Personal Lines Insurance and Risk Management

People face risks in everyday life that carry the potential of economic ruin. Automobile accidents can cause severe injury, loss of property and liability for injury to another. Sickness and personal injuries can cause significant expenses and prevent a person from working, thereby hastening an economic demise. Houses and possessions can be wiped out without warning and can leave a person homeless or an injury on a person's premises can result in life altering legal liability debt. In the face of all these potential sources of disaster, a person can and should manage the risk they face in their personal lives. Judicious use of the personal lines insurance form a powerful set of tools for the individual to manage risk by exchanging a potentially huge and uncertain future expense for the piece of mind and certainty that the fixed premium payment can bring. This article discusses the nature of insurance, the most common types of personal lines insurances and how individuals may use them to effectively manage risk.

Keywords Collective Bargaining Agreement; Deductible; Health Maintenance Organization; Insured; Insurer; Major Medical Insurance; Mutual Company

Insurance & Risk Management > Personal Lines Insurance & Risk Management

Overview

The normal activities of daily life can carry the risk of enormous financial loss for individuals and their loved ones. While most of these events are relatively rare and uncertain for a particular individual, they are real and often occur without warning. Therefore, most people are willing to pay a small and predictable fixed amount for protection against the occurrence of an unpredictable event that carries catastrophic economic consequences. This is the basic nature of insurance. Personal lines insurance refers to a subset of insurance products that are purchased by individuals for their personal protection. Popular types of personal lines insurance are home, automobile and health insurance. This article will overview the nature and history of insurance as well as the features and benefits of some popular personal lines mentioned.

Insurance is a contract, commonly called a policy, in which an individual or entity makes regular payments, called a premium. In return for premiums, an insurer promises to reimburse or compensate against losses incurred by the insured. Parties involved in an insurance policy are the insured (individual or entity paying premiums), the insurer (usually an insurance company), and the beneficiary (party designated to receive payment under the policy). The insured and beneficiary may be the same person or a different person, as in the case of life insurance where benefits are paid to one person upon the death of another. The range of occurrences that can result in payment by the insurance company under the policy are sometimes called covered events. The terms of the policy determine the amount of the payment and define the range of covered events; therefore, recovery under the policy may be in either whole or in part upon the happening of a covered event.

This insurance arrangement, in a broad economic sense, transfers the risk of loss from an individual to a larger group that is better able to pay for the losses. In fact, the sharing of risk between members of group is the defining feature of an insurance policy. In other words, a contract that distributes risk is an insurance policy. Insurance companies create insurance policies by grouping certain risks together. This grouping provides the uniformity that covered risks which allows insurers to predict their potential losses and set premiums accordingly. For example, drivers that have been in accidents and who have been ticketed for violations of the traffic law may form a high-risk group that are more likely to collect benefits from the insurance company. Therefore, an insurance policy to protect such drivers would be more expensive. The insurance company profits by investing the premiums it receives. A well-developed area of law governs insurance. Insurance policies are subject to the requirements of statues, administrative agency regulations, and the court decisions interpreting both of them.

To satisfy the insurance needs of the American public, the insurance industry is composed of roughly 1600 life and Health Insurance companies and possibly 3000 property and casualty reinsurance companies. The United States is the world's largest insurance market, accounting for approximately 34% of all the 2.3 trillion dollars of premiums paid in world at the end of the twentieth century. Life and Health Insurance in the United States represents approximately 20% of the worldwide market, second to Japan's roughly 29% and far ahead of the United Kingdom's 10% ranked third (Encyclopedia of Business & Finance, 2008).

Life Insurance

The life insurance industry reports date back to the colonial times. Early colonists were initially skeptical of life insurance as many considered it a gambling and against their religion. However, the expansion of the United States economy from 1830 to 1837 increased the American need to protect their financial prosperity. Four large mutual companies were founded during that period. The first was the Mutual Life Insurance Company of New York (founded in 1843) and it is currently the oldest practicing insurance company. As the insurance industry became an increasingly important component of the economy, governments began to legislate in the area. Massachusetts was the first state to establish an insurance department in 1855, by 1890 most states had established insurance departments and by 1940 all states regulated insurance (Encyclopedia of American History, 2008).

Life insurance provides financial benefits to a specified person, the beneficiary, upon the death of the insured party. There are several types of life insurance. A major distinction between the types of life insurance policies is whether they are term or whole life. Term life insurance provides benefits for a beneficiary if the insured dies within a specific period of time, or “Term,” such as twenty years. Because a person may outlive the defined term of the policy, payment on the policy is not assured. Premium payments are required throughout and those premiums, once paid, are not refunded even if the insurance company does not pay out on the policy. For this reason, term life insurance is typically far less expensive than whole life.

Term life insurance policies have several important uses related to ensuring adequate financing during a specific period of time. For example, a young person that just starting in the working may be takeout a 20 year term policy to protect young children against the economic losses that would arise if the insured died while the children were still minors. Lenders may also require that debtor buy an insurance policy as a term o f a loan to ensure repayment in the event of the debtors death, In that situation the lender would likely require to named beneficiary of the insurance policy.

Whole Life

Whole life insurance is the other major category of life insurance and has several variants. The defining features of whole life insurance are the guaranteed eventual pay out of the agreed upon benefit and the policy accumulation of cash value on the policy. The cash value of policy can generally be recovered by the insured by surrendering the policy for the cash. The cash value can also act as collateral that the insured may borrow against. For this reason, a whole life policy is considered an investment vehicle in addition to an insurance product. The whole life policy has several varieties including "universal life" and "variable life." Universal life allows the insured to vary the amount and timing of premium payments that are otherwise fixed under a traditional whole life model.

Health Insurance

Health Insurance began in the mid 19th century with accident insurance and protection from a small number of diseases. The Travelers Insurance Company, founded in 1863, receives credit for writing the first insurance policy in the United States. This first policy contained a schedule of benefits payable to the insured for each particular illness or injury. In the beginning of the twentieth century, states began to enact workers’ compensation laws to protect employees from the economic effects of injury on the job. These laws raised interest in group health insurance contracts for illnesses and non-work related injuries. Towards the middle of the twentieth century, employer provided health insurance plans for employees became an important fringe benefit in collective bargaining agreements. With the costs of medical care rising, Major Medical Insurance developed in response to the increased demand for policies that would protect families against prolonged and serious illnesses.

The insurance industry faced and overcame a number of challenges in the end of the twentieth century. After the 1992 presidential election, health insurance companies came under attack from the Clinton Administration which argued that the insurance industry’s methods harmed the medical community. President Clinton advocated a competitive model known as managed competition. The insurance industry, however, launched a successful television campaign against the proposed reform. Larger insurers responded by developing health maintenance organizations (HMO) to regulate care and costs.

The extreme rises in medical costs, nevertheless, remained a problem and Americans increasingly lost or dropped their unaffordable insurance policies. Barack Obama campaigned on a pledge to deliver universal healthcare to Americans in 2008, and in 2010 the Patient Protection and Affordable Care Act was passed over the vehement protests of many Republicans in Congress and leaders of the rising Tea Party movement. The act required private coverage in order to spread the cost over a large and healthier pool of insureds, but forbid restrictions based on pre-existing conditions. Government exchanges were created at the federal and state levels for the convenience of shoppers, high-deductible plans were eliminated, and subsidies were made available for low-income Americans. Critics on the Left asserted that the act was a gift to private insurance companies while those on the Right pronounced it socialism. Many of the provisions of the act were well received, but with a rocky rollout of the federal exchange, healthcare.gov, wariness of the new system was widespread (Custer2013).

Property & Casualty Insurance

For most people, their homes are their most valuable assets, biggest investment and potential source of liability. Prudent financial planning and savings can be wiped out overnight by natural disaster, fire or legal liability for injury that occurred on a person's property. Property and casualty insurance is intended to protect people from these types of risks. While mortgage lenders typically require borrowers to insure their homes as a condition of the loan, many homeowners may be underinsured against these types of risks, particularly for catastrophic risks to their homes. Homeowners in certain areas of the country must be certain that policies cover the risks specific to their geographic area. For example, Californians may be exposed to risk from brush fires, mudslides, and earthquakes. Floridians must ensure protection from hurricanes and floods. In certain situations when a house may be particularly valuable or unique, securing an appraisal by an appraiser approved by the insurance company may be an important step to avoid a gap in insurance coverage (Stolz, 2007).

To avoid or minimize risk, especially with respect to catastrophic losses, homeowners would be wise to analyze and understand the extent of their coverage in the event of a disaster. For example, a homeowner may be responsible for a "windstorm deductible" in the event of a hurricane. Insurance companies began including these deductibles after the massive losses caused by Hurricane Andrew. As opposed to other deductibles that are stated in dollar amounts, this deductible may appear as a percentage of the policy value. A 1% deductible would mean that on a $400,000 policy, a homeowner would have to pay $20,000 before the insurer would incur any liability.

Automobile Insurance

The first automobile insurance policy was issued by the Travelers Insurance Company in 1898. As the number of drivers in the United States increased, the value of automobile insurance became apparent. Indeed, automobile insurance became so broadly accepted that most states required vehicle owners to carry insurance on their vehicles. The state required insurance is generally considered a bare minimum and well below the recommended amount of coverage for a vehicle. Following consumer dissatisfaction with automobile insurance rates in the late 1980s and 1990s, some states implemented no-fault automobile insurance to reduce litigation. A no-fault system requires all drivers to carry insurance for their own protection, requires the insurance carrier to pay, up to policy limits, for the insured injuries, medical bills and property damages, regardless of who caused the accident. The typical no-fault system limits the ability of drivers to sue one another perhaps except in cases of severe injury. Typical no-fault state insurance laws allow accident victims to receive reimbursement for financial losses such as medical and hospital expenses as well as lost income from their own insurance companies and often place restrictions on the right to sue.

Applications

The internet has transformed business and society in general; the insurance industry has likewise been affected by the internet, to the benefit of the consumer. In the past, purchasing insurance meant a visit to a local agent who may or may not have the best rates or coverage for a particular consumer. Shopping around for the ideal coverage and rate meant actually meeting with a number of agents. The internet has enabled consumers to shop and compare offerings of many different insurance companies almost instantly with the use of aggregator cites that rapidly compare quotes from different companies either live on the screen or by email.

However, consumers should understand that this rapid flow of information may not always cause prices to fall into line among competitors as one might expect. Using the internet for an insurance purchase removes the potentially valuable advice and resources of an insurance agent and an inattentive consumer may pay too much for an insurance product that inadequately addresses their needs. For example, auto insurance quotes can vary widely between insurers for the same vehicle, with the difference between the lowest and highest price being as much as 85%. Different insurers also vary widely on the degree of control a consumer may have over the specific content of their policies. To minimize the chances of making an error with an online purchase, consumers may consider visiting many different websites, calculating precisely what rates, plans or special offers actually cost, understanding what a plan actually covers despite its name, remaining weary of ubiquitous promises to save the consumer money, and finally a consumer should consider asking an insurance agent for explanation of foreign concepts and to help in negotiations for the bet rates possible (Trembly, 2007).

In addition to rapid comparison shopping to discover the lowest prices, consumers also benefit from a more rapid and simplified purchasing experience that is powered by interactive forms. The information flow enabled by the internet allows insurance companies to increase efficiency and accuracy with online data collection. Insurance companies are deploying powerful technology to increase overall efficiency in other areas of their business as well. Consumers may now pay premiums, file and track claims and change deductibles online. Insurers use modern information technologies to streamline loss reporting. Insurance company online activity indirectly benefits the consumer both in terms of convenience and by allowing the insurance companies to reflect the efficiency in lower prices The insurance companies are then able to pass on the advantage of those efficiencies to consumers in the form of lower rates.

Conclusion

When considered together, there appears to be an overwhelming number of risks in everyday life that carry the potential for personal economic ruin. Automobile accidents can cause severe injury, loss of property and liability for injury to another. Sickness and personal injuries can cause significant expenses and prevent a person from working, thereby hastening an economic demise. Houses and possessions can be wiped out without warning and can leave a person homeless, or an injury on a person's premises can result in life altering legal liability debt. In the face of all these potential sources of disaster, a person can and should manage the risks they face in their personal lives. Judicious use of personal lines insurance forms a powerful set of tools for the individual to manage risk by exchanging a potentially huge and uncertain future expense for the piece of mind and certainty that the fixed premium payment can bring.

While some types of insurance, e.g. house and automobile, may be required by the government or a lender, the consumer should be attentive to personal needs and must not rely on required coverage without understanding their personal needs and the insurance products offered. Effective risk management must include an analysis of the understanding of the risk and attendant losses that a person may face. Fortunately, the internet provides a powerful tool to learn about our insurance needs and make purchases to fulfill those needs.

Terms & Concepts

Collective Bargaining Agreement: An employment agreement concerning wages, hours, working conditions, and benefits that is reached by bargaining between authorized union representatives on behalf of members of the labor force.

Deductible: The amount of money an insured is required to pay before the insurance company becomes liable for damages.

Health Maintenance Organizations (HMO): An organization that provides healthcare services for it members in exchange for monthly premiums. The members of the HMO are usually required to receive those services from specific providers affiliated with the HMO.

Insured: A person or entity covered by a policy of insurance.

Insurer: The entity contractually bound to reimburse or compensate an insured party upon the happening of a covered event.

Major Medical Insurance: An insurance policy that provides benefits only for extraordinary major illnesses and injuries which most people would be unable to pay without great hardship. This type of insurance is typically a supplement to a more comprehensive healthcare plan. These Major Medical Insurance plans usually have high benefit limits and deductibles.

Mutual Company: A form of private company common in the insurance industry that is owned by customers who receive distribution based on their exposure to the business.

Bibliography

Custer, W.S. (2013). Risk adjustment and the Affordable Care Act. Journal of Financial Service Professionals, 67(6), 25-26. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=91762071&site=ehost-live

Insurance. (n.d.). Encyclopedia of American History. Retrieved January 25, 2008, from Answers.com Web site: http://www.answers.com/topic/insurance

Insurance. (n.d.). Encyclopedia of Business and Finance. Retrieved January 08, 2008, from Answers.com Web site: http://www.answers.com/topic/insurance

Kerr, D.A., & Avila, S.M. (2013). Personal lines risk management and insurance simulation game. Risk Management & Insurance Review, 16(1), 123-146. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=86693636&site=ehost-live

Lenckus, D. (2003). Personal lines program proves a multifaceted tool. Business Insurance, 37(14), 22. Retrieved December 22, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=9596971&site=ehost-live

Levin, A. (1999). MetLife Buys St. Paul personal lines unit. National Underwriter / Property & Casualty Risk & Benefits Management, 103(29), 1. Retrieved December 22, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=2081387&site=ehost-live

Lonkevich, D. (1999). Industry keeps pushing for personal lines deregulation. National Underwriter / Property & Casualty Risk & Benefits Management, 103(10), 1. Retrieved December 22, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=1659492&site=ehost-live

Ruquet, M.E. (2013). Personal lines moderating; no signs of hardening. Property & Casualty 360, 117(9), 12. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=89964601&site=ehost-live

Souter, G. (2000). Internet changing face of personal lines sales. Business Insurance, 34(34), 12F. Retrieved December 22, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=3571849&site=ehost-live

Trembly, A. (2007). When buying auto insurance online, do your homework… or pay the price! National Underwriter / Property & Casualty Risk & Benefits Management, 111(31), 12-14. Retrieved January 2, 2008, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=26370923&site=ehost-live

Vala, K. (2007). Home insurance: Get the facts. Smart Money, 16(10), 132-132. Retrieved January 23, 2008, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26660011&site=ehost-live

Suggested Reading

Geary, L. (2001). What about my home? Money, 30(12), 147. Retrieved December 5, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=5363498&site=ehost-live

Higham, T., & Wands, T. (1996). Selling personal lines insurance on the Internet. CPCU Journal, 49(3), 13. Retrieved December 5, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=9611040161&site=ehost-live

Stolz, R. (2007). Bridging the property and casualty gap. Journal of Financial Planning, 20(11), 32-40. Retrieved January 23, 2008, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=27518309&site=ehost-live