Congrats! You’ve made it to the final part of my AINS 101 series! If you want to review the process of obtaining the Associate of Insurance (AINS) certification, take a look at my previous post here. We are nearly through covering the AINS 101 course, which goes over the core basics of insurance. In my last post, we found out how insurers reach their customers. Let’s take a moment to give yourself a pat on the back before we jump into this next section – What Goes Into an Insurance Policy?
1. Ideally Insurable Loss Exposures
Ideally Insurable Loss Exposures
Some kinds of loss may, unfortunately, be entirely uninsurable. Floods are a good example of this. Let’s look at the characteristics of losses that are, indeed, insurable:
- Pure Risk – Subject to pure risk rather than speculative risk. The insured should not stand to gain from a risk.
- Fortuitous Losses – Subject to fortuitous loss from the insured’s standpoint
- Definite and Measurable – Subject to losses that are definite in time, cause, and location and that are measurable
- Large number of similar exposure units – One of a large number of similar exposure units
- Independent and not catastrophic – Not subject to a loss that would simultaneously affect many other similar loss exposures; not catastrophic
- Affordable – Premiums are economically feasible
Pure Risk
An ideally insurable loss exposure is associated with pure risk, not speculative risk. If you have been following this series, you will recall that pure risk is one of which will cause only loss or no loss while speculative risk is one of which could cause either loss, no loss, or gain.
Fortuitous
The next characteristic of an insurable loss exposure is it is fortuitous. In other words, it should occur by chance and not design. For a loss to be fortuitous, the insured cannot have control over whether or when a loss will occur. This discourages fraudulent claims from an insured who caused a loss.
Definite and Measurable
This characteristic defines losses to be definite in time, cause, and location. A car is insurable because damages to a car is easy to see (definite) and the costs of damage can be calculated (measurable). Another example is life insurance, as the cause and time of death can normally be determined (definite) and the costs (often the person’s yearly salary * 1.5) is measurable.
One of a Large Number and Independent
Homes, offices, and automobiles satisfy this requirement as these units belong to many different individuals and individual companies.
Independent and Not Catastrophic
Tying into the previous characteristic, this one defines a loss that is independent and not tied to another insured unit. For instance, a home that has caught on fire will often only affect a single insured or group of insured.
Catastrophic loss is severe and involves numerous exposure units suffering from the same type of loss simultaneously with significant financial consequences for the insurer. As floods could affect many insureds, it could bring an insurer to financial breakage, and thus, this is why floods are often not coverable.
Affordable
Affordability is important in obtaining and retaining customers. The insured must be able to be afford to pay for their service, and so insurers cover only loss exposures that are economically feasible to insure.
Because of this, loss exposures involving only small losses as well as those involving a high probability of loss are generally considered uninsurable as it would be too costly for the customer.
2. Characteristics of Insurance Policies
All insurance policies are contracts, but not all contracts are insurance policies. Thus, insurance policies have all the aspects of a contract, but also more. (If you’re a programmer, you can think of insurance policies as a child or subclass of a contract superclass!) Here are what makes insurance policies unique:
- Contract of indemnity
- Contract of utmost good faith
- Contract involving fortuitous events and the exchange of unequal amounts
- Contract of adhesion
- Conditional contract
- Nontransferable contract
Contract of Indemnity
Indemnity is the restoration of a party who had a loss to the same financial position that the party held before the loss occurred. An insurance contract may not always pay the full amount to restore an insured, but the amount an insurer pays directly relates to the amount of the insured’s loss.
To prevent abuse of the insurance system, policies contain certain provisions. For instance, most policies specify a maximum limit that the insurer will pay for a single claim. They also contain various provisions to clarify that the insured cannot collect more than the amount of the loss to prevent the insured from profiting from a loss. An “other insurance provision” prevents the insured from receiving full payment from two different insurance policies for the same claim.
Utmost Good Faith
This contract requires that both the insurer and insured are ethical in their dealings with each other.
Fortuitous Events and the Exchange of Unequal Amounts
Insurance contracts involve an exchange of unequal amounts. Let’s illustrate this with an example:
Let’s say an insurer charges $1,000 annual premium to insure a vehicle valued at $20,000. There are three situations that may occur:
- The car is not damaged throughout the policy period – the insurer pays nothing.
- The car is partially damaged – the insurer pays the cost of repairs after subtracting a deductible.
- The car is a total loss – the insurer pays the entire value of the car minus the deductible.
The policy premium reflects the insured’s proportionate share of the total amount the insurer expects to pay to honor its agreements with all insureds having similar policies.
Conditional Contract of Adhesion
Unlike other contracts, an insurance policy is a conditional contract of adhesion. The insured must adhere to the contract drafted by the insurer.
An insurance policy is a conditional contract because the parties have to perform under certain conditions. Before an insurer pays out a claim, a covered loss must have occurred and the insured must fulfill certain duties beforehand, such as giving prompt notice to the insurer after a loss has occurred.
Nontransferable
Once an insurance policy is in effect, an insured cannot transfer the policy to another party because the insurer may not want to insure the other party. Most insurance policies contain a provision that requires the insurer’s written permission before an insured can transfer a policy to another party.
3. Insurance Policy Structure
An insurance policy serves as a guide to insureds. Oftentimes, if an insured is unsure about something regarding their coverage, they should check their policy first.
Types of Policy Forms
- Preprinted or Manuscript – Most policies are issued on preprinted forms, but insurers develop specific policies called manuscript forms when needed for certain customers.
- Preprinted forms are usually developed by advisory organizations, such as the Insurance Services Office (ISO) and the American Association of Insurance Services.
- An insurer or insurance broker may draft manuscript forms for customers that require special, customized policies and terms.
- Self-contained or Modular – Policies may be self-contained as they’re made up of one document or modular if they consist of several different documents.
- An insurer may suggest a self-contained policy to a client who needs a type of coverage common to a large number of insureds as their needs are often similar.
- Modular policies are used for customers who need a variety of coverages that may not be common to a large number of insurance.
What Other Documents Can a Policy Contain?
Documents that are not part of an insurance form may also become part of a policy, such as the insured’s application, endorsements, bylaws, and statutes.
4. Insurance Policy Provisions
Let’s see how insurance policies are constructed. An insurance policy is a collection of policy provisions, which contain the following:
- Who’s covered by the policy
- What is and is not covered by the policy
- What types of loss the policy covers
- What the keywords in the policy mean
- How much an insurer must pay in the event of a covered loss
- What duties both the insurer and insured have under the policy
An insurance policy is structured with a snapshot of the coverage and then a fuller explanation of the coverage in more detail.
Breaking Down the Provisions
These are the five main provisions of every insurance policy:
- Declarations
- Definitions
- Insuring agreement
- Policy conditions
- Policy exclusions
The Declarations, Definitions, and Insuring Agreement
These three things form the core of every insurance policy.
The declarations are usually the first page of an insurance policy. They personalize a policy by outlining who or what is covered and when and where coverage applies.
The definitions section defines policy terms and is usually located near either the beginning or the end of the policy. Its function is to help consumers understand the policy and to reduce potential confusion.
The insuring agreement states the insurer’s promises to the insured. Its function is to introduce a coverage section with a summary of what the insurer will do. There may be more than one insuring agreement.
Conditions and Exclusions
An insurer does not have to fulfill its promise to pay for covered losses if the insured does not adhere to the rules laid out in the policies conditions section, some of which include paying premiums, reporting losses promptly, and cooperating with the insurer.
Exclusions state what the policy does not cover, and may be used by insurers to eliminate coverage for uninsurable loss exposures, to discourage insured from intentionally causing a loss, to reduce duplicate coverage, to eliminate unnecessary coverage, and to eliminate coverages that need special treatment.
Property Policy Provisions
A property insurance policy compensates an insured who suffers a financial loss because property has been lost, stolen, damaged, or destroyed.
A policy must identify which property loss exposures are covered, including the types and locations of property, cause of loss, and financial consequences that are covered. It should also indicate which parties are covered and how much an insurer will pay in the event of a loss.
Liability Policy Provisions
Liability policy provisions promise to pay for damages for bodily injury or property damage for which an insured becomes legally liable and to which the coverage applies. The insurer will also need to pay for defense costs if necessary. The provisions must address the following:
- Covered activities
- Covered types of injury and damage
- Excluded loss exposures
- Covered costs
- Covered time period
- Covered parties
- Amounts of recovery
5. Conclusion
There we have it, folks. I hope you learned as much about insurance as I did! If you are working on your AINS certification, good luck! If not, well I applaud you for being interested in insurance because I don’t know if I could read through all of this if I wasn’t in the industry. Either way, thanks for sticking it through with me! 🙂