimum liability coverage (or financial responsibility) is required by law. At least the minimum limits of liability coverage should be purchased. He would also be wise to buy at least the basic $10,000/$20,000 uninsured motorist coverage. This coverage is attractive due to its low cost relative to the amount of protection it provides. Medical payments insurance is also advisable since it is also relatively low cost and provides protection above and beyond other health and accident insurance. Because Mr. Morris is buying a brand new car, he should also have both collision and comprehensive coverage. Buying these coverages with high deductibles ($250 or more) reduces the cost of the coverage. He will have to select the deductible amount on the basis of his own risk disposition. If Mr. Morris’ son is not yet driving, he will be shortly, and that means his auto insurance rates will increase dramatically. He can lessen the blow somewhat by selecting higher deductibles and paying for smaller bumps out of pocket. However, it would be wise to select higher liability limits, as unfortunately, new drivers are more likely to have accidents, and to also obtain umbrella liability insurance. Umbrella insurance would kick in if the amount of damage in an auto accident were to be greater than the amount of protection offered by the auto and homeowner’s policies. He needs to be sure to protect himself and his son against large losses which would be catastrophic for them. In summary, it is recommended that Mr. Morris buy an insurance policy on the new car that provides all five coverages. When shopping for this coverage, he should get quotes from several agents and not assume that Paula Rathbone, his agent with Chairman’s Insurance Company, will provide the lowest cost coverage. He should shop around since other insurers may offer even lower rates on comparable coverage for the two cars. It is important that Mr. Morris compare similar coverage and that he purchases the legal minimum of financial responsibility coverage required by Virginia insurance and motor vehicle laws. He should also compare the cost of various deductibles on the collision and comprehensive coverages to decide which deductible best fits his risk-cost preferences. The ultimate goal is to get the desired coverage at the lowest premium cost through a good agent representing a reputable, financially sound insurer that is known to have good claims settlement practices. Solution Manual for PFIN Personal Finance Michael D. Joehnk, Randall S. Billingsley, Lawrence J. Gitman 9781305271432