Opener

• It is important to expect nothing, to take

every experience, including the negative
ones, as merely steps on the path, and to
proceed.

Ram Dass Quote

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Chapter 10
Analysis of
Insurance
Contracts

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Agenda

• Basic parts of an insurance contract

• Definition of the “Insured”
• Endorsements and Riders
• Deductibles
• Coinsurance
• Other-insurance provisions

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Basic Parts of an Insurance Contract
– Declaration
– Definitions
– Insuring agreement
– Exclusions
– Conditions
– Miscellaneous provisions

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Declarations

• Declarations are statements that provide

information about the particular property or activity
to be insured
– Information contained in the declarations section is used
for underwriting and rating purposes and for
identification of the property or activity to be insured.
– Usually the first page of the policy
– In property insurance, it contains name of the insured,
location of property, period of protection, amount of
insurance, premium and deductible information

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Definitions

• Insurance contracts typically contain a page

or section of definitions
– For example, the insured is referred to as “you”

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Insuring Agreement

• The insuring agreement summarizes the major

promises of the insurer
– The two basic forms of an insuring agreement in property
insurance are:
• Named perils policy:
– Only those perils specifically named in the policy are covered.
– The burden of proof is on the insured to show that loss was
caused by a named peril.
• “All-risks” policy:
– All losses are covered except those losses specifically
excluded.
– To deny payments the insurer must prove that the loss is
excluded.

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Exclusions

• Insurance contracts contain three major

types of exclusions
– Excluded perils, e.g., flood, intentional act
– Excluded losses, e.g., failure of an insured to
protect the property from further damage after a
loss occurs is excluded in the homeowners
policy
– Excluded property, e.g., pets are not covered as
personal property in the homeowners policy

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Exclusions (cont)

• Exclusions are necessary because:

– Some perils are not commercially insurable
• e.g., catastrophic losses due to war
– Extraordinary hazards are present
• e.g., using the automobile for a taxi
– Coverage is provided by other contracts
• e.g., use of auto excluded on homeowners policy
– Moral hazard is present or it would be difficult to measure the
amount of loss
• e.g., coverage of money limited to $200 in homeowners policy
– Coverage not needed by typical insureds
• e.g., homeowners policy does not cover aircraft

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Conditions

• Conditions are provisions in the policy that qualify

or place limitations on the insurer’s promise to
perform
– If policy conditions are not met, insurer can refuse to
pay the claim

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Miscellaneous provisions

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Definition of the “Insured”

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• An insurance contract must indicate the persons or
persons from whom the protection is provided
– Some policies insure only one person, e.g., most life
insurance policies
– The named insured is the person or persons named in
the declarations section of the policy
– A policy may cover other parties even though they are
not specifically named
• e.g., the homeowners policy covers resident relatives under age
24 who are full-time students away from home

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Endorsements and Riders
• In property and liability insurance, an endorsement
is a written provision that adds to, deletes from, or
modifies the provisions in the original contract
– e.g., an earthquake endorsement to a homeowners
policy
• In life and health insurance, a rider is a provision
that amends or changes the original policy
– e.g., a waiver (miễn trừ)-of-premium rider on a life
insurance policy

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Deductibles
• A deductible is a provision by which a specified amount is subtracted from the total
loss payment that otherwise would be payable
• The purpose of a deductible is to:
– Eliminate small claims that are expensive to handle and process
– Reduce premiums paid by the insured
• Under the large loss principle, insurance should pay for high severity losses;
small losses can be budgeted out of the person’s income
– Reduce moral and morale hazard

Note: Dedictibles = $4000

If cost of loss < 4000
-> the insurer will not pay
If cost of the loss = $6500
-> the insurer pays 2500 only

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Deductibles
• With a straight deductible, the insured must pay a certain amount before the insurer makes a loss payment
– e.g., an auto insurance deductible
• An aggregate deductible means that all losses that occur during a specified time period are accumulated to
satisfy the deductible amount

Aggregave deductibles
If in the period a year (12 months)
Aggregate deductibles = $10000
If: In Jan: loss= $3000
In June: loss= $ 1,200
In Dec: loss= $2,800
= $7000
-> the insurer will not pay

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Deductibles in Health Insurance

• A calendar-year deductible is a type of aggregate

deductible that is found in basic medical expense
and major medical insurance contracts
• A corridor deductible is a deductible that can be
used to integrate a basic medical expense plan
with a supplemental major medical expense plan
• An elimination (waiting) period is a stated period of
time at the beginning of a loss during which no
insurance benefits are paid

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Coinsurance
• A coinsurance clause in a property insurance contract
encourages the insured to insure the property to a stated
percentage of its insurable value
– If the coinsurance requirement is not met at the time of the loss, the
insured must share in the loss as a coinsurer

Amount of insurance carried

x Loss  Amount of recovery
Amount of insurance required

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Coinsurance

• The purpose of coinsurance is to achieve

equity in rating
– A property owner wishing to insure for a total
loss would pay an inequitable premium if other
property owners only insure for partial losses
– If the coinsurance requirement is met, the
insured receives a rate discount, and the
policyowner who is underinsured is penalized
through application of the coinsurance formula

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Exhibit 10.1 Insurance to
Full Value

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Exhibit 10.2 Insurance to Half
Value

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Coinsurance in Health Insurance

• Health insurance policies frequently contain

a percentage participation clause
– The clause requires the insured to pay a certain
percentage of covered medical expenses in
excess of the deductible
– The purpose is to reduce premiums and prevent
overutilization of policy benefits

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Other-insurance Provisions

• The purpose of other-insurance provisions is to

prevent profiting from insurance and violation of the
principle of indemnity
– Under a pro rata liability provision, each insurer’s share of
the loss is based on the proportion that its insurance
bears to the total amount of insurance on the property
– Under contribution by equal shares, each insurer shares
equally in the loss until the share paid by each insurer
equals the lowest limit of liability under any policy, or until
the full amount of the loss is paid

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Exhibit 10.3 Pro Rata Liability
Example

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Exhibit 10.4 Contribution
by Equal Shares (Example 1)

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Exhibit 10.5 Contribution
by Equal Shares (Example 2)

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Other-insurance Provisions
– Under a primary and excess insurance
provision, the primary insurer pays first, and the
excess insurer pays only after the policy limits
under the primary policy are exhausted
– The coordination of benefits provision in group
health insurance is designed to prevent
overinsurance and the duplication of benefits if
one person is covered under more than one
group health insurance plan
• e.g., two employed spouses are insured as
dependents under each other’s group health
insurance plan
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End

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