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CHAPTER 10

PROPERTY AND LIABILITY INSURANCE

CHAPTER CONTEXT: THE BIG PICTURE

This is the final chapter in this section titled “Part 3: Protecting Yourself with Insurance.” An underlying premise of this section is the use of insurance products to provide financial control, a fundamental element of financial planning. This chapter completes the sequence on protecting life, health, and property. An important message for students is the role of property and liability insurance in planning and controlling their financial future. Paying to repair or replace assets that were not covered by insurance or were underinsured can have a devastating effect on the budget. But paying for uninsured liability damages could impact household finances for years. Consistent with the other chapter, this one focuses on strategies to match policy features with individual needs, to control policy costs, and to use the coverage to recover a loss.

CHAPTER SUMMARY

As the term property and liability insurance implies, these policies provide multiple forms of defense and protection of assets. First, property and liability insurance provides protection from unexpected damage expenses to repair or replace assets such as home, personal property, or auto. Second, the coverage protects from liability losses when the policyholder(s) is (are) judged to be the cause of damages or losses to others. Provisions of homeowner’s policies are introduced; strategies for selecting, buying, and maintaining a cost-effective policy are considered. The role of insurance credit scoring in premium determination is also explored. Strategies for establishing proof of ownership and filing and collecting on a claim are illustrated. Features of an automobile policy are introduced, as well as driver and auto characteristics that determine policy costs and available discounts. The chapter concludes with a discussion of how to file an auto insurance claim.

LEARNING OBJECTIVES AND KEY TERMS

After reading this chapter, students should be able to accomplish the following objectives and define the associated key terms:

1. Understand, buy, and maintain homeowner’s insurance in a cost-effective way.a. perilb. HO’s or Homeowner’sc. named perils

Copyright ©2010 Pearson Education, Inc. publishing as Prentice Hall

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d. open perilse. property insurancef. personal liability insuranceg. endorsementh. personal articles floateri. inflation guardj. actual cash valuek. replacement cost coveragel. personal umbrella policym. coinsurance provisionn. 80 percent ruleo. insurance credit scorep. deductibleq. direct writer

2. Recover on a liability or a loss to your property.3. Buy the automobile insurance policy that’s right for you.

a. Personal Automobile Policy (PAP)b. combined single limitc. split-limit coveraged. uninsured motorist’s protection coveragee. collision lossf. other than collision loss or comprehensive physical damage coverageg. no-fault insuranceh. umbrella liability insurance or umbrella policy

4. File a claim on your automobile insurance.

CHAPTER OUTLINE

I. Protecting Your HomeA. Packaged policies: HO’s

1. Section I: Property coverage2. Section II: Personal liability coverage

B. Supplemental coverage1. Personal articles floaters2. Earthquake coverage3. Flood protection4. Inflation guard5. Personal property replacement cost coverage6. Added liability insurance


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II. Your insurance needsA. Coinsurance and the “80 percent rule”B. The bottom lineC. Keeping your costs down—insurance credit scoringD. Keeping your costs down—discounts and savings

1. High deductible discounts2. Security system/smoke detector discounts3. Multiple policy discounts4. Pay your insurance premiums annually5. Other discounts6. Consider a direct writer7. Shop around8. Double-check your policy

III. Making Your Coverage WorkA. Make an inventory of property ownedB. Know what to do in the event of a loss

1. Report your loss immediately.2. Make temporary repairs to protect your property.3. Make a detailed list of everything lost or damaged.4. Maintain records of the insurance settlement process.5. Confirm the adjuster’s estimate.

IV. Automobile InsuranceA. Personal automobile policy (PAP)

1. PAP Part A: Liability Coverage2. PAP Part B: Medical Expense Coverage3. PAP Part C: Uninsured Motorist’s Protection Coverage4. PAP Part D: Damage to Your Automobile Coverage5. Exclusions

B. No-fault insuranceC. Buying automobile insurance

1. Determinants of the cost of automobile insurance2. Keeping your costs down

D. Filing a Claim

APPLICABLE PRINCIPLES

Principle 8: Risk and Return Go Hand in HandPooling the risk and sharing the cost among all covered consumers allows everyone to pay a little, and lose a little, every year. As a result, the insurance company accumulates enough


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funds to reimburse those who randomly experience a loss. Paying a little every year helps everyone avoid a catastrophic loss.

Principle 7: Protect Yourself Against Major CatastrophesProperty and liability insurance provides two major protections. First, it provides funds to repair or replace damaged or lost possessions—assets that make up a major part of the net worth for most households. Second, it protects against the financial losses incurred by others when we are judged to be at fault for causing those losses. Most of us could not pay for large property or liability losses without the help of insurance. But it is our responsibility to avoid another catastrophe by buying adequate, cost-effective coverage. The saying “don’t sweat the small stuff” applies—keep insurance costs manageable by protecting from the major losses.

CLASSROOM APPLICATIONS

1. Ask a local insurance agent to provide price quotes for a popular sports car or sport utility vehicle using different scenarios (for example, male and female, under and over age 25, with lower and higher deductibles, and with minimal and more adequate liability coverage). Discuss the quotes with the class. Highlight the effect of changes in deductibles and liability coverage on the premium. Consider the cost-effectiveness of increasing annual premiums versus paying for liability losses that exceed the policy limits.

2. Review the “Suggested Projects” at the end of the chapter for possible student reports and/or guest lecturers to enrich the student experience.

3. Collect newspaper articles or other media reports about court-ordered liability awards for homeowner or driver negligence. Use the articles to help students understand the potential financial impact of inadequate liability coverage.

4. Invite an insurance agent or claims adjuster to discuss issues related to establishing proof of ownership and filing a claim to collect on a loss. How might this process differ in a small town with a relatively stable population versus an urban area with a transient population?

5. Have students individually or in small groups evaluate their current auto insurance or homeowner’s insurance coverage. What potential property, medical, liability, or financial losses might they face given their current insurance coverage? Next, have the students obtain at least three insurance quotes for needed coverage by using Internet sites or talking to a local agent. For convenience, perhaps an agent would visit class to discuss coverage or premiums. Invite students to present their findings.



REVIEW QUESTION ANSWERS

1. The six basic types of standardized homeowner (HO) policies are: HO 1–Basic Form: provides the narrowest coverage of all HO policies limited to only

11 specifically named perils. Because of its limitations, the policy is not widely available.

HO 2–Broad Form: a “named perils” form of insurance that limits coverage to a set of specific perils (e.g., fire, windstorms). Perils not named in the policy, are not covered.

HO 3–Special Form: an “open perils” form of insurance that covers all perils except those that are specifically excluded (e.g., earthquakes, nuclear accidents).

HO 4–Tenant Insurance: policy that provides funds to replace furnishings and personal property in a rented dwelling. These policies also provide liability insurance for renters up to a specified limit.

HO 6–Condo Insurance: policy that covers the personal property of condo or co-op owners, plus any structural improvements or alterations made to their unit.

HO 8–Modified Coverage: policy designed for an older home that limits coverage to repair costs or actual cash value, rather than replacement cost. The coverage limitation is due to the expense of replacing materials and construction details used in older homes.

An HO 3, Special Form, policy offers more comprehensive coverage than an HO 1 or HO 2 Policy. The additional protection explains the 10 to 15 percent increase in cost over an HO 1 policy. An HO 3 covers all direct physical losses to the structure (except the four that are typically excluded), but coverage on the contents is limited to the named perils listed in an HO 2 policy. Both the HO 2 and the HO 3 offer 20 percent of the insurance on the home as loss of use coverage; an HO 1 policy includes only 10 percent coverage.

2. Section I has four parts: Coverage A: Dwelling: protects a house and any attachments (e.g., a garage). Coverage B: Other Structures: protects other structures on a policyholder’s premises that

are not attached to a house (e.g., a detached garage, landscaping). Coverage B is limited to 10 percent of the home’s coverage, or Coverage A.

Coverage C: Personal Property: protects personal property owned or used by a policyholder, regardless of its location. Coverage C is limited to half of the home’s Part A coverage, with limits on losses of specific types of property (e.g., jewelry, coins).

Coverage D: Loss of Use: provides benefits if a home can’t be used as a result of an insured loss. This coverage provides funds to live elsewhere (e.g., a rental property) until the home is repaired. Coverage is limited to 20 percent of the home’s coverage.

Section II has two parts: Personal Liability Coverage: protects a policyholder and family members from financial

loss if someone is injured on their property or as a result of their actions. Liability


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insurance is important protection against potentially catastrophic losses resulting from a liability judgment.

Medical Payments to Others: provides payment for a limited amount (e.g., $1,000) of medical expenses incurred by non-family members injured in a policyholder’s home (e.g., if someone falls down the stairs and breaks a leg).

3. The following restrictive limits apply under Section I, Coverage C: $200 limit on money, bank notes, gold and silver $1,000 limit on securities, valuable papers, manuscripts, tickets and stamps $2,500 limit on the theft of silverware, goldware, and pewterware No coverage on animals, birds or fish

Personal articles floaters protect from losses associated with these restrictions. The “all-risk” coverage is typically an extension of the homeowner’s policy, and covers all losses except for those specifically excluded: war, wear and tear, mechanical failure, vermin and nuclear attack.

4. Common examples of supplemental homeowner’s policy coverage include: Personal Articles Floater: provides extra insurance to increase the limits of coverage on

personal property (e.g., silverware, jewelry) beyond those written in a standard HO policy.

Earthquake Coverage: recommended for homeowners in high-risk areas, this policy provides coverage for damage caused by earthquakes, which are otherwise excluded in standard HO policies.

Flood Insurance: recommended for homeowners in flood-prone areas, this policy provides coverage for water damage including floods, mudslides, and water erosion. A policy can be purchased after a community receives approval from HUD. Otherwise, floods are specifically excluded in standard homeowners’ policies.

Inflation Guard: recommended for all policyholders to allow for annual automatic increases in coverage based on a national index of replacement costs. Protects against inflationary losses to the real coverage provided by the policy.

Personal Property Replacement Cost Coverage: policy option which provides for the actual replacement cost of a stolen or destroyed item rather than its actual cash value, which reflects depreciation and can be well below the cost of replacing it. Replacement cost coverage adds about 5 percent to 15 percent to the cost of an HO policy and provides the peace of mind that personal property can be replaced, in the event of a loss, without incurring a lot of expense.

Added Liability Coverage: option available through most insurance companies to raise a homeowner’s liability limit from $100,000 to $300,000 or $500,000 for a relatively modest additional premium.



Umbrella Liability Policy: provides from $1 million to $10 million of protection against large lawsuits and judgments. The policy goes into effect after the insured has exhausted the limits of the liability coverage provided in the homeowner’s or auto policy.

Full protection means full replacement from a total loss. For the average policyholder, supplements for inflation guard and replacement cost coverage on the structure and contents are most likely to provide that protection.

5. Most homeowners should consider purchasing a personal umbrella policy as their net worth increases; in other words, when their assets exceed the liability limits of their policy. These policies provide liability coverage once the limits of existing homeowner’s and auto policies are exhausted. Umbrella policies, which are relatively inexpensive, provide protection from $1 million to $10 million against lawsuits and judgments. Most losses are covered except for acts committed with intent to cause injury, activities associated with aircraft and some watercraft, and most business and professional activities.

6. This is a policy provision that requires homeowners to carry dwelling coverage equal to at least 80 percent of their home’s replacement cost in order to be fully reimbursed for a partial loss to the structure. If the 80 percent figure is not met, then homeowners must pay a prorated percentage of their loss, or the coinsurance. The 80 percent of replacement cost figure is considered the minimum amount of coverage that a homeowner should buy. Many people insure their home for 100 percent of replacement cost in order to receive full reimbursement if their home is totally destroyed. Restrictions still apply in that the maximum amount paid is limited to the policy coverage (regardless of the amount of the loss), the home must be rebuilt on the same location, and if the home is not rebuilt coverage is limited to the actual cash-value loss for the destroyed portion of the home.

7. Guidelines to consider when purchasing a homeowner’s policy include: Amount of replacement cost insurance needed to rebuild the home in the event of a

complete loss, with 80 percent of this estimated value as minimum coverage. Need for protection against the effects of inflation on home building costs. Special protection (e.g., flood or earthquake) needed according to home location. Value of detached structures, elaborate landscaping, or other personal property that may

not be adequately covered. Additional business liability coverage needed for a home-based business. Replacement cost coverage needed for personal property to be able to replace items at

current prices. Floater policies needed for personal property valued above stated limits in the policy. Additional liability coverage or an umbrella policy to insure that liability coverage

exceeds the value of assets. Need for coverage on personal property in a rented dwelling.


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8. Insurance companies use the insurance credit score to set premiums because of the strong relationship between credit score and insurance loss ratio, or the frequency of claims for both homeowners and auto insurance and the cost of those claims. Claims frequency and cost reflect losses, or costs, to the insurance company that are passed on to policyholders. The higher the insurance credit score, the lower the premium, because the statistical relationship would predict fewer claims. The insurance credit score is based on the same factors as a credit score although weightings for two factors are slightly different. To improve your credit score and control insurance premiums, be sure to: Pay bills on time. Pay down your debt—monitor the total amount owed and how close the balance is to

your credit card limit(s). Maintain long-term accounts to increase your FICO credit or insurance score. Use different types of credit, but be careful when adding new credit cards or other

accounts. Monitor borrowing capacity. Keep your financial life in order— don’t add too much new credit too soon!

9. Five ways to reduce the cost of homeowner’s insurance include: (individual student answers may vary) Select a financially sound insurer with lower rates compared to other companies. Increase deductibles. The larger the deductible, the lower the premium. Obtain a discount for installing equipment, such as smoke detectors and security alarms,

designed to reduce the risk of loss. Obtain a multiple policy discount by purchasing more than one type of insurance from

the same company. Pay premiums annually or semi-annually rather than in frequent installments. Obtain any other discounts available (e.g., for using fire-resistant building materials,

turning age 55, or for having coverage with the same insurer for several years). Shop around to compare the cost of homeowner’s insurance offered by a number of

insurance companies. Get bids on the total cost, including floaters, so equal comparisons can be made.

Consider using a direct writer that sells policies without the use of agents. Because the company does not incur high salary or commission costs, policies often cost less.

Check the policy to be sure it matches types and amounts of coverage as well any supplements requested.

10. Simply owning a homeowner’s policy is not sufficient protection for the assets owned. A homeowner, or renter, must document the assets and their value for adequate reimbursement. Without sufficient records, neither the policyholder nor the insurance company can verify the loss. Steps a homeowner should take to establish proof of property ownership to substantiate a claim include:



Make a detailed list of household items including the brand, model number, serial number, cost, and date of purchase, if known. Pre-printed inventory worksheets are available.

Get an appraisal of valuable personal property (e.g., jewelry) and get close-up pictures. Videotape the household inventory by walking through each room of the house and

describing the contents, including the contents of cabinets, drawers, and closets. Include all home furnishings or other property, both inside and outside of the home, including storage areas.

Store the household inventory and/or video in a safe deposit box or other safe location away from the home.

11. A homeowner should follow these steps to file an insurance claim: Report the loss immediately to the insurance agent and to the police (in the event of a

theft). Should credit cards or ATM cards be involved, cancel the cards immediately. Make temporary repairs to property to prevent further damage (e.g., putting a tarp on a

damaged roof to keep out rain) or burglary. Make a detailed list of all lost, damaged, or stolen items and their value for use by the

insurance agent or the police. Maintain records of the settlement process, including the expenses involved. Get a damage estimate from a local contractor to confirm the insurance adjuster’s

estimate. Don’t agree until you get fair settlement.

12. The four parts of a standardized personal auto policy (PAP) are: Part A: Liability Coverage: provides protection from losses resulting from lawsuits

associated with an auto accident. Drivers should carry at least $100,000 of bodily injury liability coverage per person, at least $300,000 for all persons involved in an accident, and at least $50,000 of property damage liability insurance.

Part B: Medical Expenses Coverage: pays reasonable medical and funeral expenses incurred within 3 years by a policyholder, family members, and others involved in an accident in an insured vehicle. Typical per person limits are from $1,000 to $10,000.

Part C: Uninsured Motorists Coverage: provides coverage for injuries caused by an uninsured motorist, a negligent driver whose insurance company is insolvent, or a hit-and-run driver.

Part D: Coverage for Damage to Auto: provides for two types of coverage, collision and comprehensive. Collision benefits cover damage resulting from an accident with another vehicle or object. Comprehensive covers physical damage caused in a variety of ways (e.g., falling objects, fire, theft).

13. With split limit coverage (e.g., 100/300/50), there are separate coverage limits for each category of liability: bodily injury per person, bodily injury per accident, and property damage coverage. With a combined single limit (e.g., $500,000), the liability coverage applies to all bodily injury and property damage liabilities without a separate limit for each.


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14. Provided no criminal charges (e.g., drunk driving) are involved, the insurance company will pay all legal costs to defend you in any civil cases brought as the result of an accident. No specific dollar limit of protection applies; legal costs are in addition to the specified policy limits.

15. Both forms of insurance are important. Uninsured motorist’s protection covers medical losses caused by a hit-and-run driver, an uninsured motorist, or a negligent driver whose insurance company is insolvent. Underinsured motorist’s coverage provides protection against negligent drivers with inadequate liability coverage.

16. Collision loss covers damages to the policyholder’s auto resulting from a collision, or accident, with another vehicle or object. Payment for collision losses, less the deductible, is paid regardless of fault. However, if the other driver was at fault and has insurance, the losses should be paid by the other driver. Comprehensive physical damage, also known as “other than collision loss,” covers losses that result from fire, theft, larceny, or causes other than a collision. Collision coverage typically does not cover rental cars used for business purposes.

17. No-fault auto insurance is based on two principles. First, the insurance company of the driver pays for his or her losses, and those of the passengers, without regard to fault. Second, by removing the litigation associated with the determination of fault, insurance should be less costly. The major problem with the no-fault system focuses on the limits on medical expenses and other claims. In some states, the limits are inadequate to cover legitimate medical expenses associated with an accident. Injured parties can collect up to a specified limit, regardless of fault. If the other driver was at fault, an injured party can sue for “pain and suffering.”

18. Standard exclusions that tend to limit the amount of coverage in a PAP include: Cases of intentional injury or damage. Using a vehicle without permission of the owner. Using a vehicle with fewer than four wheels. Driving another person’s car that is provided for you on a regular basis. Owning and driving an automobile that is not listed on your policy. Carrying passengers for a fee. Driving in a race or speed contest.

19. Factors that determine the cost of auto insurance include the following: Type of vehicle (sporty cars generally cost more). Use of the vehicle (the less distance people drive, the lower the premium). Personal characteristics such as age, gender, and marital status. Policyholder’s driving record (those with accidents and tickets pay more).



Area of residence (insurance is generally more expensive in urban areas). Use of available discounts (e.g., for good grades or a good driving record). Policyholder’s insurance credit score.

20. Auto insurance discounts are typically based on characteristics of the driver and the vehicle. Premium discounts that are commonly available include: Discount for going 3 years or more without a chargeable accident. Discount for more than one vehicle on the same policy. Discount for low annual mileage, or fewer than 7,500 miles per year. Discount for purchasing auto, homeowner’s, or other insurance from the same company. Discount for a low damageability auto that is cheap to repair or less appealing to thieves. Discount for being a good student, as measured by high school or college grades. Discount for being a mature driver (e.g., over age 50 or 55) discount. Discount for taking a defensive driving course. Discount for passive restraints (e.g., airbags and automatic seatbelts) and antilock

brakes. Discount for driving short distances to work or participating in a carpool. Discount for antitheft devices or where you live.

A low “damageabilty” auto designation may earn a 10 to 30 percent discount, while a good student discount could carry a discount of up to 25 percent. Up to a 40 percent discount applies to passive restraints. Several discounts save 15 percent, but some save as little as five percent.

21. Ways to reduce the cost of auto insurance premiums include: Comparison shop for coverage by obtaining quotes from a minimum of three different

insurers and with different deductible amounts. Purchase from only high-quality, efficiently operated insurance companies by checking

ratings with A. M. Best Reports (choose companies earning the two highest ratings) and Consumer Reports.

Take advantage of available discounts that can lower premiums. Buy a car that is relatively inexpensive to insure. Improve your driving record (e.g., fewer tickets, driving course). Raise insurance deductibles (e.g., $100 to $500 on collision). Maintain adequate liability insurance.

22. If involved in an accident, be sure to follow these steps: If there are injuries, get help by calling the police and the ambulance. Don’t leave the

scene; that’s a felony. Prevent other accidents by moving the car(s) or putting out flares.


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Get the names, addresses and license plates of all those involved or those who saw the accident.

Work with the police; check the report for accuracy and get a copy. If the alcohol is suspected, insist that both of you take an alcohol test. Write down all details and take pictures or measurements, if possible. Don’t sign anything, don’t admit guilt, and don’t discuss amount of insurance coverage. Call your insurance agent as soon as possible. Cooperate with the insurance company; if necessary, they will defend you, but if the

accident is serious, seek your own legal advice. Record all expenditures associated with the accident.

PROBLEM AND ACTIVITY ANSWERS

1. The $140,000 dwelling coverage is the base amount for determining Parts B, C, and D coverage as outlined below: Coverage B: Other Structures is limited to 10 percent of the dwelling coverage, or

$14,000. Coverage C: Personal Property is limited to half of the home’s coverage, or $70,000 Coverage D: Loss of Use is limited to 20 percent of the home’s coverage, or $28,000.

2. Keith and Nancy Diem: personal property limits

Item Amount Insurance Pays Amount the Diems Pay TotalCash $250.00 $250.00 $500.00Jewelry $1,000.00 $1,400.00 $2,400.00Pewter ware $1,500.00 $0.00 $1,500.00Totals $2,750.00 $1,650.00 $4,400.00

Without the additional coverage provided by a personal property floater, the Diem’s coverage is limited by the maximum amounts specified in their policy. Accordingly, $2,750 of their $4,400 loss would be covered by their insurance policy and $1,650 would need to be absorbed or paid out-of-pocket: $250 over the limit for currency and $1,400 over the limit for jewelry. Based on a $250 deductible, the Diems will receive $2,500 on their claim ($2,750 - $250).

3. Actual cash value insurance subtracts estimated depreciation from the cost of replacing an asset. In the case of the sofa, if it originally cost $850 and it has been used for half of its expected life (3 years out of 6 years), it would have an actual cash value of $425. With replacement cost coverage, the homeowner would receive the actual cost, or $1,000, to purchase a comparable sofa at the time of the loss.



4. Carmella can do the following to increase her liability coverage: Ask her insurance agent to raise the amount of her liability coverage from $100,000 to

$300,000 or $500,000. The increase in premium for this additional coverage should be modest.

Purchase an umbrella liability policy to provide protection of $1 million or more. An umbrella policy goes into effect after the liability limits of an underlying homeowner’s policy are exhausted. Umbrella policies are reasonably priced and offer the added benefit of increasing liability coverage on the auto as well as the homeowner’s policy.

5. Jerry’s house is insured for less than 80 percent of its replacement value ($235,000 / $315,000 = 74.60%), therefore, Jerry will receive 93.25 percent of his claim, because $235,000 is 93.25 percent of the 80 percent requirement ($252,000). So his reimbursement will be $23,779.76 = (($235,000 / ($315,000 x 0.80)) x $25,500), assuming this amount is greater than the actual cash value of the kitchen. If Jerry’s home were totally destroyed, the maximum he could collect is $235,000, or the full amount of his policy. This is $80,000 less than the cost to replace his home. He should maintain at least 80 percent coverage and probably 100 percent coverage to protect against a total loss. Recall that the deductible also must be applied as part of the homeowner’s coinsurance, so he will actually receive something less than $23,780 once the deductible amount is subtracted.

6. Reimbursement for Carmen’s house equals ($300,000) x ($280,000 / ($300,000 x 0.80)) or $350,000, based on the home value at the time, although the true replacement cost could be much higher and is not known. The equation results in a possible benefit of nearly $350,000, because her coverage exceeds the 80 percent minimum; however, reimbursement will never exceed the amount of the policy. So Carmen will receive a benefit equal to the $280,000 amount of the policy less the $1,000 deductible, or $279,000 for the structure.

Coverage for other structures, Part B, in an HO 2 policy is 10 percent of the coverage on the structure, or a total of $28,000 so Carmen would be reimbursed for only $28,000 of the $38,000 loss for the detached garage and pool house.

Coverage for the contents, Part C, in an HO 2 policy is 50 percent of the coverage on the structure, or $140,000 (0.50 x $280,000) so Carmen would be reimbursed for the $91,000 actual cash value loss. However, the cost of replacing the contents could potentially be much higher as a replacement cost amount is not known.

Coverage for loss of use, Part D, in an HO 2 policy is 10 percent of the coverage on the structure, or a total of $28,000 so Carmen would be fully reimbursed for the $4,500 in loss of use living expenses incurred.


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Carmen would receive no reimbursement from her HO 2 policy for her medical expenses or the $18,000 value of her three dogs. Medical expenses would have been covered by her health insurance. The dogs are excluded from the homeowner’s policy.

Carmen’s situation can be summarized as follows:

Losses ReimbursementStructure $300,000 $279,000Other structures 38,000 28,000Contents 91,000 91,000Loss of use 4,500 4,500Medical expenses 10,000 0Value of dogs + 18,000 + 0 Total $461,500 $402,500

7. Larry’s policy will pay $300,000, the maximum liability limit per accident. This amount must cover payments to all persons involved in the accident. Unfortunately, it is not enough, because the four liability claims total $400,000. The other $100,000 awarded in the judgment will not be covered by his insurance, and would be a personal expense.

8. The total amount of property damage caused by Bill’s accident is $15,000. The property damage liability limit of his auto policy is $10,000. Therefore, Bill’s insurance will pay $10,000 of the claim. Bill will be responsible for the other $5,000 out-of-pocket.

9. The discount for having more than one policy with the same insurance company would save Jessica at total of $164, calculated as $44 ($550 x 0.08) on her HO 6 policy and $120 ($1,200 x 0.10) on her auto policy. Another advantage is that if Jessica ever had a claim involving both her home and her car (e.g., a tree falling on a car at home during a wind storm), it would be handled by one company. Also, Jessica only has to build a relationship with one company and insurance agent if she purchases all of her property insurance with one firm.

10. Jana qualifies for the following discounts: 10 percent no accident discount 5 percent age 24 – 49 discount 5 percent defensive driving discount 15 percent antitheft discount



Her total discount is 35 percent of total premiums. Her new premium would be $780 ($1,200 x 0.65), assuming the costs are similar between her current company and the Superior Insurance Company. Insurance premiums vary widely by company, so Jana should carefully compare premium costs, coverage, and discounts available as well as the ratings and reputation of the company.

DISCUSSION CASE 1 ANSWERS

1. The HO-3 (Special Form) of homeowner’s insurance is the best choice for the Leylands. It is the most comprehensive form available because it covers all perils except those that are specifically excluded (e.g., flood, earthquake, war, and nuclear accident). Given the winter weather, “weight of ice, snow, or sleet,” or “freezing of plumbing, heating, air-conditioning, fire sprinkler, or appliance” may be of particular interest to the Leylands. The HO-3 provides protection from all perils on the structure; however personal property coverage is limited to the 17 named perils.

2. The minimum amount of insurance required to receive full payment for partial losses is 80 percent of the home’s replacement cost or $148,000 ($185,000 x 0.80). This is a bare minimum of coverage, and is based on the assumption that the cost of the home is equal to the replacement cost. This is typically not true, so the Leylands should seek a reliable replacement cost estimate to serve as the foundation of their insurance decision.

Without the inflation guard, or personally remembering to annually increase their coverage, the Leylands run the risk of their coverage falling to less than 80 percent, which means they would have to pay more of the cost for any loss. Since the Leylands indicated a desire to avoid out-of-pocket expenses if their home should be destroyed, they should consider insuring the home for its full replacement value and adding the inflation guard. That way, if a fire or flood, assuming supplemental flood coverage, totally destroyed their home, they would collect the full replacement amountnot a reduced amount because of co-insurance. This is a risk they want to avoid. Another option is a coverage amount between 80 percent and 100 percent of replacement cost, say 90 percent or $166,500. Recall that the deductible also must be applied for the homeowner coinsurance payment.

3. If the Leylands’ personal property is really worth $165,000, the standard 50 percent of the insurance on the house for contents coverage, or $92,500, will be very inadequate. The stamp collection, $15,000, and art, $25,000, need endorsements or floater policies to provide coverage up to the market value. The computer and electronics should be covered under the contents coverage, but they should check with the agent. To help themselves and their insurance agent, the Leylands should complete a comprehensive household inventory, with pictures or video, to document their property and the value. The Leylands should


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purchase replacement cost coverage so that their personal property would be replaced at its actual replacement cost, not actual cash value with depreciation, in the event of a loss. Adding more contents coverage to their basic HO 3 policy, as well as replacement cost coverage and additional riders or endorsements will add to the cost of the Leylands’ insurance. But the costs will be minimal compared to uninsured losses of valuable personal property. Furthermore they should review the list of ideas for keeping costs down, such as the multiple policy discount, other discounts based on their home or themselves, a higher deductible, and comparison shopping.

4. Section II Personal Liability Coverage will protect the Leylands if someone is injured on their property due to the Leylands’ actions, or inactions. For example, long winters with snow and ice can be a potential danger for anyone visiting their home, and a potential liability claim if the Leylands could be judged to be at fault for the damages caused. The small medical insurance coverage offers payment of up to $1,000 for medical expenses to non-family members injured at the Leylands’ home. Because of the winter conditions and the potential for small or large claims, the Leylands should carry adequate liability protection and consider increasing the minimum of $100,000 coverage per accident to $300,000 or $500,000. Even if the Leylands enjoy clearing the snow and ice, accidents can happen for which they could be judged to be responsible.

5. The Leylands should consider flood insurance due to their proximity to the flood-prone river. They should check with the real estate agent selling them their new home or their insurance agent to see if the community has received approval from the Department of Housing and Urban Development (HUD). If necessary, they can purchase up to $250,000 of HUD-subsidized flood insurance on the dwelling and an additional $100,000 on contents. Otherwise, flood and related water damage will not be covered.

6. Since the Leylands’ net worth exceeds the standard homeowner’s liability protection, the Leylands should consider purchasing a personal umbrella policy. These policies, which provide protection from $1 million to $10 million against lawsuits and judgments, are relatively inexpensive.. In today’s litigious society, an umbrella policy simply makes good sense. The greater a household’s assets, the greater the liability insurance need.

DISCUSSION CASE 2 ANSWERS

1. Bronwyn is not adequately insured given her potential liability. For example, if she were involved in an accident on her daily commute, and found to be at fault, her potential bodily injury liability and property liability could easily add up to more than $75,000. Split limit coverage of $100,000/$300,000/$50,000 is recommended. She is also underinsured for medical expenses, as a minimum of $50,000 in coverage per person is recommended. Her coverage for Part C: Uninsured Motorists Protection should be increased to the



recommended minimums of $250,000 per person and $500,000 per accident. Part D: Coverage for Damage to Your Auto is acceptable, assuming that “full” coverage is based on actual cash value and has a reasonable deductible applied.

2. No, the policy quoted to Bronwyn does not offer adequate protection. She should consider carrying at least $100,000 of bodily injury liability coverage per person, $300,000 of bodily injury liability coverage for all persons, and at least $50,000 of property damage liability insurance coverage. Her premium will increase; however, she can reduce the impact of the premium increase by increasing her annual deductible.

3. The standard financial planning rule states that an increase in the deductible will result in a decrease in premiums. Thus, Bronwyn should choose the highest possible deductible in order to reduce her premium, particularly given that she has sufficient savings to cover the higher deductible. In practice, she should choose either the $500 or $1,000 deductible.

4. Without adequate liability coverage, Bronwyn may be held personally liable for additional expenses and costs. This means that the equity in her home, her savings, and other assets may be subject to creditors and legal judgment, should a lawsuit be brought against her. (The insurance company would pay to defend her.) If Bronwyn is not judged to be at fault for the accident, others involved would not be compensated from Bronwyn’s liability coverage. However, even if she is not judged to be at fault, passengers riding with her could be compensated under Part B: Medical Expense Coverage for reasonable medical expenses and funeral expenses incurred within 3 years of the accident. This protection is also available to Bronwyn in addition to her health insurance.

5. Given Bronwyn’s long daily commute, and the value of her vehicle and other personal assets, she should purchase Part C: Uninsured Motorist’s Protection to protect herself from losses sustained from an uninsured motorist, a negligent driver covered by an insolvent insurance company, or a hit-and-run driver. For Bronwyn to collect, the other driver must be at fault and not have available insurance. Recommended coverage limits are at least $250,000 per person and $500,000 per accident.

Because of the number of drivers who do not carry adequate liability insurance, underinsured motorists coverage is another important consideration in Part C. This coverage would pay the difference between the liability limit of coverage available from a negligent driver and the actual loss sustained by Bronwyn, to the limit of the underinsured coverage she carries. If every driver was fully insured, Part C coverage would be unnecessary. To protect her assets and financial future, Bronwyn would be well advised to buy this coverage.

Part D coverage protects against collision and physical damage losses. Because her Ford Escape is relatively new, Bronwyn should maintain this coverage to insure that losses


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caused by an accident or other physical damage will be repaired. Recommended coverage is the actual cash value of the vehicle, so Bronwyn should not consider reducing or canceling this part of the policy until the vehicle is several years old and the fair market value is negligible.

6. Bronwyn is potentially eligible for the following common discounts: Accident free discount Automobile and homeowner’s multiple policy discount Passive restraint discount (e.g., air bag, automatic seat belts, antilock brakes) Antitheft discount Low “damageability” vehicle

7. Principle 5: Stuff Happens, or the Importance of Liquidity is a reminder that the unexpected happensbut insurance and savings provides a way to manage the unexpected. Adequate insurance protection provides coverage not only for the loss, but also for the income and assets of the insured individual. Unfortunately, that was not the case for the person reported on the radio story. But buying more coverage means higher premiums. By increasing the deductible, the premium can be significantly reduced. This makes adequate coverage more affordable, but it may necessitate a review of liquid assets to insure that (1) the emergency fund is sufficient to cover the deductible and smaller claims that might otherwise have been reported to the insurance company and (2) a reasonable amount is available as liquid assets. Probably Bronwyn, like most people, would rather pay herself in anticipation of a high deductible or the cost of a small claim, than paying the insurance company more! If stuff doesn’t happen, the money will stay in the account to grow!

8. Due to Bronwyn’s promising earnings growth and appreciating assets, she should consider purchasing a personal umbrella policy. This policy provides excess liability insurance with protection against lawsuits and judgments in the amount of $1 million to $10 million. With a multiple policy discount, and maximum PAP and HO insurance liability coverage, her premium for $1 million in coverage should be quite inexpensive.

9. While Bronwyn should make every effort to get help for anyone injured in an accident, she should not admit guilt or sign any statements of guilt until discussing the accident details with her insurance agent or insurance company representative or attorney. Any admission of guilt at the scene of an accident may hinder her efforts to defend her actions later in court. Further, she should not discuss the amount of her liability coverage with those involved in an accident. Although most people are honest, there are those who might try to commit medical or disability fraud if they knew her insurance coverage limits.


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