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Course One
Protecting Personal Assets
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ADAPTED FROM WORKS BY
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PROTECTING
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PROTECTING PERSONAL ASSETS
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TABLE OF CONTENTS
CHAPTER 1
HEALTH INSURANCE
The Potential of Medical Rationing
The Importance of Health Benefits
A Standard of Unemployment Compensation
Making Informed Decisions
Health Care Plans
Prepaid Plans
How Blue Cross Works
Health Maintenance Organizations (HMOs)
HMO Exclusions
Preferred Provider Organizations (PPOs)
Other Managed Care Plans
Group vs. Individual Heath Insurance
Master Policies
The Boss Didn’t Enroll in Medicare
A Lack of Significant Reliance
Types of Groups
Medical Expense Insurance
Basic Medical Expense
Hospital Expense
Surgical Expense
Other Medical Expense
In-Hospital Physician Visits
Emergency Accident Benefits
Maternity Benefits
Mental and Nervous Disorders
Hospice Care
Home Health Care
Outpatient Care
Major Medical Insurance
Deductibles
Co-Insurance
Out-of-Pocket Limit
Maximum Benefit
Restoration of Benefits
Covered Medical Expenses
Limits of Coverage
Supplemental Major Medical
Comprehensive Medical Expense
Medical Expense Limitations
Other Limitations
Medical Expense Exclusions
Optional Features & Benefits
Prescription Drugs
Vision Care
Hospital Indemnity Rider
Nursing/Convalescent Home
Organ Transplants
Dental Expense
Expenses Covered
Limits
Coinsurance and Deductible Provisions
Prepaid Dental Plans
Health Insurance Policy Provisions
Mandatory Provisions
Entire Contract
Time Limit on Certain Defenses
Grace Period
Reinstatement
Notice of Claim
Claim Forms
Proof of Loss
Time of Payment of Claims
Payment of Claims
Physical Examination and Autopsy
Legal Actions
Change of Beneficiary
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Optional Provisions
Change of Occupation
Misstatement of Age
Other Insurance
Relation of Earnings to Insurance
Unpaid Premium
Cancellation
Conformity with State Statutes
Illegal Occupations
Intoxicants and Narcotics
Other Health Insurance Provisions
The Policy Face
Free Look
Insuring Clause
Consideration Clause
Renewability Clause
Benefit Payment Clause
Exclusions and Reductions
Pre-existing Conditions
Waiver of Premium
Case Management Provisions
Group Insurance Policy Provisions
Conversion Privilege
Certificates of Insurance
Dependent Coverage
Records and Recordkeeping
Regulations Affecting Group Policies
Continuation of Benefits (COBRA)
Omnibus Budget Reconciliation
Act of 1989 (OBRA)
Tax Equity and Fiscal Responsibility
Act of 1982 (TEFRA)
Employee Retirement Income Security
Act of 1974 (ERISA)
ERISA Lawsuit
Health Insurance Underwriting
The Application
Other Sources of Information
Underwriting Criteria
Occupation as a Risk Factor
Group Underwriting
Small Groups
Pensions and Group Plans
CHAPTER 2
DISABILITY INCOME INSURANCE
Statutory Protections
Inadequate Insurance
Group Disability Policies
Conditional Disability Riders
Exercising Income Options
Definitions and Concepts
Selling Disability Income Coverage
Dangerous Avocations
Standard vs. Sub-Standard Risks
How Net Worth Comes into Play
CHAPTER 3
LONG-TERM CARE INSURANCE
The Myths that Color Many Decisions
What LTC Insurance Covers
Regulatory Uncertainty Poses Risks
Benefit Schedules
LTC Preexisting Conditions
Prior Hospitalization
Spousal Coverage
Underwriting LTC Insurance
Better Information Means Better Rates
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Policy Restrictions
Standard Group Benefits
LTC Riders
LTC Option
Terminal Illness Option
Prohibited Provisions
Cancellation
Benefits
Termination of Benefits
Post Claims Underwriting
Disclosure Requirements
Certificates
Life Insurance
LTC Applications
Consumer Protections
Every Reasonable Effort
Controlling Agents and Brokers
Continuation and Conversion Rights
Who Should Buy LTC Insurance?
Options for the Average Person
Special Provisions
Nonforfeiture Provisions
LTC - Partnership Programs
LTC Needs Careful Explanation
CHAPTER 4
LIFE INSURANCE
Basic Mechanics
The General Rules of Life Insurance
Types of Coverage
Some History … And Some Context
More than Just Death Benefits
Parties to A Life Insurance Contract
Insurable Interest
The Life Insurance Application
The Needs Satisfied by Life Insurance
Benefits of Life Insurance
A Human Life – What’s It Worth?
Considering Other Sources of Protection
Planning Money – Long Term
What Is The “Monthly Nut?”
Typical Family Goals
Naming and Maintaining Beneficiaries
Class Designation
Spendthrift Clause
Exclusions and Limitations
Provisions Not Permitted
Special Family Needs
Taking Care of Minors and Spouses
Life Insurance Terms and Definitions
Adverse Selection
Age
Assignment
Bad Faith
Beneficiary
Contract
Free Look
Grace Period
Incontestability
Insuring Clause
Intentionality
Medical Examinations and Autopsies
Misstatement of Age or Sex
Modification
Owner
Payee
Premium Payment
Proceeds
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Policy Change Provision (Conversion Option)
Policy Date and Due Date
Reinstatement
Renewal
Riders and Other Modifications
Suicide
Uniform Simultaneous Death Act
The Mechanics of Term Insurance
Renewal and Conversion
Provisions
Participating Term Policies
Restrictions on Exchanges and Conversions
Conversion Limitations
The Mechanics of Whole Life Insurance
Policy Loans
Participating Policies
Term Additions
Lapse or Surrender
Surrender Charges
Surrendering to Purchase More Insurance
Universal Life, Variable Life, and Group Policies
Progressive Underwriting
Variable Life
Group Life Policies
Economic Pressures
Choosing the Right Life Insurance
Whole Life vs. Term
Term/Whole Life Mix – Level
Term/Whole Life Mix – Increasing
Package/Family Insurance
Joint Life Policies
Modified Life
Split-Life Policy
Adjustable Life Insurance
Industrial Life Policy
Credit Life Insurance
Estate Planning
The Role of Wills and Trusts
Distributing the Estate
A Trust as Beneficiary
The Insured’s Estate as Beneficiary
Issues of Insurance Benefits Going to Children
Isn’t Life Insurance Always Tax Free?
The Unfunded Irrevocable Life Insurance Trust
Living Trusts
Insurance as an Investment
Life Insurance and Retirement Planning
Retirement Options with Cash Value
Annuities
Calculating Guaranteed Interest Rates
Annuities and Retirement Planning
Accelerated Benefits and Other Claims Issues
Structured Settlement Options
Accelerated Benefits
Long Term Care Coverage
Underwriting and Related Concerns
The Underwriting Process
Sources of Underwriting Information
Adverse Underwriting Decisions
Loss Ratios and Related Concepts
Classification of Risks
Determining Premiums
Expense Loading
The Gross Annual Premium
Reserves
Policy Receipts
Uninsurable Individuals
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CHAPTER
1
health care today than they did in 1961, four years before
Medicare was created. In 1965, out-of-pocket health care
costs consumed 10.6 percent of seniors' income. In 1995, the
figure was 17.1 percent a 60 percent increase.
For these reasons and others, having adequate health
insurance is perhaps the greatest Insurance concern for
seniors. As we age, we are more likely to have health
problems and tend to use the health care system more
frequently. Also, many retirees are living on a fixed income
and face increasing health care costs. A major illness, or even
a prolonged minor illness, can have serious financial
consequences if you do not have the right health coverage.
The Importance of Health Benefits
In Patricia S. Trupo v. Board of Review and Liberty Mutual
Insurance, Co., the New Jersey courts were faced with
deciding whether someone who was "forced" into early
retirement because she was afraid to lose her health
insurance coverage was entitled to unemployment
compensation benefits.
Trupo worked as an office assistant for Liberty Mutual from
February 22, 1982 until her retirement on February 28, 1992
at age 61. In November 1991, Trupo, along with other
employees, was offered an early retirement package which
included: the addition of five years to her age or work history
which would increase her pension benefits; company-paid
medical benefits until age 65, when she would qualify for
Medicare; and payment of $700 per month until age 62, when
she would be entitled to Social Security benefits.
At her administrative hearing, Trupo admitted that she was not
told she definitely would be laid off if she did not accept the
retirement package, and that she knew that Liberty had not
decided as to which employees would be laid off or which
employees would be transferred to other vacant positions
within the company.
Trupo testified that she would have preferred to continue to
work, but she feared if she was laid off she would become
medically uninsured. But if she had declined the early
retirement and continued her employment, she feared she
would be terminated because she had the least seniority in
her 14-employee department. After considering her options,
Trupo believed she had no choice but to accept the early
retirement and therefore should not be disqualified from
receiving unemployment compensation benefits.
In Massachusetts, courts have found that if a claimant
reasonably believes that he will be terminated if he does not
accept an early retirement plan, his leaving work will not be
viewed as voluntary (White v. Dir. of Division of Employment
Security). In this case the claimant with only six years
seniority elected to take an early retirement after he heard a
rumor of an impending layoff if the work force were not
reduced by early retirement.
In explaining his decision to accept an early retirement
proposal, White testified, "I could see that I would be laid off."
He took the incentive rather than accepting a layoff. The court
concluded that if the claimant believed this layoff was
imminent and if that belief was reasonable, a finding was
required that the claimant did not leave his employment
voluntarily.
A Standard of Unemployment Compensation
New Jersey statutes provide that a person is disqualified for
unemployment compensation benefits when he or she leaves
work "voluntarily without good cause." But the courts have
construed good cause to include "cause sufficient to justify an
employee's voluntarily leaving the ranks of the employed and
joining the ranks of the unemployed" and "when an individual
voluntarily leaves a job under the pressure of circumstances
which may reasonably be viewed as having compelled him to
do so.
Good cause for voluntarily terminating employment was found
in the case of a music therapist at Ancora State Psychiatric
Hospital who expressed fear of physical harm by hospital
patients, and in the case of a worker who had been
threatened with physical violence by a co-worker. They were
not disqualified from receiving unemployment compensation
benefits.
HEALTH INSURANCE
According to the Alliance for Aging Research, by 2010 the 65plus population will account for $1.9 trillion in healthcare
costs, about half of all such costs in the nation.
Over the past decade the average age of people who have
coronary bypass surgery has jumped from 55 to 61.
Thousands of patients in their 70s have undergone the
operation which usually costs about $25,000. When surgeons
began to master the art of transplanting hearts two decades
ago they limited the procedure to patients under 50. Now they
sometimes sew hearts into people in their 60s. A transplant
can cost over $200,000. As with coronary bypasses, Medicare
pays the bill for those over 65.
Medicare subsidizes dialysis for more than 100,000 people,
half of them over 60, at a cost of more than $2 billion a year.
Geriatrician Meghan Gerety, associate director of the
Veterans Affairs Department's Geriatric Research, Education
and Clinical Center, says that 10 million older people will
require care in the home by 2040. One reason why: the cost
of Alzheimer's disease to society now is about $100 billion a
year in medical care, nursing-home costs and paid care. And
that's not factoring in the loss of productivity of caregivers –
usually younger family members.
In the mid 1990s, physician and researcher Dr. David Espino,
director of the division of geriatrics in the family practice
department, the University of Texas Health Science Center at
San Antonio recognized the problem; and said, “The epidemic
that is coming in Alzheimer's is not even being discussed". He
estimated fourteen million people might have the disease by
the year 2040 and that number, it seems, may be a low
estimate.
The future has arrived and is available for viewing In Florida,
where 18 percent of the residents are over 65. That's what the
elderly population of the whole U.S. will amount to in 30 years;
it's 12 percent now. Those over 65 now consume about one
third of the federal budget, including Social Security. A third of
the multi-billon a year budget for Medicaid goes to those over
65, primarily to support them in nursing homes.
Daniel Callahan of the Hastings Center, a New York based
bioethical think tank argues there should be a generally
agreed on age (probably around 80) that would serve as an
automatic cutoff point for aggressive lifesaving medical
treatment. This is of course an extremely shocking and
controversial issue.
The Potential of Medical Rationing
In his book, Setting Limits: Medical Goals in an Aging Society,
Callahan makes a harsh case for medical rationing. While you
may object to this kind of scheme, we should all probably be
thinking about what the changing demographics mean to
health coverage and why people are even proposing this type
of thing. Some people believe the continuing rise in the United
States government outlay for healthcare makes some sort of
rationing inevitable, and that an age based cutoff to life
extending measures may be the first approach considered.
Medical and scientific research, Callahan argues, constantly
uncovers new and usually expensive technologies to prolong
life. Add to this the rapidly growing numbers of older people,
and you begin to see one reason the nation's medical outlays
could grow beyond society's ability to pay.
The specter of cost saving, health care rationing for the
elderly conjures up enormous ethical issues for society.
In the mid 1990s Medical ethicist Miguel Bedolla said:
"Rationing has always existed, except it is based on how
much money you have or if you have insurance… I'm afraid of
any rationing that puts a price on lives."
According to a report by the Families USA Foundation, older
Americans pay a startlingly higher portion of their incomes for
1
Health insurance is unusual in that it differs based on
providers as well as the coverage. So first we will discuss the
various types of insurers and health care plans that are
available.
Health Care Plans
The insurers of health care are not only the traditional stock
and mutual companies, and Blue Cross and Blue Shield, but
also the health maintenance organizations and preferred
provider organizations formed by hospitals and physicians to
deliver health care directly to enrollees in their plans.
The traditional broad health coverage provided by commercial
insurance plans provides little incentive for efficient, cost
effective health care delivery. One response from insurers and
providers has been to reorganize the health care delivery
system into a form of managed care. Managed care imposes
controls on the use of health care services, the providers of
health care services, and the amount charged for these
services, usually through health maintenance organizations or
preferred provider arrangements. All discussed below.
Commercial insurers are stock and mutual life insurers, and
sometimes, casualty companies. Commercial insurers have
traditionally provided coverage on a reimbursement basis but
have also begun to embrace alternative approaches.
Reimbursement plans pay benefits directly to the insured after
the insured has already paid the provider.
Commercial insurers offer both individual and group health
insurance products. These products include basic medical
expense coverage, major medical plans, comprehensive
medical plans, disability income policies and other types of
health products.
When considering representing health coverage from a
commercial carrier, you should not only consider the extent
and types of coverage available for the premium charged, but
also the insurer's financial health and ability to pay claims.
You can be sure the prospects will. There are a number of
rating companies which provide financial analysis of an
Insurer's credit-worthiness. The ratings are based on the
company's assets, surplus, premiums, revenue and
investment performance, and other relevant information.
Prepaid Plans
The 69 Blue Cross and Blue Shield plans nationwide provide
coverage to about 100 million people. When considered in
combination, they are the dominant health insurer of the
United States.
Blue Cross and Blue Shield are different from traditional
commercial insurers in several important areas. They provide
the majority of benefits on a service basis rather than on a
reimbursement basis. This means that the insurer pays the
provider directly for the medical treatment given, instead of
reimbursing the insured. Also, Blue Cross and Blue Shield
have contractual relationships with the hospitals and doctors.
As participating providers, the doctors and hospitals
contractually agree to accept specific pre-determined fees for
the medical services provided to subscribers.
Blue Cross is a hospital service plan and Blue Shield is a
physician’s service plan. Under the hospital plan the contract
is between Blue Cross and the hospital providing the hospital
care. Under the medical plan the contract is between Blue
Shield and the physicians providing the service.
Blue Cross and Blue Shield plans are called prepaid plans
because the plan subscribers pay a set fee, usually each
month, for medical services covered under the plan.
How Blue Cross Works
Blue Cross offers broad coverage and pays claims on a
service basis. The plan covers hospital daily room and board,
outpatient services for minor surgery or accidental injury,
medical emergencies, diagnostic testing, physical therapy,
kidney dialysis, chemotherapy; and, in some cases,
preadmission testing. Family plans may also include coverage
for dependent handicapped children. Maternity benefits may
also be made available the "same as for any other disability.”
Blue Cross also has a supplemental coverage for catastrophic
loss, which is similar to commercial major medical plans.
Blue Shield offers medical coverage to cover the physician
In the Trupo case, the issue raised was: "Does a 61-year old
woman, who is the head of her household and who holds a
position of office clerical assistant without seniority at her
place of employment and who fears an impending job layoff,
have any realistic option when offered an early retirement
incentive with full medical coverage other than to accept early
retirement?"
The court agreed that her choice was either to accept the
offered retirement proposal or continue her employment
experiencing a daily fear that she would be laid off. The court
also stated that the daily fear of a future employment layoff
having no relation to work performance and which would
cause the loss of all medical insurance, could engender as
great a fear in an employee, subjectively, as the fear
expressed by the employee described above.
The Ohio case Mason v. Board of Review, involved the claims
of ten former employees of TRW, which sold its corporate
business to a successor company. Employees aged 55 and
older were given the option of working for the successor or
taking early retirement and receiving a benefit package that
included payment of 75 percent of health insurance costs for
retirees and their dependents. Those who chose employment
with the successor corporation would be ineligible for the
former employer's health insurance benefits upon retirement.
The claimants in Mason chose early retirement in order to
preserve their health insurance and applied for unemployment
benefits because they were involuntarily unemployed. The
Board of Review disqualified the claimants. The decision was
affirmed by the trial court, but was reversed on appeal. The
Ohio Appeals Court concluded that "in no sense is a loss of a
health benefit package an insignificant factor for a person
aged 55 or older."
Making Informed Decisions
There is a growing movement in this country for more
involvement in and control over health care costs and how
health care dollars are spent. It is particularly important for
seniors to make informed decisions regarding their own health
care costs, coverages, and benefits.
A competent insurance agent can help determine how much
additional coverage, if any, is needed. Among the most critical
considerations are the kinds of health insurance the client has
in force, whether these policies are individual or group
policies, how long they are effective, and what the major
exclusions and limitations are.
Clients need to remember, group policies acquired through
their employment are "rented" insurance, with coverage
ending when they retire or employment otherwise ends. They
may not have options for converting this group coverage into
individual insurance, so it is important they check the group
contract language and find out for sure.
Determining what health insurance needs are is similar to
identifying your life insurance requirements. First, consider the
types of health insurance already in place. These might
include:

Workers compensation benefits for job-related
disabilities;

Social Security disability benefits;

Medicare;

work–related benefits through employer–sponsored
plans;

health coverage under any statutory plans.
In this section we will discuss the different types of health care
providers, types of health insurance available, common
benefits, policy provisions, exclusions, limitations, and
underwriting practices. We will also talk about government
health insurance, Medicare and Medicaid, Medicare
supplement insurance, and long-term care insurance.
Health insurance varies according to the methods of
underwriting, the injury or illness covered, the types of
insurers, the types and amounts of benefits and services
provided, and the types of losses covered. There are health
policies that cover losses from specific or limited causes, such
as accidents only or cancer only. And there are policies which
are much more comprehensive.
2
to make a co-payment when they get treatment. A copayment is a specific dollar amount, or percentage of the cost
of a service that must be paid by the HMO member in order to
receive a basic health care service. For example, a $10 copayment might be required for an office visit to a member's
physician, or a member might be required to pay a 30 percent
co-payment (30 percent of the cost of the services) for alcohol
and drug rehabilitation.
HMO Exclusions
Exclusions and limitations are used to either limit a benefit
provided or specifically exclude a type of coverage, benefit,
medical procedure etc. HMOs may not exclude and limit
benefits as readily as commercial insurers. This is because
the rationale of an HMO is to provide comprehensive health
care coverage. Some of the benefits an HMO may exclude
from coverage, and often do, include: eye examinations and
refractions for persons over age 17, eyeglasses or contact
lenses resulting from an eye examination, dental services,
prescription drugs (other than those administered in a
hospital), long-term physical therapy (over 90 days) and outof-area benefits (other than emergency services).
HMOs must provide evidence of coverage to members within
60 days of their enrollment. In it, the member's coverage and
benefits (including required co-payments), benefit limits,
exclusions and conversion privileges are specified. The
evidence of coverage will also include the name, address and
telephone number of the HMO, the effective date and term of
coverage, a list of providers and a description of the service
area, terms and conditions for termination, a complaint
system, a 31-day grace period for premium payment
provision, a coordination of benefits provision, incontestability
clause, and a provision on eligibility requirements for
membership in the HMO. Other provisions may also be found
in the evidence of coverage, but those outlined above must be
included.
HMOs, like traditional commercial insurers, are not allowed to
engage in certain types of business practices, policies, etc.
Specifically, HMOs are prohibited from excluding a member's
preexisting conditions from coverage, from unfairly
discriminating against a member based on age, sex, health
status, race, color, creed, national origin, or marital status.
HMOs are also prohibited from terminating a member's
coverage for reasons other than: nonpayment of premiums or
co-payments, fraud or deception in the member's use of
services, a violation of the terms of the contract, failure to
meet or continue to meet eligibility requirements prescribed by
the HMO or a termination of the group contract under which
the member was covered.
Preferred Provider Organizations (PPOs)
Preferred Provider Organizations developed as a compromise
between the benefits of an HMO and a traditional
reimbursement insurance plan offered by commercial
insurers. A PPO is made up of various hospitals and private
physicians in an area who agree to provide services to the
insurer's clients at a predetermined price. In return, the insurer
designates these doctors and hospitals as preferred
providers.
If the insured seeks treatment from a preferred provider the
coverage for the services rendered is 100 percent minus a
nominal co-payment for each office visit or hospital stay. If the
insured elects to receive treatment from a non-preferred
provider then the reimbursement benefits will be reduced to
the usual 80 percent. This type of plan allows a choice
between cost savings and freedom of choice in selecting a
health care professional.
Other Managed Care Plans
Exclusive provider organizations (EPOs) are a type of PPO in
which individual members use particular preferred providers,
instead of having a choice of a variety of preferred providers.
Providers are not paid a salary, but are paid on a fee-forservice basis.
EPOs are characterized by a primary physician who monitors
care and makes referrals to a network of providers (this is
known as the gatekeeper concept), strong utilization
management, experience rating, and simplified claims
expenses incurred by plan subscribers. Again, through the
contractual arrangement with the providers, Blue Shield will
normally pay the participating physician a pre-determined
amount for the specific service provided. Usually this amount
will be based on a usual, customary and reasonable (UCR)
basis depending on the charges made by other physicians in
the same geographical area for the same or similar medical
procedure.
Jointly operated (consolidated) Blue Cross/Blue Shield plans
are often so comprehensive that supplementing them with
major medical coverage is not necessary. Plan provisions
applying to consolidated Blue Cross/Blue Shield plans are
similar to plan provisions applying to comprehensive major
medical plans.
Health Maintenance Organizations (HMOs)
Health maintenance organizations (HMOs) provide prepaid
doctor and hospital care. Their growth has been encouraged
by rising health care costs and federal legislation. HMOs are
sometimes owned and controlled by commercial insurers,
however, many are independently owned.
The majority of HMOs are organized as for-profit corporations
although they may also be nonprofit. HMOs must operate
within a specified geographical area known as the service
area. The service area must be approved by the state
Department of Insurance and all members of the HMO must
reside in the prescribed service area. The service area is
usually a city, or part of a city, and occasionally, an entire
state. HMOs may be state qualified (able to provide services
within a single state or states) and/or federally qualified (able
to provide services in specified areas throughout the nation for
national contracts like the United Auto Workers, Teamsters, or
government employees). If an HMO is federally qualified, it
must also be state qualified in the states where it serves
members obtained through a national contract.
The HMO Act of 1973 required that employers with at least 25
employees, who are paying at least minimum wage, and who
offer a health plan to their employees to offer coverage by a
federally qualified HMO as an alternative to an indemnity plan.
HMO benefits are not limited to treatment resulting from
illness or injury, but include preventive health care measures
like routine physical examinations. HMO members pay a set
fee, usually on a monthly basis, which entitles them to all
necessary health care.
Health maintenance organizations are required to provide a
wide range of health care services. These required services
are referred to as basic health care services. Any services or
benefits provided by the HMO to members in excess of the
basic health care services are referred to as supplemental
health care services. A basic menu of health care services
must be provided:

inpatient hospital and physician services for at least
90 days per calendar year for treatment of illness or
injury (If inpatient treatment is for mental, emotional
or nervous disorders including alcohol and drug
rehabilitation and treatment services may be limited
to 30 days per calendar year. Treatment for alcohol
and drug rehabilitation may be restricted to a 90-day
lifetime limit.);

outpatient medical services when prescribed or
supervised by a physician and rendered in a nonhospital based health care facility (i.e. physician's
office, member's home, etc.), including diagnostic
services, treatment services, short term physical
therapy and rehabilitation services, laboratory and Xray services and outpatient surgery;

preventive health services, including well child care
from birth, eye and ear examinations for children
under age 18 and periodic health evaluations and
immunizations;

in-area and out-of-area emergency services,
including medically necessary ambulance services,
available on an inpatient or an outpatient basis 24
hours per day, seven days per week.
Many HMOs and other managed-care plans require members
3
union or trust, etc. The individuals covered under the group
policy are issued certificates of insurance. The certificate lists
what the policy covers, and explains such things as how to file
a claim, the term of insurance and the rights to convert from
group coverage to an individual policy. Many of the group
health insurance contracts features are similar to the contract
features of group life insurance.
The Age Discrimination in Employment Act provides that
employers with 20 or more employees that provide medical
coverage to employees must provide the same coverage to
older employees (and their spouses) as younger employees.
There is no upper age limit on this protection. When
employees become entitled to Medicare benefits, the
employer must allow them to choose which coverage will be
primary: their group health coverage or Medicare. Also, an
employer may not in any way encourage employees to make
Medicare their primary coverage, such as offering to pay for
Part B coverage on your behalf, or by offering to pay for a
Medicare supplement policy.
In the 1992 decision James Maxa v. John Alden Life
Insurance Co., the U.S. Court of Appeals for the eighth circuit
considered a denial of group coverage for an insured that was
eligible for Medicare. (As a note, the Age Discrimination in
Employment Act did not apply here because the employer had
fewer than 20 employees.)
In July 1984, at the request of Neil Maxa, president of H.R.
Peterson Co., John Alden Life Insurance Company ("John
Alden") instituted a group health benefit plan. Maxa, then 62
years old, was accepted by John Alden for group health
insurance coverage as an employee of Peterson and received
a certificate of group insurance and a brochure, each of which
outlined in some detail Maxa's rights and responsibilities
under the group plan. When Maxa turned 65, his insurance
premium was reduced from $210 to $134. At that time, Maxa
did not apply for Medicare benefits.
The Boss Didn't Enroll in Medicare
In early 1989, while still employed by Peterson, Maxa
underwent a lengthy hospitalization and then died in June.
John Alden paid only some of the hospital bills, claiming that
Maxa should have enrolled in Medicare and that John Alden
was not liable under the terms of the plan for the bills which
Medicare would have covered if Maxa had enrolled for
Medicare.
Maxa's son, James, as personal representative of his father's
estate, sued John Alden in September, 1990, alleging that the
summary plan description was faulty, that John Alden
breached its fiduciary duty by failing to notify Maxa upon his
65th birthday that his plan benefits would be reduced by the
amount of the Medicare coverage he would receive if he were
to apply for Medicare, and that the reduction of plan benefits
was unlawful.
The district court wasn't persuaded, concluding that although
the summary plan description may not have met the
requirements of ERISA, there was not enough evidence that
Maxa relied to his detriment upon that description.
The estate appealed, maintaining that none of the three sets
of documents which Maxa received from John Alden could be
considered a summary plan description. However, even
though none of the documents was entitled "summary plan
description," at least one, the certificate of group insurance,
provided a benefits summary.
The estate also contended that the certificate of group
insurance failed to meet the requirements of federal law,
because its description of the Coordination of Benefits (COB)
provision was ambiguous. The COB provision read: "We will
coordinate your Medical and Dental Benefits (if applicable)
with benefits payable under other plans. The other plans are
those which provide benefits or services in connection with
medical or dental care or treatment through Medicare (Parts A
& B) when you are eligible for Medicare coverage. For
purposes of determining your Medicare benefits, you will be
deemed to have enrolled for all coverages for which you are
eligible under Medicare (Parts A and B), whether or not you
actually enroll.”
The court found that while the COB provision wasn't crystal
processing. EPOs can serve as an alternative to or
companion to HMOs and PPOs.
With a self-funded plan an employer, not an insurance
company, provides the funds to make claim payments for
company employees and their dependents. In the event that
claims are higher than predicted, a self-funded health
insurance plan can be backed-up by a "stop-loss" contract,
which limits the employer's total liability to a specified amount
in the event claim payments go too high. The back-up insurer
then pays all claims once the specified amount is reached.
If an employer self-funds its health insurance plans,
employees may be more at risk than they think. The main
disadvantages of self-insurance are:

actual losses may be higher than predicted, causing
the employer to experience financial difficulty or
discontinue the plan;

contracts are usually not regulated by the state
Insurance
Department;
and
therefore,
the
Department cannot assist consumers with problems;

contracts are not subject to mandated benefit laws
and can be modified by the employer more easily.
Small employers (usually defined as those with fewer than 20
to 25 employees) have been especially hard hit by increases
in health care insurance premiums. Because many group
plans are "experience rated", small employers see an
immediate premium increase whenever claims are high. If the
average age of the participants is particularly high, or if claims
experience is high, or if there has been even one long or
catastrophic illness in a small employer plan, it can have a
devastating effect, making health insurance unaffordable for
the whole group. Recent surveys by the Health Insurance
Association of America (HIAA) indicate a substantial decline in
the number of small firms that are able to offer health
coverage to their employees.
Group vs. Individual Health Insurance
Although group and individual health insurance policies share
many of the same policy provisions, there are a few significant
differences.
There are usually fewer limitations for group coverage. Group
members may not have to prove insurability. For an individual
policy, the contract is between the insurer and the covered
individual. For a group policy, the contract is between the
insurer and the employer, union, trust or other sponsoring
organization. This gives each individual member much less
input when changes are made to the policy, or when coverage
is moved to a different carrier.
While group policies may have fewer limitations, they do have
one important drawback. If an insured changes jobs or retires,
they probably will lose coverage under the group policy.
Individual health insurance contracts continue regardless of
changes of employment.
The federal law COBRA (Consolidated Omnibus Budget
Reconciliation Act) provides for continuation of group
coverage for employees whose coverage ends because of a
“qualifying event." When retiring from a company with 20 or
more employees that provides medical coverage, the
employee will have the right to continue coverage for 18
months, but will be responsible for paying premiums.
It is important employees clearly understand in advance how
coverage may change after retirement. If the employer offers
retiree coverage, it is required to offer COBRA coverage, as
well. Retirees will be asked to elect one and reject the other.
Most times it is a better idea to reject the COBRA coverage
and take a retiree plan or group conversion privilege. The
COBRA coverage will continue only for 18 months (or 36
months, with a surviving spouse extension). A conversion plan
is generally designed to last until age 65. Retiree coverage,
even if it is less comprehensive, is generally designed to
continue indefinitely. However, most employers preserve the
right to unilaterally make changes to the group health
insurance plan, and it is possible that coverage could end.
Master Policies
The group insurance policy is called a master policy and is
issued to the policy owner, usually the employer, association,
4
for the daily hospital room and board benefit; although, the
trend is toward coverage of not more than the semi-private
room rate unless a private room is medically necessary.
Room and board (R&B) rates will vary by geographical
location but it is not unusual to find R&B rates starting from
$500 per day or more. The hospital expense part of a basic
medical expense policy accordingly would provide an R&B
daily rate of a specified amount which may or may not be
equal to the actual R&B expenses incurred.
For example, if the R&B benefit was $400 per day and the
hospital actually charged $500 per day, one is liable for the
$100 per day not covered by the policy.
In addition, there are normally time limitations associated with
a basic medical expense policy. For example, benefits may be
provided for only 30, 60, or 90 days, after which no further
benefits would be provided unless one was subsequently
hospitalized at a later date with a different ailment.
If confined to an intensive care unit of a hospital, then the
R&B benefits will be increased. Normally, benefits for
intensive care are at least twice the regular R&B benefit.
The miscellaneous hospital expense part of the basic
hospitalization policy includes benefits for such things as
surgical dressings, in-hospital drugs, charges for operating
rooms, anesthetics, lab work, in-hospital diagnostic tests, etc.
Except for the R&B charges and surgery, most other hospital
expenses could be identified as miscellaneous expenses or
hospital extras.
Usually miscellaneous benefits are limited to specific dollar
amount ($2,000, $3,000, $5,000, etc). Most often the benefit
is limited to a multiple of the plan's daily R&B benefit. For
example, if the basic medical expense policy provides for a
daily R&B benefit of $500, the miscellaneous benefit might be
expressed as an amount equal to ten or 20 times the R&B
benefit or $5,000 or $10,000. Again, it should be noted that
this is a limitation of the basic hospitalization plan in that only
a specified amount may be paid for miscellaneous hospital
expenses.
Generally, in-hospital miscellaneous expenses are very high.
Depending on the reason for admittance to the hospital, one
could exhaust a modest miscellaneous benefit of $5,000 in a
matter of a couple of days.
Surgical Expense
Surgical expense coverage provides benefits for the surgical
services of a physician performed in or out of the hospital.
Surgical expense benefits are usually limited to a dollar
amount, although they maybe expressed as multiples of the
hospital benefit maximum. Usually a schedule of operations is
attached to the policy and the maximum amount payable for
each operation is listed. The more serious and complicated
the surgery the higher the benefit. Operations that are not
listed on the schedule are covered and the limit that applies to
them is determined by the insurer on a basis consistent with
comparably listed operations.
Some surgical schedules do not list dollar amounts but assign
a relative value unit to each procedure. For example, a
schedule may be identified as a $1,000 schedule which
basically means that the maximum benefit for a surgical
procedure will be $1,000. Naturally, this maximum amount of
$1,000 would be paid for the most serious types of surgery
such as open heart surgery. All other surgical procedures
would have a relative value in relation to this $1,000 schedule.
This relative value would be expressed by a number and then
multiplied by a conversion factor to arrive at the benefit to be
paid.
To illustrate this point, let's assume that Stephanie is about to
have her gall bladder removed. Her basic hospitalization
policy has a $1,000 surgical schedule and gall bladder
surgery has a relative value of 40. The schedule's conversion
factor (which remains constant) is 20. Multiplying 40 by 20,
results in a benefit of $800 for the gall bladder surgery.
Other Medical Expense
Hospital R&B, miscellaneous and surgical expenses incurred
as an inpatient represent the major benefits provided by a
basic plan. Thus, if you were hospitalized due to a sickness or
clear, it could reasonably be read to imply that benefit
coverage would be reduced by the amount of Medicare
coverage for which one is eligible. On the other hand, the
court doubted that the summary plan description met the
requirements of ERISA.
A Lack of Significant Reliance
Nevertheless, that was not enough to provide coverage. While
Maxa's estate certainly appeared to have suffered a loss
because he failed to enroll in Medicare, the estate would have
to prove that the plan description caused him not to apply for
Medicare. And the estate did not provide any direct evidence
that Maxa failed to enroll in Medicare because of the language
of the plan summary.
Even though the language of the group certificate did not state
that applying for Medicare was absolutely necessary to assure
total coverage, a reasonable person would conclude that he
or she might have to enroll in Medicare in order to avoid a
reduction of overall benefits, and, at the very least, there was
no suggestion that there was no need to apply for Medicare.
Moreover, the reduction of Maxa's premiums from $210 to
$134 undercut the estate's argument because it should have
brought to his attention the possibility that his benefits had
been reduced.
With regard to the argument that John Alden breached its
fiduciary duty by failing to notify Maxa on his sixty fifth birthday
that his benefits would be reduced and that he needed to
enroll in Medicare in order to have full medical coverage, it
was observed that most courts have not imposed upon an
ERISA plan fiduciary any additional duty to notify participants
and/or beneficiaries of the specific impact of the general terms
of the plan upon them, beyond providing the summary plan
description. So the district court found in favor of John Alden.
Types of Groups
Group policies usually are issued to employers, where
insurance is secured for the benefit of the employees. The
employer is the policy owner and establishes the eligible class
of employees to be covered under the group policy. Usually
this includes all full-time employees, but the eligible class of
employees may also include retired employees (this is
becoming less and less common).
Group policies may be issued to other groups such as labor
unions or fraternal benefit societies. The usual requirements
are that the group must have a constitution and bylaws, and
be organized and maintained in good faith for purposes other
than obtaining insurance.
Medical Expense Insurance
Medical expense insurance, commonly referred to as
hospitalization insurance, provides benefits for expenses
incurred due to in-hospital medical treatment and surgery as
well as certain outpatient expenses such as doctor's visits, lab
tests and diagnostic services. Hospitalization insurance may
be issued as an individual or group policy. Benefits provided
cover the individual and eligible dependents.
Contracts may provide for payment of medical expenses
incurred on a reimbursement basis (by paying benefits to the
policy owner), on a service basis (by paying those who
provide the services directly), or a contract may provide for
payment of an indemnity (by paying a set amount regardless
of the amount charged for medical expenses).
Although there are many types of benefits available, medical
expense insurance can generally be categorized as basic
medical expense insurance, major medical Insurance,
comprehensive medical insurance, and special policies.
Basic Medical Expense
Basic coverages provided by an individual medical expense
policy Include hospital expense, surgical expense and medical
expense. These three basic coverages may be sold together
or separately. Frequently this is written as "first dollar"
coverage, which means it does not have a deductible.
Hospital Expense
Hospital expense coverage provides benefits for daily hospital
room and board and miscellaneous hospital expenses (not
including telephone and television) while confined to the
hospital. The policy may provide for a certain dollar amount
5
plan. Major medical is characterized by deductibles,
coinsurance and large benefit maximums.
Deductibles
Major medical benefits begin to be paid after the deductible is
satisfied. The policy's deductible is usually between $100 and
$500; although higher deductibles are not that uncommon.
The deductible is considered satisfied as long as one can
show evidence of having incurred the necessary expense.
For example, let's assume that a major medical policy
contains a $500 deductible. The insured has no other medical
expenses and is hospitalized for surgery. The total hospital bill
is $7,500. Of this amount, $7,000 would be eligible for major
medical benefits and $500 would be identified as the
deductible amount. Thus, the insured has incurred an
expense equal to the deductible. Notice that payment of the
deductible is not necessary; only incurring the expense is
required to satisfy the deductible.
The deductible may be identified as a per-cause deductible or
a calendar year deductible. Each of these applies to each
covered person. The per cause deductible requires that a
deductible be satisfied for each separate claim. The calendar
year (all cause) deductible specifies that one deductible needs
to be satisfied for a calendar year period regardless of the
number of claims.
Most policies provide that if a family is insured, a maximum of
two or three deductibles will satisfy the deductible requirement
for the entire family for a year.
Also related to the family situation is the common accident
provision which states that if members of a family are injured
in a common accident, only one deductible applies.
Most major medical policies will contain a carry over provision.
This provision usually stipulates that if the insured has no
claims during the year but incurs medical expenses in the last
three months of the year, these late year expenses may be
carried over to a new calendar year and applied to the new
year's deductible.
Coinsurance (Percentage Participation)
Most policies have a coinsurance provision. Under its terms,
all expenses in excess of the deductible are shared on some
basis between the insurance company and the insured. In a
great many policies expenses are shared on an 80/20 basis.
The insurer pays 80 percent, the insured pays 20 percent.
Other coinsurance percentages encountered are 75/25 and
85/15.
Out of Pocket Limit
The out-of-pocket limit is the maximum amount the insured
will be required to pay during a policy year. After having paid
out a pre-determined amount, the insurer will pay 100 percent
of covered expenses for the remainder of the year, up to the
policy limit.
A major medical policy may reflect a $500 deductible followed
by 80/20 coinsurance on the first $5,000 of covered expenses.
If expenses exceed $5,000, the insurer pays 100 percent,
because the out-of-pocket limit will have been reached.
Basically, this means that the insured would be expected to
incur the $500 deductible and 20 percent of $5,000 of medical
expenses or an additional $1,000. Thus, the insured would be
liable for a maximum expense of $1,500, regardless of how
large the claim might be.
If a major medical claim was exactly $5,500, the insured
would be liable for $1,500 or approximately 27 percent of the
entire amount. On the other hand, if the claim totaled
$105,500, the insured would still be responsible for the same
$1,500 which represents only a little more than 1 percent of
the entire claim.
Frequently, this out of pocket limit is also referred to as the
stop loss, which is the point at which the insureds’ losses
(coinsuring the claim) stops and the insurer assumes
responsibility for 100 percent of the claim. Thus, in the
previous example, the stop loss limit is $1,500.
Maximum Benefit
Major medical plans include a maximum benefit which applies
on a "lifetime" basis, "per person.” The maximum benefit is
usually substantial, such as $500,000 or $1 million. Each
an accident, daily R&B charges, miscellaneous hospital
expenses and surgical charges would be paid in accordance
with the policy and its limitations.
Other medical expense benefits maybe included as part of the
policy or as options added to the policy. Following is a
description of some of the more common policy benefits or
options.
In-Hospital Physician Visits
Frequently, a basic hospitalization policy will include a daily
benefit for expenses incurred when a physician visits the
insured in the hospital. This benefit is limited to a dollar
amount such as $50 per day. This amount would be paid for
any charges made by the doctor for visiting the patient.
Emergency Accident Benefits
A basic plan may include a specific benefit for expenses
incurred due to an accident when the insured is taken to the
emergency room of a hospital as an outpatient. Typically, this
benefit Is stated as $300 to possibly $500 or $1,000. The
benefit is to cover the cost of treatment in the emergency
room including physician expenses, X-rays, stitches, etc.
Maternity Benefits
Most often, maternity benefits are optional benefits which may
be elected by the insured or the group. As a benefit, maternity
coverage is very expensive and to keep the cost of this benefit
reasonable, the benefit amount is frequently very limited. For
example, for an additional premium, you may add a maternity
benefit of a specific dollar amount. This amount is the total
benefit paid for prenatal care, delivery of the baby and the
hospital confinement for mother and child due to the delivery.
Mental and Nervous Disorders
This benefit is usually part of the policy and covers expenses
for outpatient mental and nervous disorders. Normally, this
would include out-of-the-hospital therapy provided by a
psychiatrist or clinical psychologist. The benefit is usually
limited to a specific dollar amount per visit. There may also be
a lifetime maximum.
Hospice Care
Most states require that any hospitalization policy (individual
or group) include benefits for hospice expenses. The hospice
is a facility designed to control pain and suffering of terminally
ill patients until their death. It does not treat diseases nor does
it attempt to cure. In addition, the hospice also provides
counseling for the patient and the family of the terminally ill.
Expenses covered include R&B, medication, as well as out
patient services and expenses.
Home Health Care
This is usually an optional benefit which provides for
reimbursement of expenses incurred for the services of a
visiting nurse, a therapist or some other support-type person
who due to a medical necessity, visits the insured in their
home and provides necessary medical services.
Outpatient Care
Outpatient care refers to expenses incurred by you for
doctor's office visits, and out-of-the-hospital diagnostic
services such as lab work, and X-rays. Often a basic medical
expense policy only covers in-hospital expenses (inpatient)
whereby treatment is provided to the patient who has been
assigned a room and a bed and is staying in the hospital for
some period of time. Basic plans may add coverage for
certain medical services provided to an outpatient.
In summary, it is clear that basic medical expense plans have
time and/or benefit amount limitations. Thus, insureds may
well expect to have to pay a considerable amount out-ofpocket for medical expenses. The solution to this problem is
another type of hospitalization coverage referred to as major
medical insurance.
Major Medical Insurance
Unlike basic medical expense policies with benefit amount
limitations, major medical coverage is designed to provide a
large sum of money from which to pay covered medical
expenses. Sometimes, major medical insurance is referred to
as catastrophic health insurance because its focus is on large,
catastrophic medical expenses. Major medical policies may
be issued as individual coverage or as a group hospitalization
6
plan or a major medical plan with a$100 deductible and 80/20
coinsurance on the first $2,500 of covered medical expenses.
Comprehensive Medical Expense
Comprehensive medical expense insurance is a combination
of basic medical expense coverage (first dollar coverage) plus
a major medical plan. Both major plans are simply combined
into one policy. The basic part of the plan provides first dollar
coverage, usually without any deductibles or coinsurance
features. Once the basic benefits are exhausted, the major
medical portion of the plan kicks in subject to a corridor
deductible and coinsurance provisions.
For example, assume that Keith has a comprehensive
medical policy which provides 100 percent coverage of the
first $10,000 of medical expenses followed by a deductible of
$100 and a $1 million major medical plan with 80/20
coinsurance on the next $5,000 of medical expenses with 100
percent paid thereafter. Keith incurs medical expenses
totaling $11,100. His plan would pay as follows:
Keith's plan would cover $10,800 of the total expenses. It
pays the first $10,000. Keith then pays the $100 deductible.
The plan then pays 80 percent of the $1,000 balance and
Keith pays 20 percent, or $200. Thus, Keith pays a total of
$300.
Comprehensive plans will pay considerably more benefits in a
typical situation than a basic hospitalization policy and slightly
more benefits than a major medical plan. However, the
inclusion of the block of first dollar benefits under the basic
part of the comprehensive plan is expensive. This premium
difference is often large enough to motivate many people to
simply purchase a major medical plan with a reasonable
deductible and a more reasonable premium.
Medical Expense Limitations
Medical expense policies frequently provide limited coverage
or benefits for certain medical conditions, as outlined below.

Mental or Emotional Disorders. Lifetime benefit
amounts are limited for outpatient treatment of these
disorders. For example, a major medical policy may
have a lifetime maximum of $1 million; but, the policy
may limit coverage for outpatient treatment of mental
or emotional disorders to a lifetime benefit of
$25,000. In addition, frequently there may be a
limitation with regard to the number of outpatient
psychiatric visits per calendar year (such as a
minimum of 26 visits per year) and/or the benefit
amount paid per visit (such as a maximum benefit of
$50 per visit or coverage for no more than 50 percent
of the actual charges). These limits would not apply
to inpatient treatment of mental or emotional
disorders.

Substance Abuse. Outpatient treatment for drug or
alcohol problems is usually limited in much the same
way that nervous or emotional disorders are covered.
Usually, if the insured is hospitalized as an inpatient
for treatment of the substance abuse problem, then
regular medical expense benefits would be payable.

Chiropractic Services. The treatment rendered by a
chiropractor is normally a covered expense subject
to a limitation with regard to total benefits (i.e.
$10,000 lifetime) or a limitation with regard to the
number of visits that will be covered in a given year
and/or the amount that may be paid per visit.

Pre-existing Conditions. Generally, a pre-existing
condition is any condition for which treatment or
advice is sought prior to the effective date of
coverage. Many policies contain a pre-existing
conditions limitation which excludes coverage for
unspecified conditions for a period of time (usually
six months). If an insurer wants to permanently
exclude a pre-existing condition, it usually has to
specify the condition by name in the issued policy.
Depending on the severity of the condition, it may be
permanently excluded or temporarily excluded (i.e.,
the first 12 months following the effective date of
coverage). Seldom is a pre-existing condition
member of an insured family is separately insured for the
maximum benefit amount.
Restoration of Benefits
Most major medical policies have a restoration of benefits
provision. If a claim is paid, the total amount of insurance is
reduced by the amount of the claim. A policy with a $250,000
limit and a $10,000 claim, would only have $240, 000 of
coverage after that claim had been paid. The restoration of
benefits feature restores a certain amount of coverage, such
as $2,500 or $3,000 each year to replace, in effect, the
coverage lost as a result of the claim.
Covered Medical Expenses
The coverage provisions of major medical policies are very
broad. One way of looking at a major medical policy is to
consider that the insurer has opened a bank account in the
insured’s name and almost all medical expenses pass through
this account. The term, "covered expenses", usually includes
doctors' fees, nursing fees, hospital R&B charges,
miscellaneous expenses, surgical expenses, out of the
hospital expenses such as doctor's office calls, prescription
medication, diagnostic services, etc. These expenses are
covered in accordance with the policy's deductible and
coinsurance provisions up to the policy's maximum benefit.
Limits of Coverage
The limits of coverage are also established by the concept of
reasonable and customary charges (also referred to as usual,
customary and reasonable (UCR). These charge or expense
factors represent the average charge in a given geographical
area for the medical service provided. These factors are
adjusted periodically to reflect changes. A major medical
policy might specify that it will pay the reasonable and
customary charges for various covered medical expenses up
to the policy's lifetime maximum of $1 million.
This does not imply that the policy will pay all medical
expenses. It states it will pay what is reasonable and
customary, and there may be inside limits; limits which apply
to particular types of expense such as hospital room and
board and surgery. The inside limit may be expressed as a
maximum dollar amount. Inside limit amounts are higher than
the amounts allowed under basic medical expense policies.
For example, David has his tonsils removed. The surgeon's
fee is $750. However, upon review by the insurer, it is
determined that the reasonable and customary charge for a
tonsillectomy is $550. Thus the covered expense is $550
subject to the policy's deductible and coinsurance provisions.
If the policy also had an inside limit of $500 for a
tonsillectomy, that would be the most it would pay.
Supplemental Major Medical
In the past, major medical policies were frequently sold as
supplemental coverage. The insured person had a basic
medical expense plan which paid specific dollar amounts for
various medical services. These amounts were often referred
to as "first dollar" benefits because there were no deductibles
or coinsurance features and the basic plan covered expenses
up to these first dollar limits.
However, as medical expenses soared, the basic medical
expense plan quickly exhausted Its benefit limits and the
insured was in need of additional coverage. These additional
benefits were often provided by a major medical policy which
was initially designed to supplement the basic plan so that
when basic benefits were reduced or used up, the
supplemental benefits would pick up where the basic plan left
off.
Today, due to the high cost of health care and the high cost of
hospitalization insurance, most employers and individuals will
carry major medical plans as their main source of health care
insurance. Because of the deductibles, coinsurance features
and lack of first dollar benefits, major medical plans are
typically less expensive. The higher the plan's deductible, the
lower the premium. The higher the stop-loss point with regard
to coinsurance, the lower the premium.
For example, a major medical plan with a $500 all cause
deductible and 70/30 coinsurance on the first $10,000 of
covered medical expenses will be less costly than a first dollar
7
must only be performed for life-threatening situations. Some
of the more commonly covered transplants include bone
marrow and kidney.
Dental Expense
Dental insurance usually is offered only under group plans. It
is most often excluded from medical expense insurance.
Under group insurance it is usually offered as optional
coverage.
Expenses Covered
Dental insurance may be covered under the benefits of a
major medical plan on a scheduled or nonscheduled basis, in
which case the dental coverage and medical coverage would
be an integrated plan. The deductible amount can be met by
either dental or medical expenses.
Dental expenses offered as an optional benefit (nonintegrated
plan) may also be either scheduled or non-scheduled. A nonscheduled plan is paid on a usual, customary and reasonable
basis (UCR). A scheduled plan has specific categories of
dental treatment and dollar amounts are set for each category
of dental care. The scheduled plan reimburses dental charges
only up to the maximum amount specified on the schedule as
to each covered service. A schedule would list the following
categories:

preventive care, diagnostic care,

restoration (which includes fillings, inlays, and
crowns),

prosthodontics (which concerns bridgework),

oral surgery,

periodontics (treatment of gum problems),

endodontics (treatment of problems with dental pulp,
or root canals),

orthodontics.
The scheduled maximum amounts differ from one part of the
country to another. This difference in the amount of benefit
payable on a particular procedure is based on the difference
in dental costs throughout the nation. Dental costs in New
York City, New York would be higher than dental costs in Des
Moines, Iowa. There are many reasons for this, including
higher office rents in New York than in Iowa.
Limits
Limitations usually apply to prophylaxis (preventive care), no
more than two, and only one fluoride treatment during any 12month period. A bridge or denture will not be replaced within
the first five years, except under special conditions. A kind of
preexisting condition for dental coverage is the fact that teeth
missing prior to the effective date of coverage will not be
covered, or, if covered, the co-payment will increase.
Coinsurance and Deductible Provisions
Most dental plans have a deductible amount (e.g., $25, $50,
$100) which must be met each calendar year. If the plan also
covers the cost of preventive care, the deductible often does
not apply to treatment for prevention (e.g., cleaning and
routine examinations).
Most dental plans, as with most medical plans, have a
coinsurance feature. That is, the insured pays some
percentage of the dentist's charge and the plan pays a
percentage.
The plan will generally pay a maximum amount per calendar
year (e.g., $500, $1,000, $5 000).
Dental services which are for cosmetic purposes, or are not
considered to be standard procedure are usually not covered,
except in rare instances, as when such benefits are offered to
key employees or company executives.
Prepaid Dental Plans
Prepaid dental plans operate in much the same way as health
maintenance organizations. Subscribers must have the right
to select any participating dentist as a provider. The dentists
are paid (other than the co-payment or deductible) by the
prepaid dental plan. Provider contracts are subject to state
laws designed to protect enrollees from becoming liable for
services the prepaid dental plan fails to pay because of
insolvency.
All enrollees must receive an evidence of coverage describing
covered by means of limited benefit amounts.
Generally, it is either excluded or covered in full as
any other condition.
Other Limitations
In past years, many health insurance contracts placed
limitations on the kind of provider who could perform covered
treatments and services. In many cases, coverage was limited
to treatment rendered by a "physician." In effect, this
eliminated coverage for treatments rendered by chiropractors,
midwives, and other nontraditional healers.
In recent years, many alternative providers who are subject to
state licensing or standards of conduct have been recognized
as qualified health care providers. Use of alternative providers
can help to minimize health care costs and reduce the
demand on hospitals and doctors. Under current laws, in
many states, policies must provide benefits for services given
by various providers if benefits would be payable for the same
services when given by a physician. These include:
chiropractors,
optometrists,
opticians,
psychologists,
podiatrists, clinical social workers, dentists, physical
therapists, and professional counselors.
Medical Expense Exclusions
Medical expense policies contain many exclusions that are
found in all health and disability policies: pre-existing
conditions, war, intentionally self-inflicted injuries, and active
military duty. Exclusions which are common in medical
expense policies include: workers compensation, government
plans (care in government facilities), well-baby care, cosmetic
surgery, dental care, eyeglasses, hearing aids, routine
physicals and medical care.
Optional Features & Benefits
Prescription Drugs
The prescription drug benefit is most often found in group
health insurance policies. Some individual health insurance
policies offer this benefit as a rider. Usually prescription drug
coverage requires a small deductible of typically $2, $3 or $5.
A prescription drug benefit generally works one of two ways.
Either insureds can be reimbursed for their prescription drug
expenses using standard claim forms, or a prescription drug
card can be issued. A prescription drug card allows
prescriptions to be paid for by paying only the deductible with
each prescription purchase. The pharmacy bills the insurer
issuing the card directly for the prescription.
For example, Sally has a prescription drug card as part of her
group medical plan which has a $5 deductible per
prescription. Her doctor prescribes two medications for a
serious cold. Each of these medications would cost Sally $5.
The balance of the prescription cost will be billed to the
insurer by the pharmacy.
Vision Care
Vision care includes eye examinations (refractions) and
eyeglasses. Although not a very common benefit, it
occasionally is offered as an optional benefit under group
health insurance. Generally, this option will pay a specific
amount or the entire cost of an annual eye examination. It
normally also covers all or part of the cost of prescribed
eyeglasses once in every two-year period.
Hospital Indemnity Rider
A hospital indemnity benefit provides for the payment of a
daily benefit for each day that you are hospitalized as an
inpatient. Available amounts are usually $50 to $100 per day
or possibly slightly higher. In addition to any other medical
benefits paid to the insured, the hospital indemnity benefit will
pay the daily amount as long as the insured is hospitalized,
usually for a benefit period of one or two years.
Nursing/Convalescent Home
Under this benefit, a daily maximum amount is paid for each
day the insured is confined to a nursing or convalescent home
after a hospital stay. Benefits are paid generally for as short
as one month or up to one year.
Organ Transplants
More and more insurers are offering this coverage as it
becomes less experimental and more commonplace. To
provide coverage, many insurers require that a transplant
8
not send notice of approval or disapproval within 45 days of
the date the insured applied for reinstatement, the policy will
be automatically reinstated after the forty-fifth day. A
reinstated policy covers accidents immediately. However,
there is a ten day probationary (waiting) period for coverage of
any sickness under a reinstated policy. This means that any
sickness must begin after the policy has been in force for ten
days.
Notice of Claim
The insured must give written notice of a claim to the insurer
or agent within 20 days of the loss or as soon as reasonably
possible. In the case of a disability income benefit payable for
at least two years, notice of claim regarding the continuance
of the disability may be required every six months. If the
nature of the disability is such that the insured is legally
incapacitated, that is, unable to satisfy this requirement due to
physical or mental disability, then the continued notice of
claim requirement would be waived.
Claim Forms
This provision requires the insurer, after it has been notified of
the claim, to furnish claim forms within 15 days. If the forms
are not furnished, and the insured submits written proof of the
occurrence, character, and extent of the loss, the insured will
be deemed to have complied with the requirements of filing
proof of loss.
Proof of Loss
The proof of loss provision limits the time within a written proof
of loss must be filed. A proof of loss is a formal statement
given to the insurer regarding a loss. It may include a doctor's
statement or death certificate. Proof of loss must be filed
within 90 days of loss; or, in the case of a continuing loss,
within 90 days after the end of a period for which the insurer is
liable. If the insured cannot comply with these requirements,
proof of loss must be filed within a reasonable time not
exceeding one year. In the event of legal incapacity there is
no time limit on filing a proof of loss.
Time of Payment of Claims
Claims must be paid immediately upon receipt of proof of loss
except for periodic payments, which are to be made as
specified in the policy or made at least monthly. Balances
unpaid when the claim terminates shall be paid immediately
upon receipt of due proof of loss.
Some states have substituted a specific number of days in
place of the word, "immediately." In some states, immediately
means within 30 or 60 days of receipt of the proof of loss.
Payment of Claims
The payment of claims provision specifies to whom the
policy's benefits will be paid. Benefits may be paid to a named
beneficiary or to an estate if there is a death benefit to be paid
under the health insurance policy, such as an accidental
death benefit.
Normally, the health insurance benefits are paid to the loss
payee: that is, the person who has experienced the loss.
Often medical expense benefits payable under a health
insurance policy may be paid to the provider of the medical
care if the insured has executed an assignment form. The
assignment authorizes the insurer to pay benefits directly to
the provider of the medical services, such as a physician or a
hospital.
Insurers may add either or both of two optional provisions.
The first optional provision provides that if no beneficiary is
named or if the named beneficiary is legally incapable of
signing a valid release (such as a minor or legally incompetent
person), the insurer may pay an amount specified in the
provision not to exceed $1,000 to any relative by blood or
marriage of the insured or to the beneficiary who is deemed
by the insurer to be equitably entitled thereto. This is usually
referred to as a facility of payment clause.
The second optional provision gives the insurer the option of
making payments for medical, surgical and nursing expenses
to the person or hospital rendering the services.
Physical Examination and Autopsy
The physical examination and autopsy provision allows the
insurer, at its own expense, to examine the insured while a
the dental services covered, limitations on those services
(including deductibles and co-payments), how to obtain
services and information, and methods for resolving
complaints.
Health Insurance Policy Provisions
All 50 states have enacted the provisions of the Uniform
Policy Provisions Law, developed by the National Association
of Insurance Commissioners. The law includes 12 mandatory
provisions that must be included in individual health insurance
policies and 11 optional provisions. The optional provisions
are not required to be included in the policy, but if the subject
of any of them is contained in the policy, it must be worded in
accordance with the wording of the appropriate optional
provision. An insurer may reword any of the mandatory or
optional provisions so long as the new wording is not less
favorable to the insured or to the beneficiary. One can usually
find the mandatory provisions in the policy under a section
entitled Mandatory or Required Provisions.
Mandatory Provisions
Entire Contract
This provision states that the policy, including riders and
attached papers (such as the application) constitutes the
entire contract. This is to ensure that the policy owner have a
copy of the entire contract and can't be surprised by changes
made later. The provision also states that the contract cannot
be modified unless the change is authorized by an officer of
the insurance company and attached to the contract. Just as
in life insurance, the agent cannot change any of the policy
provisions.
Time Limit on Certain Defenses
The purpose of the time limit on certain defenses provision is
to limit the period of time in which an insurer may challenge
the contract or deny a claim on grounds of material
misrepresentation in the application. This provision is similar
to an incontestable provision in an individual life insurance
contract.
A health insurance policy may not be contested regarding any
statement on the application, nor may a claim be denied, after
the contract has been in force for two years (three years in
some states). No material misrepresentation can void the
health insurance contract after it has been in force for two
years except for fraud. Fraud can void the health insurance
contract whenever it can be proven by the health insurer.
The insurer cannot deny a claim on the basis of pre-existing
conditions after expiration of a two-year time limit, unless the
condition was excluded from coverage under the policy by
name or specific description. A pre-existing condition is one
that existed before the effective date of the policy, such as
heart disease.
Grace Period
The grace period provision gives additional time in which to
pay the premium, keeping the insurance in force for a certain
period of time after the premium is due but unpaid, protecting
the insured from unintentionally allowing the coverage to
lapse. The extra time allowed is seven days for weekly
premium policies, ten days for monthly premium policies and
30 or 31 days for all other policies.
If a policy contains a cancellation provision, a reference to the
cancellation provision may be made in the grace period
provision. If a policy provides that the insurer reserves the
right to refuse renewal of a policy, an additional provision
allows the insurer to avoid the grace period provision by giving
notice of its intention not to renew.
Reinstatement
Similar to life insurance, the reinstatement provision allows
the insured to put a policy that has lapsed for non-payment of
premiums back in force. If no application for reinstatement is
required, usually acceptance of the past due premium by the
insurer will reinstate the policy.
If an application for reinstatement is required, the insured
must prove insurability and pay all past due premiums plus
interest and submit the application and premiums to the
insurer. Reinstatement becomes effective when the insurer
notifies the insured. However, if the insurance company does
9
disability income benefits will be reduced proportionally.
Premiums for any excess coverage will be refunded.
Unpaid Premium
This provision allows deduction of unpaid premiums from
claim payments. Upon the payment of a claim, any premium
then due and unpaid may be deducted.
Cancellation
This provision allows the insurer or the insured to cancel the
policy with proper written notice. If the insurer cancels the
policy, the notice of cancellation cannot take effect until at
least five days from receipt of the notice. In reality, most
insurers will provide for cancellation of the policy 30 days after
receipt of the cancellation notice. If the insurer cancels the
policy, the insured are entitled to a pro rata return of the
unearned premium. Since premiums are paid in advance, the
actual premium earned by the insurer may be retained but any
unearned premium must be returned.
The insured may also cancel the policy with proper written
notice. The effective date of such cancellation will be the date
the notice is received by the company or the date specified in
the cancellation notice. When the insured cancels a policy, the
insurer may keep any earned premium plus a portion of
unearned premium. Since the insurer can keep part of the
unearned premium, the refund is referred to as a short rate
return.
Conformity with State Statutes
This provision amends the policy to conform to minimum
requirements of State law, if necessary. Any provision of a
policy which, on its effective date is in conflict with the statutes
of the state, in which the insured resides, is amended to
conform to the minimum requirement of the statutes.
Illegal Occupations
Under this provision, liability is denied if loss results from
committing or attempting to commit a felony or from engaging
in an illegal occupation.
Intoxicants and Narcotics
This provision states that the insurer is not liable for any loss
resulting from the insured being intoxicated or under the
influence of any narcotic unless administered on the advice of
a physician.
It should be noted that treatment for substance abuse is a
covered expense under a health insurance policy. The
optional exclusion only relieves the insurer of responsibility for
a loss caused by drug or alcohol use.
Other Health Insurance Provisions
The Policy Face
The face of the policy is a standard printed form containing
the name of the insurance company and providing enough
information to give a capsule summary of what type of policy
and what type of coverage is provided by the contract. The
policy face identifies the insured and states the term of the
policy (when it goes into effect and when coverage expires). It
also states how the policy can be renewed.
The policy face usually gives a brief statement of the type or
types of benefits. However, it is essential to examine the
benefit provisions within the body of the contract to obtain a
complete understanding of the coverage provided.
Free Look
Many states now require that health policies contain a clause
allowing the policyholder a period of ten days (or even 30
days) from date of receipt of the issued policy in which to
inspect it and, if dissatisfied for any reason, return it for a full
refund. If the policy is canceled, the company is not liable for
any claims originating during the free-look period.
Insuring Clause
The insuring clause represents the insurer's promise to pay
benefits, and the conditions under which these benefits will be
paid. This clause further identifies the insurer and the insured,
and states what kind of loss is covered. An example of an
insuring clause would be:
The insurer, ABC Mutual, agrees to pay disability income
benefits to the insured upon receipt of proof of loss and the
timely payment of premiums by the insured. All benefits will be
claim is pending; and, in the event of death, to perform an
autopsy, at its own expense, where not prohibited by law.
Legal Actions
The legal actions provision restricts the time period during
which the insured may bring legal action against the insurance
company. This provision requires that no legal action to collect
benefits may be started sooner than 60 days after the proof of
loss is filed with the insurer. This waiting period allows the
insurer time to evaluate the claim. The insurer may also not
be sued later than three years after the time that the proof of
loss is required to be filed.
Change of Beneficiary
If an individual health insurance policy provides a death
benefit, it must also provide a change of beneficiary provision.
This provision gives the policy owner, unless he or she has
made an irrevocable designation of a beneficiary, the right to
change beneficiaries or make any other change without the
consent of the beneficiary or beneficiaries.
Optional Provisions
There are "optional" provisions that, if covered by the policy,
must be worded in accordance with the wording specified in
the law. An insurer may use other wording not less favorable
to the policy owner, subject to approval by the state Insurance
Department.
Change of Occupation
Occupation is an important underwriting factor, especially as it
would pertain to disability income insurance. Disability income
policies are partially rated on the degree of risk inherent in the
insured’s occupation. For example, a police officer would pay
a higher premium than a doctor because of the more
hazardous nature of the police officer's occupation.
If this provision is contained in the policy, it allows the insurer
to adjust policy benefits if there is a more hazardous
occupation.
Conversely, this provision will also allow the insured to notify
the insurer of a change to a less hazardous occupation in
which case the premium would be reduced.
Misstatement of Age
If the insured has misstated his or her age on the application
for health insurance, this provision allows for an adjustment of
the benefit payable. All amounts payable under the policy will
be adjusted to the amount that the premium would have been
purchased at the insured’s correct age.
Other Insurance
This provision is designed to limit problems of over insurance
with the same insurer, and is most often found in disability
income policies in order to discourage a person from
purchasing several disability income policies (with the same
insurer) which could make a disability very profitable.
Remember, most insurers limit the amount of disability income
which may be purchased to 60 to 70 percent of gross earned
income, as an encouragement to return to work.
There are two versions of this provision. The first enables the
insurer to place a cap on benefits received from all similar
policies with the same insurer.
The second version of this option allows the beneficiary to
select which policy or policies are to be kept in force. The
remaining policies will be voided and the premium refunded.
There is also the possibility of over insurance when there is
similar coverage with more than one insurer. If there are other
valid policies with other insurers, and the other insurers are
unaware of the other policies before a claim occurs, benefits
may be limited to a proportion of the total loss or claim. This is
designed to keep insureds from profiting from an insurance
claim. Insurance should avoid loss, not create profit.
Relation of Earnings to Insurance
The relation of earnings to insurance provision is concerned
with over insurance for disability benefits, so that an insured
will not receive more money from disability insurance than he
or she would receive from working. The provision may only be
used in non-cancelable and guaranteed renewable contracts.
The provision states that if at the time the disability begins, the
total disability income exceeds the insured’s earned income or
average earned income for the preceding two years, the
10
Benefit Payment Clause
This clause describes the type of benefits provided by the
policy and the circumstances under which they will be paid.
Often information on the specific benefit amounts, duration of
the benefit, and elimination periods is contained in a benefit
schedule, which is a detachable page appended to the policy.
Certain benefits, referred to as mandated benefits, are
required by state law to be included in certain types of
policies. Examples of mandated benefits include coverage of
newborn children, and coverages for mental, emotional or
nervous disorders. Some benefits must be provided as
options, such as optional coverage for obstetrical services or
for alcohol and drug dependence.
Exclusions and Reductions
An exclusion or exception is a provision that entirely
eliminates coverage for a specified risk. A reduction is a
decrease in benefits as a result of specified conditions.
Most health Insurance policies exclude war and acts of war,
self inflicted injuries, aviation, military service and overseas
residence. Benefits will not be provided if the cause of a loss
is due to military service, a war or civil disorder, a self inflicted
injury such as an attempted suicide, or if the loss is due to
aviation as a pilot. Individuals who live overseas, or fly a
private plane, will need to purchase additional insurance
coverages or riders.
Generally, coverage is temporarily suspended if an individual
resides in a foreign country for a specified period of time or if
the individual is serving in the military. Coverage is reinstated
or reactivated when he or she returns to the United States or
is no longer serving in the military.
Pre-existing Conditions
Pre-existing conditions can be excluded from coverage under
a health insurance policy. This exclusion may be permanent
or temporary. A pre-existing condition is usually defined as
any condition for which the insured sought treatment or advice
prior to the effective date of the policy.
Further, a pre-existing condition can also be defined as any
symptom that would cause a reasonable and prudent person
to seek diagnosis and medical treatment. This concept
prevents an applicant who suspects that he or she may have
a serious medical problem from buying health insurance and
then going to a doctor for diagnosis and treatment. Preexisting conditions may be covered by the insurer if they are
indicated on the application. The insurer will then review the
medical information and depending on the condition may elect
to cover the problem or exclude it. Usually, only serious or
chronic conditions will be excluded.
A Pre-existing Condition Dispute
In its 1990 decision Janet Fuglsang v. Blue Cross of Western
Iowa and South Dakota, et al, the Supreme Court of Nebraska
offered a good explanation of how pre-existing conditions
exclusions work in group health insurance policies.
Janet Fuglsang was diagnosed on July 1, 1986, as suffering
from myasthenia gravis, a disease which affects different
muscle groups of the body and results in weakness, but not in
sensory loss or pain.
Earlier in the year, in January, FugIsang had seen Dr. Tom
Surber, a family physician in Norfolk, Nebraska. She
complained of difficulty with swallowing, chewing, moving her
tongue, and weakness of the muscles of the arms and legs.
Surber knew that Fuglsang was taking a thyroid medication. A
series of tests indicated that there was not enough thyroid
medication in her body, so Surber adjusted her medication
and advised Fuglsang to let him know if she did not feel
better.
Fuglsang felt fine from February through May, but the
symptoms returned sometime in June. She contacted Surber
again and he referred her to a Dr. Simons, who hospitalized
her and referred her to a neurologist. When he noted her
symptoms, the neurologist's diagnosis was that she had
myasthenia gravis.
At trial Blue Cross asked several questions of the neurologist
designed to find out whether FugIsang's myasthenia gravis
existed or could have been diagnosed in January 1986. The
paid in accordance with the policy's provisions contained
herein.
Consideration Clause
Consideration means giving something of value as part of a
contractual agreement. The insurer agrees to provide
something of value (policy benefits) in exchange for value
received from the insured: this value being the premium and
the statements on the health insurance application.
Renewability Clause
The renewal provision, which contains the terms and
conditions for renewal of the policy, must appear on the first
page of the policy. Renewal provisions vary; but, they can be
categorized into five types.
Cancelable.
A health insurance policy which is cancelable may be
canceled at any time with proper written notice from the
insurer and a refund of any unearned premium. Cancellation
of the policy does not relieve the insurer of any claim's
responsibility. If the insured is in the midst of a claim at the
time the policy is cancelled, the insurer must continue to
honor the claim. (This type of renewability is not very
common.)
Optionally Renewable.
The insurer may elect not to renew the policy for any reason
or no reason at all. If the election of non renewal is made, it
can only be exercised on the policy's premium due date or the
policy's anniversary. The policy's anniversary date is the
"birthday" of the policy; that is, the anniversary of the policy's
effective date. The insurer can also elect to renew the policy
on the anniversary and it may also increase the policy’s
premium.
Conditionally Renewable.
This provision is very similar to the optionally renewable
provision. The primary difference is that a conditionally
renewable policy may be cancelled for specific conditions
contained In the policy. Optionally renewable policies basically
do not require a policy condition or any reason for
cancellation. Premiums may also be increased on the policy's
anniversary date if the policy is to be renewed.
Guaranteed Renewable.
This type of renewability guarantees that you have the right to
continue the policy in force until a specified age by timely
payment of the premiums. The insurer cannot refuse to renew
the policy. What is not guaranteed is the premium. The insurer
has the right to increase the premium on each policy
anniversary. However, premiums may be increased but only
for the entire class of insureds, not for an individual. This is a
very common form of renewability, especially in hospitalization
policies.
Non-cancelable.
A non-cancelable policy is one which provides for the
guarantee of both renewability and the premium. The insurer
cannot cancel the policy or increase the premium. This type
of renewability is most common with some forms of disability
income policies.
Thus, there are two types of renewability which guarantee that
the policy cannot be cancelled by the insurer: guaranteed
renewable and non-cancelable. However, under either type of
renewability, the guarantee not to cancel typically only applies
until age 65. At age 65, if the insured owns a medical expense
policy, he or she becomes eligible for Medicare and normally,
the medical expense policy will not be renewed. A disability
income policy will only be renewed beyond age 65 if the
insured provides evidence that he or she is still working at a
full time job. In this situation, the policy may be renewed for
one year periods from age 65 to age 70 or 72.
Finally, it should be noted that only the non-cancelable type
guarantees that its premium cannot be increased. All other
renewability provisions allow the insurer to increase premiums
on the policy's anniversary.
In any type of health insurance, when renewal is denied, the
insured must be given a written explanation for non-renewal
or be notified that the explanation is available upon written
request.
11
an evaluation of the appropriateness, necessity, and quality of
health care, and may include preadmission certification and
concurrent review.
Under the pre-certification provision (or pre-certification
authorization) the physician can submit claim information prior
to providing treatment to know in advance if the procedure is
covered under a specific plan and at what rate it will be paid.
This way both the physician and the patient know in advance
what the benefit will be and can plan accordingly. This
provision allows the insurance company to evaluate the
appropriateness of the procedure and the length of the
hospital stay.
Under the concurrent review process the insurer will monitor a
hospital stay to make sure that everything is proceeding
according to schedule and that the insured will be released
from the hospital as planned.
Recent evidence has shown that many treatments can be
satisfactorily provided without the need for a hospital stay.
Ambulatory outpatient care is the alternative to the costly
inpatient diagnostic testing and treatment, and is usually
offered through hospital outpatient departments. However,
this care can be provided by special ambulatory care health
centers, group medical services, hospital emergency rooms,
multi-specialty group medical practices, and health care
corporations. These ambulatory facilities provide, in addition
to diagnosis and treatment, preventive care, health education,
family planning, and dental and vision care.
Group Insurance Policy Provisions
Conversion Privilege
The conversion privilege allows conversion of group coverage
to individual coverage without having to provide evidence of
insurability. This privilege goes into effect only when the
insured is no longer eligible for group coverage when:

employment is terminated, or

the “class” insured is no longer eligible for coverage.
(For example, to save expenses, a company that formerly
provided coverage for all employees may decide to only
provide coverage to the "class" of full-time employees).
Usually, employees have 31 days from the time of ineligibility
to convert to the new plan of Insurance. The new insurance
will usually be an individual plan, normally a hospitalization
policy, which will not provide the same benefits that the group
plan did. Usually, the group medical expense benefits are
more liberal than the converted policy's benefits. Often, those
who elect to exercise this conversion privilege do so because
they have insurability problems.
Certificates of Insurance
Insureds must be issued a certificate summarizing the
coverage they have under the group policy. Information is
usually provided on benefits, age limits, notice of loss and
proof of loss requirements, the insurers right of examination,
and conversion. Certificates are sometimes issued in booklet
form.
Dependent Coverage
Life or health insurance benefits may be extended to the
primary insured's dependents. Dependents may be the
individuals: spouse, children, dependent parents, and any
other person for whom dependency can be proved.
Children can be stepchildren, foster children or adopted
children. Dependent children must be under a specified age,
usually to age 19, or to age 21 if attending school full time.
The law further requires that any other person dependent on
the insured must be eligible for coverage. Such dependency is
proved by the relationship to them, residency in the home, or
the person being listed on their income tax return as a
dependent.
A child may be a dependent beyond the ages of 19 or 21 if
that child is permanently mentally or physically disabled prior
to the specified age. Also, a dependent child may be offered
coverage beyond the limiting age of 19 if he or she is a full
time college student in an accredited college. Usually,
dependent coverage will be extended until age 21 or even to
age 25.
central issue in the trial was whether the myasthenia gravis
was in fact a pre-existing condition which relieved Blue Cross
from liability under the terms of the policy. The trial court
sustained several of Fuglsang’s objections to these questions,
and, thus, the neurologist was not allowed to answer them.
Blue Cross contended that Fuglsang's condition existed prior
to her effective coverage date, and it therefore denied
coverage under policy provisions that restricted her coverage
for pre-existing conditions until she had been a member for 11
consecutive months. Pre-existing condition was defined as
"any illness or injury or other condition for which medical or
surgical treatment or advice was rendered within one year
prior to said person becoming a Member."
Suing Over When the Policy Took Effect
Fuglsang sued Blue Cross, arguing that coverage which she'd
obtained through her employer had begun in February 1986.
Blue Cross argued that the policy became effective in June
1986. The trial court ruled in favor of Fuglsang and ordered
coverage plus damages and attorney fees. The entire award
totaled a little over $40,000.
Blue Cross appealed, arguing that the trial court had made a
number of mistakes; among them excluding expert medical
testimony of whether Fuglsang suffered from myasthenia
gravis prior to the effective coverage date of the policy and
whether the condition could have been diagnosed prior to the
coverage date.
But the Nebraska Supreme Court ruled that: "Whether
coverage commenced in February or June makes little
difference in this case, for Blue Cross argues that Fuglsang's
condition existed and was capable of diagnosis as early as
January 1986, prior to both of the asserted coverage dates."
The neurologist would have testified, if allowed, that
myasthenia gravis possibly could have been diagnosed in
January 1986; that there was a possibility that Fuglsang's
condition was related to her thyroid problem, which could, to
some extent, mimic symptoms of myasthenia gravis; and, that
Fuglsang probably did have myasthenia gravis, then, but one
could not be certain and could also suspect other things such
as hypothyroidism.
Blue Cross argued that the law in Nebraska is that a disease
exists not when it becomes known to the insured, but when it
becomes manifest. The court declared that those terms are
actually synonymous. This serves the dual purpose of
protecting insurers from fraudulent applicants seeking
coverage for known diseases while protecting innocent
premium-paying insureds from being deprived of benefits for
preexisting conditions of which they have no knowledge. Not
only did Fuglsang get to keep her original award, she was
awarded another $2,500 for attorneys’ fees incurred by Blue
Cross' appeal.
Waiver of Premium
Under this provision, the insurer waives premium payments
after an insured has been totally disabled (as defined in the
policy) for a specified period of time, usually three or six
months. If the insured remains totally disabled, no further
premium payments will be required. The insurer will pay the
premiums until the insured reaches age 65 and becomes
eligible for Medicare.
Case Management Provisions
In order to control the costs associated with medical care,
many insurers are instituting methods to reduce costs while
giving more options for health care. The second surgical
opinion is a provision that can be included in policies that offer
surgical expense benefits. This coverage allows the insured to
consult a doctor, other than the attending physician, to
determine alternative methods of treatment. While the use of
this provision is sometimes optional, it is more often
mandatory for certain procedures, such as tonsillectomy,
cataract surgery, coronary bypass, mastectomy, and varicose
veins. Some insurance companies have medical examiners
review claims, and the examiner's decision to approve or deny
a claim is considered the required second opinion.
One cost control mechanism being used by insurers and
employers is utilization review. Utilization review consists of
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Records and Recordkeeping
This provision contains information as to whether the insurer
or the policyholder will maintain records on the insured. It
provides for the policyholder to furnish the insurance company
with necessary information to determine premiums and
administer coverage.
A clerical error provision provides that if there is an error or
omission in the administration of a group policy, the person's
insurance is considered to be what it would be if there had
been no error or omission.
For example, an employer has the responsibility to send
group enrollment forms for newly hired employees to the
Insurer. Sean is a new employee and through an
administrative error, his enrollment form is never forwarded to
the insurance company. A few months later he submits a
medical expense claim to the insurer and is told that they
have no record of his coverage.
This recordkeeping and clerical error provision protects the
new employee in this type of situation. Usually, the insurer
would accept an enrollment form and all of the past due
premium and proceed to pay the medical claim.
Regulations Affecting Group Policies
A number of federal regulations enacted over the past 20
years affect group life and health insurance policies. These
are known by the acronyms COBRA, OBRA, TEFRA, and
ERISA.
Continuation of Benefits (COBRA)
The Consolidated Omnibus Budget Reconciliation Act
(COBRA) is a federal law that requires employers with 20 or
more employees to provide for a continuation of benefits
under the employer's group health insurance plan, for former
employees and their families. Coverage may be continued for
18 to 36 months. Employees and other qualified family
members, who would otherwise lose their coverage because
of a qualifying event, are allowed by COBRA to continue their
coverage at their own expense at specified group rates.
COBRA specifies the rates, coverage, qualifying events,
qualifying beneficiaries, notification of eligibility procedures,
and time of payment requirements for the continuation of
insurance. Below are the terms and concepts most important
to the understanding of COBRA and its limitations.
Qualifying Event.
A qualifying event is an occurrence that triggers an
insured's protection under COBRA. Qualifying events
include: the death of a covered employee,
termination or reduction of work hours of a covered
employee, Medicare eligibility for the covered
employee, divorce or legal separation of the covered
employee from the covered employee's spouse, the
termination of a child's dependent status under the
terms of the group insurance plan, and the
bankruptcy of the employer. Termination of
employment is not a qualifying event if it is the result
of gross misconduct by the covered employee. In
short, a qualifying event occurs when the employee,
spouse, or dependent child becomes ineligible for
coverage under the group insurance contract.
Qualified Beneficiary.
A qualified beneficiary is any individual covered
under an employer-maintained group health plan on
the day before a qualifying event. Usually this
includes the covered employee, the spouse of the
covered employee and/or dependent children of the
employee.
Notification Statements.
Employers are obligated to provide notification
statements to individuals eligible for COBRA
continuation. This notification must be provided when
a plan becomes subject to COBRA, an employee is
covered by a plan subject to COBRA, or a qualifying
event occurs.
In addition to notifying current employees, the
company must also notify new employees when they
are informed of other employee benefits. Initial
notification made to the spouse of an employee, or to
his or her dependents must be made in writing and
sent to the last known address of the spouse or
dependent.
Following the notification of eligibility for continuation
of benefits an individual has 60 days in which to elect
such continuation. If continued coverage is not
elected within 60 days the option to do so is forfeited.
Duration of Coverage.
An employer is not required to make continuation
coverage available indefinitely. The rationale behind
COBRA is to provide transitional health care
coverage until the employee or family member can
obtain coverage or employment elsewhere. The
maximum period of coverage continuation for
termination of employment or a reduction in hours of
employment is 18 months. For all other qualifying
events the maximum period of coverage continuation
is 36 months. There are also certain disqualifying
events that can result in a termination of coverage
before the time periods specified above. The dates of
these events are as follows:

the first day for which timely payment is not
made;

the date the employer ceases to maintain
any group health plan;

the first date on which the individual is
covered by another group plan (even if
coverage is less comprehensive);

the date the individual becomes eligible for
Medicare.
It should be remembered that COBRA deals with continuation
of the exact same group coverage that the employee had as a
covered employee. This distinction is important so as not to
confuse this provision with the conversion of group coverage
to a lesser amount of insurance as part of an individual plan.
Not only is the type of coverage the same that the insured had
while employed, the premium is also the same except now the
terminated employee will pay the entire premium to the
employer for the privilege of continuing the group benefits. To
cover any administrative expense that the employer may
incur, the terminated individual may also pay an additional
amount each month not to exceed 2 percent of the premium.
It should also be noted that only the health benefits can be
continued under COBRA. Any group life insurance under the
plan may not be continued. It can, of course, be converted.
Recent amendments to COBRA require the continuation of
coverage if a preexisting condition limitation is included in the
new group health coverage. However, the new group health
coverage is primary and the continuation coverage is
secondary.
Omnibus Budget Reconciliation Act of 1989 (OBRA)
The Omnibus Budget Reconciliation Act of 1989 (OBRA)
extended the minimum COBRA continuation of coverage
period from 18 to 29 months for qualified beneficiaries
disabled at the time of termination or reduction in hours. The
disability must meet the Social Security definition of disability,
and the covered employee's termination must not have been
for gross misconduct.
Under OBRA '89, an employer may terminate COBRA
coverage because of coverage under another health plan
provided the other plan does not limit or exclude benefits for a
beneficiary's pre-existing conditions.
OBRA '89 also clarifies that COBRA coverage may be
terminated only because of Medicare entitlement, not merely
eligibility. Before terminating COBRA coverage for
beneficiaries at age 65, an employer must first be certain that
the individual has actually enrolled under Medicare. Also, 36
months of COBRA coverage must be provided for the spouse
and dependent children of a covered employee who becomes
entitled to Medicare.
Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)
The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)
is intended to prevent group term life insurance plans (usually
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retirees. The promise of continued benefits at no cost after
retirement was continually reaffirmed in various ways.
American General Corporation, a Texas corporation which
owns a number of other insurance companies, acquired NLT
in November 1982, and began to administer the plaintiffs'
pension and welfare plans. In the merger agreement and
elsewhere, American General agreed to maintain existing NLT
employee benefits, including the Security Program at the time
of the merger, and promised that if it integrated NLT’s benefit
programs with its own programs, overall benefits would
compare to those in effect at the time of the merger.
Until December 1983, the retirees' and their spouses received
medical insurance having a lifetime maximum benefit of
$100,000 per person and an annual deductible of $100 per
person. It paid 100 percent of surgical fees, 100 percent of the
first $3,000 of hospital expenses, and 80 percent of hospital
expenses over that amount. A retiree and his spouse or
dependents had a maximum annual cost of $500 per calendar
year, in addition to the per person deductible. Finally, the
retiree was not required to make any further contributions to
be eligible to receive this insurance.
In November 1983, American General held numerous
meetings across the country for active employees of NLT or
its subsidiaries. Individuals who had already retired were not
invited. At the meetings as well as in documents and other
communications, employees were informed that changes
would be made in future retirement benefits effective January
1984. After that date, employees would fall under the
American General plan.
By coming under the American General plan, the former
NLT/NLA employees received an increased lifetime maximum
benefit to $750,000 per person. The "up front" costs for a
future retiree, his spouse and dependents, however, were
increased. The annual deductible per person was $275, $200
or $125. The maximum annual cost was $1,500, $1,000, or
$1,000 per person and $2,500, $2,000, or $1,500 per family,
respectively. Additionally, surgical and hospital costs were
reduced from 100 to 80 percent.
Retirees leaving employment after January 1984 also were
required to make contributions to receive medical insurance.
The dollar amount of monthly contributions varied depending
upon the retiree's age, whether he elected to have coverage
for dependents, and which of the three plans was chosen.
Contributions for those retirees over age 65 were lower since
their benefits were coordinated with Medicare. All retirees
contributed approximately 20 percent of the cost of their
chosen insurance.
Neither during these meetings nor at any other time were
plaintiffs advised that the insurance benefits would or could be
reduced. As with NLT, the express reservation was made only
in the plan documents. Testimony indicated that company
agents advised employees of the termination clause only if
directly asked a specific question on the policy term.
Paraphrasing the words of one such agent "you do not
emphasize the negative."
A number of the still actively employed plaintiffs relied on
American General's representations regarding planned future
changes in benefits. Some retired prior to January 1984, so
that they could receive the benefits under the NLT Security
Program. Others decided not to retire but to remain as active
employees and retire under the promised benefits plan.
In May 1984 American General notified all former employees
who had retired before May 1984 (both pre- and post-January
1984) that certain retirement benefits would be changed
effective July 1, 1984. Six months after the January changes
were put into effect, American General changed the plan
again.
The New Program
The July 1984 medical insurance program applied to all
retirees, regardless of their retirement date. The plan provided
a lifetime maximum benefit of $200,000 per person, an annual
deductible of $200 per person and a maximum annual cost of
$1,000 per person and $2,000 per family.
All were required to make contributions for continued
insurance coverage or permanently forfeit any and all
always part of group health insurance programs) from
discriminating in favor of "key employees." Key employees
include officers, the top ten interest holders in the employer,
individuals owning five percent or more of the employer, or
owning more than one percent who are compensated
annually at $150,000 or more.
TEFRA also amends the Social Security Act to make
Medicare secondary to group health plans. TEFRA applies to
employers of 20 or more employees, and to active employees
and their spouses between ages 65 and 69. TEFRA also
amends the Age Discrimination in Employment Act (ADEA) to
require employers to offer these employees and their
dependents the same coverage available to younger
employees.
Employee Retirement Income Security Act of 1974
(ERISA)
The Employee Retirement Income Security Act of 1974
(ERISA) was intended to accomplish pension equality, but it
also protects group insurance plan participants. ERISA
includes stringent reporting and disclosure requirements for
establishing and maintaining group health insurance and other
qualified plans. Summary plan descriptions must be filed with
the Department of Labor and an annual financial report must
be filed with the IRS. For other qualified plans, legal
documentation of the trust agreement, plan instrument, plan
description, plan amendments, claim and benefit denials,
enrollment forms, certificates of participation, annual
statements, plan funding, and administrative records must all
be maintained.
ERISA Lawsuit
Perhaps the most important federal lawsuit involving heath
care plans designed for pensioners: the U.S. District Court for
the middle district of Tennessee's 1985 ruling in Robert
Musto, etal. v. American General Corp., etal.
This case considered whether an employer (or Its successor)
could "unilaterally terminate or materially alter retirement
benefits after employees have provided years of service and
have left active employment with the company." ERISA
requirements came into play in the former employees favor.
In 1939, The National Life and Accident Insurance Company
established an annuity and life insurance program for its
employees and future retirees. In 1945, National Life
established a health insurance plan for its employees and
future retirees. In 1968 NLT Corporation was formed to be a
holding company for National Life and other affiliated
subsidiaries. NLT assumed plan sponsorship for the
employee benefit plans established by National Life. All
subsidiaries of NLT were thereafter covered by the NLT plans.
The named plaintiffs are all retirees of National Life, NLT or its
subsidiaries who receive or were eligible to receive pension
and welfare benefits as a result of their service to their former
employer.
The employee benefit plans provided by National Life and
NLT were collectively known as the Security Program. The
Security Program offered retirees a pension, paid-up life
insurance and lifetime medical insurance. National Life and
NLT used the Security Program as a recruiting device to
solicit new agents and also as a bargaining point in attempting
to convince its own agents to continue on with the corporation.
Some individual retirees had received promises that all
benefits received upon retirement would be fully funded.
Over the years, the National Life/NLT Security Program
underwent changes, including those necessitated by ERISA,
resulting in overall improvements in retirement benefits under
the program. Until January 1984, life and medical insurance
coverage which continued after retirement required no
payment of premiums.
NLT and National Life utilized the Security Program as a
major inducement to attract employees. The promise of
continued benefits at no cost to the individual after retirement
was a material part of the presentation to prospective
employees. Potential employees were advised that the
Security Program was one of the most liberal benefit
packages in the country. National Life and NLT aggressively
promoted the protection it would give its employees and
14
sure to ask clear and precise questions and to record the
applicant’s answers accurately. State law usually requires the
agent and the applicant to certify in writing that the applicant
has read the completed application and realizes that any false
statement or misrepresentation may result in loss of coverage.
As with the life insurance contract, the agent may be the
applicant’s sole personal contact in the insurance process. It
is the agent's job to explain all aspects of coverage. Also, on
any matters pertaining to the insurance contract, notice to the
agent is the same as notice to the company.
The insurer may conduct investigative reports and gather
information about the applicant. The applicant should also
receive a "Notice of Information Practices" which explains the
information that will be collected about him or her and who will
have access to that information. If applicants are rejected
based on the information contained in an investigative report,
they have the right to access the information, challenge it and
request that corrections be made. An "investigative consumer
report" includes information on character, general reputation,
personal habits, and mode of living obtained through
interviews with associates, friends and neighbors.
Insurers can obtain more information about an applicant’s
insurance history from the Medical Information Bureau (MIB).
Insurers can request a report that tells them whether an
applicant has applied for insurance with any other MIB
member insurers, and what the responses were to the
questions on those applications. MIB Information cannot be
used as the sole reason to decline a risk.
Underwriting Criteria
The insurance company underwriter selects those risks which
are acceptable to the insurer, and at an acceptable premium.
But the selection criteria used in this process, by law, must be
only those items which are based on sound actuarial
principles or expected experience. The underwriter cannot
decline a risk based on sex, blindness or deafness, genetic
characteristics (such as sickle cell trait), marital status, or
sexual preference.
Age is a factor in health insurance because older people are
more likely to have accidents and become sick, and they do
not recover as quickly as younger people. Statistically,
females offer a higher health Insurance risk as they usually
have more health problems than males. Accordingly, more
health problems mean more insurance usage and increased
claims. Typically this results in higher health insurance
premiums for females.
Ironically, it could be that as a result of more frequent health
care, the female's life expectancy is longer than males.
Accordingly, female life insurance rates are typically lower
than a male of comparable age. It is not that unusual for a
male, age 35, to suddenly drop dead from a heart attack. It is
unusual for a female, age 35, to die suddenly as the result of
a heart attack. This fact could be the result of more frequent
health care by females and less by males.
Some insurers have unisex rates for health insurance which
results in both male and female insureds paying the same
premium. In these cases, the sex of the applicant is not an
important underwriting factor.
Occupation as a Risk Factor
A person's occupation has a greater impact on his or her
health. Occupations are classified into broad groups having
approximately the same claims experience. Classifications are
based on frequency and severity of injury, exposure to
hazards, moral hazards, nature of work, and length of
disability by occupation. For example, a factory worker is
more likely to injure his back than an office worker.
Most companies have accident insurance manuals which list
hundreds of different occupations and a grading is assigned to
each occupation depending on how hazardous it is. A clerical
office worker (with a minimal occupational hazard) might be
Class 1 and the rates would be low. On the other hand, a
deep sea diver might be assigned to Class 10 (severe
occupational hazard) and the rates would be high.
Physical condition refers to the applicant's current state of
health and past medical history. Applicants who are in good
retirement medical insurance benefits. Retirees under age 65
were required to contribute 25 percent of the cost of the
insurance. Retirees 65 and older were required to contribute
50 percent of the cost. (Because of the coordination with
Medicare for those over 65, the costs for all retirees were
roughly the same.) Then American General announced it
would increase the contribution of retirees under age 65 to 50
percent on July 1, 1985: but they were restrained by the court
from doing so.
Of 1800 retirees or spouse survivors, 230 "chose" not to
enroll; probably, because the cost was prohibitive.
Another feature of the July 1984, modifications was that if any
retiree or spouse was eligible as an employee for another
employer's group medical insurance, then American General
would permanently cancel all medical insurance for that
person, even if they had elected not to be covered by the
other insurance. This termination of coverage applied
immediately to eight people.
The plaintiffs sued under ERISA and the applicable federal
common law. The district court, setting certain conditions,
allowed the lawsuit to proceed as a class action. The court's
conclusions:
"Unlike medical insurance benefits, spousal survivor benefits
constitute a form of pension benefit and are therefore covered
by the comprehensive vesting and participation provisions and
the funding provisions under ERISA. Under the terms of the
Security Program, retirees who left active employment with
NLT/NIA prior to age 65 were given a window period during
which they could decide whether to elect to enter the spousal
survivor program. The election was not required to be made
until age 65. If American General can modify the plan at will,
the retirees have no assurance as to the future level of
benefits, the premiums, or the deductible they must meet."
The court ruled in favor of the pensioners.
Health Insurance Underwriting
Like life insurance, health insurance underwriting is the
process of selection, classification, and rating of risks. Most
companies offering health policies have a variety of policies
available and underwriting standards for each policy are
usually well established.
Underwriting is extremely more restrictive for individual than
for group policies. The underwriter's principal functions are to
review applications to eliminate those that do not meet
underwriting standards, thus reducing adverse selection, and
to classify risks to establish benefits and corresponding
premium.
The Application
The insurance company relies on the information in the
application when deciding whether to issue a policy or not.
Application forms vary as to the type and amount of
information required. Usually the application asks for personal
information such as name, address, Social Security number,
dependent status, date of birth, work address and specific
occupational duties. In addition, questions regarding earned
and unearned income may be included.
Applications also usually request information regarding other
health Insurance coverage that the applicant may own, the
type of coverage, benefit amounts and the name of the
insurer(s).
Applicants will also probably have to supply specific medical
information regarding themselves and any family members to
be covered, including past medical history, current physical
condition, moral habits and hobbies. This part of the
application is usually completed by the agent or by medical
personnel if a physical exam is required.
The application must be signed by the proposed insured and
the policy owner (usually this is the same person), as well as
by the insurance company's agent.
Remember that the responses to questions on the application
are considered representations, that is, statements the
applicant believes to be true to the best of his or her
knowledge.
Other Sources of Information
It is the responsibility of the agent taking the application to be
15
any condition which exists before the effective date of
coverage. This provision will normally exclude these
conditions for a period of six or 12 months after the effective
date of coverage.
Although there have been changes to underwriting standards
due to the passing of unisex laws, there are still instances
where a group composed largely of women in general, young
women, or older employees pay higher premiums.
Pensions and Group Plans
In a William M. Mercer Inc. survey conducted in the 1990’s, 44
percent of employers questioned had increased the amount
retirees must pay for health-care coverage. Retirees with
spouses were forced to pay an even larger share. The Mercer
survey found that a significant number of the companies were
dropping all healthcare coverage for future retirees.
For many early retirees, the bitterest pill comes when they try
to re-enter the deteriorating job market. Data from the
University of Massachusetts Gerontology Institute in Boston
indicates that less than 48 percent of unemployed workers
age 55 and older can expect to find work.
In 1993, General Motors Corp. forced many retirees to pay
part of their own health-care premiums for the first time. Some
102,000 retirees from salaried jobs now have to shell out
premiums running over $100 a month for family coverage at a
health-maintenance organization.
Leaving a company's group plan can mean paying premiums
until an individual qualifies for Medicare at 65. For a married
couple, that can run $7,000 or $10,000 a year.
Looking Back
These are the major issues considered in this chapter:

Having adequate health insurance is perhaps the
greatest insurance concern we have as we age. It is
important to understand the coverages clients have
in force now, how long they are effective, and what
their major exclusions and limitations are.

If clients have group health insurance, find out what
their conversion options upon retirement might be, so
you understand in advance how their coverage will
change. Find out how much time they will have (for
example, 30 days) to convert to the new Insurance
plan.
Remember that a group insurance provider usually reserves
the right to makes changes in the coverage, or even the right
to cancel the coverage altogether. So there's no guarantee
people won't have some unpleasant surprises after retirement.
If prospects are buying new, individual health insurance, they
may be subject to medical underwriting and may face being
rated as a "substandard" risk because of medical conditions
they have. Still, it is important they answer health-related
questions on the insurance application honestly and
accurately. Applicants also will be subject to a waiting period
until pre-existing conditions are covered by the new policy.
Encourage taking advantage of the free look period to read
through the coverage to make sure it's what they want.
physical health and have had few, if any, health problems in
the past, present the best risk to the underwriter.
Conversely, applicants who are currently being treated for
health problems such as high blood pressure, ulcers, heart
problems, and chronic back conditions, present a serious risk
factor for the underwriter.
Chronic medical conditions which reflect a history of treatment
and medical advice reflect negatively on a health insurance
applicant. Underwriting considerations are based on what has
been, what is, and what is expected to be the medical
condition of the applicant in the future.
Habits, including personal avocations are of particular interest
to the underwriter. The underwriter would like to know about
personal habits, such as the use of drugs and alcohol, and
whether or not you smoke. Avocations would be interest and
participation in hazardous activities, such as skydiving,
motorcycle racing, or mountain climbing.
The major function of an insurance company's underwriting
department is to select risks that will fall into the “normal
range" of expected losses. Once a company underwriter has
all of the information on an applicant, one of four underwriting
actions will be taken: accept the applicant on a standard
basis, reject the applicant, accept the applicant at a higher
premium charge, or accept the applicant by issuing the policy
with a restrictive rider attached.
A rider is an amendment attached to the policy contract which
modifies the conditions of the policy by decreasing (or
expanding) its benefits or excluding certain conditions from
coverage.
Group Underwriting
Group underwriting is different from individual underwriting in
that usually there is no medical information required regarding
plan participants. No proof of insurability is required. The
underwriter focuses on the group as a whole, rather than
individual members.
There are statutory requirements imposed on group
underwriting. For example, a group may not discriminate in
favor of individuals in a manner that increases the opportunity
for adverse selection against the insurance company. For
instance, if an employer has five typists in the same job
classification (job title and salary range) the employer cannot
single out one typist to receive benefits greater than the other
four typists. Therefore, employees will be grouped under
"classifications," such as, "all eligible full-time employees," "all
clerical workers," "all hourly employees," "all salaried
employees," "all executives," "employees working one year or
more," or "employees earning not less than $20,000 but not
more than $25,000."
The employer is in charge of enrollment, premium payment,
benefit selection and all other areas of administration that are
not an insurance company function.
Most insurers require a minimum number of employees or
plan participants before a group health insurance plan may be
written. This requirement may vary depending on state laws.
Typically, the minimum group size for health insurance is ten
but it could be as low as five or some other number. The
larger the group, the more predictable will be the loss
experience.
Small Groups
Relatively small groups (25 employees or less) may require
some form of individual underwriting whereby each plan
participant may be required to prove insurability. Generally,
larger groups do not need to prove insurability.
The insurance company requires that a majority of eligible
individuals be members of the group of insureds. For
example, under a plan of insurance where an employer pays
the entire premium, and the employee does not contribute to
the premium payment (noncontributory plan) 100 percent of
all eligible employees must be covered. Under a plan where
both the employer and the employee contribute toward the
premium payment (contributory plan) 75 percent of all eligible
employees must be covered.
Also a new insurer may establish a preexisting condition
provision in the group contract which excludes coverage for
16
CHAPTER
DISABILITY INCOME
INSURANCE
2
The key factor however, is whether or not a claimant can
qualify for benefits under the rigid definition of total disability
used by the Social Security Administration.
Workers compensation (regulated at the state level) provides
benefits to workers who have occupational or job-related
disabilities. Workers compensation benefits are usually
expressed as a percentage of the worker's wage before
disability.
The compensation rate in Illinois for most cases of total
permanent disability is 66 2/3% of the employee's average
weekly wages but not less than the following amounts in the
following cases:
$80.90 in case of a single person;
$83.20 in case of a married person with no children;
$86.10 in case of one child;
$88.90 in case of 2 children;
$91.80 in case of 3 children;
$96.90 in case of 4 or more children;
Workers compensation and Social Security are the two
principal statutory disability programs which cover most
people. Some people may also be eligible for other disability
benefits. Most federal Civil Service workers who began
working for the government prior to 1984 are not covered by
Social Security. They have their own Civil Service program
which
provides
disability
benefits.
The
Veteran's
Administration (VA) provides disability benefits for disabilities
incurred while on duty with any of the military branches. The
VA benefits are paid so long as the veteran remains totally or
partially disabled even after discharge from the military
service.
Inadequate Insurance
Without adequate disability income insurance, the only
resources available to offset the devastating effects of a
disability are:

savings,

business assets,

borrowing,

other personal assets, and

government programs.
Some people may have health insurance provided by their
employer, and may even have coverage at work under a
group disability income plan, which provides for continuation
of compensation at a percentage of salary (such as 60 or 70
percent). Most often disability income benefits are provided to
age 65.
When group disability income insurance is provided by the
employer, the employer enjoys a tax-deductible premium, but
benefits will be taxable to the employee as income. One
advantage of group coverage is that usually employees will
not have to prove insurability by answering health history
questions or undergoing a medical examination. This enables
a person who is a substandard risk to acquire disability
income protection regardless of his or her health history or
current physical condition.
When an employee pays for his or her own group disability
income insurance through payroll deductions, the insurer will
normally issue an individual policy, and the employee would
probably have to show evidence of insurability. An advantage
to this type of coverage is that it is generally less costly than
individual coverage.
Group Disability Policies
However, group policy coverage is basically rented coverage.
The employer is the policy owner, and could terminate the
policy. If employment is terminated, the disability coverage is
also terminated. Working for the employer is a condition of
having the coverage.
Related to the concept of group coverage is the association
plan. Professional associations such as the American Medical
Association or the American Bar Association offer association
or group-type disability income coverage to association
members. Basically, association coverage is individual
coverage. As a member of a professional association, the
member would complete an application for insurance and an
In the United States, more mortgage foreclosures happen not
because of death but because of disability. We tend to insure
"things," purchasing protection against premature death but
too often we overlook our most important asset, the ability to
earn an income.
When someone suffers a serious disability, life insurance is of
no value. Benefits related to a pension plan are not readily
available and, if an individual can qualify for Social Security
disability benefits (this is a big if, as we'll show later), actual
receipt of the money is at least one year after the disability
strikes. Earned income stops, but all of normal expenses
continue and the added medical and related expenses of the
disability add to the amount. Although there are certain
statutory disability benefits available, most earners are
probably best protected by having some amount of disability
income insurance.
Disability income insurance is basically paycheck insurance. If
an insured is totally disabled due to accident or sickness, the
policy will provide income to replace part of lost income, which
is defined as salary, wages, commissions, fees, or other
earned remuneration. It excludes rents, royalties, interest,
dividends, and other forms of unearned income. Further, most
insurers will limit the amount of disability income insurance
which they will issue to 70 or 75 percent of gross earned
income. The reason for this limitation is to encourage them to
return to work by providing benefits which are no greater than
net pay. If people could insure 100 percent of their gross
income, there would be little incentive to return to work,
because the insured would be receiving an income (usually
tax free) greater than take-home pay.
Net worth may also serve as a limiting factor. If net worth is
high, say several hundred thousand dollars or more, the
insurer may decline to provide any disability income coverage.
Statutory Protections
There are two primary statutory programs available in the
event of a disability: Social Security and workers
compensation insurance.
To be eligible for Social Security disability benefits, the
individual must be fully insured, which means that you have at
least 40 calendar quarters of coverage during which he or she
have paid Social Security taxes. In essence, this means that
Social Security taxes must be paid for at least ten years.
The individual must also satisfy the Social Security definition
of total disability: "the inability to engage in any substantial
gainful activity by reason of any physical or mental impairment
which is expected to last for at least 12 months and/or end in
death."
For Social Security benefits to kick in, the disability must be so
severe that the individual is unable to work in any gainful
employment which exists in the national economy regardless
of whether such work exists in the immediate area where he
or she lives or whether a specific job vacancy exists.
In addition, a five-month waiting period must be satisfied
before qualifying for benefits. Once a claim is filed following
the elimination period, It will take several months for the claim
to be processed. In reality, even if qualified for Social Security
benefits, the disabled person won't receive the first check until
nearly the end of the first year of disability.
The disability benefit received from Social Security is equal to
the individual’s Primary Insurance Amount (PIA). The PIA is
based on the claimant’s average earnings history under Social
Security. Depending on the claimant’s average earnings, age
at the onset of the disability and dependent status, the
monthly benefit generally can range from a low of $400 to a
high of $1,500 or more.
17
was insufficient to warrant such an increase in monthly
benefits."
Sanghavi sued Paul Revere in June 1983, claiming that Paul
Revere breached its contract with him by not increasing his
monthly benefits in accordance with the rider. He also alleged
that Paul Revere had violated the Connecticut Unfair Trade
Practices Act (CUTPA), and he sought retroactive payment of
the additional benefits due since the suit was filed.
Five years, later, in June 1988, a state trial judge found in
favor of Sanghavi that Paul Revere had breached its contract
and owed him retroactive benefits, but disagreed that the
company had violated fair trade practices.
In particular, the court found that conditions three and four in
the rider were invalid and retroactively awarded Sanghavi the
two increase options that he attempted to exercise in May
1982. The trial court also held that Sanghavi was entitled to all
future increase options as they became due.
The trial court ruled that condition three was invalid because it
violated Connecticut insurance law, which required that the
policy, application and endorsements constitute the entire
insurance contract.
Condition three based the determination of whether an
increase in benefits will be granted by reference to "the
company's then published income limits." But the limits were
not appended to Sanghavi's policy, and at no time were such
limits made available to him.
The trial court ruled that by not providing income limits, the
insurance company failed to present the entire contract to
Sanghavi and enumerate all of his rights. Rather, the
company had drafted its policy in such a way that it could
modify the benefits it chose.
Condition four limited the policyholder to only one increase
during each period of disability. The trial court held that this
condition was invalid "because it was in conflict with the rider
itself, creating an ambiguity in the contract that must be
resolved against the Insurance company [or] because it was
inconspicuous and unenforceable."
Paul Revere appealed the court's decision that condition three
and four of the rider were invalid. The Supreme Court agreed
with the lower court on condition three but found condition four
valid. It "clearly and unambiguously state[d] that the
policyholder bargained for only one, increase in monthly
benefits during a period of disability. As a result, Sanghavi is
entitled only to one increase in benefits," the high court
concluded.
Definitions and Concepts
From the Sanghavi case, we can see how important it is to
clearly understand the contract. To fully understand disability
income insurance, you first need to understand the language
of the product. Following are some basic definitions and
concepts.
Disability income insurance is a contract which pays a
monthly benefit, following the elimination period, for total
disabilities due to accident or sickness. Disability income
policies are sometimes called "loss of time" policies.
The elimination period (EP) is the period of time the
policyholder must be totally disabled before benefits are
payable. The elimination period is also known as the "waiting
period" (WP). The elimination period is usually measured in
days or months, such as 30, 60, or 90 days; or one month,
three months, six months, etc.
The benefit period (BP) is the length of time benefits will be
paid for each disability following the elimination period.
The benefit period is usually expressed in years, i.e., one
year, two years, five years or to age 65.
For example, when an applicant elects a five-year benefit
period, total disability benefits will be paid for up to five years
for each claim or disability sustained by the policyholder. It
should also be noted that benefits are paid for each day of a
disability after the elimination period has been satisfied. For
example if a policyholder had a 30 day EP and was totally
disabled for 35 days, he or she would receive five-thirtieths of
the monthly benefit for the five days of total disability following
the EP.
individual policy would be issued through the association.
Association plans are "packaged plans" in that only certain
elimination periods, benefit periods, and benefit amounts are
offered to members.
Premiums for association coverage are usually banded or
grouped based on increments of age. For example, everyone
ages 25-30 pays the same premium; ages banded between
31 and 35 would pay the same premium and other bands of
five years would continue to age 55 or possibly age 60.
Typically, the amounts of coverage are also predetermined
such as a $1,000 benefit or a $2,000 plan. This packaging of
the product is facilitated by the fact that all members have the
same occupational classification and job duties, i.e.,
physicians, lawyers, etc.
Association plans may offer a minimum guaranteed issue
policy without regard to the insurability of the member. This of
course, is an advantage for the uninsurable individual.
Through an association plan, members can acquire disability
income insurance regardless of their health history.
Disadvantages of association coverage include the fact that
the policy may be canceled by the insurer or the association.
In essence, the association members are "renting" the
coverage much like the participant in an employer-employee
group plan. In addition, the coverage is lost if the individual
drops membership in the association.
A final disadvantage is the fact that the premiums are not
guaranteed. The insurer can raise the premium for the entire
plan. Also, members will pay higher premiums whenever they
move into a new age band.
Conditional Disability Riders
The Supreme Court of Connecticut considered the language
of conditional disability riders added to a standard disability
income policy in the 1990 decision Jagdish Sanghavi v. The
Paul Revere Life Insurance Co.
Paul Revere issued a disability policy to Sanghavi in July
1976 that provided indemnity benefits of $600 per month
during the period of disability. For an additional premium, Paul
Revere issued a rider to the policy that provided for seven
future income options, each in the amount of $100 per month
that could be exercised by Sanghavi until July 1990.
Specifically, the rider stated that monthly payments would be
increased, regardless of the status of Sanghavi's health,
provided that he met four conditions:
1. That the insured submit a written request and pay an
additional premium, unless the premium is waived,
within prescribed time limits.
2. The requested increase cannot exceed the maximum
disability income coverage then being offered by the
company to new applicants of the same classification
of risk as is the insured, according to the company's
then published underwriting and participation limits.
3. The insured's monthly earned income is sufficient to
qualify for an increase on the anniversary option date
according to the company's then published income
limits.
4. The insured may exercise only one increase during
each period of the continuous disability regardless of
the number of anniversary options which become
due during such disability."
In July 1978, Sanghavi completed and forwarded an
application to exercise the first option pursuant to the rider.
His application was approved and his monthly benefit was
increased by $100 to $700 per month.
In February 1979, Sanghavi was declared to be totally
disabled. In accordance with the policy, Paul Revere paid
Sanghavi $700 per month.
Exercising Income Options
By correspondence dated May 1982, Sanghavi attempted to
exercise two options to purchase additional monthly benefits
which would have increased his monthly benefits to $900.
Paul Revere refused to honor Sanghavi's request, claiming,
under the third condition: "that Sanghavi failed to provide
adequate information concerning his income and other
sources of disability insurance; and that Sanghavi's income
18
of the benefit for the lifetime of the policyholder;
59, total benefits are paid to age 65; then 60 percent
of the benefit for the lifetime of the policyholder;

60, total benefits are paid to age 65; then 50 percent
of the benefit for the lifetime of the policyholder.
This progression of benefits would continue until age 65. If the
total disability began at age 65 (normally the policy is not
renewed past age 65), then the payment of total disability
benefits would be limited to one or two years.
Selling Disability Income Coverage
A broker or agent should conduct a fact finding interview to
determine the specific needs and concerns of the applicant so
he or she can make a competent and professional
recommendation. The essential elements of the interview
should include:

personal information; name, address, occupation,
dependent status, etc.;

individual insurance; individually owned life, health,
and disability income insurance including names of
insurers, amounts of coverage, and beneficiary
designations;

statutory
benefits;
eligibility
for
workers
compensation, social security or other similar
benefits;

business information, business address, earned
income, specific occupational duties, employee
benefits (group health, group life, pension, sick
days);

liabilities; fixed monthly expenses (rent, food, shelter,
clothing, insurance premiums, etc.) and variable
monthly expenses (medical, dental, home or auto
repair, etc.);

other assets-savings, investments and unearned
income.
In addition to this factual type of information, you should
discuss their goals, objectives or special needs, such as
educational objectives for dependent children, business
objectives, retirement goals, etc. Upon completion, the agent
should be able to generate a proposal for an individual
program of disability income coverage that suits the individual
needs of the prospect.
An applicant may be required to have a physical examination
performed by a doctor or paramedical facility in lieu of simply
answering medical questions posed by the agent. Depending
on the medical problem, an applicant's personal physician
maybe requested to complete an Attending Physician's
Statement (APS). The purpose of this report is to provide
more detailed information about an applicant's medical history
or current physical condition.
Normally, the amount at risk, age of the applicant,
occupational class and the benefit period elected are the
factors which determine whether or not a physical exam is
necessary.
Disability income premiums are based on age, sex, and
occupation of the policyholder. The application is the principal
tool of the underwriter as it will contain important information
about the risk which will include:

the age, sex and occupation of the applicant;

past medical history and current physical condition;

moral habits;

information regarding other insurance owned,

family history information;

unusual hobbies or avocations.
Statistically, females become disabled more frequently than
do males. Therefore, females present a higher risk.
Accordingly, the disability income premium for females will be
higher than for males. The opposite is true with regard to
females and life insurance underwriting. Ironically, women
tend to take care of themselves better than men.
Consequently, they use health insurance more frequently than
their male counterparts. This contributes to their longer life
expectancy and lower life insurance rates but due to more
Evidence of insurability is sometimes required by the insurer
before a policy will be issued. This is especially important for
seniors, since it becomes more and more difficult to prove you
are insurable as you get older. Insurers may require detailed
answers to medical questions or even a physical examination,
and may increase standard rates or even decline to issue an
individual policy depending on the answers to those questions
or the results of the examination.
The free look provision gives the policyholder the opportunity
to review the policy upon receipt and return it to the insurer
within ten days for a refund of all premiums paid if not
satisfied for any reason. This provision must be included by
law in almost all individual life and health insurance policies so
that consumers can have time to review the entire policy after
it is delivered and decide whether or not it is the right policy
for them.
A disability income policy may be issued as cancelable,
optionally
renewable,
guaranteed
renewable,
or
noncancelable.
You may have noticed in reading through this section that
most provisions are applicable only until the policyholder's
65th birthday. Most often, the policy will not be renewed past
the policyholder's 65th birthday regardless of the type of
renewability. It is assumed that the policyholder will retire and
no longer be employed or have any earned income to protect.
However, in the event that the policyholder does not retire at
age 65 and continues to work and earn an income, the
disability income policy may be conditionally renewable past
age 65. The policy may be continued for subsequent one year
periods on the condition that the policyholder continues to
work full time, or a certain number of hours per week, and
earn an income. This period of conditional renewability will
continue to age 70 or 72. On each annual renewal date, the
premium will be increased. Additional riders, especially riders
like residual disability benefits, are usually not allowed.
A Future Increase Option may also be referred to as the
Guaranteed Insurability Option, since it enables the
policyholder to purchase additional disability income
protection, regardless of his or her insurability, at specified
future dates.
The future increase option is more important to applicants
who are under 40 years of age as it protects future insurability
by providing the guaranteed right to purchase additional
amounts of disability income insurance in subsequent years.
Normally, the rider is not available past age 40 although some
insurers may offer it up to age 50.
The Cost of Living Benefit adjusts benefits over time. The
purchasing power of fixed disability benefits may be eroded
due to inflation and increases in the cost of living. To protect
against these trends, most insurers will offer an optional cost
of living benefit.
The Lifetime Benefits Option extends the benefit period from
age 65 to lifetime. This extension may apply to accident only
benefits or to accident and sickness benefits. Normally, if the
total disability is due to an accident occurring before age 65,
benefits will be paid for the lifetime of the policyholder
provided he or she remains totally disabled.
Most companies will place some time limitations on the
lifetime sickness benefit. That is, the disabling sickness must
begin prior to a specified age such as 50, 55 or 60. A policy
providing lifetime sickness benefits may stipulate that if the
sickness begins at age 55 or earlier, then 100 percent of the
total disability benefit will be provided for the lifetime of the
policyholder. However, if the disability begins after age 55, but
before age 65, a reduced benefit will be paid for life.
For example, a policy might state the following: If total
disability, due to sickness, begins at age 55 or earlier, total
disability benefits will be paid for the lifetime of the
policyholder. If total disability benefits begin at age:

56, total benefits are paid to age 65; then 90 percent
of the benefit for the lifetime of the policyholder;

57, total benefits are paid to age 65; then 80 percent
of the benefit for the lifetime of the policyholder;

58, total benefits are paid to age 65; then 70 percent

19
the monthly benefit payable will be reduced by the
amount of the following other income benefits...
Partial Payment
Transport Life paid 60 percent of Wallace's salary from
December 1984 to March 1987. In April 1987, the company
didn't make the payment. Instead, it demanded that Wallace
sign a letter agreeing to apply for Social Security benefits as
an offset against the amounts payable under the plan.
Wallace signed the letter, applied for and began to receive
Social Security benefits. Payments also began for his wife and
child. Transport Life also notified Wallace that his prior lengthy
delay in seeking Social Security benefits had created an offset
against the future plan payments.
Wallace sued his employer and Transport Life, seeking
disability payments not made since April 1987, damages for
emotional distress, mental suffering and bad faith. He argued
that he'd been coerced into seeking Social Security benefits.
Transport Life countersued for the amount of its alleged
overpayment.
The trial court held the plan to be within the scope of the
ERISA. (State courts have been granted concurrent
jurisdiction with federal courts to determine and enforce rights
under an insurance plan covered by ERISA.)
The trial court held that Transport Life was entitled to the
difference between the plan payments actually made and
those that would have been due if Wallace had applied for
Social Security benefits when eligible, as required by the plan
provisions.
The trial court also found the plan provisions requiring
Wallace to apply for Social Security or other benefits were
clear, unambiguous and not in violation of public policy.
The Oklahoma Supreme Court upheld the lower court's ruling.
Standard vs. Substandard Risks
Once all the underwriting information on an applicant has
been reviewed, a decision is made as to acceptance of the
risk. Most applicants are classified as standard risks, which
basically mean they fit the norm. They are an average risk
and the policy will be issued as applied for by the applicant.
The rate or premium charged will be the standard premium
relative to the individual's age, sex, occupation, benefit
amount, elimination and benefit periods selected.
While an estimated 90 percent of life insurance risks are
accepted, only about 75 percent of disability income risks are
accepted. Sometimes an applicant for disability income is
classified as substandard due to some underwriting reasons
such as a past or current medical problem. Remember that
the risk being insured is disability and not death. Thus, if an
applicant has a history of a bad back, this medical problem
would not affect the underwriting of life insurance, but very
definitely would affect the underwriting of disability income. An
applicant will not die due to a backache, but certainly could
become totally and even permanently disabled.
When an applicant is classified as substandard due to medical
history or current physical condition, the insurer has several
alternatives available for issuance of a substandard disability
income policy.

An extra premium may be charged to compensate
for the higher risk involved.

A rider may be attached to the policy modifying the
coverage. A full exclusion rider is used when the
nature of the condition is likely to result in recurrent
disabilities. For example, a full back exclusion rider
may be used for chronic back disorders.

A qualified condition exclusion rider may be used to
exclude coverage for a specified medical problem for
a specified period of time. This is normally
accomplished by altering the elimination period or
benefit period for the particular medical condition.

Depending on the medical condition, the insurer may
increase the elimination period or shorten the benefit
period to compensate for the medical disorder.

A final alternative available to the underwriter and the
insurer is simply to deny coverage due to the medical
condition.
usage of the health insurance policy, the females pay higher
rates.
Occupation is an underwriting factor for both life and health
insurance. A policeman applying for life insurance is normally
a standard risk and does not present any unusual hazard with
regard to mortality. However, due to the nature of the work, a
police officer applying for disability income insurance is a
different matter. The officer is more likely to be injured and
thus disabled due to the occupational risks involved.
Therefore, as an underwriting factor, occupation is more
heavily weighted in terms of disability income coverage.
Dangerous Avocations
Related to hazardous occupations is the hazardous avocation
factor. Hobbies, such as skin diving, scuba diving, sky diving,
and auto racing are certainly more hazardous than golf or
tennis. As such, the underwriter must be made aware of these
high risk hobbies when considering the applicant for disability
income.
The applicant’s medical profile will normally consist of past
medical history and current physical condition. To a degree,
family medical history may also be a factor.
To prevent over insurance, it is necessary for the insurer to be
aware of any other disability income coverage in force. The
agent has to obtain accurate information regarding the
amount of other coverage, elimination and benefit periods.
The insurance company may have specific issue and
participation limits which are based on the applicant's earned
income. As a general rule, most insurers will offer coverage
equal to 60 or 70 percent of earned income. This limitation
may also be adjusted (decreased) due to the occupational
class of the applicant. Most insurers will offer smaller amounts
of disability income protection to those in the more hazardous
occupations.
Another financial underwriting factor is other disability income
coverage which the applicant may have. Any amount of
coverage applied for may be reduced by the amount of
coverage in any other insurance.
The Employee Retirement Income Security Act of 1974
(ERISA) is a federal law that sets minimum standards for most
voluntarily established pension and health plans in private
industry to provide protection for individuals in these plans.
In discussing the guidelines that allow a plan under ERISA to
incorporate the Social Security benefits paid, the Supreme
Court has said:
It is particularly pertinent for our purposes that Congress did
not prohibit "integration," a calculation practice under which
benefit levels are determined by combining pension funds with
other income streams available to the retired employees.
Through integration, each income stream contributes for
calculation purposes to the total benefit pool to be distributed
to all the retired employees, even if the non-pension funds are
available only to a subgroup of the employees. Under this
practice, an individual employee's eligibility for Social Security
would advantage all participants in his private pension plan,
for the addition of his anticipated Social Security payments to
the total benefit pool would permit a higher average pension
pay out for each participant.
Income Influences Disability Payments
In the 1992 decision Harvey Wallace v. Transport Life
Insurance Co. et al., the Oklahoma Court of Appeals
considered the other benefits and income streams that
influenced disability payments.
Harvey Wallace was employed by Oklahoma Farmers Union
Mutual Company. In August, 1984, at the age of 46, he
became disabled due to heart disease and was unable to
work. Farmers provided a group disability insurance plan
through Transport Life Insurance Company. In essence, the
plan provided that 90 days after disability, it would pay 60
percent of Wallace's salary until he reached 65 years of age.
The Plan contained the qualifying provision:
"If an insured employee is entitled to other income
benefits... or if such income benefits become payable to
the insured employee for the same period of disability for
which a monthly benefit is payable, then the amount of
20
How Net Worth Comes into Play
Net worth may serve as a limiting factor for the amount of
disability income insurance an applicant can purchase. In fact,
the financial underwriting process is said to be as rigid as the
medical underwriting in disability income insurance. A wealthy
person with a net worth of several hundred thousand dollars
or more may have the amount of insurance limited, or the
insurer may decline to provide any disability income coverage.
Of course, those who are very wealthy probably do not need
disability income insurance.
The amount of total net worth and the liquidity of such assets
will determine whether a reduced amount of disability income
will be issued (or even no coverage at all). If a person's assets
are easily marketable and/or if the total net worth reflects a
large amount of unearned income, then the underwriter may
decide that the applicant is not eligible for any coverage.
A plan with a 60 day elimination period generally costs about
20 percent less than a plan with a 30 day EP. Longer
elimination periods will reduce the premium even more. Most
companies will offer elimination periods from 30 days to as
long as two years, but the longer EP may not be to the
insured’s best advantage.
When determining which elimination period to elect, the
applicant asks him or her self, "How long can I go without any
income from my disability income plan?
Their answer should depend on:

fixed obligations such as mortgage or rent payments,
car payments, utilities, food, installment purchases,
insurance premiums, etc.;

other expenses: unexpected, non-fixed expenses
which occur from month-to-month, such as the
automobile repair, medical expenses, prescriptions,
home repairs, the dreaded miscellaneous expenses,
etc.
In addition, the insured will have the added expense of the
disability, such as medications, doctor's bills, medical
equipment (such as wheelchairs) and hospital bills which are
not fully covered by hospitalization insurance.
Be careful of assuming that because the insured earns a high
income that he or she can live with a six-month or even 90day elimination period. Usually the more income people earn,
the more they spend and the higher their expenses. An
executive earning $250,000 may not have anymore liquidity
than a worker earning $25,000.
CHAPTER
LONG-TERM CARE
INSURANCE
3
Better medical care means more of us will be living into our
eighties, nineties and beyond. But even though life
expectancy has increased, many older individuals have
serious health problems that keep them from living on their
own or completely caring for themselves.
There are over 35 million people over the age of 65,
accounting for 13 percent of the population. Of that number,
about 70 percent will suffer from a cognitive impairment or
have limitations requiring long-term care services.
The fear of running out of money in your old age and
becoming a burden to children or other family members is a
powerful incentive to purchase long-term care (LTC)
insurance.
The costs of those facilities do run high. Insurance industry
experts have estimated that the cost of long-term care will
financially ruin 70 percent of all single people admitted to a
nursing home within three months and 50 percent of all
couples within six months after one spouse is admitted.
Given population trends, by 2040 as many as 5.9 million
people may reside in nursing homes. Currently, over 3.5
million senior citizens receive LTC services in their homes,
and more than 1.5 million live in licensed nursing homes.
By 2011, those over 65 will number 38 million and represent
14 percent of the population. Thus, the numbers of people
potentially requiring LTC will increase as will the "dependency
ratio" or the relationship between retired and nonworking
people to FICA-taxpaying workers. By 2011, over 6 million
elders will need LTC services.
Statistically, the likelihood of a person requiring confinement
in a nursing home after age 65 is about one in three. At age
75, this likelihood is about one in two. In 2000, the average
annual cost for a person confined to a nursing home was
$50,000.
The Myths that Color Many Decisions
Half-truths and myths about LTC and its financing persist:

The belief that the person will never need LTC
services;

The highly questionable generalization that home
care costs much less than nursing home care;

The fear that all nursing homes are terrible and
abuse the residents;

The myth of no difference in quality among nursing
homes;

The hope that retirement income, savings, and real
estate assets will be adequate, and will not be
depleted by LTC costs;

The
myth
that
Medicare
and
Medicare
Supplementary (Medigap) insurance are significant
LTC payers. Too few people understand that
Medicare coverage covers only two percent of LTC
services and more importantly, that uncovered LTC
costs often exceed the costs of acute medical care;

The hope that the government will pay for LTC,
whether through Medicaid or through creation of
some new comprehensive program. Yet it is unlikely
that any expensive new government programs will be
created in the near future at least until budget deficits
can be reduced; and

The myth that private LTC insurance is not affordable
and the related assumption, that since it is not
affordable, it offers poor value.
One thing is true: the longer people wait to purchase a longterm health care policy, the more expensive the coverage and
21
married William Thompson and had children, she treated
Shirley's children like grandchildren. Indeed, Shirley
Thompson testified that she and Wroblew were as close as a
mother and daughter. Likewise, William Thompson, all the
children and their spouses testified to having a close personal
relationship with Wroblew.
The Thompsons lived in a house that Wroblew and her
husband had purchased for them, paying nominal rent at first
until Wroblew gave the house outright to Shirley. Over the
years, Wroblew gave gifts to Shirley and her family, mostly in
cash. On one occasion, she gave the Thompsons $9,000 for a
driveway and on another occasion she gave Shirley $12,000
to divide evenly among the children. None of these gifts came
with any conditions.
In 1988, a year after her husband died, Mrs. Wroblew
returned to Connecticut from Florida where she had lived
since 1976. During the next year she moved frequently, finally
settling in an apartment in Hamden in June 1989. She
enjoyed a good relationship with the Thompsons and their
children during this time and saw them frequently.
In June 1990, Wroblew decided to try to get a place in a
senior citizen's home in North Haven and devised a plan that
she believed would help her get into the home without waiting
several years. At the time, Wroblew made her own decisions
about her money but Shirley's husband William helped her
with her taxes. She discussed her plan with him and they both
agreed with it and approved it.
Wroblew had $100,000 in maturing certificates of deposit
which listed the Thompsons and their children as beneficiaries
in the event of her death. Mrs. Wroblew decided to divide the
$100,000 by ten, giving $10,000 to Shirley, William, their five
children and three daughter’s in-law with the understanding
that they were to invest the money in their own names in six
month certificates of deposit and name her as beneficiary on
the account in the event of death.
Furthermore, while they could use any interest earned they
were not to touch the principal and they were to return the
money to Wroblew when she needed it.
Wroblew discussed these terms with Shirley and William
Thompson and told them to tell the others what she wanted
done. Shirley assured Wroblew that she shouldn't worry and if
she needed the money she could get it back at any time.
Likewise, William told Wroblew that he would follow her
instructions and pass them on to the children. Wroblew
withdrew the funds and distributed them to the Thompsons.
Sometime in August 1990, Wroblew changed her mind about
the senior citizen's home and decided to move to Florida with
Bill Thompson and his wife Susan. The three of them left for
Florida at the end of September. Shortly thereafter, Bill and
Susan returned to Connecticut for a visit and told the other
family members that Wroblew would be asking for her money
back to use to purchase a house in Florida in which they
would all live.
When Wroblew telephoned, asking the Thompsons to return
her money, they refused.
Bryan Thompson testified that he originally agreed to give the
money back to Wroblew but changed his mind when he
learned that she was going to use the money to buy a house
for Bill and Susan. Shirley Thompson testified that she didn't
feel that Wroblew was treating all her children evenly because
the money would benefit Bill and Susan. Shirley and William,
Sr. testified that they felt Wroblew was asking for "our money"
back.
When all the certificates of deposit matured, instead of
returning the money, Shirley and William took the funds and
placed them in their joint account. David put the money in a
certificate of deposit in his own name. Patricia rolled the funds
over into a certificate in her own name and later loaned some
of the money to her sister. James took $5,000 and used it to
buy a used car and put the balance in a joint savings account
with his wife. Cheryl put the funds in a certificate in the name
of herself and her husband. Kathleen put the funds in her own
savings account. Bryan put the funds in a certificate in his own
name which he has continued to roll over.
Bill and Susan Thompson testified that Wroblew spent time
greater the chance that a preexisting condition will disqualify
them for coverage or reduce potential benefits.
The skilled nursing care provided by Medicare and Medicare
supplements is extremely limited. Medicare pays less than
five percent of the United States annual nursing home
expenses. To be eligible, a person must be admitted to a
nursing home within 30 days of a hospital stay that lasted at
least three days; coverage for skilled nursing care is limited to
100 days per calendar year and there is a co-payment
required.
Many times, the person is admitted to a nursing home
because he or she needs custodial care, in which case
Medicare pays nothing.
The primary methods available for meeting the costs incurred
due to a nursing home confinement include:

personal income and assets;

gifts and financial support from family members;

some local government or social service programs;

Medicaid;

Medicare;

Long-term Care insurance.
What LTC Insurance Covers
LTC insurance pays for the kind of care needed for individuals
who have a chronic illness or disability. Although some
consumers and even some insurance producers still view the
product as coverage for a nursing home stay, a modern LTC
policy also provides coverage for home-based care, visiting
nurses, chore services, and respite care for daily care givers
who need time away from these difficult duties.
LTC insurance usually provides coverage for at least 12
consecutive months for medically necessary diagnostic,
preventive, therapeutic, rehabilitative, maintenance, or
personal care services, provided in a setting other than an
acute care unit of a hospital.
This kind of insurance normally provides a daily benefit
(usually $50 to $250) following an elimination period (EP). The
EP usually expressed as 30, 60 or 90 days, and serves as a
"time deductible" during which no benefits are provided. Once
the EP is satisfied and the daily benefit begins to accrue, it will
usually be paid for the benefit period selected by the
policyholder. Typical benefit periods range from one to five
years.
Regulatory Uncertainty Poses Risks
LTC insurance is still in an evolutionary stage. In 1980, there
were a few standard products offered. By 1990, a wide variety
of products had emerged. There are literally hundreds of
individual contracts available today, each with its own unique
language since these polices have not been standardized like
Medicare supplement policies.
For example, early LTC policies excluded Alzheimer's
disease. Today, most policies cover this ailment. In addition,
early policies usually required a period of prior hospitalization
before benefits were triggered. Many of today's policies do not
have such a requirement.
In the early years, the LTC policy was a contract sold only to
individuals. Today LTC coverage is also marketed on a group
basis, as an employer-sponsored benefit, and as a rider to life
insurance policies.
Probably the most important advantage to ownership of LTC
insurance is protection of personal assets. There is protection
against the risk of liquidating assets and exhausting personal
financial resources to pay for a nursing home stay.
Dangerous Manipulations
Many older people resort to complicated financial acrobatics
to qualify for Medicaid support for their long-term care needs.
This can be an extremely risky process. The 1993
Connecticut decision Alice Wroblew v. Shirley Thompson
shows just how risky this can be.
Alice Wroblew was an 85-year-old woman who had been
widowed for the second time. Although Mrs. Wroblew had no
children of her own, she had spent 14 years raising her
sister's daughter, Shirley Thompson, giving up her job to do
so. She treated Shirley like a daughter and, when Shirley
22
provision which basically will not provide benefits for any
preexisting condition during the first six months that the policy
is in force. More liberal policies may state that all preexisting
conditions are covered as of the effective date of the policy if
the condition is stated on the application.
A preexisting condition is usually defined as any medical
treatment or advice received or recommended within a certain
period of time prior to the effective date of coverage. The
specified period of time is most often six months. The
definition of preexisting condition does not prohibit an insurer
from using an application form that elicits the applicant's
complete health history, or underwriting based on the
applicant's answers. No long-term care insurance policy may
exclude, limit, or reduce coverage or benefits for specifically
named or described preexisting conditions or diseases
beyond the waiting period.
One way to limit the insurer's risk with regard to preexisting or
impaired conditions is by means of reduced benefit amounts.
Marie applies for a LTC policy with a daily benefit amount of
$150, following a 30-day elimination period. Benefits are
payable for up to five years. Marie indicates on the application
that she has several medical problems: high blood pressure,
arthritis, borderline diabetes, and hardening of the arteries.
Marie's medical history presents underwriting problems. One
recourse will be to limit the daily benefit for this impaired risk.
For example, the underwriter may approve the policy issue
but only for $50 per day in benefits. In essence, the policy is
reduced from a total benefit of $273,750 (five years x $150
per day) to $91,250.
Another underwriting device which can be used with Marie's
case is to increase the elimination period from 30 days to
possibly 90 or 100 days.
Finally, the underwriter could approve the policy with a shorter
benefit period to reduce the dollar amount of the potential loss
to the insurer.
Prior Hospitalization
Early policies normally required a period of prior
hospitalization before the policyholder would be eligible for
benefits. Most of the newer versions of LTC policies no longer
require prior hospitalization as a condition for receipt of
benefits. Some insurers may offer prior hospitalization as an
optional provision to be elected or rejected by the
policyholder.
When elected, the cost of the LTC policy will be slightly less
than a policy without the prior hospitalization provision.
However, many states require that when benefits are only
provided following institutionalization, they cannot be
conditioned upon admission to a facility for the same or
related conditions within a period of less than 30 days from
date of discharge.
In general, a policyholder must meet one of three
requirements in order to receive LTC insurance benefits.
Some policies feature a “medical necessity” benefit trigger,
which allows a person to receive covered care if a physician
and an insurer agree that the patient requires regular
assistance to maintain personal health and safety. More
commonly, however, benefits are triggered when a person is
either diagnosed with a cognitive impairment, such as
Alzheimer’s disease, or is unable to perform a certain number
of six so-called “activities of daily living” (ADLs). For example,
if an individual is unable to perform personal hygiene or is
unable to walk or "get around," he or she might be eligible for
admission to a nursing home and payment of policy benefits.
Newer policies take a liberal approach to the needs for LTC
protection due to the fact that they do not require that the
policyholder's admission to the nursing home be related to a
sickness or injury.
The recurring provision found in LTC policies is similar to the
relapse provisions found in other forms of health insurance.
Under this provision, if the policyholder is released from a
nursing home and is re-admitted within 180 days of the
discharge due to the same or a related condition, the second
admission (the relapse) will be considered a continuation of
the previous nursing home stay. If 180 days has elapsed
crying in her room, was despondent, wouldn't eat, and
threatened suicide over the refusal to return her money.
The court had to decide whether Wroblew made a gift of her
money to the defendants. "Wroblew's intentions can be
ascertained from her words and her actions," the court ruled.
"Clearly, Wroblew intended that if any of the Thompsons died
during the time they held her money the funds were to revert
to her rather than belong to their individual estates. Just as
clearly, she intended for the Thompsons to return her money
upon her request."
By refusing to return her funds, the Thompsons engaged in
unauthorized acts over Wroblew's money with the intention of
permanently depriving her of the property and to her clear
harm.
In summary, the court found that "there was a special
relationship of confidence between Wroblew and the
defendants, that Wroblew did not intend to give her money to
the defendants but rather for them to hold it for her and return
it upon her request, that the defendants failed to honor
Wroblew's request for the return of the money, that the
defendants then used Wroblew's money for their own benefit
and that they were thereby unjustly enriched."
The Thompsons suggested that Wroblew was equally at fault
because her efforts to divest herself of her savings were an
attempt to defraud the senior citizen's home where she
thought she wished to live. The court found two problems with
this argument. First, there was no indication that Wroblew
intended to perpetuate a fraud upon the court. Second, she
never actually applied for admission to the senior citizen's
home; therefore no fraud was perpetrated on it.
The Thompsons were each directed to pay to the plaintiff the
amount of $10,000 plus interest at ten percent a year from
December 1990 until the certificates of deposit became due.
Further, the court awarded $40,000 in damages to Wroblew
for negligent infliction of emotional distress, for which the
defendants were held jointly and severally liable.
Wroblew got her money back. But she probably should have
bought LTC insurance and avoided the whole problem.
Benefit Schedules
LTC policies, even though they are not standardized, contain
similar benefits and provisions. Occasionally, some of these
policies will offer newer or unique benefits or features. We will
attempt to draw a composite of the common benefit features
and provisions found in most individual contracts.
Most LTC policies provide a daily benefit during confinement.
Benefit amounts range from $50 per day up to $200 or $250
per day. Some insurers may pay the actual charges incurred.
To illustrate these points, let's use the example of Kim who
has a LTC policy with a 30 day elimination period, a daily
benefit of $75 per day and a two-year benefit period. Kim is
confined to a nursing home for a total of seven months. Her
benefit calculation would be as follows:
First 30 days: No benefit paid (elimination period)
Next six months: $75 per day (assumes 30-day month)
$75 x 180 = $13,500
If Kim's actual charges were more than $75 per day, this
amount would have to be paid by her.
Most individual LTC policies are guaranteed renewable. That
is, the insurance company guarantees to renew the policy but
reserves the right to increase the premium. A small number of
individual LTC policies are optionally renewable. The insurer
has the option to renew, cancel, or increase the premium by
class. Eventually, there may be non-cancelable LTC contracts
where the right to renew and premium are guaranteed for the
life of the policy.
If the premiums are to be increased, they will be changed on
the policy anniversary and the increased premium will apply to
an entire class of policyholders, not just a single individual.
For example, all policyholders in a given state might have
their premiums increased on their respective policy
anniversaries.
LTC Preexisting Conditions
All policies will contain a preexisting condition provision of
some kind. Most will contain a six month preexisting condition
23
element of the coverage or be declined.
since the individual was released from the nursing home
facility, a subsequent admission for the same or a related
cause will result in a new elimination and benefit period.
Spousal Coverage
Often one spouse is confined to a nursing home and the other
spouse remains at home. Since the income and assets of
both spouses are considered when determining eligibility for
Medicaid, the process of income and asset depletion could,
and often did, reduce the stay-at-home spouse to the point of
poverty as well as the confined spouse. Before coverage
would begin, the healthy spouse would either be driven in
poverty or have to divorce the ill spouse so that he or she
could qualify as a single person. This created a generation of
so-called "nursing home widows," who had to take drastic
measures to make sure that their mates received decent care
while still protecting some existing assets.
To remedy the situation, Congress passed the Spousal
Impoverishment Act which protects a portion of the income
and assets that a stay-at-home spouse may retain without
terminating Medicaid eligibility for a confined spouse.
Under rules which took effect in 2003 the healthy spouse was
allowed to keep some of the couple's joint monthly income (a
minimum consisting of the first $1,493 of monthly income, up
to a maximum of $2,675 of joint monthly income) and joint
assets (not to exceed to maximum of $90,660 of assets).
These amounts are indexed for inflation and increase
annually.
The federal law provides a degree of protection for a healthy
spouse, but it is designed to be a safety net and is not a
substitute for insurance. Without long-term care insurance,
most middle and upper-class families would still be exposed
to a considerable reduction in family resources if an extended
stay in a nursing home became necessary.
Underwriting LTC Insurance
LTC policies contain some exclusions or limitations. Common
exclusions include: war or act of war, intentionally self-inflicted
injuries, losses covered by workers compensation or other
government programs, and losses due to personality
disorders which are not subject to a physical or organic
disease. Mental or personality disorders resulting from an
illness or accident are covered, including Alzheimer's disease.
Long-term care underwriting is concerned with the same
factors as health insurance underwriting, with the major
emphasis on the likelihood of prolonged confinement in a
nursing home.
For example, a person who has a heart condition that could
require surgery might not be a good candidate for health
insurance, but might be accepted for LTC insurance because
the condition would probably not result in a nursing home
stay.
The application will, of course, include questions about the
applicant’s health. Some companies use "short form" which
only asks if the applicant has been hospitalized in the last 12
months or is confined to a wheelchair. If the questions are
answered, "no," the policy will usually be issued.
It is important the applicant answers these health questions
truthfully. If the company later finds out he has lied about his
health, and the company relied on his statements to grant
coverage, it can cancel the policy and return the premiums
paid, leaving him with no coverage. They can usually do this
within two years after the policy is issued.
Medical information is extremely important to the underwriter.
Much of this information will be found on the application.
Additional medical information may be obtained from the
applicant by means of an investigative report or directly from
the applicant's doctor through the use of an Attending
Physician's Statement. Applicants for LTC insurance are
rarely required to take a complete physical exam.
Once all of the underwriting information is gathered, the
underwriter will basically classify the person as a standard or
substandard risk. Accordingly, if the applicant is a standard
risk, he or she will pay the standard rate or premium for the
policy. Substandard risks may have to pay an extra premium
for the policy, have a policy issued with a rider omitting some
24
Better Information Means Better Rates
Affordability is often cited as an issue and reason not to buy
LTC insurance. This argument is often made politically to
advocate universal LTC coverage. However, it also has to be
acknowledged that LTC often costs less than private medical
insurance. The amount of coverage may be geared to a
person's budget and strategy. The younger a person is, the
more affordable the coverage. The pricing of LTC products
depends on the following actuarial assumptions:

mortality;

persistency (the length of time a policy remains in
force without lapsing);

investment return earned by the insurance company;

expenses of marketing, compliance with government
regulations, and operations,

morbidity (i.e., the length of time benefits are paid);

state required minimum loss-reserve ratio;

company's underwriting standards and experience;
and

product profitability.
Considering these actuarial factors, it is possible to
understand the favorable cost benefit values and pricing of
LTC. Also, with LTC services required on average at about
the age of 80 and an estimated payment period of four years
at home and two years in a nursing home, it is understandable
that the premiums paid increase with age.
Policy Restrictions
Many of the recent generation of policies have been greatly
improved with standard provisions, home care benefits, and
valuable, affordable coverage. However, possibly only 50
percent of elders may qualify or be able to afford more than a
minimum level for Medicaid strategy purposes. LTC policies, if
available at all, become increasingly limited and restricted as
consumers age and as health care costs rise. Based on these
limitations and restrictions, some senior advisers believe the
insurance is not cost-effective if their clients wait until they are
elderly to apply for coverage.
A study by the United Seniors Health Cooperative showed
that 82 percent of long-term care policies contained clauses
that seriously restricted coverage. This makes it necessary for
the public to be made aware of the importance of purchasing
long-term care at a younger age to avoid exclusions.
Group plans, typically group health insurance, are written for
employer-employee situations, professional associations and
trade unions. Eligibility for participation in these group health
plans typically is restricted to employees and their
dependents.
Many employer group LTC contracts marketed today provide
the following participation eligibility:

the employee and spouse;

parents of both the employee and the spouse;

retired employees and their spouses.
This is very liberal in that it not only covers the employee and
his spouse but reaches out to provide coverage for a second
generation as well as retired workers and their spouses.
Standard Group Benefits
The standard benefits offered under group contracts are very
similar to those offered as individual policies. These benefits
include:

skilled nursing care;

intermediate care;

custodial care;

home health care;

certain optional benefits.
Hospice care may also be provided by the group policy as a
standard or optional benefit. Another optional policy benefit is
adult day care which provides the functionally impaired adult
with a day-time environment of social as well as certain
functional activities. Adult day care usually includes
transportation to the day care facility, at least one meal and
certain vocational or recreational activities.
Most group contracts provide that benefits will be paid based
on one or more of the following criteria:

the policyholder has been hospitalized for a minimum
period of time (usually three days) due to an accident
or illness and, due to the accident or illness, it is
necessary to confine the individual to a nursing
home;

the policyholder is forced into a nursing home due to
an accident or illness without the need for prior
hospitalization;

care is needed due to the fact that the person is
unable to perform some of the activities of daily living
(ADLs).
Most group contracts are on an indemnity basis as opposed to
an expense incurred concept. Daily benefits range from $50 to
$500.
Elimination periods under group contracts range from ten
days to three years and the benefit periods are usually three
to five years in length. Typically, the group elimination period
seems to fall between 30 and 90 days with at least a three
year benefit period.
LTC Riders
Some insurers offer long-term care coverage in the form of a
rider attached to a new issue of life insurance or possibly
some other policy form, such as a disability income policy.
With this marketing approach, there are two sales, the life sale
and the LTC sale which should be beneficial to the insurer,
the policyholder and the agent.
LTC rider benefits are very similar to those found in a LTC
policy. The benefit structure includes the following:

elimination periods in the range of ten days to three
years;

benefit periods of three to five years or longer;

prior hospitalization of at least three days may be
required;

benefits may be triggered by impaired activities of
daily living;

levels of care include: skilled, intermediate, custodial
and home health care.
In addition, certain optional benefits may also be provided
such as adult day care, cost of living protection, hospice care,
etc.
One difference with this "LTC package" is the method of
determining LTC benefits. The benefits may be expressed as
a specific daily amount: $50, $100 or $150 per day for
example. They may also be expressed as a factor of the face
amount of the life policy. For example, two percent of the face
amount of the policy may be paid monthly as a LTC benefit up
to a specified maximum.
This combination of life insurance and LTC benefits is
marketed as a "Living Benefit" or "Living Needs" rider. This
approach draws on the life insurance benefits to generate
LTC benefits. Thus, the LTC rider is attached to the life policy
"at no charge." In a sense, it's like borrowing from the life
insurance to pay LTC benefits.
Generally the "Living Needs" rider provides funds for LTC
expenses or for expenses incurred with a terminal illness.
Under this rider, the policyholder may be advanced life
insurance dollars to cover these expenses. There are usually
two options associated with this rider.
LTC Option
The first is the LTC Option which typically may provide up to
70 to 80 percent of the policy's death benefit to offset nursing
home expenses.
Terminal Illness Option
The second option is the Terminal Illness Option which can
provide 90 to 95 percent of the death benefit as a pre-death
benefit to be used to offset medical expenses.
One obvious difference of course is that the payment of LTC
benefits reduces the face amount of the life policy.
Two unique concepts have begun to appear involving the use
of annuities and disability income insurance. An annuity,
designed to be a retirement vehicle, may be issued with a
LTC rider in much the same way that the LTC rider may be
25
incorrect or untrue, the company has the right to deny benefits
or rescind the policy. Companies are generally prohibited from
"post claims underwriting," which means they investigate
medical records only when one files a claim or after entering
the nursing home and then attempts to deny benefits based
on inconsistencies in the application. If the insurer were
allowed to reject a claim, the insured would get their
premiums back.
Disclosure Requirements
An Outline of Coverage must be delivered at the time of
application for LTC insurance. For direct-response
solicitations, the Outline of Coverage must be delivered at the
applicant’s request, but no later than at the time of policy
delivery. The Outline of Coverage must include a description
of the principal benefits, and coverage provided, a statement
of the principal exclusions, reductions, and limitations of the
policy, its renewal provisions, including any reservation of a
right to change premiums, and a description of the insured’s
rights regarding continuation, conversion, and replacement.
The Outline of Coverage must state that it is a summary of the
policy only, and the policy should be consulted to determine
governing contractual provisions.
Certificates
A certificate issued under a group long-term care insurance
policy must include a description of the principal benefits and
coverage provided, a statement of the principal exclusions,
reductions, and limitations, a statement that the group master
policy determines governing contractual provisions.
Life Insurance
When an individual life insurance policy provides long-term
care benefits, it must be accompanied by a policy summary
that includes an explanation of how the long-term care
benefits interact with other components of the policy, an
explanation of the amount of benefits, the length of benefits,
and the guaranteed lifetime benefits, if any, for each covered
person, any exclusions, reductions, or limitations on long-term
care coverage If applicable, disclosure of effects of exercising
other rights under the policy, of guarantees related to longterm care costs, and current and projected lifetime benefits.
LTC Applications
Applications for long-term care insurance (except guaranteed
issue LTC insurance) must contain clear, simple questions
designed to ascertain your health condition. Questions must
contain only one inquiry each and require only a "yes" or "no"
answer (except for names of physicians and prescribed
medications).
Many times, states require the application to include the
warning: Caution: If your answers on this application are
misstated or untrue, the insurer may have the right to deny
benefits or rescind your coverage.
If the insurer does not complete medical underwriting and
resolve all reasonable questions on the application before
issuing the policy, the insurer may only rescind the policy or
deny a claim on clear evidence of fraud or material
misrepresentation. The fraud must pertain to the condition for
which benefits are sought, involve a chronic condition or
involve dates of treatment before the date of application, and
must be material to the acceptance for coverage.
The contestability period is usually two years. Some states
require insurers to maintain records of all policy rescissions
and annually report them to the insurance department.
Consumer Protections
Riders or endorsements which reduce or eliminate benefits
usually require the applicant’s signed acceptance. Riders or
endorsements which increase benefits and increase the
premium must be agreed to in writing by the policyholder
unless the change is required by law.
Limitations on preexisting conditions must be set forth in a
separate paragraph on the first page of the policy and clearly
labeled. Any limitations or conditions for eligibility must also
be set forth as a separate paragraph and labeled "Limitations
or Conditions on Eligibility for Benefits."
Some states set loss ratio standards for LTC policies as well
as Medicare supplement policies. Usually, for individual LTC
attached to a life policy. With this arrangement, the annuity
provides necessary funds to help with LTC expenses. It might
be said that the annuity and the LTC policy are cousins in that
annuities provide retirement income and LTC needs normally
occur after retirement. Thus, one approach involves adding
the LTC rider to the annuity.
When and if needed, annuity funds will be paid to cover LTC
expenses. This of course will have the effect of reducing the
amount of money in the annuity and consequently, the
monthly retirement income may be reduced as well.
One final use of a LTC rider is in combination with a disability
income policy. Disability income insurance is designed to
protect a person's most important asset -- the ability to earn
an income. However, the disability income need normally
ends at age 65 or retirement since the policyholder no longer
has earned income.
Like Medicare supplement insurance, long-term care policies
are heavily regulated by the state Insurance departments.
Consumer protections that have been implemented at the
state level include rules for full and fair disclosure of long-term
care insurance terms and benefits, including:

disclosure for sale;

terms of renewability;

conditions of eligibility;

non-duplication of coverage;

preexisting conditions;

termination of insurance;

probationary periods;

limitations;

exceptions and reductions;

elimination periods;

requirements for replacement;

recurrent conditions; and

definitions of terms.
Prohibited Provisions
Many states have passed laws, based on National
Association of Insurance Commissioners (NAIC) model laws,
which prohibit certain provisions from being included in longterm care insurance policies. Although the provisions differ
slightly from state to state, below is a summary of the most
common consumer protections.
Cancellation
LTC policies may not be canceled, non-renewed, or otherwise
terminated on grounds of age or deterioration of the insured’s
mental or physical health.
Benefits
Unless the applicant elects otherwise, policies may not
provide coverage for skilled nursing care only, or provide
more coverage for skilled care in a facility than for lower levels
of care.
No long-term care insurance benefits may be reduced
because of out-of-pocket expenditures made by the insured or
on his or her behalf.
Termination of Benefits
If long-term care insurance is terminated, it shall be without
prejudice to any benefits payable for institutionalization which
began while the insurance was in force. Benefits must
continue without interruption after termination. This extension
of benefits may be limited to the duration of the benefit period,
if any, or to payment of a maximum benefit, and maybe
subject to any policy waiting period and all other applicable
provisions of the policy.
Post Claims Underwriting
Applications for long-term care insurance usually contain clear
questions designed to determine the applicant’s health status.
Applicants may be asked whether they have had medication
prescribed by a physician, and to list the medication. If the
medications listed are directly related to a medical condition
for which coverage would otherwise be denied, and the policy
or certificate is issued, it may not be later rescinded for that
condition. However, a policy is issued based upon the
responses to questions on the application. If the answers are
26
time of replacement;
offer coverage to all persons covered under the
replaced policy,

not exclude coverage for preexisting conditions that
would have been covered under the terminating
coverage;

not require new waiting periods, elimination periods,
probationary periods, or similar preconditions;

not vary the benefits or premiums based on the
policyholder's health, disability status, claims
experience, or use of LTC services.
If existing coverage is converted to or replaced by a new form
of LTC insurance with the same company (except for an
increase in benefits voluntarily selected by the policyholder)
the insurance company may not establish any new waiting
periods.
Continuation and Conversion Rights
Under NAIC guidelines, Group LTC certificates must provide
for continuation/conversion coverage for certificate holders if
the group coverage terminates for any reason except:

failure to make premium payment or contribution;

when the group coverage is replaced within 31 days
by identical or substantially equivalent benefits, and
the premium for the replacement coverage is
calculated on the policyholder's age at the time of the
original policy issue date.
Continuation means the insured can maintain their coverage
under an existing group policy provided they keep paying their
premium.
Conversion means the insurer will issue an individual LTC
policy without considering insurability, containing identical or
equivalent benefits. The premium for the converted policy
must be calculated based on the insured’s age at the time the
group certificate was issued.
The insurer may require that the insured was continuously
insured under the group policy for at least six months prior to
termination in order to be entitled to conversion coverage.
Application for conversion must be made within a reasonable
period after termination of the group coverage.
Who Should Buy LTC Insurance?
Not everyone who is approaching retirement is necessarily a
candidate for LTC insurance. Insurers and insurance agents
have been roundly criticized for selling long-term care
insurance to people who do not need it; either because they
cannot afford it or because they do not have enough assets to
protect. Buying LTC insurance should not cause financial
hardship or make you neglect more important financial needs.
If a senior's sole source of income is a relatively small pension
and he or she has minimal financial assets then this person
may already be eligible for Medicaid reimbursement of LTC
expenses. Occasionally, the retiree may receive financial
assistance from friends and relatives to help cover nursing
home expenses.
But assume that a person aged 65 buys an LTC policy, paying
a level premium of $1,900 for 15 years. At age 80, which is
the average age at which LTC services are required, the
purchaser will have paid $28,500 in premiums for $500,000
worth of home-care and nursing-home benefits. This results in
a 17.5-to-1 value ratio.
Of course, a person may purchase as much or as little
coverage for as many years as are deemed at risk. However,
the financial risk is greater for LTC services above the
average required time, and it is made economically attractive
to purchase more coverage rather than a lesser amount on a
conservative basis. What other investment might an elder
consider with a potential return of better than 10-to-1? And no
one would be disappointed if, at the age of 80 because of
good health, LTC services were not yet required and the value
ratio ended up being lower.
Options for the Average Person
Margaret, age 66, has limited assets and a small retirement
income. She would like to purchase a LTC policy with a $100
per day benefit, a ten-day elimination period and a five year
policies, benefits are considered reasonable in relation to
premiums if the expected loss ratio is at least 60 percent.
Copies of long-term care insurance policy advertisements
intended for use must usually be filed with the state insurance
department at least 30 days before they are used. Copies of
the advertisements used must be retained by the insurer for a
period of time, usually at least two or three years.
Ads designed to produce leads must disclose that "an
insurance agent will contact you." Agents, brokers, or others
who contact consumers as a result of receiving information
generated by a "cold lead" must immediately disclose that fact
to the consumer.
Insurers offering LTC insurance must establish marketing
procedures to assure comparisons of policies will be fair and
accurate, and to assure that excessive insurance is not sold
or issued.
Insurers must display prominently on the policy and the
Outline of Coverage Notice to buyer: This policy may not
cover all of the costs associated with long-term care incurred
by the buyer during the period of coverage. The buyer is
advised to review carefully all policy limitations.
Every Reasonable Effort
Insurers must make every reasonable effort to discover
whether an applicant already has accident and sickness or
LTC insurance, and the types and amounts of such insurance.
In recommending the purchase or replacement of a LTC
policy, an agent must make reasonable efforts to determine
the appropriateness of the recommended purchase or
replacement. Many states have incorporated language to this
effect in their insurance laws, and the NAIC Senior Issues
Task Force is working to finalize suitability proposals for longterm care insurance policies.
Controlling Agents and Brokers
Laws prohibit insurers, brokers, and agents from persuading
anyone to replace a long-term care insurance policy
unnecessarily, especially when the replacement causes a
decrease in benefits and increase in premium. Some
insurance departments will set a limit, such as three or more
policies sold to a policyholder in a 12-month period, as being
presumed unnecessary.
Long-term care insurance application forms must include a
question about whether the proposed insurance is intended to
replace any other long-term care Insurance presently in force.
Upon determining that a sale will involve replacement, the
insurer is required to furnish the applicant with a Notice to
Applicant Regarding Replacement of Accident and Sickness
or Long-term Care Insurance.
Insurers using agents must furnish this notice prior to
issuance or delivery of the policy or certificate. One copy is
retained by the applicant, and an additional copy signed by
the applicant shall be returned to and retained by the insurer.
Except when the replacement coverage is group insurance,
the replacement notice must include a statement to be signed
by the agent documenting that, to the best of the agent's
knowledge, the replacement coverage materially improves the
policyholder's position. The notice must also include the
specific reasons the agent Is making this recommendation.
Insurers making a direct response solicitation through the mail
must furnish this notice upon issuance of the policy or
certificate. Separate notice forms have been prescribed by
some Insurance Departments for use by direct response
insurers and by other insurers.
If a group LTC policy is replaced by another group LTC policy,
the replacing insurer must:

provide benefits identical or substantially equivalent
to the terminating coverage;

calculate premiums based on the policyholder's age
at the time of issue of the group certificate for the
coverage being replaced (If the coverage being
replaced itself replaced previous group coverage, the
premium must be based on the original policy).
However, if the replacement coverage offers new or
increased benefits, the premium for those benefits
may be calculated on the policyholder's age at the

27
Nonforfeiture provisions, which return some of the investment
in premiums if coverage is dropped, are now included in most
LTC policies and will probably be required eventually in all
LTC policies. Without a nonforfeiture provision, LTC insurance
provides no recovery for the policyholder who lapses the
policy, or who dies without ever having needed LTC benefits.
If the policyholder surrenders the policy, all value and all
premiums paid are lost. If coverage is cancelled after ten or
20 years, for example, and no policy benefits have ever been
triggered, the loss can be significant. The same might be true
for someone who buys a policy very late in life and drops the
coverage after only a few years.
The standard nonforfeiture options which would apply to LTC
insurance include:

Cash Surrender Value. A guaranteed sum is paid to
the policyholder upon surrender or lapsing of the
policy. This sum is generally equal to some portion or
percentage of the insurer's policy reserve at the time
premiums cease.

Reduced Paid-Up. A lesser or reduced amount of
daily benefit payable for the maximum length of the
policy's benefit period with no further premium
payments required.

Extended Term. A limited extension of insurance
coverage for the full amount of the policy benefits
without any further premium payments, for a limited
period of time only.
The reduced paid up and extended term options are paid from
the policy's cash value. These are fairly standard and are very
similar to the nonforfeiture options found in permanent life
insurance policies.
Another form of nonforfeiture option sometimes offered is a
Return of Premium option. Under this option, a lump sum
cash payment equal to some percentage (60 percent, 80
percent, etc.) of the total premiums paid would be paid to the
policyholder upon lapsing or surrendering the policy.
Normally, any claims previously paid to the policyholder,
would be deducted from the return.
Consumer advocates argue that, unlike life insurance, when
LTC policyholders lapse their LTC policies by halting premium
payments (and without ever having made a claim on the
policy); they lose their accumulated equity in the product (all
the premiums they've paid in).
Because of the lack of nonforfeiture benefits, some insurers
have been charged with "predatory pricing" in which initial
premiums are low but increase dramatically, “squeezing out"
policyholders who cannot afford the premium payments and
allowing the policies to lapse.
Similarly, policies sold without an inflation protection provision
could leave the insured with inadequate coverage at claim
time.
Thus there is disagreement, leaving it to the consumer. While
some in the insurance industry maintain that the inclusion of
these benefits could more than double the already high cost of
LTC insurance, pricing it out of the reach of most people,
other insurers offer these options.
The issues remain unresolved. Even though its Long-term
Care Task Force has taken a position in favor of requiring
nonforfeiture benefits in all new LTC policies, the NAIC is
holding off suggesting that the benefits be mandatory,
pending further study. There is, however, support for the
mandatory inclusion of these benefits.
LTC – Partnership Programs
The Robert Wood Johnson Foundation, a private foundation
affiliated with the Center on Aging at the University of
Maryland, has assisted several states (California,
Connecticut, Indiana, Illinois, and New York) in developing
public/private long-term care insurance programs which help
safeguard against the total depletion of assets before a
person qualifies for Medicaid.
The overall goals of the partnership are to reduce the financial
strain LTC imposes on the states and federal government and
to offer a LTC product that is affordable and attractive to
consumers. Partnership policies are endorsed by the state but
benefit period. However, she cannot afford the premium. What
options are available to her?
Any of the following or any combination of the following will
permit Margaret to purchase a LTC policy at a premium she
can possibly afford:

she can naturally reduce the daily benefit to a lesser
amount, i.e., $50;

she can increase the elimination period to 60 days,
90 days or longer;

she can reduce the benefit period to two or three
years.
In addition to these obvious alternatives, another factor which
would enable Margaret to purchase the LTC care policy of her
choice is age. Most insurers offer policies beginning at age 50
(a few, as low as age 40). As loss experience and
underwriting data are accumulated, possibly this minimum
age of 50 will be reduced to a much lower entry level and
consequently, lower premiums.
However, to date, no insurer appears to offer a noncancelable contract, meaning one in which both renewability
and the premiums are guaranteed. The vast majority of
policies are guaranteed renewable but the premium is not
guaranteed. Thus, even if Margaret had purchased a LTC
policy at a much younger age, she still might find difficulty
paying the premium at her present age of 66. She would have
had the advantage of paying this increasing premium over a
period of time which would have possibly enabled her to
"budget" for this periodic premium increase.
Special Provisions
Each LTC insurance company has its own special contract
provisions. An agent must review contracts to understand
these differences before marketing a LTC policy.

The amount of daily/annual benefit coverage, years
of coverage, amount of home care coverage, waiting
period before benefit begins, and inflation rider
options vary by contract.

Home care coverage is usually available at the 50
percent, 80 percent, or 100 percent level of the base
nursing home care coverage. This is the most
important variable area. If home care is a priority, it is
important to factor the different level of home care
coverage into any comparison of premiums between
different company proposals. A home care rider has
an incremental cost for the extra years purchased for
this purpose which amounts to about 30 percent of
the base nursing home cost.

Claims can be paid on either a reimbursement or an
indemnity basis. In a reimbursement policy, an
insurance company reimburses a licensed agency
for custodial aid services or a nursing home up to but
not more than a policy benefit limit. In an indemnity
policy, the full coverage is paid directly to the
policyholder.

While a disability income approach recently
introduced allows the policyholder to use the benefits
paid for any purpose, this approach is relatively
expensive. Disability policies also include LTC riders.
As LTC costs are likely to be greater than the
amount of coverage purchased, the three different
payment approaches are not an important
contractual, financial issue.

The definition of activities of daily living varies, but
inability to perform two or more ADLs is the usual
qualification for LTC benefit payments.

Contracts also vary slightly on extra areas such as
respite care or day care, reimbursement for certain
home equipment, starting time period for a waiver of
premium payments, and waiting time periods after an
interruption in LTC services.
Nonforfeiture Provisions
An issue of contention in the industry is whether or not the
incorporation of nonforfeiture benefits and inflation protection
in LTC policies should be mandatory.
28
are marketed by private licensed insurance companies.
Partnership programs define formulas for asset protection,
identify those eligible for coverage, and provide minimum
coverage and standards. Individuals who purchase
partnership policies are allowed to retain more assets and still
qualify for Medicaid assistance.
LTC Needs Careful Explanation
Due to the type of product LTC insurance is, and its unique
market, insurance just can't announce the existence of a new
feature and tell the field force to read a rate manual to learn
more about the policy. To fully understand the LTC product
requires training where the market is identified and the policy
studied in detail. In addition, because of the complexity of the
coverage, it is essential that agents have the ability to explain
the product to the consumer who is often a senior citizen.
The state of Illinois has recognized the importance of properly
trained agents who work in the long-term care marketplace.
Any agent who intends to sell these products must satisfy a
six (6) hour continuing education requirement to qualify to
offer these lines of insurance.
CHAPTER
LIFE INSURANCE
4
BASIC MECHANICS
Life insurance has been bought and sold in the United States
since the mid-1700s, but it wasn’t until the 1840s that the
industry made a significant impact on the American business
scene. Since that time, individual life insurance has grown
steadily, due primarily to the agency distribution system.
Life insurance plays an important role in the financial planning
of many families. More than 80 percent of American
households have purchased individual life insurance policies.
In the purest sense, life insurance is something that pays a
death benefit to someone when an insured person dies. The
primary purpose of life insurance is to protect against the risk
of premature death.
Premature death exposes a family or a business to certain
financial risks such as burial expenses, paying off debts, loss
of family income and business profits.
An insured may also want a life insurance policy to pay estate
taxes or to set up a college fund for her/his children.
Over the years, life insurance policies have evolved from fairly
straightforward contracts that provided one type of benefit into
complex contracts that often include numerous types of
benefits and features. New products have frequently been
introduced in response to changing economic conditions and
consumer preferences, and that trend is expected to continue
in the future.
An individual with no dependents probably does not need life
insurance. But an individual who does have a dependent, a
spouse, children, elderly parents-that relies on the individual’s
income probably needs to consider life insurance to pay
expenses. People may also consider insuring the life of a
spouse who is not earning money. That spouse may be
helping with family expenses by caring for children (instead of
putting them in child care) or an elderly or sick parent.
Today, individual life insurance represents the greatest
percentage of in-force insurance business in the United
States. It may be characterized as life insurance issued for
face amounts of at least $1,000 (the face amount is the
amount of money paid when an insured person dies).
Life insurance is the only financial services product that
guarantees a specific sum of money will be available at the
exact time it is needed. Bank savings accounts, mutual funds,
stocks, bonds and other investments do not make such a
guarantee.
Since the face amount of the policy is payable upon the death
of the insured person, the element of risk to the insurance
company is much different than it is for an automobile policy.
When an insurance company issues an auto policy, it hopes
that the insured will be a safe driver and never have an
accident. When an insurance company issues a life policy, it
knows it will someday be called upon to pay a claim because
every human being dies. For the insurer, the only unknown is
whether the claim will be made in one year...or in 50.
The term ordinary insurance is sometimes used to describe
individual insurance. There are three broad types of individual
or ordinary life insurance: term life, whole life, and endowment
policies.
Life insurance costs vary based on age, health habits and the
amount of insurance.
A life insurance policy may offer a larger benefit when the
death of an insured person is accidental. When twice the face
amount of the policy is paid upon death occurring accidentally,
such coverage is popularly known as double indemnity.
The General Rules of Life Insurance
An insurance policy is a legal contract. The validity of life
insurance policies as such has been established in the United
States since 1815. As does any contract, a policy contains
29
provisions setting forth the rights and duties of parties to the
contract.
While it is necessary to look beyond the actual wording of the
policy contract and into the statutes and court decisions for a
full interpretation of policy provisions, those provisions are the
basis of the agreement between the company and the
policyholder (and the beneficiaries, heirs, and assignees of
the policyholder).
There are no standard policies in life insurance, as there are
in the property and casualty insurance field. However, many
states have provisions that are required in all life policies so
that some provisions have become more or less standard.
Types of Coverage
Term life insurance provides protection for a specified and
limited period of time, typically from one to 20 years. Term life
is temporary insurance that essentially provides a death
benefit only. The benefit is paid only if the insured dies before
the end of the specified term. If the insured person lives
beyond the end of the term coverage, the policy simply
expires. A term policy does not build any cash, loan, or
surrender values.
Since term insurance does not build cash values, an insured
only has to pay for the death benefit and policy expenses. For
this reason, it is usually the least expensive form of life
insurance. It may be used as an inexpensive tool to satisfy a
variety of temporary insurance needs, such as a mortgage
obligation or the need to protect insurability until an insured
can afford permanent protection.
There are different types of term policies. Level premium term
provides a consistent amount of insurance. Decreasing term,
which is a good type of insurance to cover a shrinking debt
obligation (like a mortgage loan), starts with a specified face
amount that decreases annually until it reaches zero at policy
expiration. Increasing premium term provides a growing
amount of insurance, but the need for this type of protection is
rare.
Some term policies are renewable. The insured does not need
to provide evidence of insurability to renew the policy, but the
premiums will be higher each time the policy is renewed
because the insured is older and more likely to die.
Renewable for limited period is how most new term is being
offered. But by the time an insured person reaches 70 or 80
years of age, the premiums for a term policy usually approach
the face amount of insurance, because the insurance
company figures the person is going to die soon.
Many term policies are also convertible, which means they
may be exchanged for another type of life insurance.
Whole life insurance, sometimes called straight life or
permanent life, is protection that can be kept for a lifetime.
With this kind of insurance, the premium does not increase as
the insured grows older, averaging the cost of the policy over
the insured’s life.
Whole life insurance has a cash value, which is the sum that
grows over the years with taxes deferred. If the policy is
canceled, a lump sum equal to this amount is paid (and taxes
are paid only if the cash value plus any dividends exceeds the
sum of premiums paid).
The face amount in a whole life policy is constant, and this
amount is paid if the insured person dies at any time while the
policy is in effect. The policy is designed to mature when the
insured person reaches 100 years of age. At this point,
payments end and the policy’s cash value equals the face
amount. At maturity, the face amount of a whole life policy is
usually paid even if the insured person is still living.
Although whole life policies are among the most common
forms of life insurance sold, most individuals do not plan to
continue paying premiums until age 100. More commonly,
whole life insurance is used as a form of level protection
during the income producing years. At retirement, many
people then begin to use the accumulated cash value to
supplement their retirement income.
This type of life insurance plays an important role in financial
planning for many families. In addition to the death benefit or
eventual return of cash value, the policy has some other
significant features. During a financial emergency, policy
loans may be taken and the full policy values may later be
restored.
Ordinary policies may be participating (par) or nonparticipating
(non-par). A participating policy is one in which the
policyholders share in dividends (if a dividend is declared). A
nonparticipating insurer does not pay dividends to
policyholders. It pays dividends to outside shareholders. Par
policies are issued by mutual life insurance companies. Nonpar policies are issued by stock life insurance companies.
Many people use dividends to buy additional amounts of
insurance instead of taking the dividends in cash. This is
really no different than taking a few extra dollars out of your
pocket and making a separate purchase. Still, dividends are
often a successful sales tool because some people like the
idea of getting something extra back, even though they’ve
usually paid more initially.
Universal life insurance is protection under which a
policyholder may pay premiums at any time, in virtually any
amount, subject to minimums. The amount of the cash value
reflects the interest earned and premiums paid, minus the
cost of the insurance and expense charges. Universal life
policies seek to compete in the term insurance marketplace.
They offer standard rates that can be substantially cheaper;
as much as 30 percent or more than standard rates charged
by term insurers for comparable coverage.
Some universal life policies feature progressive underwriting,
which is meant to attract otherwise uninsurable consumers.
These policies are usually structured so that if policyholders
pay the level minimum annual premiums, coverage won’t
lapse for 15 or 20 years.
Progressive underwriting means companies are aggressive in
determining a person’s true risk. Instead of evaluating risk on
a “by-the-book” basis, they pursue questions to find out what’s
causing any abnormalities in a person’s claims history.
Variable universal life insurance provides death benefits and
cash values that vary according to the investment returns of
stock and bond funds managed by the life insurance
company. These policies also allow the policyholder
significant discretion in the premiums paid each year. These
policies allow the policyholder discretion to choose how funds
are invested. For many people, variable universal life is as
much an investment tool as a true insurance tool.
The cost basis of universal life becomes too uncertain
because of the open-ended method of premium payment.
There’s trouble if the insurer can’t project costs. Target
premiums are fixed in the first year but policyholders, because
of the flexible nature of the products, are not contractually
bound to pay those amounts in subsequent years.
In fact, target premiums for this kind of insurance are among
the highest in the industry. Many agents sell variable universal
aggressively because their commissions are often based on
target premiums and they can make more selling this than
other kinds of life insurance.
Some History... And Some Context
Although the first policy of life insurance on record was issued
in 1563, all policies issued for the next 200 years were either
term or endowment. The few whole life policies issued were
for undetermined face amounts.
The formula for a policy issued for the whole of life on a level
premium basis eluded mathematicians until 1762. In that year,
the Society for the Equitable Assurance of Lives and
Survivorships (today commonly referred to as Old Equitable
and one of Britain’s leading life insurance companies) came
out with a whole-life, level-premium, fixed-amount policy.
The first day the policy is in force, the insured person has
$100,000 of protection. If the insured should die one week,
one month, one year, 10 years, or 50 years later his
beneficiaries would be paid $100,000. The face amount of the
policy remains the same throughout the life of the policy and
the life of the insured.
Death benefits are the one thing that all types of life insurance
contracts have in common. Any contract that did not pay a
death benefit could hardly be called life insurance. The
30
attached to life insurance contracts.
In the case of living benefits, a portion of the proceeds that
would otherwise be payable as a death benefit is advanced to
an insured who has a terminal disease and a need for special
medical care. It is widely acknowledged that this is a humane
application of life insurance proceeds, because the funds are
often used to ease pain, suffering and discomfort during the
final period of life.
Long-term care benefits pay for nursing care, home health
care, or custodial care (assistance with the tasks of daily
living, such as eating, bathing, dressing, etc.) which may be
needed following a period of hospitalization. This is actually a
health insurance benefit that is often sold separately. When
long term care is sold as a separate benefit, an additional
premium is charged and the benefit will not affect the policy’s
face value or cash value. When sold as part of an integrated
plan, an additional premium is not charged; long-term care
benefits are simply borrowed from the life insurance benefits
and accordingly reduce the remaining face value and cash
value.
Parties to A Life Insurance Contract
When a life insurance policy is issued, a number of parties
may be involved with respect to contract obligations and
benefits. Obviously, the insurance company is a party to the
contract; in exchange for the premium payment, it has agreed
to pay certain benefits if the insured dies.
Since the insurance will pay a benefit if the insured person
dies, it is also obvious that this person is a party to the
contract. But there may be other parties. To identify these
parties, we need to consider who owns the policy, whose life
is insured, and who is entitled to the benefits. In the life
insurance business, these parties may differ depending upon
how the policy is issued and what rights are exercised.
The insured is the person whose life is insured. A death
benefit will be paid if this person dies while the insurance is in
effect.
The owner of a policy is the person who applies for the
insurance, agrees to pay the premiums, and has certain
ownership rights. Generally, the policy owner has the right to
elect or change the beneficiary, to elect settlement options,
and to assign ownership to another person.
A beneficiary is someone who is entitled to death benefits if
the insured person dies. There may be one or more
designated beneficiaries. There may be primary beneficiaries
who are entitled to the proceeds if they are living, and
contingent beneficiaries who are entitled to the proceeds if
there is no surviving primary beneficiary when an insured
dies.
For example: George buys life insurance on his own life and
directs that the proceeds be paid to his spouse. George is the
owner. George is the insured. George’s spouse is the
beneficiary.
The owner of a policy may or may not be the insured person,
and may or may not be the beneficiary. The same person
cannot be both the insured and the beneficiary, but the
insured’s estate may be the beneficiary.
Let’s say Sally buys life insurance on her husband Jim’s life.
She names herself as beneficiary. In this case, Sally is both
the owner and the beneficiary. Jim is the insured.
The owner of a life insurance policy is entitled to certain
valuable rights. These include the right to assign or transfer
the policy, and the right to select and change the payment
schedule, beneficiary and settlement option.
The owner also has the right to receive cash values or
dividends and the right to borrow from the cash values.
Insurable Interest
Individuals cannot purchase life insurance on the lives of
anybody they choose. In order for someone to purchase life
insurance, he/she must have a legitimate insurable interest in
the subject of the insurance. There must be a personal risk of
emotional or financial loss, and a legitimate interest in
preserving and protecting the life being insured.
Without a requirement for insurable interest, people might
gamble on the lives of total strangers, particularly those who
product gets its name from the fact that a life is being insured,
and it is the loss of life that triggers payment of the benefit.
Death benefits represent the true insurance element, the pure
protection aspect, of all life insurance policies.
You could argue that anyone who knew for certain that he or
she would live to an old age would be foolish to spend money
on life insurance. The premiums could be put to better use
over the course of a long life, and it would only be necessary
to set aside a small sum for the eventual funeral. But none of
us can be certain that we will live for a long time, even if
ancestors were long-lived. There is always the possibility that
a disease or accident will end things prematurely. Anyone can
become a victim of a natural disaster or an act of violence.
The need to cover expenses and replace lost family income if
early death occurs may be the main reason people purchase
pure life insurance protection, but it is not the only reason
people purchase life insurance products.
Originally, life insurance contracts only provided death
benefits. That has changed. Today, many forms of life
insurance include other types of benefits, and people also buy
life insurance to protect against the risk of not dying
prematurely; to protect against the risk of living for a long time.
More than Just Death Benefits
The many uses of life insurance today extend far beyond the
original concept of a death benefit. Certainly death benefits
continue to play a major role in life insurance sales
presentations and purchase decisions, and that will always be
true.
It is worth pointing out that many transactions that may add to
family finances and security may be backed up by life
insurance. When a person borrows money for a real estate
purchase, an investment opportunity, or for starting a small
business, the funds may not be available unless life insurance
on the life of the borrower is purchased to protect the interests
of the lender. Use of life insurance in this manner may, in the
long run, help an individual to build personal assets and
advance family security.
In addition to death benefits, many life insurance policies
include other features, such as savings or investments. This
makes it possible to use life insurance as a vehicle for building
capital, accumulating assets or funds designed to serve
specific purposes. Thus, some people use life insurance to
accumulate funds for children’s education, to provide
retirement income, to create or add to an estate and for other
purposes. Many people question whether life insurance is the
best method of getting access to capital, but there’s not much
question that it is one of the safest and most conservative
methods.
Many life insurance contracts include other types of insurance
benefits. These non-life insurance benefits may be included in
a policy or may be attached as optional riders.
One of the most commonly found types of additional benefit is
known as waiver of premium. This is actually a disability
insurance benefit, which pays the life insurance premiums
while an insured person is disabled.
Another type of disability benefit that is commonly attached to
life insurance policies is a disability income benefit. This is
usually provided as “waiver of premium with disability
income,” but it may be attached as a separate benefit. A
disability income benefit pays a monthly income to an insured
person who is totally disabled.
Dismemberment benefits may be attached to a life insurance
policy, most frequently in the form of accidental death and
dismemberment benefits. The accidental death benefit pays
an additional death benefit if an insured person dies because
of an accident. The dismemberment benefit pays specified
sums if the insured loses one or more limbs, or sight of one or
both eyes, and in some cases hearing, as the result of an
accidental injury. Since the insured person is still alive and
this is not a death benefit, it is not technically a form of life
insurance.
In recent years, the concepts of living or accelerated benefits
and long-term care needs have begun to take hold in the life
insurance field. They are increasingly showing up as benefits
31
and medical history (if an individual has been previously
declined or rated for life insurance).
In most cases applicants are also asked to take a physical
examination, paid for by the insurance company to which the
individual is applying. All of this information is needed for the
insurance company’s underwriting process.
The insurance company wants to know exactly what type of
risk a person might be. It assesses all of a person’s
information concurrently to make a well informed decision.
The risk it sees within the obtained information is all taken into
consideration when the company makes a decision to offer or
decline a request for coverage.
An applicant may end up somewhere between insurable and
not insurable. If so, the insurance company may offer a rated
policy with a higher premium.
By signing the application, the applicant is not committing to
buy insurance; the applicant is requesting that the insurance
company review his/her information and offer coverage.
Insurance is not in force until premiums are paid. Even if
premiums are paid with the application, the applicant may
refuse to accept the policy when it is delivered and get his or
her premiums returned.
At the time of completion of the application, the applicant must
sign and date it to confirm that all the information given is true
to the best of his/her knowledge. Most companies have a
clause regarding misstated information or a fraudulence
clause. This gives the company the right to review its decision
if an applicant has provided false information or omitted
information.
The contestability period, which usually lasts for two years, is
the time within which an insurer may deny a claim based on
information provided in the application. After this period, the
policy becomes incontestable and the insurer may not deny a
claim even if fraudulent or concealed information is
discovered. The insurer may then deny a claim only on the
ground that an insurable interest was not present between the
insured and owner at the time of application.
Upon receiving the policy, the insured must be sure to review
the type of plan, owner, beneficiary, premium, face amount
and schedule of future premiums thoroughly before accepting
it. The insured should understand the exclusions, length of
time the policy will be in force and optional values. Most
policies provide a summary page that minimizes any
confusion.
If an insured receives a rated (or classified) policy, you may
want to try other carriers for alternative rates since
underwriting standards vary from company to company.
Conclusion
The increased efficiency created by new communications
technologies is spawning a wave of mergers and
consolidations in the financial services industry. It is
reasonable to expect that insurance companies will be
consolidated and the smaller companies will be bought out.
The policies a person holds may be managed by new entities.
While no one knows what the future will bring to the insurance
industry over the next 10 or 20 years, it makes sense to
consider the size and history of mortality experience, and
operating expenses and commissions as a percentage of
revenue of the insurance company. These may prove to be
important factors in choosing a company to best represent
and serve the needs of your client.
Beyond this issue, the basics of life insurance are pretty
simple.
The primary purpose of life insurance is to pay a death
benefit, and a death benefit is the one feature that all forms of
life insurance share in common. Death benefits are usually
purchased and used to cover final expenses, pay outstanding
debts, and provide income and security for survivors.
In addition to providing protection against premature death,
life insurance attempts to protect against the risk of not dying
early. Many life insurance contracts include cash values or
savings features which make it possible to accumulate funds
for education, retirement income, and other purposes on a
tax-free basis.
engage in high-risk activities. Additionally, the absence of
insurable interest might actually put lives in danger; a person
might act to cause another person’s death or fail to exercise
reasonable safety precautions to protect someone else if that
person had no personal risk of loss and stood to gain
financially from the death.
Every person is presumed to have an insurable interest in his
or her own life. However, this interest is not necessarily
unlimited. If the amount of insurance applied for is
disproportionate to a person’s apparent needs, it will raise
underwriting concerns on the part of the insurance company.
Dave, who has an annual income of $25,000 and
very few assets, applies for $5 million of life
insurance. Dave’s economic status would not seem
to justify such a large need for insurance, and his
income is inadequate to pay the required premiums.
Upon investigation, the insurance company
discovers that Dave has numerous outstanding
gambling debts and other financial problems. He also
has a wife and three children. This application would
probably be turned down because of the extreme risk
that Dave may be planning to stage his own death.
Everyone also has an insurable interest in the lives of close
relatives through blood or marriage. This usually extends to
those who could be considered immediate family members,
such as a spouse, children, parents, and perhaps brothers
and sisters. The requirement for insurable interest becomes
more difficult to justify when insurance is sought on the lives
of more distant relatives, such as uncles, aunts, nephews,
nieces, and cousins. Insurable interest certainly may exist in
these cases, especially when such relatives live in the same
household.
Insurable interest may also be established on the basis of
business and financial relationships. Members of a
partnership have an insurable interest in the lives of other
partners. Lenders have an insurable interest in the lives of
borrowers to the extent of the funds at risk. Any commercial
enterprise, ranging from corporations to movie studios and
professional sports organizations, may have insurable
interests in the lives of individuals who make significant
contributions to sales and profits.
An insurable interest must exist at the time of application and
inception of the policy and not necessarily at the time of
death. If a policy is valid when it is issued, the death benefit is
payable even if insurable interest no longer exists at the time
of the insured’s death. The requirement for insurable interest
applies only to the owner of a policy. There is a greater
flexibility allowed when it comes to the proposed insured’s
selection of a beneficiary.
Example: Roseanne purchased life insurance
covering Tom, naming herself as beneficiary, when
they were married. They never had children and
divorced a few years later. Both remarried. Many
years passed by, during which Roseanne and Tom
had no communication with each other, but
Roseanne continued paying premiums to keep
Tom’s life insurance in force. When Tom died and
Roseanne read about it in the paper, she submitted a
claim. The claim is valid because Roseanne had an
insurable interest when she originally bought the
policy.
In real life situations, people don’t usually continue to pay life
insurance premiums after an insurable interest has ended.
When insurable interest no longer exists, ownership of a
policy may be transferred or assigned to the insured, to the
insured’s new spouse, to children, or to someone else who
has a more current insurable relationship with the insured.
The Life Insurance Application
In completing a life insurance application, the applicant will
usually be asked to provide some general information,
including: full name, address, phone number, social security
number and billing address. The applicant may also be asked
to provide some more specific information, including: hobbies,
and whether or not they are considered dangerous (scuba
diving, hang gliding, flying small aircraft and bungee jumping)
32
Life insurance products have evolved in response to changing
economic conditions and consumer preferences. All life
insurance policies include some form of true life insurance
protection. Many policies also include other types of insurance
benefits and non-insurance elements.
Various parties may be involved in any life insurance contract.
There is always a policy owner and an insured person. There
may or may not be a designated beneficiary. An agent should
be aware of the tax consequences of these arrangements.
In order to purchase life insurance, an applicant must have an
insurable interest in the life of the person to be insured. This
insurable interest must exist at the time the policy is issued,
but need not exist at the time of the insured’s death.
In the next chapter, we will look at what to do after an
individual has decided whether or not he needs life insurance.
We will look at how to calculate the amount and type of life
insurance the insured needs to purchase.
THE NEEDS SATISFIED BY LIFE INSURANCE
Only 43 percent of American adults own individual life
insurance and the average insured has just $45,000 of life
insurance. Relying on the group life insurance provided at
work can build a false sense of security, since coverage is
usually insufficient for family needs. In addition, coverage
generally ceases when employment terminates. Most financial
planning experts agree that few people protect their own full
value with life insurance, leaving their families at risk.
Benefits of Life Insurance
The death of an insured person creates an instant estate for
the benefit of the individual’s family. From a personal
perspective, life insurance may be used to provide peace of
mind and financial security for a family.
But individuals are probably more interested in figuring out
what they need rather than what they want.
When a person dies, he or she typically leaves behind the
unfinished business of a lifetime. This is particularly true of
individuals who die earlier than normal life expectancy would
predict. Costs associated with death include:

doctor and hospital bills from a final illness or
accident,

funeral expenses,

estate taxes, and

other debts (credit cards, consumer loans, etc.).
In addition, to people leaving behind a family or other
dependents that were financially dependent on them for
support, the following financial needs will immediately become
apparent:

mortgage payments,

immediate income needs—to pay for groceries,
utilities, car payments, and other day-to-day living
expenses, and

long term needs—money to pay for children’s
educations, retirement income for a spouse.
People in the insurance industry call the process of calculating
a person’s insurance requirements needs analysis. This
needs analysis is often accomplished by identifying the
specific financial objectives of the individual by means of a
fact-finding interview. In this interview, an insurance
salesperson talks with the client, either in person or on the
phone, and asks about the person’s circumstances and goals.
After the needs analysis is complete, the salesperson makes
recommendations as to the amount and type of insurance
needed. These recommendations should consider the
following:

Should the coverage be permanent, term insurance,
or a combination of the two?

How much premium can the individual afford to pay?

Should the premium be level, increasing or
decreasing?

Is the individual insurable?
A Human Life – What’s It Worth?
The human life value concept was developed in the 1920s by
Dr. S.S. Huebner. His concept was based on the fact that
when a working person dies his or her ability to produce
income or support a family is lost. Huebner realized that value
cannot be placed on a human life the way it is on a piece of
machinery. So the value was placed, not on the life itself (as
the name of the concept may imply) but on the earning
potential of the insured person, calculated and projected over
a period of years.
In formulating the items to determine need, Huebner looked at
four general areas:

the individual’s net annual salary,

the individual’s annual expenses,

the number of years the individual has left to work
(the present to retirement age), and

the value of the individual’s dollar as it depreciates
over time.
The human life value concept was a way of determining what
a family would lose in income by the death of the principal
wage earner. By this method, if the insured died, the family
could be reimbursed for that loss.
The issue of what a life is worth is one that claimants and
insurance companies sometimes end up fighting over in court.

A 28-year old construction worker earning $35,000
per year was training to become an engineer. At a
trial, after his accidental death, an economist testified
that the economic loss to his family was $1.6 million.
The court awarded $2.5 million for economic loss,
which was held up on appeal.

A 37-year old maintenance worker was earning $160
per week before he died. At trial, an economist
testified that the economic loss to his family was
$341,591. The appeals court agreed.

A 44-year old truck driver earned $24,000 per year
and was attending classes to qualify for a
management position before he was killed in an
accident. A court awarded $1.22 million for loss of
financial support and services to his family.
How do courts come up with these figures? They consider not
just what an insured person earns today but also what he or
she may earn in the future, accounting for inflation, pensions,
retirement benefits, etc.
In addition to economic factors, a court may consider personal
and family factors such as:

children’s school performance and socialization skills
after they experience the death of a parent,

the effect on a family of a surviving parent having to
work full time,

financial stress and/or job pressures that follow from
the death of an income-earning parent or spouse,
and

emotional impacts of grieving and coming to terms
with the unexpected loss of a family member.
Although money can’t replace a deceased family member,
courts will often decide that money offsets the impact of the
death on a family’s opportunities.
Considering Other Sources of Protection
In determining the amount and kind of insurance needed, you
should consider other sources of income or benefits the
insured currently has in place or for which the insured may be
eligible under other insurance plans, government programs
(such as Social Security), and retirement plans (pensions,
IRAs, Keogh accounts, etc.).
Some other sources of funds to be considered are:

Medicare,

Medicaid,

group retirement plans,

savings,

investments,

other income (from property rental, etc.),

annuities, and

other insurance.
These other assets will help in determining the amount, and
33
The amount needed to generate income at 6%
Pre-tax Monthly Income Needed: $____ x 200 =?
For example, if a family needs $3,000 per month, then
multiply $3,000 x 200 = $600,000. As you can see, $600,000
invested at 6 percent will yield $36,000 per year—that is,
$3,000 per month (before tax).
During the early 1990s, inflation remained relatively low.
However, inflation did average 3 percent per year between
1945 and 1995.
We know that $36,000 in the future won’t buy as much as it
does today. In fact, the impact of inflation is devastating. The
following chart shows what $36,000 is worth in the future—
expressed in today’s dollars.
Equivalent of $36,000 in the Future
Inflation Today 10 Years 20 Years 30 Years 40
Years
0%
$36,000 36,000
36,000
36,000
36,000
4%
$36,000 51,239
75,847 112,271
166,189
6%
$36,000 60,821 108,922 195,062
349,326
This means a family will need $75,847 per year in twenty
years to equal $36,000 in today’s purchasing power at an
inflation rate of 4 percent.
Typical Family Goals
The typical American family shares similar goals:
1. Remain in the same home, neighborhood, and
schools.
2. Pay off mortgage.
3. Provide an emergency fund.
4. Pay off current small debts.
5. Set aside a college fund for each child.
6. Replace some or all of the lost income resulting from
the death.
These factors must be considered when calculating the
amount and type of insurance needed for any given family;
they are common items included in the budget worksheet
frequently provided by the insurance agent.
Naming and Maintaining Beneficiaries
An important part of determining how much life insurance a
person needs is determining to whom the money will be left.
Some insurance agents consider this a separate function, but
that’s a mistake. You should consider it part of the same
process. The beneficiary provisions of most life insurance
contracts allow the insured or the policy owner to direct the
payment to any person he or she chooses.
A variety of different parties may be designated as
beneficiaries under the life insurance policy. The beneficiary
can be a person or institution, such as a foundation or charity.
A specifically designated person, more than one person, or a
class or classes of persons may be named as beneficiaries.
An estate, trust, or any other legal entity may also be named
as a beneficiary.
Almost all life insurance beneficiary designations are
revocable, or changeable. Usually the insured person retains
the right to change the beneficiary, unless he or she has
specifically given up that right.
It is possible, however, for the owner of the policy to give up
the right to change the beneficiary designation at will. In such
cases there is an irrevocable beneficiary and the designation
cannot be changed without the consent of the beneficiary.
An irrevocable designation might be used when a court orders
a husband in a divorce settlement to continue payment on an
insurance policy on his own life, with an irrevocable
beneficiary designation on behalf of his wife (the primary
beneficiary) and his children (the contingent beneficiaries).
In the event that the irrevocable beneficiary dies before the
insured, the right to select the beneficiary may revert to the
policy owner on a reversionary basis.
It is customary in life insurance contracts to specify a primary
and a contingent beneficiary (or beneficiaries). The primary
beneficiary has first claim to the proceeds of the life insurance
policy following the death of the insured. If the primary
beneficiary dies before the insured, however, the contingent
beneficiary is entitled to the benefits of the life insurance
kind, of insurance necessary to meet current and future
needs.
Planning Money — Long Term
Most people think about money in the short term: annual
salary, cost of a car, cost of taxes, price of housing.
But there are long-term money issues to consider when
planning for a family’s well-being. How much money will the
bread-winner make between now and retirement? What will
be needed for retirement, factoring in inflation? How long does
a set amount of money, even a million dollars, last?
These questions apply even more directly to a family’s needs
if the breadwinner dies prematurely.
The following charts show:

how much you need to put away to accumulate
$1,000,000;

how long $1,000,000 will last; and

the impact of inflation on a set amount of money.
The charts allow you to calculate how much insurance a
family will need.
EARNING POTENTIAL CHART
What is a Person Worth?
$25,000
$50,000
$100,000
$150,000
Yearly
Yearly
Yearly
Yearly
Age
Income
Income
Income
Income
20
1,125,000 1,800,000
4,500,000
6,750,000
21
1,100,000 1,760,000
4,400,000
6,600,000
22
1,075,000 1,720,000
4,300,000
6,450,000
23
1,050,000 1,680,000
4,200,000
6,300,000
24
1,025,000 1,640,000
4,000,000
6,150,000
25
1,000,000 1,600,000
4,000,000
6,000,000
26
975,000 1,560,000
3,900,000
5,850,000
27
950,000 1,520,000
3,800,000
5,700,000
28
925,000 1,480,000
3,700,000
5,550,000
29
900,000 1,440,000
3,600,000
5,400,000
30
875,000 1,400,000
3,500,000
5,250,000
31
850,000 1,360,000
3,400,000
5,100,000
32
825,000 1,320,000
3,300,000
4,950,000
33
800,000 1,280,000
3,200,000
4,800,000
34
775,000 1,240,000
3,100,000
4,650,000
35
750,000 1,200,000
3,000,000
4,500,000
36
725,000 1,160,000
2,900,000
4,350,000
37
700,000 1,120,000
2,800,000
4,200,000
38
675,000 1,080,000
2,700,000
4,050,000
39
650,000 1,040,000
2,600,000
3,900,000
40
625,000 1,000,000
2,500,000
3,750,000
41
600,000
960,000
2,400,000
3,600,000
42
575,000
920,000
2,300,000
3,450,000
43
550,000
880,000
2,200,000
3,300,000
44
525,000
840,000
2,100,000
3,150,000
This chart is not adjusted for inflation or salary increases.
Inflation or salary increases may be calculated by multiplying
the value numbers 2 to 4 times.
How much money does a family need—invested at 6
percent—to guarantee its current monthly income?
Assets
Pre-Tax
Pre-Tax
Available
Rate of
Annual
Monthly
To Invest
Return
Income
Income
200,000
@6%
12,000
1,000
400,000
@6%
24,000
2,000
600,000
@6%
36,000
3,000
800,000
@6%
48,000
4,000
1,000,000
@6%
60,000
5,000
1,200,000
@6%
72,000
6,000
1,400,000
@6%
84,000
7,000
2,000,000
@6%
120,000
10,000
What Is The “Monthly Nut?”
While there are software programs for calculating base
income needs, most families have an instinctual
understanding of the so-called “monthly nut” that is required to
maintain their lifestyle. Typically, the base income need is 60
to 70 percent of current income. In some cases, it is more.
If it is easier for you to think in terms of a dollar-value of
monthly income needs, use this formula:
34
Spendthrift Clause
One of the most appealing features of life insurance is that the
proceeds are exempt from the claims of creditors as long as
there is a named beneficiary other than the insured’s spouse
or the insured’s estate and there is not a lump-sum
distribution. A similar provision with reference to the
beneficiary is the spendthrift clause.
The spendthrift clause is designed to protect the beneficiary
from losing the life insurance proceeds to creditors, assigning
the proceeds to others or spending large sums recklessly. The
clause is not applicable to lump sum settlements but is
applicable to installment settlement options. It only protects
the portion of proceeds not yet paid (due, but still held by the
insurer) from the claims of creditors to the extent permitted by
law.
As long as the proceeds are paid on one of several settlement
options, whereby the insurer keeps the proceeds and sends a
monthly payment to the beneficiary, the amounts received by
the beneficiary are exempt from the claims of his or her
creditors.
Exclusions and Limitations
The last factor to consider in figuring out how much insurance
is needed is what standard policies do and do not cover. Life
insurance policies may contain certain exclusions or
restrictions. The main exclusions are:

Suicide. Initially, life insurance contracts excluded
the risk of suicide entirely. This exclusion left
dependents without protection, defeating the purpose
of purchasing insurance coverage. Also, it was
incorrect to exclude suicide completely because
death by suicide is included in the mortality tables
upon which premiums are based. The majority of life
insurance policies issued today contain a time
provision restricting liability in the event of suicide.
Usually the time limit on the restriction is two years,
although occasionally it is less. A typical provision is
that, in the event of suicide within this period, the
liability of the company shall be restricted to an
amount equal to the total of premiums paid, without
interest, less any indebtedness. Accidental death
benefit is excluded from suicide coverage, since
suicide is not considered an accident.

Aviation. In the past, aviation exclusions were very
common. Today, this type of exclusion is rarely found
in life insurance policies. Among the types of aviation
restrictions still found are these:
Exclusion of all aviation caused or related deaths
except those of fare-paying passengers on regularly
scheduled airlines. Some policies do not include the
phrase, regularly scheduled airlines, thus covering
nonscheduled flights also, but only for a fare-paying
passenger.
Exclusion of deaths in military aircraft only or death
while on military maneuvers.
Exclusion of pilots, crew members, student pilots,
and (sometimes) anyone with duties in flight or while
descending from an aircraft, e.g., parachuting.
Companies using any or all of these restrictions will
afford coverage of civil aviation deaths for an extra
premium. The exclusions or restrictions apply only to
those unwilling to pay the extra premium required
and to military duties.

War and Military Service. In wartime, it has been
common for companies to include restrictions that
limit the death benefit paid to a refund of premium
plus interest or possibly an amount equal to the
policy’s cash value. Often in the past, the policy’s
benefits were suspended during a war or an act of
war. The term, “act of war” has been used to
describe the Korean and Vietnam conflicts.
Today, most insurers will provide some form of life
insurance coverage for those on military duty.
Traditionally, there are usually two types of
restrictions or clauses that may be used. The status
policy. If the primary beneficiary dies before the insured
person and there is no contingent beneficiary, the estate of
the insured becomes the beneficiary and is subject to the
claims of unsecured creditors.
In a family situation, a common primary and contingent
designation is as follows:
Mary Jane Smith, wife, as primary beneficiary and as
contingent beneficiaries all children, adopted or born of this
marriage, to share equally.
After the death of the insured, the proceeds belong to the
beneficiary. If a lump sum benefit is paid, the insurance
company has no further obligation to the beneficiary. If an
option other than a lump sum payment is selected, or an
arrangement is made where benefits continue over a period of
time, the beneficiary should name his or her own beneficiary.
Careless wording of beneficiary designations can result in
undesirable consequences. A tremendous amount of time is
spent each year in courtroom litigation attempting to
determine beneficiaries and heirs. It is important that you
designate the beneficiary by full name to avoid
misunderstanding.
If an insured person designates his “wife” as the beneficiary,
confusion may arise. If the insured has married more than
once, does “wife” mean his present wife or does it mean his
wife at the time the policy was written? Or does it apply to
another ex-wife who is now caring for his minor children?
The insurance company will make every effort to distribute the
proceeds of a policy in compliance with the wishes of the
insured person, as long as the insured makes his or her
intention clear.
When the intention is not clear, the company must distribute
the funds according to the apparent intent of the insured, or
pay the funds to a local court and request a judicial
determination of the proper distribution.
Naming children who are minors as beneficiaries may be
easiest for an individual when completing an insurance
application. But consider the practicability of a six-year-old
receiving $100,000 and not even knowing what a bank is.
Class Designation
In naming children as beneficiaries, a class designation is
sometimes desirable. Class designations should be used
when individuals of a specific group (such as children of the
insured person) are to share the policy proceeds equally.
If an insured person designates his children as beneficiaries
by naming each child specifically, other children might be
excluded from sharing in the proceeds of the policy. This
might occur if the insured failed to update his beneficiary
provision in his policy to include children who were born,
adopted or otherwise joined the family after the date the policy
was purchased.
The wording of the class designation must carefully specify
intent. A designation of “my children” might include children of
previous marriages or relationships when, in fact, the insured
might have preferred to exclude them. An even more complex
scenario: Naming “my children” as beneficiaries would allow
children living at the time of death to share in the proceeds;
but a child born after the insured’s death would not be entitled
to receive a portion.
By using the spouse’s full name followed by the designation
my “wife” or “my husband,” fewer questions can arise about
the intent.
If an insured person wants to restrict the designation to the
children of his present marriage, he might designate his
present spouse Carolyn Jones Bennett as primary beneficiary
and use the term “our children” or “children born of this
marriage” as contingent beneficiaries.
In addition to the class designation, the per capita and per
stirpes designations are used to benefit children. The per
capita designation means by heads (individual) and per
stirpes means by stock (family line or branch).
Under a per capita designation, each surviving child shares
equally in the death benefit. Under a per stirpes designation
each child, grandchild, or great grandchild, etc., moves up in a
representative place of a deceased beneficiary.
35
Taking Care of Minors and Spouses
Even after deciding to buy life insurance, most parents really
stumble when confronted with the worst case scenario, the
tragedy of both parents dying simultaneously:

Who will the guardians be?

Who will manage the insurance and other
investments after our death?

How and when should the children receive
inheritance without spoiling them, ruining them or
controlling them from the grave?

Who can we trust? Who will make sure the person is
trustworthy?
While life insurance is a key part of most family planning, it is
only a part. The insurance guarantees liquidity – cash, to help
survivors. But there are other critical questions for most
people. Insurance needs to be integrated into a total plan.
Here are some common issues that most people try to
consider when they plan for their family’s future:

If there are no children or a spouse, who will receive
the estate and insurance proceeds? How will it be
managed? Will large sums of cash be dumped as a
surprise? Is this prudent?

If there is a spouse, what if both die accidentally at
the same time?

Will the families fight? Bicker? Sue?

If there are children, who will be their guardians?
Who will manage the assets and insurance
proceeds? Will the cash fall into the hands of the
children when they turn 18? Is this prudent?

If there are children from a previous marriage, has
the insured designated how each will be treated?

If the insured and spouse have children from several
marriages, who gets what? How are they to be
treated? Will the children’s blood mother have input
into how the distribution and management is
handled?

If the insured co-owns properties or business
interests with partners, will they want the spouse as
their partner after the insured is gone? Will the
insured want a deceased partner’s spouse as a
partner? Will the insured’s spouse want to be tied to
the partner when the insured is gone? Will your
children be their partner if you and your spouse are
both gone?

Who manages the assets and insurance proceeds
for minor children? Who files all the fiduciary
documents? Who makes decisions about what child
receives what? How much? When? What if the child
is on drugs? A Rhodes Scholar? A missionary? A
bum?
Life is not always simple. It does not usually resemble a
1950s television sit-com. The insured may have parents or inlaws who depend on him now or will be dependent on him in
the future. The costs of long-term nursing care may be an
expense the insured wants to guarantee.
Young families often have low incomes and have not yet
purchased their first home. Those just starting out, or who
have dependents that are, may want to modify the incomereplacement formula to include an ideal family income level
that is higher than the current income. Also, adding mortgage
payments and a home down payment to the calculations
would be a good idea.
Conclusion
Knowing how much life insurance an insured needs is
probably the most important part of buying coverage. The
process of figuring out how much should be purchased
includes three steps:

Needs analysis. This is the technical review of a
family’s expenses and liabilities. It should give you a
dollar amount or range of dollar amounts that can
serve as a starting point for pricing insurance
policies.
clause excludes the payment of the death benefit
while the insured is serving in the military. The
results clause excludes the payment of the death
benefit if the insured is killed as a result of war.

Hazardous Occupations and Avocations. By
today’s underwriting standards, few applicants are
declined life insurance because of their occupations.
For example, firefighters and police personnel can
purchase life insurance at standard rates. Even
commercial airline pilots can usually purchase life
insurance (although possibly at higher than standard
rates).
Much of the underwriting attention is focused on
avocations or hobbies. If an applicant participates in
a hazardous hobby such as auto racing, sky diving,
scuba diving, etc., then the amount of insurance that
may be purchased may be limited or an extra
premium may be charged due to the additional risk.
Depending on the hobby, the death benefit may be
excluded if death was caused as a result of the
hazardous avocation.
Provisions Not Permitted
By law in most states, life insurance policies are not permitted
to contain the following provisions:

A provision that limits the time for bringing a lawsuit
against the insurance company to less than one year
after the reason for the lawsuit occurs.

A provision that allows a settlement at maturity of
less than the face amount plus any dividend
additions, less any indebtedness to the company and
any premium deductible under the policy.

A provision that allows forfeiture of the policy
because of the failure to repay any policy loan or
interest on the loan if the total owed is less than the
loan value of the policy.

A provision making the soliciting agent the agent of
the person insured under the policy or making the
acts or representations of the agent binding on the
insured.

The law of the state in which the policy is sold
governs the contract. The policy may not contain a
provision by which the laws of the home state of the
insurance company govern the policy provisions.
Special Family Needs
Many people have dependents that are dependent for various
reasons. Some middle-aged people want to guarantee that
their elderly parents have little extra income support for
retirement or long-term care. Also, as we’ve seen in some of
the examples above, children of previous marriages may pose
complicated insurance issues. And some people have several
children, but one with a disability or handicap who may require
a little more financial security than the others. Special
situations like these are without limit, as are the solutions
available.
Sometimes in planning, people discuss multiple beneficiaries
and designate insurance proceeds specifically: 30 percent to
a parent, 50 percent to a spouse, and 20 percent to the
children of a previous marriage. Many parents consider it a
bad idea to dump a huge pot of cash into the hands of a 21year-old who has not had the experience necessary to
manage it properly. Therefore, many parents arrange the
distribution of assets to come at designated ages or situations
by means of a trust.
While it may be expedient to designate funds specifically, it
could be a serious mistake if not handled correctly. It might be
a better idea to put money for specific relatives into several
trusts. These trusts can designate monthly sums to be
distributed and other amounts to be put aside for
emergencies. If any money is left when the beneficiary dies,
the insured can designate that it go to other relatives, a
charity, or wherever else.
36

a.
an insurance contract between the parties and a
breach thereof by the defendant;
b. an intentional refusal to pay the insured’s claim;
c. the absence of any reasonably legitimate or arguable
reason for that refusal (the absence of a debatable
reason);
d. the insurer’s actual knowledge of the absence of any
legitimate or arguable reason;
e. if the intentional failure to determine the existence of
a lawful basis is relied upon, the plaintiff must prove
the insurer’s intentional failure to determine whether
there is a legitimate or arguable reason to refuse to
pay the claim.
In short, the plaintiff must go beyond a mere showing of
nonpayment and prove bad faith nonpayment, nonpayment
without any reasonable ground for dispute.
Beneficiary
A beneficiary is the person or institution that receives the
proceeds of an insurance policy when the insured person
dies. The beneficiary can be the owner of the policy, a third
party or just about anyone, except the insured person.
A beneficiary designation stays in effect unless changed by
the owner. Policy proceeds will be paid to the owner or the
owner’s estate if there is no living beneficiary at the time of an
insured person’s death.
Contract
The policy and attached application are the entire contract.
Statements made in the application are now treated as
representations rather than warranties. Under the law, a
warranty carries more weight than a representation, and any
breach of warranty (whether or not material) could void the
insurance policy.
To the extent that the insurance company may challenge the
policy or deny a claim during the first two years of coverage, it
may do so only if a misrepresentation is material and is
contained in the application.
Free Look
In most states, a life insurance policy cannot legally be issued
unless it has printed on or attached to it a notice stating that
the consumer has a free look period. The free look period is
the period of time during which the policy may be surrendered
to the insurance company together with a written request for
cancellation of the policy. In such an event, the policy shall be
void from the beginning and the insurer shall refund any
premium paid. The length of the free look period varies by
state and/or insurer.
This provision allows the policyholder an opportunity to review
the entire contract and reevaluate the purchase decision.
Grace Period
Technically, all premiums are due on the due date. The policy
provides a grace period of 31 days for late payments. This
does not extend the due date (the premium is still in default),
but it keeps the policy in force until the end of the grace
period. If an insured person dies during the grace period while
a premium is late, one month’s premium will be subtracted
from proceeds.
If the premium remains unpaid at the end of a grace period,
the policy will expire or lapse.
Incontestability
The insurance company may only challenge the validity of a
policy during the first two years that coverage is in effect. After
that time, the policy may not be contested or coverage denied
for any reason except nonpayment of premiums.
Insuring Clause
The insuring clause states that in consideration of the
payment of premiums, the company agrees to pay the face
amount to the named beneficiary, upon proof of death of the
insured, or to pay certain benefits if the insured lives to some
specified age. It sets forth the most basic agreement between
the company and the insured.
Intentionality
If the death of an insured person results from intentional
behavior, an insurance company doesn’t have to pay any
Identifying beneficiaries. An integral part of figuring
out how much coverage one needs is figuring out
who should benefit from your policy. This is an
especially important part of the process if the family
(the usual beneficiary of a life insurance policy) is
large or complicated.

Understanding policy terms. There can be
substantial difference between life insurance policies.
You should pay particular attention to the provisions
and exclusions sections of any life insurance you
consider selling. These are the parts of the contract
that usually limit how, when and how much insurance
will be paid at the time of death. These issues impact
how insurance needs are met to such a large extent
that you should consider them from even this early
stage.
It is important to understand the language of life insurance to
fully understand the different types of protection provided
against the risk of premature death. In Chapter 3, we will
discuss some terms that are important to understand when
purchasing life insurance.
LIFE INSURANCE TERMS AND DEFINITIONS
The life insurance market changes all the time, in tandem with
the changing financial needs of people and groups.
Annotating every variation of life insurance would take several
long books. In this chapter, we’ll take a look at the key
definitions that control life insurance coverage.
These definitions will include all of the basic ideas and
language that set the conditions of life insurance coverage.
Even if you’re considering working with more complicated
variations, like annuities or variable universal policies, this
chapter should give you a sound basis to work from.
Adverse Selection
Adverse selection exists when the group of insureds is more
likely to experience loss than the average group.
Age
References to an insured person’s age may be found in
premium and benefit provisions. For the purposes of
determining life insurance premiums and values, any
reference to an insured’s age means the age as of the nearest
birthday.
Assignment
The policy owner may assign some or all of the rights under
the policy to another person. These include the right to
choose or change the beneficiary, to change the method of
premium payments, and to select settlement options for the
payment of proceeds.
There are two types of assignments of life insurance
contracts. The absolute assignment gives the assignee every
right in the policy the owner possessed before the
assignment; all incidents of ownership are transferred. Of
course, the assignee can receive only the rights the owner
had himself. Thus, any assignment is subject to debts owed to
the insurance company. Upon the completion of an absolute
assignment, the prior owner retains no ownership interest
whatsoever.
A more limited type of assignment is the collateral
assignment. The collateral assignment is used to provide
security (collateral) for some transaction between the owner of
the policy and the assignee. For example, the policyholder
may borrow money and make a collateral assignment of the
policy to serve as security for repayment.
If a collateral assignment is made, only some of the incidents
of ownership are transferred to the assignee, generally for a
limited period of time. The assignee receives only those rights
necessary to provide security for the loan. Thus, the owner
retains some ownership rights.
Bad Faith
Bad faith refers to a claim for which an insurance company
has refused payment without good cause.
The courts have summed up the terms of bad faith in an
insurance context:
...the plaintiff in a “bad faith refusal” case has the
burden of proving:
37
If the exchange is to a policy form with a lower premium, then
proof of insurability may be required (this usually means
another medical exam), as the exchange could result in
adverse selection against the insurance company.
Policy Date and Due Date
The policy date is usually the original effective date. It is
treated as an anniversary date and used to determine
premium due dates and other dates.
The due date is simply the date on which all premium
payments, after the first payment, are due.
Reinstatement
If the premium has not been paid by the end of the grace
period, this provision allows the policy owner to apply for
reinstatement within a specified period of time following the
policy’s lapse. In most states, this period of time is at least
three years. Some states or companies allow up to five years.
Usually the reinstatement process includes the submission of
a reinstatement request or application by the policy owner,
evidence of continued insurability, and the payment of all back
premiums plus interest. In addition, any outstanding loans or
other indebtedness against the policy must be paid.
The insurer has the right to decline the request for
reinstatement if, for example, the insured person is unable to
provide satisfactory evidence of continued insurability. Any
statements made on the reinstatement application are subject
to a new incontestable period (usually two years).
There are several reasons for considering reinstatement.
These include:

the lapsed policy may have more liberal policy
provisions,

the older policy may offer lower interest rates on
policy loans,

suicide and incontestable clauses probably will no
longer apply if the policy is three years old or older,
and

the lapsed policy probably has a lower premium than
a new policy.
This last point is especially true if you purchased the lapsed
policy 10 or 15 years earlier. Instead of paying attained age
rates for a new policy, you may be able to reinstate the lapsed
policy at original issue age rates.
Renewal
The policy schedule for annual renewable term insurance will
show a policy date (original effective date) and an expiry date
(expiration date), plus renewal premiums for the insured
person’s attained age, up to age 69.
If the policy owner does not pay a renewal premium, the
policy will expire. But it may be renewed for another year on
any expiration date before the anniversary date nearest an
insured’s seventieth birthday, without a medical exam or
evidence of good health, simply by paying the renewal
premium.
Riders and Other Modifications
One mechanism used to tailor insurance policies to an
insured’s needs is through the use of riders and other
modifications to standard policies.
Riders take their name from the concept that they have no
independent existence. They have force and effect only when
they are attached to a policy. A rider is a special provision or
arrangement not in the basic policy contract but that has been
attached to and made a part of the contract, sometimes for an
extra premium. Riders can be used to enhance or add
benefits to the policy or they can be used to take benefits
away from the policy.
Riders usually require the payment of a relatively small
additional premium for the benefits provided. These additional
premiums are often less than the cost of a customized policy.
Among the most common kinds of riders:

Accidental Death (Double Indemnity). This
provides an additional death benefit and a
dismemberment benefit for loss of certain body
members, if the death or the loss is due to an
accident. The accidental death benefit, usually
accidental death benefit.
Medical Examinations and Autopsies
Some states require life insurance policies to include a
provision that gives the insurer the right and opportunity at its
own expense to conduct a medical examination of the insured
person as often as reasonably required when a claim is
pending, and to perform an autopsy in case of death where it
is not forbidden by law.
Misstatement of Age or Sex
For example, let’s say Cindy, age 37, applies for whole life
insurance. By mistake, her age is recorded as 35 on the
application. The policy is issued and the premium is based on
age 35 rates. Forty years later, Cindy dies and the misstated
age is then discovered. Cindy has paid a premium which was
lower than it should have been. The death benefit will be
decreased slightly to reflect the amount of insurance which
should have been purchased (with the premium that was paid)
had her correct age been stated.
Due to gender differences in life expectancy, males usually
pay more for life insurance than females, since females live
longer. Therefore, if the insured person’s sex has been
misstated on the application, an adjustment in the death
benefit will be made.
If the mistake is found while the insured is alive, an
adjustment in the premium will be made. The premium
adjustment will usually include a new, higher premium and a
request for additional premium to take care of the amount
which should have been paid in the past.
Modification
Modifications, or changes in the policy, or any agreement in
connection with the policy (such as changes in the
beneficiaries, face amount, or additional coverage), must be
endorsed on or attached to the policy in writing over the
signature of a specified officer or officers of the company. No
one else has any authority to make changes or agreements,
to waive provisions, or to extend the time for premium
payment.
This means that an agent or broker cannot obligate the
company by making a promise that is not part of the contract.
Some modification clauses go further and specifically state
that no agent has the right to waive policy provisions, make
alterations or agreements, or extend the time for payments of
premiums.
Owner
The owner of a policy is the person who makes the contract
with the insurance company. The owner has various rights
and obligations (such as designating a beneficiary and making
premium payments).
The owner does not have to be the person insured (when a
parent takes out a policy covering a child, the child is the
insured and the parent is the owner).
Payee
The payee is the person entitled to benefit payments under
the policy. Usually, this is a designated beneficiary.
Premium Payment
Life insurance does not take effect until the first premium is
paid, so the first premium is due on the policy date. Future
premiums are due on or before each due date.
Proceeds
Proceeds are any moneys payable as a death benefit. If a
policy has an original face amount of $100,000 and dividends
have been used to buy $5,000 of additional insurance, then
the proceeds equal $105,000 at that point in time. On the
other hand, if the policy owner has borrowed $50,000 against
the policy, the proceeds would be only $55,000.
Policy Change Provision (Conversion Option)
The policy may contain a provision permitting the insured to
exchange a policy for another type of policy form offered by
the company. This exchange is usually made from one policy
type to another policy form with the same face amount.
If the exchange is to a policy with a higher premium, the
insured merely pays the higher premium and no proof of
insurability is required.
38




referred to as the principal sum (the rider’s face
amount), pays an additional death benefit if the
cause of death is due to an accident as defined by
the policy. Usually, death must occur within 90 days
of the accident for the benefit to be paid.
Example: John has a $10,000 whole life policy that
contains the accidental death rider (double
indemnity). If he is killed accidentally as defined by
the policy, the total death benefit will be $20,000.
However, it should be noted that the value of the
accidental death rider is $10,000. It is an amount
equal to the face amount of the policy. The basic
whole life amount of $10,000 is increased by another
$10,000 due to the rider.
Waiver of Premium. This provides that, in the event
of total disability as defined by the policy, premiums
for the policy will be waived for the duration of the
disability. The rider is temporary in that it usually
expires when the insured turns 65. However, if a total
disability occurred prior to the expiration of the rider,
the premiums are waived for the duration of the
disability.
There is usually a six-month waiting period
before the rider’s benefits are payable. This
means that the insured must be totally disabled
for six months (a few insurers only require three
months) and then future premiums will be
waived for the duration of the total disability.
Once the six-month waiting period has been
satisfied, any premiums paid during the waiting
period will also be refunded to the policy owner.
A variation of this rider is Waiver of Premium with
Disability Income. The same concept applies as with
waiver of premium, but this rider will pay a weekly or
monthly disability income benefit to the insured in
addition to the life insurance premiums being waived.
Guaranteed Insurability. This guarantees that, at
specified dates in the future (or at specified ages or
upon the event of specified occurrences such as
marriage or birth of a child), the policy owner may
purchase additional insurance without evidence of
insurability. The rate for this additional coverage will
be that for the insured person’s attained age, not the
age at which the policy was issued.
The amount of insurance that can be purchased on
the option dates is usually limited to the amount and
type of the base policy. If the policy owner has a
$10,000 whole life policy with the guaranteed
insurability rider, he or she can purchase up to an
additional $10,000 of whole life coverage on the
option dates.
The biggest advantage offered by this rider is the
opportunity to buy additional amounts of insurance
as one’s responsibilities and needs change, without
proof of insurability.
The option dates are usually the policy anniversary
nearest the insured’s birthdays at ages 25, 28, 31,
34, 37, and 40. In addition, marriage and the birth of
children between the ages of 25 and 40 also trigger
additional options.
Return of Premium. This was developed primarily
as a sales tool to enable the agent to say, “In
addition to the face amount payable at your death,
we will return all premiums paid if you die within the
first 20 years.” The rider is simply an increasing
amount of term insurance that always equals the
total of premiums paid at any point during the
effective years. Technically, the rider does not return
premiums but pays an additional amount equal to
premiums paid to date of death. The policy owner
who purchases the rider is simply buying additional
term insurance.
Return of Cash Value. This seldom-used rider was
designed to offset the common, though invalid,



complaint, “When I die, the company confiscates the
cash value.” This complaint is based on lack of
understanding of the mathematics involved in a level
face value life insurance policy. However, if the agent
can say, “We can attach a rider returning the cash
value in addition to the face amount,” the objection is
more easily answered than if it is necessary to
explain the mathematics involved.
The return of cash value rider is similar to the return
of premium in that it is merely an additional amount
of term insurance that is equal to the cash value at
any point while effective. Buying it, the policy owner
is simply getting additional term insurance.
Cost of Living Adjustment. This rider is important
to people who are in a position to be impacted
strongly by inflation. Because of the high inflation
years of the 1970s, many policy owners were
concerned that the face amounts of policies
purchased would not be adequate to cover expenses
by the time the death benefit was paid. The cost of
living rider changes the face amount of the policy
each year by a stated percentage, such as 5 percent.
This amount is compounded annually.
Additional Insureds. These riders are commonly
attached to life insurance policies to provide
coverage on the lives of one or more additional
insured people. These are usually term insurance
riders covering a spouse, one or more children, or all
family members in addition to the named insured.
Many companies will issue additional insured riders
on request. Some companies actively market
combination coverage policies for family members as
a family protection policy.
Living Need. This rider is a recent development in
life insurance. It allows a terminally ill individual to
obtain part of the insurance proceeds prior to death.
To be eligible for this benefit, the individual must
present medical proof of the terminal illness. Most
companies offering this benefit will limit the amount
of the insurance proceeds which may be paid in this
manner. Most companies do not charge additional
premium for this rider because it is an advance
against the death proceeds for which the policy
owner is already paying premiums.
Suicide
Nearly all life insurance policies have a suicide limitation. If an
insured person commits suicide within the first two years after
the effective date, the insurance company is only obligated to
return the premiums paid. After two years, it is assumed that a
person did not buy insurance with the intent of committing
suicide and death by suicide is covered.
Uniform Simultaneous Death Act
A problem arises when the insured person and the primary
beneficiary die simultaneously. Many states have adopted the
Uniform Simultaneous Death Act. Under this law, if there is no
evidence of who died first, the policy will be settled as though
the insured survived the beneficiary.
Accordingly, the life insurance proceeds would be paid to the
estate of the insured, not the estate of the beneficiary. Of
course, if contingent beneficiaries are designated, the
proceeds would be payable to the beneficiaries. If there is
clear evidence that the beneficiary survived the insured, then
the proceeds are payable to the beneficiary’s estate.
To avoid the problem of the primary beneficiary living for a
very short time following the death of the insured and thus
receiving the insurance proceeds, many policies will include a
common disaster provision. This provision places a time
element on the survival period of the primary beneficiary by
stipulating that the primary beneficiary must survive the
insured by a specified period of time such as 30, 60 or 90
days.
Conclusion
This chapter considered only a few of the important definitions
involved in purchasing life insurance. There will be more
39
Provisions
In the ordinary term policy, the insurance company agrees to
provide insurance on the insured’s life and to pay the benefits
listed. The benefit, or “face amount” of insurance shown in the
policy schedule, will be paid to the beneficiary upon proof that
the insured died while the policy is in force.
An annual renewable term policy may be renewed annually,
or converted to another type of policy at any time, until the
insured reaches age 70.
The policy schedule for annual renewable term insurance will
show a policy date (original effective date) and an expiry date
(expiration date), plus renewal premiums for the insured’s
attained age up to age 69.
An example: If Evelyn’s birthday is March 1st and the policy
st
anniversary date is June 1 , it may be renewed after her sixtyninth birthday. On the next policy date, her nearest birthday
will be the sixty-ninth (although coverage in this case will
actually continue for three months beyond age 70).
Many term policies will include language that instructs the
insured, or policy owner, to contact the company’s home
office about any change that might affect terms or conditions.
This provision also encourages the policy owner to contact the
insurance company for assistance when changing an
address, collecting benefits, or considering exchanging
policies.
Participating Term Policies
Some term policies are participating policies. While in force,
they will share in any divisible surplus of the company’s
participating business as determined each year by the
company. The premium may be a little higher, but the net cost
(premium less dividend) may be less. Dividends, if any, are
due on policy anniversaries. The dividend at the end of the
first policy year will be payable only if the premium then due
for the second policy year is paid.
The owner of a participating policy has options as to how
dividends will be received. They may be taken in cash or
applied toward premium payments. If desired, dividends can
be held by the insurance company to earn interest and be
received later. They may also be used to buy one year term
insurance additions—as much coverage as the dividend will
purchase at the insured person’s attained age (this option is
often selected when a policy owner needs more insurance
than he or she can afford).
Restrictions on Exchanges and Conversions
A term life policy may be exchanged for a whole life policy or
endowment policy at any time before the insured reaches an
attained age of 70. Evidence of good health is not required.
Written application must be made for the desired exchange
option.
Under an original age option, a new policy will have the same
effective date as the term policy and the premium will be
based on the insured’s age as of that date. Since the values
of the policy (cash value and net death benefit) are based on
premium payments, cash accumulations, and interest earned
since the effective date, the policy owner must pay the
accumulated difference between the premiums for the two
policies plus interest.
Under an attained age option, a new policy will have a current
effective date and the premium will be based on the insured’s
attained age when it is issued. The policy owner only needs to
pay the current premium, which will be higher than it would
have been at the original age.
In this scenario, the new policy will not initially have any
accumulated cash value. This will begin to accumulate only in
future years.
If the insured had elected to use dividends to purchase one
year term additions, any available option may be exercised
under the new policy without evidence of good health at any
time before the third anniversary of the new policy. After that
date, limitations may apply. The most common of these:
evidence of good health may be required before the insurance
company will approve the exchange.
If the term policy includes additional benefits, such as
disability or accidental death benefits, similar benefits may be
terms that impact life insurance coverage throughout this
book.
THE MECHANICS OF TERM INSURANCE
As discussed earlier, term life insurance is temporary
insurance that essentially provides a death benefit only. The
benefit is paid only if the insured person dies before the end of
the specified term (whether one year, five years, ten years, or
some other term). If the insured lives beyond the end of the
term coverage, the policy simply expires. A term policy does
not build any cash, loan, or surrender values.
Since term insurance does not build cash value, a policy
owner only has to pay for the death benefit and policy
expenses. For this reason, it is usually the least expensive
form of life insurance for a short term period of coverage. It
may be used as an inexpensive tool to satisfy a variety of
temporary insurance needs, such as a mortgage obligation or
the need to protect insurability until an insured can afford
permanent protection.
Premiums start low and increase over time. They do not
accumulate cash. Generally speaking, they are too expensive
to maintain in later years.
The terminology of naming term insurance may refer to death
benefit or premiums. It is important to understand the
difference.
There are different types of term policies. Level death benefit
provides a consistent amount of insurance. Decreasing death
benefit, which is an ideal type of insurance to cover any
shrinking debt obligation (like a mortgage), starts with a
specified face amount that decreases annually until it reaches
zero at policy expiration. Increasing death benefit provides a
growing amount of insurance over the course of the term. This
type of policy is rare.
Other common names of term life insurance reflect the
premium structure:

Annual Renewable Term

Yearly Renewable Term

5 Year Level Term

10 Year Level Term

15 Year Level Term

20 Year Level Term
The most common of these is the 10 Year Level Term policy.
Yearly renewable term and annually renewable term are two
names for the same plan. The premiums increase annually
and death benefit remains level.
Five, 10, 15 and 20 year level term reflects the period of level
premiums. At the end of the period the premiums increase
dramatically and medical evidence of insurability may be
required.
Renewal and Conversion
Many term policies are renewable, which means they may be
renewed without providing evidence of good health until a
specified age. A one year renewable term policy expires after
one year but is renewable for other one year periods. A five
year renewable term policy can be renewed for subsequent
five year periods. Because of an insured person’s advancing
mortality (that is, increasing chance of death as he or she gets
older), renewal premiums will always be higher than previous
premiums.
Many term policies are also convertible, which means they
may be exchanged for another type of policy, such as whole
life. If the conversion privilege is exercised it will be at the
attained age, meaning the premium paid for the new policy
will be based on the insured’s age at the time of conversion.
Assuming the level term policy is issued as renewable and
convertible, every time the policy renews for a subsequent
term period, the policy’s premium will increase due to the
increased age of the insured.
Decreasing term is also temporary protection for a specified
period of time; the death benefit decreases, but the premium
remains level or constant for the term of the policy.
Decreasing term is usually written as convertible but generally
is not renewable at the end of the specified term period.
40
the equity value built. The insurance company will make loans
against the net surrender value of the policy.
Compared with other loans, borrowing in this way is usually a
straightforward process. The life insurance company’s home
office will send a loan form on request. This form asks for the
amount of the loan, the tax ID number, address and policy
number. Within a matter of weeks, or sometimes days, the
insurance company will send a check.
The policy is used as security for the loan. The insurance
company will not lend an amount which, with interest, would
exceed the net surrender value of the policy. However,
overdue repayments plus interest can push a policy into
default.
A quality product will typically show some cash value in the
first year and cash value that equals at least one year of
premium by the third year. Thereafter, most of the premium is
used to increase cash value.
When the owner of a policy borrows money, interest is
charged just like any other loan. Therefore, if the borrowing
continues, the interest amount will increase each year.
Most companies want to see the loans repaid as quickly as
possible, so they make it as easy as possible to accomplish.
The loan may be paid in a lump sum, periodic payments,
interest-only payments, or applying any dividends generated
by the policy.
It is possible to take money out of the policy in the form of
loans and continue to keep the death benefit in force.
A policy loan reduces the value of a policy. Any amount
outstanding will be deducted from the proceeds if the insured
dies or surrenders the policy for its remaining cash value.
Most policies provide for automatic premium loans against
cash value to prevent a lapse in coverage when a premium is
not paid before the end of the grace period. In order for this to
take effect, the policy owner must make a written request
before the end of the grace period.
Once this arrangement is in effect, future unpaid premiums
will be borrowed against the policy until the cash value is
insufficient to cover a premium payment. As long as the policy
remains in force, a policy owner may resume making premium
payments without having to provide evidence of insurability.
The automatic premium loan feature may be canceled at any
time by written request.
Let’s say Sara’s job was eliminated due to restructuring, and
she finds herself on a tight budget. To minimize expenses,
she requests that automatic premium loans be made to cover
her quarterly life insurance payments. Two premium
payments were paid in this manner. After six months, Sara
found another full-time job and was then able to pay her next
premium.
In order to restore a policy to its full value, an outstanding
policy loan must be repaid with interest. The interest rate
charged on a policy fluctuates with interest rates in general.
Unpaid interest is added to the amount of the outstanding
loan.
Some people don’t understand why they have to pay interest
on their own money; the cash value they have borrowed. The
reason is that the insurance company no longer has use of
this money and it is no longer earning interest for the
company.
Projected policy values (the face amount, cash value on future
dates, etc.) are based on the assumption that premiums will
be paid to cover mortality costs and expenses and that there
will be enough left over to invest and earn interest and equal
the cash value. When the company does not have use of the
money, these values fall short. So a policy loan must be
repaid with interest to restore the contract to its full value.
Participating Policies
Like term insurance, a whole life policy can be either
participating or non-participating. A participating policy is
usually preferable because it can pay dividends.
Premiums should not be confused with cost. Premiums may
be a little higher but net cost (premiums less dividends) may
be lower.
The policy owner has options as to how dividends will be
included in the new policy if the insurance company regularly
issues those benefits under the plan at the current rated age
and risk classification of the insured on the new effective date.
Conversion Limitations
The right to convert a term policy to a cash value policy
without medical examination is very valuable. When an
insurance company restricts this conversion right, the value of
the policy is decreased.
The bold print on a convertible term policy may read
Guaranteed Convertible, but fine print may say for five years
only or to age 70. Some policies will have limited conversion
timeframes, such as the first three years the policy is in force.
Others limit the types of policies to which the insured can
convert.
Conclusion
Only a small percentage of people die owning term policies.
Why is this? Most people die between the ages of 65 and 85
years old. The premiums for term insurance become so
expensive by 60 years old that people cancel the term policy
or convert it to another form of life insurance.
Term life insurance is a good solution for providing coverage
against short term risks.
THE MECHANICS OF WHOLE LIFE INSURANCE
Unlike term life insurance, which has no value after a set
period of time, there are some forms of life insurance that
build a cash equity value over time. These are the most
common kinds of so-called cash value insurance:

whole life,

universal life,

blended whole/universal life,

interest sensitive whole life,

variable life,

variable universal life, and

variable blended whole/universal life.
In most of these cases, premiums start higher than term
insurance, but they stay level. The policy accumulates a
redeemable cash value as time goes on. This kind of
insurance makes sense for individuals trying to accumulate
cash for the future or needing coverage for more than 15
years.
The most common of these kinds of insurance is whole life.
Whole life insurance is a permanent form of insurance
protection that combines a death benefit with cash value
accumulations. In a whole life policy, the face amount is
constant; this amount will be paid if the insured person dies at
any time while the policy is in effect. Premium payments are
fixed and remain the same from the original effective date to
the maturity date.
The policy is designed to mature at age 100. At this age,
premium payments end and the cash value equals the face
amount. At maturity, the face amount is paid to the beneficiary
if the insured person is still living.
Although whole life policies are one of the most common
forms of life insurance sold, most people do not plan on
paying premiums until age 100. Because cash value
accumulates, the cash value at retirement may allow the
policy to remain in force to age 100 without subsequent
premiums. More commonly, whole life insurance is used as a
form of level protection during the income producing years. At
retirement, many people then begin to use the accumulated
cash value to supplement retirement income. This gradually
reduces the death benefit.
Whole life plays an important role in financial planning for
many families. In addition to the death benefit or eventual
return of cash value, the policy has some other significant
features. During a financial emergency, policy loans may be
taken and the full policy values may later be restored. If the
contract is a participating policy, it may also pay dividends.
Most of the preliminary language-setting provisions, terms and
conditions are the same for whole life and term life policies.
Policy Loans
The issue at which whole life policies diverge from term is the
fact that in a whole life policy, the insured can borrow against
41
extended term insurance may also be surrendered for its
present value. This value includes any cash value, the refund
of unused premium due to early termination of the paid-up
contract, plus any dividend additions or accumulations.
Conclusion
Whole life insurance coverage provides protection and
savings that remain in effect for the whole of the insured’s life.
This type of life insurance is preferred by many and used
widely for security because it combines protection and
savings - two major factors in the financial plans of most
families.
In the next chapter we will focus on a variety of flexible
insurance policies. Different types of policies may allow the
policy owner to vary the amount or timing of premium
payments. These policies provide consumers with more
options and attractive alternatives to benefits, premiums,
policy terms, and interest rates than the traditional policies.
UNIVERSAL LIFE, VARIABLE LIFE, AND GROUP
POLICIES
The introduction of universal life policies shifted the risk from
the insurance company to the consumer.
Universal life was the insurance industry’s answer to the
extremely high interest rates that Americans experienced in
the 1980s. Traditional whole life contracts had earned 3½ to 5
percent interest. In an effort to be more competitive, many
insurers developed universal life products with interest rates
that reflected the current market (prime + 1). During the 1980s
these rates were attractive (as high as 12 percent). Since the
early 1990s, these rates have fallen considerably and
universal life has lost much of its desirability. These higher
interest rates provide universal life with its distinctive
characteristic: flexibility.
Universal life is basically a whole life policy divided into its two
components: death protection and cash value. In essence, the
death protection takes the form of one-year renewable term
insurance and the cash value account realizes current interest
rates.
The universal life policy was designed for people who need
flexible coverage over the course of their lifetime. Flexibility is
realized by the following factors:

the policy owner may increase or decrease the death
benefit subject to any insurability requirements,

premium amounts may be changed as long as
enough premium is paid to maintain the policy, and

most universal life policies are sold based on the
accumulation values and tax-deferred retirement
income, rather than on the proposed death benefit.
It is important for policy owners to understand that returns can
and do fluctuate, based on investment performance and
interest rates. Therefore, there is greater uncertainty.
Example: A universal life premium is $1,000 annually
for $100,000 of coverage. When the premium is paid,
an amount necessary to provide one-year renewable
term coverage is used to cover the death protection
element of the policy. The balance is deposited into
the cash account where it will earn competitive
current interest rates.
Progressive Underwriting
Universal life competes in the term insurance marketplace. It
can offer standard rates substantially cheaper (as much as 30
percent or more) than standard rates charged by many term
insurance companies.
Some universal life policies feature progressive underwriting,
which is meant to attract otherwise uninsurable consumers.
These policies are usually structured so that if policy owners
pay the level minimum annual premiums, coverage won’t
lapse for 15 or 20 years.
Progressive underwriting means companies are aggressive in
determining a person’s risk profile. Instead of evaluating risk
on a by-the-book basis, the companies pursue questions to
find out what’s causing any abnormalities in a person’s claim
history.
There are actually two interest rates associated with the
universal life policy: the current year guaranteed rate and the
received. They can be taken in cash or applied toward
premium payments. They can also be held by the insurance
company and earn interest to be transferred later. Finally, they
may also be used to buy additional amounts of whole life
insurance or one year term insurance additions.
When whole life additions are purchased with dividends, they
usually comply with the terms, provisions and valuation
schedules that apply to the underlying policy.
Term Additions
Additional amounts of term insurance are available only if the
policy is in a standard premium class and it is requested in the
application or by a later written request. When a policy is
issued as nonstandard, it means the insured person poses a
higher risk. An insurance company is not usually willing to
provide additional amounts of coverage under this option.
When term additions have been purchased, the additional
benefit is payable when the insurance company receives
proof that death occurred within one year after the dividend
was paid. Term additions usually expire on the next
anniversary date, so they may not accumulate from year to
year.
An insurance company will usually provide life insurance
coverage in increments of $1,000. If term additions are
elected, any part of a dividend not used to buy additional
insurance may be taken in cash, applied toward a premium, or
left with the company. If no other option has been elected, the
insurance company will automatically apply dividends toward
premium payments for existing coverage (it will reduce the net
amount due).
When term additions are purchased, the additional amount is
payable when the insurance company receives proof that
death occurred within one year after the dividend was paid.
The premium charge for term additions is based on the
extended term mortality table being used by the insurance
company for the policy in effect.
Lapse or Surrender
After a whole life policy has a cash value, certain values are
guaranteed upon the lapse or surrender of the policy. Any of
these options (which are known as nonforfeiture options) may
be elected in writing by the owner within 90 days of the due
date when a premium is in default. If no election is made, one
of the automatic options will apply—non-participating
extended term insurance for a standard premium class policy,
or participating paid-up insurance for a special premium class
policy.
The net surrender value is the cash value, plus the present
value of dividend accumulations and additions, minus any
outstanding policy loans. Values are determined as of the last
premium due date. Any outstanding loans that are subtracted
from the surrender value will include any interest or other
amounts charged against the policy after the due date.
Surrender Charges
The surrender charge is a penalty the company charges the
policy owner for terminating the policy during the first few
years. It reduces the cash value of a policy to its surrender
value.
Surrendering To Purchase More Insurance
When used to purchase paid-up participating insurance, the
surrender value will be used as a single premium to purchase
as much paid-up whole life insurance as possible at the
insured’s attained age. The amount may not exceed the death
benefit under the current policy plus additions and dividend
accumulations (normally, it would be considerably less).
Since this additional insurance is paid-up, no further
premiums will be due.
When used to purchase non-participating extended term
insurance, the surrender value will be used as a single
premium to purchase the same amount of protection for as
long as possible at the insured’s attained age. The amount
may include the amount of any paid-up additions and dividend
accumulations.
Since this additional insurance is also paid-up, no further
premiums will be due.
While it remains in force, participating paid-up insurance or
42
bonds, real estate, certificates of deposit, etc. The premiums
from a traditional life insurance contract are placed in the
general account and the entire contract is fully guaranteed by
the company. But these conservative investments may lose
value during periods of high inflation.
Traditional mutual companies’ policies have hedged against
inflation, whereas stock company products have not.
Variable life is a risk investment without guarantees. It may be
a better vehicle for a sophisticated investor than a novice.
Historically, during periods of inflation, the stock market
usually has kept pace with inflationary trends by increasing in
value. In recognition of this fact, an insurance company selling
variable life establishes a separate account consisting
primarily of a portfolio of common stock and other
investments.
The premiums from a variable life insurance contract are
placed in the company’s separate stock market account, so
there is considerable investment risk to the policy owner and
few guarantees. Due to this element of investment risk, the
federal government has declared that variable contracts are
securities and are thus regulated by the Securities and
Exchange Commission (SEC), the National Association of
Securities Dealers (NASD) and other federal bodies.
At the time of solicitation, variable life illustrations or
projections may not be based on assumed interest rates
greater than 12 percent. This prevents both the agent and the
policy owner from assuming excessive and unrealistic rates of
return. The applicant should see a variety of policy
performance illustrations at different rates in order to clearly
understand a variable life product. Remind applicants that
interest rates are not guaranteed and historical performance
may not be duplicated in the future.
There are basically two types of variable life insurance:
scheduled premium variable life and flexible premium variable
life.
Scheduled premium variable life requires that a periodic level
premium be paid to keep the policy in force. Because a
specific premium will be paid, this type of variable life provides
a guaranteed minimum death benefit equal to the initial face
amount of the policy. Excess death benefit may be paid
depending on the performance of the policy’s separate
account.
The scheduled premium is not guaranteed. If mortality
expenses increase or investment return decreases, additional
premium may be required.
If the portfolio of common stock in the separate account does
well, then the variable life policy will perform well. However,
the policy owner is guaranteed a minimum death benefit
regardless of the performance of the separate account.
The cash value of the scheduled premium variable life policy
is not guaranteed. The values are solely dependent upon the
performance of the separate account. Due to this factor, any
cash value loan is usually limited to 75 percent of the policy’s
available cash value.
In most other respects, the scheduled premium variable life
contract is very similar to traditional whole life.
Flexible premium variable life is basically variable universal
life. Variable universal is a universal life policy that allows the
policyholder to select investment risk. Although this insurance
may provide a minimum guaranteed death benefit, most often
there is no guarantee of death benefit or cash values. It is
very difficult for an insurance company to provide a
guaranteed death benefit when the amount of premium you
will pay is unknown.
So, the performance of this kind of policy is solely based on
the performance of the separate account.
Target premiums are fixed in the first year but policy owners,
because of the flexible nature of the products, are not
contractually bound to pay those amounts in subsequent
years.
Group Life Policies
Employers generally offer group life insurance as an
employee benefit. This kind of insurance is usually written as
one-year term insurance.
contract rate.
The current guaranteed rate refers to the annual rate which is
reflective of current market conditions. Thus, the current rate
can change every year. The contract rate is the minimum
guaranteed interest rate that the policy guarantees will be
paid. For example, the policy’s guaranteed rate may be 5
percent. This amount would be credited to the cash account if
the current year’s rate fell below 5 percent.
There are two options regarding the death benefit payable
under a universal life policy. The first option provides a level
death benefit equal to the policy’s face amount. As the policy’s
cash value increases, the mortality risk decreases. Thus, the
cost of the death protection actually decreases over the life of
the policy and, accordingly, more of the premium can be
placed in the cash account. This is exactly the same concept
that applies to whole life.
However, due to the higher current interest rates credited to
the account, if the cash value increases to an amount equal to
or in excess of the policy’s face amount, then the death
benefit will automatically be increased. Under current tax
laws, if the universal life policy is to maintain its status as life
insurance and thus provide a tax free death benefit, there
must be a degree of mortality risk until the insured person
reaches age 95. This is the reason for the automatic increase
in the death benefit if the cash value equals or exceeds the
policy’s face amount. This buffer or corridor between the
death benefit and the cash value must be maintained.
The second option provides for an increasing death benefit
equal to the policy’s face amount plus the cash account.
Unlike the first option, the mortality risk remains at a level
amount equal to the policy’s face value. Thus, the policy
owner will incur a higher expense for the cost of the death
protection over the life of the policy and less of the premium
will be deposited in the cash account.
Universal life provides for cash value loans in the same
manner that whole life or any cash-value insurance policy
does. If a loan is taken, it is subject to interest and, if unpaid,
both the interest and the loan amount will reduce the face
amount of the policy. Many universal life policies will also
permit a partial surrender or withdrawal from the cash
account. This is not treated as a loan. A partial surrender is
not subject to any interest and will reduce the total cash value
in the account.
Variable Life
Variable life insurance provides death benefits and cash
values that vary according to the investment returns of stock
and bond funds. The policyholder can select from available
funds. This allows the policyholder to be more aggressive, or
less aggressive, with the investments.
Historically, to offset imbalances in interest paid under a
standard life policy, some insurance companies made special
provisions for people to purchase life insurance and still take
part in any increase in interest earnings. Some variable and
flexible premium policies contain provisions that guarantee
you certain interest earnings, which will not ever be less than
a predetermined percentage. Four percent was a commonly
used figure through the ‘90s. Lately, some insurers have
adjusted this guaranteed rate to the lower interest market
place.
Variable Life Policies cannot guarantee any return. It is
possible that the policyholder will lose the cash value by
selecting a fund that loses money.
Then by actuarially calculated methods, the insurance
company will also guarantee that you will make a certain
percentage of the current interest rate should that interest rate
go above the interest rate necessary to maintain the policy.
This additional interest percentage is the excess interest over
the minimum guaranteed interest. For example, if the
insurance company is earning 7 percent on an investment, the
insured will earn the guaranteed 4 percent. But if the
insurance company earns 11 percent, the insured may earn
an additional 3 percent on the current interest rate. Therefore,
the combined interest earnings will be 7 percent.
An insurance company’s general investment account usually
consists of safe, conservative investments such as high grade
43
only temporary coverage. An individual member of the group
may lose that coverage when he or she leaves the group.
To lessen this disadvantage, group term policies must include
provisions to provide for conversion to individual coverage.
They may also include continuation of insurance provisions,
and waiver of premium provisions. Some employers continue
group term insurance at reduced amounts for retired workers.
Economic Pressures
A last caveat: as actual interest rates fell below projections
during the late 1980s and early 1990s, consumers became
wary of interest-sensitive policies like universal life. As
aggressive assumptions were proved wrong, consumers
found their vanishing premiums didn’t vanish and their level
premium policies required more money.
Conclusion
Although universal life policies and other variations were
developed to provide flexibility in the type of protection
available, these policies are sometimes accompanied by a
degree of uncertainty and increased risk.
They may provide attractive alternatives, but it is important to
focus on how these products perform when compared to other
alternatives. In the next chapter, we will examine these
alternatives further and discuss how to go about choosing the
life insurance policy that best suits each situation.
CHOOSING THE RIGHT LIFE INSURANCE
Determining what type and amount of life insurance is right for
each customer requires careful investigation of the individual’s
needs and circumstances.
Even the basic types of policies we have described can be
confusing. What’s more, a number of derivative insurance
products are available. These products are usually based on
the three major kinds of insurance: term, whole life, and
universal. These more complex forms of life insurance are
usually designed to fit extremely specialized situations.
In this chapter, we will consider how you can help your
prospects choose the kind of life insurance that best fits their
needs. We’ll review the most common kinds of insurance, as
well as the derivatives.
Whole Life vs. Term
The debate over whether term life or whole life is the better
deal will likely go on as long as there is insurance. Some
people who believe in (and often sell) term insurance that
swear whole life is a rip-off. People who believe (and often
sell) whole life swear that term is the rip-off. But there are
some important differences.
An old insurance industry rule of thumb holds that people who
rent their houses tend to buy term insurance and people who
own their houses tend to purchase whole life insurance.
There’s some logic behind these conclusions. The factors that
influence someone to rent are typically that he or she is:

short on cash;

in transition - not settled in job, family or place;

facing financial uncertainty;

not in a position to make long-term commitments;

interested in investing money in other ways.
These are the same reasons people give to explain why they
purchased term insurance instead of cash value insurance.
Other factors influence people to purchase a home. These
typically include:

belief in owning and building equity,

focus on long-term thoughts and plans,

sufficient stability to make commitments,

a desire to accumulate wealth and build savings,

a need for tax benefits,

a desire to accomplish financial goals during working
years,

a desire to pass wealth and assets on to children.
You can use the following questionnaire to decide which
category of insurance applies best for a prospect.
Available Cash
YES NO
Does your current cash flow allow
you to save money?
□
□
The legal requirements of group insurance are uniform
throughout the majority of states and include the following
basic characteristics:

Most states define a true group as having at least 10
people covered under one master contract. Some
states make allowance for even smaller groups.

Coverage is generally available without individual
medical examinations.

The policy is issued to the employer, trust, union, or
other association. Certificates of insurance are
issued to the individual insured.

The insurance cannot benefit the employer, trust,
union, or other association. It must benefit the
covered employee or member and any dependents.

Premiums are based on the experience of the group
as a whole.

Premiums can be paid entirely by the policy owner or
jointly by the policy owner and the insured
employees. If the premium is paid entirely by the
policy owner, it is a noncontributory plan and all
eligible employees or members must be covered. If
premium is paid by both the policy owner and the
insured employees, the plan is a contributory plan
and at least 75 percent of all eligible employees or
members must be covered.

Employees can be deemed eligible or non-eligible
according to any legitimate occupational distinction
(salary or hourly status, staff position, time on the
job, etc.).
Group life policies have some special provisions unique to
group insurance. Some of these provisions are the same as
those found in policies of individual insurance. Group policies
must contain provisions relating to the following:

Evidence of insurability. Individual insurability must
be proven if the employee or member joins the plan
after the enrollment period.

Conversion. An employee or member must have the
right to convert to an individual policy when the group
coverage is terminated because of termination of
employment or the elimination of a class of insured
people.

Termination of master policy. An employee or
member must also have the right to convert to an
individual policy because the master policy has been
terminated.

Individual certificates. These must be issued as
evidence of coverage under a master policy.
It is possible for people in poor health to receive group
insurance benefits because there is no medical underwriting.
All eligible participants obtain coverage. But, insurance
companies will consider the risk factors posed by employees
as a group and price the insurance accordingly. For example,
coal miners will pay more for group life insurance than office
workers.
Nevertheless, there are many advantages to purchasing this
kind of life insurance. Most importantly:

Underwriting is frequently either guaranteed or very
easy.

The price per $1,000 of coverage is frequently the
same for all employees regardless of age. Clearly,
this is a much better deal for older employees than
for younger employees.

The ability to purchase insurance without a medical
exam is a major convenience.

Payment is made via payroll deductions, making it
both convenient and minimizing paperwork at the
same time.

Some employers offer employees the option to
purchase additional insurance through the group
plan. This can be a big opportunity for people who
would otherwise have trouble getting insurance.
One disadvantage of group life insurance is that it is usually
44
whole life portion provides the lifetime protection.
Package/Family Insurance
The insurance industry has developed a package life
insurance contract to protect all members of a family under
one policy, usually termed a family policy or family plan. Its
purpose is to provide minimal amounts of coverage on each
member of the family. Usually, most of the premium dollar
purchases whole life insurance for the head of the household,
and term insurance in smaller face amounts is written on the
other members of the family.
In general, family plans are sold or purchased with reference
to units of insurance worth a predetermined amount of face
value. So, a family plan might state that the husband/father
has four units of coverage, the wife/mother two units of
coverage and each child one unit of coverage. If a unit was
worth $10,000, this would mean $40,000 in whole life and
$20,000 and $10,000 each in term life, respectively.
Joint Life Policies
Joint life policies are whole life contracts written with two or
more persons as named insureds. Most commonly, the policy
is issued on two lives with the insured amount payable on the
death of the first insured only. The “first to die” policy has not
achieved popularity because actuarial costs result in
prohibitive premiums. However, some policies pay on both
deaths and even (usually for business insurance purposes)
pay on the first death and then increase the amount of
coverage on the remaining insured or insureds so that the
total coverage remains the same.
A variation of the joint life policy is the last survivor policy. It
pays the insured amount not to the beneficiaries of the first
insured to die but to those of the last.
Usually, a joint life policy will provide a conversion or
exchange privilege for the surviving insured whereby that
person may continue the coverage on his or her life following
the death of the other insured.
Modified Life
Modified life is typically a whole life product purchased at a
very low premium for a short period of time (three to five
years) followed by a higher premium for the life of the policy.
The policy may be a combination of term for the modified
period, automatically converting to a whole life premium so
that premiums are lower than average during the modified
period and slightly higher than average (to make up for the
early deficit) thereafter.
Generally, this type of policy is sold to people who want whole
life, but will be unable to pay the typical premium for the next
few years. The person can thus afford the opportunity to
purchase whole life with a modified premium for the initial
three to five years of the policy.
Graded premium whole life is similar to modified whole life in
that initially the premium is very low. Unlike modified life,
which has one increase to a higher level premium for the life
of the contract, graded premium policies provide for an
increase in premium each year for the first 5 to 10 years of the
policy. At the end of this step rated premium period, the
premium remains level for the life of the policy.
Note that graded premium and modified life policies build cash
value, but the amount of the cash value is usually less
because of the smaller outlay of premium. Typically, a graded
premium policy will have very little, if any, cash value during
the graded premium period.
Split-Life Policy
The split-life policy is a combination of a whole life or a term
life insurance contract and an annuity contract. The savings
feature is a retirement annuity to age 65, and the life
insurance feature is usually yearly renewable term insurance.
The sale of the split-life policy has not been approved in all
states, because it seems to discriminate in favor of those
individuals who purchase annuities. Those who do not
purchase an annuity along with their life insurance do not
receive the same low cost benefits as those who do purchase
the annuity. The insurance contract may be renewed as long
as the annuity premium continues to be paid. The most
common amount of coverage found is up to $10,000 of term
Could you save money if you really
tried, or is cash just too tight?
□
□
If the answers to these questions are “no,” then term
insurance is the only option.
Available Savings
YES NO
Are you currently consistently
saving every month?
□
□
Are you saving as much as you
think you could be if you had a
systematic plan?
□
□
If the prospect answers “no” to the above questions, then the
systematic savings feature of cash value insurance may be of
interest.
Specific Savings Goals
YES NO N/A
Do you need to start
or increase your
retirement savings plan?
□
□
□
Do you need to start
or increase your college
savings plan for the
children?
□
□
□
If the answer here is “yes,” then the “tax free” accumulation
inside a cash value policy may be the best choice.
Retirement and Tax-Free Incentives
Are you in a high tax bracket?
□
□
□
Do you plan to work 10 or more
years before retiring?
□
□
□
If prospects answer yes to most of the questions in the
survey, then whole life or other cash value life insurance may
be of interest. These types of coverage make the most sense
for people in higher tax brackets who plan to maintain the
coverage for more than 10 years.
Even the most structured kind of term life insurance will offer a
steady price for 10 years. The catch is that the premium can
rise drastically at the end of the 10-year period.
For the person who answers yes to these last questions, the
most important right he/she has in a life insurance policy is the
right to keep the policy in force without restrictions or dramatic
premium increases. If the company requires an insured to
pass a medical examination to avoid a premium increase in
the future, the insured has assumed a big risk. The insured
receives a discount for taking the risk, but the risk is probably
too great to be desirable for members of this group.
The life insurance industry has become creative in the last few
decades. A number of combination and derivative coverages
developed in recent years can be used to answer specific
needs.
In the rest of this chapter, we’ll consider the basic issues
addressed by combination or derivative policies.
Term/Whole Life Mix – Level
One of the most popular, and perhaps most useful, of the
combination life insurance contracts is the term/whole life mix
policy. Combining whole life insurance with decreasing term
coverage, this policy provides temporary protection and
permanent coverage. The term portion of the coverage
provides monthly income benefits for the family and the
permanent (whole life) part of the policy provides a lump sum
payment.
So, a term/whole life mix policy has two time elements. The
family income term portion of the policy corresponds to the
decreasing term time period. The base part of the policy is
usually whole life and thus some degree of protection is
provided for the whole of life (to age 100).
The family income policy fulfills the need for higher amounts
of coverage during the initial child rearing years. When the
children become self-supporting, the need for protection and
coverage is reduced.
Term/Whole Life Mix - Increasing
The family maintenance policy consists of a combination of
permanent whole life insurance plus level term insurance. It
also consists of a temporary income period plus lifetime
protection. The level term part of the policy provides a monthly
income (triggered by the death of the insured person) and the
45
insurance for each $10 of annuity premium paid.
Adjustable Life Insurance
Adjustable life is a policy that offers the policy owner the
option to adjust the policy’s face amount, premium and length
of protection without having to complete a new application or
have another policy issued. This kind of insurance introduces
the flexibility to convert to any form of insurance (such as from
term to whole life) without adding, dropping, or exchanging
policies.
Adjustable life is based on a money purchase concept. The
basic premise becomes not so much which type of policy
does a person buy but rather how much premium is to be
spent.
If a 25-year-old applicant states that he or she can afford to
pay a $500 annual premium, an adjustable policy may be
mostly term the first few years, then a blend of term and
whole, then finally a whole policy several years later. By the
time the insured is 50 years old and planning for retirement,
the same $500 premium would be used for some form of
permanent insurance protection with guaranteed cash values.
If the insured makes an adjustment in the policy that results in
a higher death benefit, proof of insurability may be required for
the additional coverage.
Industrial Life Policy
The industrial policy is written for a small face amount, usually
$1,000 or less, and the premiums are payable as frequently
as weekly. This coverage derives its name from the fact that it
was originally sold in England to the industrial class of factory
workers.
The industrial policy owner determines how much he or she
can pay each week and the face amount of coverage is
determined from this. A company representative will call on
the policy owner each week, usually at home, to collect the
premium. The policy benefit is usually used to pay for last
illness and burial expenses.
This method of distribution is very expensive for two reasons.
First, the mortality rates are higher for industrial policy owners
because these people tend to have higher than average
health risks and poorer than average living standards.
Second, having the agent collect the premium each week
increases overhead costs.
The market for industrial life has decreased considerably over
the last several decades. Today, industrial life represents
about one percent of life insurance in force.
Recently, a variation in the industrial life concept known as
home service life insurance has emerged. Policies are usually
modest in size, ranging from $10,000 to $15,000 in face
value, and are typically sold on a monthly debit plan
(automatic bank draft) or payments by mail.
Most of the provisions found in individual life insurance
policies are also found in industrial life insurance. However,
because the face amount of the policy is so small and the cost
of this type of insurance is expensive, certain provisions do
not have the same impact on industrial insureds as on
individual insureds:

The application is not required to be part of the policy

Medical examinations are not required

Cash values do not accumulate sufficiently to provide
loans

Settlement options do not apply because of limited
cash value

Suicide provisions are not included in the policy
because of the small benefit amount

Nonforfeiture provisions do not allow the cash option
until premiums have been paid for five years
(compared to three years for ordinary policies)

Dividends are always used to reduce the premium
payment or to purchase paid-up additions
Credit Life Insurance
The unexpected death of an individual who has time payment
obligations can create serious problems for his or her family.
Credit life insurance provides that, in the event of the death of
an insured debtor, outstanding balances are paid off in full.
Credit life insurance can be written on a group basis or in
individual credit life policies. It is usually written as a
decreasing term type of coverage so the amount of insurance
reduces as the amount of the obligation reduces. Level term
insurance may also be written that would remain level for the
term of the loan. The benefits are payable to the creditor and
are used to reduce or extinguish the unpaid indebtedness.
Usually, the individual debtor pays the total premium, even
though the creditor is the policy owner. The premium is added
to the finance contract amount so that, in effect, the insurance
premium is being financed along with the item being
purchased.
Conclusion
Cash value insurance is a poor short-term investment
because the costs of operations, commissions, marketing,
etc., are loaded into the first few years of the policy.
Therefore, the cash accumulates slowly at first.
Cash value insurance is a good long-term investment
because the cash accumulates tax-free. Therefore, for people
in higher tax brackets who need the insurance for more than
15 years, cash accumulating policies are the most cost
effective.
The decision is not always easy. Specialized policy forms are
designed to provide coverage in special situations. These
forms can vary from insurance company to insurance
company but are designed to help provide the right kind of life
insurance for specific needs.
ESTATE PLANNING
Life insurance can create an immediate estate for the insured
person and provide funds that will help preserve the greatest
amount of value in the estate. The field of estate planning is
very complicated. It requires expertise in the areas of wills,
taxes, law and life insurance.
Federal estate tax is a tax on the right to transfer property. It is
based on the fair market value of property and is usually due
within nine months of death. The tax must be paid before
beneficiaries receive their inheritance.
In most instances, inheritance tax does not apply to insurance
proceeds.
The Role of Wills and Trusts
One of the biggest reasons that people create wills and trusts
is to eliminate any family conflict regarding the distribution of
money.
Example: Barry and Iris have children ages 2, 12,
and 18. They are in their 40’s. The distribution of
assets needed to stipulate that money be available to
the guardians monthly for normal expense as well as
a lump sum for college. Monies remaining would be
distributed equally when each child reached the age
of 21. Iris was concerned that no one child should
feel less important than the others. She and her
husband decided that, at age 21, the children would
receive 10 percent of their designated lump sum.
This required a document laying out the terms for
paying out the money in accordance with Barry’s and
Iris’s wishes.
Simply stated, the money in the above example is an estate,
and the document is a trust.
Distributing the Estate
The first step in the estate planning process should be an
ongoing analysis of needs and objectives with emphasis on
the changing needs of beneficiaries and what property is, was
and will be part of the estate. This process is important
because the needs and objectives of an estate are constantly
changing. What is true of an estate plan today may not be true
tomorrow.
There are two methods of distributing the estate; inter vivos
transfers or testamentary transfers.
Inter vivos transfers are made while the estate owner is still
alive. Testamentary transfers are made by will after the death
of the estate owner. More specifically, transfers can be made
through the use of wills, gifts, trusts, or insurance policy
ownership under rights of survivorship.
One objective of estate planning that may be lengthy and
46
planning. A better approach is to structure the distribution in a
trust. This allows the inheritance to coincide with greater
maturity.
Insurance proceeds held in a trust and distributed over time
are less likely to be included in a divorce settlement,
bankruptcy, or lawsuit. While these unhappy events can
happen at any age, they are very likely to be more costly
when they happen early. Hopefully, by the time a child has
reached his or her 30s, he or she has become more aware of
the risks of poor money management.
As we’ve seen, if arrangements are made for the proceeds of
insurance or other assets to be put into a trust, a trustee will
manage the funds.
The person designated to manage the money is not
necessarily the same person an insured must choose as
guardian for the children. One person may be great with
financial matters, but not good with children. Another might be
perfect with children but unable to care for them. The solution
is simply to choose different people for different tasks.
The trustor who creates the trust may choose three different
people for these tasks:

The trustee executes the terms of the trusts.

The guardian takes care of the children.

The money manager manages the money.
Isn’t Life Insurance Always Tax Free?
Despite what we’ve said before, the answer here is only a
qualified
yes.
There
are
some
frequent,
basic
misunderstandings about the tax free nature of life insurance.
Death proceeds pass to a spouse income and estate tax free.
If the insured person owns the policy upon death, the death
benefit is included in the taxable estate. If the policy is owned
by children or a trust, then the policy, cash value, and death
benefit are not included in the taxable estate.
If life insurance proceeds are left to a trust for minor children
through a will, the probate court will probably become involved
with the proceeds.
The Unfunded Irrevocable Life Insurance Trust
The unfunded irrevocable life insurance trust is an estate and
income tax planning tool for use in solving a variety of
problems. It can be used to:

protect and preserve assets;

manage
assets
professionally
where
the
beneficiaries may be unable, by way of disability,
minority, or lack of expertise, to manage the assets
adequately;

avoid probate (court supervision of the property);

provide a source of estate liquidity by allowing the
trustee to buy assets from or loan assets to the
grantor’s estate;

create tax exempt wealth; and

save taxes in general.
Living Trusts
Historically, trusts of any kind were considered a tool for the
rich to avoid tax burdens. But living trusts have become a
standard planning technique for millions of Americans to avoid
probate and organize their affairs.
If insurance proceeds are left to an estate, the insurance
proceeds will be required to go through probate. However, life
insurance proceeds that are payable to adult beneficiaries or
living trusts escape the process of probate.
Conclusion
A Simple Estate with Limited Assets and No Controversy may
be probated in a short period of time. On the other hand,
properties, businesses, multiple beneficiaries and family
conflicts can cause probate to be an expensive, long and
drawn-out process. The primary complaints against the
probate system are that it is public, time consuming,
expensive, and puts control in the hands of the courts.
A revocable living trust eliminates the potentially long and
drawn out time and expense of probate. Revocable living
trusts are created during one’s lifetime (hence living) and are
revocable (can be changed). The revocable trust can be
expensive is probate. Although most people have heard the
term probate and some have experienced it, the definition
eludes them. In its most simplified form, probate is the
process of:

the court viewing and understanding a will to
determine validity;

determining the location and valuation of all
properties;

determining creditors and paying them;

determining the identity of heirs;

resolving controversy between concerned parties;

paying the agents and attorneys for handling of
probate;

filing and paying current and past tax returns;

appointing guardians, if necessary;

appointing money management for minors, if
necessary; and

distributing any remaining property.
A Trust as Beneficiary
A trust is formed when the owner of property (the grantor)
gives legal title of that property to another (the trustee) to be
used for the benefit of a third individual (the trust beneficiary).
This fiduciary relationship allows the trustee to manage the
property in the trust for the benefit of the trust beneficiary only.
The trustee, legally, must not benefit from the trust.
When a trust is designated as the beneficiary of a life
insurance policy, the policy proceeds provide funds for the
trust. Upon the death of the insured person, the trustee
administers the funds in accordance with the instructions set
forth in the trust provisions.
While there are many benefits in naming a trust as beneficiary
of an estate or life insurance policy, particularly for minor
children, there may be drawbacks as well. A trustee may
charge a fee for managing a trust.
The manner in which the trust’s property is managed is often
left up to the trustee, leaving the trust beneficiary powerless to
intervene if the trust is poorly managed. Also, the trustee may
not provide resources for the trust beneficiary as he, she, or
even the grantor would have wanted. The trustee must follow
the directions of the individual who created the trust, which
may become outdated, or inapplicable, due to changing
circumstances.
The Insured’s Estate as Beneficiary
It is rarely advisable to name an insured person’s estate as
beneficiary of an insurance policy. An insured person who is
also the policy owner may direct that the policy proceeds be
payable to his/her executors, administrators or assignees.
Such a designation might be made in order to provide funds to
pay estate taxes, expenses of past illness, funeral expenses,
and any other debts outstanding prior to the settlement of the
estate. However, when an estate is made the beneficiary of
life insurance, the insurance proceeds are included in the
estate for estate tax purposes. Additionally, the insurance is
subject to probate.
Furthermore, when an estate is named as beneficiary, the
insurance proceeds are then subject to the claims of creditors.
This situation may very well not be what the insured intended
when the decision was made to name the estate as
beneficiary.
One of the unique features of life insurance is that the life
insurance proceeds are exempt from the claims of the insured
person’s creditors as long as there is a named beneficiary
other than the insured person’s estate. Even the cash value of
a life insurance policy is generally protected from creditors.
Issues of Insurance Benefits Going To Children
Today’s typical upwardly mobile family has several hundred
thousand dollars of life insurance. If both parents die
simultaneously, the children inherit the total estate and the life
insurance proceeds on their eighteenth or twenty-first
birthdays, depending on the state.
Many people, including professional estate managers, believe
that to allow hundreds of thousands of dollars to be controlled
by inexperienced decision-makers is irresponsible estate
47
used in several ways. The insured can borrow cash values or
annuitize payment plans. Both will allow the insured to use the
money for retirement, but each has distinct pros and cons that
must be assessed individually.
If there is accumulated cash value in a life insurance policy at
the time of retirement, the insured can begin borrowing the
money on a tax-free basis. On the other hand, money
withdrawn from qualified retirement plans like Keoghs or IRAs
will be taxed as income.
Borrowing avoids income taxes on the amount borrowed.
That’s the good news. The bad news is that if the insured
borrows all of the cash value and the policy terminates, the
insured will be hit with capital gains tax on the growth in
excess of premiums. This kind of capital gains tax can be a
nasty surprise at age 80 or 85, when most people are busy
worrying about health coverage or estate taxes.
Depending on the individual policy characteristics (the
crediting rate, the dividend, etc.) and the actual amount
withdrawn, an insured may be able to avoid paying back a
policy loan. If enough cash is left in the policy to keep it in
force, the life insurance proceeds will pay off the loan upon
death.
Annuities
Strictly speaking, annuities are not life insurance, but they are
often sold by life insurance agents so we will cover how they
work.
Life insurance is designed to protect against the risk of
premature death. Annuities are designed to protect against
the risk of living too long. Annuities are sometimes also called
upside down life insurance.
The basic function of an annuity is to liquidate a sum of
money systematically over a specified period of time. An
annuity contract provides for a scheduled series of payments
that begins on a specific date—such as when the recipient
reaches a stated age or a contingent date, such as the death
of another person. The payments continue for the duration of
the recipient’s life or for a fixed period.
The annuitant is the insured, the person on whose life the
annuity policy has been issued. As is the case with life
insurance, the owner of the contract may or may not be the
annuitant. Unlike insurance, though, the annuitant is in most
cases also the intended recipient of the annuity payments.
Depending on the type of annuity and the method of benefit
payment selected, a beneficiary may also be named in an
annuity contract. In these cases, annuity payments may
continue after the death of the annuitant for the lifetime of the
beneficiary or for a specified number of years.
There are two principal types of annuities: fixed and variable.
A fixed annuity is a fully guaranteed investment contract.
Principal, interest and the amount of the benefit payments are
guaranteed. Fixed annuity payments are considered part of
the insurer’s general account assets (the conservative
investment portfolio, not the stock market one).
There are two levels of guaranteed interest: current and
minimum. The current guarantee reflects current interest rates
and is guaranteed at the beginning of each calendar year. The
policy will also have a minimum guaranteed interest rate, such
as 3 percent or 4 percent, which will be paid even if the
current rate falls below the policy’s guaranteed rate. The
minimum guarantee is simply a predetermined lowest rate.
A variable annuity, like variable life insurance, is designed to
provide a hedge against inflation through investments in a
separate account of the insurer consisting primarily of
common stock. A variable annuity is not a fully guaranteed
contract. However, either a fixed or a variable annuity can
guarantee expenses and mortality.
Any expense deductions made to annuity benefits are
guaranteed not to exceed a specific amount or percentage of
the payments made. The guarantee of mortality provides for
the payment of annuity benefits for life.
Variable annuities may be purchased in the same way as
fixed annuities: single premium immediate or deferred and
periodic payment deferred contracts.
Also, variable annuities include a variable premium feature,
thought of as a pot into which you put property, life insurance
or any other assets. These assets can be put into the trust
during lifetime or upon death.
Clients concerned about having enough money to pay any
estate taxes the government may levy against the assets they
want to leave their heirs should consider setting up an
unfunded irrevocable life insurance trust. This mechanism
allows the insured to move some cash out of the estate and
use it to leverage protection by means of a life insurance
policy that benefits the estate.
INSURANCE AS AN INVESTMENT
In May 1994, North Carolina Insurance Commissioner Jim
Long announced an out-of-court settlement with the
Metropolitan Life Insurance Co. over deceptive sales tactics
used by some of the company’s agents. The agreement called
for Met to pay more than $1.2 million in fines and make full
restitution to affected consumers.
The dispute centered on the misrepresentation of whole life
insurance policies as retirement products. Rather than setting
up retirement plans, many Met clients were in fact buying life
insurance policies.
“Our investigation concluded that some Met Life agents were
deliberately obscuring the fact that they were selling life
insurance by calling the policies retirement plans. We believe
that insurance consumers have the right to know what they’re
buying and we hope this settlement sends the message that
slippery sales tactics have no place in North Carolina,” said
Long.
The agreement also detailed an extensive accountability and
compliance plan to assure that the deceptive practices did not
recur in the future.
Similar agreements with Met Life were reached with
regulators in more than 40 other states through the National
Association of Insurance Commissioners.
Life Insurance and Retirement Planning
Life insurance and related annuity products are frequently
used to provide the funding for retirement plans and other
types of plans. Some of these plans may also be funded with
other products such as mutual funds, certificates of deposit,
stocks and bonds, cash held in bank accounts, etc.
A cash value policy accumulates a sum of money for
retirement while providing a death benefit. Upon retirement,
the policy pays an income such as $10 per $1,000 of life
insurance for the insured’s lifetime, or for a specified period.
Once the cash value in the policy becomes greater than the
face amount, that cash amount becomes the death benefit.
These policies can be tailored to accumulate rapidly with high
premium or slowly through lower premiums.
The IRS designates plans that meet certain criteria as
qualified plans. The fact that a nonqualified plan does not
meet the criteria set by the IRS does not imply that it is illegal
or unethical. A nonqualified plan is a legal method of
accumulating money for retirement funds and other purposes.
The difference is that a qualified plan may allow the insured to
deduct some portion of the premiums from current income,
creating a tax savings.
Pension plans and other qualified plans may include incidental
life insurance benefits, but these must be incidental to the
purpose of the plan. The primary purpose of the plan must be
to provide retirement benefits.
In order to stay within the requirements established by the
IRS, qualified plans must satisfy the incidental limitation rule,
which requires that the cost for life insurance benefits
provided by a pension plan (or profit-sharing plan) must be
less than 25 percent of the cost of providing all benefits under
the plan.
Generally, the cost for insurance protection under a pension
or profit-sharing plan is taxable as income to the employee, to
the extent that any death benefit is payable to the employee’s
beneficiary or estate. The cost for any protection for which the
proceeds are payable to and may be retained by the plan,
trustee, or employer is not taxable as income to the employee.
Retirement Options with Cash Value
Upon retirement, a cash value life insurance policy can be
48
annuity benefits for the life of the annuitant with no further
payment following the death of the annuitant. There is a risk to
the annuitant in the fact that he or she must live long enough
once the annuity period begins to collect the full value. If an
annuitant dies shortly after benefits begin, the insurance
company keeps the balance of the unpaid benefits. This
option will pay the highest amount of monthly income to the
annuitant because it is based only on life expectancy with no
further payments after the death of the annuitant.
A refund option will pay the annuitant for life; but, if he or she
dies too soon after the annuity period begins, there may be a
refund of any undistributed principal or cost of the annuity.
The refund may take the form of continued monthly
installments (an installment refund annuity) or it may be in one
lump sum (a cash refund annuity), whichever has been
elected by the annuitant. This option assures the annuitant
that the full purchase price of the annuity will be paid out to
someone other than the company issuing the annuity.
If an individual lives well beyond average life expectancy, then
all of the investment in the annuity will probably have been
paid and there will be no refund.
Life with period certain is basically a straight life annuity with
an extra guarantee for a certain period of time. This option
provides for the payment of annuity benefits for the life of the
annuitant but, if death occurs within the period certain, annuity
payments will be continued to a survivor for the balance of
that period. The period certain can be for just about any length
of time 5, 10, 15, or 20 years. Most often, the period selected
is 10 years because 10 years is approximately the average
life expectancy of a male who retires at age 65. Thus, an
annuitant retires at age 65, selects life with 10 years certain
and dies at age 70, his survivor will continue to receive the
monthly annuity payments for the balance of the period
certain (five more years).
The joint-survivor option provides benefits for the life of the
annuitant and the life of the survivor. A stated monthly amount
is paid to the annuitant and, upon the annuitant’s death, the
same or a lesser amount is paid for the lifetime of the survivor.
The joint-survivor option is usually classified as joint and 100
percent survivor, joint and two-thirds survivor, or joint and 50
percent survivor.
The joint-survivor annuity option should be distinguished from
a joint life annuity, which covers two or more annuitants and
provides monthly income to each annuitant until one of them
dies. Following the first annuitant’s death, all income benefits
cease.
Calculating Guaranteed Interest Rates
Premiums or payments made during the accumulation period
earn a guaranteed return on a tax-deferred basis. There are
two ways to calculate guaranteed interest paid on these
contributions.
The guaranteed purchase rate is the minimum interest rate
that is guaranteed for the life of the contract. This will be a
fairly modest amount, such as 4 or 5 percent. This is the
minimum return that will be paid even if the current annual
rate falls below the guaranteed rate.
Thus, deferred annuities guarantee a minimum interest rate
that contributions will earn. Since the guaranteed rate is less
than prevailing interest rates, the insurer will often credit
excess interest on the contract.
Excess interest is calculated based on how much the insurer
has earned through its investments. If the insurer considers all
of its invested reserves and net investment earnings over a
relatively long period of time, the interest rate calculation is
said to be made based on the portfolio method. If the insurer
instead considers portions of its invested reserves over a
shorter period of time, the interest rate calculation is based on
the tier method.
Annuities and Retirement Planning
Most often, the primary purpose of an annuity is to provide
retirement income. Like life insurance policies, annuity
contracts may include nonforfeiture provisions to protect the
contract holder from total forfeiture or loss of benefits if he or
she stops making the required periodic payments.
known as a flexible premium deferred annuity (FPDA)
contract. Variable annuities offer the same annuity options for
settlement of the contract as fixed annuities. Both types of
annuities are primarily used as retirement vehicles.
A variable annuity poses several other unique issues:

If the portfolio of securities performs well, the
separate account performs well and the variable
annuity, backed by the separate account, will also do
well. Due to this dependence, there is investment
risk to the annuitant. There is no guarantee of
principal, interest or investment income associated
with the separate account.

As evidence of the annuitant’s participation in the
separate account, units of the trust are issued. This
is very similar to shares of a mutual fund which are
issued to mutual fund investors. During the
accumulation period, these units are identified as
accumulation units. Both the number of the units and
the value of these units will vary in accordance with
the amount of premium payments made and the
subsequent performance of the separate account.
Example: Jan invests $100 per month in her
variable annuity. On the day the insurer received
her $100 payment, the value of an accumulation
unit was $10. Thus, Jan is credited with 10
additional accumulation units.

When the annuitant reaches the annuity period,
these accumulation units are converted to annuity
units. The number of annuity units remains constant.
No further money is being contributed to the annuity;
thus, there is no further increase in the number of
annuity units.
However, the value of the annuity units will vary in accordance
with the daily performance of the separate account.
Accordingly, during the annuity period, benefit checks issued
to the annuitant will vary depending on the value of the
annuity units at the time the monthly check is issued.
Occasionally, an annuitant may decide that it is in his or her
best interest to purchase an annuity that offers some
guarantees but also offers protection against inflation. This
type of annuity is usually identified as a combination or
balanced annuity.
A single premium or single payment annuity is usually
purchased by making one lump sum payment.
Example: Barry cashes in a 20-year-old cash value
life insurance policy soon after he retires. This
generates a sizable lump sum of cash, perhaps a
little over $100,000. Barry can use the cash to buy a
single premium annuity that creates income for the
remainder of his life.
When an Annuity Pays
When an annuity is purchased with a single payment, the
benefits may begin immediately or they may be deferred. If an
annuity offers a series of periodic payments, the benefits will
be deferred until all payments have been made. This second
kind of annuity is commonly called a periodic payment
deferred annuity.
There are two periods of time associated with an annuity: the
accumulation period and the annuity or benefit period.
The accumulation period is the time during which the
annuitant is making contributions or payments to the annuity.
The interest paid on money contributed during this time is tax
deferred. The interest earned will be taxed eventually, but not
until the annuitant begins to receive the benefits.
Annuity settlement options are the provisions of the annuity.
Generally, when the annuitant decides to take money from the
annuity, an annuity option will be selected as a method of
disposing of the annuity’s proceeds. It is not unusual for an
annuity option to be elected at the time of application.
The amount of money available during the annuity period is
determined by the annuity option selected, the amount of
money accumulated by the annuitant, and the life expectancy
of the annuitant.
A life only or straight life option provides for the payment of
49
policy proceeds in a lump sum. The policy owner has the right
to elect one or more settlement options while the insured is
alive. If the insured dies when no election is in effect, the
beneficiary may elect a form of settlement.
The fixed period option may be a logical choice if the
beneficiary needs temporary security and not a lifetime
income. If one or more children are named as the beneficiary,
it might be desirable to only provide financial assistance until
they finish their education, begin their own careers, and reach
independence.
The life income option is designed to satisfy an entirely
different need: the need for lifetime income. It is frequently
elected as the form of payment for a death benefit to a
surviving spouse, or for payment of cash values to an insured
who lives to retirement age.
The amount of the scheduled installments is based on the
adjusted age of the payee when benefit payments begin and
the remaining life expectancy (insurance companies calculate
this by using mortality tables). The younger a person is when
benefits begin, the smaller the amount paid, since the
insurance company expects to continue paying longer.
The straight life income option continues to pay for as long as
the beneficiary lives, but all obligations of the insurance
company end as soon as that person dies. Under this method,
a person could die after receiving a single installment, or live
far beyond normal life expectancy and collect many times the
amount of premiums paid in.
This option may also be elected with a guaranteed period
(also known as a period certain), in which case payments will
be guaranteed for a specified period of time even if the payee
dies sooner.
A guaranteed period helps offset the concern of some people
that they may die before receiving the insurance benefits they
have paid for. But since the insurance company is no longer
dealing only with life expectancy, it must set some funds aside
to cover the possibility that it will continue payments beyond a
person’s death. For this reason, a guaranteed period will
reduce the benefit payments; the longer the period
guaranteed, the smaller the benefit.
Under the interest option, the insurance company holds the
entire proceeds and makes period payments of the earned
interest only. The interest rate may be flexible, but a minimum
rate of interest is usually guaranteed in the policy.
This option might be elected if a beneficiary, such as a
surviving spouse, was financially secure and had little need
for the proceeds. With the approval of the insurance company,
an insured might specify that the proceeds will be paid to
another person (such as surviving children) upon the death of
the beneficiary.
Under the fixed amount option, the insured chooses the dollar
amount of the benefit payment. This fixed amount will be paid
periodically until the entire proceeds are exhausted. Interest,
at a minimum guaranteed rate, will be added to the proceeds
annually. Payments may be received under a combination of
options. Elections of settlement options are made in the same
manner as changing a beneficiary, namely, by written notice
to the insurance company. Election by an entity other than an
individual, such as a trust or an estate, is allowed only if the
insurance company consents.
A number of miscellaneous provisions apply to settlement of
the proceeds. Total proceeds of under $5,000 payable to any
one person will generally be paid as a single sum. If
scheduled payments would be less than $50, the payment
period will be shortened so that at least $50 will be paid.
The life income or joint and survivor income options apply only
if the policy owner is the insured person or a beneficiary who
has survived the insured. Proof of age is usually required
when a lifetime income will be paid, because age affects the
amount of the payments.
Generally, a beneficiary cannot assign installment or interest
payments to someone else and may not withdraw proceeds
that are to be held by the insurance company under the option
selected. Exceptions may be permitted if requested by the
policy owner and agreed to by the insurance company.
Annuities may be purchased on an individual basis to help
solve individual retirement needs. In this case, the annuitant is
the owner of the annuity. Often, annuities are purchased on a
group basis covering a number of annuitants typically in an
employment situation.
Group annuities are often used to fund an employersponsored retirement plan, with the employer as the contract
owner. If the annuitant dies during the accumulation period,
the money accumulated is paid to a survivor.
A common illustration is the annual premium retirement
annuity contract, in which the total accumulation is calculated
based on an annual premium, an assumed interest rate and
retirement age (usually 65).
During the accumulation period, the annuity contract is very
flexible in that the annuitant may make payments or not make
payments. In addition, the annuitant has withdrawal options,
whereby the money accumulated can be withdrawn totally, or
in part, during the accumulation period.
Annuities may be used to fund individual retirement accounts
(IRAs), in which case premium payments may be tax
deductible. But, in this application, there are more restrictions
on withdrawals (including tax penalties for withdrawals before
age 59).
Conclusion
There are few guarantees associated with a variable annuity
or other insurance-related investment vehicles.
These contracts will usually guarantee that expenses
chargeable will not exceed a specific amount or percentage.
In addition, they may also guarantee mortality, which means a
benefit check will be guaranteed for the life of the beneficiary
or annuitant. However, these investment tools do not
guarantee the amount of the benefits at retirement, nor do
they guarantee principal or interest.
ACCELERATED BENEFITS AND OTHER CLAIMS ISSUES
During the insured person’s lifetime, the owner may select
from several different options for paying the proceeds of a life
insurance policy to beneficiaries. The most common of these
include:

lump sum,

interest only,

total amount spread over several years,

fixed amount every year for several years, or

lifetime income.
This is important to consider where the beneficiary may not be
experienced in investing large sums of money, where minor
children are involved or when the insured is clear on specific
goals. In any of these situations, the insured may want to
request one of the scheduled distribution plans.
Investment-type insurance can pose some complicated claims
issues. When an insured person dies, any unpaid amounts
that are guaranteed will be paid as a single lump sum to the
insured’s estate, unless other arrangements have been made.
This applies to the current value of any remaining installments
under the fixed period option or life income with guaranteed
period option of annuities and similar tools.
Example: A beneficiary who was receiving payments
under a 10-year fixed period option dies during the
sixth year, so the present value of the remaining
payments will be paid to the beneficiary’s estate.
Another example: If the same beneficiary had
requested that upon premature death, the remaining
payments continue to be paid in installments to
another person (a contingent beneficiary), and the
insurance company approved, the remaining
payments would be paid in this manner to the
beneficiary.
A caveat: These provisions for payment following the death of
an insured person only apply if there are guaranteed amounts
unpaid. Nothing would be payable under the straight life
income or upon the death of the last survivor under a joint life
income annuity.
Structured Settlement Options
Structured settlements provide alternatives to receiving the
50
Example: If the insured elects the interest option for
payments to a beneficiary, the beneficiary would
receive interest only and never have a right to
withdraw the principal. But, if the insured directs that
the beneficiary may be permitted to withdraw a
specific dollar amount or percentage of the proceeds
for special needs (such as education or purchase of
a home) and the company agrees, the beneficiary
would be permitted to withdraw some of the
proceeds.
Under all options that provide scheduled payments, the
benefits may be paid monthly, quarterly, semi-annually, or
annually. The fixed period option pays equal installments for a
specified number of years. Amounts to be paid are
determined by the number of years selected and interest
earnings on the unpaid balance at a rate specified in the
policy. Naturally, the longer the payment period is, the smaller
the benefit.
Just about every life insurance policy contains
settlement tables which show dollar amounts per
$1,000 of insurance for the option selected. These
are simply rows of numbers representing periods of
time, adjusted ages of insured people, and benefit
amounts.
Accelerated Benefits
If you have a terminal illness, a life insurance policy may be
your last substantial source of money. The life insurance
benefits may be made available for medical expenses and
living expenses prior to death through accelerated benefit
provisions or viatical settlement agreements.
Accelerated benefits are living benefits paid by the insurance
company that reduce the remaining death benefit. The
government does not currently consider accelerated death
payments to be taxable income, and the policy owner can get
between 50 and 95 percent of the policy’s face value.
Under a viatical settlement, the policy owner sells all rights to
the life insurance policy to a viatical settlement company,
which advances a percentage (usually 60 percent to 80
percent) of the eventual death benefit. The viatical settlement
company then receives the death benefit when the insured
person dies.
Unlike accelerated benefits, proceeds from viatical
settlements are considered taxable income by the
government.
Accelerated death benefits may require life expectancy of one
year or less. Viatical settlements may be available for a
person who has up to five years to live.
Long Term Care Coverage
Long-term care (LTC) insurance, which reimburses health and
social service expenses incurred in a convalescent or nursing
home facility, is often marketed as a rider to a life insurance
policy. In many respects, this coverage resembles an
accelerated benefit.
LTC rider benefits usually include the following provisions:

elimination periods of 10 to 100 days,

benefit periods of 3 to 5 years or longer,

prior hospitalization of at least three days may be
required,

benefits may be triggered by impaired activities of
daily living, and

levels of covered care include skilled, intermediate,
custodial, and home health.
In addition, certain optional benefits may also be provided
such as adult day care, cost of living protection, hospice care,
etc.
The accelerated benefit or living needs clause combines life
insurance and LTC benefits, drawing on the life insurance
benefits to generate LTC benefits. In a sense, it’s like
borrowing from the life insurance to pay LTC benefits.
Under the LTC option, up to 70 to 80 percent of the policy’s
death benefit may be used to offset nursing home or skilled
care expenses. Under the Terminal Illness option, 90 to 95
percent of the death benefit may be used to offset medical
expenses. Of course, payment of LTC benefits reduces the
face amount of the life policy.
Conclusion
How the proceeds of a life insurance policy are paid is as
important as what will be paid. It is the agent’s responsibility to
make all available options clear to the insured and their
beneficiaries.
UNDERWRITING AND RELATED CONCERNS
To understand how insurers set their prices, imagine a
hypothetical life insurance company starting from scratch.
When customers buy insurance from the company, it isn’t
betting on a client living a long time or dying tomorrow. Its
management knows that out of 1,000 34-year-old males, only
two will die this year.
If 1,000 34-year-old males want to buy a $1,000 policy each,
the company knows it will pay $2,000 in death benefit claims
during the next twelve months.
Therefore, the company would have to charge $2.00 per
$1,000 of insurance to cover mortality costs. This is a key part
of the premium. Next year, out of one thousand 35-year-old
males, 2.11 are expected to die, so the premium will go up a
little bit. By the time the men are 75, 64 out of the 1,000 will
die—so the mortality charge is much higher.
The insurance company also has to pay rent, salaries,
overhead, etc. These operating and administrative expenses
are added into the premiums.
It would be risky if the company didn’t keep a reserve fund in
case of unexpected changes in mortality or income. If an
earthquake or some other catastrophe struck and the
company didn’t have enough to pay all the resulting claims, it
would go bankrupt. So, the company adds an additional
amount to the premiums it charges in order to guarantee its
reserve.
Since the company needs to sell its products, it has sales
expenses: commissions, advertising, promotion, etc. It also
adds these expenses to the premium.
The company has to charge premiums for insurance that will
cover all of these costs.
The Underwriting Process
Underwriting is the process of selection, classification and
rating of insurance risks. Simply put, underwriting is a risk
selection process.
The selection element of the process consists of gathering
and evaluating information and resources to determine how
an individual will be classified: standard or substandard. Once
this part of the underwriting procedure is complete, the policy
will be rated in terms of the premium which the policy owner
will pay. The policy will then be issued.
The job of the underwriter is to use all the information
gathered from many sources to determine whether or not to
accept a particular applicant. The underwriter must exercise
judgment based on his or her years of experience to read
beyond the facts and get a true picture of the insured’s
lifestyle. The underwriter must determine if there are any
factors (occupation, hobbies, lifestyle) that make an individual
likely to die before his or her natural life expectancy.
An underwriter cannot, and is not, expected to foresee all
circumstances. However, the underwriter’s purpose is to
protect the insurance company insofar as he or she can
against adverse selection: very poor risks, and those parties
with fraudulent intent.
Sources of Underwriting Information
The underwriter has various sources of information to provide
the necessary information for the risk selection process.
These sources include:

the application,

medical exams and history,

inspection reports,

the Medical Information Bureau (MIB),

the agent or salesperson.
The form of the application may differ from one company to
another. However, most applications provide the same basic
information.
51
Adverse Underwriting Decisions
A risk is rejected when the insurance company believes the
applicant cannot be profitable at a reasonable premium or
with reasonable coverage modifications.
In recent years, there have been various state and federal
court decisions holding that sex cannot be used as a factor to
determine a life insurance or annuity policy premium.
As a response to gender discrimination, the Norris Act was
passed into law in the late 1970s, prohibiting the use of
gender as a rating factor. In the past, using sex as a factor in
determining rates generally resulted in women paying lower
life insurance premiums than men.
Acquired Immune Deficiency Syndrome (AIDS) is having a
large impact on the insurance industry. The costs associated
with AIDS are those of premature death and medical costs
including long hospital stays and very expensive drug
treatments. These costs affect medical, disability, and life
insurance coverages.
AIDS testing prior to policy issuance has become a common
underwriting requirement. Typically, this takes the form of a
blood test consented to and acknowledged by the prospective
insured.
The requirement for AIDS testing will especially hold true for
those situations in which a large amount of insurance is
desired. Each company sets the ages and amounts of
insurance as underwriting requirements for physical exams
and blood tests for the AIDS virus. In many jurisdictions, HIV
testing requires informed consent of the applicant,
confidentiality of results, and proper notification procedures.
Loss Ratios and Related Concepts
Loss and expense ratios are basic guidelines regarding the
quality of company underwriting.
A loss ratio is determined by dividing losses by total premiums
received. Loss ratios are often calculated by account, by line
of insurance, by book of business (all accounts placed by
each agent or agency) and for all business written by an
insurer. Loss ratio information may be used to make decisions
about whether to renew accounts, whether to continue agency
contracts, and whether to tighten underwriting standards on a
given line of insurance.
An expense ratio is determined by dividing an insurer’s
operating expenses (including commissions paid) by total
premiums. When the combined loss and expense ratio is 100
percent, the insurer breaks even. If the combined ratio
exceeds 100 percent, an underwriting loss has occurred. If the
combined ratio is less than 100 percent, an underwriting profit,
or gain, has been realized.
Example: The ABC Insurance Company realizes $3
million in underwriting losses for all term insurance
policies. This same block of business also generates
$10 million in premium. The loss ratio would be
calculated as follows:
Loss Ratio = Losses/Premiums
Loss Ratio = $3 million/$10 million = 30 percent
Further, assume that the ABC Insurance Company
has operating expenses totaling $2 million for this
same block of term insurance. The expense ratio
would be:
Expense Ratio = Operating Expenses/Premiums
Expense Ratio = $2 million/$10 million = 20 percent
The combined loss and expense ratio equals 50
percent. Thus, the ABC Insurance Company has an
underwriting gain or profit on this block of term
insurance.
As noted earlier, adverse selection exists when a specific
insured or group of insureds is more likely to experience loss
than the average insured or group.
Example: In a randomly-selected group of 1,000 25year-old individuals, only two might be expected to
die in a given year. However, human nature is such
that many healthy 25-year-olds do not see the need
to buy life insurance and prefer to spend their money
elsewhere. It is only those 25-year-olds who are ill or
perhaps employed in dangerous occupations who
Part 1 of the application asks for general or personal data
regarding the insured. This would include such information as:
name and address, date of birth, business address and
occupation, Social Security number, marital status, and other
insurance owned. In addition, if the applicant and the insured
are not the same person, then the applicant’s name and
address would be included here.
Part 2 of the application is generally designed to provide
information regarding the insured’s past medical history,
current physical condition and personal morals.
Part 2 also requires information regarding the current health of
the insured by asking for current medical treatment for any
sickness or condition and types of medication taken. The
name and address of the insured’s physician is also required.
Part 2 will usually also include questions regarding alcohol
and any drug use by the insured. Avocations and high risk
hobbies are also usually reported here.
If the amount of insurance applied for is relatively high, the
applicant may be required to take a medical examination, and
Part 2 is completed as part of the physical exam.
Increasingly, underwriters are relying on paramedical exams
and blood tests for information in order to accurately evaluate
a health risk. Blood testing is almost universally used to
determine cholesterol levels, elevated liver enzymes, and the
presence of AIDS or HIV infection.
Another source of medical information available to the
underwriter is an Attending Physician’s Statement (APS).
After a review of the medical information contained on the
application or the medical exam, the underwriter may request
an APS from the applicant’s doctor. Usually, the APS is
designed to obtain more specific information about a particular
or potential medical problem.
Some simplified forms of life insurance require no medical
exam and only ask very basic health-related questions on the
application. Usually, this type of insurance is only available in
low face amounts, to minimize the impact of adverse
selection.
The application will also record information regarding the
policy owner’s choices with regard to the mode of premium
(monthly, annually, etc.), the use of dividends, and the
designation of a beneficiary.
Finally, the signatures of the insured (and the policy owner if
different from the insured) are required in the appropriate
places on the application.
To supplement the information on the application, the
underwriter may order an inspection report on the applicant
from an independent investigating firm or credit agency, which
covers financial and moral information. This information is
used to determine the insurability of the applicant. If the
amount of insurance applied for is average, the inspector will
write a general report in regard to finances, health, character,
work, hobbies, and other habits. The inspector will make a
more detailed report when larger amounts of insurance are
requested.
Another source of information that may aid the underwriter in
determining whether or not to underwrite a risk is the Medical
Information
Bureau
(MIB),
based
in
Westwood,
Massachusetts. This is a nonprofit trade association that
maintains medical information on applicants for life and health
insurance. The MIB has 650 member companies that write 80
percent of the health insurance and 99 percent of the life
insurance policies in the U.S. MIB information is reported in
code form to member companies in order to preserve the
confidentiality of the contents. The report does not indicate
any action taken by other insurers, nor the amount of life
insurance requested.
An insurance company may not refuse to accept a risk based
solely on the information contained in an MIB report. There
must be other substantiating factors which lead an insurer to
decide to deny coverage. Since 1995, the MIB has been
required to provide explanations to applicants who are denied
coverage, allowing consumers to challenge possibly
inaccurate information about their medical history.
52
coverage is granted.
If a substandard risk presents an above average risk of loss, a
preferred risk presents a below average risk of loss. In an
effort to encourage the public to practice better health, the
insurance industry has developed preferred risk policies with
lower (or preferred) premium rates.
Those applicants who may be eligible for preferred risk
classification are those who:

work in low risk occupations and do not participate in
high risk hobbies (scuba diving, sky diving, etc.),

have a very favorable medical history,

are presently in good physical condition without any
serious medical problems,

do not smoke, and

meet certain weight limitations.
Determining Premiums
The final step in the underwriting process is the rating of the
risk or the determination of the premium. There are three
factors used in determining life insurance rates:

mortality,

interest, and

expenses.
If an underwriter could predict exactly how long each insured
person would live, he/she could calculate the precise premium
to charge for covering the policy face amount and expenses,
while taking into account the interest to be earned on the
premium paid. Of course, an underwriter cannot do this on an
individual policy. But an underwriter can predict the probability
of numbers of deaths for a large group of people by using a
standard mortality table. The table is based on statistics kept
by insurance companies over the years on mortality by age,
sex and other characteristics.
The deaths per 1,000 (or mortality) rate is taken from the
mortality table and converted into a dollar and cents rate. For
instance, if the mortality rate for a particular age group is 3.00,
then, on average, three out of every 1,000 can be expected to
die at that age in the next year.
The basic cost of life insurance is the cost of mortality.
However, in constructing a rate, interest enters the equation. It
is assumed that all premiums are paid at the beginning of the
year and all claims paid at the end. Therefore, it becomes
necessary to determine how much should be charged at the
beginning of the year, assuming a given rate of interest, to
assure enough money at the end of the year to pay all claims.
Expense Loading
An expense loading is added to the net premium in order to:

cover all expenses and contingencies,

have funds for expenses when needed, and

spread cost equitably among insureds.
Loading consists of four main items:

Acquisition Costs. All costs in connection with
putting the policy on the books are charged as
incurred in the insurance accounting. In most cases,
these costs will be so proportionately high in
comparison to ensuing years that they must be
amortized over a period of years. One of the highest
acquisition costs is the agent’s first year commission.
This is the reason a policy that lapses in the first two
or three years creates a loss for the insurer; it has
not yet recovered acquisition costs.

General Overhead Loading. Clerical salaries,
furniture, fixtures, rent, management salaries, etc.,
must be considered when determining expenses.
The allocation of these costs is unaffected by the
size of the premium, probably little affected by the
face amount, but is most likely affected by the
number of policies.

Loading for Contingency Funds. Once a level
premium policy has been issued, the premium can
never
be
increased.
However,
unforeseen
contingencies could make the rate inadequate.
Assessment companies reserve the right to charge
are likely to buy insurance. An underwriter must take
care not to accept too many of these poorer-thanaverage risks or the insurance company will lose
money.
Besides the problem of adverse selection, the underwriter
must guard against moral hazards and morale hazards.
A moral hazard is the likelihood of an applicant to
misrepresent himself or herself to the insurance company with
reference to health status, occupation, or other pertinent
information. In other words, a moral hazard deals with an
individual’s tendency to lie or be dishonest.
A morale hazard is a person’s indifferent attitude toward risk.
Example: An insurance applicant with a history of
speeding tickets and drunk driving would display an
indifferent or apathetic attitude toward his or her own
health and well-being and thus present a morale
hazard to the underwriter.
Classification of Risks
Risk classification refers to the determination of whether a risk
is standard or substandard based on the underwriting or risk
evaluation process.
Standard risks are those who bear the same health, habit, and
occupational characteristics as the persons used in compiling
the corresponding mortality table. Basically, a standard risk is
simply an average risk.
About 90 percent of individuals covered are standard risks.
Less than two percent of individuals applying are turned down
for coverage completely. That leaves about eight percent that
fall somewhere in between.
More high risk cases are becoming acceptable (and, also,
many conditions once considered high risk are now, on the
basis of more experience, being accepted as standard).
Today it is a rare case when coverage cannot be found
anywhere for almost any risk.
Insurers offer special but higher rates to persons who are not
acceptable at standard rates because of health, habits or
occupation. This is sometimes called substandard or extra risk
insurance.
There are several methods of determining the extra rate for
the substandard class of risk:

Rated-Up Age. This assumes that the insured is
older than his or her actual age, which is a way of
saying that he or she will not live as long as a
standard risk. Thus an impaired risk of age 35 may
be issued a policy as applied for but with the rate of
age 40. While having the merit of simplicity of
handling, this method is no longer widely used.

Flat Additional Premium. A constant (no variance
with age) additional premium is added to the
standard rate.

Tabular Rating. Applicants are classified on the
basis of the extent to which mortality of risks with
their impairment or degree of impairment exceeds
that of the standard risk. Percentage tables are
developed and used to calculate the amount of extra
premium to be charged for any class of increased
risks.
Extra percentage tables are usually designated as
Table A, Table B, etc. Each usually reflects about a
25 percent increase above 100 percent, or standard.
Insurers vary in the number of tables on which they
will accept risks. One may not accept anything lower
(or higher, depending on the insured’s perspective)
than, say, Table C (175 percent). Another may write
through Table F (250 percent). Companies can be
found that will write up to 1,000 percent (and even
higher).

Graded Death Benefits. The policy owner pays the
standard premium for, say, $20,000 of insurance but
receives a policy with a face amount of perhaps
$15,000. After some time has elapsed the company
may increase the amount of insurance periodically
and, when the company considers the substandard
condition to no longer exist, the full $20,000 of
53
of this type of receipt is rare.
A temporary insurance agreement is a type of receipt that
provides immediate life insurance coverage while the
underwriting process is taking place whether or not the
individual is insurable.
Example: When the initial premium and application is
submitted, the applicant is provided with a temporary
insurance agreement stating that coverage is
effective immediately and will continue during the
underwriting process. If he or she should die during
this period, the coverage is in force regardless of
insurability or risk classification as a result of the
underwriting process.
Uninsurable Individuals
What should you do if an applicant has health problems that
make him or her uninsurable?
If health problems are so severe that an applicant is classified
as uninsurable, or even if a new life insurance policy is just
too expensive, some companies offer guaranteed issue life
insurance. This insurance is available in smaller face
amounts, like $10,000.
The full face amount is payable in the event of accidental
death, but for death from natural causes the benefit is limited
to the total of premiums, plus interest, at least for the first few
years of the policy. After that, the benefit equals the face
amount. Guaranteed issue life insurance is a good solution
for covering expenses such as funeral costs for otherwise
uninsurable people.
If applicants are rated a substandard risk, there are a number
of things you can do to get them at least some life insurance
coverage.
A life insurance policy may be issued as applied for, modified,
or even amended if the applicant does not meet the
underwriting standards of the insurance company. While
uncommon, an insurance company may issue a waiver with
the policy which states that death by a particular event will not
be covered. This might be done if the insured person has a
particularly hazardous occupation or hobby. More commonly,
an insurer might issue a more limited form of policy or a policy
with lower limits than that desired by the insured.
Conclusion
All insurance companies price their policies to cover mortality
and operating costs. What happens after that makes each
company unique. Some will keep prices low in order to sell a
high volume of policies; others will build in more cost drivers
to weed out certain kinds of risks or bolster profits. Some pay
higher sales commissions, some lower.
As an insurance professional, it is your job to ask the right
questions to help you identify the strategies a company is
using to price the life insurance it sells. This can help you
choose between similar policies to represent. It can also
suggest what a specific company expects from its products
and the marketplace, and provide some idea of what to expect
from the company over the course of several years.
additional premiums in such a case. Legal reserve
companies establish contingency reserves to draw
on in such cases.

Immediate Payment of Death Claims. In ratemaking, it is assumed that all claims are paid at the
end of the year. This is not literally true, of course.
Relying on the law of large numbers, it is safe to
assume that death claims will be spread throughout
the year. Therefore, theoretically, all claims will be
paid six months before the end of the year.
Allowance must be made for this loss in the expense
loading.
The Gross Annual Premium
The gross annual premium, the amount the policy owner
actually pays for the policy, equals the mortality risk
discounted for interest, plus expenses.
By formula:
Gross Premium = Mortality – Interest + Expenses
Net Premium = Mortality – Interest
The mortality risk factor increases with age. This is why some
life insurance policy premiums increase periodically.
The level premium concept was devised to solve this problem
of increasing premiums. Mathematically, the level premiums
paid by the policy owner are equal to the increasing sum of
the premiums caused by the increased risk of mortality.
In the early years of a policy, the level premiums paid are
actually more than the amount necessary to cover the cost of
mortality. Conversely, in the later years of the policy, the
premiums paid are less than the amount necessary to cover
the increased cost of mortality. This shortage in the later years
of the policy is accounted for by the overages (plus interest
earned) in the early policy years.
Reserves
Reserves are accounting measurements of an insurance
company’s liabilities to its policyholders. Theoretically, the
reserve is the amount—including interest to be earned and
premiums to be paid—that will exactly equal all of the
company’s contractual obligations.
A life insurance reserve is a fixed liability of the insurer. This
liability represents the insurer’s promise to pay the face
amount of the policy at some future time. By law, a portion of
every premium must be set aside as a reserve against the
future claim from the policy as well as other contractual
obligations such as cash surrender and nonforfeiture values.
Insurance companies demonstrate their solvency to state
insurance regulators by showing their assets as well as
adequate funds to cover their reserve obligations. In addition
to its assets, the insurer must show that it will continue to
receive future premiums plus interest in order to cover its
reserve obligation.
In most states, the insurance commissioner requires that a
specific reserve be maintained if a company is to be solvent.
The reserve is calculated using a mortality table and an
interest specified by the Commissioner. The estimated
investment return or interest rate paid on the premiums will
also be determined by the Insurance Commissioner. Usually,
a very conservative interest rate is specified.
Policy Receipts
Once the underwriting process is complete and the insured
has been approved, the life insurance policy will be issued by
the insurance company. The coverage is not effective until the
policy is delivered and the initial premium has been paid.
Often, the applicant will pay the initial premium with the
application. When this occurs, the agent will provide a receipt
for the initial premium and the effective date of coverage will
depend on the type of receipt issued.
A few companies use an unconditional or binding receipt that
makes the company liable for the risk from the date of
application. This coverage lasts for a specified time or until the
insurer either issues a policy or declines the application, if
earlier. The specified time limit is usually 30 to 60 days.
With a binding receipt, regardless of insurability, coverage is
guaranteed for a specific period of time following completion
of the application and the payment of the initial premium. Use
54
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REAL ESTATE INSTITUTE
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the corresponding exam for each course.
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FIRST COURSE EXAM ANSWER SHEET
(Use Pen or Pencil to Darken Correct Choice For Each Question)
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
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PRINT COURSE NAME: _______________________________________________
EXAM QUESTIONS APPEAR AT THE END OF EACH COURSE
SECOND COURSE EXAM ANSWER SHEET
(Use Pen or Pencil to Darken Correct Choice For Each Question)
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
A
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PROTECTING PERSONAL ASSETS
Final Examination
1. Employees may not have options for converting ________ into individual insurance.
a. group coverage
b. disability benefits
c. Medicare
d. Blue Cross
2. Traditional broad health care coverage provided by commercial plans creates the incentive to provide efficient,
cost effective health care delivery.
a. True
b. False
3. Reimbursement plans pay benefits directly to the ________.
a. provider
b. state sponsored program
c. insured
d. federally sponsored program
4. Blue Cross is a ________.
a. governmental service plan
b. physician’s service plan
c. ineffective service plan
d. hospital service plan
5. Blue Shield offers medical coverage to cover physician expenses incurred by ________.
a. plan subscribers
b. Blue Cross
c. Medicare subscribers
d. conventional plans
6. The majority of HMOs are organized as ________.
a. governmental corporations
b. for profit corporations
c. non-profit corporations
d. foreign corporations
7. Any services provided by the HMO to members in excess of the basic health care services are referred to as
________ health care services.
a. incremental
b. supplemental
c. unnecessary
d. required
8. Hospitals and private physicians who agree to provide services to members of a PPO charge:
a. half of the standard price for services.
b. a predetermined price for services.
c. twice the standard price for services.
d. the state recommended price for services.
9. Basic medical expense plans have no time or benefit amount limitations.
a. True
b. False
10. Hospital expense coverage does NOT include:
a. daily hospital room coverage.
b. daily hospital board coverage.
c. miscellaneous hospital expense coverage.
d. telephone and television coverage.
11. The out-of-pocket limit is the maximum amount the ________ will be required to pay during a policy year.
a. insurer
b. insured
c. provider
d. servicer
57
PROTECTING PERSONAL ASSETS
Final Examination
12. Major medical plans include a maximum benefit which applies on a ________ basis, “per person.”
a. “lifetime”
b. “annual”
c. “per occurrence”
d. “policy period”
13. UCR is the abbreviation for:
a. underwriters correct report.
b. under care regularly.
c. upper care requirement.
d. usual, customary and reasonable.
14. Comprehensive medical expense insurance is a combination of basic medical coverage plus a PPO.
a. True
b. False
15. Under standard coverage health insurance, pre-existing conditions are automatically covered for the first 30days of the policy period.
a. True
b. False
16. The purpose of the time limit on certain defenses provision is to limit the period of time in which ________ may
challenge the contract.
a. the National Association of Insurance Commissioners
b. the insured
c. the insurer
d. the Director of the State Department of Insurance
17. A ________ is a formal statement given to the insurer regarding a loss.
a. misrepresentation
b. proof of loss
c. record of accident
d. payment of claim
18. COBRA is a federal law that requires employers with ________ to provide for a continuation of benefits.
a. 20 or more employees
b. 20 or less employees
c. 10 or more employees
d. 10 or less employees
19. Under COBRA, a ________ is any individual covered under an employer-maintained group health plan on the
day before a qualifying event.
a. notification statement
b. coverage duration
c. qualified beneficiary
d. dependent
20. Underwriting is extremely more ________ for individual than for group policies.
a. expansive
b. restrictive
c. arbitrary
d. uniform
21. A ________ is an amendment attached to the policy contract which modifies the conditions of the policy.
a. codicil
b. treatise
c. mark-up
d. rider
22. In the 1990’s the Mercer survey found that a significant number of employers were dropping all healthcare
coverage for future retirees.
a. True
b. False
58
PROTECTING PERSONAL ASSETS
Final Examination
23. When someone suffers a serious disability, life insurance ________.
a. benefits double
b. benefits are paid
c. is of no value
d. becomes convertible
24. To be eligible for Social Security disability benefits, the individual must have at least ________ calendar
quarters of coverage during which he or she has paid Social Security taxes.
a. 25
b. 40
c. 50
d. 75
25. The ________ is the period of time the policyholder must be totally disabled before benefits are payable.
a. benefit period
b. evidence of insurability
c. elimination period
d. future increase option
26. A future increase option may also be referred to as the ________.
a. Time Premiums Increase
b. Time Benefits Increase
c. Guaranteed Insurability Option
d. Benefit Period Option
27. Statistically, males become disabled more frequently than females.
a. True
b. False
28. ________ pays for the kind of care needed for individuals who have a chronic illness or disability.
a. LTC insurance
b. Disability income insurance
c. Health insurance
d. Life insurance
29. All newer Long Term Care policies require a period of prior hospitalization before a policyholder is eligible for
benefits.
a. True
b. False
30. Under current rules, a healthy spouse is allowed to keep only a portion of the couple’s monthly income.
a. True
b. False
31. Long-term care underwriting is concerned with the same factors as ________ underwriting.
a. health insurance
b. automobile insurance
c. homeowners insurance
d. crime insurance
32. An Outline of Coverage must be delivered ________ for Long Term Care insurance.
a. with the policy
b. at the time of application
c. upon termination
d. at each renewal date
33. Riders or endorsements which reduce or eliminate benefits usually require ________.
a. the agent’s signed acceptance
b. the insurer’s signed acceptance
c. the applicant’s signed acceptance
d. no special action
59
PROTECTING PERSONAL ASSETS
Final Examination
34. Inability to perform two or more Activities of Daily Living is the usual qualification for Long Term Care benefit
payments.
a. True
b. False
35. Whole life insurance ________.
a. has a cash value
b. premiums increase over the policy life
c. premiums decrease over the policy life
d. is the same as term insurance
36. A death benefit is the one feature that all forms of life insurance share in common.
a. True
b. False
37. ________ should be used when individuals of a specific group (such as children of the insured person) are to
share the policy proceeds equally.
a. Exclusions and limitations
b. Confessions of judgment
c. Class designations
d. A new application
38. Suicides are excluded from coverage in all life insurance policies.
a. True
b. False
39. A ________ is the person or institution that receives the proceeds of an insurance policy when the insured
person dies.
a. free rider
b. beneficiary
c. grace period
d. trustee
40. The ________ of a policy is the person who makes the contract with the insurance company.
a. payee
b. beneficiary
c. owner
d. insurer
41. ________ are any moneys payable as a death benefit.
a. Proceeds
b. Premiums
c. Modifications
d. Reinstatements
42. Term life insurance is temporary insurance that essentially provides only a death benefit.
a. True
b. False
43. Under a whole life insurance policy, a policy loan ________.
a. is never permitted
b. reduces the value of a policy
c. increases the value of a policy
d. terminates a policy
44. The introduction of universal life policies shifted the risk from the insurance company to the ________.
a. government
b. beneficiary
c. consumer
d. insurance department
60
PROTECTING PERSONAL ASSETS
Final Examination
45. ________ insurance provides death benefits and cash values that vary according to the investment returns of
stock and bond funds.
a. Term life
b. Health
c. Universal life
d. Variable life
46. Variable contracts are securities and are regulated by the SEC, NASD, and other federal bodies.
a. True
b. False
47. The industrial life policy is written for ________.
a. a large face amount
b. a small face amount
c. only women
d. only men
48. In most instances, inheritance tax does not apply to insurance proceeds.
a. True
b. False
49. A fixed annuity is not a fully guaranteed investment contract.
a. True
b. False
50. ________ is the process of selection, classification and rating of insurance risks.
a. Underwriting
b. Annuitizing
c. Long term planning
d. Insuring
61
PROTECTING BUSINESS ASSETS
Final Examination
1. In the late 1980s, the Insurance Services Office (ISO) introduced a modular approach for constructing
commercial insurance policies called ________.
a. package policies
b. commercial plan policies
c. ISO policies
d. excellent
2. A commercial property policy will cover any type of business ownership.
a. True
b. False
3. The building and personal property coverage form applies to which of the following?
a. Accounts.
b. Animals.
c. Furniture.
d. Automobiles held for sale.
4. The automatic extension for newly acquired locations or newly constructed property is ________.
a. temporary
b. permanent
c. limited to a maximum of 180 days
d. limited to a maximum of 120 days
5. Property insurance limits are always applied on a calendar-year basis.
a. True
b. False
6. The abandonment condition states that:
a. the insured can freely abandon property.
b. the insurer can abandon the insured.
c. the insured can abandon the insurer.
d. the insured may not abandon property to the insurance company.
7. Losses of valuable papers and records, including computer tapes and disks, will be valued at ________.
a. the original cost to create the records
b. the cost of blank materials for reproducing the records
c. a maximum of $2,500
d. a maximum of $5,000
8. The Causes of Loss form must be attached to commercial property coverage to indicate which causes of loss
are being insured against.
a. True
b. False
9. Damage caused by the weight of snow, ice or sleet is:
a. covered only when the weight exceeds the policy minimum.
b. covered only when the weight does not exceed the policy maximum.
c. covered, but not damage to personal property out in the open.
d. never covered.
10. Regarding water damage, ________ include coverage for “sprinkler damage” from an automatic fire protective
sprinkler system.
a. both the basic and broad causes of loss forms
b. only the basic causes of loss form
c. only the broad causes of loss form
d. neither the basic nor broad causes of loss forms
11. The Special Causes of Loss Form provides the very broadest coverage of all.
a. True
b. False
62
PROTECTING BUSINESS ASSETS
Final Examination
12. Valuation endorsements may provide “functional valuation coverage.” This coverage is used when:
a. replacement with identical property is impossible or unnecessary.
b. the property to be replaced is no longer functional.
c. the property has an extremely high value.
d. the property has an extremely low value.
13. The cancellation clause in the common policy conditions of a commercial policy requires a minimum ________
notice if the insurance company cancels for nonpayment of premium.
a. 5-day
b. 10-day
c. 30-day
d. 1-month
14. A ________ endorsement increases the limit of insurance for business personal property for specified periods
of time to take care of seasonal fluctuations in value.
a. vacancy permit
b. ordinance or law coverage
c. cancellation charges
d. peak season
15. The value reporting form is used by businesses with fluctuating inventories. What type of property cannot be
covered by this form of insurance?
a. Property outdoors.
b. Property above the first floor of a main building.
c. Property at fairs and exhibitions.
d. Property at secondary structures.
16. In effect, value reporting coverage imposes a ________ coinsurance requirement.
a. 0%
b. 80%
c. 90%
d. 100%
17. Toxic mold only affects homeowners; therefore, commercial buildings need not have coverage for this problem.
a. True
b. False
18. ________ is legal responsibility for damage to another party’s person or property.
a. Claims made
b. Liability
c. Occurrence
d. Accountability
19. ________ pays for (or covers) injury or damage that happens during the policy period only.
a. The claims-made form
b. The occurrence form
c. The declarations page
d. The National Association of Insurance Commissioners
20. On the claims-made form, a claim is deemed to be first made when notice of the claim is:
a. recorded in the insurance company records.
b. reported to the Department of Insurance.
c. received by the NAIC.
d. received by the insured or by the insurance company, whichever comes first.
21. The insured would not normally have any liability arising out of war, insurrection, and similar occurrences.
a. True
b. False
63
PROTECTING BUSINESS ASSETS
Final Examination
22. Under the Commercial General Liability Policy, the ________ exclusion restricts coverage for damage with
respect to property manufactured, worked on, or constructed by the insured.
a. aircraft
b. care, custody or control
c. war
d. product liability
23. Under the Commercial General Liability Policy (CGL), insurers are specifically excluding personal and
advertising injury coverage for:
a. butcher shops.
b. auto repair shops.
c. internet businesses
d. law firms
24. Under the supplementary payments section of the Commercial General Liability Policy, reasonable expenses of
an insured person, including loss of earnings up to ________ will be reimbursed.
a. $100 per day
b. $150 per day
c. $200 per day
d. $250 per day
25. Coverage for individuals, partners, and joint ventures is limited to their liability arising out of the conduct of the
insured business.
a. True
b. False
26. Under the Commercial General Liability Policy, Section III, limits of liability apply for ________.
a. a calendar year
b. a policy year
c. the life of the policy
d. each occurrence
27. Under the Commercial General Liability Policy, Section IV, the policy conditions state that the insured’s
insolvency or bankruptcy or that of the insured’s estate ________.
a. relieves the insured of the proof of loss rules
b. relieves the insurance company of its obligations
c. does not relieve the insurance company of its obligations
d. relieves the bankruptcy court of its obligation to pay the insured
28. The insurance company has the right to examine or audit the insured’s records only upon receipt of a court
order.
a. True
b. False
29. The subrogation clause transfers the insured’s rights against a third party to the ________.
a. third party
b. Insurance Services Office (ISO)
c. Department of Insurance
d. insurance company
30. The Notice of Cancellation condition requires the insurance company to give ________ notice of nonrenewal.
a. 10 days
b. 30 days
c. 60 days
d. no
31. Definitions that appear in insurance policies are important because each policy is a legal contract, and
definitions are part of the contract language.
a. True
b. False
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PROTECTING BUSINESS ASSETS
Final Examination
32. Under the Commercial General Liability Policy, Section VI, the definitions of “auto” and “mobile equipment” are:
a. the same.
b. unclear.
c. different.
d. ambiguous.
33. An accident is ________, but the term also means continuous or repeated exposure to the same harmful
conditions.
a. a problem
b. a suit
c. a windfall
d. an occurrence
34. A ________ is defined as one who is substituting in for a worker who is on leave or meeting short-term
employment needs.
a. good worker
b. temporary worker
c. scab
d. union worker
35. Commercial general liability forms exclude virtually all pollution originating from the insured’s premises or
operations, and from the handling, treatment, or disposal of waste materials.
a. True
b. False
36. Under workers compensation law, ________ are strictly responsible for the costs of any employee injuries that
arise out of any employment related injury regardless of fault.
a. states
b. employees
c. employers
d. doctors
37. The arrival of workers compensation laws drastically altered the legal relationship between employer and
employee.
a. True
b. False
38. Workers compensation is a ________ system intended to benefit both the injured employee and the employer.
a. “no-fault”
b. “all-fault”
c. “your-fault”
d. “their-fault”
39. Regarding workers compensation coverage, in some states, the hours worked or wages earned determine
whether or not an employee is ________.
a. independent
b. indentured
c. exempt
d. discharged
40. Which of the following is NOT a possible option for employers to fund workers compensation benefits?
a. state funds
b. employee funds
c. private insurers
d. self-funding
41. Under the insuring agreement portion of workers compensation, medical benefits are provided without limit
________.
a. under no circumstances
b. when death is imminent
c. in every state
d. only in states with small populations
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PROTECTING BUSINESS ASSETS
Final Examination
42. Under the other insurance portion of workers compensation, state laws commonly require that higher benefits
be paid for certain losses as a form of ________ to be paid by the employer.
a. penalty
b. gratuity
c. sympathy
d. bonus
43. Employers’ liability coverage protects against a variety of common law exposures and fills gaps in workers
compensation coverage.
a. True
b. False
44. Under Workers Compensation, Part II, Coverage Provided, the coverages under employers’ liability insurance
are based on ________ under common law.
a. fiduciary duties
b. negligence
c. statutes
d. court action
45. Workers compensation pays benefits based on a state’s statutory workers compensation laws.
a. True
b. False
46. Under Workers Compensation Part V the premium basis used with most classifications is:
a. justification.
b. averaging.
c. cancellation.
d. remuneration.
47. To prevent cancellation of the policy for nonpayment, the insured must pay all premiums, even estimated
premiums:
a. when due.
b. in advance.
c. within a 30 day grace period.
d. within a 60 day grace period.
48. Most workers compensation policies are written for a policy term of ________.
a. one month with automatic renewal
b. one year
c. three years
d. five years
49. Workers compensation premiums are intended to reflect the risk the insurance company takes based on the
exposures to injury or illness faced by the workers in that workplace.
a. True
b. False
50. A “Certified act of terrorism” must be certified by the President and the Secretary of the Treasury.
a. True
b. False
66
PROTECTING
BUSINESS ASSETS
PROTECTING BUSINESS ASSETS
THIS BOOK IS BASED ON
COPYRIGHTED MATERIAL
ORIGINALLY PUBLISHED BY
SILVER LAKE PUBLISHING,
2025 HYPERION AVENUE,
LOS ANGELES, CA 90027.
www.silverlakepub.com
COPYRIGHT © 2004 – 2011 by Real Estate Institute
All rights reserved. No part of this book may be
reproduced, stored in a retrieval system or
transcribed in any form or by any means (electronic,
mechanical, photocopy, recording or otherwise)
without the prior written permission of Silver Lake
Publishing and Real Estate Institute.
A considerable amount of care has been taken to provide accurate and timely
information. However, any ideas, suggestions, opinions, or general knowledge
presented in this text are those of the author and other contributors, and are subject to
local, state and federal laws and regulations, court cases, and any revisions of the
same. The reader is encouraged to consult legal counsel concerning any points of law.
This book should not be used as an alternative to competent legal counsel.
Printed in the United States of America.
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All inquiries should be addressed to:
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TABLE OF CONTENTS
CHAPTER 1
COMMERCIAL PROPERTY
Commercial Property Coverage Review
Commercial Property Coverage Forms Review
Building and Personal Property Coverage Form
Major Coverages Offered
Building Coverage
Business Personal Property Coverage
Coverage for Personal Property of Others
Property Not Covered
Additional Coverages
Debris Removal
Preservation of Property
Fire Department Service Charge
Pollutant Clean Up and Removal
Increased Cost of Construction
Extensions of Coverage
Newly Acquired or Constructed Property
Business Personal Property
Personal Effects and Property of Others
Valuable Papers and Records
Property Off Premises
Outdoor Property
Non-Owned Detached Trailers
Exclusions
Limits of Insurance
Sublimits
Deductibles
Common Policy Conditions
Loss Conditions
Abandonment
Appraisal
Duties in the Event of Loss
Insurance Company Rights
Loss Payment
Recovered Property
Vacancy
Valuation
Coverage for Minor Damages
Valuable Papers and Records
Additional Conditions
Coinsurance
Mortgage Holders
Optional Coverages
Agreed Value
Inflation Guard
Replacement Cost
Extension of Replacement Cost to
Personal Property of Others
Pollutants
Stock
Causes of Loss Forms
Basic Causes of Loss Form
Covered Causes of Loss
Fire and Lightening
Explosion
Wind and Hail
Smoke Damage
Aircraft or Vehicles
Riot or Civil Commotion
Sprinkler Leakage
Sinkhole Collapse
Volcanic Action
Exclusions
Ordinance or Law
Earth Movement
Government Action
Nuclear Hazard
Utility Services (Off Premises Power Failure)
War and Military Action
Water
Exclusions with Exceptions
Specific Coverage Form Exclusions
Business Income Coverage
Leasehold Interest Coverage
Legal Liability Coverage
Animals
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Broad Causes of Loss Form
Covered Causes of Loss
Falling Objects
Weight of Snow, Ice, or Sleet
Water Damage
Exclusions
Additional Coverage – Collapse
Special Causes of Loss Form
Covered Causes of Loss
Exclusions
First Group of Exclusions
Second Group of Exclusions
Third Group of Exclusions
Final Group of Exclusions
Limitations
Additional Coverage – Collapse
Additional Coverage – Extensions
Covering Special Needs of the Insured
Endorsements
Valuation Endorsements
Additional Property Covered Endorsements
Specified Property Covered Endorsements
Vacancy Permit Endorsement
Ordinance or Law Coverage Endorsement
Utility Services – Direct Damage Endorsement
Cancellation Changes Endorsement
Functional Valuation Endorsements
Peak Season Endorsement
Earthquake Cause of Loss Form
Covered Causes of Loss
Exclusions
Earthquake Limitation
Earthquake Deductible
Value Reporting
Difference in Conditions (DIC)
Issues in Commercial Property Insurance Today
Mold
Terrorism
Increasing Premiums
CHAPTER 2
GENERAL LIABILITY
Occurrence versus Claims-made
Commercial General Liability Policy
Declarations Page
Coverage Forms
Section I – Coverages
Policy Preamble
Coverage A - Bodily Injury and Property Damage
Insuring Agreement
Coverage Agreement and Notice of Claim
Coverage A Exclusions
Expected or Intended Exclusion
Contractual Liability Exclusion
Liquor Liability Exclusion
Required Statutory Benefits Exclusion
Pollution Exclusion
Auto, Watercraft, Aircraft Exclusion
Mobile Equipment Exclusion
War Exclusion
Care, Custody, or Control Exclusion
Product Liability Exclusion
Subcontractor Exclusion
Impaired Property Exclusion
Recall Exclusion
Rental Premises Exclusion
Coverage B
Personal and Advertising Injury Liability
Insuring Agreement
Coverage Agreement and Notice of Claim
Coverage B Exclusions
Personal and Advertising Injury Exclusions
Internet and Media Businesses Exclusions
Coverage C – Medical Payments
Intent
Coverage C Exclusions
Supplementary Payments
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Section II – Who Is An Insured
Other Insureds
Using Equipment with Permission
Newly Acquired or Formed Organizations
Section III – Limits of Liability
Section IV – Policy Conditions
Bankruptcy
Insured’s Duties
Legal Action against the Company
Other Insurance
Premium Audits
Representations
Separation of Insureds
Subrogation
Notice of Cancellation
Insured’s Right to Claim Information
Section V – Extended Reporting Periods
Basic Extended Reporting Periods
Supplemental Extended Reporting Periods
Section VI – Policy Definitions
Advertisement
Auto
Bodily Injury
Coverage Territory
Employee
Executive Officer
Hostile Fire
Impaired Property
Insured Contract
Contractual Liability
Leased Workers
Loading or Unloading
Mobile Equipment
Occurrence
Personal Injury
Pollutants
Products and Completed Operations
Property Damage
Suit
Temporary Worker/Volunteer Worker
Your Product
Your Work
Endorsements
Nuclear Energy Liability Exclusion Endorsement
Laser Beam Exclusion Endorsement
Deductible Liability Insurance Endorsement
Additional Insureds or Vendors Endorsements
Exclusionary and Special Risk Endorsements
Amendments to Coverages or Limits
Endorsements
Other Coverage Forms
Pollution Liability Coverage
Pollution Liability Extension
Coverage Endorsement
Limited Pollution Liability Extension
Endorsement
Total Pollution Exclusion Endorsement
Pollution Liability Coverage Form
Limited Pollution Liability Coverage Form
Liquor Liability Coverage
Issues in General Liability Coverage Today
Terrorism
Costs of Coverage
CHAPTER 3
WORKERS COMPENSATION
History of Workers Compensation
The Current Workers Compensation System
Benefits of the Workers Compensation System
Coverage Provided
Employees Exempt from Workers Compensation
Injuries Covered
Methods of Providing Coverage
State Funds
Private Insurers
Self-Funding
Workers Compensation Policy
Information Page
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General Section
Who Is Insured
Workers Compensation Law
Policy Territory
Locations
Part I – Workers Compensation
Exposure During Policy Term
Insuring Agreement
Defense Coverage
Other Insurance
Subrogation
Part II – Employer’s Liability
Coverage Provided
Third Party Suits
Family Member Services
Dual Capacity
Exclusions
Contractual Liability
Punitive Damages
Legal Obligation
Willful Acts
Outside Policy Territory
Stress
Limited Jurisdiction
Defense Coverage
Other Insurance
Policy Limits
Subrogation
Legal Action Against Insurance Company
Part III – Other States’ Insurance
Notice for New Operations
Work in a New State
Part IV – Duty if Injury Occurs
Part V – Premium
Manual Rates
Classifications
Remuneration
Premium Payments
Final Premium
Cancellation
Records
Audit
Part VI – Conditions
Inspection
Policy Term
Cancellation
First Named Insured
Endorsements
Voluntary Compensation Endorsement
Longshore and Harbor Workers Endorsement
Voluntary Compensation Maritime Coverage
Endorsement
Foreign Coverage Endorsement
Workers Compensation Premium Determination
Classifications
Rates and Premiums
Manual Rates
Remuneration
State Rating Bureaus
Premium Determination
Loss Sensitive Rating Plans
Experience Rating
Retrospective Rating
Review of Premium Determination Process
Premium Audits
Declination of Coverage
Assigned Risk Plans
Reducing Premiums
Issues in Workers Compensation Today
Workers Compensation Cost Issues
Medical Costs
Return to Work Programs
Integrated Disability Management
Employee Leasing
Fraud in the Workers Compensation System
HIPAA, Privacy and Medical Records
Terrorism
Final Comments
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CHAPTER
1
For example: ABC Monogram Company is a jobber in the
garment industry. ABC machine stitches monograms and
logos on bowling shirts. They don’t make the shirts; they don’t
own the shirts. They just apply the monograms. But should
5,000 newly-monogrammed shirts be destroyed in a fire at
their shop, ABC’s business personal property coverage would
cover the value of ABC’s labor and materials for the
monograms.
Consider another scenario. The shirts, although the property
of another company, were in ABC’s care, custody, and control
when destroyed by fire. If ABC carried coverage for property
of others, ABC’s insurance company would reimburse Active
Sportswear for their loss.
Coverage for business personal property has traditionally
been known as contents coverage. But it includes more than
building contents because it applies to property located in or
on the described building, or within 100 feet of the described
premises while in a vehicle or out in the open.
Personal property includes furniture and fixtures; machinery
and equipment; “stock” (which, as we’ll see, can have
disputed meaning); all other personal property owned by the
insured and used in the insured’s business; labor, materials or
services furnished or arranged by the insured on the personal
property of others; and the insured’s use interest as a tenant
in “improvements and betterments.”
The definition of “business personal property” also includes
leased personal property for which there is a contractual
responsibility to procure coverage. The value of such leased
property is included in the limit of insurance for business
personal property. Other methods for insuring leased personal
property, by endorsement, also remain available.
“Stock” means merchandise held in storage or for sale, raw
materials and in-process or finished goods, including supplies
used in their packing or shipping. “Improvements and
betterments” of an insured tenant means fixtures, alterations,
installations or additions which are made a part of a building
which the insured occupies but does not own, and which are
acquired or made at the insured’s expense, but cannot legally
be removed by the insured.
Coverage for personal property of others means property of
others which is in the insured’s care, custody or control. This
coverage also applies to property located in or on the
described building, or within 100 feet of the described
premises while in a vehicle or out in the open. The insurance
company’s payment for any loss to personal property of
others will only be for the account of the owner of such
property.
Commercial Property Coverage Forms Review
Property coverage forms establish the conditions for coverage
and describe the types or kinds of property insured, e.g.,
buildings, contents, extra expense, structures in course of
construction, glass, leasehold interest, etc.
Each coverage form is designed to insure specific types of
property or losses.
Coverage forms:

identify the subject of the insurance,

describe coverages,

describe additional coverages

describe optional coverages, and

list exclusions and conditions.
Eleven different commercial property coverage forms are
included in the CPP program. Each one can be issued alone
or be combined with other property forms on a monoline
policy, or can be issued with other coverages as part of a
package policy. They are:

building and personal property coverage form,

builders risk coverage form,

business income coverage form (with extra
expense),

business income coverage form (without extra
expense),
COMMERCIAL PROPERTY
In the late 1980s, the Insurance Services Office (ISO)
introduced a modular approach for constructing commercial
insurance policies called package policies. The ISO
developed a series of specialized forms, with each form
fulfilling a specific policy function. The right combination of
forms would create a complete, custom-made policy. Any of
the available coverage forms could also be issued as part of a
monoline policy (only one major kind of coverage), or could be
joined with other coverages to form a package policy
(consisting of two or more coverage parts).
Under the Commercial Package Policy (commonly called
CPP) program, the coverage for commercial property is made
up of a set of forms:

a property declarations page;

the property conditions;

one or more property coverage forms;

one or more causes of loss forms; and

any endorsements.
Most package policies consist of both casualty (liability forms)
and property forms. In this part of the course, we will discuss
the property portion of the package.
Commercial Property Coverage Review
The commercial property policy is intended to provide
coverage for commercial insureds – businesses. Any type of
business ownership is eligible for coverage including sole
proprietorships, partnerships, joint ventures, and any type of
corporation.
Commercial property forms are designed to provide insurance
for the risks common to a business for its real property and
business personal property. Real property is the actual
building, as well as permanent fixtures. Business personal
property are the items usually found in a commercial building
including furnishings, machinery, equipment such as
computers, raw materials or the insured’s finished inventory.
Nearly every business has commercial buildings or contents
that need to be insured for losses. The Building and Personal
Property Coverage Form covers most types of completed
commercial buildings or contents or both.
The building and personal property form may be used to
provide any or all of the following coverages. A limit of
insurance must be shown in the declarations for each type of
property covered:

Coverage A - Building(s)

Coverage B - Business personal property belonging
to the insured

Coverage C - Personal property of others
Building coverage means the building or structure described
in the Declarations Page. It includes completed additions;
permanently installed fixtures, machinery and equipment;
outdoor fixtures; and personal property used for service or
maintenance of the building or its premises (such as fire
extinguishers, outdoor furniture, floor coverings and
appliances used for refrigerating, ventilating, cooking,
dishwashing or laundering).
If not covered by other insurance, building coverage also
includes additions under construction, building alterations and
repairs, and materials, equipment, supplies and temporary
structures on or within 100 feet of the described premises
used for making additions, alterations or repairs to the building
or structure.
The building coverage category provides coverage for more
than just structures. It’s important to keep these non-building
items in mind when establishing property insurance limits.
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




Coverage for Personal Property of Others
This coverage applies to personal property of others in the
insured’s care, custody or control. Any payment for loss will
be made only for the account of the owner, which means the
coverage is designed to reimburse the owner for the loss.
Payment will not be made to the named insured under any
circumstances, and payment would not be made if the owner
had other insurance and was able to recover under that
policy.
Property Not Covered
The building and personal property coverage form does not
cover all types of property, and this section contains
exclusions of kinds of property that are not covered. They are:

Accounts, bills, money, securities, and other
evidences of debt,

Animals, unless boarded or held for sale by the
insured

Automobiles held for sale

Land, water, growing crops and lawns

Personal property while airborne or waterborne

Contraband or illegally traded or transported property

Vehicles, aircraft or watercraft

Grain, hay, straw, or other crops outside of buildings

Outdoor signs not attached to buildings

Outdoor radio or television antennas (including
satellite dishes)

Outdoor fences, trees, shrubs, and plans

Bridges, roads, walks, patios and other paved
surfaces

Cost of excavations and other ground preparation

Foundations of buildings if below basement or
ground level
Exclusions appear in insurance policies for a variety of
reasons. Some types of property are simply not insurable. It
would be against public policy to insure contraband. Other
types of losses are not verifiable, for example, petty cash or
currency left on premises.
Yet other types of property are excluded because they are
more appropriately insured by other policies or coverage
forms. Vehicles licensed for road use, for example, should be
insured by automobile insurance.
A few exclusions are designed to remove coverage for
exposures that reflect a unique hazard that is not included in
basic premium rates, but for which separate coverage is
available at an additional charge. In some cases, a limited
amount of coverage for excluded items is provided elsewhere
in the policy. Notice that the cost to research and restore
valuable papers and records, and the loss of outside radio or
television antennas and signs, are excluded. Limited amounts
of coverage for these same exposures are restored by the
coverage extensions, and additional amounts of coverage
may be added by endorsement or under a separate policy
form.
Additional Coverages
Additional coverages are limited amounts of coverage for
specific types of losses or expenses which are provided in
addition to the major property coverages.
Debris Removal
Coverage is provided for the expenses of removing the debris
of covered property that is damaged by a covered cause of
loss during the policy period. Debris removal expenses must
be reported in writing within 180 days of the date of loss.
Removing the consequential debris from a major loss (such
as what’s left when a building is damaged by fire) can be
costly. Provided it’s reported within 180 days of the loss, the
insurance company will pay up to 25% of the total of the
following for debris removal: (1) the amount paid for the direct
loss plus (2) the deductible.
Example: For an $8,000 loss, for which a $500 deductible
applies, the insurance company pays $7,500 for the direct
extra expense coverage form,
leasehold interest coverage form,
legal liability coverage form,
condominium association coverage form,
condominium commercial unit owners coverage
form,

mortgage holders errors & omissions coverage form,
and

tobacco sales warehouses coverage form.
Building and Personal Property Coverage Form
In this section, we’ll look at the first form listed, ISO Form CP
00 10, and most commonly used. The Building and Personal
Property Coverage Form describes the types of property
coverages that apply, and establishes the conditions for
coverage. A separate set of Commercial Property Conditions
(which apply to this form and other property forms) must be
attached, along with one or more Causes of Loss forms
(which describe the perils insured against). Together, these
items complete what is known as a Commercial Property
Coverage Part.
The policy begins with a Declarations Page, which identifies
the named insured covered by the policy and the
distinguishing elements of the coverage. As part of its
simplified approach, the policy uses a conversational tone.
Throughout the policy, “you” refers to the named insured, and
“we” means the insurance company. No “party of the first part”
found here.
The coverage form begins with a few simple statements. First
it cautions you to read the “entire policy,” meaning all parts of
the policy in addition to this coverage form.
It then explains that various pronouns (such as “you” and
“we”) are used to refer to the named insured and the
insurance company.
The last statement points out that the coverage form has a
specific “definitions” section, and that the meaning of any
words that appear in quotation marks can be found in that
section.
Major Coverages Offered
This form covers direct physical loss or damage to covered
property. Each major coverage applies only if a limit of
insurance is shown for that coverage in the declarations.
Building Coverage
The first major coverage is for building(s). More than one
building or structure may be described in the commercial
property declarations. Notice that coverage applies to more
than just the building itself. Building additions, permanently
installed fixtures and equipment, and property used to service
the building or premises (such as fire extinguishing and
laundering equipment and ventilating systems) are covered as
part of building coverage.
Additions under construction and building materials and
supplies within 100 feet of the premises are also insured as
part of the building coverage, but only if not covered by other
insurance.
All of these items are covered because they either become
part of, or are directly related to the operation and
maintenance of, the building.
Business Personal Property Coverage
Business personal property includes most types of
commercial property owned or used by businesses that are
not considered part of the building. This coverage applies to
furniture, machinery, equipment, stock or merchandise held
for sale, office supplies, and other such items.
If the insured is a tenant, this coverage also applies to the
insured’s interest in improvements and betterments made at
his or her expense.
Leased personal property may also be covered under this
section, but only if the insured has a contractual obligation to
insure it and it is not otherwise insured under the coverage for
personal property of others.
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Extensions of Coverage
Five extensions of coverage are available under the building
and personal property coverage form, but only if a
coinsurance percentage of 80% or more or a value reporting
symbol is shown in the declarations (however, coinsurance
does not apply to these extensions).
The five extensions are:

newly acquired or constructed property,

personal effects and property of others,

valuable papers and records,

property off-premises, and

outdoor property.
Each of the extensions is additional insurance, which means
the amount of insurance provided is “in addition” to the limits
shown in the declarations. In most cases, the amounts of
insurance extended are small and are provided without
charge to cover incidental exposures. There is one exception;
coverage for newly acquired or constructed property can be
significant, and an additional premium will usually be charged
for this coverage.
Newly Acquired or Constructed Property
For new construction on the same premises or acquired
buildings at a different location, the extension is a maximum of
$250,000 per building.
For business personal property at newly acquired locations
(other than fairs or exhibitions), existing coverage for personal
property may be extended to a maximum of $100,000 at each
new building.
But this automatic extension for newly acquired locations or
newly constructed property is temporary. It applies for a
maximum of 30 days (but not beyond the policy’s expiration or
the date the insured notifies the carrier of the new locations).
This extension is not free insurance. It simply allows a
policyholder 30 days to update his or her coverage. Additional
premium for the new exposure will be calculated from the date
of acquisition or beginning of construction. It also does not
apply to personal property of others that is in the insured’s
possession as a part of work on the insured’s property.
The additional values must be reported and an additional
premium will be charged for this coverage.
Business Personal Property
If personal property coverage is written, the insurance may be
extended to cover personal effects of the named insured,
officers, partners or employees (but such coverage shall not
apply to loss by theft), and to personal property of others in
the insured’s care, custody or control. The most the insurance
company will pay for loss or damage under this extension is
$2,500 at each described premises.
Personal Effects and Property of Others
The coverage for “personal effects and property of others” is
virtually identical to the major coverage having that same
name. The extension provides a small amount of coverage
without charge for those who may only have an incidental
exposure. A business with a more significant exposure should
purchase a specific amount of the major coverage.
Valuable Papers and Records
Personal property coverage may also be extended to apply to
the costs of researching, replacing or restoring the lost
information on valuable papers and records, which have
suffered loss or damage, for which duplicates do not exist.
The most the insurance company will pay under this extension
is $2,500 at each described premises.
(Note: This restores a limited amount of coverage for this type
of loss, which was listed earlier under “property not covered.”)
Property Off Premises
Up to $10,000 of coverage may be extended to apply to
covered property while temporarily off-premises, but not while
the property is in or on a motor vehicle, or in the care, custody
or control of the insured’s salespeople, except at a fair or
exhibition.
loss and an additional $2,000 is available for debris removal
expenses.
An additional amount for debris removal is available when the
applicable limit is exhausted.
As you will see when we get to the “limits of insurance”
section, if the actual debris removal expense exceeds this
25% limitation, or if the sum of the direct loss and the debris
removal expense exceeds the limit of insurance, the
insurance company will pay up to an additional $10,000 at
each location (per occurrence) for debris removal expenses.
The debris removal provision wasn’t intended to deal with
pollution or provide environmental restoration to land or water.
Another additional coverage provision, found later in this
section, provides for limited pollution cleanup following a
covered direct loss.
The additional coverage for debris removal expense does not
apply to the cost of extracting pollutants from land or water,
because that is a separate additional coverage.
Preservation of Property
Coverage for preservation of property has traditionally been
known as “removal” coverage. When covered property is
removed from a premise to protect it from a covered cause of
loss, coverage is provided for any direct loss up to 10 days
while it is at another location. This coverage is very broad
because the loss at the temporary location need not be a
covered cause of loss.
This coverage offers “all risk” insurance to covered property
that is moved from the insured premises in order to protect it
from an insured peril there.
Example: To protect her inventory from a fire (a covered
cause of loss under her policy); a storeowner moves her stock
to a nearby vacant garage. Within days of the move, there’s a
break-in at the garage and everything is stolen. Preservation
of property coverage would pay for the theft loss at the
temporary location, the garage, even if theft was not a
covered cause of loss under the policy.
Fire Department Service Charge
If the fire department is called to protect covered property
from a covered loss, the insurance company will pay up to
$1,000 of the insured’s liability for fire department service
charges if those charges are required by local ordinance or
are assumed by contract or agreement prior to the loss. No
deductible applies to this coverage.
This coverage is provided as an additional amount of
insurance.
Pollutant Clean Up and Removal
The cost of extracting pollutants from land or water is another
additional coverage if the discharge, dispersal, seepage,
migration or escape of the pollutants is caused by a covered
cause of loss. These expenses will be paid only if reported to
the insurance company in writing within 180 days of the date
of loss. The maximum payable under this additional coverage
is $10,000 for each described premises in any 12-month
policy period.
Example: If a fire at the insured’s warehouse caused barrels
of chemicals to rupture, coverage would be provided for clean
up. But no coverage would be provided if an employee
knocked over a barrel of chemicals and caused a spill.
A long book could be written about this pollution liability
exclusion. Most disputes involve complex issues of chemical,
nuclear and other exposures. But it’s easier than you might
think to get into trouble with pollution risks.
Increased Cost of Construction
If a building is covered for replacement costs, this coverage
provides for the increase in costs that must be incurred to
bring the building up to code. The limit is the lessor of $10,000
or 5% of the applicable limit of insurance. There is both no
coverage for the cost of demolition of the undamaged portions
of the building that must be demolished to repair the building,
and no coverage for code requirements the insured should
have complied with prior to the loss.
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Outdoor Property
Coverage may be extended to apply to outdoor property, such
as outdoor fences, radio and television antennas, signs which
are not attached to buildings, and trees, shrubs and plants
(other than “stock” held for sale). This extension applies only
to losses resulting from the specific perils of fire, lightning,
explosion, riot or civil commotion, or aircraft. The most the
insurance company will pay for loss under this extension is
$1,000, and not more than $250 for any one tree, shrub or
plant.
Note: This extension also restores a limited amount of
coverage for these items, which were all listed earlier under
“property not covered.”
Non-Owned Detached Trailers
Coverage is provided for trailers, while detached, and in the
custody of the insured. This typically occurs when a trucking
company leaves a detached trailer at the insured’s premises
for loading or unloading of the insured’s product for transport,
or goods brought to the insured for unloading. The insured
must be legally liable for the loss for coverage to apply, and
the basic limit is $5,000 (this limit can be increased).
Exclusions
Earlier we reviewed the “property not covered” section and
mentioned that the items listed were “exclusions” of a sort.
Indeed, anything not covered (whether a type of property or a
cause of loss) is in fact an exclusion.
Exclusionary language may actually be found in an insuring
agreement, or a definition, or any policy provision where an
exception or reference is made to something that is not
covered. But in property insurance forms the formal term
“exclusions” has traditionally been used to mean the causes
of loss, or perils, which are not covered.
Under the current commercial lines program, these exclusions
are found in the causes of loss forms that apply to the
coverages. We will be discussing the causes of loss forms
later in this section.
Limits of Insurance
Property insurance limits apply per occurrence. The
applicable limit(s) of insurance shown in the declarations is
the most the insurance company will pay for all loss or
damage resulting from any one occurrence.
For the major coverages of the building and personal property
form, the most the insurance company will pay for loss or
damage in any one occurrence is the applicable limit of
insurance shown in the declarations. One or more limits may
be shown, depending upon how the coverage is written.
The building and personal property form may be written on a
specific, schedule, or blanket basis.
Specific coverage provides a specific amount of insurance for
specific types of property at a specific location. An example
would be a form providing insurance amounts of $200,000 for
a building and $50,000 for personal property at one location.
Schedule coverage may be used to provide insurance for
different types of property at different locations. Various
buildings and contents may be itemized on a schedule, and a
specific amount of insurance will apply to each. A few items
may be scheduled on the declarations page. When longer
schedules are involved, the schedule of locations and
insurance amounts is usually attached by endorsement.
Blanket coverage provides a single amount of insurance that
applies to all types of property at a single location, or to all
types of property at multiple locations. Blanket coverage may
be written simply by showing the proper entries on the
declarations page. For example, showing a limit of “$1 million”
for Coverages “A, B and C” would mean that the single limit
applied per occurrence to combined losses under the three
major coverages. Another example would be a single limit that
applied to all coverages at multiple locations. This allows a
retail or manufacturing operation with more than one location
to move merchandise or stock between locations without
having to adjust insurance limits at each location.
If blanket coverage is written for a large number of different
locations, the schedule of locations may have to be attached.
Another variation affecting insurance limits is use of reporting
forms, which allow the amount of insurance to fluctuate during
the policy period. Businesses that have large changes in
inventory values during the year often use reporting forms to
avoid costly over insurance or problems with underinsurance.
Sublimits
A separate limit, known as a sublimit, of $1,000 applies to
outdoor signs attached to buildings. (This differs from the
coverage extension for outdoor property, which covers signs
not attached to buildings. That coverage has a single $1,000
per occurrence limit, and only covers losses by a few
specified perils.)
For signs attached to buildings, the limit applies per sign, and
all perils shown in the applicable causes of loss form are
covered.
The limits applicable to the Covered Extensions and the Fire
Department Service Charge and Pollutant Clean Up and
Removal Additional Coverages are in addition to the Limits of
Insurance.
Coverage for property removed to preserve it from loss and
for debris removal expenses does not increase the applicable
limit of insurance.
Deductibles
The insurance company has no obligation to pay for a loss
until the amount of loss exceeds the deductible shown in the
declarations, and then it agrees to pay only the amount in
excess of the deductible (subject to the limits of insurance,
and any adjustments required because of coinsurance or the
agreed value option). The standard deductible is $250 per
occurrence. The insured has the option of selecting higher
deductible amounts, which will reduce the premium charged.
Example: If the limit of insurance is $100,000 and the
deductible amount is $500 when a $450 loss occurs, the
insurance company will not pay anything.
Example: If the limit of insurance is $100,000 and the
deductible amount is $500 when a $10,000 loss occurs, the
insurance company would pay $9,500.
Example: If the limit of insurance is $100,000 and the
deductible amount is $500 when a $115,000 loss occurs, the
insurance company would pay $100,000.
Common Policy Conditions
Conditions spell out rights and obligations of the parties to the
contract, and describe some of the provisions that affect the
scope of coverage.
In addition, a separate form attaches property insurance
conditions to the property coverage forms included in the
policy (these apply in addition to the common policy
conditions). Individual coverage forms also include conditions
applicable to specific coverages or losses.
Loss Conditions
Loss conditions apply in addition to all other conditions that
affect the coverage form and the entire policy, and address
issues that relate only to commercial property losses.
Abandonment
The abandonment condition states that the insured may not
abandon property to the insurance company. This means that
if property is only partially damaged, the insured has no right
to turn it over to the insurance company and demand payment
for a total loss. Other conditions give the insurance company
the right to “repair, rebuild or replace” any portion of damaged
property.
Appraisal
An appraisal condition establishes procedures for having an
appraisal when the parties cannot agree on the value of
property or the amount of a loss. Either party may demand an
appraisal, and each will share the costs of appraisal.
Duties in the Event of Loss
The next condition specifies the insured’s duties in the event
of loss. These include giving prompt notice of loss, providing a
description of how and when the loss occurred, protecting
property from further damage, permitting the insurance
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providing ACV coverage would pay only $7,000 less the
deductible.
Coverage for Minor Damages
If building coverage satisfies any coinsurance requirement,
the insurance company will pay the full repair or replacement
costs for building losses of $2,500 or less (with the exception
of certain items such as awnings or floor coverings).
“Stock” sold but not delivered will be valued at the selling price
less discounts and expenses the insured otherwise would
have had.
Glass will be valued at the cost of replacement with safety
glazing material if such replacement is required by law.
Tenant’s improvements and betterments will be valued
according to the nature of the repair or replacement efforts
following a loss. If the insured makes prompt repairs, ACV will
be allowed. If the insured does not make prompt repairs, the
insurance company will only pay for a proportion of the
original installation cost. If others pay for repair or
replacement for the benefit of the insured, the insurance
company will pay nothing.
Valuable Papers and Records
Losses of valuable papers and records, including computer
tapes and disks, will be valued at the cost of blank materials
for reproducing the records. The cost of labor to transcribe or
copy lost records will be covered only when duplicate records
exist.
Additional Conditions
Coinsurance
The first additional condition addresses the issue of
coinsurance, which is an important concept with respect to
property insurance coverages. The purpose of coinsurance is
to induce the insured to maintain an adequate level of
insurance in relation to the actual value of covered property.
Property insurance rates are based on the expectation that
insureds will purchase adequate amounts of insurance to
cover expected losses. But most property insurance losses
are partial losses. Without a coinsurance requirement, many
companies might underinsure. They might underinsure to
save on premiums.
If the insurance companies paid partial losses in full when a
risk was underinsured, they would lack the premium volume to
cover their losses, and basic insurance rates would have to be
much higher. Coinsurance helps to broaden the premium
base and keep rates down by creating incentives to purchase
adequate amounts of coverage, and reducing the obligations
of the insurance company when a risk is underinsured.
A customary coinsurance ratio is 80%.
A coinsurance penalty (only partial recovery for losses)
applies when a risk is underinsured. The first step in
determining how this affects losses is to multiply the true
value of covered property at the time of loss by the applicable
coinsurance percentage (for example, if the true value of a
building is $500,000 and an 80% coinsurance percentage
applies, the insured needs to maintain at least $400,000 of
coverage to avoid a coinsurance penalty).
The formula for the application of coinsurance is explained
and illustrated in the coverage form. In simple terms, the
actual amount of insurance is divided by the required amount,
and the result is multiplied by the amount of loss, and then the
deductible is subtracted to determine the amount of recovery.
Example: If the insured had $300,000 of coverage and
$400,000 was required when a $100,000 loss occurred, the
insurance company would only be obligated to pay $75,000
minus any deductible (three-quarters of the loss).
Mortgage Holders
The second condition specifies the rights and duties of a
mortgage holder (mortgagee) who holds the mortgage on
insured property. When loss occurs, a mortgage holder is
entitled to recovery to the extent of its interest in the property.
In cases when a policyholder has failed to comply with the
terms of the coverage, a mortgage holder may still be entitled
to recovery if it meets certain conditions.
company to inspect property, and submitting a signed proof of
loss within 60 days after a request.
Insurance Company Rights
The insurance company has the right to examine the insured
under oath and to examine the financial books and records.
This right is preserved because financially troubled companies
are sometimes suspected of filing fraudulent claims.
Conversely, a questionable insurance claim is often a sign of
bigger financial problems.
Loss Payment
The loss payment condition specifies the rights and
obligations of the insurance company after a covered loss
occurs. The insurance company has the option of paying the
value of lost or damaged property, paying the cost of repairing
or replacing lost or damaged property, or of repairing,
rebuilding or replacing property with property of like kind and
quality. It may also take possession of any part of the property
at an agreed or appraised value. The insurance company
must give notice of its intent within 30 days after receiving a
sworn statement of loss.
The insurance company may adjust losses with the owners of
property, if other than the insured, and may elect at its own
expense to defend against any suits brought by the owners of
lost or damaged property.
Within 30 days after receiving a sworn statement of loss, the
insurance company will pay for the loss or damage, that is, if
the insured has complied with all coverage conditions and the
parties agree on the amount of loss or an appraisal has been
made. However, under no circumstances will the insurance
company pay more than the insured’s financial interest in
covered property.
Example: You enter a joint venture with another company that
gives you a 20% interest in the new entity. The facilities used
by this new venture are destroyed by fire. Your insurable
interest is only 20% of the value of the materials destroyed,
and your recovery can’t be more than that.
Recovered Property
The recovered property condition states that either party who
recovers property after a loss settlement must notify the other.
At the insured’s option, an exchange of value may then be
made.
Example: If theft coverage applies and the insurance
company pays for a theft of personal property that is later
recovered, you may keep the loss settlement amount or
request return of the item. If the item is returned, you must
repay the amount of the settlement, but if the item is damaged
the insurance company will pay for repairs.
Vacancy
A vacancy condition applies to loss or damage at buildings
which have been vacant for more than 60 days at the time of
loss. A building is considered to be vacant when it does not
contain enough business personal property for conducting
customary business operations. Buildings under construction
are not considered to be vacant.
If loss occurs when the building has been vacant for more
than 60 consecutive days, losses are not covered if caused by
vandalism, theft or attempted theft, water damage, building
glass breakage, or sprinkler leakage (unless the system has
been protected from freezing). Payment for all other covered
causes of loss occurring after 60 days of vacancy will be
reduced by 15%.
Insurance companies exclude vacant properties because
they’re more prone to risks like vandalism, squatting and
arson.
Valuation
Most commercial property losses under the building and
personal property coverage form are valued and settled on
the basis of actual cash value (ACV), which means
replacement cost at the time of loss, less depreciation.
Example: If an item of personal property which had
depreciated 30% due to age was destroyed, and the
replacement cost for a new item was $10,000, a policy
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The insurance company will not pay replacement cost until
lost or damaged property is actually repaired or replaced, and
such payment will be made only if the repairs or replacements
are made as soon as reasonably possible after the loss. The
maximum payment under replacement cost coverage may not
exceed the smallest of the following amounts:

the limit of insurance for the affected property, or

the amount the insured actually spends to repair or
replace the lost or damaged property, or

the cost to replace (on the same premises) the lost
or damaged property with other property, of
comparable material and quality, used for the same
purpose.
All things considered, valuation remains one of the most
common disputes between policyholders and insurance
companies. Some people try to inflate loss valuations in order
to recover their deductibles. Also, issues like vandalism,
vacancy and duties after loss can be serious problems for
many businesses, especially smaller ones in less-thancorporate locations.
Extension of Replacement Cost to Personal Property of
Others
Coverage can be extended to replacement cost for property of
others. If there is a written contract between the insured and
the property owner, valuation will be governed by the lesser of
the contract amount, the replacement cost, or the applicable
limit of insurance.
Definitions
Pollutants
In this section, it makes clear that the additional coverage for
pollutant cleanup and removal is only a limited form of
property insurance, and this form does not provide any
pollution liability coverage.
Stock
By making the proper declaration entries, replacement cost
coverage can be written for buildings and the insured’s
personal property, including “stock.” It may not be written to
cover property of others, contents of a residence,
manuscripts, works of art, antiques, etchings, statuary,
pictures, marbles, bronzes, porcelains and bric-a-brac. Even
when coverage is written on a replacement cost basis the
insured may elect to make a claim on an ACV basis, in which
case the additional amount can later be claimed, if the insured
notified the insurance company of the intent to claim full
replacement cost within 180 days after the loss.
Example: If the insured makes the business decision not to
replace property damaged in an insured loss, he or she might
ask for an ACV settlement.
Items classified as “stock” depend upon the type of business
insured. For a retail store, stock would include inventory and
merchandise held for sale. For a factory, it would include raw
materials, work-in-process, finished goods and packaging.
Causes of Loss Forms
The Causes of Loss form must be attached to commercial
property coverage to indicate which causes of loss, also
known as perils, are being insured against. The applicable
causes of loss are shown in the declarations section of most
policies.
Causes of loss forms identify the perils insured against. There
are four variations of causes of loss forms under the program:

basic form,

broad form,

special form, and

earthquake form.
The first three forms represent a progression of an increasing
number of insured perils: basic” insures against the fewest
perils; “broad” provides more coverage than basic; and,
“special” provides more coverage than “broad.”
The terms “basic,” “broad” and “special” coverage are used
throughout the property insurance field, and the meaning of
the terms is fairly consistent.
This section also specifies the insurance company’s obligation
to notify any mortgage holders in the event of cancellation or
non-renewal of the coverage. Most lenders require insurance
coverage as a condition of financing, and may recall a loan if
coverage lapses.
Optional Coverages
Agreed Value
A few common optional coverages, which used to be available
only by endorsement, are built into the current coverage forms
and may be activated by entries on the declarations page.
The commercial property declarations include a space for
indicating that certain property has an agreed value. This
option may be used for property that has an unusual value, or
for which outside forces affect the value for a particular period
of time.
Example: A piece of art in the insured’s offices may have an
investment above what the insured paid for it. That value may
be difficult to determine after a loss has occurred. Therefore,
the insured would want to provide his or her insurance
company with a prearranged value.
Traditionally, the amount of loss used in the above
calculations has been the actual cash value of the loss. Today
policies are frequently written on a replacement cost basis.
Whether the ACV or replacement cost of a loss is used in the
formula will depend upon how the coverage is written.
For certain types of property losses, other departures from
ACV apply. The “Valuation Clause” of the form describes the
special loss determination provisions.
The valuation clause is the condition that determines how the
amount of various losses will be determined. Unless changed
by optional coverage provisions, all losses will be valued at
the ACV at the time of loss.
To discourage insurance companies from over insuring, states
have enacted so-called “valued policy laws” (VPLs) to assure
policyholders proportional settlements to the premiums paid.
If a VPL applies or if a valued amount (or prearranged value)
has been written, the full limit of insurance for the property will
be paid in the event of a total loss. Regardless of the actual
cash value of property, a valued policy law or contract stands
in place of any valuation clause when a total loss is involved.
When agreed value coverage applies, the full coverage
amount written for the property would be paid in the event of a
total loss. For a partial loss, the insurance company will pay
only the prearranged percentage of the agreed value.
Coinsurance does not apply to any property that is insured on
an agreed value basis.
An expiration date applies to agreed value coverage. If the
agreed value expiration date passes and is not extended, the
option automatically expires and a coinsurance requirement (if
any) is reinstated for the affected property.
Inflation Guard
When elected, the inflation guard option automatically
increases the limit of insurance for property to which it applies
(it may be applied to either or both buildings and personal
property). The increase amount is an annual percentage
stated in the declarations (applied pro rata if a loss occurs at
mid-term). When the insured elects the replacement cost
option, the phrase “replacement cost without deduction for
depreciation” replaces “actual cash value” in the valuation
clause.
The inflation guard option may be used for building coverage,
personal property coverage, or both. When applicable, it
automatically increases the limit of insurance by an annual
percentage stated in the declarations.
Replacement Cost
Optional replacement cost coverage may be selected to apply
to buildings, or personal property, including tenants’
improvements and betterments. Coverage for personal
property will exclude “stock” unless the “including stock”
option is shown in the declarations. When replacement cost
coverage is selected, it applies instead of “actual cash value”
in the valuation condition with respect to the covered property.
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Smoke Damage
Smoke damage is covered when it is sudden and accidental,
usually as the result of a fire on the premises or at a nearby
property. But there is no coverage for smoke originating from
agricultural smudging or industrial operations.
Aircraft or Vehicles
Damage caused by aircraft, spacecraft, missiles and vehicles,
including objects thrown from a vehicle, is covered, but not
damage caused by vehicles owned by the insured or operated
by the insured’s business.
Example: If a board lying in the road is thrown by the tires of a
passing truck against the insured’s front door and causes
damage, there is coverage. But there would be no coverage if
the same damage was caused by one of the insured’s trucks.
Riot or Civil Commotion
Coverage is provided for damage caused by riot, civil
commotion, vandalism, and malicious mischief. Under
vandalism there is no coverage for damage to easily broken
glass parts of a building, but resulting damage is covered.
Only glass building blocks are covered.
While damage caused by burglars breaking in or exiting is
covered, the form states that it does not cover other losses
“caused by or resulting from theft.” This makes it clear that
vandalism coverage is not coverage for theft of property.
Example: If a rock is thrown through a store window and there
is damage to clothing on display, there would be no coverage
for the window but there would be coverage for the damaged
clothing.
A general note: Though some coverage for broken glass and
losses caused by broken glass is offered by standard forms,
this coverage is limited. More extensive coverage is provided
by endorsement, which costs extra.
Vandalism coverage does not apply to theft losses. However,
building damage caused by burglars entering or leaving is
covered.
Sprinkler Leakage
Damage caused by the leakage or discharge of “any
substance” (water, fire retardant chemicals such as halon,
etc.) from an automatic fire protective sprinkler system is
covered. Under earlier policy forms, this was an optional
additional coverage. But in recognition of the fact that the
benefits of sprinkler systems in preventing or reducing fire
losses outweigh the risks of occasional accidental sprinkler
leakage damage, this is now included in basic coverage.
“Automatic sprinkler system” means any automatic fire
protective or extinguishing system, including connected
sprinklers and discharge nozzles, ducts, pipes, valves and
fittings, tanks and their component parts and supports, pumps
and private fire protection mains. When supplied by an
automatic fire protective system, hydrants, standpipes,
outlets, and other non-automatic fire protective systems are
considered to be part of the automatic system.
Sprinkler leakage coverage protects covered property from
sprinkler leaks. If “covered property” includes the building or
structure containing the automatic sprinkler system, the
insurance company will pay the cost of repairing or replacing
any damaged parts of the sprinkler system when damage is
caused by freezing or results in leakage. The insurance
company will pay the cost of tearing out and replacing any
part of the building to repair damage to a sprinkler system that
has leaked.
Sinkhole Collapse
Coverage is provided for damage caused by sinkhole
collapse, which means land sinking into natural underground
cavities. There is no coverage for filling sinkholes, or for
collapse into any man-made cavities.
Volcanic Action
All volcanic eruptions that occur within any 168-hour period
will constitute a single occurrence. This prevents the insured
from making multiple claims from a single eruption.
This cause of loss does not include the cost to remove ash,
dust or particulate matter that does not cause direct physical
At least one Causes of Loss form must be attached to the
property coverage part. More than one causes of loss form
can be attached to the coverage part, with different causes
applying to different classes or locations of insured property.
For example, there may be special coverage for buildings and
basic or broad coverage for personal property.
The earthquake form is always used in conjunction with one of
the other forms, because it simply adds coverage for two
additional perils. If the insured wants earthquake coverage for
buildings, one of the other causes of loss forms plus the
earthquake form would have to be attached to building
coverage.
Basic Causes of Loss Form
We’ll begin with the basic form, which provides the most
limited coverage. However, as you will see, even the basic
form includes an impressive list of 11 named perils.
The form is divided into three major sections:

Covered Causes of Loss,

Exclusions,

A brief Limitation for loss of animals.
Covered Causes of Loss
Fire and Lightening
Basic coverage will pay for losses caused by fire and/or
lightning. Early fire insurance policies only covered fire losses,
but that created a problem when a lightning bolt caused
damage and started a fire. For that reason, fire insurance
policies were modified long ago to cover losses by “fire and
lightning,” and to treat these two causes of loss almost as if
they were a single peril. Today, virtually all property insurance
policies that cover fire losses also cover lightning, including
damage caused by the direct explosive force of a lightning
bolt and any resulting fire.
“Fire” is combustion accompanied by a visible light, a flame,
glow or incandescence. Heat or smoke in the absence of such
light is not considered to be fire. A “friendly fire” is intentionally
set and remains within its container or intended limits. A
“hostile fire” or “unfriendly fire” is one that escapes its
intended limits or is not started intentionally. A fire in a
fireplace is “friendly,” but when a spark from it ignites nearby
curtains, a hostile fire has started. Only “hostile fires” are
covered by fire insurance.
Before moving on, we should point out that generally property
insurance will pay for a loss when an insured peril is the
proximate cause of the loss.
Proximate cause exists when there is an uninterrupted chain
of events between the initial cause of the loss and resulting
damage. Under the doctrine of concurrent causation, if a loss
is caused by one peril that is covered and another that isn’t,
the loss is covered.
Example: If firefighters need to break down a door to enter a
burning building, and cause additional water damage while
putting out the fire, the broken door and the water damage
would be covered as part of the fire loss (since it was the
“proximate cause” of such losses).
Explosion
Coverage for explosion generally applies to losses caused by
fuel, gases or dust that ignite. It does not apply to losses
resulting from the sudden rupture or bursting of devices
caused by pressure, water or steam (separate boiler and
machinery coverage is available for this exposure).
Wind and Hail
Coverage is provided for damage caused by the direct force
or impact of wind or hail. Interior damage to the building
and/or its contents is not covered unless wind or hail first
creates an opening in the walls or roof (in which case,
resulting damage by rain, snow, sand or dust would also be
covered).
Example: If the insured left a window open, there would be no
coverage for interior damage caused by wind, hail, rain, snow,
sand or dust which entered through the open window.
77
loss or damage to the described property.
Volcanic “action” means loss caused by the airborne blast or
shock waves, and by ash, dust or lava, from a volcanic
eruption. There is no coverage under this peril for earth
movement or damage caused by land shock waves resulting
from a volcano (such coverage is available under the
earthquake causes of loss form, which appears later in this
chapter).
Exclusions
The first set of seven exclusions is virtually identical on the
basic, broad and special forms. Many exclusions are intended
to eliminate coverage for catastrophic losses that, if included
in the policy, could bankrupt the insurance company.
The first set applies to certain causes of loss regardless of
whether any other cause or event contributes to the loss
(although exceptions are made for some resulting losses).
Ordinance or Law
There is no coverage for loss resulting from the enforcement
of any ordinance or law regulating construction or repair of
property, or requiring demolition of property.
Loss by ordinance or law is excluded because property
coverage is not intended to cover additional costs that might
result from building codes or regulations.
Example: If an older building is damaged, a newer law
regulating construction may require replacement with
additional features designed to reduce fire or earthquake
losses. This additional cost would not be covered.
Ordinance or law coverage may be purchased and added by
endorsement.
Insurers will fight any attempt on the part of a policyholder to
rebuild to stricter code, since this leaves the policyholder in a
better position than he or she was before the loss. A number
of high-profile lawsuits on the issue were waged in the early
1990s. insurance companies usually prevailed.
Earth Movement
Losses caused by earth movement (other than sinkhole
collapse) or volcanic eruption (other than volcanic action) are
not covered, but any resulting loss by fire or explosion is
covered.
Governmental Action
Any loss resulting from the seizure or destruction of property
by a government authority is not covered, except acts taken at
the time of a fire to prevent its spread.
Example: If an entire neighborhood is burning and authorities
order demolition of the insured’s building to stop the spread of
the fire, the loss would be covered.
Otherwise, if a government seizes or destroys property, any
claim should be made against the government and not against
the insurance company.
Nuclear Hazard
There is no coverage for loss caused by any nuclear hazard
or contamination, but any resulting fire loss would be covered.
Utility Services (Off Premises Power Failure)
Losses caused by off-premises power failure are excluded,
but resulting losses by any covered cause of loss are covered.
Example: If a power failure causes meat in a freezer to spoil,
there is no coverage for the loss. However, if the same power
failure prevented a cooling system from operating and
resulted in a fire, the resulting loss would be covered.
War and Military Action
Losses caused by war or military action are excluded without
exception. War risks include declared and undeclared war,
civil war, military attack, insurrection, rebellion, revolution,
terrorist attack or action taken by any governmental or
sovereign authority in hindering or defending against any of
these (including expected attack).
This cause of loss is so catastrophic that no coverage is
granted for any resulting losses.
Water
The water exclusion applies primarily to flood losses. This
exclusion also eliminates coverage for damage caused by
underground water that backs up through sewers or drains or
seeps through foundations or basements. Coverage for flood,
waves, overflow, and mudslide may be obtained under a
separate flood policy.
Exclusions with Exceptions
The second set of six exclusions eliminates coverage for
things that are the primary or proximate cause of a loss. This
set of exclusions is less restrictive than the first. The
statement “regardless of whether any other cause contributes
concurrently or in sequence to the loss” does not appear.
Exceptions are often made to these exclusions, which means
coverage is available if the excluded cause of loss is triggered
by a covered cause of loss.
Under the basic form, there is no coverage for damage
caused by artificially generated current or the bursting of
water pipes or discharge of water or steam from any system
or appliance (other than an automatic sprinkler system).
The next four exclusions in this section refer to losses caused
by the explosion of steam boilers, steam pipes, steam engines
and turbines, and mechanical breakdown including rupture or
bursting by centrifugal force. All of these are boiler and
machinery losses and can be covered by a separate coverage
form.
The final exclusion is to eliminate coverage for loss resulting
from the insured’s neglect to protect property from further
damage.
Specific Coverage Form Exclusions
The last group of exclusions applies only to the coverage
forms specified. They appear here because for all coverage
forms the exclusions are listed in the causes of loss forms.
Business Income Coverage
In most cases, business interruption coverage offered by
standard property insurance is extremely limited. If the insured
needs extended income replacement while the facility is being
repaired, he or she will have to buy separate, additional
insurance.
This exclusion applies only to business income and extra
expense coverage forms. These are indirect loss or
consequential loss forms, which cover losses of income and
additional costs while a business is shut down because of
direct damage.
Business income and/or extra expense coverages are
designed to cease when repairs are completed and the
business operations resume. Therefore, there is no coverage
for additional loss due to a delay in resuming operations
caused by strikers, or due to suspension, lapse or cancellation
of any license, lease or contract (unless caused directly by the
suspension of operations).
Some parts of this exclusion address direct damage. There is
no coverage for damage or destruction of “finished stock”
because that is a direct damage loss (which may be covered
under the business and personal property coverage form).
Other portions of the exclusion restrict coverage to the intent
of the coverage forms. Generally, these forms are designed to
cover consequential losses that result from a suspension of
operations caused by a covered cause of loss. However, they
do not cover damage from the cancellation of a contract
during the period of restoration.
Example: If a building suffers serious fire damage, a business
may shut down and lose income while repairs are being
made. The loss of income would be covered.
This exclusion also specifies that “any other” consequential
loss, beyond what is provided for in the applicable coverage
form, is not covered.
Leasehold Interest Coverage
This exclusion applies only to the leasehold interest coverage
form. The first part actually gives back some coverage by
removing the “ordinance or law” exclusion.
Example: If the insured leases his or her building and
government agents seize the building from its owner, any
resulting loss, such as the costs of a move, an increase in the
rent pay somewhere else, etc. will be covered.
78
protective sprinkler system. Under the broad form, the “water
damage” peril adds coverage for damage caused by the
discharge or leaking of water or steam from other types of
systems and appliances.
If the building is covered, the cost to tear out and replace part
of the building in order to repair the sprinkler system is
covered, as well as the cost of repairing the system itself.
Loss caused by continuous or repeated seepage or leakage
occurring for a period of 14 days or more is not covered,
because this is considered a reasonable period during which
the insured is expected to detect such problems and take
action before additional damage occurs. The insurance
company will not pay for losses that have become worse due
to neglect of the building or premises.
Losses caused by freezing of a system or appliance will not
be covered unless the insured took reasonable steps to either
maintain heat in the building or drain the system. Once again,
certain losses should be anticipated (such as pipes freezing in
an unheated building in the winter), and the insurance
company will not pay for losses caused by neglect.
In the case of water damage, if the building or structure
containing a system or appliance is “covered property,” the
insurance company will also pay the cost to tear out and
replace any part of the building or structure to repair damage
to the system or appliance from which water or steam
escapes. But it will not pay the cost of repairing or replacing
the system or appliance itself. These losses are covered
under a boiler and machinery form.
Exclusions
In the first set of exclusions, only the Earth Movement
exclusion differs on the broad form. In addition to covering
resulting losses by fire or volcanic action, the broad form also
covers breakage of glass following a volcanic eruption.
The rest of the exclusions are identical to exclusions found on
the basic form, but in this section we find only three
exclusions instead of five.
The broad form drops two of the basic form exclusions. It
does not exclude “rupture or bursting of water pipes” or
“leakage or discharge of water or steam resulting from
breaking or cracking” of a system or appliance. These two
exclusions are eliminated because the broad form specifically
covers water damage involving the breaking or cracking of
any part of a system or appliance containing water or steam.
In the second set of exclusions, you will find the same
exclusions as in the basic form, including:

Artificially generated electrical current

Explosion of steam boilers, pipes, engines and
turbines

Mechanical breakdown

Neglect of the insured to preserve property
Additional Coverage - Collapse
In addition to listing perils, the broad form adds an additional
coverage, which does not increase the limits of insurance
provided by the coverage part. The insurance company
agrees to pay for loss or damage caused by or resulting from
direct physical loss involving collapse of a building or part of a
building.
Collapse is defined as the “abrupt falling down or caving in of
a building or a part of a building” so it cannot be occupied for
its usual and intended purpose. Collapse does not include a
building in danger of collapsing or the settling, cracking,
shrinkage, bulging or expansion of a building.
The collapse coverage is slightly broader than other broad
form coverage, because it applies to collapse caused by any
of the 15 broad form perils or any of the following five
additional perils:

hidden decay,

hidden insect or vermin damage, if the insured had
no knowledge of the damage prior to the collapse,

weight of people or personal property,

weight of rain that collects on a roof,
But there is no coverage for loss caused by the insured
canceling a lease, or by the suspension, lapse or cancellation
of any license, or for any other consequential loss beyond
what is provided in the coverage form.
Legal Liability Coverage
A number of the exclusions contained in the basic causes of
loss form are not applicable to legal liability coverage, so the
first part of this exclusion simply removes some exclusions
with respect to legal liability coverage only.
The next paragraph establishes a contractual liability
exclusion for legal liability coverage. This means that the
insurance company will not pay for losses that are suffered
because the insured intentionally assumes someone else’s
liability.
Example: If you offer a performance guarantee in order to get
an account, losses you sustain by failing to perform are not
covered.
Animals
The basic causes of loss form, concludes with a brief
limitation. In the building and personal property coverage
form, animals are listed as “property not covered,” unless the
animals are stock held for sale or are owned by others and
boarded by the insured. This limitation specifies that, to the
extent that animals are covered, the insurance company will
pay for loss of animals only if they are killed or their
destruction is necessary.
Broad Causes of Loss Form
This form includes all of the causes of loss covered by the
basic form, but adds four additional causes of loss and one
additional coverage. The broad form has two fewer exclusions
than the basic form, because the additional perils specifically
apply to these causes of loss. One exclusion, earth
movement, is modified to provide coverage for any resulting
breakage of glass. All other provisions, including the special
exclusions that apply to specific coverage forms and the
limitation for the loss of animals, are identical on the basic and
broad forms.
The broad form provides broader coverage than the basic
form. This form is divided into four major sections:

Covered Causes of Loss,

Exclusions,

Additional Coverage - Collapse, and

the brief Limitation for loss of animals.
Covered Causes of Loss
Since most of the covered causes of loss and exclusions are
the same as those contained in the basic form, we will only
review the additional causes of loss and discuss the
differences in the exclusions.
The first 11 perils listed on the broad causes of loss form are
identical to those contained in the basic form. The additional 3
broad form perils are reviewed here.
Falling Objects
Coverage is provided for damages caused by falling objects to
buildings and contents, but interior damage, and damage to
personal property in buildings is covered only if the falling
object first damages the roof or an outside wall. Personal
property in the open is not covered.
Under the separate “aircraft” peril, coverage is already
provided for damage caused by objects falling off of aircraft,
or by spacecraft or a self-propelled missile. The “falling
objects” peril applies to many other types of falling objects, for
example, something that falls off a taller building, or a limb
falling from a tree. If a tree falls on the insured’s building and
rain subsequently damages furniture inside, that loss would
be covered.
Weight of Snow, Ice or Sleet
Damage caused by the weight of snow, ice or sleet is
covered, but not damage to personal property out in the open.
Water Damage
Both the basic and broad causes of loss forms include
coverage for “sprinkler leakage” from an automatic fire
79

and the intent of some coverages is virtually identical, in many
cases the same policy provisions have been rearranged.
Direct loss caused by a specific peril does not necessarily
mean that the peril was the only factor damaging insured
property. When a specific peril is the “proximate cause” of a
loss, courts have held that the peril in question caused the
loss. For example, loss from water damage, chemicals,
firefighters breaking down a door, or smoke may be a direct
loss caused by fire if an uninterrupted chain of events existed
between the fire and the loss.
Covered Causes of Loss
Although the special form includes a “covered causes of loss”
section, it does not list any perils. Instead, it simply states that
it covers risks of direct physical loss unless excluded or
limited by other sections that follow.
Exclusions
First Group of Exclusions
The first group of exclusions are virtually identical on the
broad and special forms. The only difference is that “volcanic
action” is a specified peril on the broad form and it is defined
in the causes of loss section. Since the special form does not
specify perils, the same definition has simply been added to
the earth movement exclusion.
Although all forms exclude direct loss by volcanic eruption, the
special form (like the broad form) will cover resulting glass
breakage in addition to damage by fire or volcanic action.
Second Group of Exclusions
Again, because this is an open perils form, a number of
exclusions must be added to limit coverage. Because it covers
all losses that are not excluded, the special form contains
additional exclusions eliminating coverage for loss or damage
caused by or resulting from:

artificially generated electrical current

delay, loss of use, or loss of market

smoke, vapor or gas from agricultural smudging or
industrial operations (needed because the form does
not describe the “smoke peril” which includes this
limitation)

wear and tear

rust, corrosion, fungus, decay, deterioration, hidden
or latent defect, or “inherent vice” (any quality in
property that causes it to damage itself or selfdestruct over time)

smog

settling, cracking, shrinking or expansion

insects, birds, rodents or other animals

mechanical breakdown

release, discharge or dispersal of contaminants or
pollutants (unless caused by a “specified” cause of
loss)

damage to personal property caused by dampness
or dryness of atmosphere, changes in or extremes of
temperature, marring or scratching

explosion of steam boilers

seepage of water

plumbing leaks - Coverage for water damage under
the special form is similar to coverage under the
broad form, but it is not stated as a peril. We find the
two exclusions that impose the same limitation on
continuous or repeated seepage over 14 days, and
the same requirement to maintain heat or drain
systems in order to have coverage for losses caused
by freezing. These are reasonable requirements. The
insurance company will not pay for losses that result
from the insured’s neglect or carelessness.
Example: There is no coverage for water damage
caused by leakage over a period of more than 14
days because the problem should have been
discovered and acted upon during that time.

dishonest or criminal acts of the named insured, or
use of defective materials or methods in
construction, remodeling or renovation, if the
collapse occurs during the course of the
construction, remodeling or renovation.
With respect to the five additional perils, the insurance
company will pay for loss or damage to the following items
only if the loss is a direct result of the collapse of a building:
outdoor antennas and their lead-in wires, masts, towers,
awnings, gutters and downspouts, yard fixtures, outdoor
swimming pools, fences, piers, wharves, docks, diving
platforms, retaining walls, walks, roadways and other paved
surfaces.
Example: Loss of a building which collapses due to hidden
decay or insect damage would be covered. Loss of a
television antenna or outdoor swimming pool which collapses
due to hidden decay or insect damage would not be covered
(these items are covered only if the damage is caused by part
of a building that collapses).
The wording of this additional coverage is designed to
eliminate a problem known as concurrent causation: a term
used to refer to a situation where two or more perils occur at
the same time, or in sequence, to cause a loss. The issue
arose when insurance companies were challenged to pay
earthquake losses under collapse coverage. Many property
insurance forms used to list “collapse” as a peril insured
against. At the same time, the forms excluded losses caused
by earth movement and earthquake coverage was not
automatically included. But when claims were filed under
collapse coverage, some courts held for the policyholders, on
the grounds that losses due to building collapse were suffered
regardless of whether an earthquake was a concurrent or
contributing cause.
Since the insurance companies never intended to
automatically provide earthquake coverage, the policy forms
were modified to clarify intent. Collapse coverage was set
aside as an “additional coverage” that applies only to losses
caused by specified perils (which do not include earth
movement).
Loss of personal property is also covered, in some cases, if it
collapses, even if this is not the result of a building collapse,
as defined in this form.
Special Causes of Loss Form
The Causes of Loss–Special Form provides the very broadest
coverage of all. It covers all risks that are not excluded. On
the special form, exclusions and limitations are particularly
important because there are no named perils and it is the
exclusions and limitations that shape the coverage. It is
important to remember that all causes of loss forms contain
exclusions.
Unlike the other causes of loss forms, this is not a named
perils form; it covers risks of direct physical loss that are not
otherwise excluded or limited by the form. The special form
does not list any covered causes of loss and, because of the
nature of the coverage, it contains many more exclusions and
limitations. Since there are no stated perils to describe or
define the coverage, a number of definitions and exceptions
are intermingled with the exclusions and limitations. This form
also has a separate definitions section which attempts to
clarify the coverage.
In addition to providing special causes of loss coverage, this
form contains the same additional coverage for collapse as
the broad form, and adds two additional coverage extensions.
The special form is divided into six major sections:

Covered Causes of Loss,

Exclusions,

Limitations,

Additional Coverage - Collapse,

Additional Coverage Extensions and

Definitions.
The special Causes of Loss form does include provisions that
are not found on the other forms. While some special form
exclusions are the same as basic and broad form exclusions,
80
company will not pay for “loss of or damage to” the following
items. These provisions limit coverage for certain types of
property, rather than causes of loss.

The first two paragraphs specify that there is no
coverage for damage to steam boilers, steam pipes
or turbines, hot water boilers and similar items
caused by any internal event or condition. Generally,
this means pressure explosions or mechanical
breakdowns of the type which are covered by boiler
and machinery insurance. An exception is made for
explosions of gases or fuel within fired vessels (such
losses are also covered by the basic and broad
forms under the “explosion” peril).

Coverage for damage to building interiors and
contents caused by rain, snow, sleet, ice, sand or
dust is expanded on the special form, because it
applies whenever the building is first damaged by
any “covered cause of loss.” On the basic and broad
forms such interior coverage applies only when the
building is first damaged by “wind or hail” only.

There is no theft coverage for building materials and
supplies not attached to buildings, unless such
property is held for sale by the insured, because the
property is easily removed.
Example: Loose building materials, such as 2 x 4’s
stolen from an insured office building that’s being
remodeled, would not be covered, but such materials
stolen from an insured hardware or building supply
store would be covered. (Note: A separate limitation
applies when builders risk coverage is written.)

The special form does provide some coverage for
mysterious disappearance, which means property
which is missing although there is no evidence of a
burglary and nobody witnessed the theft. But there is
no coverage for missing property when the only
evidence of loss is an inventory shortage. Example:
A missing computer or other office machine would be
covered, because the absence of the item would be
immediately apparent.

The next limitation states that there is no coverage
for property that has been transferred outside of the
premises on the basis of unauthorized instructions.
This is intended to limit the theft coverage to actual
theft of property from the premises and to exclude
certain losses (such as those arising from computer
fraud) which should be covered by fidelity bonds or
crime coverage forms.

This next set of limitations is designed to limit
coverage for various types of property to losses
resulting from the “specified causes of loss” or
building glass breakage (together these are the
same as the 15 broad form perils). This includes
valuable papers and records, a number of fragile
items, and builder’s machinery or equipment while
away from the premises. (Note: A separate limitation
applies when builders risk coverage is written.)

In this section we also find the same limitation for
loss of animals that appears on the basic and broad
forms. Animals are covered only if killed or
destruction becomes necessary.

While the special form is the only causes of loss form
that provides theft coverage, the coverage for
various classes of property is limited to specified
amounts. Generally, these are items which may have
a high value and reflect an above-average exposure
to theft losses. A businessperson with a significant
exposure of this type, such as a jeweler or furrier,
should purchase separate insurance under crime
coverage forms or one of the special inland marine
forms designed for such risks.

Note: These limitations apply only to theft losses loss of jewelry, watches or furs by fire or other
any of the insured’s partners, employees, directors,
trustees, authorized representatives, or anyone
entrusted with the insured’s property (theft by
employees is not covered, but an act of destruction
by employees is covered)

voluntary parting with any property if induced to do
so by any fraudulent scheme, trick, device or false
pretense

rain, snow, ice or sleet damage to personal property
in the open

collapse, except as provided for in the additional
coverage for collapse

discharge, dispersal, seepage, migration, release or
escape of pollutants, unless caused by one of the
“specified causes of loss” - Example: If a fire on the
premises caused a barrel of dye to rupture and the
dye caused additional damage, the additional loss
would be covered because fire (a specified cause of
loss) was the proximate cause of the loss. But if the
same barrel of dye was leaking due to corrosion (not
a specified cause of loss), there would be no
coverage for resulting damage.
Third Group of Exclusions
Because the special form provides extremely broad coverage,
this next group of exclusions is designed to close the door on
some possible additional loopholes in the contract. These
include:

weather conditions if the weather conditions
contribute in any way with a loss caused by building
ordinance, earth movement, government action,
power failure, or major water risks (flood, etc.); There
is no coverage for losses caused by weather
conditions, if weather conditions contribute to a
cause of loss that is specifically excluded by the first
group of exclusions.
Example: Losses caused by off-premises power
failures aren’t covered by your policy. An insured
submits a claim for loss due to power failure but
argues that the power failure was the result of
weather conditions. The insured argues that the loss,
therefore, should be covered. In effect, the insured
would be trying to substitute one cause of loss for
another. There would be no coverage.

acts or decisions, including failure to decide, of any
person, group, organization or government body; and

faulty, inadequate or defective planning, zoning,
development, surveying, design, specifications,
workmanship, repair, construction, renovation,
remodeling, grading, compaction, maintenance, or
materials used in repair, construction, renovation, or
remodeling. Example: If a building collapses as a
result of faulty architectural design, the policy will not
cover this loss.
This group of exclusions also eliminates coverage for losses
resulting from acts or decisions of any individual or
government body, and faulty planning, design, materials or
maintenance. Coverage is intended to apply to unpredictable,
fortuitous and accidental causes of loss (such as fire,
explosion, wind or hail), not to losses caused by the actions or
errors and omissions committed by individuals or government
entities. However, the insured may have a legitimate case for
liability claims against such individuals or entities when such
losses occur.
Final Group of Exclusions
The same group of exclusions applying only to special
coverage forms applies to the Special form, the same as it did
to the basic and broad forms.
Limitations
The special form includes a number of “limitations.” Unlike the
exclusions, this section does not begin by stating that there is
no coverage for loss or damage “caused by or resulting from”
the following items. Instead, it states that the insurance
81
Additional Property Covered Endorsements
Coverage may be expanded by attaching an additional
covered property endorsement. It states that “the following is
withdrawn from the Property Not Covered” section of the
coverage form and a schedule of items follows. The schedule
is flexible and could be used to add coverage for a number of
items.
Specified Property Covered Endorsements
Other endorsements exist for adding coverage for specific
types of property which are not normally covered, or which
may be covered on a very limited basis under an extension of
coverage. Items such as outside signs and radio and
television antennas may be covered by endorsements, which
remove the items from “Property Not Covered.”
Vacancy Permit Endorsement
A vacancy permit may be attached to a policy to modify the
vacancy clause. Normally, losses caused by vandalism or
sprinkler leakage would not be covered if they occur after a
building has been vacant for more than 60 days. For an
additional premium, the insured can buy back this coverage at
specified locations for a specified period of time. The buildings
must be scheduled and a permit period must be entered
(showing dates “from” and “to”). This allows the underwriter to
evaluate the additional risk being assumed, the longer the
permitted period of vacancy, the greater the risk. Finally, for
each building an “X” would be entered under the excepted
causes of loss of vandalism, or sprinkler leakage, or both.
When attached, the endorsement states that the vacancy loss
condition does not apply at the locations and during the permit
period shown in the schedule. Many of the exclusions found
on a coverage form are not cast in stone, and coverage is
available providing that a charge is made for it.
Ordinance or Law Coverage Endorsement
An endorsement may be used to add building ordinance
coverage, which is normally excluded by the causes of loss
form. When attached, coverage is provided for loss or
damage caused by enforcement of laws that regulate building
repair or construction, or require the demolition of damaged
property. Debris removal coverage is also included. This is an
important coverage because local building codes can push
costs well beyond normal replacement cost.
Example: When a building suffers $100,000 of direct damage,
building codes may prohibit the repair or replacement with like
property and may require that all new construction incorporate
expensive modernizations.
Utility Services – Direct Damage Endorsement
Coverage for damage caused by off-premises power failure
may be attached by endorsement. This type of loss is also
excluded by causes of loss forms. When coverage is
attached, loss or damage to insured property will be covered
when utility service is interrupted by a covered cause of loss
that does direct damage to water, communication, or power
services away from the insured’s premises.
Cancellation Changes Endorsement
A “cancellation changes” endorsement must be attached to
every commercial property coverage policy, unless it is in
conflict with state law or is replaced by a special state
endorsement that affects the cancellation clause of the
common policy conditions. The cancellation clause in the
common policy conditions of a commercial policy requires a
minimum 10-day notice if the insurance company cancels for
nonpayment of premium, and a minimum 30-day notice if the
insurance company cancels for any other reason. Because of
the special nature of property insurance, this general provision
is not considered flexible enough to meet the needs of special
situations.
The Insurance Services Office has developed a “cancellation
changes” endorsement that affects property coverages only.
This is a standard endorsement that must be attached unless
superseded by a required state endorsement. The
endorsement adds an additional cancellation provision
allowing the insurance company to cancel with only five days
accidental peril is not subject to limitation. In any
event, valuable items should be listed separately to
ensure full coverage.

This final limitation provides coverage similar to the
combination of the sprinkler leakage and water
damage perils as stated in the broad form. The
insurance company will pay the cost to repair or
replace damaged parts of fire extinguishing
equipment if the damage results in sprinkler leakage
or is caused by freezing. However, it will not pay the
cost to repair any other system or appliance from
which water, liquid, powder or other material
escapes. Again, these losses should be covered by
boiler and machinery insurance.
Additional Coverage – Collapse
The Special form provides the same additional collapse
coverage as the broad form.
Additional Coverage – Extensions
The special form provides three extensions of coverage.
The first extension is for property in transit. This is a limited
amount of coverage, up to $5,000 per loss, provided as
additional insurance. It applies to the insured’s covered
personal property while in transit more than 100 feet away
from the insured premises while in or on a motor vehicle, but
not property in the care, custody or control of salespersons.
The coverage applies only to loss by the perils of fire,
lightning, explosion, windstorm, hail, riot, civil commotion,
vandalism, collision, upset, overturn, or theft of an entire bale,
case or package by forced entry into a securely locked body
or compartment on which there are visible marks of forced
entry.
The second coverage extension applies to water damage or
damage by “other liquids, powders, or molten materials.” The
cost of tearing out and replacing part of the building to repair
damage to the system or appliance from which the water or
other substance escaped is also covered. This is similar to
coverage for water damage under the broad form, although
the special form refers to other substances and related
provisions (relating to repair of fire extinguishing equipment
and losses caused by freezing) are scattered throughout the
special form.
The third extension is for glass. Coverage is added for the
expense of boarding up openings, and inserting temporary
plates of glass, plus the expense of removal in order to repair
or replace building glass.
Definitions
The special form has a brief definitions section, which defines
specified perils. The phrase “specified causes of loss” is used
repeatedly throughout the form to limit certain areas of
coverage to the broad form package of perils (the perils listed
plus breakage of building glass are the same as the 15 broad
form perils). Additional statements define sinkhole collapse,
coverage for falling objects, and water damage. These same
statements are found in the causes of loss section of the
broad form.
Covering Special Needs of the Insured
Endorsements
Various endorsements may be used to alter coverage to fit the
insured’s specific needs. Endorsements may be used to
change the nature of recovery, the property that is covered
and not covered, and the exclusions found on the causes of
loss forms.
Valuation Endorsements
One way in which recovery may be affected is by attaching an
endorsement that provides functional valuation coverage.
When this applies to a loss, it covers the cost to replace
property with similar property intended to perform the same
function. It is used when replacement with identical property is
impossible or unnecessary. Recovery may also be affected by
an endorsement providing market value coverage. “Market
value” means the selling value of property at the time of loss.
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
exclusions,

limitation and

deductible.
Covered Causes of Loss
Coverage is provided for two causes of loss: earthquake and
volcanic eruption. The other causes of loss forms cover
“volcanic action,” which means damage by the airborne shock
waves or ash, dust or lava flow from a volcano, but under the
earth movement exclusion they specifically exclude coverage
for damage caused by the land shock waves of a volcanic
eruption or explosion. Such coverage is provided by this form.
An important aspect of this coverage is that all earthquake or
volcanic shocks occurring within a 168-hour period are
considered to be a single event, and this period is not reduced
by policy expiration. The reason for this provision is that earth
movements are frequently clustered, with strong aftershocks
being related to an original shock. If each tremor were treated
as a separate event, it might be difficult to determine how
much damage was caused by each and to separate the
losses for the purpose of applying deductibles.
Exclusions
There are fewer exclusions on this form because the
coverage is narrowly defined. For example, there is no need
for an earth movement exclusion, because that coverage is
specifically provided by this form.
Most of the remaining exclusions (ordinance or law,
governmental action, nuclear hazard, off-premises power
failure, and war) are essentially the same as those found on
the basic form; but if you compare this form to the basic form,
you will find that many of them are briefer. There is no need to
make exception for resulting losses by fire or other causes of
loss, because those perils are not covered by this form.
However, there are two exclusions which are unique to the
earthquake form. Losses due to fire, explosion, tidal wave,
flood and other causes will not be covered even if resulting
from an earthquake or volcanic eruption. The reason for this
entry is that the insured should have separate coverage for
such exposures (resulting fires or explosions would be
covered by the basic, broad or special causes of loss forms;
and separate flood insurance policies are available to cover
tidal waves, floods or mudslides).
The exclusion of an earthquake or volcanic eruption that
begins before the effective date of the insurance is an
important provision because of the earlier provision stating
that all shocks within a 168-hour period will be treated as a
single event. This prevents a policyholder from buying
coverage after an initial land shock has occurred, and
attempting to recover for losses by attributing them to
aftershocks.
The last group of exclusions, the special exclusions that apply
only to specific coverage forms, are identical to those that
appear on the other causes of loss forms and are not
repeated here. Refer to our review of these exclusions in the
basic causes of loss section of this course if you wish to
examine these provisions in detail or our comments about
them.
Earthquake Limitation
The earthquake form includes a limitation stating that it will not
pay for loss or damage to exterior masonry veneer (except
stucco) on wood frame walls caused by earthquake or
volcanic eruption. However, this limitation will not apply if the
declarations specifically state “including masonry veneer,” or
less than 10% of the total outside wall area is faced with
masonry veneer.
Earthquake Deductible
The earthquake form includes special earthquake deductible
provisions. For all coverage forms except business income
and extra expense coverages, the earthquake deductible will
be a percentage of the insured property’s value. The
applicable percentage must be stated in the declarations, and
will be applied separately to (1) each building or structure, (2)
the contents of each building or structure, and (3) personal
notice under a number of special circumstances. This shorter
notice will be permitted if:

the building has been vacant or unoccupied for 60 or
more consecutive days; or

after damage by an insured cause of loss, repairs
have not been started or contracted for within 30
days; or

the building has been declared unsafe by a
government authority; or

the building has an outstanding order to be vacated
or demolished; or

fixed or salvageable items have been or are being
removed from the building and are not being
replaced; or

heat, water, sewer service or electricity have not
been furnished for 30 consecutive days or more (this
does not apply during a period of seasonal
unoccupancy); or

property taxes have been outstanding for more than
one year following the due date (this does not apply
when the taxes are in dispute).
Many states have implemented special cancellation
provisions, which alter the standard ISO conditions. In each
state where an exception applies, a special state
endorsement would be attached instead of the standard
cancellation changes endorsement.
Functional Valuation Endorsements
Insured property is usually valued at its actual cash value or
its replacement cost (if optional replacement cost coverage
applies). In some cases, ACV coverage might not be practical
and replacement cost coverage might not be economical.
Coverage under the building and personal property coverage
form and both of the condominium coverage forms may be
endorsed to change the method of valuation to “functional”
valuation.
Separate endorsements are available for functional building
valuation and functional personal property valuation. When
attached, these endorsements allow property to be replaced
with less costly property that is functionally equivalent to the
damaged or destroyed property or similar property that
performs the same function when replacement with identical
property is impossible or unnecessary. If a loss occurs, this
coverage will pay the lesser of the limit of insurance or the
cost to repair or replace the building or personal property (or
the damaged portion thereof) with less costly property that is
functionally equivalent.
Peak Season Endorsement
This form increases the limit of insurance for business
personal property for specified periods of time to take care of
seasonal fluctuations in value.
For example, many merchants have increased inventories
during the Christmas season. They may need additional
amounts of protection for only 30 to 60 days. Instead of
purchasing more coverage than they need for the balance of
the year, the peak season endorsement may be used to cover
the temporary increases.
Earthquake Cause of Loss Form
The Causes of Loss - Earthquake Form must be used in
conjunction with one or more of the other causes of loss
forms, because it does not provide a complete package of
perils. It is a named peril form used to add optional coverage
for two additional causes of loss: earthquake and volcanic
eruption.
Since the scope of the coverage being provided is narrowly
defined to begin with, this form has fewer exclusions than the
other forms. It also includes special provisions for earthquake
deductibles, which apply to earthquake losses instead of the
standard or optional deductibles that apply to other types of
losses. The earthquake form is divided into four major
sections:

covered causes of loss,
83
property in the open.
Example: If earthquake coverage applies to a building valued
at $100,000 which contains personal property valued at
$40,000, and if the deductible is shown as 5%, the amount of
the deductibles would be $5,000 for the building and $2,000
for the contents regardless of the amount of loss. So if an
earthquake caused $20,000 of building damage and $10,000
of damage to the contents, the insurance company would pay
a total of $23,000 ($15,000 plus $8,000) and you would have
to assume a $7,000 loss (the sum of the deductibles).
As a result of catastrophic earthquake losses in the early
1990s, insurance companies have sought to increase these
deductibles dramatically. If the insured is considering this
coverage, he or she should prepare to pay more than 5%.
In the case of business income and/or extra expense
coverages, the earthquake form excludes coverage for the
first 168 hours of loss, but only for buildings over four stories
in height.
Recent amendments to the earthquake form define all
earthquake shocks or volcanic eruptions occurring within a
168-hour period as a single event. The 168-hour period is not
affected by policy expiration, which means that an expiring
policy would continue to cover shocks or eruptions following
an event that “begins” while the policy is in effect.
This does not present a problem when new forms are
renewed. But it leaves a coverage gap when new forms are
first used to replace earlier forms, which terminated coverage
at expiration. Because all events during any 168-hour period
are treated as a single event, and because the form excludes
events that begin before the effective date, aftershocks or
eruptions during the first policy period may not be covered if
the event began prior to inception.
The problem is solved by attaching an “earthquake inception
extension endorsement” when one of the new forms is first
issued. It replaces the exclusion of events that begin before
inception with a statement saying that loss or damage that
occurs on or after the inception of the insurance is covered if
the series of earthquakes or volcanic eruptions began within
168 hours prior to the inception date.
After the earthquake causes of loss form has been used to
cover a risk, the endorsement is not needed at renewal.
Value Reporting
When a business has fluctuating inventory values during the
year, a fixed amount of insurance for personal property would
be inappropriate. In order to avoid costly levels of overinsurance, problems with underinsurance, and the
inconvenience of continually endorsing policies to change
insurance limits, reporting forms were created. The value
reporting form allows the level of coverage to float with
changing values. Premiums are adjusted at the end of the
policy period, based on average values reported.
The value reporting form is an endorsement that may be
attached to all commercial property coverage forms for which
value reporting is appropriate, except builders risk forms.
The value reporting form covers personal property at locations
described in the declarations, and extends “covered property”
to include personal property at any of three types of additional
locations for which a limit of insurance is shown in the
declarations.
Coverage may therefore apply at four different types of
locations. Described locations are those shown in the
declarations. Reported locations are locations, other than
those shown in the declarations, which are reported to the
insurance company at the inception of the value reporting
coverage period. Acquired locations are locations acquired
after inception of the coverage and during the coverage
period. Incidental locations are locations other than described,
reported and acquired locations, at which the value of insured
property is $25,000 or less.
There is one exception to the property that may be covered by
the reporting form - personal property at fairs and exhibitions
may not be insured by this form.
Although values are reported during the coverage period, it is
important that the “limit of insurance” written be based on the
highest expected value during that period. The limit is a
maximum limit, and in the event of loss or damage the
insurance company will not pay more than the written limit
even if reported values exceed that limit. During the coverage
period, there is full coverage up to the “limit of insurance” as
long as timely and correct reports have been made.
At the beginning of the coverage period, the insured will be
charged an advance premium (also known as “provisional
premium”). The final premium will be determined after the end
of the policy period, based on the average values actually
reported. At that time, the insurance company will charge an
additional premium (if the advance premium was inadequate),
or will return the excess premium (if the advance premium
was too high).
The insured has the option of selecting one of five periods of
time for which the values must be reported. The type of period
selected will be identified in the declarations by a two-letter
code in brackets. The five periods and codes are:

daily reports (DR) - monthly reports compiled on the
last day of each month must show actual values at
the end of each day during the month;

weekly reports (WR) - monthly reports compiled on
the last day of each month must show actual values
at the end of each week during the month;

monthly reports (MR) - monthly reports compiled on
the last day of each month must show actual values
at the end of each month;

quarterly reports (QR) - quarterly reports compiled on
the last day of March, June, September and
December must show actual values as of the last
day of each month during the reporting period; and

policy year (PR) - annual reports compiled on the
policy anniversary date must show actual values as
of the last day of each month during the reporting
period.
Although there are five different types of reports, there are
only three ways of recording values (daily, weekly, monthly)
because quarterly and annual reports must also show values
at the end of each month. In addition, there are only three
times for submitting reports (monthly, quarterly, and annually)
because daily and weekly reports are submitted monthly.
All reports must be filed with the insurance company within 30
days after the end of each reporting period and after
expiration of the policy term. Each report must show values as
of the required report dates, and must show values separately
at each location. For incidental locations, reports must also
show separately the total values in each State. Accuracy of
reports is important inaccurate reports cannot be corrected
after a loss has occurred.
In effect, value reporting coverage imposes a 100%
coinsurance requirement. The endorsement replaces the
coinsurance clause of the coverage part to which it is attached
with a different provision that applies to the personal property
it covers. It states that if values are underreported, the
insurance company will not pay a greater proportion of a loss
than the amount reported divided by the actual value on the
report date.
Example: If the actual value is $60,000 and the insured
reports an amount of $40,000, only two-thirds of any loss
would be covered by the insurance. The insured must report
actual values even if they exceed the maximum limit of
insurance. Although there is no coverage for values in excess
of the limit of insurance, reporting the full value is the only way
to avoid the coinsurance penalty for underreporting.
In most cases, the actual and reported values at each location
are used for the determination of loss settlements; but in the
case of locations acquired after the last report made, reported
values at all locations would be divided by actual values at all
locations as of the last report date.
If reports are made accurately and on time, the insured will
84
actually provides a considerable amount of protection at a
minimum cost.
One of the most frequent reasons for purchasing a DIC policy
is to pick up coverage for a specific peril, notably earthquake
coverage. When written for this purpose, the policy will
exclude the “covered causes of loss” attached to the
traditional commercial property coverage, and will be written
to cover all other risks including earthquake. Although
earthquake coverage may be attached to traditional property
policies, it is often obtainable on a DIC policy at a lower rate
and lower deductible, and with the added advantage of having
no coinsurance clause.
DIC coverage and limits may be structured in different ways
for different purposes. In some cases, a DIC policy may be
written as a low-limit supplement to a greater amount of
property coverage.
Example: An insured has a personal property exposure in the
amount of $2,000,000 which must be insured for loss by fire
and other major perils. However, the realistic exposure to
other types of miscellaneous losses is only $50,000. A DIC
policy covering these other exposures could be written for
$50,000, probably at a substantial savings over attaching the
coverage to the other policy with the higher limit.
In other cases, DIC coverage may be written as excess over
an underlying layer of basic property coverages, in which case
the common perils would not be excluded. When written as an
excess policy, the coverage might carry substantial
deductibles ($10,000 or more) for losses which are not
covered by the underlying insurance.
DIC insurance might also be written as excess coverage for a
particular peril for which underlying insurance is limited, such
as flood insurance. The insured might purchase the maximum
amount of flood coverage available under the flood insurance
program, and then buy a DIC policy including flood insurance
to be excess over the amount written under the flood program.
Difference in conditions insurance is an uncontrolled line, and
nearly all carriers are free to write the coverage. In reality, it
has been offered only by a limited number of carriers.
Although a number of traditional property insurers will write
the coverage, they tend to be conservative in their approach
to both underwriting and pricing. For this reason, the coverage
is most frequently written in the excess and surplus lines
market, where underwriters tend to have a more realistic view
of the coverage and the pricing tends to be more favorable for
policyholders.
Issues in Commercial Property Insurance Today
Mold
One of the issues that is talked about with personal lines of
insurance, particularly homeowners, is toxic mold. But toxic
mold affects commercial buildings as well. According to the
Environmental Protection Agency, about 1 million buildings
nationwide have been affected by toxic mold, exposing at
least 10 million workers to its effects.
Mold starts from moisture on building materials. Any indication
of water leakage should be treated seriously by the
commercial property owner. Many problems stem from
energy-efficient buildings built after 1970 to comply with new
building code requirements, but which reduced the ventilation.
The EPA has made recommendations for mold prevention. If
mold is not prevented, mold remediation must occur, which is
extraordinarily costly, and may not be covered by insurance.
Mold remediation necessitated by poor building maintenance
itself is not covered by insurance. Only mold caused by an
insurable event, such as storm damage is insurable.
A number of insurers have sought to exclude mold in general
from coverage. Most will allow an insured to buy back mold
coverage for an additional premium.
It is certain that there will continue to be controversy over
mold and the actual health impacts.
Terrorism
The events of September 11, 2001 have a dramatic effect on
the insurance industry, particularly for commercial property.
have the benefit of full coverage for loss up to but not to
exceed the limit of insurance written. However, penalties
apply if reports are delinquent. If a loss occurs before the first
report is due, coverage up to the full limit of insurance applies.
If, at the time of loss, the insured has failed to submit the first
required report in a timely manner, the insurance company will
not pay more than 75% of the amount it otherwise would have
paid. Also, it will only pay for loss or damage at locations
shown in the declarations: it will not pay for any loss at
acquired, reported, or incidental locations.
If a loss occurs after the first report has been made but while
any later report is delinquent, the insurance company will not
pay more than it would pay at any location based on the last
report made, and it will only pay for loss at locations included
in the last report before the loss. For example, if the last
reported value was $100,000 and the insured failed to make a
report on time after values had grown to $150,000, there will
only be $100,000 of coverage until a higher value is actually
reported.
Difference in Conditions (DIC)
A Difference in Conditions Policy is property insurance,
usually written on a large risk, to supplement a named-perils
policy. It provides open perils coverage (often including flood
and earthquake) but excludes the named perils provided by a
standard fire policy. The policy is written for a specific limit
(e.g., $5 million or $10 million) without a coinsurance
provision. Difference in conditions (DIC) insurance is
frequently written with fire and property coverages to
supplement the protection and fill insurance gaps. It is often
used to provide a specific type of coverage which is excluded
on traditional property insurance forms. One of its advantages
is that it may provide coverage for a wide variety of
unanticipated miscellaneous perils at a relatively low cost. It is
sometimes used to provide a layer of excess coverage over
whatever limits are available in the normal market.
The coverage varies because there are no standard forms,
and individual insurers often use their own forms. Because it
is intended to supplement more traditional coverages, it
usually excludes losses which are commonly insured on other
policies (such as loss by fire, lightning, wind, hail, explosion,
riot, smoke, vehicles, aircraft, vandalism and malicious
mischief). This is why it is called “difference in conditions”; it
does not cover what is covered elsewhere, while it covers
almost everything else.
Coverage is often written specifically to provide insurance
against one or more particular perils which are excluded on
most property insurance policies (such as flood, earthquake,
mysterious disappearance, or weather conditions). DIC
policies may be written to cover direct losses and
consequential losses. In addition to filling specific insurance
gaps, broad coverage for loss by unknown perils is a great
advantage. There are a number of potential loss exposures
that might not be anticipated or might simply be overlooked,
which a DIC policy may cover.
The covered property on DIC policies is similar to what may
be insured by fire insurance forms. Coverage may be written
on buildings, machinery, and business personal property
including “stock.” A DIC policy will usually exclude coverage
for the same types of property not covered by fire insurance
(such as money, securities, growing crops, aircraft, and
vehicles); because these are subjects for other types of
insurance and specific policies exist to cover those items.
DIC insurance may be used to fill insurance gaps which
cannot be filled using traditional policy forms, and it may also
be used to close gaps which are created by underwriting
decisions. For some hazardous risks, underwriters may not
want to provide the broadest coverage available, or insure
against a given peril, or write the high limits you request. In
these cases, DIC is often the answer.
Originally, DIC coverage was available only for very large
risks. Gradually it has become available for medium- and
small-sized business risks. Because it provides broad
coverage over other insurance or with a high deductible, it
85
The Terrorism Risk Insurance Act of 2002, which went into
effect late in that year created a 3-year Terrorism Insurance
Program. The program guarantees the availability of terrorism
insurance for commercial properties, but allows insurers to set
premiums. The federal government covers up to 90% of the
certified losses (up to a total maximum of $100 billion per
year). Certified losses are those caused by acts resulting in
more than $5 million in property and casualty losses and
which are caused by a large-scale foreign-sponsored act of
terrorism. Certification is done by the Secretary of the
Treasury.
Participation is mandatory for all commercial lines property
and casualty insurers, and mandates that insurers must offer
terrorism coverage on the same terms or about the same
terms as coverage provided for other types of perils, such as
similar deductibles and limits. The Program is intended to end
at the end of 2004, although it can be extended by the
government for an additional year.
The way this worked was to immediately void all the terrorism
exclusions in commercial property policies for 90 days, during
which time insurers were required to notify policyholders that
coverage would only be available going forward for an
additional premium. Policyholders could accept the new
coverage and pay the new premium, or coverage would again
be excluded.
Increasing Premiums
The year 2002 was particularly difficult for owners of
commercial buildings. Many saw their insurance premiums
rise as much as 300%. The reason for the increase was
primarily terrorism related, although continuing increases in
medical claims (such as those for mold) have also had an
affect on premiums.
Prior to September 11, the worst property insurance disaster
was Hurricane Andrew which did about $18 billion in damage.
The damage to the World Trade Center Buildings and other
property is estimated to be about $40 billion in damage.
Not only is this instance a problem, the concern about future
disasters continues to loom on the horizon, leaving property
insurers not knowing how to properly price their insurance.
Although the government’s Terrorism Act does assist, it is a
difficult time for commercial insurance.
CHAPTER
2
GENERAL LIABILITY
Liability is legal responsibility for damage to another party’s
person or property. If an accident occurs on the insured’s
premises for which the insured’s business is found liable, the
insured can expect to owe money damages to the person
whose person or property was harmed.
Businesses have many potential sources of liability –
employees, customers, products, service operations, facilities,
advertising, and many others. Because accidents or injuries
are difficult to predict and damage awards can be enormous,
liability insurance is perhaps the most important coverage for
any business. A multi-million dollar judgment can disrupt, if
not bankrupt, many businesses. These judgments are entirely
possible in today’s lawsuit-happy environment.
General liability insurance protects an insured company from
a wide variety of exposures. This insurance usually covers
legal obligation arising out of injuries or damage suffered by
members of the public, customers, tenants and others.
Coverage is established by insuring agreements, which tend
to be quite broad.
Because general liability insuring agreements are so broad,
the exclusions are particularly important in shaping the
coverage.
There are two major sublines: One is a broad
premises/operations subline and the other subline is for
products and completed operations.
The commercial general liability program is very flexible.
Endorsements may be used to eliminate coverage for
products and completed operations, advertising injury,
personal and advertising injury, medical payments, or fire
legal liability. Other endorsements may be used to exclude
specific coverage’s for liability arising out of scheduled
locations only, while preserving the coverage elsewhere. An
endorsement may also be used to reduce the broad
contractual liability coverage to a more limited coverage for
incidental contracts.
Separate forms are available for companies that have very
limited and specific exposures. There is a form that provides
only the products and completed operations insurance.
Another form provides owners and contractors protective
coverage, and it is used when an owner or contractor requires
a contractor or subcontractor to provide coverage for a
specific job, which can only be done by issuing the coverage
as a separate policy.
Occurrence versus Claims-made
Originally general liability covered accidents, sudden,
unexpected events that happened at a specific time and
location. Under the current general liability forms, the concept
of accident has been expanded to include occurrences continuous or repeated exposure to conditions that result in
bodily injury or property damage that was neither expected
nor intended (by the insured).
Older occurrence policies covered events that happened
between the effective date and the expiration date of the
policy. Regardless of when a claim was made, the policy in
effect at the time of exposure to the injurious condition was
the one that would respond to the claim, whether or not the
same carrier was providing the coverage.
Several insurance companies issued occurrence policies for
asbestos manufacturers in the 1940s and 1950s. Forty years
later, these insurers are still paying millions of dollars in claims
and legal defense costs for policies under which they
collected only a few thousand dollars in premiums.
Because the delay between the occurrence and filing of a
claim resulted in difficulty in developing premiums adequate to
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forms.
Commercial General Liability Policy
General liability coverage includes common policy
declarations and a common policy conditions. In addition, it
must have a general liability coverage part, which consists of:

the CGL declarations page,

a general liability coverage form,

the broad form nuclear energy liability exclusion
endorsement, and

any other endorsements that may apply.
Declarations Page
In the declarations page, the insurance company “declares”
the facts of the policy: The name of the person or organization
who is insured is shown. The policy number here identifies the
policy indisputably, like your social security number identifies
you; the date when the coverage begins and when it ends; the
name of the insurance company and the producer, the
organization that sells the policy; the charge, or premium, for
the period the policy covers, and the amounts, or limits, the
policy will pay.
The declarations page may also show a retroactive date,
before which no coverage applies.
A retroactive date is a mechanism that defines when coverage
begins. It is most useful for creating a clean division between
occurrence and claims-made coverage, but it has other
applications. A retroactive date is not required. “None” may be
entered on the declarations. If a retroactive date is to apply, it
must be shown on the CGL declarations.
When claims-made coverage is written without a retroactive
date, duplicate coverage may exist. All claims made during
the policy term may be covered even if they are also covered
by earlier occurrence forms. However, the claims-made
coverage would apply as excess over any earlier occurrence
policies that cover the same loss.
Usually, when an occurrence policy is renewed by a claimsmade policy, the retroactive date will be the effective date of
the claims-made policy. This eliminates overlapping coverage.
For example, a risk that transfers from occurrence coverage
to claims-made coverage on January 1, 2003 is likely to carry
a retroactive date of January 1, 2003. Any claim resulting from
an occurrence prior to January 1, 2003 would fall back on an
earlier occurrence policy, and the claims-made form would
only cover claims resulting from occurrences on or after
January 1, 2003.
In the absence of a major change in the risk or a shift to a
different insurance company, the same retroactive date
should be continued on claims-made renewals to avoid gaps
in coverage. If the above policy is renewed on January 1,
2004 while retaining the January 1, 2003 retroactive date, a
claim made on April 1, 2004 for an injury that occurred during
2003 would be covered by the 2004 policy. If the retroactive
date had been advanced to January 1, 2004, a claim reported
during 2004 for an occurrence in 2003 would not be covered
by the 2004 policy (because the occurrence happened before
the retroactive date), or by the 2003 policy (because the claim
was not reported before the end of that policy period), or any
earlier occurrence forms (because the loss happened after
those policies expired).
Before the retroactive date can be advanced, the insurance
company must obtain from the first named insured written
consent and acknowledgment that the insured has been
informed of the right to buy the extended reporting period.
Claims-made CGL forms have an additional section providing
for “extended reporting periods,” also referred to as “ERPs.”
The insuring agreement limits coverage to claims first made
“during the policy period.” When claims-made forms are
continuously renewed by other claims-made forms, the
agreement does not present any problems; whenever a claim
is made, it will be charged against current coverage. But
coverage gaps would result if the coverage were to be
renewed on an “occurrence” form, or if a retroactive date were
moved forward at renewal, or if the insurance were
anticipate claims that had been incurred but not reported,
insurance companies developed so-called “claims-made”
coverage for risks with a long delay, sometimes called long
tailed exposures.
Basically, the occurrence form pays for (or covers) injury or
damage that happens during the policy period, while the
claims-made form responds to claims filed during the policy
period.
One purpose of introducing the claims-made form was to
create a precise claim trigger that would prevent the stacking
of limits. An occurrence form covers injury or damage that
occurs during the policy period, even if the claim is made
three, four, or five years later.
Some courts decided that a loss resulting from a cause that
occurred during two or more policy periods meant that two or
more sets of policy limits applied.
For example, if the insured’s company had $1 million of
coverage in each of three separate years in which an
occurrence contributed to a loss, a court might require the
insurance company to pay up to $3 million for a single loss.
This is the problem of “stacking.” In contrast, a claims-made
form covers claims that are first made during the policy period.
If the insured continually renews claims-made coverage with a
$1 million occurrence limit, a single loss can only be charged
to one policy.
The claims-made coverage provided a precise claim trigger
that made it possible for insurance companies to determine
when coverage began and which policy should respond.
Under the occurrence form, the policy or coverage in effect at
the time the incident occurs responds. Under the claims-made
form, coverage in effect at the time the claim is reported
responds.
Other features of the claims-made form are that it reduces the
time that records must be kept for future claims, and it is more
inflation proof than occurrence coverage. Suppose an
accident happened during 1996 and the claim was not made
until 2003. With occurrence coverage, the loss would be
charged to the policy in effect in 1996 and the claim would be
paid under that policy. Also suppose that the insured had a
$250,000 per occurrence limit during 1996 but gradually
increased the amount to $1 million by 2003 because of
inflationary trends. With occurrence coverage, there would
only be $250,000 of coverage available for a loss that
occurred in 1996. If claims-made coverage applied, the same
loss would be charged to the policy in effect during 2003,
there would be $1 million of coverage available, and the claim
would be paid under the more recent policy.
The claims-made form also has an additional section and a
few necessary differences in its conditions. The written
provisions of the claims-made form differ from the occurrence
form only in the following three areas:

Coverage A and B Insuring Agreements,

CGL Conditions (added provisions), and

Additional Section—Extended Reporting Periods.
Claims which trickle in after the end of a policy period create
an exposure known as a claims tail. Tail coverage is
automatically built into the insuring agreements of occurrence
forms. This is not the case with claims-made forms, and the
forms would be unacceptable if they left policyholders
exposed to serious insurance gaps which could not be
covered. Extended reporting periods were created to solve the
problems of coverage terminations and transitions back to
occurrence coverage.
Most policy provisions under the two CGL coverage forms are
identical. The insuring agreements differ slightly, because the
coverage trigger is different under claims-made coverage.
There are a few differences in the claims-made conditions,
and the claims-made form has an additional section
concerning extended reporting periods. We will review the
claims-made coverage form because most of the claims-made
provisions are additional provisions, and the remaining policy
provisions, conditions and exclusions are the same on both
87
permanently discontinued (a possibility when an insured
business fails). In such cases, future claims from past
operations could not be charged against any future
“occurrence” policy, nor would any “claims-made” coverage
exist at the time the claim is made.
Claims-made coverage has been designed so that transitions
between “occurrence” and “claims-made” coverage can be
managed without gaps or duplications of coverage. Proper
use of a retroactive date and extended reporting periods will
prevent situations where a loss is covered by two different
policies or is not covered at all.
Coverage Forms
Commercial general liability (CGL) insurance protects a
business from a variety of business liability exposures arising
out of its premises, operations, products and completed
operations. The major coverages apply to bodily injury,
property damage, personal injury, and advertising injury
claims. The Insurance Services Office (ISO) Policy Forms
program was updated in 2001.
The CGL coverage forms are organized into sections. The
occurrence form has five sections and the claims-made form
that we will review in this chapter, has six, the only difference
being an additional section for extended reporting periods on
the claims-made form. The coverage forms are organized in
the following way:

Coverages - Section I

Who Is An insured - Section II

Limits of Insurance - Section III

CGL Conditions - Section IV

Definitions—Section V on “occurrence” form; Section
VI on “claims-made”

Extended Reporting Periods - Section V on “claimsmade” only
Section I – Coverages
Section I of both forms describes all of the following
coverages:

Coverage A - Bodily injury (BI) and property damage
(PD) liability

Coverage B - Personal and advertising injury liability

Coverage C - Medical payments

Supplementary payments - Coverages A and B
Each of the coverages has an insuring agreement and a list of
exclusions.
Policy Preamble
These policies are written in first person, the insured is
referred to as “you” and the company as “we”, in the policy
preamble, the definition of “you” has been expanded to
include “any other person or organization qualifying as a
Named Insured under the policy.” This gives “Named Insured”
status to newly acquired organizations.
COVERAGE A - BODILY INJURY AND PROPERTY
DAMAGE
Insuring Agreement
The insuring agreement defines the duties of the insurance
company under the policy. The insurance company must
defend the insured in any suit seeking damages and pay any
judgment arising out of the suit for bodily injury or property
damage. It may also investigate any occurrence and settle a
resulting claim or suit if it wishes to do so.
The damages it will pay will not exceed the limits of liability
shown in the policy and the insurance company’s obligation to
defend the insured ends when the limits of liability are used up
in payment of claims under Coverage A (bodily injury and
property damage), Coverage B (personal injury and
advertising liability), or Coverage C (medical payments). The
only payments it is responsible for above the policy limits of
liability are those described in supplementary payments.
1. Insuring Agreement.
a. We will pay those sums that the insured becomes legally
obligated to pay as damages because of “bodily injury” or “property
damage” to which this insurance applies. We will have the right and
duty to defend any “suit” seeking those damages. We may at our
discretion investigate any “occurrence” and settle any claim or “suit”
that may result. But:
(1) The amount we will pay for damages is limited as described
in Limits of Insurance (Section III); and
(2) Our right and duty to defend end when we have used up the
applicable limit of insurance in the payment of judgments or
settlements under Coverages A or B or medical expenses under
Coverage C.
No other obligation or liability to pay sums or perform acts or
services is covered unless explicitly provided for under
Supplementary Payments—Coverages A and B.
Coverage Agreement and Notice of Claim
On the claims-made form, a claim is deemed to be first made
when notice of the claim is received by the insured or by the
insurance company, whichever comes first. All claims for
damages because of “bodily injury” to the same person,
including damages claimed by any person or organization for
care, loss of services, or death resulting at any time from the
“bodily injury” will be deemed to have been made at the time
the first of these claims is made against any insured person.
Under the claims-made policy form coverage is provided only
if the bodily injury or property damage takes place in the
coverage territory and does not occur before the retroactive
date or after the end of the policy period. In addition to the
injury or damage occurring within these dates, a claim must
be first made during the policy period or during any extended
reporting period. A claim is deemed to be “first made” when
notice of the claim is received by the insured or the insurance
company or when it is settled by the insurance company,
whichever comes first.
The only difference between Coverage A as provided by the
claims-made form and the occurrence form is the coverage
“trigger.” The occurrence form covers injury or damage that
occurs during the policy period regardless of when the claim is
made.
b. This insurance applies to “bodily injury” and “property damage”
only if:
(1) The “bodily injury” or “property damage” is caused by an
“occurrence” that takes place in the “coverage territory”;
(2) The “bodily injury” or “property damage” did not occur before
the Retroactive Date, if any, shown in the Declarations or after the
end of the policy period; and
(3) A claim for damages because of the “bodily injury” or
“property damage” is first made against any insured, in accordance
with paragraph c. below, during the policy period or any Extended
Reporting Period we provide under Extended Reporting Periods
(Section V).
c. A claim by a person or organization seeking damages will be
deemed to have been made at the earlier of the following times:
(1) When notice of such claim is received and recorded by any
insured or by us, whichever comes first; or
(2) When we make settlement in accordance with paragraph 1.a.
above.
Coverage A Exclusions
Coverage A exclusions on the claims-made form and
occurrence form are identical. There are no differences.
If the insured intentionally injures another person or damage
property of others, there is no coverage under the policy. The
word “intentionally” means an act which is expected or
intended to cause injury to a person or damage to property.
However, this exclusion does not apply if the injury or damage
is the result of using reasonable force to protect persons or
property.
Exclusions shape coverage and serve a number of purposes.
Some exclusions eliminate coverage for things which are not
considered insurable, such as intentional acts on the insured’s
part. Exclusions are also used to eliminate coverage which is
properly the subject of other types of insurance; CGL
coverage does not apply to losses which should be covered
by property insurance, automobile insurance, and workers
SECTION I—COVERAGES
COVERAGE A. BODILY INJURY AND PROPERTY DAMAGE
LIABILITY
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for its liquor liability exposure if it provided beer at a company
picnic or served drinks at a holiday party.
Another example: One of the insured’s employees drinks too
much at the office Christmas party. The employee is involved
in an accident on his way home and sues the insured because
the insured provided the drinks. The court rules that the
insured precipitated the employee’s drunkenness and finds for
the employee. The insurance company will pay the damages
the court awards to the employee.
Of course, the insurance company will not pay damages if the
insured is held legally responsible for getting someone drunk;
or for giving liquor to someone under age or who is already
drunk, or if the insured sells, distributes or gives alcohol to
someone in violation of any law.
compensation. Finally, exclusions are often used to remove
coverage which is available, but which is not given
automatically because it is not universally needed or it needs
to be underwritten and rated separately, such as liquor liability
and pollution liability coverages.
Expected or Intended Exclusion
The exclusion clarifies that this policy does not provide
coverage for events that an insured could have expected or
intended would happen.
2. Exclusions.
This insurance does not apply to:
a. “Bodily injury” or “property damage” expected or intended from
the standpoint of the insured. This exclusion does not apply to “bodily
injury” resulting from the use of reasonable force to protect persons or
property.
c. “Bodily injury” or “property damage” for which any insured may
be held liable by reason of:
(1) Causing or contributing to the intoxication of any person;
(2) The furnishing of alcoholic beverages to a person under the
legal drinking age or under the influence of alcohol; or
(3) Any statute, ordinance or regulation relating to the sale, gift,
distribution or use of alcoholic beverages.
This exclusion applies only if you are in the business of
manufacturing, distributing, selling, serving or furnishing alcoholic
beverages.
Contractual Liability Exclusion
This exclusion is designed to prevent the policyholder from
assuming exposure beyond normal business agreements. If
the insured fails to read the fine print and signs a contract that
says he or she will be responsible for any bodily injury or
property damage the insurance company will not pay for any
such damage that might occur.
But some contracts the insured signs are considered “insured
contracts”, which are covered. These include: lease of
premises agreements, sidetrack, construction, or demolition
agreements with railroads, indemnification agreements with
municipalities in connection with work done for them, elevator
maintenance agreements, and the assumption of the tort
liability of another party. Since this definition is quite broad,
the policy actually does cover many types of contractual
liability. However, in order to be covered, the contract or
agreement must be made prior to the occurrence of any bodily
injury or property damage.
The policy also covers liability the insured would have even if
no contract or agreement existed, because the policy would
have covered the loss anyway and the agreement does not
increase the exposure.
In addition, if the insured is responsible legally for the third
parties’ litigation expenses as part of the contract, these
expenses will be covered under the policy as well.
Required Statutory Benefits Exclusion
Exclusions d. and e. pertain to the relationship between
general liability coverage and various statutory benefits which
an employer is required to provide.
Exclusion d. is designed to prevent payment under the
general liability coverage for obligations an insured employer
might have under workers compensation laws, disability
benefit laws, and similar laws. Generally, these are statutory
obligations and are paid without regard to fault or negligence.
Separate forms of insurance coverage are available for these
exposures. In contrast, CGL coverage is intended to be “legal
liability” insurance.
Exclusion e. relates more specifically to employee injuries and
consequential injuries to family members of employees. There
is no coverage for injury suffered by an employee in the
course of employment or while performing duties related to
the insured’s business, and no coverage for injury to a family
member, such as a spouse who claims psychological trauma
as a result of injury to the employee. These types of injuries
would be covered by a workers compensation and employers
liability policy, and an employer should carry that kind of
insurance.
b. “Bodily injury” or “property damage” for which the insured is
obligated to pay damages by reason of the assumption of liability in a
contract or agreement. This exclusion does not apply to liability for
damages:
(1) That the insured would have in the absence of the contract or
agreement.
(2)Assumed in a contract or agreement that is an “insured
contract”, provided the “bodily injury” or “property damage” occurs
subsequent to the execution of the contract or agreement. Solely for
the purposes of liability assumed in an “insured contract”, reasonable
attorney fees and necessary litigation expenses incurred by or for a
party other than an insured are deemed to be damages because of
“bodily injury” or “property damage”, provided:
(a)Liability to such party for, or for the cost of, that party’s
defense has also been assumed in the same “insured contract”, and
(b) Such attorney fees and litigation expenses are for defense of
that party against a civil or alternative dispute resolution proceeding in
which damages to which this insurance applies are alleged.
d. Any obligation of the insured under a workers compensation,
disability benefits or unemployment compensation law or any similar
law.
e. “Bodily injury” to:
(1) An employee of the insured arising out of and in the course of
: (a) Employment by the Insured; or
(b) Performing duties related to the conduct of the insured’s
business; or
(2) The spouse, child, parent, brother or sister of that employee
as a consequence of (1) above.
This exclusion applies:
(1) Whether the insured may be liable as an employer or in any
other capacity; and
(2) To any obligation to share damages with or repay someone
else who must pay damages because of the injury.
This exclusion does not apply to liability assumed by the insured
under an “insured contract.”
Liquor Liability Exclusion
The liquor liability exclusion applies only to an insured
business that is in the business of manufacturing, distributing,
selling, serving or furnishing alcoholic beverages, such as a
brewery, liquor store, bar or restaurant where drinks are
served. For these companies, a separate liquor liability
coverage form is available and a premium will be charged for
the coverage because of the greater exposure.
However, the policy does cover the incidental liquor liability
exposure of a company that is not in the business of making,
supplying, serving or selling liquor. An insured building owner
who leases a premises to someone engaged in the business
of selling drinks would be covered if sued as the owner of the
premises. An insured business which provided financial
services and consists only of clerical offices would be covered
Pollution Exclusion
Exclusion f. eliminates coverage for virtually all types of
pollution exposures.
With respect to a premises, site or location owned or occupied
by, rented to, or used by an insured business, or on which
work is performed for that company by contractors or
subcontractors, any injury or damage resulting from the heat,
smoke or fumes of a hostile fire is not excluded as pollution
damage. A “hostile fire” is one which is out of control or
breaks out of the area to which it was intended to be confined.
89
Example: If the insured burns some old paper trash and the
fire spreads beyond the fire-break, any resulting
environmental damage will not be covered.
The pollution exclusion is a very broad one that applies to
bodily injury or property damage arising out of the discharge,
migration, release or escape of pollutants. It applies to any
premises, site or location owned or occupied by, rented to, or
used by an insured business, or which at any time was used
for the handling, storage, disposal, processing or treatment of
waste. This exclusion also applies to activities by others for
whom the insured may be responsible, and to work performed
by contractors or subcontractors on behalf of an insured
business.
Part (2) of the pollution exclusion specifies that, in addition to
excluding injury and damage, there is no coverage for the
costs of testing, monitoring, cleaning up, removing or
neutralizing pollutants, and no coverage for any claims or
suits brought against the insured by any governmental entity
for damages related to pollution cleanup or removal.
Pollution coverage is not granted automatically because the
nature of the exposure depends upon the insured’s
operations, and the wide variation in possible exposures
cannot be reflected by average rates. Separate pollution
liability coverage forms are available for pollution exposures.
Pollution risks are underwritten and rated separately.
While the “absolute” pollution exclusion should have resolved
coverage disputes, there is still litigation over its application to
environmental claims under CGL policies. CGL coverage may
also be inapplicable if the claim is not a “suit” or does not seek
“damages” as those terms are defined in the policy.
Most property/casualty insurance companies sell separate
environmental impairment liability (EIL) insurance which
covers pollution risks. As a result they work hard to keep
pollution claims out of CGL coverage. However, EIL insurance
remains nonstandard, so not many companies buy it. Most
policyholders try to claim coverage for pollution risk under
CGL policies.
intention discharge, dispersal or release of the fuels, lubricants or
other operating fluids, or if such fuels, lubricants or other operating
fluids are brought on or to the premises, site or location with the intent
that they will be discharged, dispersed or released as part of the
operations being performed by such insured, contractor or
subcontractor;
“Bodily injury” or “property damage” sustained within a building
and caused by the release of gases, fumes or vapors from materials
brought into that building in connection with operations being
performed by you or on your behalf by a contractor or subcontractor;
or
“Bodily injury” or “property damage” arising out of heat, smoke or
fumes from a “hostile fire”.
(e) At or from any premises, site or location on which any insured
or any contractors or subcontractors working directly or indirectly on
any insured’s behalf are performing operations if the operations are to
test for, monitor, clean up, remove, contain, treat, detoxify or
neutralize, or in any way respond to, or assess the effects of,
“pollutants”.
(2) Any loss, cost or expense arising out of any:
(a) request, demand or order that any insured or others test for,
monitor, clean up, remove, contain, treat, detoxify or neutralize, or in
any way respond to, or assess the effects of pollutants; or
(b) claim or suit by or on behalf of a governmental authority for
damages because of testing for, monitoring, cleaning up, removing,
containing, treating, detoxifying or neutralizing or in any way
responding to or assessing the effects of pollutants.
However, this paragraph does not apply to liability for damages
because of “property damage” that the insured would have in the
absence of such request, demand, order or statutory or regulatory
requirement, or such claim or “suit” by or on behalf of a governmental
authority.
Auto, Watercraft, Aircraft Exclusion
Coverage is excluded for “autos” (as defined in the policy),
watercraft, and aircraft that you own, use, maintain or entrust
to others. The exclusion also states that the word “use” not
only means the operation of the auto, watercraft, or aircraft
but includes the loading or unloading of any of them.
The exclusion specifically discusses negligent supervision. If,
for instance, an employee of the insured injures others in a
boating accident using the insured’s covered watercraft, the
injuries would be covered. However, if the insured were
subsequently sued for negligent hiring because the employee
was not properly trained to operate the boat (although he told
the insured he was) that cause of action would not be
covered.
There are several situations which are exempt from the
exclusion and for which coverage is provided:
1. Watercraft which are ashore and on premises that the
insured owns or rents are covered.
2. Watercraft not owned by the insured are also covered if
they are less than 26 feet long and are not being used to carry
property or persons for a charge.
3. Parking an auto on the insured’s premises or on the “ways”
adjoining (i.e., alleys, streets, roads, etc.) is covered if the
auto is not owned, rented, or loaned to the insured. This
exception allows coverage for parking facilities in connection
with the insured’s business.
4. Coverage is also included for contractual liability involving
watercraft and aircraft if the contract is within the definition of
an “insured contract” under the policy. Note, however, that
“autos” are not included because contractual liability for autos
is covered under most auto policies.
5. Some self-propelled vehicles with permanently mounted
equipment are defined as “autos” under the policy and not as
“mobile equipment.” Cherry pickers, generators, air
compressors, spraying, and well-digging equipment are types
of equipment which are mounted on truck bodies to move the
equipment from location to location. Coverage for these
“autos” is to be provided by an automobile policy. However,
when these vehicles are not being operated and are
stationary while the mounted equipment is in use, coverage is
provided under this policy for the operation of the equipment
mounted on these vehicles.
f. (1) “Bodily injury” or “property damage” arising out of the
actual, alleged or threatened discharge, dispersal, seepage,
migration, release or escape or pollutants:
(a) At or from any premises, site or location which is or was at
any time owned or occupied by, or rented or loaned to, any insured.
However, this subparagraph does not apply to:
“Bodily injury” if sustained within a building and caused by
smoke, fumes, vapor or soot from equipment used to heat that
building;
“Bodily injury” or “property damage” for which you may be held
liable, if you are a contractor and the owner or lessee of such
premises, site or location has been added to your policy as an
additional insured with respect to your ongoing operations performed
for that additional insured at that premises, site or location and such
premises, site or location is not or never was owned or occupied by,
or rented or loaned to, any insured, other than that additional insured;
or
“Bodily injury” or “property damage” arising out of heat, smoke or
fumes from a “hostile fire”;
(b) At or from any premises, site or location which is or was at
any time used by or for any insured or others for the handling,
storage, disposal, processing or treatment or waste;
(c) Which are or were at any time transported, handled, stored,
treated, disposed of, or processed as waste by or for any insured or
any person or organization for whom you may be legally responsible;
or
(d) At or from any premises, site or location on which any insured
or any contractors or subcontractors working directly or indirectly on
any insured’s behalf are performing operations if the “pollutants” are
brought on or to the premises, site or location in connection with such
operations by such insured, contractor or subcontractor. However,
this subparagraph does not apply to:; or
“Bodily injury” or “property damage” arising out of the escape of
fuels, lubricants or other operating fluids which are needed to perform
the normal electrical, hydraulic or mechanical functions necessary for
the operation of “mobile equipment’ or its parts, if such fuels,
lubricants or other operating fluids escape from a vehicle part
designed to hold, store or receive them. This exception does not
apply if the “bodily injury” or “property damage” arises out of the
90
that the insured no longer owns or exercises any control over,
which have been called “alienated premises.” Note that this
exclusion does not apply to bodily injury arising out of the
alienated premises, nor does it apply to damage to property
other than to the alienated premises. The purpose of this is to
exclude coverage for repairs to the premises, which should
have been made by the insured prior to its sale or other
disposition. An exception to this exclusion is made further
down, which provides that it does not apply if the premises are
“your work” and they were never occupied, rented, or held for
rental by the insured. This exception provides coverage for
building contractors, etc., who construct buildings solely for
the purpose of resale.
Parts (5) and (6) of the exclusion are related. Part (5)
excludes coverage for damage to a particular part of real
property the insured, contractors, or subcontractors are
working on. Part (6) excludes damage to any property that
must be restored, repaired, or replaced because of improperly
performed work by the insured. Under part (5), if an
improperly installed gas heater explodes and not only
demolishes the gas heater but causes severe damage to the
building, the policy would cover the damage to the building but
not replacement of the gas heater. Part (6) excludes coverage
for faulty workmanship, and excludes coverage to replace,
repair, or restore property because the insured’s work was not
performed correctly. Again note that the exclusion only
pertains to the particular part that was worked on, and not
damage to other property that results. Further, this exclusion
does not apply to the products or completed operations
hazard.
Parts (3), (4), (5), and (6) do not apply to railroad sidetrack
agreements. Railroad sidetrack agreements are covered
contracts under the policy, and these exclusions would nullify
such agreements if they were applicable.
g. “Bodily injury” or “property damage” arising out of the
ownership, maintenance, use or entrustment to others of any aircraft,
“auto” or watercraft owned or operated by or rented or loaned to any
insured. Use includes operation and “loading or unloading.”
This exclusion applies even if the claims against any insured
allege negligence or other wrongdoing in the supervision, hiring,
employment, training or monitoring of others by that insured, if the
“occurrence” which caused the “bodily injury” or “property damage”
involved the ownership, maintenance, use of entrustment to others of
any aircraft, “auto” or watercraft that is owned or operated by or
rented or loaned to any insured.
This exclusion does not apply to:
(1) A watercraft while ashore on premises you own or rent;
(2) A watercraft you do not own that is:
(a) Less than 26 feet long; and
(b) Not being used to carry persons or property for a charge;
(3) Parking an “auto” on, or on the ways next to, premises you
own or rent, provided the “auto” is not owned by or rented or loaned to
you or the insured;
(4) Liability assumed under any “insured contract” for the
ownership, maintenance or use of aircraft or watercraft; or
(5) “Bodily injury” or “property damage” arising out of the
operation of any of the equipment listed in paragraph f.(2) or f.(3) of
the definition of “mobile equipment” (Section VI.8)
Mobile Equipment Exclusion
“Mobile equipment” as defined in the policy is covered under
most circumstances, but coverage under this policy is not
provided while mobile equipment is being transported by
another vehicle that is owned or operated by, or rented or
loaned to any insured person. A common occurrence is when
a fork lift (which is mobile equipment) is transported by a truck
carrying a load of material which will be unloaded at a
destination. If the fork lift breaks loose while being transported
and runs into parked cars, there is no coverage under this
policy. Coverage would have to be provided under the policy
covering the truck doing the hauling.
Part h.(2) excludes mobile equipment while used in racing,
speed contests or other types of exhibition or stunting
contests, or while practicing for them. An example of this
would be “tractor pulls,” which often take place at fairs, and
other similar events using farm equipment.
j. “Property damage” to:
(1) Property you own, rent, or occupy, including any costs or
expenses incurred by you, or any other person, organization or entity,
for repair, replacement, enhancement, restoration or maintenance of
such property for any reason, including prevention of injury to a
person or damage to another’s property;
(2) Premises you sell, give away or abandon, if the “property
damage” arises out of any part of those premises;
(3) Property loaned to you;
(4) Personal property in the care, custody or control of the
insured;
(5) That particular part of real property on which you or any
contractors or subcontractors working directly or indirectly on your
behalf are performing operations, if the “property damage” arises out
of those operations; or
(6) That particular part of any property that must be restored,
repaired or replaced because “your work” was incorrectly performed
on it.
Paragraphs (1),(3) and (4) of this exclusion do not apply to
“property damage” (other than damage by fire) to premises, including
the contents of such premises, rented to you for a period of 7 or fewer
consecutive days. A separate limit of insurance applies to Damage To
Premises Rented To You as described in Section III – Limits Of
Insurance.
Paragraph (2) of this exclusion does not apply if the premises are
“your work” and were never occupied, rented or held for rental by you.
Paragraphs (3), (4), (5) and (6) of this exclusion does not apply
to liability assumed under a sidetrack agreement.
Paragraph (6) of this exclusion does not apply to “property
damage” included in the “products-completed operations hazard”.
h. “Bodily injury” or “property damage” arising out of:
(1) The transportation of “mobile equipment” by an “auto” owned
or operated by or rented or loaned to any insured; or
(2) The use of “mobile equipment” in, or while in practice or
preparation for, a prearranged racing, speed or demolition contest or
in any stunting activity.
War Exclusion
The insured would not normally have any liability arising out of
war, insurrection, and similar occurrences; however, note that
this exclusion only applies to liability assumed under contract
or agreement. The insured would not specifically assume
liability for war, etc., but it is possible that he or she could
assume liability under a contract with such broad language
that it would include almost any occurrence. This exclusion
would then apply under those circumstances.
i. “Bodily injury” or “property damage” due to war, whether or not
declared, or any act or condition incident to war. War includes civil
war, insurrection, rebellion or revolution. This exclusion applies only to
liability assumed under a contract or agreement.
Care, Custody, or Control Exclusion
This exclusion eliminates or restricts coverage for damage to
property that is owned by, used by, loaned to, rented to, or is
or has been in your, the insured’s care, custody or control. It
also restricts coverage for damage with respect to property
manufactured, worked on, or constructed by the insured.
Parts (1), (3), and (4) pertain to property which the insured is
using or own or which belongs to others. Coverage for
property that falls into these categories can be covered by
other forms of insurance, such as building and personal
property policies, inland marine policies, or legal liability
property insurance forms.
Part (2) excludes coverage for property damage to premises
Product Liability Exclusion
This excludes damage to the insured’s product which arises
from the product itself.
Example: A faulty connection in an electrical appliance the
insured produces causes a "short-circuit" that in turn destroys
the appliance and, in addition, damages a customer’s
property. The damage to the appliance would not be covered,
but the property damage would be covered.
It is important to note that this exclusion applies if the damage
arises “out of any part of it,” which means that if a small switch
on a large machine malfunctions and causes the damage,
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exclusion of “impaired property” because the insured’s
product may be the suspected defective component of
another product being recalled. It may be the maker of the
main product who initiates the recall, and not the insured;
therefore, the word “others” is part of the exclusion.
coverage is denied for the entire machine and not just for the
switch.
of it.
k. “Property damage” to “your product” arising out of it or any part
Subcontractor Exclusion
This excludes property damage to “your work” that arises out
of “your work” or any part of it, which is included under the
products/completed operations hazard. The exclusion does
not apply to work in progress, since this would come under
the premises-operations hazard and not the completed
operations hazard. It does not apply to damage which arises
out of the work of a subcontractor, whether the damage is to
the insured’s work or the work of the subcontractor or another
subcontractor. This is because the insured is responsible for a
subcontractor’s work; but cannot be expected to monitor all of
a subcontractor’s work as carefully as the insured’s own.
n. Damages claimed for any loss, cost or expense incurred by
you or others for the loss of use, withdrawal, recall, inspection, repair,
replacement, adjustment, removal or disposal of:
(1) “Your product”;
(2) “Your work”; or
(3) “Impaired property”;
if such product, work, or property is withdrawn or recalled from
the market or from use by any person or organization because of a
known or suspected defect, deficiency, inadequacy or dangerous
condition in it.
Rental Premises Exclusion
An exception applies to all of the exclusions except the first
two. All other exclusions (c. through n.) do not apply to fire
damage to a premises rented by the insured. General liability
coverage does provide fire legal liability insurance up to the
fire damage limit shown in the declarations.
Exclusion a. is not waived because it applies to damage
“expected or intended,” and the policy will not cover arson.
Exclusion b. is not waived because it applies to obligations
assumed under contract other than an insured contract.
Although a lease is an “insured contract,” the definition of that
term specifically excludes any obligation to indemnify a
person for fire damages to a premises rented by the insured
(but the contractual liability exclusion does not apply to liability
the insured would have had in the absence of a contract). This
means that the policy will pay for fire damage if the insured is
negligent, but will not pay if the obligation to pay for damages
is assumed under contract and negligence is not involved.
l. “Property damage” to “your work” arising out of it or any part of
it and included in the “products-completed operations hazard.”
This exclusion does not apply if the damaged work or the work
out of which the damage arises was performed on your behalf by a
subcontractor.
Impaired Property Exclusion
“Impaired property” means tangible property that cannot be
used or is less useful because it incorporates the insured’s
product or work which is defective, or because the insured
has failed to fulfill the terms of a contract or agreement, when
such property can be restored to use by repair, replacement
or removal of the product or work, or by fulfilling the terms of
the agreement. This exclusion applies to damage to impaired
property or other property that has not been physically injured,
arising out of a defect in the insured’s product or work or a
failure to perform.
The purpose of this exclusion is to remove coverage for
damages which could be avoided by repair or replacement of
the insured’s defective product or work, or by the insured’s
performance of, or failure to perform, an agreement. This
includes claims for loss of use.
Example: The exclusion might apply if the insured supplied
defective components for another manufacturer’s appliance
which would not be sold with the defect, or if an insured
contractor failed to complete a project on time and another
party lost rental income or sales opportunities as a result. The
insured should be responsible for repair, replacement or
performance when such action could eliminate the claim for
damages.
However, an exception to the exclusion states that it does not
apply to loss of use of other property resulting from a sudden
injury to the insured’s product or work after it has been put to
its intended use. If a piece of equipment could not be used
because the insured’s component exploded after it had been
used for awhile, there would be coverage for a loss of use
claim.
Exclusions c. through n. do not apply to damage by fire to
premises rented to you or temporarily occupied by you with
permission of the owner. A separate limit of insurance applies to this
coverage as described in Limits of Insurance (Section III).
COVERAGE B
PERSONAL AND ADVERTISING INJURY LIABILITY
Insuring Agreement
The insuring agreement for Coverage B reads the same as for
Coverage A, with the single exception that the words
“personal and advertising injury” replace the words “bodily
injury” and “property damage.”
A separate sub-limit applies to Coverage B, and it is also
subject to the general aggregate limit. The insurance
company’s duty to defend the insured ceases when either of
these limits is used up by payment of claims under Coverage
A, B, or C. Personal injury is not the same as bodily injury,
and includes such things as false arrest, libel, slander, and
invasion of privacy.
COVERAGE B. PERSONAL AND ADVERTISING INJURY
LIABILITY
1. Insuring Agreement.
a. We will pay those sums that the insured becomes legally
obligated to pay as damages because of “personal injury” or
“advertising injury” to which this coverage part applies We will have
the right and duty to defend any seeking those damages. We may at
our discretion investigate any “occurrence” or offense and settle any
claim or “suit” that may result. But:
(1) The amount we will pay for damages is limited as described
in Limits of Insurance (Section III); and
(2) Our right and duty to defend end when we have used up the
applicable limit of insurance in the payment of judgments or
settlements under Coverage A or B or medical expenses under
Coverage C.
No other obligation or liability to pay sums or perform acts or
services is covered unless explicitly provided for under
Supplementary Payments—Coverages A and B.
m. “Property damage” to “impaired property” or property that has
not been physically injured arising out of:
(1) A defect, deficiency, inadequacy or dangerous condition in
“your product” or your work; or
(2) A delay or failure by you or anyone acting on your behalf to
perform a contract or agreement in accordance with its terms.
This exclusion does not apply to the loss of use of other property
arising out of sudden and accidental physical injury to “your product”
or “your work” after it has been put to its intended use.
Recall Exclusion
This provision excludes any costs involved in the recall of
products from the marketplace because of some known or
suspected defect. It has in the past been known as the
“sistership exclusion” because of its origin in the aircraft
industry. When a defect in one aircraft would cause the recall
of its “sisterships” for inspection and repair as necessary. In
these cases of recall, there has been no actual bodily injury or
property damage caused by the recalled products and the
recall is a remedial or preventative action and not a claim
arising from an actual defect in a product. There is an
Coverage Agreement and Notice of Claim
All claims for damages because of “personal and advertising
injury” to the same person or organization as a result of an
offense will be deemed to have been made at the time the first
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of those claims is made against any insured parties.
Personal injury and advertising injury are mutually exclusive
exposures. “Personal injury” applies to an offense arising out
of the insured’s business activities other than advertising,
publishing or broadcasting. “Advertising injury” applies to an
offense arising out of advertising the insured’s goods,
products or services. This coverage is designed to cover the
incidental advertising liability exposure of an insured business
that advertises its own goods and services, and it does not
apply to an insured business that is in the advertising,
publishing or broadcasting business (as you will see when we
examine the exclusions).
The only difference between Coverage B as provided by the
claims-made form and the occurrence form is the coverage
trigger. Occurrence coverage applies to an offense committed
during the policy period (regardless of when the claim is
made). In contrast, claims-made coverage applies only if the
offense was not committed before the retroactive date (if any)
or after the end of the policy period, and only if the claim is
made during the policy period or any extended reporting
period provided by the insurance company.
insured business that advertises its own goods and services,
and will not cover an advertising agency or newspaper that is
in the business of advertising for others.
Separate professional liability coverage is available for
advertisers, broadcasters and publishers.
This insurance does not apply to:
Knowing Violation Of Rights Of Another
“Personal and advertising injury” caused by or at the direction of
the insured with the knowledge that the act would violate the rights of
another and would inflict “Personal and advertising injury”.
Material Published With Knowledge of Falsity
“Personal and advertising injury” arising out of oral or written
publication of material, if done by or at the direction of the insured with
knowledge of its falsity.
Material Published Prior To Policy Period
“Personal and advertising injury” arising out of oral or written
publication of material whose first publication took place before the
Retroactive Date, if any shown in the Declarations.
Criminal Acts
“Personal and advertising injury” arising out of a criminal act
committed by or at the direction of the insured.
Contractual Liability
“Personal and advertising injury” for which the insured has
assumed liability in a contract or agreement. This exclusion does not
apply to liability for damages that the insured would have in the
absence of the contract or agreement.
Breach of Contract
“Personal and advertising injury” arising out of a breach of
contract, except an implied contract to use another’s advertising idea
in you “advertisement”.
Quality Or Performance Of Goods – Failure To Conform To
Statements
“Personal and advertising injury” arising out of the failure of
goods, products or services to conform with any statement of quality
or performance made in your “advertisement”.
Wrong Description Of Prices
“Personal and advertising injury” arising out of the wrong
description of the price of goods, products or services stated in your
“advertisement”.
Infringement of copyright, Patent, Trademark Or Trade Secret
“Personal and advertising injury” arising out of the infringement
of copyright, patent, trademark, trade secret or other intellectual
property rights.
However, this exclusion does not apply to infringement, in your
“advertisement”, of copyright, trade dress or slogan.
b. This insurance applies to “personal and advertising injury”
caused by an offense arising out of your business but only if:
(1) The offense was committed in the “coverage territory”;
(2) The offense was not committed before the Retroactive Date,
if any, shown in the Declarations or after the end of the policy period;
and
(3) A claim for damages because of the “personal injury” or
“advertising injury” is first made against any insured, in accordance
with paragraph c. below, during the policy period or any Extended
Reporting Period we provide under Extended Reporting Periods
(Section V).
c. A claim made by a person or organization seeking damages
will be deemed to have been made at the earlier of the following
times:
(1) When notice of such claim is received and recorded by any
insured or by us, whichever comes first; or
(2) When we make settlement in accordance with paragraph 1.a.
above.
All claims for damages because of “personal and advertising
injury” to the same person or organization as a result of an offense
will be deemed to have been made at the time the first of those claims
is made against any insured.
Coverage B Exclusions
Coverage B exclusions on the claims-made and occurrence
forms are identical with the exception of a single reference to
the “retroactive date” in one of the exclusions. This is
necessary because of the difference in the coverage triggers
under the two forms.
Personal and Advertising Injury Exclusions
This set of exclusions applies to the personal and advertising
injury coverages. This is similar to the “expected or intended”
exclusion found under Coverage A; here there is no coverage
for injury arising out of publication of material which is known
to be false by the insured, or which is a willful violation of a
penal statute or ordinance. There is no coverage for injury
arising out of material first published before the beginning of
the policy period). There a is contractual liability exclusion.
Here there is no reference to, and no coverage for, an
“insured contract,” but once again the exclusion does not
apply to liability the insured would have had in the absence of
a contract or agreement.
There is no coverage for failure of a product or service to
perform as advertised (the insured might be obligated to
replace the product or refund the purchase price, but the
purchaser has not really suffered any additional injury or
damages). Injury resulting from errors in the description of a
price for goods or services (here the prospective purchaser
has been misinformed, but has not suffered any injury) is also
excluded.
Finally, coverage is excluded for an offense committed by an
insured business in advertising, broadcasting, publishing or
telecasting. As mentioned earlier, the CGL form is designed
only to cover the incidental advertising liability exposure of an
Insureds in Internet and Media Businesses Exclusions
With this edition of the CGL Policy, for the first time insurers
are specifically excluding personal and advertising injury
coverage for Internet businesses. In essence, coverage is not
provided under the CGL for businesses primarily in the
businesses of providing web sites or content for other
businesses or as Internet Service Providers. Coverage must
be purchased specifically for those exposures.
It is important to note that this provision does not exclude
coverage for a company’s own web site. Coverage is
restricted for that portion of a web site that is specifically to
advertise the business.
Insureds in Media and Internet Type Businesses
“Personal and advertising injury” committed by an insured whose
business is:
(1)Advertising, broadcasting, publishing or telecasting;
(2)Designing or determining content or websites for others; or
(3)An Internet search, access, content or service provider.
However, this exclusion does not apply to Paragraphs 14.1., b.
and c. of “personal and advertising injury” under the Definitions
Section.
For the purposes of this exclusion, the placing of frames, borders
or links, or advertising for you or others anywhere on the Internet, is
not by itself, considered the business of advertising, broadcasting,
publishing or telecasting.
Electronic Chatrooms or Bulletin Boards
“Personal and advertising injury” arising out of an electronic
chatroom or bulletin board the insured hosts, owns, or over which the
insured exercises control.
Unauthorized Use of Another’s Name Or Product
“Personal and advertising injury” arising out of the unauthorized
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completed operations hazard limit (which appears in detail
below), and any injuries resulting from war or an act of war,
are excluded. Under item g., all of the exclusions that apply to
bodily injury under Coverage A also apply to medical
payments coverage.
use of another’s name or product in your e-mail address, domain
name or metatag, or any other similar tactics to mislead another’s
potential customers.
Pollution
“Personal and advertising injury” arising out of the actual,
alleged, or threatened discharge, dispersal, seepage, migration,
release or escape of “pollutants” at any time.
Pollution-Related
Any loss, cost or expense arising out of any:
(1) Request, demand or order that any insured or others test for,
monitor, clean up, remove, contain, treat, detoxify or neutralize, or in
any way respond to, or assess the effects of “pollutants” ; or
(2) Claim or suit by or on behalf of a governmental authority for
damages because of testing for, monitoring, cleaning up, removing,
containing, treating, detoxifying or neutralizing, or in any way
responding to, or assessing the effects of “pollutants”.
2. Exclusions.
We will not pay expenses for bodily injury:
a. To any insured.
b. To a person hired to do work for or on behalf of any insured or
a tenant of any insured.
c. To a person injured on that part of premises you own or rent
that the person normally occupies.
d. To a person, whether or not an employee of any insured, if
benefits for the “bodily injury” are payable or must be provided under
a workers compensation or disability benefits law or a similar law.
e. To a person injured while taking part in athletics.
f. Included within the “products-completed operations hazards.”
g. Excluded under Coverage A.
h. Due to war, whether or not declared, or any act or condition
incident to war. War includes civil war, insurrection rebellion or
revolution.
COVERAGE C MEDICAL PAYMENTS
Intent
Medical payments coverage provides payment for reasonable
medical expenses without regard to legal responsibility for the
injury. It is intended to mitigate possible bodily injury claims by
providing voluntary coverage for medical expenses of an
injured person without any question of liability. The injury must
occur on the insured’s premises or adjoining ways or as a
result of the insured’s operations even if they occur away from
the premises. The accident causing the injury must take place
during the policy period and within the coverage territory;
therefore, coverage is on an “occurrence” basis on both the
“claims-made” and the “occurrence” forms.
Further restrictions require that the medical expenses be
incurred and reported to the insurance company within a oneyear period from the date of the accident, and that the injured
person must submit to reasonable requests to be examined
by a physician at company expense.
Up to the applicable limit of insurance per person, general
liability medical expenses are paid regardless of fault. The
coverage applies to reasonable expenses for first aid
administered at the time of the accident, necessary medical,
surgical, x-ray and dental services resulting from the
accidental injuries, necessary ambulance, hospital, and
professional nursing services, and funeral services if death
results from the injuries.
Supplementary Payments
Supplementary payments cover certain expenses and costs in
addition to payments made under Coverages A and B and do
not reduce the limits of liability. Coverage is included for
expenses incurred by the insurance company such as costs of
investigating a claim, costs of bail bonds related to traffic laws
(while the policy doesn’t cover autos directly, mobile
equipment might be involved in an accident involving traffic
laws), and bonds to release attachment. While the premiums
for these bonds will be paid, the insurance company does not
have to furnish them.
Reasonable expenses of an insured person, including loss of
earnings up to $250 per day, will be reimbursed but only if the
expense or time off work is at the request of the insurance
company. Costs of a suit which are charged to the insured,
such as court costs, depositions, transcripts, and legal fees,
will be paid. Prejudgment interest on the amount of a
judgment the insurance company is required to pay, as well
as interest accruing after a judgment, will be paid; however,
the insurance company will not pay interest on a judgment
which accrues after it makes an offer to settle for the policy
limits and the offer is rejected.
COVERAGE C. MEDICAL PAYMENTS
1. Insuring Agreement.
a. We will pay medical expenses as described below for “bodily
injury” caused by an accident:
(1) On premises you own or rent;
(2) On ways next to premises you own or rent; or
(3) Because of your operations;
provided that:
(1) The accident takes place in the “coverage territory” and
during the policy period;
(2) The expenses are incurred and reported to us within one year
of the date of the accident; and
(3) The injured person submits to examination, at our expense,
by physicians of our choice as often as we reasonably require.
b. We will make these payments regardless of fault. These
payments will not exceed the applicable limit of insurance. We will pay
reasonable expenses for:
(1) First aid at the time of an accident;
(2) Necessary medical, surgical, x-ray and dental services,
including prosthetic devices; and
(3) Necessary ambulance, hospital, professional nursing and
funeral services.
SUPPLEMENTARY PAYMENTS—COVERAGES A AND B
1. We will pay, with respect to any claim or “suit” we defend:
a. All expenses we incur.
b. Up to $250 for cost of bail bonds required because of
accidents or traffic law violations arising out of the use of any vehicle
to which the Bodily Injury Liability Coverage applies. We do not have
to furnish these bonds.
c. The cost of bonds to release attachments, but only for bond
amounts within the applicable limit of insurance. We do not have to
furnish these bonds.
d. All reasonable expenses incurred by the insured at our
request to assist us in the investigation or defense of the claim or
“suit,” including actual loss of earnings up to $250 a day because of
time off from work.
e. All costs taxed against the insured in the “suit.”
f. Prejudgment interest awarded against the insured on that part
of the judgment we pay. If we make an offer to pay the applicable limit
of insurance, we will not pay any prejudgment interest based on that
period of time after the offer.
g. All interest on the full amount of any judgment that accrues
after entry of the judgment and before we have paid, offered to pay, or
deposited in court the part of the judgment that is within the applicable
limit of insurance.
These payments will not reduce the limits of insurance.
Coverage C Exclusions
Medical payments coverage does not apply to injury to any
insured party, any person hired to work for an insured
business, any person (such as a tenant) who is injured on that
part of the insurance company’s premises that such person
normally occupies, any person for whom benefits for the same
injury are payable or required under any workers
compensation or disability benefits law, or any person injured
while taking part in athletics.
Injuries which would be included under the products-
Section II -Who Is An Insured
This section defines specifically the persons or organizations
who are named insureds under the policy in addition to the
named insured shown on the declarations. The extension to
unnamed insureds depends upon the type of business
organization or entity shown in the declarations. If the named
insured is an individual, the spouse is also an insured. A
94
partnership or joint venture includes the partners and their
spouses as insureds, while a corporation includes officers and
directors as insureds with respect to their duties performed for
the corporation, and stockholders with respect to their liability
that arises as a result of being stockholders. Limited liability
companies (LLCs ) and their members and managers are
covered but only in the conduct of the business. A trust may
also be an insured. Coverage for individuals, partners, and
joint ventures is limited to their liability arising out of the
conduct of the insured business.
professional health care services.
“Property damage” to property:
(a) Owned, occupied or used by
(b) Rented to, in the care, custody or control of, or over which
physical control in being exercised for any purpose by
You, any of your “employees”, volunteer workers”, any partner or
member (if you are a partnership or joint venture) or any member (if
you are a limited liability company).
Any person (other than your “employee” or “volunteer worker”) or
any organization while acting as your real estate manager.
Any person or organization having temporary custody of your
property if you die, but only:
With respect to liability arising out of the maintenance or use of
that property; and
Until your legal representative has been appointed.
Your legal representative if you die, but only with respect to
duties as such. That representative will have all your rights and duties
under this Coverage Part.
SECTION II—WHO IS AN INSURED
1. If you are designated in the Declarations as:
a. An individual, you and your spouse are insureds, but only with
respect to the conduct of a business of which you are the sole owner.
b. A partnership or joint venture, you are an insured. Your
members, your partners, and their spouses are also insureds, but only
with respect to the conduct of your business.
c. A limited liability company, you are an insured. Your members
are also insureds, but only with respect to the conduct of your
business. Your managers are insureds, but only with respect to their
duties as your managers.
d. An organization other than a partnership or joint venture, you
are an insured. Your “executive officers” and directors are insureds,
but only with respect to their duties as your officers or directors. Your
stockholders are also insureds, but only with respect to their liability
as stockholders.
e. A trust, you are an insured. Your trustees are also insureds,
but only with respect to their duties as trustees.
Using Equipment with Permission
Any person driving the insured’s mobile equipment on public
roads with the insured’s permission is an insured while doing
so. Any other person or organization responsible for the driver
of such mobile equipment will also be an insured with respect
to operation of the equipment, but only if no other liability
insurance is available to that person or organization for this
exposure. However, no other person or organization is an
insured with respect to injury to a co-worker of the person
driving the mobile equipment, or for damage to property
owned by, rented to, in the charge of, or occupied by the
named insured or the employer of any person who is an
“insured” under this provision.
A caveat: This section may duplicate liability coverage offered
by the business auto policy. If the insured has different
insurance companies for these coverages, they may disagree
about who is responsible when the insured makes a claim.
This may be a good reason for an insured to buy a single
commercial package instead of several different policies.
Other Insureds
Employees are insureds with respect to their acts which fall
within the scope of their employment. Volunteers are also
covered to the same extent as employees.
An example: The secretary to the president of the insured’s
company, while escorting a visitor to the president’s office,
accidentally allows a heavy door to close on the visitor’s hand.
The secretary is insured under this policy for her liability for
the injury to the visitor.
However, an employee is not an insured for any injury
suffered by a co-worker or any consequential injury suffered
by a member of such co-worker’s family. Also, an employee is
not an insured for any injury arising out of providing or failing
to provide professional health care services, or for damage to
any property owned or occupied by or rented or loaned to that
employee, other employees, or any of the insured’s partners
or partnership members.
Any person (other than an employee or volunteer) or
organization is an insured while acting as the named insured’s
real estate manager.
If the named insured dies, any person or organization having
custody of the insured’s property will be an insured with
respect to liability arising out of that property until a legal
representative is appointed, and a legal representative will be
an insured with respect to performing such duties.
3. With respect to “mobile equipment” registered in your name
under any motor vehicle registration law any person is an insured
while driving such equipment along a public highway with your
permission. Any other person or organization responsible for the
conduct of such person is also an insured, but only with respect to
liability arising out of the operation of the equipment, and only if no
other insurance of any kind is available to that person or organization
for this liability. However, no person or organization is an insured with
respect to:
a. “Bodily injury” to a co-employee of the person driving the
equipment; or
b. “Property damage” to property owned by, rented to, in the
charge of or occupied by you or the employer of any person who is an
insured under this provision.
Newly Acquired or Formed Organizations
CGL coverage will automatically be extended to cover newly
acquired or formed organizations as “named insureds,” if the
insured owns or holds a majority interest in such organizations
and no other similar insurance covers them. This automatic
coverage is provided only for 90 days or until the end of the
policy period, whichever is earlier. Coverages A and B will not
apply to any injury or damage that occurred, or any offense
that was committed, before the organization was acquired or
formed.
No person or entity is an insured with respect to any past or
present partnerships or joint ventures unless these are shown
as named insureds in the declarations.
2. Each of the following is also an insured:
Your “volunteer workers” only while performing duties related to
the conduct of your business, or your “employees”, other than either
your “executive officers” (if you re an organization other than a
partnership, joint venture or limited liability company) or your
managers (if you are a limited liability company) or, but only for acts
within the scope of their employment by you or while performing
duties related to the conduct of your business. However, none of
these “employees” or “volunteer workers” are insureds for:
“Bodily injury” or “personal and advertising injury”:
(a) to you , to your partners or members (if you are a partnership
or joint venture), to your members (if you are a limited liability
company), to a co-“employee” while in the course of his or her
employment or performing duties related to the conduct of your
business:
(b)To the spouse, child, parent, brother or sister of that co”employee” or “volunteer worker” as a consequence of Paragraph
(1)(a) a above.
(c) For which there is any obligation to share damages with or
repay someone else who must pay damages because of the injury
described in Paragraphs (1)(a) or (b) above; or
(d) Arising out of his or her providing or failing to provide
4. Any organization you newly acquire or form, other than a
partnership or joint venture, and over which you maintain ownership
or majority interest, will quality as a Named Insured if there is no other
similar Insurance available to that organization. However:
a. Coverage under this provision is afforded only until the 90th
day after you acquire or form the organization or the end of the policy
period, whichever is earlier;
b. Coverage A does not apply to “bodily injury”, or “property
damage” that occurred before you acquired or formed the
organization; and
c. Coverage B does not apply to “personal injury” or “advertising
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injury” arising out of an offense committed before you acquired or
formed the organization.
No person or organization is an insured with respect to the
conduct of any current or past partnership or joint venture that is not
shown as a Named insured in the Declarations.
Limit is the most we will pay under Coverage A for damages because
of “property damage” to premises, while rented to you, or in the case
of damage by fire, while rented to you or temporarily occupied by you
with permission of the owner.
7. Subject to 5. above. The Medical Expense Limit is the most
we will pay under Coverage C for all medical expenses because of
“bodily injury,” sustained by any one person.
The limits of this Coverage Part apply separately to each
consecutive annual period and to any remaining period of less than
12 months, starting with the beginning of the policy period shown in
the Declarations, unless the policy period is extended after issuance
for an additional period of less than 12 months. In that case, the
additional period will be deemed part of the last preceding period for
purposes of determining the Limits of Insurance.
Section III - Limits of Liability
These limits apply for a policy year so, if a policy is written for
more than one year, the limits are renewed each year. If a
policy was issued for a term of 30 months, a new set of limits
would apply to the final six months of the policy term.
However, if a policy was issued for one year and extended by
endorsement for an additional three months, either during the
policy term or at expiration, then the extension period would
be considered part of the original policy period and be subject
to the original set of limits.
There are six different sets of limits of liability. The primary
limits are the general aggregate limit and the
products/completed operations aggregate limit. The remaining
four limits are sublimits which are subject to either of the
primary aggregate limits. These limits are not affected or
increased by the number of insureds, the number of claims or
suits made, or the number of persons making the claims or
bringing the suits.
The general aggregate limit is a critical number. All coverages
and sublimits are subject to this overall limit with the single
exception of the products/completed operations aggregate
limit. This is the total amount that will be paid in the policy
year except for products/completed operations coverage.
The products/completed operations aggregate limit is the
other major aggregate. It is a separate aggregate and not
limited by the general aggregate, but it does have an affect on
several of the sublimits.
The sublimit applying to “personal injury” and “advertising
liability” is the most that will be paid for all damages claimed
by any one person or organization. It is also subject to the
general aggregate limit.
The occurrence limit controls the amount that will be paid for
bodily injury, property damage, and medical payments arising
from a single occurrence. It is also subject to either the
general aggregate limit or the products/completed operations
aggregate limit depending on which coverage applies to the
claim.
The medical expense limit is the most that will be paid to one
person for medical expenses arising out of a bodily injury. It is
also subject to the occurrence limit and the general aggregate
limit.
Section IV - Policy Conditions
Bankruptcy
The Bankruptcy condition states clearly that the insured’s
insolvency or bankruptcy or that of the insured’s estate does
not relieve the insurance company of its obligation under the
policy to pay damages for which the insured is found liable, to
defend any suit against the insured for such damages, or to
investigate any offense or occurrence that might result in a
claim.
SECTION IV—COMMERCIAL GENERAL LIABILITY
CONDITIONS
1. Bankruptcy.
Bankruptcy or insolvency of the insured or of the insured’s estate
will not relieve us of our obligations under this Coverage Part.
Insured’s Duties
The insured has certain obligations to the insurance company
with respect to claims and occurrences or offenses which
“may result in a claim.” Under both the claims-made and
occurrence coverage forms, when the insured has knowledge
of an occurrence or offense, a complete documentation
should be made of what happened, the names and addresses
of any injured persons and witnesses, and a description of the
nature of any injury or damage.
When any other person or organization included under the
“Named Insured” designation of the policy reports a claim to
the insured, it is the insured’s duty to record and report the
pertinent details—including the date the insured was
notified—and advise the insurance company immediately. It is
then the insured’s duty, as soon as is practicable, to provide
the company written notice of the claim.
The statement, “Notice of an occurrence is not notice of a
claim,” appears only on the claims-made form because the
distinction is important. Claims-made coverage applies to
claims which are actually made during the policy period and
not necessarily to injury or damage that occurs during the
policy period. If the insureds terminate coverage, he or she
must file a claim quickly to avoid missing the end of the policy
period or other relevant deadlines.
Most of the wording in condition 2.b. is the same on the
claims-made and occurrence forms, except that in three
places where the claims-made form refers to a “claim” the
occurrence form refers to a “claim or suit.” The insured is
required to record immediately the specifics of any claim,
notify the insurance company as soon as practicable, and
then follow up with written notice of the claim.
SECTION III LIMITS OF INSURANCE
1. The limits of insurance shown in the declarations and the rules
below fix the most we will pay regardless of the number of:
a. Insureds;
b. Claims-made or “suits” brought; or
c. Persons or organizations making claims or bringing “suits”
2. The General Aggregate Limit is the most we will pay for the
sum of:
a. Medical expenses under Coverage C;
b. Damages under Coverage A, except damages because of
“bodily injury” or “property damage” included in the “productscompleted” operations hazard;” and
c. Damages under Coverage B.
3. The Products-Completed Operations Aggregate Limit is the
most we will pay under Coverage A for damages because of “bodily
injury” and “property damage” included in the “products completed
operations hazard.”
4. Subject to 2. above, the Personal and Advertising Injury Limit
is the most we will pay under Coverage B for the sum of all damages
because of all the “personal injury” and all “advertising injury”
sustained by any one person or organization.
5. Subject to 2. or 3. above, whichever applies, the Each
Occurrence Limit is the most we will pay for the sum of:
a. Damages under Coverage A; and
b. Medical expenses under Coverage C
because of all “bodily injury” and “property damage” arising out of
any one “occurrence.”
6. Subject to 5. above, the Damage To Premises Rented To You
2. Duties In The Event Of Occurrence, Claim Or Suit.
a. You must see to it that we are notified as soon as practicable
of an “occurrence” or offense which may result in a claim. To the
extent possible, notice should include:
(1) How, when and where the “occurrence” or offense took place;
(2) The names and addresses of any injured 2 persons and
witnesses; and
(3) The nature and location of any injury or damage arising out of
the “occurrence” or offense.
Notice of an “occurrence” is not notice of a claim.
b. If a claim is received by any insured you must:
(1) immediately record the specifics of the claim and the date
received; and
(2) Notify us as soon as practicable.
You must see to it that we receive written notice of the claim as
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self-insured amounts under that other insurance. If any other
insurance and the CGL coverage both apply as excess, the
insurance companies will share the remaining portion of the
loss after all primary insurance has been exhausted.
soon as practicable.
c. You and any other involved insured must:
(1) Immediately send us copies of any demands, notices,
summonses or legal papers received in connection with the claim or a
“suit”;
(2) Authorize us to obtain records and other information;
(3) Cooperate with us in the investigation, settlement or defense
of the claim or “suit”; and
4. Other Insurance.
If other valid and collectible insurance is available to the insured
for a loss we cover under Coverages A or B of this Coverage Part, our
obligations are limited as follows:
a. Primary Insurance
This insurance is primary except when b. below applies. If this
insurance is primary, our obligations are not affected unless any of
the other insurance is also primary. Then, we will share with all that
other insurance by the method described in c. below.
b. Excess Insurance
This insurance is excess over:
(1) any of the other insurance, whether primary, excess,
contingent or on any other basis:
(a) That is effective prior to the beginning of the policy period
shown in the Declarations of this insurance and applies to “bodily
injury” or “property damage” on other than a claims-made basis, if:
(ii) No Retroactive Date is shown in the Declarations of this
insurance; or
(ii) The other insurance has a policy period which continues after
the Retroactive Date shown in the Declarations of this insurance;
(b) That is Fire, Extended Coverage, Builders, Risk, Installation
Risk or similar coverage for “your work”;
(c) That is Fire insurance for premises rented to you; or
(d) That is insurance purchased by you to cover your liability as a
tenant for “property damage” to premises rented to you or temporarily
occupied by you with permission of the owner; or
e) If the loss arises out of the maintenance or use of aircraft,
“autos” or watercraft to the extent not subject to Exclusion g. of
Coverage A (Section I).
(2) Any other primary insurance available to you covering liability
for damages arising out of the premises or operations for which you
have been added as an additional insured by attachment of an
endorsement.
When this insurance is excess, we will have no duty under
Coverages A or B to defend any claim or “suit” that any other insurer
has a duty to defend. If no other insurer defends, we will undertake to
do so, but we will be entitled to the insured’s rights against all those
other insurers. When this insurance is excess over other insurance,
we will pay only our share of the amount of the loss, if any, that
exceeds the sum of:
(1) The total amount that all such other insurance would pay for
the loss in the absence of this insurance; and
(2) The total of all deductible and self-insured amounts under all
that other insurance.
We will share the remaining loss, if any, with any other insurance
that is not described in this Excess Insurance provision and was not
bought specifically to apply in excess of the Limits of Insurance shown
in the Declarations of this Coverage Part.
Under both CGL coverage forms, the insured must send
copies of all legal papers received, authorize the insurance
company to obtain information, cooperate in the investigation
and defense of the claim, and assist the insurance company
in enforcing any right of recovery from another person or
organization who may be liable for damages. The insured is
not permitted to make payments voluntarily, assume
obligations, or incur expenses (except for first aid at the time
of an accident) without the consent of the insurance company.
(4) Assist us, upon our request, in the enforcement of any right
against any person or organization which may be liable to the insured
because of injury or damage to which this insurance may also apply.
d. No insured will, except at that insured’s own cost, voluntarily
make a payment, assume any obligation, or incur any expense, other
than for first aid, without our consent.
Legal Action against the Company
These paragraphs limit the ability of anyone, including the
insured, to sue the insurance company for any reason related
to settlement of a lawsuit.
An important note: This section states that someone who
believes he has been wronged by the insured can’t name the
insured’s insurance company in any lawsuit he files. This
means the insurance company avoids being a party to the
suit, at least initially. (The insurance company can be sued if it
doesn’t pay a settlement of judgment against a policyholder.)
3. Legal Action Against Us.
No person or organization has a right under this Coverage Part:
a. To join us as a party or otherwise bring us into a “suit” asking
for damages from an insured; or
b. To sue us on this Coverage Part unless all of its terms have
been fully complied with.
A person or organization may sue us to recover on an agreed
settlement or on a final judgment against an insured obtained after an
actual trial; but we will not be liable for damages that are not payable
under the terms of this Coverage Part or that are in excess of the
applicable limit of insurance. An agreed settlement means a
settlement and release of liability signed by us, the insured and the
claimant or the claimant’s legal representative.
Other Insurance
This condition specifies how Coverages A and B apply when
other valid insurance is available for the same loss. Paragraph
a. states that the coverage will be primary in all cases except
when the provisions of the following paragraph specify that it
will apply as excess. When coverage is primary, it is usually
not affected by other insurance. But if other insurance is also
primary, the insurance companies will share the loss.
Claims-made coverage will be excess over any prior
“occurrence” coverage if the claims-made coverage has no
retroactive date or if the occurrence coverage continues
beyond the retroactive date (this shaded provision is found
only in the claims-made form). Under both the claims-made
and occurrence forms, coverage also applies as excess over
(1) any fire insurance for a premises the insured has rented;
any fire and extended coverage, builders risk, or installation
risk coverage for the insured’s work; and (3) any other
insurance covering losses arising out of aircraft, autos or
watercraft to the extent that these losses are not excluded
under Coverage A.
Example: A business auto policy may serve as primary
coverage in the event that the insured hasn’t adequately
maintained the brakes of a covered auto. CGL would serve as
excess beyond the business auto policy’s limits.
When CGL coverage applies as excess, the insurance
company will only pay the amount of a loss that exceeds the
sum of all other insurance payments and all deductibles and
Paragraph c. describes the method of sharing when CGL
coverage and other insurance apply on the same basis,
whether primary or excess. If other insurance permits sharing
by equal shares, each insurance company will contribute
equal dollar amounts until policy limits are exhausted or the
loss is fully paid. If other insurance does not permit
contribution by equal shares, the insurance companies will
share the loss based on limits, and each will contribute to the
loss in the proportion that its limit of insurance bears to the
total of all applicable limits. This is sometimes called the pro
rata liability clause.
c. Method of Sharing
If all of the other insurance permits contribution by equal shares,
we will follow this method also. Under this approach each insurer
contributes equal amounts until it has paid its applicable limit of
insurance or none of the loss remains, whichever comes first.
If any of the other insurance does not permit contribution by
equal shares, we will contribute by limits. Under this method, each
insurer’s share is based on the ratio of its applicable limit of insurance
to the total applicable limits of insurance of all insurers.
Premium Audits
The insurance company has the right to examine and audit
the insured’s records to the extent that they relate to the
policy. (This right is also extended to rate service
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organizations.) These records can be in a variety of forms,
from ledgers to computer data. The audits, made in regular
business hours, can occur during the policy period and for
some period after its expiration.
The final audit billing should never be a “surprise”, yet audits
often develop unexpected additional premiums.
help us enforce them.
Notice of Cancellation
The common policy conditions provide for 30 days notice of
cancellation (10 days for nonpayment of premium) for all
coverage parts of the policy. This condition broadens the
obligation of the insurance company to give 30 days notice of
nonrenewal. Note that this additional requirement applies only
to the CGL coverage part. Certified mail is sufficient proof that
notice of cancellation was received.
5. Premium Audit.
a. We will compute all premiums for this Coverage Part in
accordance with our rules and rates.
b. Premium shown in this Coverage Part as advance premium is
a deposit premium only. At the close of each audit period we will
compute the earned premium for that period and send notice to the
First Named Insured. The due date for audit and retrospective
premiums is the date shown as the due date on the bill.
If the sum of the advance and audit premiums paid for the policy
term is greater than the earned premiums we will return the excess to
the first Named Insured.
c. The first Named Insured must keep records of the information
we need for premium computation, and send us copies at such times
as we may request.
9. When We Do Not Renew.
If we decide not to renew this Coverage Part, we will mail or
deliver to the first Named Insured shown in the Declarations written
notice of the nonrenewal not less than 30 days before the expiration
date.
If notice is mailed, proof of mailing will be sufficient proof of
notice.
Insured’s Right to Claim Information
This condition is found only on the claims-made form. If a
claims-made policy is canceled or nonrenewed, either by the
insured or by the insurance company, it is important that any
claims or potential claims information be made available in
order to replace the coverage with another carrier. A new
carrier will want this information to evaluate accurately the
risks the insured presents.
If the cancellation or nonrenewal is by the company, the
information must be provided to the insured at least 30 days in
advance of the termination date. If the nonrenewal or
cancellation is by the insured, a request in writing must be
made by the insured within 60 days of the termination date,
and the company must respond within 45 days after the
written request is received by it.
Representations
This statement is to affirm that the insurance company has
issued the policy in reliance on the information given by the
insured and that the information is accurate and complete to
the best of the insured’s knowledge. The effect of this
condition is questionable as it would usually require a material
misrepresentation by the insured to void coverage.
6. Representations
By accepting this policy, you agree:
a. The statements in the Declarations are accurate and
complete;
b. Those statements are based upon representations you made
to us; and
c. We have issued this policy in reliance upon your
representations.
10. Your Right to Claim and “Occurrence” Information.
We will provide the first Named Insured shown in the
Declarations the following information relating to this and any
preceding general liability claims-made Coverage Part we have
issued to you during the previous three years:
a. A list or other record of each “occurrence” not previously
reported to any other insurer, of which we were notified in accordance
with paragraph 2.a. of this Section. We will include, the date and brief
description of the “occurrence” if that information was in the notice we
received.
b. A summary by policy year, of payments made and amounts
reserved, stated separately, under any applicable General Aggregate
Limit and Products-Completed Operations Aggregate Limit.
Amounts reserved are based on our judgment. They are subject
to change and should not be regarded as ultimate settlement values.
You must not disclose this information to any claimant or any
claimant’s representative without our consent.
If we cancel or elect not to renew this Coverage Part, we will
provide such information no later, than 30 days before the date of
policy termination. In other circumstances, we will provide this
information only if we receive a written request from the first Named
Insured within 60 days after the end of the policy period. In this case,
we will provide this information within 45 days of receipt of the
request.
We compile claim and “occurrence” information for our own
business purposes and exercise reasonable care in doing so. In
providing this information to the first Named Insured, we make no
representations or warranties to insureds, insurers, or others to whom
this information is furnished by or on behalf of any insured.
Cancellation or non-renewal will be effective even if we inadvertently
provide inaccurate information.
Separation of Insureds
Except with respect to the limits of insurance, and rights and
duties specifically assigned to the “first named insured,” CGL
coverage applies as if each named insured were the only
named insured, and applies separately to each insured
against whom a claim is made or a suit is brought.
This means that the insurance company will defend each
insured, cover supplementary payments related to a claim
against each insured, and extend any other rights under the
coverage to each insured. However, this provision does not
increase any limits of insurance shown in the declarations.
7. Separation Of Insureds.
Except with respect to the Limits of Insurance, and any rights or
duties specifically assigned to the first Named Insured, this insurance
applies:
a. As if each Named Insured were the only Named Insured; and
b. Separately to each insured against whom claim is made or
“suit” is brought.
Subrogation
This is the subrogation clause which transfers the insured’s
rights against a third party to the insurance company. If the
insurance company pays a claim under the policy on the
insured’s behalf, there may be a third party who can be held
responsible. When a claim payment is made by the insurance
company, it “inherits” any rights the insured may have against
the responsible third party. The insured agrees to assist the
insurance company in recovering, from the third party, any
amounts paid on the insured’s behalf by the insurance
company.
Recoveries, if any, will be distributed in the reverse order from
the method in which the claim was assessed. In other words,
the deductible, if there was one, would be reimbursed after
the insurance company has recovered its settlement.
Section V - Extended Reporting Periods
Under the claims-made form, the “trigger” for coverage is
when a claim is made to the insurance company. For some
losses, a considerable gap may exist between the time when
injury or damage occurs and when the claim is first made. In
some cases, there may even be a gap between when an
injury occurs and when it is discovered or first becomes
known to the insured. This potential gap is known as a “claims
tail”, it may take a period of years for all losses arising out of a
given exposure to be realized.
Example: A slip and fall that occurs on the insured’s property
may cause a back injury that takes some time to manifest
8. Transfer Of Rights Of Recovery Against Others To Us.
If the insured has rights to recover all or part of any payment we
have made under this Coverage Part, those rights are transferred to
us. The insured must do nothing after loss to impair them. At our
request, the insured will bring “suit” or transfer those rights to us and
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itself. In this case, it is not until the back injury is reported that
a determination of coverage will be made. Extended
Reporting Periods (ERPs) allow the insured to obtain
coverage long after the policy period has ended and that’s
useful in situations like these.
If claims-made coverage is continuously renewed without
advancing the retroactive date, future claims will be covered
regardless of when the injury or damage actually occurred.
But if the continuity of claims-made coverage is disturbed by
cancellation, nonrenewal, or replacement by a policy with a
later retroactive date, a gap in coverage is created. This gap
may be filled by an ERP, which provides “tail coverage.”
Under an ERP, the insurance company agrees to provide one
or more extended reporting periods if claims-made coverage
is (1) canceled, (2) not renewed, (3) replaced by coverage
that has a later retroactive date, or (4) replaced by coverage
that is not written on a claims-made basis. Extended reporting
periods do not extend the policy period. An ERP simply
extends the period for reporting claims; the injury or damage
must still have occurred, or the offense causing injury must
still have been committed, before the end of the policy period.
An important feature of extended reporting periods is that
once in effect, an ERP may not be canceled.
Commercial General Liability Conditions (Section IV); and
c. Sixty days with respect to claims arising from “occurrences” or
offenses not previously reported to us.
The Basic Extended Reporting Period does not apply to claims
that are covered under any subsequent insurance you purchase, or
that would be covered but for exhaustion of the amount of insurance
applicable to such claims.
4. The Basic Extended Reporting Period does not reinstate or
increase the Limits of Insurance.
Supplemental Extended Reporting Periods
The basic ERP does not provide complete protection for an
insured. If an occurrence which could lead to a claim first
becomes known to the insured more than 60 days after the
end of the policy period, it could not be reported to the
insurance company within the required time period, and there
would be no coverage under the basic ERP. If an occurrence
is known to the insured and is reported to the insurance
company during the policy period or within 60 days after
expiration, but the claim is first made more than five years
after the expiration date, there would be no coverage under
the basic ERP.
A supplemental ERP of unlimited duration is available for an
additional charge. When purchased, the supplemental
extended reporting period picks up where the basic ERP
leaves off, it would cover claims arising out of an occurrence
first reported more than 60 days after expiration, and it would
cover claims-made more than five years after expiration. In
some ways, this converts the policy into an occurrence policy.
It gives the insured an unlimited time to report and the
insurance company will make the insured pay more for that
privilege.
The supplemental ERP must be requested by the insured in
writing within 60 days after expiration. The additional premium
for this coverage cannot exceed 200 percent of the last
annual premium charged for the claims-made CGL coverage.
Supplemental ERP coverage is put into effect by attaching an
endorsement to the policy, and it will be excess over any other
coverage in effect after the supplemental extended reporting
period starts.
SECTION V—EXTENDED REPORTING PERIODS
1. We will provide one or more Extended Reporting Periods, as
described below, if:
a. This Coverage Part is canceled or not renewed; or
b. We renew or replace this Coverage Part with insurance that:
(1) Has a Retroactive Date later than the date shown in the
Declarations of this Coverage or Part; or
(2) Does not apply to “bodily injury” “property damage,” “personal
injury” or “advertising injury” on a claims-made basis.
2. Extended Reporting Periods do not extend the policy period or
change the scope of coverage provided. They apply only to claims for:
a. “Bodily injury” or “property damage” that occurs before the end
of the policy period but not before the Retroactive Date, if any, shown
in the Declarations; or
b. “Personal and advertising injury” caused by an offense
committed before the end of the policy period but not before the
Retroactive Date, if any, shown in the Declarations.
Once in effect, Extended Reporting Periods may not be
canceled.
5. A Supplemental Extended Reporting Period of unlimited
duration is available, but only by an endorsement and for an extra
charge. This supplemental period starts when the Basic Extended
Reporting Period, set forth in paragraph 3. above, ends.
You must give us a written request for the endorsement within 60
days after the end of the policy period. The Supplemental Extended
Reporting Period will not go into effect unless you pay the additional
premium promptly when due.
We will determine additional premium in accordance with our
rules and rates. In doing so, we may take into account the following:
a. The exposures insured;
b. Previous types and amounts of insurance;
c. Limits of Insurance available under this Coverage Part for
future payment of damages; and
d. Other related factors.
The additional premium will not exceed 200% of the annual
premium for this Coverage Part.
This endorsement shall set forth the terms, not inconsistent with
this Section, applicable to the Supplemental Extended Reporting
Period, including a provision to the effect that the insurance afforded
for claims first received during such period is excess over any other
valid and collectible insurance available under policies in force after
the Supplemental Extended Reporting Period starts.
6. If the Supplemental Extended Reporting Period is in effect, we
will provide the separate aggregate limits of insurance described
below, but only for claims first received and recorded during the
Supplemental Extended Reporting Period.
The separate aggregate limits of insurance will be equal to the
dollar amount shown in the Declarations in effect at the end of the
policy period for such of the following limits of insurance for which a
dollar amount has been entered:
General Aggregate Limit
Products-Completed Operations Aggregate Limit
Paragraphs 2. and 3. of Limits of Insurance; (Section III) will be
amended accordingly. The Personal and Advertising Injury Limit, the
Each Occurrence Limit and the Fire Damage Limit” shown in the
Declarations will then continue to apply, as set forth in paragraphs 4.,
Basic Extended Reporting Periods
A basic ERP is provided automatically without charge in any
of the situations mentioned previously which might create a
gap in coverage. It has two parts: a period of 60 days after the
end of the policy period is provided for reporting any claims
(whether or not the “occurrence” or “offense” was previously
reported); and a period of five years after the end of the policy
period is provided for reporting any claims for which the
“occurrence” or “offense” has been reported to the insurance
company no later than 60 days after the end of the policy
period. This means that the insured has a long time to file a
formal claim as long as the insured has notified the insurance
company within 60 days that something has happened.
The basic extended reporting period does not apply to any
claims which are covered by any subsequent insurance
purchased by the insured, or which would have been covered
except for the exhaustion of policy limits.
The basic ERP is treated as an extension of the original
policy, and does not change or reinstate any limits of
insurance. If any part of the aggregate limits has been used
up, coverage is limited to the unused portion of those limits.
3. A Basic Extended Reporting Period is automatically provided
without additional charge. This period starts with the end of the policy
period and lasts for:
a. Five years for claims because of “bodily injury,” and “property
damage” arising out of an “occurrences reported to us, not later than
60 days after the end of the policy period, in accordance with
paragraph 2.a. of Commercial General Liability Conditions (Section
IV);
b. Five years because of claims for “personal and advertising
injury” arising out of an offense reported to us, not later than 60 days
after the end of the policy period, in accordance with paragraph 2.a. of
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covered worldwide if the employee’s home is in the covered
territory.
Example: While traveling on business, the insured goes to a
shopping mall and accidentally bumps someone down a flight
of stairs. Any damages resulting from the accident would be
covered.
5. and 6. of that Section.
Under the supplemental ERP, the two aggregate limits are
reinstated in full, and the sublimits (for each occurrence,
personal or advertising injury claims, and fire damage)
continue to apply as they did during the policy period.
Section VI - Policy Definitions
Definitions clarify the meaning of a word or group of words. As
you may have noticed from earlier cases, settlement of claims
may hinge on nuances in these policy definitions. In addition
to telling us specifically what something is, definitions also
frequently tell us what something is not. In this sense, a
definition serves to limit a meaning as well as to define it.
Definitions that appear in insurance policies are important
because each policy is a legal contract, and definitions are
part of the contract language. Terms that have specific
definitions appear in quotation marks throughout the CGL
coverage forms. It is important to keep this in mind when
examining insuring agreements, exclusions and conditions,
because the definitions may broaden coverage in some areas
and limit coverage in others.
The definitions that appear in the CGL coverage forms are
exactly the same on the “occurrence” and “claims-made”
forms. However, they appear as Section V of the occurrence
form and as Section VI of the claims-made form because of
the additional section for extended reporting periods.
Advertisement
The first definition deals with advertisement. Note that it
contains advertisements on the Internet.
4. “Coverage territory” means:
a. The United States of America (including its territories and
possessions), Puerto Rico and Canada;
b. International waters or airspace, provided the injury or damage
does not occur in the course of travel or transportation to or from any
place not included in a. above; or
c. All parts of the world if:
(1) The injury or damage arises out of goods or products made
or sold by you in the territory described in a. above; or
(2 The activities of a person whose home is in the territory
described in a. above, but is away for a short time on your business;
or
(3) “Personal and advertising injury” offenses that take place
through the Internet or similar electronic means of communication
provided the insured’s responsibility to pay damages is determined in
a “suit” on the merits, in the territory described in a. above or in a
settlement we agree to.
Employee
The definition of employee specifically includes a worker who
comes to the job through a leasing company. The term does
not include temporary workers for insurance coverage.
5. “Employee” includes a “leased worker”. “Employee” does not
include a “temporary worker”.
Executive Officer
Executives are specifically described as persons who are
company officers as designated in corporate by-laws or other
governing documents. This would include a corporate
president, secretary, treasurer, vice president, and the like.
SECTION VI—DEFINITIONS
1. “Advertisement” means a notice that is broadcast or published
to the general public or specific marketing segments about your
goods, products or services for the purpose of attracting customers or
supporters. For the purposes of this definition:
Notices that are published include material placed on the Internet
or on similar electronic means of communication: and
Regarding web-sties, only that part of a web-site that is about
your goods, products or services for the purposes of attracting
customers or supporters is considered an advertisement.
6. “Executive officer” means a person holding any of the officer
positions created by your charter, constitution, by-laws or any other
similar governing document.
Hostile Fire
A hostile fire has long been defined the insurance industry
and appears in the CGL policy.
Auto
This definition is important because CGL coverage forms
exclude almost all losses arising out of automobile exposures
(an exception is made for parking non-owned autos on the
insured’s premises). Notice that “auto” does not include
“mobile equipment”; these terms are mutually exclusive,
because losses arising out of the operation or use of mobile
equipment are covered.
7. “Hostile fire” means one which becomes uncontrollable or
breaks out from where it was intended to be.
Impaired Property
This definition relates to the “impaired property exclusion.” It
clarifies the meaning of “impaired property” by stating that
“impaired property” is property which is rendered useless or
less useful because of some defect or deficiency in the
insured’s product or the insured’s failure to complete a
contract. “Impaired property” must be undamaged and
capable of being restored to use, or put to its intended use by
repair or replacement of the insured’s product or by the
insured completing the contract.
2. “Auto” means a land motor vehicle, trailer or semi-trailer
designed for travel on public roads, including any attached machinery
or equipment. But “auto” does not include “mobile equipment.”
Bodily Injury
The definition of “bodily injury” includes sickness or disease
and death resulting from the bodily injury. Under the
occurrence form, if death results at a later date as a result of a
bodily injury, the policy covering the death would be the one in
effect at the time of the injury. If coverage applies under the
claims-made form, the policy in force at the time the claim is
made to the insurance company provides coverage.
8. “Impaired property” means tangible property, other than “your
product” or “your work,” that cannot be used or is less useful because:
a. It incorporates “your product” or “your work” that is known or
thought to be defective, deficient, inadequate or dangerous; or
b. You have failed to fulfill the terms of a contract or agreement;
if such property can be restored to use by:
a. The repair, replacement, adjustment or removal of “your
product” or “your work;” or
b. Your fulfilling the terms of the contract or agreement.
3. “Bodily injury” means bodily injury, sickness or disease
sustained by a person, including death resulting from any of these at
any time.
Coverage Territory
The land territories covered by the policy include the air space
and international waters between them but do not include
travel to or from other countries which are not covered
territories. Injury caused by goods or products that are sold or
made in the covered territories are covered in other parts of
the world. Personal and advertising injury through the Internet
is covered, but the suit for the injury must be brought in a
covered territory. Note that coverage only applies for products
and not for completed operations. Incidental activities of an
employee traveling on the business of an employer are
Insured Contract
This is an important definition because it defines what is and
is not an “insured contract.”
Although Coverage A has a contractual liability exclusion, it
makes an exception for liability that would have existed
anyway in the absence of an agreement, and an exception for
“insured contracts.” Since the definition includes many of the
most common types of contracts under which liability is
assumed, the CGL forms actually do provide a rather broad
degree of contractual liability coverage.
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Common types of contracts which are covered include a lease
of premises, a sidetrack agreement (manufacturers and
suppliers of goods or materials frequently take responsibility
for use of a railroad sidetrack which connects their premises
with a rail line), and an elevator maintenance agreement.
Certain easement and license agreements are covered, but
an exception is made for construction or demolition operations
within 50 feet of a railroad. This is potentially a very
hazardous exposure, because of complicated ownership
issues (the federal government owns many rail lines) and the
potential for causing a disastrous derailment.
rendering or failure to render professional services, including those
listed in (2) above and supervisory, inspection or engineering
activities.
9. “Insured contract” means:
a. A contract of lease of premises. However, that portion of the
contract for a lease of premises that indemnifies any person or
organization for damage by fire to premises while rented to you or
temporarily occupied by you with permission of the owner is not an
“insured contract”;
b. A sidetrack agreement;
c. Any easement or license agreement, except in connection with
construction or demolition operation on or within 50 feet of a railroad;
d. An obligation, as required by ordinance, to indemnify a
municipality, except in connection with work for a municipality;
e. An elevator maintenance agreement;
10. “Leased worker” means a person leased to you by a labor
leasing firm under an agreement between you and the labor leasing
firm, to perform duties related to the conduct of your business.
“Leased worker” does not include a “temporary worker”.
Leased Workers
Leased workers act as employees of the insured but are
“leased” to the employer through a labor leasing firm set up to
handle
the
workers
compensation
requirements,
administration, and providing other benefits to their
employees. A labor leasing firm allows small employers to
provide better benefits to employees through the leasing firm
than it could provide on its own.
Loading or Unloading
“Loading or unloading” is defined because it is included as
part of the use and operation of autos, watercraft or aircraft,
and this exposure is excluded under general liability coverage.
This definition is necessary to clarify where CGL coverage
ends and other coverages (especially coverage for
automobiles) begin. At one time, the wording of policy
provisions left some confusion as to whether auto liability or
general liability insurance provided coverage for loading and
unloading.
Today, consistent use of the same definitions in both types of
policies has eliminated that problem. Automobile insurance
covers the loading and unloading of vehicles; general liability
insurance does not cover loading and unloading of vehicles.
In order to determine which coverage applies to a particular
exposure, all that remains is to determine when loading and
unloading begins and ends.
Loading or unloading begins as soon as property is accepted
for movement into or onto an auto (or aircraft or watercraft),
continues while the property remains in or on the auto, and
ends when it is removed from the auto to the place where it is
finally delivered.
Example: Ajax Industries has its employees stack boxes of
parts on its loading dock for pickup by Wilson Shipping
Company. The delivery truck arrives, backs up to the loading
dock, and Wilson employees pick up the boxes and carry
them onto the truck. As soon as the Wilson employees begin
handling the boxes, Ajax’s CGL exposure ends and Wilson’s
automobile liability insurance applies to the exposure of
loading the boxes.
However, “loading or unloading” does not include movement
by a mechanical device (other than a hand truck) that is not
attached to the vehicle. If Ajax’s forklifts were used to load the
boxes on the truck, Ajax’s CGL exposure would continue until
the boxes were on the truck. But if hand trucks are used or the
boxes are raised by a mechanical lift attached to the truck,
Wilson’s auto liability exposure begins as soon as the first box
is moved. These distinctions are important in cases where an
accident occurs during the process of loading or unloading.
Contractual Liability
The broadest category of insured contracts is reflected by part
6.f.; it includes any other contract or agreement pertaining to
the insured’s business under which the tort liability of another
party is assumed. Because this is so broad, the remaining
portions of the definition limit coverage by describing
particular types of contracts or agreements that are not
insured contracts. There is no coverage for an agreement to
indemnify any party for construction or demolition operations
within 50 feet of a railroad affecting bridges, tunnels or road
beds. There is no coverage for an agreement to indemnify an
architect, engineer or surveyor for providing or failing to
provide professional services or giving or failing to give
instructions.
If the insured is an architect, engineer or surveyor, there is no
coverage for an agreement under which the insured assumes
liability for rendering or failing to render professional services.
All of these exposures are particularly hazardous and you or
other party performing the operations or services should make
separate arrangements for specialized insurance coverage.
The last paragraph states that any agreement to indemnify
another for fire damage to a premises rented to or used by the
insured is not an “insured contract.” However, as mentioned
earlier, general liability insurance does include fire legal
liability coverage (subject to the fire damage limit) if the
insured is negligent or responsible for the damage (but it will
not cover an obligation to pay fire damages assumed under
contract when negligence is not involved).
f. That part of any other contract or agreement pertaining to your
business (including an indemnification of a municipality in connection
with work performed for a municipality) under which you assume the
tort liability of another party to pay for “bodily injury” or “property
damage” to a third person or organization. Tort liability means a
liability that would be imposed by law in the absence of any contract
or agreement.
An “insured contract” does not include that part of any contract or
agreement. Paragraph f. does not include that part of any contract or
agreement:
(1). That indemnifies any person or organization for “bodily
injury” or “property damage” arising out of construction or demolition
operations, within 50 feet of any railroad property and affecting any
railroad bridge or trestle, tracks, road beds, tunnel, underpass or
crossing;
(2). That indemnifies an architect, engineer or surveyor for injury
or damage arising out of:
(a) Preparing, approving or failing to prepare or approve maps,
drawings, opinions, reports, surveys, change orders, designs or
specifications; or
(b) Giving directions or instructions, or failing to give them, if that
is the primary cause of the injury or damage;
(3) Under which the insured, if an architect, engineer or surveyor,
assumes liability for an injury or damage arising out of the insured’s
11. “Loading or unloading” means the handling of property;
a. After it is moved from the place where it is accepted for
movement into or onto an aircraft water craft or “auto”;
b. While it is in or on an aircraft, watercraft or “auto”, or
c. While it is being moved from an aircraft, water craft or “auto” to
the place where it is finally delivered;
but “loading or unloading” does not include the movement of
property by means of a mechanical device, other than a hand truck,
that is not attached to the aircraft, watercraft or “auto.”
Mobile Equipment
As mentioned earlier, the definitions of “auto” and “mobile
equipment” are mutually exclusive. “Autos” are intended to be
covered by automobile insurance, while “mobile equipment” is
covered by general liability insurance.
Parts a. through f. describes the many types of mobile
equipment which are covered. Generally, these are land
vehicles, designed for use principally off public roads, such as
bulldozers, forklifts, and construction equipment. Vehicles
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vibrations contributing to the loss took place over a period of
days or weeks.
While the two CGL coverage forms are known as the “claimsmade” and “occurrence” forms, both forms cover occurrences.
The insuring agreements of both forms say that injury or
damage must be caused by an occurrence that takes place in
the coverage territory. The greatest difference between the
two forms is that the “trigger” of coverage may determine
which policy period will apply to a particular claim.
designed to provide mobility to permanently mounted cranes,
shovels, loaders, differs, drills, graders, rollers, compressors,
pumps, generators, cherry pickers, and other types of
equipment are included in this definition. In some cases, these
vehicles may not be self-propelled. The last part of this
definition (paragraph f.) says that mobile equipment also
includes other vehicles not described, which are maintained
primarily for purposes “other than” the transportation of
persons or cargo (basically this means vehicles other than
typical cars and trucks).
Certain self-propelled vehicles with permanently attached
equipment are treated as “autos” and not mobile equipment.
Snow plows, road maintenance and street cleaning vehicles
are “autos” because they operate and perform their special
functions on public roads, and the exposure is covered by
auto insurance. Self-propelled vehicles with permanently
mounted cherry pickers, compressors, pumps, generators,
spraying, welding, and other equipment are also treated as
“autos” with respect to their automobile liability exposure while
being driven on public roads.
13. “Occurrence” means an accident, including continuous or
repeated exposure to substantially the same general harmful
conditions.
Personal Injury
The definition of “personal injury” starts out by saying that it
does not include bodily injury, so Coverage B is separated
from Coverage A. It specifically states the forms of personal
injury that are covered, and the offenses listed within the
definition of “personal injury” have specific legal meanings, so
the coverage would be interpreted from these legal meanings.
There are other kinds of offenses which could result in
personal injury, but if the injury doesn’t arise out of one of the
listed items, the intent of the policy is not to provide coverage.
12. “Mobile equipment” means any of the following types of land
vehicles, including any attached machinery or equipment:
a. Bulldozers, farm machinery, forklifts and other vehicles
designed for use principally off public roads;
b. Vehicles maintained for use solely on or next to premises the
insured owns or rents;
c. Vehicles that travel on crawler treads;
d. Vehicles, whether self-propelled or not, maintained primarily to
provide mobility to permanently mounted:
(1) Power Cranes, shovels, loaders, diggers or drills; or
(2) Road construction or resurfacing equipment such as graders,
scrapers or rollers;
e. Vehicles not described in a., b., c. or d. above that are not selfpropelled and are maintained primarily to provide mobility to
permanently attached equipment of the following types:
(1) Air compressors, pumps and generators, including spraying,
welding, building cleaning, geophysical exploration, lighting and well
servicing equipment; or
(2) Cherry pickers and similar devices used to raise or lower
workers,
f. Vehicles not described in a., b., c. or d. above maintained
primarily for purposes other than the transportation of persons or
cargo.
14. “Personal and advertising injury” means injury, other than
“bodily injury,” arising out of one or more of the following offenses:
a. False arrest, detention or imprisonment;
b. Malicious prosecution;
c. The wrongful eviction from, wrongful entry into, or invasion of
the right of private occupancy of a room, dwelling or premises that a
person occupies by or on behalf of its owner, landlord or lessor.
d. Oral or written publication of material that slanders or libels a
person or organization or disparages a person’s or organization’s
goods, products or services;
e. Oral or written publication of material that violates a person’s
right of privacy.
The use of another’s advertising idea in you “advertisement”, or
Infringing upon another’s copyright, trade dress or slogan in your
“advertisement”.
Pollutants
Pollutants are specifically defined here as solids, liquids, or
gasses.
15. “Pollutants” mean any solid, liquid, gaseous or thermal irritant
or contaminant, including smoke, vapor, soot, fumes, acids, alkalis,
chemicals and waste. Waste includes materials to be recycled,
reconditioned or reclaimed.
Liability arising out of the actual use of this specialized
equipment is covered by general liability insurance and is not
covered by automobile insurance. The CGL exclusion for the
use of autos does not apply to liability arising out of the use of
the mobile equipment defined in paragraphs f.(2) and f.(3), so
this is covered.
The business auto form covers the automobile liability
exposure of this equipment, but specifically excludes liability
arising out of the actual operation of the equipment. The point
to remember: If the mobile equipment is being driven on a
public road, it is covered under business auto insurance.
Products and Completed Operations
Products and completed operations are defined here, and
although they are related for coverage purposes, they need to
be treated separately. A product is sold by a manufacturer,
wholesaler or retailer, or some other entity in the
merchandising chain. Coverage for products liability does not
begin until the insured has physically relinquished possession
of the item to another, and once this occurs, there is coverage
for products liability. This coverage can travel back through
the distribution chain all the way to the manufacturer so that a
customer may make a claim against everybody involved in
distribution of the product.
For example, a customer in a furniture store sits on a chair to
see if it is comfortable, and the chair collapses injuring the
customer. The customer’s claims for injuries would fall under
the store’s premises liability and not products liability, since
the chair had not been sold and possession of it relinquished
to the customer. If a suit involved both the store and the
manufacturer, coverage for the manufacturer would fall under
its products liability since possession of the chair had been
relinquished to the store.
Completed operations coverage involves work being done or
a service being performed, such as a repair or maintenance.
While the work is being performed, coverage is provided by
the premises/operations part of the liability policy. When the
work is completed, coverage applies under completed
operations. It is necessary to define when work is completed
in order to determine which coverage will respond to a claim,
However, self-propelled vehicles with the following types of
permanently attached equipment are not “mobile equipment” but will
be considered “autos”
(1) Equipment designed primarily for:
(a) Snow removal;
(b) Road maintenance, but not construction or resurfacing;
(c) Street cleaning;
(2) Cherry pickers and similar devices mounted on automobile or
truck chassis and used to raise or lower workers; and
(3) Air compressors, pumps and generators, including spraying,
welding, building cleaning, geophysical exploration, lighting and well
servicing equipment.
Occurrence
An accident is an occurrence, but “occurrence” also means
continuous or repeated exposure to the same harmful
conditions. Example: Repeated vibrations from operation of
the insured’s bulldozer cause cracks in the walls of a nearby
building, eventually leading to collapse of part of the building.
This property damage qualifies as an occurrence, and all such
damage would result from one occurrence even if the
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and this definition sets forth the criteria for determining when
work is completed.
The definition also includes circumstances which would not be
included as part of the products/completed operations hazard.
18. “Suit” means a civil proceeding in which damage because of
“bodily injury,” “property damage,” “personal injury” or “advertising
injury” to which this insurance applies are alleged. “Suit” includes:
a. An arbitration proceeding in which such damages are claimed
and to which you must submit or do submit with our consent; or
b. Any other alternative dispute resolution proceeding in which
such damages are claimed and to which you submit with our consent.
16. “Products-completed operations hazard”
a. includes all “bodily injury” and “property damage” occurring
away from premises you own or rent and arising out of “your product”
or “your work” except:
(1) Products that are still in your physical possession; or
(2) Work that has not yet been completed or abandoned.
However, “Your work” will be deemed completed at the earliest of the
following times.
(a) When all of the work called for in your contract has been
completed.
(b) When all of the work to be done at the site has been
completed if your contract calls for work at more than one site.
(c) When that part of the work done at a job site had been put to
its intended use by any person or organization other than another
contractor or subcontractor working on the same project.
Work that may need service, maintenance correction, repair or
replacement, but which is otherwise complete, will be treated as
completed.
b. This hazard does not include “bodily injury” or “property
damage” arising out of:
(1) The transportation of property, unless the injury or damage
arises out of a condition in or on a vehicle not owned or operated by
you, and that condition was created by the “loading or unloading” of
that vehicle by any insured;
(2) The existence of tools, uninstalled equipment or abandoned
or unused materials;
(3) Products or operations for which the classification listed in the
Declarations or in a Policy Schedule, states that products-completed
operations are subject to the General Aggregate Limit.
Temporary Worker/Volunteer Worker
A temporary worker is defined as one who is substituting in for
a worker who is on leave or meeting short-term employment
needs. A volunteer worker is someone working, but not being
paid. This is, of course, most common in non-profit
organizations.
19. “Temporary worker” means a person who is furnished to you
to substitute for a permanent “employee” on leave or to meet
seasonal or short-term workload conditions.
20. “Volunteer worker” means a person who is not your
“employee”, and who donates his or her work and acts at the direction
of and within the scope of duties determined by you, and is not paid a
fee, salary or other compensation by you or anyone else for their work
performed for you.
Your Product
Products are goods manufactured, sold, handled, or
distributed by the insured or others trading under the insured’s
name; or the products of any newly acquired organization.
Real property is excluded from the definition; therefore,
“products” refers to personal property only. The exclusion of
real property also makes it definite that completed buildings or
other structures considered part of realty are to be covered as
“your work” and not “your product.” Included as part of the
product are the containers associated with the product, as
well as any warranties or representations with respect to it.
Failure to provide warnings or instructions has been added to
the definition of products, because in the past some courts
have held that the omission of warnings or instructions was
covered under premises/operations.
Vending machines are not covered as products, even though
the insured has relinquished possession of them, because
their ownership is retained by the insured and should be
covered as premises/operations exposures. Leasing of
machines such as copiers, computer equipment, telephone
systems, and even heavy industrial equipment is common
today, and these items should be covered under
premises/operations as existence hazards.
Property Damage
The definition of property damage makes it clear that
coverage is for damage to tangible property and includes loss
of use of the damaged property. Furthermore, it also covers
loss of use of tangible property that is not damaged. It is
specifically stated here that electronic data is considered
tangible property.
For example, a painting contractor is painting a gift shop in a
multiple occupancy mini-mall and due to careless handling of
materials, he causes an explosion and fire which not only
damages the gift shop, but damages the plumbing and
electrical systems for the entire building. The property
damage and loss of use (i.e., loss of business) to the gift shop
would be covered. The remaining businesses in the mini-mall
were not damaged but were not able to operate until the
plumbing and electrical systems were repaired. Their loss of
business would also be covered as property damage. All loss
of use is deemed to have occurred at the time of the original
property damage.
21. “Your product”
a. Means:
(1) Any goods or products, other than real property,
manufactured, sold, handled, distributed or disposed of by:
(a) You;
(b) Others trading under your name; or
(c) A person or organization whose business or assets you have
acquired; and
(2) Containers (other than vehicles), materials, parts or
equipment furnished in connection with such goods or products.
b. Includes:
(1) Warranties or representations made at any time with respect
to the fitness, quality, durability, performance or use of “your product”;
and
(2)The providing of or failure to provide warnings or instructions.
c. Does not include vending machines or other property rented
to or located for, the use of others but not sold.
17. “Property damage” means:
a. Physical Injury to tangible property, including all resulting loss
of use of that property. All such loss of use shall be deemed to occur
at the time of the physical injury that caused it; or
Loss of use of tangible property that is not physically injured. All
such loss of use shall be deemed to occur at the time of the
“occurrence” that caused it. For the purposes of this insurance,
electronic data is not tangible property.
As used in this definition, electronic data means information,
facts or programs stored as or on, created or used on, or transmitted
to or from, computer software, including systems and applications
software, hard or floppy disks, CD-ROMS, tapes, drives, cells, data
processing devices or other media which are used with electronically
controlled equipment.
Your Work
The definition of “your work” clarifies the differences between
products liability and completed operations liability. “Your
work” refers to completed operations. Included in the definition
are materials, parts, or equipment used for the work, as well
as warranties, representations, and providing or failing to
provide warnings or instructions.
Suit
The word “suit” was not defined in early general liability forms,
and then was initially defined to include any arbitration
proceeding. This newer definition adds “Any other alternative
dispute resolution proceeding . . . “as long as the insurance
company agrees to it. This addition to the definition would
include newer forms of dispute resolution, such as “rent-a
judge” agreements or proceedings which may be less formal
than court trials or arbitration.
22. “Your work”
a. Means:
1. Work or operations performed by you or on, your behalf; and
2. Materials, parts or equipment furnished in connection with
such work or operations.
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company to “lock in” the current insurance limits for known
exposures and occurrences. Higher policy limits in the future
would only apply to future exposures or unknown
occurrences.
When written, the laser beam endorsement allows the
insurance company to schedule the accident(s), product(s),
work or location(s) to be excluded. There are two key
provisions of the endorsement. The first part simply states that
“Section I Coverage A” does not apply to any of the exposures
described in the schedule. The second part says that if the
policy is a renewal of claims-made coverage issued by the
same insurance company, and if the previous claims-made
coverage applied to bodily injury (BI) or property damage
(PD) arising out of the described exposure, the insurance
company will provide an extended reporting period for the
excluded exposure. Endorsements are used to provide the
basic and, if desired, a supplemental extended reporting
period, which will apply only to the exposure being excluded
on renewal.
Deductible Liability Insurance Endorsement
This endorsement may be used to establish separate
deductible amounts for bodily injury liability and property
damage liability, or to establish a single deductible amount for
bodily injury and property damage combined. When attached
to a policy, the insurance company’s obligation to pay on
behalf of the insured applies only to the amount of damages in
excess of the deductibles shown in the schedule, and the
limits of insurance applicable to the coverages will be reduced
by the amount of the deductibles.
In either case, the deductibles may be scheduled on a “per
claim” or a “per occurrence” basis. If the deductibles apply per
claim, the deductibles shown apply to all damages sustained
by any one person or organization as the result of any one
occurrence. If the deductibles apply per occurrence, the
deductibles shown apply to all damages sustained as the
result of any one occurrence regardless of the number of
persons or organizations who sustain damages.
Additional Insureds or Vendors Endorsements
Various endorsements may be used to attach coverage for
other entities or interests who may be held liable for acting on
behalf or, in the name of, or for having some business
relationship with the named insured.
Example: Coverage may be added for club members for their
liability for activities of the named insured, or their activities
performed on behalf of the club.
Endorsements may be used to add as additional insureds
concessionaires who are trading under the insured’s name,
for the managers or lessors of premises which are leased to
the insured, and for vendors with respect to injury or damages
which arise out of the insured’s products which are shown in
the schedule and are sold or distributed by such vendors.
Numerous other endorsements may be used to add coverage
for individual condominium unit owners of an insured
condominium, any party who owns or controls premises
leased or occupied by the insured, volunteer workers who act
at the insured’s direction, co-owners of leased premises,
lessors of leased equipment which the insured leases or uses,
or specifically designated persons or organizations with
respect to their liability which may arise out of the insured’s
premises or operations.
A variety of endorsements exist to cover situations under
which additional interests might have a liability exposure
arising out of or some how related to the activities of the
named insured.
Exclusionary and Special Risk Endorsements
Endorsements may be used to remove all coverage for the
products-completed operations subline, or all personal and
advertising injury coverage, or all medical payments
coverage. But lesser endorsements exist to eliminate just
portions of the coverages. For example, an endorsement may
be used to retain products liability coverage while eliminating
coverage for designated products, and another may be used
to retain completed operations coverage while eliminating
b. Includes:
1. Warranties or representations made at any time with respect
to the fitness, quality, durability, performance or use of “your work”;
and
2. The providing of or failure to provide warnings or instructions.
Endorsements
As mentioned at the beginning of this chapter, CGL forms are
very flexible in the sense that endorsements may be used to
remove a number of major coverages (such as products and
completed operations, personal injury and advertising injury,
medical payments and fire legal liability), and endorsements
and other coverage forms may be used to add some
important coverages (such as liquor liability and pollution
liability). Yet a significant number of additional endorsements
are available to tailor the coverage in more subtle ways; by
imposing deductibles, adding coverage for additional
interests, excluding specific exposures, and amending
coverages and limits of insurance. Adding endorsements will
result in higher premiums, while adding exclusions will result
in lower premiums.
Endorsements may be added to general liability coverage for
a variety of reasons. Amendatory endorsements are required
whenever provisions of printed policies have been changed by
more recent filings, and whenever policy provisions are
inconsistent with state laws or regulations. An insured may
voluntarily request endorsements that add or reduce coverage
in order to meet the actual insurance needs of the business.
In some cases, insurance underwriters require certain
endorsements as a condition of accepting the risk.
Nuclear Energy Liability Exclusion Endorsement
This endorsement must be part of every general liability
coverage. It excludes coverage for bodily injury, property
damage, and medical payments resulting from the hazardous
properties of nuclear material related to the operations of any
nuclear facility. Anyone who owns, operates, supplies, or
services a nuclear facility, or who handles, transports, or
disposes of nuclear waste material may apply for special
coverages written by nuclear risk insurance companies.
Nuclear energy liability policies are written by the Nuclear
Energy Liability Insurance Association, the Mutual Atomic
Energy Liability Underwriters, and the Nuclear Insurance
Association of Canada. The broad form exclusion attached to
every CGL form states that there is no coverage for any
insured who is also an insured under a policy issued by one of
the nuclear risk insurance companies. It also excludes nuclear
liability coverage with respect to any person who is required to
maintain financial protection under the Atomic Energy Act of
1954, or who is entitled to indemnity from the United States of
America or any of its agencies under an agreement involving
nuclear materials.
Laser Beam Exclusion Endorsement
An endorsement to the claims-made form permits the
insurance company to exclude coverage for specific
accidents, products, work or locations. Because the
endorsement allows the insurance company to zero in with a
sharp focus to eliminate a specific exposure, it has been
nicknamed the “laser beam” endorsement.
The laser beam has a number of purposes. It may be used to
remove an exposure so extreme that the insurance company
would not otherwise be willing to write the risk. When
replacing “occurrence” coverage with “claims-made”
coverage, an insurance company may wish to use the laser
beam exclusion of a previous accident instead of a retroactive
date; it would dump all claims from that accident back on the
occurrence policy, and not affect claims-made coverage for
other occurrences.
The most common use of the exclusion is likely to be at
renewal of claims-made coverage after the insured has had a
serious accident or known occurrence. If insurance limits are
inadequate for expected claims (which may come in future
years), the insured might request higher limits at renewal, in
effect, attempting to buy more protection after the loss has
occurred. The laser beam endorsement allows the insurance
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Limited Pollution Liability Extension Endorsement
This endorsement differs from the Pollution Liability Extension
Endorsement in that it creates a separate aggregate limit of
liability with respect to all pollution liability coverage. It also
excludes any liability arising out of discharges from
underground storage tanks.
Total Pollution Exclusion Endorsement
This endorsement eliminates any and all coverage from the
basic policy for pollution.
Pollution Liability Coverage Form
The pollution liability coverage form provides insurance on a
claims-made basis only. It may be attached as part of a
commercial package policy that also includes a CGL coverage
part. The pollution coverage form duplicates many of the
provisions found on the CGL form, but it has its own limits
(independent from CGL limits) and a different insuring
agreement as well as a number of exclusions and definitions
that are unique to the pollution exposure.
The form includes two insuring agreements. The first
agreement sets forth that the insurance applies only to bodily
injury or property damage caused by a “pollution incident” that
commences after the retroactive date. The incident must arise
from an “insured site” or “waste facility” in the “coverage
territory.” The insurance applies only if a claim is first made
against the insured during the policy period. The second
agreement establishes coverage for mandated “off site cleanup costs” resulting from a “pollution incident” that has actually
caused “environmental damage.” Clean-up costs are covered
only when the insured’s obligation for such costs is imposed
under the statutory authority of any governmental entity or
agency of the United States of America or Canada. Therefore,
expenses incurred as a result of a voluntary decision on the
part of the policyholder to clean up would not be covered.
Among the exclusions specifically applicable to the pollution
exposure are those removing coverage for emissions from a
closed or abandoned site, and excluding all injury or damage
arising out of acid rain. Another exclusion eliminates coverage
for the escape of drilling fluids, oil, gas, and other fluids from
any oil, gas, mineral, water or geothermal well.
The pollution liability form provides for a one-year extended
reporting period if the insurance company cancels or nonrenews the coverage, renews it with a later retroactive date, or
replaces it with coverage other than claims-made coverage.
This ERP is not automatically provided; the insured must
make a written request for it within 30 days after the policy
period and pay an additional premium. Longer tail coverage
and full tails are generally not available for pollution coverage.
This is because every storage facility will eventually leak,
even if this takes centuries. The insurance company doesn’t
want to be responsible for these costs in the far future.
An endorsement may be attached to the pollution liability form
to provide for reimbursement of voluntary clean-up costs.
When attached, the endorsement adds a third insuring
agreement providing coverage for clean-up costs which are
“necessary and reasonable” to curtail or prevent a pollution
incident that poses a substantial danger of causing injury or
damage. Voluntary clean-up coverage applies only if the
insured receives prior written consent from the insurance
company granting permission to make the clean-up.
Limited Pollution Liability Coverage Form
The limited pollution coverage form is also written only on a
claims-made basis. It is identical to the pollution form just
discussed except that it does not cover clean-up and related
costs. It has only one insuring agreement, which provides
coverage for bodily injury and property damage arising from
pollution incidents. It specifically excludes clean-up costs and
obligations imposed by government authority. All other
conditions, provisions and exclusions are the same as the
more complete pollution coverage form.
Liquor Liability Coverage
CGL forms provide “host liquor liability” coverage, which
applies only to the incidental exposures of those who are not
engaged in the business of manufacturing, distributing,
coverage for designated work. For specified operations,
another endorsement may be used to exclude coverage for
the explosion, collapse and underground property damage
hazard (this is often referred to as XCU in the insurance
business). Endorsements may also be used to eliminate all
coverage in connection with designated premises, or to
exclude bodily injury coverage for any participants in athletic
or sports events which the insured sponsors.
Amendments to Coverages or Limits Endorsements
Some coverages may be expanded by using endorsements to
delete or modify certain policy exclusions. As noted earlier,
limited pollution coverage may be provided by attaching an
endorsement that removes part of the pollution exclusion.
Another endorsement may be attached which expands liquor
liability coverage by completely removing the standard liquor
liability exclusion (it simply states that Exclusion c. of
Coverage A, Section I does not apply). Such an endorsement
would be purchased by a bar or liquor store.
An endorsement may be used to amend the contractual
liability exclusion for personal injury. Various other
endorsements may be used to modify coverages and
exclusions.
A number of amendment of limits endorsements are used to
change the coverage amount for the remainder of the policy
period or for specific projects, premises or locations. The
standard amendment of limits endorsement may be used to
revise the policy limits; it contains a schedule which simply
replaces the limits shown in the declarations. A variation of
the endorsement may be used to amend limits for a
designated project or premises only. Separate endorsements
are also available to amend aggregate limits so that the
policy’s general aggregate will apply on a “per project” or “per
location” basis, rather than to the insured’s entire operations.
Other Coverage Forms
Separate forms are also available for exposures which are not
covered by CGL forms. A CGL form excludes nearly all
pollution coverage, and does not include liquor liability
coverage for insureds that manufacture, sell, distribute, serve
or furnish alcoholic beverages. Both exclusions may be
endorsed to narrow or broaden coverage, or separate
pollution and liquor liability coverage forms may be issued.
Pollution Liability Coverage
Commercial general liability forms exclude virtually all
pollution originating from the insured’s premises or operations,
and from the handling, treatment or disposal of waste
materials. Clean-up costs are also excluded. The only
pollution exposure covered by CGL forms falls within
products-completed operations; liability for emissions is
covered only away from the insured’s premises and work
sites, and only when resulting from use by others of the
insured’s finished work or products.
Not all insurance companies are willing to write pollution
coverage. In the tight pollution insurance marketplace, the
premiums are likely to be high and the risk will be carefully
underwritten, because of the special nature of the exposure.
To the extent that pollution risks are written, an insured has
the following options for purchasing coverage under the
commercial lines program:

pollution liability extension endorsement,

limited pollution liability extension endorsement,

total pollution exclusion endorsement,

pollution liability coverage form, and

limited pollution liability coverage form.
Pollution Liability Extension Coverage Endorsement
This endorsement may be attached to either the “occurrence”
or “claims-made” version of the CGL coverage part. It deletes
the first part of the pollution exclusion, which refers to bodily
injury or property damage resulting from pollution. As a result,
the endorsement creates liability insurance for third party
injury or damage caused by pollutants. But the endorsement
leaves the second part of the pollution exclusion intact; cleanup costs are still excluded when this endorsement is attached.
105
coverage would only be available going forward for an
additional premium. Policyholders could accept the new
coverage and pay the new premium, or coverage would again
be excluded.
The Insurance Service Office (ISO) filed what are called “Fast
Track” Endorsements for many commercial lines policy forms
to change terrorism coverage. “Fast track” gives them an
emergency status, and they are automatically approved by
State Insurance Departments for immediate use upon filing.

Under these endorsements, insureds can choose:

Coverage for “certified” acts of terrorism

Coverage for all acts of terrorism

An exclusion of “certified” acts of terrorism
The ISO endorsements which are intended to provide
coverage for “certified” acts of terrorism generally have four
different sections which differ slightly depending on the
wording of the underlying policy. The four sections:

Define a “certified act of terrorism”

Exclude “other acts of terrorism” (chemical or
biological terrorist acts)

Caps the losses on “certified acts of terrorism”

Maintains that the remainder of the exclusions in the
policy still apply (such as the nuclear and war
exclusions)
“Certified” acts of terrorism are those acts that meet the
Terrorism Risk Insurance Act definition. Here is some of the
actual endorsement wording which defines what acts are
covered.
selling, serving or furnishing alcoholic beverages. The CGL
liquor liability exclusion applies to insureds who are engaged
in such businesses, but liquor liability coverage may be
purchased for these exposures. A liquor liability coverage part
may be attached to a commercial package policy that also
includes a CGL coverage part. Two variations of the liquor
liability coverage are available; there is an occurrence form
and a claims-made form. Except for the sections that
specifically focus on the liquor liability exposure, the two forms
are very similar to their CGL counterparts.
The insuring agreement of both versions of the liquor liability
coverage form state that the insurance applies to damages for
“injury” if the liability “is imposed on the insured by reason of
selling, serving or furnishing any alcoholic beverage.” Injury is
later defined as including bodily injury, property damage, and
damages for care, loss of services, or loss of support. The
injury must occur in the coverage territory, and the insurance
company has a duty to defend suits.
The only difference between the insuring agreements is that
the “occurrence form” applies to injury that occurs during the
policy period, and the “claims-made” form applies to claims
first made against the insured during the policy period
provided that the injury does not occur before the retroactive
date or after the policy period.
Both versions of coverage have the same exclusions. Some
of the exclusions, such as expected or intentional injury,
obligations falling under workers compensation, and bodily
injury to employees, are also found on the CGL forms. The
liquor liability forms have some unique exclusions, but have
fewer exclusions than the CGL because the coverage has a
more narrow focus.
The insurance does not apply to injury arising out of selling,
serving or furnishing any alcoholic beverage while any
required license is suspended, nor does it apply after any
such license is expired, cancelled or revoked.
An exclusion applies to injury arising out of the insured’s
product, but the exclusion does not apply to liability resulting
from causing or contributing to a person’s intoxication, or
furnishing alcohol to someone under the legal age or already
under the influence of alcohol, or under laws regulating the
distribution or use of alcoholic beverages. This exclusion
clarifies that the coverage is not products liability insurance.
Injury resulting from a bad batch of an alcoholic beverage that
poisoned someone is excluded, but injuries resulting from the
use, distribution and known intoxicating effects of the product
are not excluded.
Issues in General Liability Insurance Today
Terrorism
Terrorism exposures have affected general liability coverage
just as they have affected most other lines of insurance.
The events of September 11, 2001 have a dramatic effect on
the insurance industry. The estimate is that $40 billion will be
the ultimate cost. The Terrorism Risk Insurance Act of 2002,
which went into effect late in that year created a 3 year
Terrorism Insurance Program. The Program guarantees the
availability of terrorism insurance for commercial accounts,
but allows insurers to set premiums. The federal government
covers up to 90% of the certified losses (up to a total
maximum of $100 billion per year). Certified losses are those
caused by acts resulting in more than $5 million in property
and casualty losses and which are caused by a large-scale
foreign-sponsored act of terrorism. Certification is done by the
Secretary of the Treasury.
Participation is mandatory for all commercial lines property
and casualty insurers, and mandates that insurers must offer
terrorism coverage on the same terms or about the same
terms as coverage provided for other types of perils, such as
similar deductibles and limits. The Program is intended to end
at the end of 2004, although it can be extended by the
government for an additional year.
The way this worked was to immediately void all the terrorism
exclusions in commercial policies for 90 days, during which
time insurers were required to notify policyholders that
The following definition is added with respect to the provisions of
this endorsement:
“Certified act of terrorism” means an act that is certified by the
Secretary of the Treasury, in concurrence with the Secretary of State
and the Attorney General of the United States, to be an act of
terrorism pursuant to the federal Terrorism Risk Insurance Act of
2002. The criteria contained in that Act for a “certified act of terrorism”
include the following:
The act resulted in aggregate losses in excess of $5 million; and
The act is a violent act or an act that is dangerous to human life,
property or infrastructure and is committed by an individual or
individuals acting on behalf of any foreign person or foreign interest,
as part of an effort to coerce the civilian population of the United
States or to influence the policy or affect the conduct of the United
States Government by coercion.
The endorsement also makes clear that coverage does not
apply to terrorist attacks that are chemical or biological.
We will not pay for loss or damage caused directly or indirectly
by an “other act of terrorism”. Such loss or damage is excluded
regardless of any other cause or event that contributes concurrently
or in any sequence to the loss. But this exclusion applies only when
one or more of the following are attributed to such act:
The terrorism is carried out by means of the dispersal or
application of pathogenic or poisonous biological or chemical
materials; or
Pathogenic or poisonous biological or chemical materials are
released, and it appears that one purpose of the terrorism was to
release such materials.
The next portion of the endorsement looks at the insurer’s
limit of liability. These endorsements also include wording to
limit or cap the benefits that will be paid under the new
coverage. Here is the actual wording.
With respect to any one or more “certified acts of terrorism”, we
will not pay any amounts for which we are not responsible under the
terms of the federal Terrorism Risk Insurance Act of 2002 (including
subsequent acts of Congress pursuant to the Act) due to the
application of any clause which results in a cap on our liability for
payments for terrorism losses.
Insurers were required to notify prospective insureds and
insureds that were mid-term in their policies by April 2003 that
they had the right to buy coverage for terrorist acts. Now,
insureds can only buy terrorism coverage at policy inception
or renewal. This is to protect the insurer against the problem
of adverse selection - thousands of policyholders suddenly
buying coverage because there is an imminent threat in their
106
area.
While insureds are offered coverage at inception and renewal,
many will decline coverage for terrorist acts. This primarily
occurs when insureds decide they do not want to pay the
required premium or don’t think they need the coverage.
Each policyholder must sign and return the disclosure notice
offering coverage whether they are accepting or declining
terrorist coverage.
Costs of Coverage
Costs of general liability coverage are on the increase, and
expected to stay high for the next few years. As always, one
of the biggest cost drivers for commercial general liability is
the size of liability verdicts in the courts. According to Jury
Verdict Research, of all the products liability verdicts in 2000
and 2001, 68% were for a million dollars or more. Of all the
business negligence verdicts during this same time, 44% were
for a million dollars or more.
The poorer the loss experience a risk has, the less likely it will
be able to find coverage, or that at least that coverage will be
very expensive.
Another general cost concern today is the vulnerability to
terrorist attacks and what liability that may bring to companies
who may be found liable for inadequate security.
CHAPTER
3
WORKERS COMPENSATION
Every state in the union requires that employers pay for onthe-job injuries. Under workers compensation law, employers
are strictly responsible for the costs of any employee injuries
that arise out of any employment related injury regardless of
fault.
Workers compensation covers the vast majority of workers.
Each year it pays out about $40 billion in benefits. In this
course we will review how the system began, the policy form,
and some of the issues confronting workers and employers
today.
History of Workers Compensation
Workers compensation insurance is relatively new. Its concept
originated during the industrial revolution in Europe, and
Wisconsin passed the first successful U.S. workers
compensation law in 1911.
Since the mid-1800s, there has been a gradual and
progressive transformation of the legal relationship between
employers and employees. At the beginning of the period, the
only recourse available to workers who were injured on the
job was to seek damages under a system of common law
(case law) liability. That system favored employers and made
it very difficult for an injured worker to obtain an award.
Courts eventually recognized that an employer did have
certain obligations to employees. To satisfy these obligations,
the employer was expected to provide:

a safe place to work,

safe equipment and tools,

reasonably competent fellow servants,

enforcement of safety rules, and

reasonable warnings about job dangers.
If an employer violated any of these obligations, there might
be a basis for establishing negligence. But the burden of proof
still fell fully on the injured employee. More significantly, an
employer, even if negligent, could invoke certain legal
defenses.
Before workers compensation, court decisions had created
three basic defenses which could relieve an employer of legal
liability:

fellow servant rule,

contributory negligence, and

assumption of risk.
The fellow servant rule held that if an injury was caused by the
negligence of a fellow employee, it was not the result of
negligence of the employer, who was therefore relieved of
responsibility. Under the principle of contributory negligence,
an injured employee who was even partially responsible for
the injury lost all right to collect damages. The assumption of
risk defense was based on the idea that an employee knew in
advance the risks of a particular job, and was presumed to be
paid for assuming those risks. These interpretations of the law
were extremely harsh from the employee’s point of view. In
some cases, negligence of an employer might create the
defense by hiring incompetent fellow workers; more injuries
might be blamed on fellow servants. In other cases, the nature
of a job would virtually preclude liability, the more hazardous
the job, the more likely it was that assumption of risk would be
raised as a defense.
As the industrial revolution created more hazardous jobs, and
drew more and more people off the land and into factories,
industrial accidents occurred more frequently. Toward the end
of the nineteenth century, the courts grew more sympathetic
toward employees. States began enacting employer’s liability
laws, which modified the common law defenses. Gradually,
107
Because employers were now liable for employee injuries,
they had to find a way to pay for them. It didn’t take long to
discover that only the largest employers could pay for injuries
and still be profitable enough to stay in business. Instead of
setting up a private fund, employers started buying insurance
to protect them.
In this course we will discuss the standard workers
compensation form used in almost every state.
Coverage Provided
Workers compensation is intended to provide financial relief
for injury, illness, and death that result from workers
performing their jobs or being on the job. It is not a substitute
for regular medical insurance, life insurance, or disability
insurance.
As you will see in the next topic, workers compensation
insurance policies are intended to cover whatever benefits are
required by state law. So contrary to many types of insurance,
state law dictates coverage with some exceptions. Here we
will discuss the common types of benefits required and
allowed by state law, and in the next section we will get more
specific with amounts by state.
Each state’s rules are different regarding workers
compensation, and so are the benefits that are required to be
paid for types of injuries. This raises the question, under what
states’ rule does an employee fall if hired by an employer in
one state, but actually working in another?
Some states allow the injured worker to apply for benefits in
both states and decide which benefits are better. Other states
have rules that say if an employer was located in one state
that state governs the benefits.
Workers compensation coverage is mandatory for most
employers to carry for their employees. Workers
compensation coverage must start the moment an employee
begins to work on the job.
If an employer does not carry workers compensation
insurance or is not properly self-insured, that employer faces
heavy fines for being illegally uninsured. In addition, of course,
the employer would be liable for any injuries sustained by
employees on the job.
Employees Exempt from Workers Compensation
The early workers compensation laws applied only to very
hazardous occupations. Over the years the scope of the laws
has expanded to embrace more and more occupational
groups. Every state has some exempt classifications, but it is
estimated that about 90 percent of the nation’s employees
now fall under workers compensation laws.
There are certain groups or types of employees for whom an
employer may not be required to carry workers compensation
insurance, and this varies by state. Some of the more
common exceptions are:

Licensed real estate brokers and agents with written
agreements
defining
them
as
independent
contractors

Farm and ranch labor

Independent contractors

Federal employees, maritime, longshore, railroad
and harbor workers (who are covered under federal
programs)

Children of an employer who are under the age of 22

Newspaper delivery personnel
with
written
agreements between the individual and the publisher
of the newspaper or shopping news that states the
individual is an independent contractor.
Coverage for some groups of employees is either compulsory
or elective depending on the state law. For certain types of
employment categories, states differ on whether they must be
covered by workers compensation programs (compulsory) or
an employer can choose to buy coverage or not. These
categories include:

domestic service workers

employers with a very small group of employees
the class of “fellow servants” was narrowed, to exclude
managers and supervisors, the negligence of a “boss” would
no longer release the employer. Contributory negligence was
replaced by comparative negligence, which would allow a
partially responsible injured party to claim partial damages. To
the extent that common law defenses are raised today, they
have been altered by modifications at the turn of the century.
Two other developments were significant at that time.
Survivors of a deceased worker were given the right to
continue a claim for damages, and many states began to
declare the signed release agreements illegal. The legal
environment for employees had improved somewhat, but
injured workers still had to prove negligence before they could
collect any damages for job related injuries.
After 1900, a growing number of industrial deaths and injuries
helped to fuel public policy changes. Workers compensation
systems were spreading in Europe and the concept gained
popularity in the U.S. New theories were being constructed to
justify providing financial relief to injured workers and their
families. Since industrial injuries were inevitable and
negligence did not always exist, advocates argued that victims
should be compensated even if employers were not directly
responsible. This reflected an effort to break away from the
common law system of legal liability. The effort would
establish a form of absolute liability; the obligation to
compensate injured workers without regard to fault or
negligence.
The Current Workers Compensation System
The arrival of workers compensation laws drastically altered
the legal relationship between employer and employee. In the
past, each tried to prove the negligence of the other in order
to secure or avoid payment. Under the new laws, employers
accepted liability for work-related injury or death regardless of
fault. In most situations, employees no longer have to prove
negligence and have given up their right to file suit, but they
are now entitled to benefits. Some classes of employees are
exempt from the laws, and suits may still be filed for damages
that are not covered by the compensation law. In those cases
that do fall outside the law, the three common law defenses
are still available to the employers.
Today, under a statutory (written law) system, workers receive
compensation for job-related injuries without having to
challenge an employer, regardless of whether or not the
employer was at fault. Statutory workers compensation
benefits are the exclusive remedy for many types of workrelated injuries, but they guarantee that benefits will be paid. It
took a major shift in social priorities and public policies to
bring about the change.
Benefits of the Workers Compensation System
Workers compensation is a "no-fault" system intended to
benefit both the injured employee and the employer. Workers
compensation laws or statutes were then written to benefit
both employees and employers:
Some of the benefits to employees are:

Prompt payment of adequate benefits according to a
predetermined schedule.

Elimination of the delays and costs of litigation

Motivation for an emphasis on safety and reduction
of accidents

Improved relationship between employee and
employer.

Improvements in employee morale
Some of the benefits to employers are:

Payments made according to a predetermined
schedule ensure some predictability in the amounts
to be paid out.

Elimination of the costs of litigation and investigation.

Greater
productivity
and
lower
workers
compensation costs

Improved relationship between employee and
employer.
108
(under 5 employees)
owners, partners, corporate officers, directors, of a
business corporation
In some states, the hours worked or wages earned determine
whether or not an employee is exempt. Employers are not
required to provide insurance or compensation benefits for
exempt employees, but it is often recommended that they do.
The fact that a worker is outside the law does not preclude
legal claims against the employer. Benefits may always be
voluntarily provided by purchasing workers compensation
insurance to cover exempt employees.
Principals who use contractors, and contractors who sublet
work to subcontractors, should secure certificates of workers
compensation insurance from the parties they work with.
Principals may be held liable for the employees of contractors
who fail to meet obligations under the law, and contractors
can be held liable if their subcontractors fail to meet their
obligations. In the absence of proper coverage at the lower
levels, the responsible party might have to provide benefits. If
an insurance company provides additional benefits, it may
add the payroll of subcontractors when it calculates a final
premium, and the principal or contractor might face a
substantial and unexpected additional charge.
Injuries Covered
Workers compensation covers both injuries that are specific
as to time and place as well as injuries that occur over a
period of time. Injuries that occur because of doing the same
type of work over and over and causing strain on the body
parts involved are called cumulative trauma. Cumulative
trauma is the result of repetitive work that over time results in
injuries, especially back injuries and wrist injuries such as
carpal tunnel syndrome.
State law is very specific about what an injured worker must
do to be covered by workers compensation. This involves
three steps:

The injured worker must inform the employer about
the injury and provide all the details he or she can.

The injured worker must be examined by a doctor
who will determine if the injury is truly work related.

The injured worker must do everything he or she can
to mitigate the injury, and return to work as quickly as
possible.
Each employer must have the workers compensation program
information that applies to that workplace posted in a place
where they can be seen by all workers. In case of injury, the
first duty is to care for the injured worker, so emergency
numbers must be posted for immediate access.
When a worker is physically able, the worker must inform the
employer of the injury. The employer must then provide forms
for the employee to put his or her claim of injury in writing. In
most states the employer must provide the forms within a few
days.
The employer also has forms to fill out, both to keep a written
record of all injuries occurring at the workplace, and to inform
the workers compensation insurer of the injury.
Methods of Providing Coverage
The employer is always 100% responsible for providing
workers compensation benefits. However, each state has
decided what options employers have in that state for
providing that coverage. The three possible options are:

state funds,

private insurers,

self-funding
In two states (North Dakota and Wyoming), only the state fund
can provide insurance coverage, and workers compensation
insurance must be purchased by the employer in order for the
employer to legally hire employees.
In three other states (Ohio, Washington, and West Virginia),
there is a state fund, but coverage is not mandatory through
the state fund – employers could also choose to fund their
own workers compensation claims.
In 21 other states, all three options are available, and
employers can buy insurance through a private insurance
company.
In 24 states and the District of Columbia, there is no state
fund, so employers can self fund or buy private insurance.
Finally, in two states (Texas and New Jersey), workers
compensation is elective, meaning that the employer can
accept or reject the workers compensation law and an
employee will be able to sue for damages due to injuries
suffered on the job.
State Funds
State funds are organizations that specialize in providing
comprehensive workers compensation programs in individual
states. Some of these funds are organized as private
insurance companies, while others are part of the state
government. All state funds must be self-supporting from their
premium and investment revenue.
State funds have been around almost as long as workers
compensation. Washington had the first state fund which was
developed in 1911. Currently, 26 states have state funds.
According to The American Association of State
Compensation Insurance Funds, an association of all the
workers compensation state funds, state funds, must comply
with the same regulatory requirements as other insurance
companies, in terms of surplus and reserves so that
employers and employees know that the fund will be around
when they need it.
State funds operate either on an exclusive or competitive
level, depending on the laws of the state.
States with exclusive funds require all employers to buy
workers compensation insurance from the state fund (in some
states they allow employers to self-insure)
Exclusive state funds develop their own rates to charge
employers.
Competitive funds are only one market available for
employers for workers compensation insurance because state
law does not require them to be used exclusively.
The two main advantages of state funds to employers are:

State funds are real specialists for workers
compensation programs in the state in which they
are located. They are able to develop broad safety
and other programs to prevent losses.

State funds are often also able to reduce costs to
employers because the cost of providing insurance is
low. The overhead expenses for state funds are
generally lower than expenses for private insurance
companies. Administrative costs are low particularly
because state funds don’t have to have marketing
programs to sell their services. Illinois does not
operate a state fund.
Private Insurers
Private insurance companies provide more insurance
coverage and pay out more in benefits than state funds.
According to the National Academy of Social Insurance, in
2000, private insurance accounted for 55.9% of the benefits
paid.
There are many private insurance companies that offer
workers compensation insurance. As with other types of
insurance coverage, they vary on their level of service, and
the rates they charge for coverage.
Self-Funding
Employers are the second largest providers of workers
compensation benefits, providing over 21% of all benefits paid
in 2000. Employers can self-fund, or partially self-fund through
the use of high deductible insurance policies either with the
state fund or private insurance companies.
Costs involved in self-funding are administrative costs and the
costs of the benefits provided.
States have very specific laws regarding what is required for
an employer to self-fund. Usually an employer must have a
funding pool or post a bond so that it is clear the employer can
afford to self-fund.

109
Workers Compensation Policy
The policy text reviewed in the following pages is that of the
1992 edition of the Workers Compensation and Employers
Liability Policy developed by the National Council on
Compensation Insurance (NCCI). In 2003 this policy form is
still in use by insurance companies in most states, Including
Illinois.
In its current form, the policy has eight parts:

Information page

General section

Part I - Workers compensation

Part II - Employers liability

Part III - Other states insurance

Part IV - Duties if injury occurs

Part V - Premium

Part VI - Conditions
Under each coverage part, the insurance applies to accidental
bodily injury, death, or disease, occurring during the policy
period and caused or aggravated by the conditions of
employment. The insurance company agrees to provide a
legal defense, and to investigate and settle all claims and
suits covered by the insurance.
Supplementary payments are also provided, including
coverage for appeal bonds, bonds to release attachments,
interest on judgments, claim expenses, litigation costs taxed
against the insured, and expenses (other than loss of
earnings) incurred at the insurance company’s request. The
insurance company has subrogation rights if anyone other
than the insured is liable for a covered injury. If any other
insurance applies, the insurance company will only pay its
share of claims and costs, subject to any limits of liability, all
shares will be equal until a loss is paid.
In contrast to most other forms of commercial casualty
insurance, workers compensation and employers liability
coverage contributes equal shares when other insurance
applies. Most other coverages contribute proportionally based
upon the respective limits of insurance.
Information Page
The Information Page (called a declarations page on most
other insurance policies) lists the particulars of a specific
policy. Among the important parts of an information page:

Item 1 shows the employers name and address, and
the type of business (individual, partnership, or
corporation). A space is provided to list any
operations conducted at locations other than the
policy address.

Item 2 shows the policy period, which begins at
12:01 A.M. standard time at the policy address.

Item 3.A. includes space for listing all of the states in
which workers compensation coverage is to apply;
states in which you have operations should be listed.

Item 3.B lists the employers liability coverage limits.
Basic limits are $100,000 per accident for injuries,
$100,000 per employee for disease, and $500,000
aggregate (annually) for disease. Higher limits may
be purchased.

Item 3.C. includes space for listing additional states
in which the insured employer might have a future
exposure. The optional “other states” coverage will
automatically begin only if the additional states are
included in item 3.C.

Space for listing job classifications and codes,
estimated payrolls, rates, and estimated premiums is
provided under item 4. Premiums may be paid
monthly, quarterly, semi-annually, or annually.
General Section
The Workers Compensation and Employers Liability
Insurance Policy has three separate and distinct coverage
parts. The provisions described in the General Agreement and
General Section apply to all three.
In addition to providing basic definitions, this section
establishes the makeup of the insuring contract: the policy’s
information page, the policy form, and all endorsements and
schedules. After issuance, the policy’s conditions can be
changed only by written endorsements issued by the
insurance company.
GENERAL AGREEMENT
In return for the payment of the premium and subject to all terms
of this policy, we agree with you as follows:
GENERAL SECTION
A. The Policy
This policy includes at its effective date the Information Page and
all endorsements and schedules listed there. It is a contract of
insurance between you (the employer named in Item 1 of the
Information Page) and us (the insurer named on the Information
Page). The only agreements relating to this insurance are stated in
this policy. The terms of this policy may not be changed or waived
except by endorsement issued by us to be part of this policy.
Who Is Insured
The employer named in the policy is the insured. If the
employer is a partnership, all partners are also insured.
B. Who Is Insured
You are insured if you are an employer named in Item 1 of the
Information Page. If that employer is a partnership, and if you are one
of its partners, you are insured, but only in your capacity as an
employer of the partnership’s employees.
Workers Compensation Law
The term “workers compensation law,” as used in the policy
means just those laws passed by the states or territories
specifically listed on the policy’s information page under item
3.A. There is no coverage for claims brought under federal
statutes such as the U.S. Longshore and Harbor Workers
Compensation Act unless endorsements adding the coverage
are attached.
C. Workers Compensation Law
Workers Compensation Law means the workers or workmen’s
compensation law and occupational disease law of each state or
territory named in item 3.A. of the Information Page. It includes any
amendments to that law which are in effect during the policy period. It
does not include any federal workers or workmen’s compensation law,
any federal occupational disease law or the provisions of any law that
provide nonoccupational disability benefits.
Policy Territory
Although it doesn’t say so here, the standard policy can
provide coverage in U.S. territories as well as in U.S. states
and in Washington D.C.
D. State
State means any state of the United States of America, and the
District of Columbia.
Locations
States and territories where coverage applies must be listed in
the information page’s item 3.A.
E. Locations
This policy covers all of your workplaces listed in Items 1 or 4 of
the Information Page; and it covers all other workplaces in Item 3.A.
states unless you have other insurance or are self-insured for such
workplaces.
Part I – Workers Compensation
Now we’ve come to the first of the three coverage parts of
workers compensation insurance. You’ll find no exclusions in
this section, a rarity in insurance policies. But remember that
it’s the state’s compensation laws, not the policy, that
determine when and what benefits are payable.
Workers compensation coverage applies to bodily injuries and
diseases “arising out of and in the course of employment.”
Covered losses must be work-related (losses that are nonwork-related are not covered by workers compensation).
Any covered bodily injury must be accidental, and the term
includes death resulting from the accident. Only occupational
diseases, which are unique to the occupation, are covered. A
cause-and-effect relationship must exist between the job and
the disease, and ordinary diseases suffered by the general
110
benefits for a temporary total disability may be limited to a
maximum number of weeks).
People with partial disabilities are able to perform some work,
so the laws provide a benefit equal to a percentage of the
wage loss (difference between earnings before and after the
accident). In addition to benefits for lost wages, nearly every
state provides scheduled benefits for specific permanent
partial disabilities, such as loss of limbs, sight, or hearing.
Usually these benefits are paid in addition to any other income
benefits.
Death benefits are provided by every state, and there are two
types of payments. Each state provides a modest burial
allowance, which is a maximum dollar amount (usually within
the $1,000 to $5,000 range). Each state also provides weekly
income payments for a surviving spouse and/or children.
Weekly benefits are usually a percentage of the deceased
worker’s wages, subject to stated minimum and maximum
dollar amounts, and a time limit. Some states have an
aggregate payment limit. A surviving spouse may receive
benefits for life, or until remarriage. Surviving children
generally receive benefits until age 18 or 19, and until age 22
or 23 if they are still in school.
Rehabilitation benefits are provided by all states. Some states
have set up a special fund to provide these benefits, while
others have not. Rehabilitation services are now recognized
as a valuable tool for reducing workers compensation costs
and returning disabled employees to their jobs as soon as
possible. Rehabilitation may include therapy, vocational
training, devices such as wheelchairs, and the costs of travel,
lodging and living expenses while being rehabilitated. Various
states impose weekly limits, maximum limits, and special
limits for specific types of rehabilitation.
public are not covered. The law is different in each state, but
usually benefits are not provided if the injury or disease is
intentionally caused by the employee, or results from
intoxication on the job, or occurs during activities which are
not part of the job.
You’ll note that nowhere does the policy actually define the
term, bodily injury. This is not an oversight. State legislatures
and courts, not the policy, determine what is and what is not a
compensable injury. Today, unlike forty years ago, workers
compensation policies commonly pay emotional and mental
stress claims as well as those for physical injuries.
PART ONE
WORKERS COMPENSATION INSURANCE
A. How This Insurance Applies
This workers compensation insurance applies to bodily injury by
accident or bodily injury by disease. Bodily injury includes resulting
death.
1. Bodily injury by accident must occur during the policy period.
Exposure During Policy Term
This section also stipulates that, in order to receive benefits
under a specific policy, an employee’s last exposure to a
disease-causing or disease-aggravating condition must occur
during that policy’s term.
2. Bodily injury by disease must be caused or aggravated by the
conditions of your employment. The employee’s last day of last
exposure to the conditions causing or aggravating such bodily injury
by disease must occur during the policy period.
What’s the intent of this provision? Let’s look at an example at
Natural Weave Textile Mill and an employee named Joe. In
the thirty years that Natural Weave’s been in business, the
company has had a dozen different workers compensation
carriers. Joe, who has “always been a textile worker,” is now
leaving Natural Weave. He contracted brown lung disease
(byssinosis) caused by the years of inhaling raw cotton and
linen fibers. Which insurance company pays Joe’s benefits?
The “last exposure” provision rules that the insurance policy in
effect when Joe was last exposed to raw textiles; that is, when
he left the company, pays.
Insuring Agreement
We find here one of the insurance world’s shortest and
clearest insuring agreements. What will the insurance
company pay? Those benefits required by a covered state’s
workers compensation laws. When will the benefits be paid?
Workers compensation laws usually provide for the payment
of four types of benefits:

medical benefits,

income benefits,

death benefits, and

rehabilitation benefits.
Medical benefits are provided without limit in every state. An
injured or diseased employee is entitled to receive all
necessary medical and surgical treatment to cure or relieve
the condition. Certain maximums or limits may apply to a type
of care or a particular medical item, but overall benefits are
unlimited.
Income benefits are paid to employees who suffer workrelated disabilities. A waiting period (usually three to seven
days) applies before benefits for loss of wages begin. If the
disability continues beyond a longer period (usually two to four
weeks), retroactive benefits will be paid for the initial waiting
period.
A disability may be total (making employment impossible) or
partial (resulting in a reduced ability to work, or a need to
perform alternative work). Either type of disability may be
temporary or permanent. For permanent total disability or
temporary total disability, the benefit is a percentage of weekly
wages, subject to stated minimum and maximum dollar
amounts. Within each state, the percentage is the same for
either type of total disability (66-2/3 percent is most common).
However, for permanent total disability the dollar maximum
and the benefit period are usually greater (benefits for
permanent total disability often continue to age 65, while
B. We Will Pay
We will pay promptly when due the benefits required of you by
the workers compensation law.
Defense Coverage
The insurance company will not only provide claim defense, it
will pay reasonable costs and expenses of that defense. The
unusual feature in this portion of the policy is that the
insurance company has the right to settle a claim without the
insured’s consent. Let’s say the employer, is pretty sure the
company’s last compensation claim has little basis; after all, it
was just a minor slip-and-fall. The employer can tell the
insurance company he doubts the employee really
experienced a serious back strain, but the insurance company
doesn’t need the employers’ permission to pay the claim.
C. We Will Defend
We have the right and duty to defend at our expense any claim,
proceeding or suit against you for benefits payable by this insurance.
We have the right to investigate and settle these claims, proceedings
or suits.
We have no duty to defend a claim, proceeding or suit that is not
covered by this insurance.
D. We Will Also Pay
We will also pay these costs, in addition to other amounts
payable under this insurance, as part of any claim, proceeding or suit
we defend:
1. reasonable expenses incurred at our request, but not loss of
earnings;
2. premiums for bonds to release attachments and for appeal
bonds in bond amounts up to the amount payable under this
insurance;
3. litigation costs taxed against you;
4. interest on a judgment as required by law until we offer the
amount due under this insurance; and
5. expenses we incur.
Other Insurance
State laws commonly require that higher benefits be paid for
certain losses as a form of penalty to be paid by the employer.
Benefits are often increased if a loss results from the serious
or willful misconduct of the employer (for example, failing to
provide required safety equipment). A number of states
require that double benefits be paid for injury to a minor who
111
is employed illegally.
These extra payments are not covered by a workers
compensation policy, and the additional amount must be
borne by the employer. If the insurance company makes such
payments, the policy requires reimbursement from the
employer.
Let’s look at examples. An employer ignores a state law
requiring safety guards on buzz saws, and an employee
looses a hand. Or a painting contractor hires a fourteen-yearold in violation of state labor laws, and the minor breaks an
arm falling off the scaffolding. Both of these cases could result
in fines and/or penalties which are not insured.
or the insurance company, or both, to collect benefits.
4. Jurisdiction over you is jurisdiction over us for purposes of the
workers compensation law. We are bound by decisions against you
under that law, subject to the provisions of this policy that are not in
conflict with that law.
Legal obligations of the employer, and judgments against the
employer, become obligations of the insurance company.
5. This insurance conforms to the parts of the workers
compensation law that apply to:
a. benefits payable by this insurance; or
b. special taxes, payments into security or other special funds,
and assessments payable by us under that law.
Statutory benefits and any special taxes, payments, and
assessments that are required by the workers compensation law are
covered by the insurance.
6. Terms of this insurance that conflict with the workers
compensation law are changed by this statement to conform to that
law.
Nothing in these paragraphs relieves you of your duties under
this policy.
Any terms of the policy which conflict with law are automatically
changed to comply with the law.
E. Other Insurance
We will not pay more than our share of benefits and costs
covered by this insurance and other insurance or self-insurance.
Subject to any limits of liability that may apply, all shares will be equal
until the loss is paid. If any insurance or self-insurance is exhausted,
the shares of all remaining insurance will be equal until the loss is
paid.
If other insurance or self-insurance covers the same loss, all
coverages share equally in payment of losses.
F. Payments You Must Make
You are responsible for any payments in excess of the benefits
regularly provided by the workers compensation law including those
required because:
1. of your serious and willful misconduct;
2. You knowingly employ an employee in violation of law;
3. You fail to comply with a health or safety law or regulation; or
4. You discharge, coerce or otherwise discriminate against any
employee in violation of the workers compensation law.
If we make any payments in excess of the benefits regularly
provided by the workers compensation law on your behalf, you will
reimburse us promptly.
These provisions declare that the insurance company and
insured are one and the same with regard to notice of injury
given by a worker, and with respect to matters of legal
jurisdiction. Bankruptcy of the employer will not relieve the
insurance company of its policy obligations. The insurance
company agrees to be directly and primarily liable to anyone
entitled to workers compensation insurance benefits.
Part II – Employer’s Liability
Employers’ liability coverage protects against a variety of
common law exposures. It is needed to fill gaps in the
compensation coverage and to cover claims which are not
subject to the compensation laws. Although an employee
gives up the right to sue in exchange for workers
compensation benefits, not all employees come under the
law. Those not covered may sue. In recent years, successful
suits against employers have also been filed by spouses and
children of injured workers. Employers’ liability insurance
covers these claims if the original suit is brought in the United
States, its territories or possessions, or Canada.
As in part one, the coverage here applies only to bodily injury
(which includes accident, disease, or death) that occurs
during the policy period and is job-related. The injury must
occur in a covered state or territory listed on the policy’s
information page. And, as in part one, the employers’ liability
section stipulates that an employee’s last exposure to a
disease-causing or disease-aggravating condition must occur
during the policy’s term.
But we now see how the two coverages differ. Benefits in part
one respond to the statutory workers compensation laws of a
state. Part two, employer’s liability insurance, responds only to
suits, legal actions, brought against the insured employer.
These legal actions must be initiated in the United States, its
territories or possessions, or Canada.
Subrogation
Commonly called subrogation, this clause acts as a form of
reimbursement to the insurance company. If a third party is
found negligent of the employee’s injury, the insurance
company pays compensation benefits to the injured worker,
and then assumes the right to recover its payments from the
responsible party. Under this process, the injured worker can’t
collect from both the insurance company and the negligent
party.
Example: A secretary, while taking the company’s deposits to
the bank, is hit by a speeding car. If the insurance company
pays the secretary workers compensation benefits, the
insurance company has the right to seek recovery of its
payments from the negligent driver. Under this principle, the
secretary is limited in how she can pursue a claim against the
driver.
G. Recovery From Others
We have your rights, and the rights of persons entitled to the
benefits of this insurance, to recover our payments from anyone liable
for the injury. You will do everything necessary to protect those rights
for us and to help us enforce them.
Statutory Provisions
Some general provisions apply automatically when required
by law.
PART TWO
EMPLOYERS LIABILITY INSURANCE
A. How This Insurance Applies
This employers liability insurance applies to bodily injury by
accident or bodily injury by disease. Bodily injury includes resulting
death.
1. The bodily injury must arise out of and in the course of the
injured employee’s employment by you.
2. The employment must be necessary or incidental to your work
in a state or territory listed in Item 3.A. of the Information Page.
3. Bodily injury by accident must occur during the policy period.
4. Bodily injury by disease must be caused or aggravated by the
conditions of your employment. The employee’s last day of last
exposure to the conditions causing or aggravating such bodily injury
by disease must occur during the policy period.
5. If you are sued, the original suit and any related legal actions
for damages for bodily injury by accident or by disease must be
brought in the United States of America, its territories or possessions,
or Canada.
H. Statutory Provisions
These statements apply where they are required by law.
1. As between an injured worker and us, we have notice of the
injury when you have notice.
Notice of an injury given by a worker to the employer has the
same legal effect as notice given to the insurer.
2. Your default or the bankruptcy or insolvency of you or your
estate will not relieve us of our duties under this insurance after an
injury occurs.
Bankruptcy of the employer does not relieve the insurance
company of its obligation to pay benefits.
3. We are directly and primarily liable to any person entitled to
the benefits payable by this insurance. Those persons may enforce
our duties; so may an agency authorized by law. Enforcement may be
against us or against you and us.
The insurance company assumes the obligations of the
employer to pay benefits. Action may be taken against the employer,
112
under the warranty that the insured employers work is
performed in a workmanlike manner.
Coverage Provided
The coverages under employers’ liability insurance are based
on negligence under common law. Here the insurance
company agrees only to pay the damages or amounts for
which the insured employer is found to be legally liable,
provided they are covered by the policy. This insuring
agreement, more detailed than that found in part one, is
typical of liability insurance contracts.
C. Exclusions
This insurance does not cover:
1. liability assumed under a contract. This exclusion does not
apply to a warranty that your work will be done in a workmanlike
manner;
Punitive Damages
Remember our earlier example. The fourteen-year-old
painter’s helper fell from the scaffolding. There, the policy’s
workers compensation section didn’t insure penalty payments.
This part of the policy excludes both punitive damage
coverages and bodily injury for an incident involving an
employee you knowingly hired illegally. No help is intended for
employers who willingly violate the law.
B. We Will Pay
We will pay all sums you legally must pay as damages because
of bodily injury to your employees, provided the bodily injury is
covered by this Employers Liability Insurance.
Third Party Suits
Employers’ liability coverage is not limited to claims filed by
injured employees. One such example is found in third-partyover suits. These actions arise when an injured worker sues
and collects from a third party for a work-related injury. The
third party then seeks damages from the insured employer.
Sound confusing? Let’s look at an example: Pete operates the
widget machine on Prefab Company’s assembly line. For the
fifth time in so many days, the widget machine malfunctions,
this time badly injuring Pete. Although it’s a work-related
injury, Pete sues a third party, Widget Manufacturing, who
made the machine and collects damages. Widget
Manufacturing, in an effort to recoup its loss, sues the insured
employer, Prefab Company, alleging negligence in permitting
the continued use of an unsafe machine.
2. punitive or exemplary damages because of bodily injury to an
employee employed in violation of law;
3. bodily injury to an employee while employed in violation of law
with your actual knowledge or the actual knowledge of any of your
executive officers;
Legal Obligation
With this exclusion, the policy reminds us of the purpose of
the employers’ liability section. It’s not to provide coverage
under statutory workers compensation laws - that’s done by
part one of the policy. Nor is it to respond to unemployment,
disability, or other similar laws. Separate insurance and
benefit programs address these needs.
The damages we will pay, where recovery is permitted by law,
include damages:
1. for which you are liable to a third party by reason of a claim or
suit against you by that third party to recover the damages claimed
against such third party as a result of injury to your employee;
4. any obligation imposed by a workers compensation,
occupational disease, unemployment compensation, or disability
benefits law, or any similar law;
Willful Acts
Employers’ liability insurance was developed to protect
employers from damages arising out of accidental
occurrences, not for deliberate, willful acts.
Family Member Services
An employer may also be held liable for damages payable to
an injured worker’s family members. The policy states it will
pay damages “for care and loss of services,” a term
commonly translated as damages for loss of consortium,
resulting from an employee’s work-related injury. The policy
also pays damages for “consequential” bodily injury to
immediate family members. For example, a Massachusetts
court awarded damages to the wife and children of an injured
worker for their mental anguish caused by seeing him as a
helpless quadriplegic.
5. bodily injury intentionally caused or aggravated by you;
Outside Policy Territory
Injuries occurring outside of the U.S. or Canada are excluded,
unless the employee is a citizen who is only temporarily
outside of these jurisdictions.
6. bodily injury occurring outside the United States of America,
its territories or possessions, and Canada. This exclusion does not
apply to bodily injury to a citizen or resident of the United States of
America or Canada who is temporarily outside these countries;
2. for care and loss of services; and
3. for consequential bodily injury to a spouse, child, parent,
brother or sister of the injured employee; provided that these
damages are the direct consequence of bodily injury that arises out of
and in the course of the injured employee’s employment by you; and
Stress
In recent years, a host of claimants (especially those recently
reprimanded or fired) have sought damages from their
employers (or ex-employers) for on-the-job stress or mental
anguish. This NCCI policy clearly excludes coverage under
the employer’s liability section for work-related acts of
coercion, criticism, demotion, discrimination, etc. The
exclusion doesn’t actually say that mental stress is not a
bodily injury. It simply says the specific acts listed are
excluded.
The workers compensation section doesn’t contain a similar
exclusion, leaving it to a state’s courts and compensation laws
to determine when compensation benefits are payable.
Dual Capacity
This clause refers to the dual capacity theory. In these cases,
the employer may be liable to an injured worker in a manner
separate from his role as the worker’s employer. For example,
a truck’s faulty tire, a tire manufactured by Bigstone Tire
Company, causes a job-related truck accident that injures a
Bigstone driver. That driver could claim workers compensation
benefits plus product liability damages from Bigstone who is
both the driver’s employer and the manufacturer of the
defective tire.
4. because of bodily injury to your employee that arises out of
and in the course of employment, claimed against you in a capacity
other than as employer.
7. damages arising out of coercion, criticism, demotion,
evaluation, reassignment, discipline, defamation, harassment,
humiliation, discrimination against or termination of any employee, or
any personnel practices, policies, acts or omissions;
Exclusions
Unlike the workers compensation section, the employer’s
liability portion of the policy specifically lists twelve exclusions,
circumstances in which coverage does not apply.
Contractual Liability
Coverage for specified common forms of contractual liability is
provided by the commercial general liability policy or separate
contractual liability insurance. It’s not the intent of employers’
liability insurance to duplicate that coverage. But, as an
exception to this exclusion, the policy does provide coverage
Limited Jurisdiction
These last five exclusions limit the jurisdiction of employer’s
liability insurance. Like the workers compensation part of the
policy, this section won’t automatically pay compensation or
damages in response to any federal or maritime or admiralty
compensation laws. And fines or penalties for violations of
these laws, as well as those of a state, are excluded.
Here we see an important role of endorsements. Suppose a
company has federal as well as state exposures. A simple
endorsement to the standard policy can add the needed
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coverages (both workers compensation and employers
liability), at an added cost, of course.
What are these federal acts? The exclusion names the most
common. Let’s look at just one - the U.S. Longshore and
Harbor Workers Compensation Act (USL&HW Act). Maritime
employees who work on U.S. navigable waters and their
adjoining piers or docks fall under this federal act. Their duties
can vary from stevedoring and freight handling to boat
building and harbor work. Some employees may come under
both state laws and those of the USL&HW Act. For example,
customhouse brokers or some electronics repairmen
frequently board ships in connection with their shore-side
jobs.
(As a note here, the USL&HW Act doesn’t cover all boat or
ship-related duties. Seamen, who have the job of operating a
U.S. commercial vessel in navigable waters, fall under a
different federal law, called the Jones Act.)
5. expenses we incur.
Other Insurance
The “other insurance” clause for employers liability coverage
is nearly the same as that for workers compensation. If other
insurance applies, each contributes equal shares until the loss
is paid or the insurance is exhausted.
F. Other Insurance
We will not pay more than our share of damages and costs
covered by this insurance and other insurance or self-insurance.
Subject to any limits of liability that apply, all shares will be equal until
the loss is paid. If any insurance or self-insurance is exhausted, the
shares of all remaining insurance and self-insurance will be equal until
the loss is paid.
Policy Limits
We’ve already established that workers compensation pays
benefits based on a state’s statutory workers compensation
laws. Because each covered state determines the amount to
be paid, the policy doesn’t show a maximum for workers
compensation benefits. But the policy’s information page does
list maximum payable amounts for employers’ liability. These
limits are the most the insurance company will pay for
damages during the policy’s term.
Item 3.B. of the information page shows three separate limits
for employers’ liability damages. The first, for bodily injury by
accident, applies “per accident” regardless of the number of
employees injured in the same accident.
8. bodily injury to any person in work subject to the Longshore
and Harbor Workers Compensation Act (33 USC Sections 901-950),
the Nonappropriated Fund Instrumentalities Act (5 USC Sections
8171-8173), the Outer Continental Shelf Lands Act (43 USC Sections
1331-1356), the Defense Base Act (42 USC Sections 1651-1654), the
Federal Coal Mine Health and Safety Act of 1969 (30 USC Sections
910-942), any other federal workers or workmen’s compensation law
or other federal occupational disease law, or any amendments to
these laws;
9. bodily injury to any person in work subject to the Federal
Employers’ Liability Act (45 USC Sections 51-60), any other federal
laws obligating an employer to pay damages to an employee due to
bodily injury arising out of or in the course of employment, or any
amendments to those laws;
10. bodily injury to a master or member of the crew of any
vessel;
11. fines or penalties imposed for violation of federal or state
law; and
12. damages payable under the Migrant and Seasonal
Agricultural Worker Protection Act (29 USC Sections 1801-1872) and
under any other federal law awarding damages for violation of those
laws or regulations issued there under, and any amendments to those
laws.
G. Limits of Liability
Our liability to pay for damages is limited. Our limits of liability
are shown in Item 3.B. of the Information Page. They apply as
explained below.
1. Bodily injury by Accident. The limit shown for “bodily injury by
accident—each accident” is the most we will pay for all damages
covered by this insurance because of bodily injury to one or more
employees in any one accident.
A disease is not bodily injury by accident unless it results directly
from bodily injury by accident.
The final two limits apply to damages arising from bodily injury
by disease. One limit shows the most the policy will pay for
disease to any one employee. The other gives the policy limit,
called an annual aggregate, for all damages arising from
disease during the policy’s term.
The standard policy’s basic employers’ liability limits of
$100,000 per accident for injuries, $100,000 per employee for
disease, and $500,000 annual aggregate for disease can be
increased for an additional charge (or premium). Many
employers often obtain even greater employers liability
protection by purchasing additional layers of coverage through
a commercial umbrella or excess liability policy.
Example: A group of employees suffers asbestosis; the lung
disease linked to inhaling asbestos fibers, and sues for
damages. The standard policy will limit any settlements per
employee as well as per the group. $500,000 wouldn’t go very
far in this kind of lawsuit, so a commercial umbrella or excess
liability policy would be essential.
Defense Coverage
The employer’s liability defense provisions are nearly identical
to those found in the workers compensation section. The
insurance company will both provide defense for a claim and
pay the reasonable costs and expenses of that defense.
These expenses are paid in addition to any amounts that are
subject to policy limits. And, as with most liability policies, the
insurance company has the right to settle a claim without the
insured’s consent.
However, employers’ liability has an additional condition in its
defense provisions. Unlike workers compensation, employers’
liability has specific maximum limits of coverage. Once the
insurance company has paid out that amount in damages,
they don’t have to provide further defense for employers’
liability.
D. We Will Defend
We have the right and duty to defend, at our expense, any claim,
proceeding or suit against you for damages payable by this insurance.
We have the right to investigate and settle these claims, proceedings
and suits.
We have no duty to defend a claim, proceeding or suit that is not
covered by this insurance. We have no duty to defend or continue
defending after we have paid our applicable limit of liability under this
insurance.
E. We Will Also Pay
We will also pay these costs, in addition to other amounts
payable under this insurance, as part of any claim, proceeding, or suit
we defend:
1. reasonable expenses incurred at our request, but not loss of
earnings;
2. premiums for bonds to release attachments and for appeal
bonds in bond amounts up to the limit of liability under this insurance;
3. litigation costs taxed against you;
4. interest on a judgment as required by law until we offer the
amount due under this insurance; and
2. Bodily Injury by Disease. The limit shown for “bodily injury by
disease—policy limit” is the most we will pay for all damages covered
by this insurance and arising out of bodily injury by disease,
regardless of the number of employees who sustain bodily injury by
disease. The limit shown for “bodily injury by disease—each
employee” is the most we will pay for all damages because of bodily
injury by disease to any one employee.
Bodily injury by disease does not include disease that results
directly from a bodily injury by accident.
3. We will not pay any claims for damages after we have paid
the applicable limit of our liability under this insurance.
Subrogation
The policy again confirms the insurance company’s rights of
recovery or reimbursement (subrogation rights). Remember
the secretary who was hit by a speeding car while taking the
company’s deposits to the bank? We said the insurance
company had the right to attempt to recover any workers
compensation benefits paid to the secretary from the
negligent driver. The same subrogation principle applies to
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employers liability damages paid by the insurance company.
work, all provisions of the policy will apply as though that state were
listed in Item 3.A. of the Information Page.
3. We will reimburse you for the benefits required by the workers
compensation law of that state if we are not permitted to pay the
benefits directly to persons entitled to them.
H. Recovery From Others
We have your rights to recover our payment from anyone liable
for an injury covered by this insurance. You will do everything
necessary to protect those rights for us and to help us enforce them.
Notice for New Operations
This clause reinforces the intent of other states insurance: to
provide incidental coverage for new operations that begin
midterm only. Here the policy says there’s no coverage for a
work exposure that existed on the policy’s effective date in a
state not listed in item 3.A. unless notice is given to the
insurance company within 30 days of the policy’s inception.
Legal Action Against Insurance Company
No one has the right to take legal action against the insurance
company:
(1) unless the ensured employer has done all that the policy
requires and
(2) until the final amount of damages is determined. The fact
that the insurance company provides coverage doesn’t make
it a co-defendant in a claim against the insured.
4. If you have work on the effective date of this policy in any
state not listed in Item 3.A. of the Information Page, coverage will not
be afforded for that state unless we are notified within thirty days.
I. Actions Against Us
There will be no right of action against us under this insurance
unless:
1. You have complied with all the terms of this policy; and
2. The amount you owe has been determined with our consent
or by actual trial and final judgment.
This insurance does not give anyone the right to add us as a
defendant in an action against you to determine your liability. The
bankruptcy or insolvency of you or your estate will not relieve us of
our obligations under this Part.
Work in a New State
The insured employer has an obligation to inform the
insurance company as soon as work begins in a new state.
The insurance company will then delete that state from 3.C.
(other states insurance) and add it under 3.A.
B. Notice
Tell us at once if you begin work in any state listed in Item 3.C.
of the Information Page.
Part III - Other States’ Insurance
Now we’ve come to the last of the three coverage parts - other
states insurance.
This section of the policy replaces the Broad Form All States
Endorsement which used to be used with earlier policy forms.
The coverage is still optional. It automatically provides
compensation coverage in additional states, but only if the
additional states are referred to in item 3.C. and the carrier is
informed as soon as work begins in any new state. The policy
cannot cover exposures in the six jurisdictions where
monopolistic state funds operate: Nevada, North Dakota,
Ohio, Washington, West Virginia, and Wyoming. So, if the
insured anticipate exposures in any of those states,
arrangements will have to be made with the appropriate state
fund.
If there is a work exposure on the effective date of the policy
in any state which is not listed in item 3.A, there will not be
any coverage in that state unless the insurance company is
notified within 30 days.
But what happens if a new office is opened in a state not
listed in 3.A., and a claim occurs there immediately, before the
insurance company is notified of the new location? The other
states insurance coverage automatically extends coverage to
additional states where operations begin midterm, but only if
these new states are listed on the information page, under
item 3.C.
To prevent overlooking a state, many insurance professionals
recommend writing the following phrase under 3.C.: “all states
except Nevada, North Dakota, Ohio, Washington, West
Virginia, Wyoming and the states [already] listed in item 3.A.
of the information page.” But the producer must be certain the
insurance company is licensed to write in these additional
states.
Why, in the last paragraph, did we say “all states except
Nevada, North Dakota, Ohio, Washington, West Virginia, and
Wyoming”?
Except
for
Wyoming,
state-operated
compensation funds have monopolies (exclusive control) over
the writing of workers compensation in these states.
Wyoming’s state fund has near control; private insurance
companies may write coverage there only for occupations for
which workers compensation is optional. So, if new operations
are planned in any of these states, the employer will have to
arrange coverage with the specific state fund.
Part IV – Duty if Injury Occurs
Part four of the policy lists the employers duties when injuries
occur, emphasizing the need for early notification to the
insurance company. To ensure that all parties respond quickly
to injuries, many states have established penalties for not
meeting a prescribed timetable.
For example, in Illinois, a worker should notify his employer of
an injury within 45 days.
The employer is obligated to inform the insurance company
“at once,” and to promptly give the insurance company all
names and addresses of injured persons and witnesses, all
legal notices and demands, and any other necessary
information.
PART FOUR:
YOUR DUTIES IF INJURY OCCURS
Tell us at once if injury occurs that may be covered by this
policy. Your other duties are listed here.
The other duties are designed to facilitate the company’s
handling of claims while minimizing expense.
When injury occurs, an employer must notify the insurance
company, provide any medical services required by the
workers compensation law, give the insurance company or
agent names and addresses of injured persons and
witnesses, cooperate with and assist the insurance company
in investigating and settling the claim or suit, and do nothing to
interfere with the insurance company’s right to recover from
others. Additionally, an employer may not voluntarily make
payments, assume obligations, or incur expenses except at
his own cost.
This section is the tool that many workers compensation
carriers use when they suspect fraudulent claims are taking
place.
1. Provide for immediate medical and other services required by
the workers compensation law.
2. Give us or our agent the names and addresses of the injured
persons and of witnesses, and other information we may need.
3. Promptly give us all notices, demands and legal papers
related to the injury, claim, proceeding or suit.
4. Cooperate with us and assist us, as we may request, in the
investigation, settlement or defense of any claim, proceeding or suit.
5. Do nothing after an injury occurs that would interfere with our
right to recover from others.
6. Do not voluntarily make payments, assume obligations or
incur expenses, except at your own cost.
OTHER STATES’ WORKERS COMPENSATION INSURANCE
A. How This Insurance Applies
1. This other states insurance applies only if one or more states
are shown in Item 3.C. of the Information Page.
2. If you begin work in any one of those states after the effective
date of this policy and are not insured or are not self-insured for such
Part V – Premium
Manual Rates
In part five, the policy gives us a look at its pricing structure
and defines elements used in premium development. All
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premiums for the policy will be determined by the insurance
company’s manual of rules, rates, and classifications.
D. Premium Payments
You will pay all premium when due. You will pay the premium
even if part or all of a workers compensation law is not valid.
PART FIVE:
PREMIUM
A. Our Manuals
All premiums for this policy will be determined by our manuals of
rules, rates, rating plans and classifications. We may change our
manuals and apply the changes to this policy if authorized by law or a
governmental agency regulating this insurance.
Final Premium
Final policy premiums are determined, based on actual rates,
classifications, and premium basis, after the policy’s
expiration. If the final premium is more than the estimated
premium previously paid, you must pay the additional
premium. If the final premium is less than the estimated
premium, the insurance company will refund the balance.
However, each policy is subject to a minimum premium.
Classifications
For workers compensation rating purposes, all occupations
are divided into classifications. Similar employments are
grouped so that each class reflects exposures common to
them all. Some jobs are inherently more dangerous than
others, and the classification system attempts to bring equity
to the rating system.
The classifying of a risk, more than any other factor, governs
the workers compensation premium. Classifications and rates,
based on expected work exposures, are listed on the policy’s
information page. From them estimated premiums are
developed. But the insurance company can correct inaccurate
policy classifications by endorsement.
E. Final Premium
The premium shown on the Information Page, schedules, and
endorsements is an estimate. The final premium will be determined
after this policy ends by using the actual, not the estimated, premium
basis and the proper classifications and rates that lawfully apply to the
business and work covered by this policy. If the final premium is more
than the premium you paid to us, you must pay us the balance. If it is
less, we will refund the balance to you. The final premium will not be
less than the highest minimum premium for the classifications
covered by this policy.
Cancellation
If the insurance company cancels the policy, the final premium
and any premium adjustment will be determined on a pro rata
basis (proportional, based on the time the policy has actually
been in effect). If the insured cancels the policy, the final
premium and adjustment will be determined on a short rate
basis (a slightly higher charge, or penalty, is imposed to cover
initial policy writing costs).
B. Classifications
Item 4 of the Information Page shows the rate and premium
basis for certain business or work classifications. These
classifications were assigned based on an estimate of the exposures
you would have during the policy period. If your actual exposures are
not properly described by those classifications, we will assign proper
classifications, rates and premium basis by endorsement to this
policy.
If this policy is canceled, final premium will be determined in the
following way unless our manuals provide otherwise:
1. If we cancel, final premium will be calculated pro rata based
on the time this policy was in force. Final premium will not be less
than the pro rata share of the minimum premium.
2. If you cancel, final premium will be more than pro rata; it will
be based on the time this policy was in force, and increased by our
short-rate cancellation table and procedure. Final premium will not be
less than the minimum premium.
Remuneration
The premium basis used with most classifications is
remuneration. (Remuneration includes payroll and other forms
of payment such as commissions, bonuses, employerprovided room and board, etc.) Simply multiply the premium
basis by the rate to obtain the premium for that classification.
Let’s look at an example of an office risk with an anticipated
annual payroll of $300,000. Let’s assume the rate for the
appropriate classification, Clerical-8810, is $.40 per $100 of
payroll. The formula for determining the premium for this class
is $300,000/100 or 3000 (premium basis) x $.40 (rate) =
$1,200 (estimated annual premium).
Payroll for all covered officers and employees is used to
compute premium, but most states have established minimum
and maximum reportable payrolls for each executive officer.
The laws of most states make a contractor liable for
compensation benefits for injured employees of an uninsured
subcontractor. And insurance companies require premium for
this added exposure. Unless the insured contractor collects,
as proof of coverage, certificates of workers compensation
insurance from each sub, the contractor can expect an
additional premium charge to cover subcontracted work. In
these cases, the contract price for the sub’s services and
materials may be used as the premium basis.
Records
Final premiums are based on actual payroll exposures, as
opposed to a policy limit, because there is no policy limit. The
limit is determined by state law. The policy requires the
insured to keep payroll records and other information
necessary to accurately compute premium and to give the
insurance company copies if requested.
F. Records
You will keep records of the information needed to compute
premium. You will provide us with copies of those records when we
ask for them.
Audit
The insurance company has the right to examine and audit
the insured’s records to the extent that they relate to the
policy. (This right is also extended to rate service
organizations.) These records can be in a variety of forms,
from ledgers to computer data. The audits, made in regular
business hours, can occur during the policy period and within
three years of its expiration.
The final audit billing should never be a “surprise”, yet audits
often develop unexpected additional premiums. Using wrong
classifications, underestimating payroll, not keeping complete
accounting records, all can result in additional premiums at
audit.
C. Remuneration
Premium for each work classification is determined by
multiplying a rate times a premium basis. Remuneration is the most
common premium basis. This premium basis includes payroll and all
other remuneration paid or payable during the policy period for the
services of:
1. all your officers and employees engaged in work covered by
this policy; and
2. all other persons engaged in work that could make us liable
under Part One (Workers Compensation Insurance) of this policy. If
you do not have payroll records for these persons, the contract price
for their services and materials may be used as the premium basis.
This paragraph 2 will not apply if you give us proof that the employers
of these persons lawfully secured their workers compensation
obligations.
G. Audit
You will let us examine and audit all your records that relate to
this policy. These records include ledgers, journals, registers,
vouchers, contracts, tax reports, payroll and disbursement records,
and programs for storing and retrieving data. We may conduct the
audits during regular business hours during the policy period and
within three years after the policy period ends. Information developed
by audit will be used to determine final premium. Insurance rate
service organizations have the same rights we have under this
provision.
Premium Payments
To prevent cancellation of the policy for nonpayment, the
insured must pay all premiums, even estimated premiums,
when due.
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Part VI – Conditions
In this last part, we find a number of specific policy conditions.
Inspection
The inspection provision clearly states that the insurance
company and rate service organization have the right to
inspect the workplace for underwriting and rating
considerations. But these inspections aren’t to be considered
safety inspections. It’s not the insurance company’s intent to
make sure that you operate a safe workplace.
E. Sole Representative
The insured first named in Item 1 of the Information Page will act
on behalf of all insureds to change this policy, receive return premium,
and give or receive notice of cancellation.
Endorsements
The standard policy’s terms and conditions may be changed
by the attachment of written endorsements issued by the
insurance company. A policy’s jurisdiction can be broadened
to include coverage for employees who fall under federal or
maritime laws; a policy’s term can be shortened to attain an
established anniversary date for experience rating, all by
endorsements.
The coverage provided by the standard workers
compensation and employers liability policy will not meet the
needs of every insured. Various endorsements are available
to adjust the coverage for special needs.
Voluntary Compensation Endorsement
A practical coverage is voluntary compensation for employees
who are normally exempt from the law. An employer may not
be required to provide the coverage, but voluntary benefits
may be an act of goodwill and may prevent lawsuits under the
employer’s liability section of the policy.
Example: If unpaid interns work at a company, the company
may want to provide benefits for the interns in the event that
they are injured. This will help avoid a civil lawsuit, which
might be more costly.
Longshore and Harbor Workers Endorsement
You should remember that certain workers fall under federal
jurisdiction no matter where they work. Those who load,
unload, build or repair ships are covered by the U.S.
Longshore and Harbor Workers Compensation Act. Miners
may require Federal Black Lung Compensation insurance. A
workers compensation policy will not automatically provide
any of these benefits, and an employer faces a risk that
required benefits under federal law may be substantially
higher than state benefits provided by the policy.
Endorsements are available for each of these exposures. For
example, the Longshore and Harbor Workers Endorsement
extends coverage under a compensation policy so that it will
pay the benefits required by federal law.
Voluntary Compensation Maritime Coverage
Endorsement
Other exposures exist outside of the area of statutory benefits.
Masters and members of the crew of ocean vessels are
protected by a section of the Merchant Marine Act, which is
known as the Jones Act. The law permits an injured seaman
to elect to sue the employer for damages and to have a jury
trial. Insurance is provided under the employers’ liability
section of a standard workers compensation policy, but when
the exposure exists the insurance company usually requires
attachment of the Maritime Coverage Endorsement, which
actually limits the insurance and adds a few more exclusions
to the policy. If an employer does not want an injured seaman
to have to sue for damages after being injured on the job, the
employer can purchase the Voluntary Compensation Maritime
Coverage Endorsement, which voluntarily provides the
statutory benefits of the worker’s home state. As is the case
with voluntary compensation coverage for other workers, this
approach is a matter of goodwill and may prevent lawsuits.
Foreign Coverage Endorsement
The foreign coverage endorsement makes the workers
compensation policy 24-hours per day/7-days per week
coverage. It also covers an endemic disease characteristic to
the area as an occupational disease, and includes the option
to buy repatriation coverage, or the additional amount it would
take to return the person to the United States.
Workers Compensation Premium Determination
In this section, we talk about what workers compensation and
employer’s liability insurance costs the employers who must
buy it. Pricing this coverage is unusually complicated, and it is
important to be able to understand what goes into the pricing
calculation in order to help insureds keep their insurance
PART SIX:
CONDITIONS
A. Inspection
We have the right, but are not obliged to inspect your
workplaces at any time. Our inspections are not safety inspections.
They relate only to the insurability of the workplaces and the
premiums to be charged. We may give you reports on the conditions
we find. We may also recommend changes. While they may help
reduce losses, we do not undertake to perform the duty of any person
to provide for the health or safety of your employees or the public. We
do not warrant that your workplaces are safe or healthful or that they
comply with laws, regulations, codes or standards. Insurance rate
service organizations have the same rights we have under this
provision.
Policy Term
Most policies are written for one-year terms. This clause
states that, in any policy written for a term longer than one
year and sixteen days, the provisions apply as if a new policy
were issued at each annual policy anniversary. For an
application of this condition, let’s look at the policy limit for
disease for employer’s liability insurance. The “policy
aggregate limit” becomes an annual aggregate limit.
B. Long Term Policy
If the policy period is longer than one year and sixteen days, all
provisions of this policy will apply as though a new policy were issued
on each annual anniversary that this policy is in force.
Transfer of Rights and Duties
Only by the insurance company’s written consent can the
policy be assigned to another. Upon the insured’s death, a
legal representative can be covered, provided the insurance
company is notified within thirty days.
C. Transfer of Your Rights and Duties
Your rights or duties under this policy may not be transferred
without our written consent.
If you die and we receive notice within thirty days after your
death, we will cover your legal representative as insured.
Cancellation
The insured may cancel the policy at any time by providing
proper notice. The insurance company may cancel by giving
at least 10 days advance written notice (cancellation notice
requirements may vary by state.) The policy will terminate on
the day and hour specified in any cancellation notice.
D. Cancellation
You may cancel this policy. You must mail or deliver advance
written notice to us stating when the cancellation is to take effect.
We may cancel this policy. We must mail or deliver to you not
less than ten days advance written notice stating when the
cancellation is to take effect. Mailing that notice to you at your mailing
address shown in Item 1 of the Information Page will be sufficient to
prove notice.
3. The policy period will end on the day and hour stated in the
cancellation notice.
4. Any of these provisions that conflict with a law that controls
the cancellation of the insurance in this policy is changed by this
statement to comply with the law.
First Named Insured
The first named insured shown on the information page will be
the sole representative for the purpose of acting on behalf of
all other insured parties to change the policy, receive return
premiums, and to give or receive notice of cancellation. This
simplifies the obligations of the parties when there are
partners, multiple businesses, affiliates and/or subsidiaries
covered by the same policy.
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expenses under control.
Workers compensation rates vary between states and
increase and decrease over time. We will talk about
classifications, rates, remuneration, premium discounts, and
other important concepts in pricing workers compensation.
Classifications
Workers compensation premiums are intended to reflect the
risk the insurance company takes based on the exposures to
injury or illness faced by the workers in that workplace.
Classifications are one of the basic components of setting
rates for workers compensation. Each type of job is classified
according to how likely it is that that job will result in an injury
for the worker doing the job. Most employers have several
classifications of jobs for employees.
It is one of the more complicated areas of insurance to be
able to correctly classify employees. We will take a look at
some of the basics for classifications.
Most states use a classification system devised by the
National Council on Compensation Insurance. States such as
California, Delaware, New York and Pennsylvania have their
own classification systems. There are about 600 different
classifications in the NCCI system.
All classification systems intend to classify the overall
business and not the risks of the individual employees. Most
employees will fit into one overall classification for the
business called the governing classification.
The NCCI manual which lists all the classifications is called
the Basic Manual for Workers Compensation and Employers
Liability Insurance. In addition, there is another manual that
goes into depth defining the classifications called the Scopes
Manual. Because business is always changing, NCCI is
constantly adding to the classifications. Each classification is
given its own 4-digit classification code. Next to the code is a
detailed description of each classification, and the rate.
While most employees will fit into the governing classification
for an employer, classification systems have standard
exceptions. Standard exceptions are for types of work that are
generally significantly less hazardous or more hazardous than
the governing classification, and therefore merit their own
classification. Standard exceptions are normally for clerical
jobs, outside salespeople, and sometimes for drivers as well.
We said before that classification systems try to classify the
overall business and not the risks for individual employees.
One exception to this general rule is the construction industry.
Workers in the construction industry are classified by their
individual risk exposures.
Which types of risks have the highest rates? Oil field workers,
miner, and roofers have some of the highest risk jobs and
therefore some of the highest rates.
Rates and Premiums
Each classification has its own rate. That rate will vary from
state to state. The rate has been calculated based on the past
experience of many similar types of risks and must be
approved by the state department of insurance before it can
be used.
The rate is given as “the cost per $100 of pay”. For example,
let’s say that the risk is a grocery store, under classification
8006. Looking up this classification in the NCCI Scopes
manual, we find that it is rated at $2.02 per $100 of pay. If an
employee makes $24,000 a year, then he or she has 240
“$100 of pay”. So to get the estimated premium for this
individual we would multiply $2.02 x 240 to get a total of
$484.80 to insure that individual for one year.
Notice in the previous example we said that the rate and the
payroll for the classification gives us an estimated premium.
When an employer buys workers compensation coverage, it
buys it up front, before it is needed. So an employer is only
making an educated guess on what the payroll for that
classification will be for the coming year.
After the year is over, the workers compensation insurer will
audit the records to determine what the actual payroll was,
and whether the classifications they used really covered the
whole risk. There will be a recalculation and then the
employer will receive the final premium. This could be higher
or lower than the estimated premium. If it is higher, the
employer must pay additional premiums. If lower, the
employer will receive a return premium.
Manual Rates
There is one rate for each classification, so the intent is to
spread the risk among similar types of employers. For
instance, there is one governing classification and therefore
one rate for plumbers. Just as with other types of insurance,
the classification has to represent a large number of similar
employers to have enough statistical data to compute a fair
rate for all of them.
The computation for an employer’s premium ultimately is
modified to take into account that specific employers loss
experience. But at this step of the process, the rate that is
calculated from the classification assigned is called the
Manual Rate.
The rate charged the employer is not just calculated from the
loss experience of the group of employers to which the
classification applies (in each state). The rate also includes
the expenses that are required to make workers
compensation available in that state.
Remember, premiums are charged up front – before the
insurer knows the actual payroll or exposure. If the rate is
calculated correctly, the premium collected from all employers
in that classification will be equal to the losses suffered plus
the costs of the expense of administering the system.
Remuneration
Remuneration means the way an employee is paid. We have
discussed rates “per $100 of pay,” but we haven’t really
defined pay. By far the most common type of remuneration is
salary that an employee is paid. But what does that include?
For the NCCI rating system salary or wages includes the
following:

Commissions

Bonuses, profit-sharing and incentive plans

Overtime pay, less the premium portion (1 x the
number of hours of overtime, even if the pay was
actually 1 ½ x the number of hours of overtime)

Holiday, vacation, and sick pay

Social Security Payments by employer of
contributions which would otherwise be paid by
employee

Value of lodging and meals provided by employer
It is also important to know what remuneration does NOT
include:

Tips and gratuities received by employee;

Payments by employer to group insurance plans;

Value of special awards paid for invention or
discovery;

Severance pay except for time worked or accrued
vacation;

Value of employer-provided automobile;

Value of employer-provided incentive vacation
contest winnings or tickets to entertainment events
State Rating Bureaus
As we’ve said, most states use the NCCI classification
system. Most also use the rates calculated by NCCI for risks
in their state. However, some states have their own Workers
Compensation Rating Bureaus to do rate calculations. The
term advisory organization is often used instead of rating
bureau.
We’ve seen that the first step in the workers compensation
process is to correctly classify the employer. In addition, we
need to know if there are any standard exceptions to this
governing classification, such as clerical employees.
Once we have classified all the employees, we need to find
what the total payroll is expected to be for the upcoming year
for each classification. We divide this total payroll by 100 to
get the number “per $100 of payroll”.
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prior to the effective date of the current policy year.
So if a policy year starts January 1, 2003, for experience
rating, the insurer will review policy years; 2002, 2001 and
2000
If an employer has lower losses than the average employer in
that industry, the employer might be eligible for a premium
credit.
If an employer has higher losses than the average employer
in that industry, the employer might suffer a premium debit,
increasing the costs of insurance.
In this way, experience rating gives an employer an incentive
to reduce the number of accidents or injuries by implementing
safety and other loss prevention programs in his or her
workplace.
In reviewing the injuries suffered at a workplace, one must
look both at the frequency of injuries and the severity of the
individual injuries. For purposes of experience rating,
frequency is considered a more important factor than severity
because it is a better predictor of future losses.
An employer with five losses of $20,000 will be more harshly
judged for premium determination than an employer with one
loss of $200,000. In fact, losses are “capped” at $100,000 for
the purposes of experience rating. In addition, the amount of
any loss over $5,000 is considered an excess loss, while the
first $5,000 is considered the primary loss.
Retrospective Rating
Retrospective rating plans are financial incentive programs to
encourage employers to reduce their accident and injury
costs. They base the employer’s workers compensation
premium on the size of the risk and the current actual
experience for the year, although it may take some time to get
the calculation completed. If an employer’s workers
compensation premium is retrospectively rated, it does not
also receive a premium discount. Retrospective rating plans
are for 12-month coverage periods.
Retrospective rating plans are either for very large employers
or created for groups so that there is a large enough pool of
employers to determine an adequate rate.
Becoming a participating employer in a retrospective rating
plan does not change the manual premium that is calculated
for the risk. The employer pays the same estimated premium
as he or she otherwise would.
But there are three retroactive adjustments made after the
policy period ends. The first is at 10 months after the annual
policy period, the 2nd is at 22 months after the end of the
annual policy period, and the final adjustment is at 34 months
after the end of the annual policy period.

If claim costs for the coverage period are lower than
anticipated, premiums can be returned.

If, however, claim costs are above what was
expected, an additional premium charge would be
made.
It is important to note that when calculating retrospective
premium, only claims with a date of injury within the policy
coverage period are considered. No other claims are
considered, even if there are claims outstanding on which
benefits are still being paid.
Some groups promote accident prevention and claim
management and assist group members in doing so. This
becomes an added benefit of being a member of an industry
trade association, especially for high-risk industries such as
construction.
Review of Premium Determination Process
We have looked at quite a number of variables to the workers
compensation premium calculation process. Let’s put them
together and see a sample of how a premium might be
calculated.
This is the order that these apply:

Determine correct classifications

Look up manual rates

Multiple manual rates x “$100s of payroll” to arrive at
Finally we need to find the rate that applies for each
classification and multiply that rate times the “per $100 of
payroll” number. Then we would add up all of these totals for
the various classifications to arrive at the estimated annual
manual premium.
Premium Determination
Once we have calculated the manual premium, the premium
may then be adjusted by a variety of programs. These
include:

Deductibles

Premium Discounts

Schedule Rating
They also include larger more complicated loss sensitive
plans which we will discuss next.
Some workers compensation plans have deductibles. These
can range in size from $250 (small deductible plans) to
$100,000 or more (large deductible plans).
While a small deductible will give an insured employer a small
premium discount, a large deductible is really a partial selffunding mechanism for an employer, and can result in a 50%
reduction in premium or more. Since it is in essence, selffunding, there are generally requirements by the state for the
insured employer to post a bond as it would for true selffunding.
In a large deductible plan, it is important to note whether
defense costs are outside of the deductible or inside to be
covered by the insured.
Additional premium discounts are sometimes available based
solely on the total size of the premium.
Sometimes an insurance company will decide to offer a
premium debit or credit based on information about the safety
practices of the employer or other features of the workplace
that make it particularly likely or unlikely to suffer major
losses. The schedule rating maximum discounts are
determined by the rating bureau for the state. Schedule rating
is applied at the sole discretion of the insurer, and schedule
rating may be used on any size risk.
There are maximum percentages based on each type of
safety feature, and overall maximum credits or debits.
Schedule rating is applied after experience modifications
(which we will discuss in the next section), if any, but before
premium discounts.
Loss Sensitive Rating Plans
This is where the rating of workers compensation policies gets
complicated. There are several ways that the loss experience
of a single employer can be taken into account for determining
the right premium for that workplace. While we won’t discuss
the calculation of these in depth, it is important to know what
each of them does. The two main loss sensitive rating plans
are

Experience Rating

Retrospective Rating
It is important to note that these are not necessarily premium
discounts. The first two could actually result in an increase to
the manual premium. We will discuss each in turn.
Experience Rating
Experience rating is used to compare the employer’s loss
statistics to the average employer’s loss statistics in that
industry and make changes in premium accordingly.
Only employers of a certain size are eligible for experience
rating. Smaller employers do not have the loss experience
necessary to accurately predict future losses by past loss
experience. Most states require experience rating for all
eligible risks. These are often risks that generate $5,000 or
more in annual premiums.
Records are kept of each loss suffered by an employer under
workers compensation coverage. Because both injuries and
illnesses can be suffered over long periods of time, the loss
experience of an employer is reviewed for the past three
years.
It is important to know that the three years back start one year
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the manual premium
Apply experience rating credit
Apply schedule rating credit
Apply premium discounts
This assumes a risk that is not retrospectively rated. A
dividend might also apply to reduce the premium, but after the
policy period.
So for example, Primo Construction has 4 classifications, and
$2 million of payroll. After doing the math (multiplying the
manual rates to the “$100s of payroll”), it is determined that
the manual premium is $75,000. If you assumed an
experience rating credit of 10% (step 1), a schedule rating
credit of 15% (step 2), and a premium discount of 10% (step
3), the estimated premium might be calculated like this:

$75,000 x 10% = $67,500

$67,500 x 15% = $57,375

$57,375 x 10% = $51,637.50
There is one final step in the process which is an expense
cost or policy fee called the expense constant that is routinely
added to each policy. It is generally a few hundred dollars and
takes into account the policy processing expenses.
Most workers compensation policies are paid quarterly, but
larger amounts may be paid monthly. The insured employer
will make quarterly payments based on this estimated
premium amount. This amount will be reviewed after the end
of the policy period in a premium audit.
Premium Audits
Premium audits are made by the insurer several months after
the end of the policy period. By the language in the policy,
however, the insured has up to three years to do the premium
audit. The audit is intended to look at the insured’s payroll
records to determine two things:

Were the correct classifications used now that we
can see what risks really existed during the policy
period?

What was the real payroll amount for each
classification now that we can see the records for the
year?
The premium audit is done at the insured’s place of business
where an insurance company official called a Premium
Auditor, can examine the insured’s records directly. The
auditor will usually ask the insured employer to have ready
particular types of records including:

Job descriptions

Payroll documents (originals from the payroll service)
It is important to separate overtime from regular time
and make it easy to discount it back to straight time.

Certificates of Insurance from independent
contractors or subcontractors to prove they are
covered under their own policies
In addition, the Premium Auditor may want to talk to
individuals at the company to get an idea of whether their job
description adequately captures their duties for purposes of
assigning classifications.
Since payroll is estimated before the policy period, it is likely
that on audit it will be different, and the insured should expect
that change in premium.
What an insured or agent should review thoroughly is for
changes in the

Classification codes

Experience modification percentages

Schedule rating percentages
If changes have been made to any of these, they will
generally be made in the insurer’s favor. The insured has the
right to review the audit work papers and to appeal the
decision.
Declination of Coverage
Just like any other type of insurance, an insured can be turned
down or declined workers compensation coverage by a
private insurer. However, since workers compensation
coverage is mandatory in virtually all states, there has to be a
mechanism for providing coverage for employers who need it.
Typically, insurers decline coverage for one of three reasons:

Small or new businesses. It is hard for an insurer to
make sure it is charging enough for a very small or
new business.

High-risk industries. Insurers will often reject risks
such as construction risks or mining risks due to their
extraordinary high loss experience

High-risk businesses. Some individual businesses
have such a large history of workers compensation
losses as to make them uninsurable for private
insurers.
States must help these employers find coverage, and to do so
they have set up assigned risk plans, also called residual
markets or insurance pools.
Assigned Risk Plans provide workers compensation insurance
to employers who are unable to obtain coverage in the
voluntary market.
Assigned Risk Plans
Assigned risk plans for workers compensation are provided
through state compensation funds.
Proof of declinations (usually two or three) from private
insurers licensed to write workers compensation in the
insured’s state must be obtained for eligibility into the
assigned risk plan.
Pools for high-risk employers are paid for by a premium tax on
insurance companies doing business in the state. The
premium for assigned risk coverage is usually higher than for
coverage through private insurers. In addition, the assigned
risk plan also does not have as many safety programs or loss
reduction programs to help employers reduce their insurance
costs.
In some states, workers compensation assigned risk plans
have been established to guarantee that employers who have
had difficulty in finding coverage will be able to obtain
insurance. The assigned risk plan is actually an insurance
pool, where risks are shared by participating insurance
companies. Participation by authorized carriers in the state
may be mandatory or voluntary. An applicant may need to
show evidence of having attempted to obtain coverage, and
having been rejected, before becoming eligible for insurance
through the pool. Risks submitted to the pool may be
assigned to a single carrier, or may be shared proportionally
by all participating carriers. The requirements will vary from
state-to-state, and the pools do not exist in every state.
However, you should be aware that this mechanism exists,
and that its purpose is to make coverage available for difficult
to place risks.
Reducing Premiums
The most important step an employer can take to reduce
premiums is to do everything it can to avoid losses.
While some types of employment are clearly more hazardous
than others, there are outstanding examples in every field of
employers who have beaten the odds and maintained an
injury-free workplace.
A loss prevention plan must be part of each employer’s
strategic plan and include:

Safety training

Frequent workplace inspections for hazards

A system of open communications between
managers and others
It is important for the insured employer to assist the insurer in
keeping losses to a minimum and preventing benefit payment
fraud. The insured should look at loss runs – records of its
past loss experience – to see if benefits are being paid
inappropriately. The insured should be aware of injuries of the
same types to look for opportunities for loss prevention as
well.
Mistakes can be made in classifications, payroll, and
experience modifications. Both the agent and the insured



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Among the types of legislative reform to the system were:

New definitions for what was a workers
compensation injury

Not making it as easy to qualify for permanent
disability

Allowing for self funding

Allowing for employers to use managed care and in
some cases allowing employers to choose doctors
In 29 states, a worker has the right to choose his or her own
physician, but in 19 of those states, the employer can insist
that a worker choose only among physicians pre-selected by
the employer as medical practitioners who will keep costs
down. Illinois allows an employee to select his or her own
doctor.
Among the many benefits of managed care service is case
management. Case management is where one individual, the
case manager, follows a workers compensation claim case
from start to finish, helping select the best care providers as
the case progresses from hospitals to doctor’s visits to
rehabilitation. One of the reasons costs have gotten out of
hand has been that the employee was learning the system at
the same time as he or she was healing from an injury. The
case manager can direct the employee to best use the
system’s resources, but also with an eye to keeping costs as
low as possible.
Managed care systems have had a major impact in controlling
costs and returning injured workers to their jobs.
Return to Work Programs
A return to work program is another way employers can help
reduce the costs of workers compensation claims. The
quicker an employer can help an employee return to work, the
less the insurer will have to pay in disability benefits.
But return to work programs benefit employees as well.
Studies have shown that the longer an injured worker stays
away from the workplace, the harder it is to return. Things
change, and it is hard psychologically to face the changes and
get back into working again. Sometimes employees just don’t
think they can do it – they get used to thinking of themselves
as ill or injured. Encouraging employees and making it
possible for them to do productive work is an important job of
the employer.
Once an employee has recovered from the initial injury or
illness, it will be up to the case manager or social worker,
employer, and employee to set a strategy to return the
employee to work as soon as possible.
It is important to identify returning to work as a goal, even if
the employee can’t return immediately (or ever) to his or her
prior job.
First, it will be important to determine what the employee can
eventually do at maximum recovery, and what the employee
can do now. How do those things fit with the job description of
the employee’s former job? Will the employee eventually be
able to do all the duties of the job, just some of the duties of
the job, or none of the duties of the job?
If the employee will eventually be able to get back to his or her
old job, then a program might be designed to do other work,
or part of the job in the meantime, with meaningful weekly
goals for progress back to the old work.
If the employee will only eventually be able to do part of the
old job, then it might be important to look for alternative jobs in
the workplace, and for the employee to consider what type of
retraining might be needed to do that new job well.
Finally, if the employee can do none of the duties of the old
job, clearly, a new job will be part of a return to work program.
Communication between all parties is pivotal to success. The
case worker must continue to contact with the employee
beyond the rehabilitation stage and into the transition from
perhaps part-time into full-time work.
It is vital that all involved understand the sometimes enormous
psychological barriers that face an employee in adjusting to
their new, perhaps short-term or even long-term disability. The
employee may be concerned about just getting to work,
employer can watch to make sure these mistakes don’t lead
to higher premiums for the insured.
The most important thing an insured can do is to keep clear
and concise records of anything related to classifications and
payroll. It is also important to keep records of past premium
audits so that documented reasons for lower classifications
can be maintained.
Issues in Workers Compensation Today
In this section, we will talk about some of the issues facing
workers compensation insurers and insured’s today. Chief
among these issues is reducing costs by containing the
medical costs of injuries and returning employees to work as
soon as possible after an accident. Another method for
reducing costs to the employer has been to use employee
leasing, a controversial method of making workers
compensation coverage affordable. Finally, we will discuss the
potential abuses of the workers compensation system with
soft tissue and repetitive motion injuries and stress and
psychological injuries all of which are hard to diagnose and
hard to limit.
Workers Compensation Cost Issues
The pull between the costs of providing workers
compensation coverage and the benefit offered to injured
workers is the core issue driving the controversy between
employer and employees. From the employee side, it seems
that benefits are often reduced. While in truth disability
payouts have increased, many times they haven’t kept up with
the costs of living. Employees often also perceive that choices
have been reduced, such as the choice to see one’s own
doctor.
On the employer side, the cost of workers compensation
escalates every year. Workers compensation costs drive
some employers out of business. Workers file claims for new
types of injuries such as stress, and workers compensation
cost containment takes more and more of an employer’s time,
time taken away from running the business.
The legislatures and the courts are the arbiters between
employer and employee on a state level. States allow for
more and greater benefits to employees. When benefits are
higher than premiums can pay for, states allow insurers to
increase rates. Rate increases paid for by employers buying
mandatory workers compensation coverage are passed on to
consumers in higher costs of goods and services. When
states decide to limit rate increases, they find ways to cut
back on benefits and costs of workers compensation go down.
Then rates stay stable for a while until the cycle starts over
again.
Workers Compensation costs have always been cyclical.
During the early 1980s workers compensation costs more
than doubled. Some of the primary causes at that time were
rising medical costs, increases in benefits (such as mental
health care) and workers compensation fraud.
The early 1990s continued the cycle of benefit and rate
increases. Simply, the benefits cost more than the system can
bear.
Two of the major reasons for continuing cost increases are
medical costs and fraud, and the new concern about the costs
of future terrorist attacks.
Medical Costs
Studies have been done in almost every state regarding the
medical costs of providing workers compensation benefits
with this finding: that medical providers – doctors, hospitals,
and other medical care givers – charge more for services for
workers compensation cases than for other reasons for injury
or illness.
Because this could be documented, employers started to fight
back, and with the help of state legislatures.
State legislatures began to put a cap on what medical
providers could expect to be paid for workers compensation
related injuries and illnesses by allowing employers to use
managed care systems to reduce costs, much as they had to
reduce group healthcare costs beginning in the 1970s.
121

Labor Law compliance

Workers compensation

Human resources management

Benefits and benefits administration
Employee leasing started as a way of not having to pay
pension benefits to all employees, and as a way to
significantly reduce workers compensation costs.
Employers had long been looking for a way to get the benefits
of a tax qualified (deductible) pension plan, without having to
apply it to all employees. When the Tax Equity and Fiscal
Responsibility Act (TEFRA) took effect in 1982, it allowed
employers to exclude leased employees from pension plans,
with some caveats.
However, this abuse was short-lived when the 1986 Tax
Reform Act eliminated that loophole if more than 20% of a
company’s employees are leased.
The other reason for the immediate popularity of employee
leasing was as a way to reduce workers compensation
premiums. Employers who had seen their premiums rise
200% and more due to their poor loss experience could lease
their employees from a company with a good loss experience
and immediately and dramatically reduce their workers
compensation expense with no change in employees or their
own safety practices. This was clearly an abuse of the
system.
In addition, employees of the leasing firm would commonly be
misclassified into lower rate classifications, further decreasing
the premium with no corresponding decrease in risk exposure.
Although both of these abuses have been eliminated, there
were other good reasons to lease employees, and the
industry has grown exponentially. By 2002, there were 3,000
employee leasing firms providing professional employment
services and greater benefits to the employees of smaller
businesses. Among the benefits to employers are:

Peace of mind in knowing that the employer is in
compliance with all labor laws

More professionalism in dealing with employees by
highly trained professionals who would be too
expensive for smaller businesses to retain

Easier to hire and retain employees with better
benefits packages to offer

Access to better employee training programs,
including those focused on safety
Employers have had high expectations about reducing
workers compensation and other costs through the use of
PEOs that have largely not materialized. In addition,
employers must realize that they may become subject to
employment laws – such as the Family Leave Act – which
apply to “employers” of 50 employees or more. The leasing
company may be the actual employer, and with many more
than 50 employees, becomes subject to this Act and others.
Even with the leasing company as the actual employer, the
small business is left with the burden of accommodating
employees who are reaping the benefits provided by the Act.
The costs of using PEOs are not inconsequential, so any
savings in workers compensation may be eliminated with
other costs.
Fraud in the Workers Compensation System
Because the workers compensation system is intended to
provide comprehensive benefits to injured workers there are,
unfortunately, ways to abuse the system. Beyond abuse,
there is the possibility for fraud on both the employer and
employee side of the system.
Abuse of the system takes place when an employee takes
longer than necessary to return to work and receives more
disability compensation than truly deserved. Fraud, on the
other hand, is when an employer knowingly falsifies or
conceals information in order to buy insurance or to buy it for
a reduced premium. Fraud also takes place when an
employee claims to have an injury but really doesn’t, or claims
to have a serious injury when only a minor injury has
managing pain or inability to function well in the workplace.
The family may be concerned about the employee going back
to work “too soon”.
While the ultimate goal is for the employee to get back to his
or her prior job full-time, there are a number of steps that can
be taken before the employee is ready to do that. To be
considered are:

Part-time work, with time off to do rehabilitation
necessary

Old job but with modifications

Different job using some of the same skills as the old
job

Retraining for a completely new job

New job in the workplace
It is important for the employee to be back in the workplace; in
whatever way that employee can be helped to do so.
Integrated Disability Management
Another attempt to reduce the total costs of employee injuries
and illnesses has been to put health care coverage and
workers compensation together to get a merged system that
takes care of the employee regardless of the origins of illness
or injury. This is called integrated disability management (or
24-hour coverage) and combines:

Workers compensation

Short term disability

Long term disability
An integrated system removes the need to term an injury
work-related or not. It keeps the focus on providing the best
care to the employee and returning them to work as soon as
possible.
While integrating these coverages may be a way to reduce
some of the administrative paperwork involved in having three
different systems, it will not help an employer reduce workers
compensation claims unless it is part of an overall emphasis
on injury prevention through attention to safety in the
workplace. What it can do is bring all the safety education and
return to work philosophies that have traditionally been part of
workers compensation to the area of disability as well.
One key decision for a company considering integration of its
programs is how widely it offers short and long term disability
plans. Workers compensation must be available to all
employees, but disability programs are a benefit that is not
required by law. If a company believes in or has already
offered all or most employees short and/or long term disability,
integration may make sense.
A company must also be ready to devote resources to training
those individuals who work with employee benefits on
knowing how to deal with injured or disabled employees. Case
managers must understand how to look at job descriptions
and determine what employees are and are not able to do,
and how to create transitional programs for employees
returning to work.
Not all states yet allow this combination of coverages.
Currently, only 13 states allow workers compensation to be
combined with other health programs. California is the state
that has the most employers using Integrated Disability
Management.
Employee Leasing
Employee leasing became popular in the 1980s as a way to
reduce benefits and workers compensation costs. An
employee leasing firm is more appropriately called a
Professional Employment Organization (PEO).
To set up a professional employment organization
arrangement, the employer decides to outsource the human
resources function of the company. The employer is no longer
the employer, but a buyer of human resource services from
another company, the professional employment organization.
The PEO becomes the responsible party for all aspects of
providing what is required for employees, including:

Payroll

Payroll taxes
122
occurred.
The workers compensation fraud problem is much bigger than
most people realize. According to the National Insurance
Crime Bureau, workers compensation fraud costs the
insurance industry $5 billion annually.
Most states have anti-fraud laws. Individuals found guilty can
receive felony convictions with prison time, fines, and be
ordered to pay restitution. Most states also have antiinsurance fraud bureaus to tackle the problem. However,
unless particularly egregious, most workers compensation
fraud is not adequately prosecuted.
Fraud is often detected or suspected by workers
compensation appeals courts that deny claims that have been
denied by the insurer and then appealed at the state level. But
even if the appeals board believes a fraud has occurred, they
have no authority to pursue it.
Common ways that employers knowingly commit fraud:

Misrepresenting the work of employees to gain a
lower rate classification

Misreporting and/or falsifying records to show less
payroll than what was actual

Avoiding the consequences of poor safety records
and high injury rates by creating a new company for
the purposes of transferring employees
Common ways that employees knowingly commit fraud:

Faking an injury or illness

Claiming injury or illness is work-related when it is
not

Working at a new job while out on workers
compensation disability at another

Perpetrating a scheme with an attorney or medical
professional by billing for services never provided
Another problem for the workers compensation system is the
increase in hard to diagnose types of disorders found among
workers. These have classically been back problems, followed
by repetitive motion injuries such as carpal tunnel syndrome.
Stress and mental health problems then became more
prevalent and equally difficult to diagnose. Most recently have
been various non-descript disorders stemming from
exposures to chemicals.
Assuming that employees are not creating fraudulent claims,
how does the workers compensation system respond when
injuries or illnesses cannot be seen or properly diagnosed?
What if there isn’t a treatment because the illness can’t be
recognized?
HIPAA, Privacy and Medical Records
The Health Insurance Portability and Accountability Act
(HIPAA) contained privacy regulations went into effect April
14, 2003. These regulations limit the situations in which
medical providers may release patient information, unless the
information is necessary for the purpose of treatment,
payment or health care operations.
Most health care providers and others that deal with health
care records are required to limit disclosure of health
information to that which is the “minimum necessary”.
However, this standard does not apply to workers
compensation.
Terrorism
A major change in thinking about workers compensation
coverage occurred in the aftermath of the terrorist attacks of
September 11, 2001.
Most of the victims of the attacks in the World Trade Center
were at work, and therefore qualifying for workers
compensation benefits for injuries or death benefits for
spouses and children.
It is estimated that workers compensation benefits paid
because of the attacks of September 11 may ultimately be as
high as $5 billion. According to the Insurance Information
Institute, injured or disabled workers and survivors will receive
between $1.5 and $2.5 billion in income replacement benefits
from workers compensation and disability insurers. And unlike
other types of coverage, these claims will continue for many
years to come.
Workers compensation premiums have begun to rise in part
because of the realization that a terrorist attack could again
kill many workers in one location. Insurers now pay more
attention to the concentration of workers on one location,
especially high-risk locations such as lower Manhattan.
In 2002, the Terrorism Risk Insurance Act allowed insurers to
exclude terrorism coverage and then offer it at an additional
premium for most commercial lines of insurance. This is not
true for workers compensation, while the Act provides
financial assistance in the event of another major terrorist
attack, it does not change state requirements for workers
compensation insurers to provide coverage for both war and
terrorism in their policies. The Act requires disclosure to
policyholders about the federal program costs and benefits
and the NCCI has provided endorsements to the basic policy
to do that.
The Act defines the type of terrorism for which it will provide
financial assistance. The federal program does not provide
financial backing for acts of domestic terrorism or chemical,
biological, or nuclear attacks.
“Certified act of terrorism” means an act that is certified by the
Secretary of the Treasury, in concurrence with the Secretary
of State and the Attorney General of the United States, to be
an act of terrorism pursuant to the federal Terrorism Risk
Insurance Act of 2002.
The criteria contained in that Act for a “certified act of
terrorism” include the following:

The act resulted in aggregate losses in excess of $5
million; and

The act is a violent act or an act that is dangerous to
human life, property or infrastructure; and

Is committed by an individual or individuals acting on
behalf of any foreign person or foreign interest, as
part of an effort to coerce the civilian population of
the United States or to influence the policy or affect
the conduct of the United States Government by
coercion.
If a loss from terrorist activities occurs, and the total loss is
more than $5 million, the federal government begins to share
in the financial burden.
For losses above $5 million, and up to $100 billion, the insurer
pays a deductible and then the insurer pays 10% of the total
loss after the deductible. The federal government pays for
90% of the loss after the deductible. The government can
recoup these amounts over time with policyholder surcharges.
Losses that exceed $100 billion are considered beyond the
scope of either the insurer or the government and are not
covered.
Final Comments
Workers compensation coverage is much more complicated
than when it was initially devised almost one hundred years
ago. The types of medical claims, the risk for fraud, and the
new burden of international terrorism have made calculating
appropriate workers compensation premiums a challenge.
Workers compensation costs have a real effect on the
economy, particularly in the costs they add to a small
business. Workers compensation reform continues to be
discussed.
123
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(Use Pen or Pencil to Darken Correct Choice For Each Question)
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SECOND COURSE EXAM ANSWER SHEET
(Use Pen or Pencil to Darken Correct Choice For Each Question)
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