Chapter 2 | The Risk Management Process and Characteristics of Insurance Learning Objectives...... 10 Introduction...... 10 Categories of Risk...... 11 Pure and Speculative Risk...... 11 Subjective and Objective Risk ...... 12 Fundamental and Particular Risk...... 12 Non-financial and Financial Risk ...... 13 Probability of Loss...... 13 Law of Large Numbers ...... 14 Risk Management Process...... 14 Determining the Objectives of the Risk Management Program...... 14 Identifying the Risks to Which the Individual is Exposed ...... 15 Evaluating the Identified Risks for the Probability and the Severity of the Loss ...... 18 Determining and Selecting the Best Risk Management Alternative...... 18 Implementing the Risk Management Plan Selected ...... 22 Periodically Evaluating and Reviewing the Risk Management Program ...... 23 Causes of Financial Loss...... 23 Perils ...... 23 Hazards ...... 24 Requisites for an Insurable Risk...... 26 Large Number of Homogeneous Exposures ...... 26 Insured Losses Must be Accidental...... 27 Loss Must be Measurable and Determinable ...... 28 Loss Must Not be Financially Catastrophic to the Insurer...... 28 Premium Must be Reasonable ...... 29 Law of Insurance Contracts...... 30 Mutual Consent...... 30 Offer and Acceptance ...... 30 Performance or Delivery...... 31 Lawful Purpose...... 31 Legal Competence of All Parties...... 32 Legal Principles of Insurance Contracts...... 32 Principle of Indemnity...... 32 Principle of Insurable Interest...... 33 Principle of Utmost Good Faith ...... 34

Preface XIII Unique Legal Characteristics of Insurance Contracts...... 36 Adhesion...... 36 Aleatory ...... 36 Unilateral ...... 36 Conditional...... 36 Personal...... 37 Law of Agency...... 37 Express Authority ...... 37 Implied Authority...... 38 Apparent Authority ...... 38 Waiver...... 38 Estoppel...... 39 Characteristics of Insurance Companies...... 39 Types of Insurance Companies...... 39 Agents and Brokers ...... 40 Reinsurance ...... 40 Important Provisions and Features of Insurance Contracts ...... 41 Policy Provisions ...... 41 Riders and Endorsements ...... 44 Underwriting and Managing Adverse Selection ...... 45 Deductibles and Copayments...... 45 Coinsurance ...... 46 Valuing Property for Losses ...... 49 Actual Cash Value...... 49 Replacement Cost...... 49 Appraised or Agreed Upon Value...... 50 Regulating the Insurance Industry ...... 50 Legislative...... 50 Judicial...... 51 Executive or State Insurance Commissioner...... 51 National Association of Insurance Commissioners (NAIC)...... 51 Insurance Rate Regulation ...... 52 Prior Approval Law ...... 52 File and Use Law...... 52 Use and File Law...... 52 Open Competition ...... 52 Selecting an Insurance Company...... 53 General Guidelines for Insurance Policy Selection ...... 54 Key Terms...... 55 Discussion Questions...... 59 Multiple-Choice Problems...... 61 Quick Quiz Explanations...... 62

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Chapter 3 | Health Insurance Learning Objectives...... 66 Introduction...... 66 Deductibles, Coinsurance, and Maximum-Out-Of-Pocket ...... 68 Deductibles and Coinsurance...... 68 Maximum-Out-Of-Pocket (MOOP) Limits ...... 71 The Affordable Care Act ...... 74 Essential Benefits as a Result of the Affordable Care Act...... 75 Health Insurance Marketplace...... 76 Comparing Policies ...... 77 Marketplace vs Non-Marketplace...... 85 Group Health Insurance...... 86 Eligibility ...... 86 Features of Group Health Insurance ...... 86 The Mechanics of Group Health Insurance...... 88 Regulation of Employer-Provided Health Insurance...... 90 Tax Advantages of Employer-Provided Health Insurance...... 92 Health Care Reform and Employer-Provided Coverage...... 93 Individual Health Insurance...... 96 Need for Coverage...... 96 Cost of Individual Policies...... 96 Eligibility ...... 97 Types of Individual Policies ...... 97 Types of Group and Individual Plans...... 100 Indemnity Health Insurance...... 100 Managed Care Insurance...... 100 Consumer-Directed Health Plans ...... 105 Health Savings Accounts (HSA)...... 105 Eligibility ...... 106 High Deductible Health Insurance Plans...... 106 Contribution Limitations...... 107 Distributions...... 109 Flexible Spending Accounts ...... 110 Health Insurance Policy Provisions ...... 114 Policy Provisions of Group and Individual Plans...... 114 Preexisting Conditions ...... 114 Incontestability Clause...... 115 Grace Period...... 115 Reinstatement Clause ...... 115 Time Limit Clause...... 115 Renewability Clause ...... 115 Taxation and Health Insurance ...... 117 Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) ...... 118 Planning for Health Care Costs in Retirement...... 121 Medicare and Medicare Supplement Insurance...... 121 Conclusion ...... 126 Key Terms...... 127

Table of Contents XV Discussion Questions...... 129 Multiple-Choice Problems...... 130 Quick Quiz Explanations...... 132

Chapter 4 | Life Insurance Learning Objectives...... 134 Introduction...... 134 Parties to a Life Insurance Contract ...... 135 Life Insurance Underwriting...... 139 Life Insurance and Mortality Risk ...... 140 Risk Exposures from Dying Early...... 140 Measuring the Life Insurance Need...... 143 Types and Uses of Life Insurance in Financial Planning...... 154 Term Insurance...... 154 Universal Life Insurance...... 159 Whole Life Insurance...... 162 Variable Life Insurance...... 169 Policy Illustrations...... 171 Modified Endowment Contracts (MECs)...... 173 Group-Term Insurance ...... 175 Protection ...... 176 Other Types of Group Life Insurance...... 177 The Life Insurance Contract and Common Policy Provisions ...... 178 The Declarations Page...... 178 Policy Riders...... 184 Settlement Options for Life Insurance...... 185 Lump-Sum Payment...... 185 Interest Only...... 185 Annuity Payments from Life Insurance...... 186 Life Insurance Policy Replacements...... 188 Conclusion ...... 189 Key Terms...... 190 Discussion Questions...... 194 Multiple-Choice Problems...... 195 Quick Quiz Explanations...... 197

Chapter 5 | Life Insurance: Advanced Concepts Learning Objectives...... 200 Introduction...... 200 Taxation of Life Insurance Benefits ...... 200 Premium Payments ...... 200 Death Benefit Taxation ...... 201 Taxation of Lifetime Benefits ...... 202 Section 1035 Policy Exchanges ...... 205 Transfer for Value ...... 207 Life Settlements...... 208 Terminally or Chronically Ill Insureds...... 209

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Life Insurance and Buy-Sell Agreements ...... 213 Entity (Redemption) Agreements ...... 215 Cross-Purchase Agreements...... 216 Wait-and-See Buy-Sell Agreements...... 219 Life Insurance is the Perfect Hedge for a Buy-Sell Agreement Triggered at Death...... 220 Tax-Related Issues for Buy-Sell Agreements...... 220 Nonqualified Deferred Compensation ...... 222 Deferred Executive Compensation ...... 223 Salary Continuation...... 223 Funding Arrangements ...... 223 Tax Treatment of Nonqualified Deferred Compensation...... 227 Funding with Insurance...... 231 Other Business Uses of Life Insurance ...... 232 Split-Dollar Life Insurance Arrangement...... 232 Key Person Life and Disability Insurance ...... 234 Section 162 Bonus Plans (Group Carve-Out Life Insurance)...... 235 Conclusion ...... 240 Key Terms...... 241 Discussion Questions ...... 243 Multiple-Choice Problems...... 245 Quick Quiz Explanations...... 247

Chapter 6 | Disability Insurance Learning Objectives...... 250 Introduction...... 250 Amount of Coverage...... 253 Term of Coverage ...... 254 Analyzing Disability Income Policies and Client Need ...... 254 Disability Income Insurance Underwriting...... 255 Characteristics of Disability Insurance Policies ...... 257 Definition of Disability ...... 257 Elimination Period ...... 262 Benefit Period...... 262 Other Disability Policy Provisions and Riders...... 263 Incontestability Clause...... 265 Renewability...... 265 Exclusions ...... 266 Group Disability Insurance...... 267 Social Security Offset...... 268 Taxation of Disability Insurance Benefits...... 269 Disability Insurance - Employee Benefit Analysis...... 271 Creating a Plan for Disability Income Needs...... 272 Household Financial Resources ...... 272 Existing Coverage Under Employer Plans ...... 272 Social Security Disability...... 273 Individual DI Policy Options...... 273 Selecting an Insurance Company...... 273

Table of Contents XVII Conclusion ...... 274 Key Terms...... 275 Discussion Questions...... 277 Multiple-Choice Problems...... 278 Quick Quiz Explanations...... 279

Chapter 7 | Long-Term Care Insurance Learning Objectives...... 282 Introduction...... 282 Long-Term Care Services...... 284 The Cost of Long-Term Care Services...... 285 Paying for Long-Term Care Services...... 286 Medicaid...... 287 Funding...... 290 Mandatory and Optional Benefits ...... 290 Eligibility...... 291 Income...... 291 Assets...... 292 The Need for Long-Term Care Insurance...... 300 Population Statistics for the United States...... 300 Factors that Influence the Need for Long-Term Care Insurance...... 301 Long-Term Care Insurance ...... 305 HIPAA Rules and NAIC Model Legislation ...... 305 Eligibility and Underwriting...... 307 Long-Term Care Premium Factors ...... 308 Long-Term Care Insurance Features and Benefits ...... 308 Long-Term Care Benefit Periods (Benefit Multiplier)...... 315 Tax-Qualified Long-Term Care Contracts ...... 315 Conditions that Trigger Long-Term Care Benefits...... 317 Selection of Long-Term Care Policy ...... 318 The Period of Coverage (Benefit Period)...... 319 The Benefit Amount ...... 320 The Inflation Adjustment...... 321 Elimination (Deductible) Period...... 322 Services Included and Excluded ...... 323 How Benefits are Paid ...... 323 Alternatives to Long-Term Care Insurance...... 324 A Comprehensive Individual Illustration of a Long-Term Care Policy ...... 328 Inflation Adjustments...... 331 Conclusion ...... 333 Key Terms...... 334 Discussion Questions...... 337 Multiple-Choice Problems...... 338 Quick Quiz Explanations...... 339

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Chapter 8 | Annuities Learning Objectives...... 342 Introduction...... 342 Characteristics of Annuities...... 345 What is an Annuity?...... 345 Parties to an Annuity Contract...... 348 Annuity Payout Period ...... 348 Immediate vs. Deferred...... 349 Flexible Premium vs. Single Premium...... 350 Earnings...... 350 Annuity Benefit Options...... 351 Single Life Annuities...... 351 Joint and Survivor Life Annuities...... 353 Types of Annuity Contracts...... 355 Fixed Annuity ...... 356 Variable Annuity ...... 356 Equity-Indexed Annuities ...... 362 Advantages and Disadvantages...... 366 Advantages of Annuity Contracts ...... 366 Disadvantages of Annuity Contracts ...... 367 Taxation of Annuities...... 369 Income Taxation ...... 369 Section 1035 Exchanges ...... 374 Estate Taxation...... 375 Rules for Distributions to Beneficiaries...... 377 Tax Treatment for Non-Natural Owners...... 378 Uses and Applications...... 378 Use of Annuity Contracts...... 378 Use of Annuities in Retirement Planning ...... 379 Longevity Insurance...... 380 Social Security...... 382 Structured Settlements ...... 382 Structured Settlements and the Secondary Market...... 383 Regulation of Annuity Contracts...... 386 The Importance of Company Credit Rating...... 387 What Happens if an Insurance Company Fails? ...... 387 Other Factors to Consider When Evaluating Annuity Decisions ...... 387 Conclusion ...... 390 Key Terms...... 391 Discussion Questions ...... 395 Multiple-Choice Problems...... 397 Quick Quiz Explanations...... 398

Table of Contents XIX Chapter 9 | Property and Liability Insurance Learning Objectives...... 402 Introduction...... 402 Risk Management Principles & Personal Property and Liability Insurance ...... 403 Homeowners (HO) Insurance ...... 404 Covered Perils...... 404 Liability Insurance Coverage in Homeowners Policies ...... 413 Homeowners (HO) Insurance Policy Forms...... 418 Financial Planning Applications and Homeowners Insurance...... 420 The Duties of an Insured after a Loss and Contractual Limitations...... 422 Automobile Insurance...... 427 Introduction to Liability Coverage...... 427 Personal Auto Policy (PAP) Coverages ...... 429 Part A: Liability Coverage (Bodily Injury and Property Damage)...... 429 Part B: Medical Payments Coverage...... 430 Part C: Coverage for Uninsured or Under-Insured Motorists...... 430 Part D: Damage to Insured’s Automobile...... 431 Part E: Duties After An Accident Or Loss ...... 433 Coverage for GAP Insurance...... 433 Public Policy Issues ...... 434 Coverage for Personal Injury Protection (PIP)...... 434 Covered Autos...... 434 Insured Individuals ...... 435 Exclusions to the Auto Policy...... 435 Coverage in Other States, Canada, and Mexico...... 435 Premiums...... 436 Legal Liability...... 442 Personal Liability Insurance ...... 444 Business and Professional Property and Liability Insurance...... 446 Risk of Loss of Assets and Liability Insurance...... 446 Professionals ...... 446 Products Liability Insurance ...... 447 Key Terms...... 448 Discussion Questions...... 451 Multiple-Choice Problems...... 452 Quick Quiz Explanations...... 454

Chapter 10 | Credit Protection Learning Objectives...... 456 Introduction...... 456 History of Consumer Lending...... 456 Consumer Lending...... 457 Secured vs. Unsecured Loans...... 458 Credit Reports...... 458 Credit Scores...... 465 Establishing Credit...... 475

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Debit, Credit, and Charge Cards...... 480 Debit Cards vs. Credit Cards ...... 480 Charge Cards...... 483 Identity Theft and Fraud...... 483 Sources of Identity Theft ...... 486 Avoid Becoming a Victim of Identity Theft...... 488 Key Terms...... 494 Discussion Questions ...... 496 Multiple-Choice Problems...... 498 Quick Quiz Explanations...... 499

Chapter 11 | Social Security Learning Objectives...... 502 Introduction...... 504 Social Security Taxes and Contributions...... 506 Additional Medicare Taxes Beginning in 2013...... 507 Trust Funds...... 510 Social Security Benefits – Eligibility and Calculations ...... 511 Covered Workers and Insured Status...... 511 Social Security Beneficiaries...... 513 Social Security Retirement Benefits – A Closer Look...... 516 The Retirement Benefit Calculation ...... 517 Taxation of Social Security Benefits...... 531 Other Social Security Benefits...... 536 Disability Benefits and Disability Insured ...... 536 Family Benefits...... 538 Survivors’ Benefits...... 538 The Maximum Family Benefit ...... 539 Choosing When to Begin Social Security Retirement Benefits...... 541 Medicare Benefits...... 544 Traditional Medicare ...... 545 Medicare Part B...... 547 Medicare Exclusions...... 548 Medicare Part D Subsidy ...... 549 Medicare Part C - Medicare Advantage ...... 551 Medicare Savings Programs...... 552 Enrolling in Medicare...... 552 Supplemental Security Income Benefits...... 555 Filing for Social Security Claims...... 555 Other Issues...... 556 Effect of Marriage or Divorce on Benefits...... 556 Change of Name...... 556 Projected Benefit Statements...... 557 Leaving the United States...... 557 Windfall Elimination Provision (WEP) and Government Pension Offset (GPO) Provision...... 558

Table of Contents XXI Key Terms...... 565 Discussion Questions...... 567 Multiple Choice Problems ...... 568 Quick Quiz Explanations...... 569

Appendix Glossary...... 571 Index...... 589

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