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    Principles of Insurance: Life, Health & Annuities Page 1 of 110

    Dated: 26th Feb, 2003


    CHAPTER 1: INTRODUCTION AND INDIVIDUAL LIFE INSURANCE ...................... 2 CHAPTER 2: REGULATION OF THE INSURANCE INDUSTRY .................................. 4 CHAPTER 3: INTRODUCTION TO RISK AND INSURANCE ....................................... 8 CHAPTER 4: MEETING NEEDS FOR LIFE INSURANCE ........................................... 13 CHAPTER 5: THE INSURANCE POLICY ..................................................................... 17 CHARTER 6: PRICING LIFE INSURANCE. ................................................................. 20 CHAPTER 7: TERM LIFE INSURANCE........................................................................ 24 CHAPTER 8: PERMANENT LIFE INSURANCE AND ENDOWMENT INSURANCE 28

    CHAPTER 9: SUPPLEMENTARY BENEFITS .............................................................. 35 CHAPTER 10: LIFE INSURANCE POLICY PROVISIONS ........................................... 41 CHAPTER 11: LIFE INSURANCE BENEFICIARY POLICIES ..................................... 47 CHAPTER 12: ADDITIONAL OWNERSHIP RIGHTS .................................................. 48 CHAPTER 13: PAYING LIFE INSURANCE POLICY PROCEEDS. ............................. 56 CHAPTER 14: PRINCIPLES OF GROUP INSURANCE POLICY ................................. 60 CHAPTER 15: GROUP LIFE INSURANCE. .................................................................. 64 CHAPTER 16: ANNUITIES AND INDIVIDUAL RETIREMENT SAVINGS PLANS ... 68

    CHAPTER 17: GROUP RETIREMENT AND SAVINGS PLAN. ................................... 78 CHAPTER 18: MEDICAL EXPENSE COVERAGE ....................................................... 83 CHAPTER 19: DISABILITY INCOME COVERAGE. .................................................... 87 CHAPTER 20:TRADITIONAL GROUP HEALTH INSURANCE PLANS ..................... 91 CHAPTER 21: TRADITIONAL INDIVIDUAL HEALTH INSURANCE POLICIES ..... 97

    CHAPTER 22: MANAGED CARE PLANS .................................................................. 102 CHAPTER 23: REGULATION OF HEALTH INSURANCE ........................................ 106 Principles of Insurance: Life, Health & Annuities Page 2 of 110

    Dated: 26th Feb, 2003


    Insurance companies are organized as either

     Stock Insurance companies

    Company has stock that is bought by shareholders. So company is owned by shareholders. These shareholders get dividends.

    No. of companies: 1604

    Income from Premium: 226 billion

    Dollar amount of Life Insurance in force: 9.8 trillion

     Mutual Insurance companies

    This type of company is owned by its policy owners. Policy owners receive dividends out of operating profits.

    No. of companies: 91

    Income from Premium: 127 billion

    Dollar amount of Life Insurance in force: 6 trillion

     Fraternal Benefit companies

    Provided by a society to its members who share a common ethnic, religious etc. background. No. of companies: 135

    Income from Premium: 4.1 billion

    Dollar amount of Life Insurance in force: 238 billion ? Members must select the officers of the

    Fraternal society ? Operate under a lodge system ; where only lodge members and their

    families cvan own fraternal societyˇs insurance.


    It is harder to raise money being mutual insurance companies. So most companies start as stock company and then convert to mutual companies when they have enough funds. This process of converting from share insurance company to Mutual Insurance Company is called mutualization. Why Mutualization?

    Demutualization: Self explanatory. Why Demutualization?

    Home office: Headquarter of Insurance Company.

    Home office

    Field office also known as Branch office or agency office.

    Reg. Off

    Reg. Off

    Reg. Off

    Field Off

    Field Off

    Field Off

    Principles of Insurance: Life, Health & Annuities Page 3 of 110

    Dated: 26th Feb, 2003

    Insurance companies are financial intermediaries.

    A financial intermediary is an organization which uses surplus amount of savers ( for insurance company it is premium) and invests that in other sectors.

    Individual and Group Insurance:

    Individual Insurance covers individuals where as Group Insurance covers a group of people. Life Insurance:

    A policy where insurance company provides some benefits if insured person dies. They are of 3 types.

    ? Term Insurance:

    Pays benefit if insured dies within the covered time period. No cash value ? Permanent Insurance:

    Provides coverage throughout insuredˇs lifetime.

    Cash value available

    ? Endowment Insurance:

    Is similar to Term since pays benefit if insured dies while covered or till a stated date. Has cash value available.


    Annuity is a series of periodic payments. If insuredˇs die then instead of paying a lump some benefit to the nominees, it can be spaced out in equal installments.

    An Annuity can also be a contract under which an insurance company promises to make a series of periodic payments to a named individual in exchange for a premium or series of premiums.

Health Insurance:

    Protection towards sickness, accident and disability.

    Types of coverage:

     Medical expense coverage:

    o Hospital expense

    o Surgery expense

    o Physician expense

    Specified expense coverage:

     Long Term care: like for old people who need constant care and treatment Dental coverage

     Prescription Drug

     Vision care

     Dread disease coverage

     Critical illness coverage

    Principles of Insurance: Life, Health & Annuities Page 4 of 110

    Dated: 26th Feb, 2003


    Every business must comply with several federal, state and provincial laws so that it operates in a fair manner.

    Insurance Regulation requires that the Insurance companies remain:

    1. Solvent: They are able to meet their debts and to pay policy benefits when they come due 2. Conduct business fairly and ethically

    USA Regulations

    According to the McCarran-Ferguson Act (Public Law 15), regulations are made by State Government until the regulation made is adequate. If not, Congress interferes. Constitutional authority remains with Federal government

     State Government owns primary authority.

    State regulations

    State Insurance administration is governed by State Insurance Department (SID) under an Insurance Commissioner or State Superintendent of Insurance. SID ensures that the companies within the state comply with all state insurance laws and regulations. Most state regulations are similar in nature since they are based on a model by National Association Insurance Commissioners (NAIC). NAIC is a non-governmental organization consists of all state Insurance Commissioners. The NAIC develop model bill, a sample law that state insurance regulators are encouraged to use as a basis of state laws.

    To start business in a state, any insurance company requires two certificates: Certificate of incorporation or corporate chapter: issued by state, required for any corporation to start its business in a state

     Certificate of authority or license: Issued by SID, only for insurance companies Solvency Regulation

    As per this regulation, the SID imposes a minimum limit on the amount of assets, liabilities and on ownersˇ equity.

    Assets = Liabilities + Ownersˇ Equity

    Assets: Cash and Investment

    Liabilities: Debts and future obligations (Policy reserves shares the large portion of liabilities for a insurance company)

    Ownersˇ Equity: Capital + Surplus (Capital is the money invested in the company by its owners, zero in case of a mutual insurer)

    Principles of Insurance: Life, Health & Annuities Page 5 of 110

    Dated: 26th Feb, 2003

    The states oversee the Annual Statement, which each insurer prepares each calendar year and files with SID. This is the accounting report of a company. The NAIC has developed the format of this statement that is accepted by all state.

    Also the state regulators conduct an on-site examination to manually check the insurerˇs

    business records, usually on every 3 to 5 yrs. In case an insurer becomes financially unsound, the State Insurance Commissioner have the authority to take certain actions:

    In case of domestic insurer (incorporated by the state): It can rehabilitate or liquidate, depending on the condition of the company.

    In case of a foreign insurer (incorporated under the laws of another state): Revoke or suspend the insurerˇs license to operate in the state.

    Life and Health Guaranty Association: An organization that operates under the supervision of the SIC to protect policy owners, beneficiaries and specified others against losses that may occur in case of insolvency. This association provides funds to guarantee payment for certain policies up to stated limits.

    Regulation of Market Conduct

    Market Conduct Laws: This law regulates how insurance companies conduct their business within the state. As per this law, they perform periodic market conduct examinations of the insurers. Marketing of Insurance products: In order to obtain an agentˇs license, a prospective agent must

     Be sponsored for licensing by a licensed insurance company

     Complete approved educational course work/ or pass a written examination

     Provide a reputable character certificate

    The agentˇs license must be typically renewed each year. A state may revoke a license if he/she engages in certain unethical practices and violates the stateˇs insurance laws.

    Policy Forms:

    It is a standardized contract forms that shows the terms, conditions, benefits and ownership rights of a particular insurance product. An insurance company must file this forms and receive the SIDˇs approval before launching a new product. SID may ask the company to revisit the form for reducing jargons so that it could be clearer to the general public.

    Federal Regulations

     This applies to the sale of investment type insurance product. Businesses that sell

    securities must comply with Securities and Exchange Commission (SEC). Ex: Variable life insurance, Variable annuities Before selling these products, the sales agent must be

    registered with the National Association of Securities Dealership (NASD). Employee benefit

    plans must comply with the terms of Employee Retirement Income Security Act (ERISA). Principles of Insurance: Life, Health & Annuities Page 6 of 110

    Dated: 26th Feb, 2003

    CANADA Regulations

    Unlike a US insurance company, a Canadian company may be incorporated under the authority of

either the Fed government or one of the provincial governments.

    Federal Regulations

    The Insurance Companies Act is the primary Federal law that governs specified insurance companies operating in Canada.

    Companies that must comply with this act are:

    Federally incorporated insurers, Foreign insurers (insurers incorporated in countries other than Canada) and specified provincially incorporated insurers.

    Office of the superintendents of financial institutions (OSFI): A federal agency that is responsible for overseeing all financial institutions in Canada including all life and health insurance companies. This institute runs under the direction of Superintendents of financial institutions (SFI). Every insurance company must file an Annual Return with the OSFI. This gives the financial statement of the company. OSFI also examine financial conditions of a company on a periodic basis (usually on every 3 year, but it may be anytime)

    SFI may take control or declare a company as insolvent or obtain a court order to liquidate to company if finds it financially unsound.

    Canadian Life and Health Insurance Association (CLHIA): An industry association of life and health insurance Company operating in Canada.

    Canadian Life and Health Insurance Compensation Corporation (CompCorp): It is a federally incorporated, non-profit company established by CLHIA to protect Canadian consumers against loss of benefits in the event of a life and health insurance company becomes insolvent. CompCorp collects money from all its member companies to fund these guaranteed payments. Provincial Regulations

    In most respects, laws to regulate insurance companies operating in different provinces are similar in all provinces except from Laws of Quebec. This is because the Quebec law is based on a Civil Law system but other jurisdictionsˇ laws are based on a common law system.

    Office of the Superintendent of Insurance: An administrative agency, established in each province to enforce the provinceˇs insurance laws and regulations. It operates under the direction of an individual known as the Superintendent of Insurance.

    The various provincial Superintendents of Insurance have voluntarily formed a collective body known as the Canadian Council of Insurance Regulators (CCIR). The purpose of CCIR is to discuss insurance issues and to recommend uniform insurance legislation to the provinces. Principles of Insurance: Life, Health & Annuities Page 7 of 110

    Dated: 26th Feb, 2003

    The CCIR has adopted Superintendentsˇ Guidelines, a series of recommendations that concerns a variety of matters. These guidelines were developed in cooperation with the insurance industry, working through its industry association, the CLHIA.

    Solvency Regulation

    These laws require the Office of the Superintendent of Insurance to supervise companies that were incorporated by the province and to examine those companies periodically. Also the insurance company should obtain a license from the office to start business in a particular province. Most of the licensing requirements seek to ensure that insurance companies are financially able to provide the benefits they promise to pay when they issue insurance policies. Regulation of Market Conduct

    Unlike requirements in the US, however the provinces do not require that all policy forms be filed

    before being issued but the insurers are required to file policy forms in only two situations: 1) As a condition of obtaining a license to conduct an insurance business within the province 2) Before marketing a variable life insurance contract in the province

    The provinces also regulate many of the marketing activities of the companies to: 1) Prohibit from unfair trade practices, false or misleading advertisement 2) Agent should get the license form the state before marketing in that state. The licensing requirements are similar to requirements in the United States.

    Principles of Insurance: Life, Health & Annuities Page 8 of 110

    Dated: 26th Feb, 2003


    Concept of Risk:

    Risk exists when there is uncertainty about the future.

    Types of Risk:

    Both individual and businesses experience 2 kinds of risk.

    a) Speculative risk.

    b) Pure risk.

    What is speculative risk?

    This involves 3 possible outcomes: loss, gain or no-change.

    Example: Your purchase shares of stock. This is a speculative risk you are taking. If the value of the stock raises you gain.

    If the value of the stock falls you lose.

    If the value of the stock remains the same there is no change.

    What is pure risk?

    This involves no possibility of gain. Either there is a loss or no loss occurs. Example: The possibility of a professional getting physically disabled. If the disability renders the professional incapable of continuing in his profession, he suffers from a financial loss. If the professional does not get disabled he will incur no loss from that risk.

    Which type of risk is insurable and why?

    Pure risk is insurable. Speculative risk has the possibility of financial gain. The purpose of insurance is to compensate for financial loss. Hence speculative risk is not insurable. Risk Management:

    Risk management involves identifying and assessing the financial risks we face. In order to eliminate or reduce our exposure to a specific financial risk we may choose any of at least 4 options: -

    a) Avoiding risk

    For example: One can avoid the risk of personal injury that may result from an air crash by avoiding travel by airplane.

    b) Controlling risk

    We can try to control risk by taking steps to prevent or reduce losses.

    For example: A shop owner might control the risk of suffering financial loss due to his shop burning down by installing fire extinguishers and banning smoking inside the shop. Principles of Insurance: Life, Health & Annuities Page 9 of 110

    Dated: 26th Feb, 2003

    This way he reduces the likelihood of a fire breaking in his shop and also lessens the extent of

damage in case of a fire.

    c) Accepting risk

    When an individual or a business assumes all the financial responsibility for a risk. Self-insurance

    This is a risk management technique by which a person or business accepts the financial responsibility for financial losses associated with a particular risk.

    d) Transferring risk

    When the financial responsibility for an associated risk is transferred from one party to another (generally in exchange of a fee), it is called transferring of risk.

    A most common example is purchasing an insurance coverage.


    Written document that contains the terms of the agreement between the insurance company and the owner of the policy. This is a legally enforceable contract.

    Policy benefits or policy proceeds

    The amount of money that the insurance company agrees to pay ; when a specific loss

    covered by that policy occurs.


    The fee that the insurance company takes from the owner of the policy in exchange of assuming the financial responsibility for losses incurred, if the specific risk covered by the policy occurs. What are the three types of pure risks that are generally covered by insurance companies? Property damage risk: risk of economic loss to your automobile, home or other personal belongings due to accident, theft, fire or natural disaster. Property insurance covers a property damage risk.

    Liability risk: risk of economic loss resulting from you being responsible for harming others or their property. Liability insurance covers a liability risk.

    Property and Casualty insurance or Property and Liability insurance

    Covers a property risk as well as a liability risk. The insurance company offering such insurance is called a Property and Casualty insurer or a Property and Liability insurer.

    Personal risk:

    Risk of economic loss associated with death, poor health, outliving oneˇs savings. Life and health

    insurers sell insurance policies to provide financial security from personal risk. Principles of Insurance: Life, Health & Annuities Page 10 of 110

    Dated: 26th Feb, 2003

    How an insurance company can afford to be financially responsible for the economic risks of its insureds?

    Insurers use a concept called risk pooling. If the economic losses that actually result from a given peril, such as disability, can be shared by large numbers of people who are all subject to the risk of such losses and the probability of loss is relatively small for each person, then the cost to each person will be relatively small.

    Characteristics of Insurable risks:

    1) The loss must occur by chance. (Unexpected event, not intentionally caused by the person covered) 2) The loss must be definite. (In terms of time and amount)

    3) The loss must be significant. (In financial terms)

    4) The loss rate must be predictable. (The probable rate of the loss must be predictable)

    5) The loss must not be catastrophic to the insurer. (A single or few occurrence of the loss must not cause or contribute to catastrophic financial damage to the insurer)

    Classification of policies:

    Depending on the way in which a policy states the amount of the policy benefit, every insurance policy can be classified as being either of the following:

    Contract of indemnity: amount of the policy benefit payable for a covered loss is equal to the amount of the covered financial loss determined at the time of the loss or a maximum amount stated in the contract, whichever is less.

    Example: Many types of health insurance policies.

    Valued Contract: specifies the amount of benefit that will be payable when a covered loss occurs, regardless of the actual amount of the loss that was incurred.

    Example: Most life insurance policies.

    Some other important terms:

    Face amount: The amount of the benefit that is listed in the policy.

    Claim: The request for payment under the terms of the policy.

    Law of large numbers: It states that, typically, the more times we observe a particular event, the more likely is it that our observed results will approximate the ?true probability that the

    event will occur.

    Mortality tables: Charts that indicate to a great degree of accuracy the number of people in a given group (of 100,000 or more) who are likely to die at each age.

    Morbidity tables: Charts that indicate to a great degree of accuracy the incidence of sickness and accidents, by age, occurring among a given group of people.

    Reinsurance: is the insurance that one insurance company- known as the ceding company-sells to another insurance company-known as the reinsurer.

    Principles of Insurance: Life, Health & Annuities Page 11 of 110

    Dated: 26th Feb, 2003

    Retention limit: The maximum amount of insurance that the insurer is willing to carry at its own risk on any one life without transferring some of the risk to a reinsurer.

    Retrocession: When a reinsurer cedes risks to another reinsurer then that transaction is called a retrocession. The reinsurer to which the risk has been ceded is called a retrocessionaire. People who are involved in the creation and operation of an insurance policy

    Applicant: The person or business that applies for an insurance policy.

    Policy owner: The person or business that owns the insurance policy.

    Insured: The person whose life or health is insured under the policy.

    Third-party policy: When one person purchases insurance on the life of another person. Beneficiary: The person or party the policy owner named to receive the policy benefit. Assessing the Degree of Risk

    Underwriting: This is the process of identifying and classifying the degree of risk represented by a proposed insured. There are 2 primary stages in this process:

    1) Identifying the risks that a proposed insured presents.

    2) Classifying the degree of risk that a proposed insured represents.

    Underwriter: The employee of the insurance company who is responsible for underwriting. Identifying risks

    Insurers cannot predict when a specific individual will die, become injured, or suffer from illness.

    But there are a number of factors that can increase or decrease the likelihood that an individual will suffer a loss.

    The most important of these factors are the following:

    Physical hazard: Physical characteristic that may increase the likelihood of a loss. Example: A person with a history of heart attacks possesses a physical hazard that will increase the likelihood that the person will die sooner than a person of the same age group and sex without such a physical hazard.

    Moral hazard: The likelihood that a person may act dishonestly in the insurance transaction. Example: An individual with a confirmed record of illegal behavior is more likely to defraud an insurer than is a person with no such records.

    Classifying risks

    The purpose of classifying a proposed insured into an appropriate risk category is to enable the insurer to determine the equitable premium rate to charge for the requested coverage. Underwriting guidelines: Rules of risk selection that are applied by underwriters to classify proposes insureds. The insurer establishes these guidelines.

    Principles of Insurance: Life, Health & Annuities Page 12 of 110

    Dated: 26th Feb, 2003

    Generally the risk categories that are identified by all underwriting guidelines are: a) Standard risks: Proposed insureds that have the likelihood of loss that is not significantly greater-than-average. Premium rates that they are charged are standard premium rates. b) Substandard risks: Proposed insured who have significantly greater ;than- average likelihood

    of loss but are still found insurable. This category is called special class risks. Premium rates that they are charged are higher and are called the substandard premium rate or special class rate. c) Declined risk: Proposed insureds that are considered to present a risk that is too great for the insurer to cover.

    d) Preferred risks / Super Preferred risks: Proposed insureds that present a significantly less-than-average likelihood of loss. They are generally charged a lower than standard premium rate.

    Insurable Interest Requirement

    Laws in all states and provinces require that when an insurance policy is issued the policy owner must have an insurable interest in the risk that is insured- the policy owner must be likely to suffer a genuine loss or detriment should the event insured against occurs.

    Insurable interest requirement in health insurance

    For health insurance an insurable interest exists if the applicant can demonstrate a genuine risk of economic loss should the proposed insured require medical care or become disabled. Insurable interest requirement in life insurance

    An insurable interest exists when the policy owner is likely to benefit if the insured continues to live and is likely to suffer some loss or detriment if the insured dies.

    The figure below shows the family tree of a certain insured. The circles in the bold outline depict the relationships that create an insurable interest in the life of the insured. Grandfather









    Childˇs spouse







    Principles of Insurance: Life, Health & Annuities Page 13 of 110

    Dated: 26th Feb, 2003


    Points to remember:

    1) Insurance Agent / Sales Agent is an authorized person by an insurance Co. to represent the Co. in its dealings with applicants for insurance.

    2) Insurance meets

    (a) Individual / Personal needs

    I. Funds to cover final expenses

    II. Dependentsˇ support

    III. Education costs

    IV. Retirement income

    V. Others

    (b) Business needs

    2.a.I. Funds to cover final expenses

    Estate: All things of value, called ?Assets. Assets include cash, bank & investment A/Cs, real

    estate, and ownership interests in business. Estate Plans: A plan to settle oneˇs Estate as per

    oneˇs wishes. The Estate Plan considers the amount of assets and debts that one is likely to have when one dies and how best one can preserve those assets so that that can be passed to oneˇs heirs. Note: Settling an estate means identifying & collecting the deceasedˇs property,

    filing any required tax forms, collecting all debts owed to the deceased, and paying all outstanding debts owed by the deceased.

    2.a.II. Dependentsˇ support

    To provide funds to support the family members, if the financially supporting member dies, until they obtain new methods of support or until they adjust to a lower income. In addition, LIP (Life Insurance Policy) can be used to supplement the familyˇs expense, which is tax-free as well.

    2.a.III. Education costs

    To insure the education of the children even after the death of the parents. 2.a.IV. Retirement income

    To provide support to individuals with retirement income. Permanent LIPˇs accumulated savings will not be reduced if the Insurance Companyˇs investments lose money, rather guarantees that

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