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FREQUENTLY ASKED QUESTIONS How can I enroll and submit my exam(s) to the school? You can enroll and submit your course exam(s) by fax or mail using either the form on page 114 or the form on the back cover. Courses may also be completed at our website. Online exams are identical to those printed in this book. What is the passing score required to earn credit for each of the courses in this book? The state of Illinois requires a passing score of at least 70% on each exam. Most students pass on the first attempt. However, course enrollments include a second attempt, if necessary. How quickly will you grade my exam and report my course completion(s) to the state of Illinois? We will process your course enrollment and grade exams within one business day of receipt. All successful course completions are reported to the state within two business days. Why does the school charge a credit reporting fee? In March 2011, the Illinois Department of Insurance began requiring a fee to be paid for each course credit-hour reported. Our course pricing remains the same, but students are required to pay this Department-mandated fee. State fees are subject to change without notice. Please visit our website or call for current fees. How can I keep records of courses I have completed with your school? Upon successful course completion, we will provide you with a Certificate of Completion for your records. How can I be sure that I have not already completed these courses? If you are concerned about course repetition, please call us to review your state transcript (which provides a history of your course completions). If necessary, we’ll suggest an alternate course. I want to take advantage of the discounted 21 credit-hour program, but I don’t need that many credit hours. What should I do? If completing both courses in this book will cause you to exceed your 21 credit-hours that may be completed by self-study, up to 12 credit hours may be carried forward to your next renewal period. However, you may also take advantage of our discounted 21 credit-hour program and complete only one course at this time to satisfy your current requirement. You can then submit the other exam within six months of your enrollment to be used toward your next renewal period. I sell long-term care insurance. Is there a special requirement I need to consider? Yes, a special training and continuing education requirement affects all resident producers who sell or solicit any type of long-term care insurance. We offer the required training course and continuing education through convenient self-study. Please contact us or visit our website for additional information. Illinois requires 3 credit-hours of instructor-led “Ethics” training. How do I satisfy this continuing education requirement? We offer programs to satisfy this requirement. Please call or visit our website to learn more. PLEASE CALL US WITH ANY ADDITIONAL QUESTIONS! INSURANCE EDUCATION DIVISION REAL ESTATE INSTITUTE (800) 289-4310 www.InstituteOnline.com

INSURING MAJOR RISKS

Continuing Education for Illinois Insurance Professionals

INSURING MAJOR RISKS COPYRIGHT © 2011 BY REAL ESTATE INSTITUTE All rights reserved. No part of this book may be reproduced, stored in any retrieval system or transcribed in any form or by any means (electronic, mechanical, photocopy, recording or otherwise) without the prior written permission of the Real Estate Institute. A considerable amount of care has been taken to provide accurate and timely information. However, any ideas, suggestions, opinions, or general knowledge presented in this text are those of the authors and other contributors, and are subject to local, state and federal laws and regulations, court cases, and any revisions of the same. The reader is encouraged to consult legal counsel concerning any points of law. This book should not be used as an alternative to competent legal counsel.

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INSURING MAJOR RISKS

TABLE OF CONTENTS LIFE INSURANCE .......................................................................1 INTRODUCTION .................................................................1 Why Buy Life Insurance? .......................................... 1 Needs Analysis ......................................................... 2 Addressing Business and Tax Issues ....................... 3 KINDS OF LIFE INSURANCE ........................................... 3 Term Life Insurance .................................................. 3 Permanent Life Insurance ......................................... 4 Group Life Insurance ................................................ 6 Accidental Death Insurance ...................................... 6 Credit Life Insurance ................................................. 6 Funeral Insurance ..................................................... 6 Joint and Survivor Life Insurance ............................. 6 PARTS OF A LIFE INSURANCE POLICY......................... 7 The Face Page and the Entire Contract Clause ....................................................................... 7 Minding the Application ............................................. 7 Ownership Clauses ................................................... 7 Assignment Clauses ................................................. 8 Incontestable Clauses............................................... 8 Suicide Clauses ...................................................... 10 Misstatement of Age or Sex Clause ....................... 10 Dividends, Vanishing Premiums and Policy Illustrations ................................................... 10 Policy Loans ............................................................ 12 Automatic Premium Loans ...................................... 12 Life Insurance Premiums ........................................ 12 Free-Look Periods .................................................. 12 Grace Period ........................................................... 13 Cancellations and Nonforfeiture Benefits ............... 13 Reinstatement Clauses ........................................... 14 Replacement Policies ............................................. 14 Beneficiary Designations ........................................ 14 LIFE INSURANCE CLAIMS ............................................. 16 Settlement Options ................................................. 17 LIFE INSURANCE RIDERS ............................................. 17 Waiver of Premium ................................................. 17 Living Benefits ......................................................... 17 Other Riders ............................................................ 17 CONCLUSION ................................................................. 18 NATURAL DISASTERS ............................................................18 INTRODUCTION ...............................................................18 WILDFIRES .......................................................................19 Why and Where Wildfires Occur ............................. 19 Controlled Burns ..................................................... 19 The Urban Wildland Interface ................................. 20 Wildfires Fueled by Global Warming ...................... 20 HURRICANES AND TORNADOES ..................................20 Why and Where Hurricanes and Tornadoes Occur .................................................... 21 Covering Collapse ................................................... 21 Removal of Debris and Trees ................................. 21 Windstorm Deductibles ........................................... 21 Windstorm Coverage From the States ................... 22 DISASTER COVERAGE FOR HOMEOWNERS ..............22 Be Aware of Moratoriums ....................................... 22 What Is Homeowners Insurance? ........................... 22 How Much Will Coverage Cost? ............................. 23 What About the Deductible? ................................... 23 Levels of Replacement Coverage ........................... 23 Covering People’s Stuff .......................................... 24 Dealing With Additional Living Expenses ............... 24 Coverage During Evacuations ................................ 24 Limits on Detached Structures and Business Property ................................................... 24 Coverage for Renters.............................................. 25 Fire Safety Tips for High-Risk Homes .................... 25 Wind Safety Tips for High-Risk Homes .................. 25 A FEW WORDS ON FLOODS ..........................................26 EARTHQUAKES ...............................................................26 Earthquakes Throughout History ............................ 26 Why and Where Earthquakes Occur ...................... 27 Measuring Earthquakes .......................................... 27 The Non-Popularity of Earthquake Insurance ................................................................ 28

Earthquakes and Homeowners Insurance.............. 28 Working Around Earthquake Exclusions ................ 29 Earthquakes and Mortgage Loans .......................... 29 Be Aware of Moratoriums ....................................... 29 How Much Will Coverage Cost? ............................. 29 What About the Deductible? ................................... 29 Dealing With Additional Living Expenses ............... 30 Limits and Exclusions.............................................. 30 Coverage for Renters and Condo Owners ............. 30 Earthquake Insurance for Businesses .................... 30 GENERAL DISASTER INFORMATION ........................... 31 Keeping Coverage Current ..................................... 31 Minding Local Building Codes................................. 31 Disaster Insurance for Business Owners ................ 31 Avoiding Problems at Claim Time ........................... 32 Dealing With Contractors ........................................ 33 Federal Assistance for Disaster Victims ................. 33 Tax Breaks for Disaster Victims .............................. 34 How Disasters Affect Affordability and Availability ............................................................... 34 Catastrophe Models ................................................ 34 Covering Your Car .................................................. 35 Liability for Disasters ............................................... 35 Managing Risks Through Catastrophe Bonds ...................................................................... 35 A Federal Catastrophe Fund?................................. 35 CONCLUSION ................................................................. 35 BUSINESS INTERRUPTION INSURANCE ............................. 36 INTRODUCTION .............................................................. 36 AVAILABILITY AND AFFORDABILITY ............................ 37 BASIC BENEFITS ............................................................ 37 Kinds of Insurable Properties .................................. 37 Business Income Insurance .................................... 38 Continuing Expenses .............................................. 38 Payroll Coverage..................................................... 38 Extra Expenses ....................................................... 38 Period of Restoration .............................................. 39 Treatment of New or Failing Businesses ................ 39 Covered Perils and Benefit Triggers ....................... 40 Excluded Perils ....................................................... 40 Computer Interruptions ........................................... 41 Power Outages and Service Interruptions .............. 41 OPTIONAL AND ADDITIONAL COVERAGE .................. 41 Civil Authority Clause .............................................. 41 Ingress/Egress Clause ............................................ 42 New Buildings and New Locations.......................... 42 Extended Period of Indemnity ................................. 43 Contingent Business Interruption Insurance ................................................................ 43 BUSINESS INTERRUPTION CLAIMS............................. 44 Duties of the Insured ............................................... 44 Proving Business Assets and Expenses ................ 44 Handling the Claim .................................................. 44 BENEFIT LIMITS.............................................................. 44 Probable Maximum Loss ........................................ 44 Coinsurance Clauses .............................................. 45 Maximum Period of Indemnity ................................ 46 Monthly Limit of Indemnity ...................................... 46 Agreed-Value Option............................................... 46 DISASTER PLANNING .................................................... 47 CONCLUSION ................................................................. 47 FINAL EXAM ............................................................................. 48

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INSURING MAJOR RISKS While exploring many common life insurance contractual features in this material, students will learn or be reminded of what these policy elements mean, why they exist and how they have been interpreted by courts in various circ*mstances. Readers will also review the various kinds of life insurance products and the importance of analyzing each prospect’s unique needs.

LIFE INSURANCE INTRODUCTION In early America, many people could provide posthumous financial support to their heirs merely by relying on wills and common law and passing farmland along to their descendents. As prized as real estate inheritances might be today, these kinds of property transfers were even more important to beneficiaries 200 years ago.

The reader should note, however, that insurance texts, longtime agents and other reputable sources often contradict one another when listing the most common policy components and the ways an insurer can properly word a policy. These contradictions arise for several reasons.

In Jeffersonian times, farmland symbolized more than a neat asset that could be sold for residential, commercial or industrial purposes. It was often a multi-dimensional safety net for families who had depended on loved ones for financial security. Heirs could have certainly tried to make up for the deceased’s income by selling the property, but they also had the attractive option of living on the land for as long as they wished and growing various crops to sustain themselves and sell to neighbors. In short, a fortunate beneficiary could receive a home, potential nourishment and a potential source of income for the rest of his or her life, all in the form of a few acres.

The insurance industry’s state-level regulatory structure represents the most obvious cause of conflict, with insurance laws in California differing from those in Illinois, with Illinois insurance laws differing from those in Indiana and so on. In states where a particular insurance law is less stringent than other states or does not exist at all, each individual insurance company might have its own way of wording and interpreting a particular clause in the insurance contract.

The 19th century’s Industrial Revolution instigated a slow, steady movement away from these resourceful farming communities and toward the cities. Along with that movement came a change in the way breadwinners managed risks related to untimely death.

Market demands play a role in non-conformity, too, as companies go beyond a law’s minimum requirements in order to attract preferred policyholders. Meanwhile, new products can influence even the most basic policy provisions and have, in fact, been created over the years in response to popular demand for improved policy features.

With fewer people possessing assets that could be transferred and used on as many levels as farmland, Americans needed to find a new way to protect their loved ones from tragic, financial disaster. This desire for risk management has ultimately led millions of men and women to purchase what is still one of your industry’s most popular and, perhaps, most beneficial products: the life insurance policy.

With all this in mind, preemptive apologies might be in order for the student who wants absolute answers about how policy provisions are written, interpreted and applied. The main point to derive from the following factual presentation is not that a court with jurisdiction in another region of the country ruled in favor of or against an insurer in a specific policy-related case. Instead, we hope you are reminded of how important these contractual elements can be and that you always consider this importance when working with customers, colleagues and supervisors.

If we wish to validate how highly the public regards life insurance, several studies can provide us with evidence. The Life Insurance and Market Research Association (LIMRA) has reported that 68 percent of Americans have some form of this coverage. Other reports put that number even higher, at 80 percent or so, and a news item from the early 1990s said there were roughly two life policies for every U.S. resident.

Why Buy Life Insurance? Modern insurance companies offer several kinds of life insurance policies with numerous product features. Offering policies with various provisions and riders makes good business sense because different people buy life insurance for different reasons. Even when two prospective buyers articulate the same general reasons for wanting life insurance, each person might have ordered those identical reasons differently on their individual lists of priorities.

As much as the public seems to like life insurance, policy language often confuses prospective buyers. As a contractual agreement between the policyholder and the insurance company, a life insurance policy frequently contains commonly misunderstood passages and incomprehensible legalese. This is often true even in cases when an insurer claims to have presented its terms and conditions in plain English.

For the sake of review, we should briefly mention some of the important roles a life insurance policy can play in people’s lives.

Legal disputes between policyholders and insurers confirm that the public is occasionally perplexed by language pertaining to policy loans, investment features and other contract provisions. Insurers, too, are sometimes surprised by courts’ interpretations of policy terms and conditions and sometimes find themselves having to honor claims that were never meant to be covered in the first place.

Historically, people have bought life insurance in order to ensure that a dependent or other loved one will not suffer financial hardship after a death. Sometimes, the death benefit—the amount paid to a beneficiary—is helpful because it allows an otherwise independent person (such as a working spouse) to adapt to life without a shared income. More importantly, life insurance can create adequate income for those dependents who either need even longer periods to adjust to a devastating financial reality or might never be able to adapt to such change.

In order to minimize ugly and costly disputes between the customers they encounter and the companies they represent, insurance producers must know more about contractual terms and conditions than just what is spelled out in a sales brochure. They must school themselves in the details of provisions and restrictions to the point where they can answer any questions they would have about a policy if they were the ones shopping for coverage.

Examples of possibly needy beneficiaries might include a stay-at-home spouse who would suddenly need to find a job with competitive pay in order to make ends meet, a child who would need such essentials as food, clothing and a decent education, an elderly parent who would need to 1

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INSURING MAJOR RISKS Depending on the customer, the old five-year figure might be too high, or the 12-year figure might be too low. Although software programs and worksheets can help buyers and sellers arrive at a potentially adequate amount of death benefits and assist the two parties in policy selection, the numbers used to calculate a suitable death benefit are unlikely to protect the insured’s present and future interests unless the seller raises important issues and receives honest responses from the client.

hire someone to help with various household tasks or any loved one with special needs. Life insurance can also help beneficiaries pay specific expenses in either a short-term or long-term capacity. A policy boasting significant benefits could help satisfy a mortgage loan on a family home or free a spouse from other debt obligations. A small policy might be enough to ensure that a low-income family will not need to lose thousands of hard-earned dollars in order to cover the cost of a respectable funeral.

A proper needs analysis analyzes a customer’s deathrelated risks and insurance objectives. When calculating a dollar amount for a proper death benefit, the producer and the client might find it helpful to ask and answer the following questions:

No matter if their child is a few days old or has already spent years in the school system, middle-class parents might want to eventually borrow money from a life insurance policy and create a substantial college fund for a son or daughter, thereby making the policy not just a risk management tool but also a source of investment gains.



How much money will dependents need in order to maintain their current standard of living and keep up with inflation?  How much money will dependent children need for school tuition and basic necessities?  How long is a person likely to remain a dependent and rely on income from a policy?  How much money should beneficiaries receive— regardless of need—as a gift from the deceased?  If the insured is in training for a potentially lucrative career, how much money should dependents receive in order to offset the loss of expected high earnings?  How much money should beneficiaries receive in order to offset debts (such as a mortgage loan) that the insured person would normally pay for?  How much should beneficiaries receive in order to pay estate taxes?  How much money should beneficiaries receive in order to pay funeral costs, burial costs and other expenses related to the insured person’s death?  How much money should be reserved for a favorite charity or some other non-traditional beneficiary? A needs analysis can lead buyers and sellers to the best kind of life insurance policy for a given situation. For instance, a high-income client might prefer a policy that could maximize the amount of death benefits without causing major estate tax problems. Middle and low-income clients, on the other hand, are less likely to need this same kind of policy because their estates do not commonly face significantly negative tax consequences upon death. Instead, their financial situations might call for a traditional policy that guarantees necessary death benefits to children, spouses and other dependents in as simple a manner as possible.

That last example can help us bridge the gap between traditional views on life insurance, which center on death benefits, and current views on the policies, which treat life insurance as yet another wise addition to a diversified financial plan. Following the annuity’s lead, some life insurance policies have been marketed as smart investments for eventual retirement. Customers have been told about the various tax incentives that some life policies might provide. Even businesses have noted the financial flexibility of the product by taking out policies on valued employees and using life insurance as a prominent feature in buyout agreements.

Needs Analysis On average, according to Advisor Today (the official publication of the National Association of Insurance and Financial Advisors), agents will handle 10 death claims during their time in the business and will therefore have at least that many chances to witness what life insurance can do for beneficiaries. Those occurrences are bound to bring positive or negative “what if” scenarios to mind. Agents might recognize a death benefit’s positive effects on a grieving family and think, “Thank goodness! What if that person had not bought this policy?” Or, in a more troubling scenario, they might meet people whose lives are unnecessarily worse due to either a bad policy or no policy at all. In these instances, they might think, “How awful! What if this person had been properly covered?” These examples of good and bad experiences help explain why all people who express interest in buying life insurance need more than just a salesperson. Customers deserve a knowledgeable insurance representative who takes the time to understand their unique needs and who attempts to sell them only the products that could reasonably meet those needs. In keeping with this service attitude, insurance producers can help reduce the millions of underinsured and overinsured people in this country by performing a “needs analysis.” A needs analysis tries to determine how much insurance a person ought to possess. This analysis will obviously have a statistical base, but it should also be influenced by each individual client’s concerns and risk potential.

A needs analysis might weigh the cost of a proposed policy against its potential benefits. This will be a particularly important consideration if a low-income buyer would need to make significant financial sacrifices in order to pay premiums. The insurance community remains divided, if not evenly so, in its approach to these low-income customers. Whereas some agents and brokers are likely to convince people with modest incomes that purchasing a policy with decent, nearly guaranteed death benefits is well worth the expense, others will appeal to these consumers by highlighting policies that offer extremely affordable premiums in exchange for few benefits.

For many years, life insurers pounded home the idea of purchasing coverage equal to five times one’s income. These days, the five-year standard conflicts with the advice of insurance representatives who say people should buy coverage that is equal to eight, 10 or even 12 times their income. © Real Estate Institute

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INSURING MAJOR RISKS right to borrow money from the policy’s cash value at any time during the employee’s lifetime.

A final factor to consider in a needs analysis is the potential buyer’s eligibility for a particular policy. The good and bad news for buyers in this regard is that eligibility requirements will probably differ depending on the insurer, with the only near certainties being that someone who has been diagnosed with an aggressive terminal illness, such as AIDS and certain cancers, has probably waited too long to pursue coverage.

Life Insurance and Taxes As long as a policyholder does not borrow money from or cancel a policy, life insurance proceeds are generally exempt from income taxes. This tax break serves beneficiaries well, but the policy is still taxable as part of the deceased person’s estate.

The task of understanding industry-wide eligibility guidelines is made even more complicated by nonuniformity among the 50 states and their respective insurance laws. Though many companies will disclose the exact reasons for rejecting a life insurance applicant, insurers have not always needed to do so in every part of the country.

The federal estate tax (generally due within nine months of a death) can drastically reduce compensation for legal heirs. To combat this situation, many financial advisers champion the use of insurance trust funds. An insurance trust puts the policy irrevocably under the control of an executor. This person acts on the deceased’s behalf by giving policy proceeds to beneficiaries at designated times and in designated amounts.

In spite of such non-uniformity, we can address eligibility issues in a general sense and say that a person with medical problems will probably encounter more success when applying for a life insurance policy than when applying for a health insurance policy. After all, life insurers are concerned with life expectancy rather than pure health. As long as a person is likely to live long enough for an insurer to make a profit on a policy, a pre-existing condition will not disqualify someone entirely for coverage.

On occasion, policyholders look to avoid estate taxes by transferring policy ownership to heirs. In order for the proceeds to receive an exemption from estate taxes, such transfers must occur at least three years before the initial policyholder’s death. Transferring ownership of a life insurance policy can still require the initial policyholder to pay gift taxes. In general, a person can pass along assets worth up to roughly $10,000 to non-spouses, without fair compensation, and avoid gift taxes.

Regardless of their exact criteria for eligibility, life insurers have traditionally placed healthy, low-risk applicants in a “preferred” or “preferred-plus” class and granted lower premiums to those customers. People with smoking habits, weight problems, high cholesterol and a record of personal or family health problems have found themselves paying higher premiums as part of a “standard” or “substandard” class.

This course’s reduced emphasis on the federal estate tax stems not only from the daunting complexity of modern tax law but also from the issue’s arguably minimal relevance to the majority of consumers. The federal government allows each person’s estate to exempt a set dollar amount from taxation, and these exemptions tend to grow as the years go by. At the time of this writing, a person could exempt up to $5 million from federal estate taxes.

Addressing Business and Tax Issues Before moving further toward our course objectives, we ought to address two topics that appear frequently in trade literature but do not fit into our particular educational agenda. These topics—corporate-owned life insurance and tax issues—will certainly be relevant to some producers and their careers, but only a few specifics about them exist in the main body of this text. The following summaries are intentionally basic and have been included merely for background purposes so that the reader will more easily comprehend some concepts and facts discussed later in this text.

Numerous trade publications have published articles about how to structure estate plans with life insurance policies and how to maximize one’s tax-protected assets. It is worth noting, however, that most individuals will not have estates that will be impacted by the federal estate tax. According to the Internal Revenue Service, only 2 percent of estates face the so-called “death tax.” With this and the “needs analysis” concept in mind, an insurance producer could probably serve clients best by emphasizing a policy’s tax advantages to people with large estates and deemphasizing them to people with few assets.

Corporate-Owned Life Insurance Some companies purchase life insurance that protects their financial interests in the event of a key employee’s death. In its traditional form, “corporate-owned life insurance” pays no death benefit to an employee’s family or to any other worker-designated beneficiary. Proceeds from the policy go to the company, which may use the money in several ways, including as a subsidy for the business while it searches for a replacement, or as a source of funding for employee benefit programs.

KINDS OF LIFE INSURANCE Before we begin to investigate the purpose and intention of various life insurance provisions, terms and conditions, we will first review the most common kinds of life insurance policies.

Term Life Insurance Term life insurance is sometimes called “pure insurance” because, unlike other policies, it lacks investment options and has no cash value. Instead, term life customers pay premiums only so that beneficiaries can potentially receive the policy’s “face value.”

A “corporate split-dollar policy,” allows the company and the employee to share benefits as stipulated in the contract. Typically, upon the employee’s death, the company receives compensation that is the greater of the amount of premiums paid for the policy and the policy’s cash value. (In basic terms, a policy’s “cash value” represents the amount of money that would be payable to the policyholder if he or she were to cancel or “cash in” the policy.) Any remaining death benefits from the corporate split-dollar policy go to the employee’s chosen beneficiaries. In exchange for allowing the employee to designate a beneficiary, the business also reserves the © Real Estate Institute

The face value is clear to the insurer and the policyholder when the policy is issued, and it generally does not change as long as premiums are paid. The face value is not dependent on the economy or the insurer’s financial performance. If a person who is insured through a $100,000 term life policy dies, the insurance company pays

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INSURING MAJOR RISKS $100,000 to circ*mstances.

beneficiaries,

barring

any

the cost of some term life policies can increase dramatically as the insured person ages, many permanent life policies feature locked-in premiums that remain the same for several years.

unusual

As their name suggests, term life policies remain in effect for a contractually agreed-upon time and then expire. People who opt for a term life policy instead of a permanent life policy tend to have short-term needs and view beneficiaries’ welfare as their top life insurance concern. A father, for example, might purchase a term life policy in order to ensure that his young children will have some financial support if he were to die before they reach adulthood.

Cash Value In addition to paying premiums for possible death benefits, people who purchase permanent life insurance are engaging in a financial investment. Permanent coverage allows buyers to turn the money they spend on their policy into accessible cash that will hopefully increase in value over time. Part of the premiums paid to the insurer is set aside and allowed to grow in tax-deferred accounts until the policyholder decides to use the money. The sum of paid premiums and accumulated interest is known as the policy’s “cash value.”

When a policy’s term concludes, the insured individual can reapply for another term insurance policy. However, premiums for the new term policy are likely to be higher than premiums under the old policy. This is because the person’s susceptibility to mortality risks will have increased with age.

Cash value makes permanent life insurance a very versatile asset. It allows policyholders to either obtain a low-interest loan from their insurer or use their policy as collateral for a loan from another lender. It also gives people who no longer want their policies the chance to recover a portion of the money that was spent on the insurance. This amount of money is known as the “cash surrender value.”

If policyholders have no interest in renewing a term life policy they can sometimes exchange it for one of the several permanent life policies that we will discuss later. Term life insurance policies may be categorized based on the way consumers pay for them. An “annual renewable” term life policy might attract buyers who can see themselves canceling the insurance before the term expires. Premiums for these policies are at their lowest in the first year of coverage and either rise after each additional year or rise after a few years.

The cash surrender value is equal to the policy’s cash value minus any unpaid policy loans and unpaid premiums. As a policy’s cash value rises, the death benefits that will be paid by the insurance company technically decline, although this has no impact on the guaranteed amount beneficiaries will receive after a death. To better understand this idea, let’s imagine that a client bought a permanent life insurance policy at a young age with a $20,000 face value and has paid enough premiums and earned enough interest to give the policy a cash value of $2,000. If the client were to die today, a beneficiary would receive $20,000. Out of the $20,000, the insurer would end up losing $18,000, and the remaining $2,000 would be treated somewhat like a return of the client’s money.

Technically, people with annual renewable term policies enter into a new contract with the insurer for every year of coverage, but the insurer can change nothing but the premiums throughout the term. The insured does not need to medically qualify for the annual renewable policy every year. He or she must only continue to pay the company’s asking price. "Level term life insurance” lets policyholders maintain their term coverage at the same price for several years. Companies that sell these policies work around agespecific mortality risks by charging customers a consistent average of the cost that would be charged for all years in an annual renewable contract.

If the same client lives long enough to give the same policy a $15,000 cash value, the beneficiary would still receive $20,000. However, the true death benefit (the amount of money funded by the insurer) would only amount to $5,000, and the remaining $15,000 would come from the money created through paid premiums and investment gains. When a policy’s cash value equals its face value (the amount payable to beneficiaries), the policy has reached its “endowment date.”

Suppose, for example, the insured’s policy costs $40,000 over a 20-year term. Instead of paying a low first-year premium of $500 and a twentieth-year premium of $5,000 under an annual renewable contract, the level term customer could pay $2,000 each year for the entire term. A level term insurance policy will probably cost more than a standard annual renewable policy near the beginning of the term when the insured person is younger, but it will cost less than a standard annual renewable term policy near the end of the term when the insured person is older.

Some policies’ cash surrender values are lessened by dividends. In the context of insurance, a “dividend” is a yearly partial return of premiums that insurance companies believe is in excess of their operating needs.

A third yet less-common option for the term life insurance customer is “decreasing term life insurance.” These policies are designed to help people manage risks that will decrease over time. An example of this would be the risk of death of the sole provider for a family with young children. The premiums for these policies tend to shrink as the insured grows older. The death benefits associated with decreasing term life polices drop in value each year along with the falling premiums.

It is important to note that not all permanent life insurance policies pay dividends. Insurers that are configured as stock companies share profits with stockholders and do not incorporate dividends into their policies. Mutual life insurers, on the other hand, share their profits with their policyholders and do incorporate dividends into their cashvalue contracts. This distinction helps explain why policies from mutual insurance companies are often called “participating policies” and why policies from non-mutual insurance companies are often called “nonparticipating policies.”

Permanent Life Insurance Permanent life insurance is very different from term life insurance. Whereas term life insurance is either renewed frequently or allowed to expire after a specified number of years, permanent life insurance should cover the insured individual no matter how long a person lives. Also, whereas © Real Estate Institute

Permanent life insurance ideally benefits the person buying coverage as well as the company selling it. The buyer not only remains covered as long as premiums are paid. He or 4

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INSURING MAJOR RISKS insurance in a far simpler manner than under a whole life agreement.

she also has a financial incentive to maintain the coverage for various investment purposes. At the same time, the insurer benefits from offering this incentive because customers who maintain their coverage give the company a steady supply of capital to invest.

Rather than needing to pay an agreed-upon premium for permanent coverage and investment purposes, a universal client has some control over the size and even the frequency of premiums. A person looking to grow a universal policy’s cash value can increase premiums when the insurer’s interest rates are high and decrease premiums when those interest rates drop. Of course, the policyholder might also have personal reasons for raising or decreasing premiums at any given time.

Despite this give and take, some critics say cash-value accumulation takes too long to materialize. This waiting period for growth exists, in part, because much of the premiums paid during the early years of coverage go toward sales commissions and administrative fees rather than toward the policy’s cash value. On the positive side of this issue, disclosures in cash-value insurance policies and opportunities for consumers to remain informed about their policies’ worth have increased over the years.

This freedom demands respect from buyers because paying too little in premiums for too long could jeopardize coverage and allow the insurer to reduce the policy’s face value. If policy loans become a factor, the outlook for a positive cash surrender value or sufficient death benefits could become uncertain.

Whole Life Insurance Unlike the different kinds of term life insurance, the various types of permanent life insurance policies differ significantly in ways beyond their premiums. The three main varieties of permanent coverage are whole life insurance, universal life insurance and variable life insurance.

Like whole life insurance, universal life insurance typically offers a guaranteed interest rate (probably up to 4 percent or 5 percent). Yet unlike the bundled, un-itemized premiums for whole life insurance, universal premiums are often disclosed in a divided manner, showing how much of each payment ultimately goes toward the death benefit and how much goes toward the policy’s interest component. The insurer still chooses how to invest the premiums.

Whole life contracts can usually remain in force at least until the insured person reaches age 100, and premiums for these policies usually stay the same as long as the policyholder pays them on time. The price for whole life insurance pays for more guarantees than a person will find in a typical universal life or variable life policy, and the product remains popular among people who want permanent coverage but remain fearful of possible economic downturns.

Due to the flexibility involved with premiums, universal life insurance policies are less likely than whole life policies to guarantee large death benefits. Some insurers have offered policy riders that can fatten the guaranteed payouts, but these riders can make a universal contract cost just as much as (or even more than) a whole life policy. Guaranteed death benefits from a universal life policy tend to only apply when the policyholder has paid at least a specified minimum amount of premiums to the insurance company. Buyers should also understand that, in addition to facing the usual deductions for any outstanding policy loans, a universal client who gives up a policy is more likely than a whole life client to confront “surrender charges.” These fees lessen cash value and will usually be higher for recently issued policies than for policies that have been in force for several years.

Unless the policy’s owner borrows against the policy’s cash value, whole life policies will pay guaranteed minimum death benefits and feature guaranteed minimum increases in cash value. Guaranteed interest rates—anywhere from 3 percent to 5 percent depending on the insurer—are achieved through investments in low-interest bonds and other low-risk ventures. The insurer takes responsibility for managing the investment portion of the policy, allowing customers to develop a financial asset without forcing them to wade through numerous investment options. In some respects, the modest performances and guarantees involved with whole life insurance can encourage saving among consumers who would not normally conserve much of their money. Many parents have utilized whole life’s relative security as a foundation for college funds.

When confronted with the possibility of surrender charges, fewer guarantees and greater responsibility in regard to premiums, people who own universal life insurance might need to pay close attention to their policies and to their financial goals. With their increased risk factors, these policies make clear and continued communication between clients and insurance professionals integral to customer satisfaction.

Still, among other clients who favor growth potential over security, the investment features of whole life insurance can seem insignificant. When interest rates on policy loans are low, some whole life customers borrow money from their policies and put that money into high-growth opportunities. Though this strategy has certainly not paid off in every instance, it has absolutely encouraged insurers to develop different life products that give buyers more control over how their premiums are invested.

Variable Life Insurance Perhaps no life product demands as much caution and expert consultation as “variable life insurance.” Like universal life insurance, variable life insurance features a relatively modest guaranteed death benefit, allows customers to see where the money from their premiums is going and allows for greater personal control than whole life insurance.

Universal Life Insurance By the 1980s, more and more life insurance policyholders had begun venturing out into the stock market and developing a strong taste for the freedom to make more financial choices on their own. These general concerns and desires sparked significant sales and development in the universal life insurance market.

The major difference between universal and variable life insurance is that a variable life policy transfers significant investment responsibilities from the insurer to the policy’s owner. Unlike whole or universal life contracts, variable policies lack investment guarantees. A variable policy’s cash value might experience major increases over time or major losses, and it is the client who absorbs market risks.

“Universal life insurance” tends to get tagged with the adjective “flexible” quite often. Even though risks exist for the owner of a universal life policy, this product attracts people because it allows them to make changes to their © Real Estate Institute

When a customer pays a premium for variable life insurance, any investment portions of the premium go into 5

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INSURING MAJOR RISKS risks for people who are in debt. This product is similar to mortgage insurance, but beneficiaries can use its death benefits to eliminate debts that have nothing to do with real estate.

a separate account with the policyholder at the controls. The customer must then decide how to invest his or her money. Each insurer will feature its own assortment of investment options that work somewhat like mutual funds. Investment dollars are pooled together from all policyholders with similar investment preferences, and the pool’s designated manager works to maximize growth. Investment options might include domestic or foreign stock funds, bond funds, money market funds and more.

Though no specific numerical limits exist regarding the face value of a credit life policy, the face value is nearly guaranteed to be low because the insurance is only designed to cover outstanding debts and any interest that is owed to a lender. The policy usually does not include a death benefit that can replace income or provide for a dependent.

Policyholders can diversify their investments by allocating different dollar amounts to different funds, and they are usually neither taxed by the government nor charged fees by the insurer for moving their money around within the insurer’s assorted investment vehicles.

In many ways, credit life insurance is like a hybrid of decreasing term life insurance and group level term life insurance. Premiums are likely to remain the same throughout the coverage period, and the policy’s face value drops as the insured person pays down debts. Insurers price the coverage as if it was an extremely inclusive group policy, with eligibility rarely jeopardized by a person’s age or health status.

Group Life Insurance Though it can perform other functions, “group life insurance” is most commonly used to insure several people who work for the same employer. Premiums for group coverage usually depend on the collective age of the group participants and help pay for limited death benefits in the neighborhood of one or two times an insured person’s annual salary.

Some financial professionals question credit life insurance’s value and have criticized lenders for making this kind of coverage so prevalent in the United States. On occasion, lenders have been known to automatically insert a credit life insurance contract into a lending agreement, meaning that consumers who do not want the coverage offered by the lender have needed to wait for new paperwork to be drawn up before the lending process could proceed.

Group life insurance involves very little underwriting and, therefore, can allow an ill or older individual to obtain some coverage at a low price. Some employers even offer limited group life benefits at no cost to their workers. The typical employer-funded group plan will pay at least enough death benefits to offset funeral and burial expenses and perhaps some debts.

Some controversy also surrounds the occasionally low number of claims that are made by credit life beneficiaries. In studies conducted during the 1980s and 1990s, researchers discovered the fraction of premiums paid back as benefits to customers ranged from one-fifth to just over one-third.

Unfortunately, many consumers do not realize group life insurance is unlikely to help beneficiaries meet their longterm financial needs. Death benefits from these policies are not likely to sustain a young child for several years and might not satisfy outstanding debts on a home.

In response to all the criticism, lenders and credit insurers have defended themselves and their products by saying roughly 90 percent of customers are glad they purchased the coverage and that people would stop buying the product if they believed they were not receiving a fair deal. No matter their ultimate choice, consumers deserve to know they do not need to accept the exact credit life policy offered by a lender.

Laws and products that address insurance portability have allowed people who leave a group to convert their group life coverage into an individual policy.

Accidental Death Insurance “Accidental death insurance” is often bought by consumers who want to pay low premiums for at least some level of coverage and by travelers who are buying plane tickets. Many employers offer accidental death coverage as a free employee benefit.

Funeral Insurance Most popular in low-income, minority neighborhoods, funeral insurance remains a multi-billion dollar industry despite criticism from some consumer advocacy groups. For a few dollars each month, this insurance offers a modest death benefit (usually anywhere between $5,000 and $10,000) that families can use to pay for burial and other death expenses. The death benefit from a funeral insurance policy is rarely intended to replace the deceased’s income.

This insurance can be purchased in combination with dismemberment coverage, or it can be bought as a rider to another policy. As a rider, the coverage will generally pay double the death benefit if the insured’s life ends in an accident. This explains why accidental death benefits are often associated with the term “double indemnity.” In order for accidental death policies to pay benefits, there must be clear evidence that a death occurred because of an accident and not because of other factors or some combination of accidental and non-accidental factors. Most policies will only pay benefits if the undisputed accident occurred no more than three or four months before the insured person’s death.

Funeral insurance companies term life insurance policies, insurance policies can be paid dies. Other insurance workers purchase a funeral policy only other life insurance products.

Deaths that are unlikely to be covered by this product include death by sunstroke, drug overdoses, suicide by insane persons and deaths suffered by people aboard noncommercial aircrafts.

Joint and Survivor Life Insurance Joint and survivor life insurance policies extend permanent life coverage to two or more people (usually a married couple), but they only pay one death benefit. Because only one death benefit goes to beneficiaries, a joint or survivor policy can cost about 75 percent less than two individual permanent life products.

Credit Life Insurance “Credit life insurance” is typically included in an umbrellalike policy that also covers unemployment and disability © Real Estate Institute

have stressed that, unlike claims on many funeral no matter when the person believe a consumer should if he or she is ineligible for

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INSURING MAJOR RISKS must make an effort to explain how customers should fill out applications and how incorrect information on the application could have a negative impact on coverage.

“Joint life insurance” is often called “first-to-die” coverage because the death benefit comes when the first person among the insureds passes away. This product became popular initially as a tool to help ensure that one spouse could pay off a mortgage loan and remain in a family home after the death of the other spouse. Some joint life insurers offer a “survivor purchase option,” which might allow the survivor to trade in the death benefit for another first-to-die policy or an individual policy of equal value.

Ownership Clauses Each life insurance policy will mention “pre-maturity rights,” also known as “ownership” rights. The policy owner (who might or might not be the person insured by the policy) is the individual who is legally held to the consumer’s responsibilities that are spelled out in the life insurance contract.

“Survivor life insurance” is often called “second-to-die” coverage because the death benefit comes when the last of the insureds passes away. This product became popular initially as a tool to help ease estate tax concerns for heirs.

Other than the insurance company, the policy owner is the only party who controls how the policy is set up. The owner is also the only person capable of choosing beneficiaries.

PARTS OF A LIFE INSURANCE POLICY

Once the policy is issued, the owner reserves the right to do any of the following:

Now that we understand the general differences among the various life insurance products available in today’s market, we can explore the intricacies involved with policy terms and conditions.

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Borrow money from the policy. Use the policy as collateral for a loan. Access the policy’s cash value within the limits of the contractual agreement.  Utilize accelerated death benefit features.  Designate and change beneficiaries.  Make any other permissible changes to a policy, such as deciding how much to pay for a universal life product or how to invest premiums for a variable life product. The owner may also transfer some or all pre-maturity rights to another entity without needing consent from beneficiaries or the insured.

The Face Page and the Entire Contract Clause Perhaps the most important element to understand throughout our exploration of these issues is that an issued life insurance policy is a legally binding contract between the client and the insurance company. This point is usually stressed somewhere on the policy’s “face page” or within the policy’s “entire contract” clause. The face page explains the duties that the insured and the insurer are expected to perform throughout the policy’s lifespan. It declares that the client will be held accountable for filling out a valid, honest application and for paying premiums. Meanwhile, the insurer will be held accountable for paying benefits on any valid claims, as long as the client fulfills his or her end of the agreement.

The insured individual and the owner of the life insurance policy will often be the same person. Yet it is possible for a beneficiary or a third party to own an insurance policy on another person’s life.

An entire contract clause can only be found within the actual policy (as opposed to within a policy summary or other document). This clause alerts all involved parties to the fact that the delivered policy contains all the terms and conditions related to coverage. It says the terms and conditions within the policy cannot be changed by the insurer to the detriment of the consumer during the policy period.

Practical reasons exist for this kind of arrangement. For example, even though some children are covered by life insurance or are listed as beneficiaries on policies, laws might prohibit anyone under the age of 18 from owning a policy. Other reasons for transferring policy ownership tend to involve probate and tax issues. Some applicants grant ownership to a trust in order to avoid estate taxes.

Agents and brokers do not have the authority to directly negotiate terms and conditions with customers and cannot independently alter policy provisions or restrictions. These prohibitions exist because the contractual relationship detailed in an insurance policy does not technically seal an agreement between the individual agent and a client. Instead, it finalizes an agreement between the client and the insurance company.

Insurable Interest In general, a person can take out a life insurance policy on another person if the proposed owner can demonstrate an “insurable interest” in the other person’s life. In simple terms, insurable interest within this context is a reasonable desire, on the owner’s part, for the insured person to remain alive.

Minding the Application

Ever since insurable interest became an industry issue, insurers have assumed that an individual has a reasonable desire to remain alive. Therefore, people are allowed to own life insurance policies on themselves. Insurers have also traditionally assumed close family members (such as spouses, parents and children) and business partners have reasonable desires to see one another remain alive. So these people are usually allowed to own policies on one another.

The life insurance application and any personal medical records used by the insurer to underwrite a policy become part of the contract. The policyholder who makes false statements on these documents might risk either a reduction in his or her coverage or full termination of the contract. Policyholders will typically receive copies of the completed application no later than when they receive a copy of the full policy. By retaining and reviewing copies of these documents, insurers and their clients can substantiate or dispel various alleged misstatements that could affect a person’s right to death benefits.

Over time, the definition of insurable interest has become broader. Employers can now own policies on key personnel, and former spouses can often take out policies on each other, particularly when alimony and child support factored into a divorce settlement. Some insurers will even allow an unmarried person to own a policy that insures a significant other.

Providing copies of the completed application to the consumer does not entirely eliminate the potential for disputes between insurers and the public. In order to reduce additional legal problems, insurance producers © Real Estate Institute

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INSURING MAJOR RISKS right to receive dividends on a participating life insurance policy but be willing to forfeit all other pre-maturity rights.

Different states and different insurers tend to have their own way of defining insurable interest and of applying that definition. For instance, some carriers require that beneficiaries, as well as owners, demonstrate an insurable interest in the person who would be covered by a policy.

Incontestable Clauses The “incontestable clause” specifies how long an insurer may investigate possible frauds or misstatements on an application and deny coverage after the policy has been issued.

In some cases, the company will only care about insurable interest when the policy is issued. At other times, a presumed loss of insurable interest (perhaps resulting from a divorce) could affect a person’s role in a life insurance arrangement.

Incontestable clauses typically give the company two years to probe for untrue statements that affected the price and scope of coverage. These untrue statements are known as “material misrepresentations.” When an insurance company refuses to cover a person based on alleged material misrepresentations, it must usually return all premiums to the policy owner in exchange for voiding the insurance.

Situations in certain jurisdictions demand that the insured person consent to another person owning a policy on his or her life. This consent might or might not be required when there is a spousal relationship between the policy owner and the insured. If people wish to void life insurance policies that have been taken out on their lives by another person or corporate entity, they should seek out local legal counsel.

Depending on state laws and judicial opinions, an insurer might be able to lean on the incontestable clause to deny a death claim based on a material misrepresentation even if the misrepresentation was not a factor in the insured person’s death. This means that someone who lies about not having cancer, for example, can jeopardize death benefits for beneficiaries even if he or she ends up dying in an accident or from a disease other than cancer.

Assignment Clauses The owner’s option to transfer his or her rights to another entity is spelled out in a life insurance policy’s “assignment clause.” In general, insurers put few restrictions on assignments, but some insist that the new owners either demonstrate an insurable interest in the insured’s life or pay fair market value for the policy. Even when the insurer sets conditions for assignment, the company typically warns it will not be liable for any negative consequences that may arise as a result of the assignment.

Insurers generally cannot rescind a policy after the contestability period has passed, even if they realize a client has clearly engaged in material misrepresentation. Exceptions to this rule might include cases in which the policyholder bought the coverage with intent to murder the insured, lacked an insurable interest in the insured or recruited an impostor to impersonate the insured in a medical examination. In these situations, it is often assumed that no valid contract ever existed and that the insurer is therefore not liable for overstepping the incontestable clause’s boundaries.

Collateral Assignment There are a few kinds of assignments that the owner can choose from. In a “collateral assignment,” the policy owner uses the insurance strictly as a means of obtaining credit from a lender. Collateral assignments are meant to be temporary, with the end date dependent on when the policy’s owner repays a loan.

The incontestable clause protects policy owners from some potential instances of “post-claims underwriting,” in which an insurer does not fully judge an insurance applicant’s risk potential until after a policy has been in effect and after beneficiaries have requested compensation for a loss. With the incontestable clause in effect, the client does not need to spend several years worrying about having made an innocent mistake when he or she applied for coverage. The incontestable clause has proven to be broad enough to even protect some clients who intentionally defraud insurance companies.

Rather than granting the lender major ownership rights, a collateral assignment only allows the creditor to collect a portion of the death benefit and to access part of the cash value if the owner never repays a debt. If the owner dies, collateral assignees who are listed as beneficiaries are entitled to a death benefit equal to any remaining debt. A collateral assignment agreement will be made in writing and will state whether or not the lender has assumed any responsibility for paying policy premiums. If creditors take on responsibility for paying premiums, they might be able to borrow money from the policy’s cash value in order to keep the policy active.

Some Incontestable Clause Case Studies In order to comprehend the significance of the incontestable clause and the varying legal interpretations of other clauses, the reader is asked to examine the real-life case studies in this course. These examples were chosen in order to show students how different policies, laws and circ*mstances can lead to different legal outcomes even if two given situations seem very similar. Our first two case studies deal with alleged medical misrepresentations and an insurer’s limited right to deny death benefits.

Absolute Assignment In an “absolute assignment,” the original owner transfers all rights to a different person or entity, thereby losing control of the coverage and its cash value. Absolute assignments can greatly affect insured persons and beneficiaries. The new policy owner is under no obligation to continue paying for the coverage and can exchange the policy for its cash value at any time. Depending on the insurer and the policy, an absolute assignment might either remove beneficiaries automatically from the contract or give the new owner the opportunity to revoke the existing beneficiary designations.

A man bought a $2 million life insurance policy on himself for use as collateral for his business. He listed the business as the intended owner and beneficiary. On an application, the man was asked if he had ever had cancer, and he answered, “No.” The application stated, “The statements and answers are true to the best of my knowledge,” and also said, “No insurance shall take effect unless and until the policy has been physically delivered and the first full premium paid during the lifetime of the insured and then only if the person to be insured is actually

Other Forms of Assignment Other transfer-related options exist somewhere between collateral and absolute assignments and allow the original policyholder to retain certain ownership rights. The original owner might, for instance, insist on preserving his or her © Real Estate Institute

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INSURING MAJOR RISKS reduced or denied because a disease or physical condition existed before the date of issue, unless it is excluded by name or specific description.”

in the state of health and insurability represented in … this application.” The man took a physical to obtain coverage, and the insurance company received copies of his medical records from a physician. The insurer believed the man’s health was satisfactory and issued the policy on April 26. On May 1, the man filled out an identical application for a policy that listed a trust, rather than his business, as the owner and beneficiary. This new policy was delivered to him 24 days later, and the initial policy never went into effect.

When the man filed a disability claim on January 7, 1991, for loss of vision, the insurer denied benefits and said its action was based on material misrepresentation. According to an attending physician, the man exhibited symptoms related to an eye disease in late 1989 and had sought similar treatment from two other doctors in 1985. The man admitted playing a role in insurance fraud, yet he reasoned the insurance company could not deny his claim since the contestable period had ended.

The application from May 1 contained no mention of an April 18 physical examination that revealed blood in the man’s stool. On June 20, the man was diagnosed with colon cancer and later died from the disease. The insurance company learned the man had a tumor at least since January, roughly three months before he ever applied for the coverage, and it decided to void his policy.

The Supreme Court ruled in the insurer’s favor and said incontestable clauses were created to protect policyholders who made “technical” mistakes on their insurance applications. According to the court, “Statutory language that precludes a defense based on a pre-existing disability does not protect insureds who make fraudulent misrepresentations in their applications. Rather, the language is intended to protect those insureds who are unaware of their diseases.”

The man’s wife sued for breach of contract, but the insurer claimed it was within its rights because the man had misrepresented his medical condition. The wife argued that even though her husband had misrepresented his health, he had not intended to commit fraud. Though he might have had cancer when applying for coverage, he had not been conclusively diagnosed with the disease by that time.

A different outcome surfaced in a decision from the Supreme Court of California. In this instance, a man with AIDS lied about his condition in order to obtain a life insurance policy and recruited an impostor to take a medical examination in his place.

The United States Court of Appeals for the 8th Circuit ruled in the insurance company’s favor, determining that the man’s good faith was not the issue at hand. Instead, the coverage had been denied because the information given to the insurer about the man’s health turned out to be factually inaccurate.

On his application, the man claimed he was 5’6”, weighed 142 pounds and did not smoke. But the man who gave a physician an HIV-negative blood sample stood 5’10”, weighed 172 pounds and produced urine that proved he was a smoker. The examined person had no identification to match him with the applicant, and the insurer’s medical examiner documented this fact.

In another case, a Michigan woman filed a $44,000 death claim after her husband died in a swimming accident. Despite the expiration of the policy’s contestable period, the insurance company denied the claim and offered to return premiums to the wife after it learned the man had not disclosed a heart condition when applying for coverage.

The insurance company opted to issue a policy for the applicant on May 1, 1991, which said, “We will not contest coverage under the certificate after it has been in force during the life of the covered person for two years from the certificate effective date, if all premiums have been paid.”

Both parties agreed the heart condition did not play a role in the husband’s death, but the insurance company claimed it was within its rights to deny benefits because the man would not have received coverage in the first place if he had properly told the insurer about his health.

The applicant eventually sold his policy on the secondary market, and the policy’s new owner received confirmation from the insurer that the contract’s contestable period had expired. The applicant died on June 11, 1993, and the new policy owner filed a death claim with the insurer.

Though judges acknowledged that laws in other states might contradict their ruling and that misrepresentations need not relate to death in order to merit a denied claim, the state Supreme Court ruled in the wife’s favor. In its opinion, the judiciary said the incontestable clause “balances the concerns of insureds that years after the application date an insurance company would refuse to pay benefits and desire to avoid contracts, no matter how old, if there was material misrepresentation at the time the contract was made.”

A tip eventually alerted the insurance company to possible fraud, and after conducting a handwriting analysis, the insurer denied the claim. The new policy owner sued for compensation, and the court ruled against the insurance company. The court acknowledged that fraud is bad but also said the insurer only has a limited time to look for it. The judiciary reasoned that the insurer had all the evidence it would have needed to void the policy within a two-year period and said the company squandered that chance by just accepting premiums rather than investigating the matter promptly.

Our next two case studies demonstrate different interpretations of how the incontestable clause can protect either the insured or the insurer when relatively obvious instances of fraud are revealed. A New Jersey man applied for disability insurance on January 20, 1987 and claimed, on his application, he had not been treated, observed or examined by a doctor in the preceding five years and had not been alerted to any possible eye diseases he might have developed. The insurer issued the policy less than two months later and used an incontestable clause that said, “After your policy has been in force for two years, excluding any time you are disabled, we cannot contest the statements in the application. No claim for loss incurred or disability beginning after two years from the date of the issue will be © Real Estate Institute

In response to the insurer’s impostor defense, the court said the sick man was the one who applied for coverage and was the person who the company intended to cover. Therefore, the covered person was not an impostor. According to the court, “When the named insured applies for the policy, and the premiums are faithfully paid for over two years, the beneficiaries should be assured they will receive the expected benefits, and not a lawsuit, upon the insured’s death.”

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INSURING MAJOR RISKS representative has clearly and intentionally tried to defraud the company.

Suicide Clauses Since self-administered deaths factor into the mortality tables that insurers use to underwrite coverage, it would be illogical for insurance companies to exclude all suicides in their life insurance contracts. But insurance professionals still hope to discourage people from taking their own lives in order to create income for beneficiaries.

If an insurance company can prove a misstatement of age or sex, the policyholder will typically need to pay an adjusted premium in order to avoid a change in coverage. When the insured’s age is actually higher than originally thought, either premiums will rise or the death benefit will be reduced. When the insured’s age is actually lower than originally thought, the insurer will either return a portion of premiums or increase the death benefit.

Similar to the incontestable clause, the “suicide clause” usually states that an insurer will not pay death benefits when insured people kill themselves within two years of obtaining coverage. A clear and complete suicide clause will also mention the company’s claim responsibilities in cases when the insured commits suicide while sane or insane.

Sometimes uncertainty arises when an insurance company confirms a misstatement of age. The client and the salesperson might understand that the premiums and coverage will be adjusted. But how will this be done?

Contrary to tradition, some modern courts have put the burden of proof on the insurance companies’ shoulders in regard to denying death claims based on suicide. This means an insurance company that wants to deny a claim on suicidal grounds might need to prove that a person’s death was a suicide and had nothing to do with any accidents or medical problems.

Suppose a client has been covered by a life insurance policy for 20 years, and the insurer finally recognizes that the person’s stated age is incorrect. Will the coverage and premiums be adjusted based on the insurer’s current rates, or will the adjusted premiums and coverage be based on prices from 20 years ago? A proper misstatement clause will explain how the insurer will handle this sort of situation.

A Suicide Clause Case Study

Adding to possible confusion is the fact that insurance companies treat age in different ways, even before misstatements are realized. Some insurers base their rates on a person’s actual age upon application for coverage, while others round the person’s age to the nearest birthday.

Firm disagreements between insurers and beneficiaries in regard to an alleged suicide are very likely to push the arguing parties into a courtroom. For a real-life example, we will turn our attention to a case heard by a U.S. district court.

Misstatements of age do not always stem from a client’s conscious desire to receive a lowered premium. They also can grow out of confusion and mistakes. These mistakes can apply to the producer as well as to the applicant.

A depressed man went to a physician, who prescribed antidepressant medication for him. According to the doctor, the man did not seem suicidal during the appointment.

In one documented case, a person applied for life insurance, received an issued policy and had a birthday in between. In error, the insurer used the age listed on the application and gave the insured a lower premium than he deserved.

At some point, the doctor doubled the dosage, and the man shot himself two days later without leaving a note. His wife filed a claim with the company that insured him through an accidental death policy. The accidental death policy did not cover “suicide or any intentionally self-inflicted injury,” but the wife claimed the policy should have paid benefits because it failed to differentiate between sane and insane suicide. She said her husband did not intend to kill himself and that the antidepressant medication was to blame for his actions.

When discussing age-related errors, experts have offered precautionary suggestions to their peers. The suggestions include the following: 

The wife, who also sued the drug company, conceded that a statement on the policy summary said the insurer had the power to interpret the policy, but she also claimed this statement did not exist within the policy itself and that the actual policy’s content ought to have overruled the content of the policy summary. She brought the insurance company to court, alleging it needed to prove the policy did not cover her husband’s death.

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Dividends, Vanishing Premiums and Policy Illustrations As we learned earlier, certain types of insurance companies pay back a portion of premiums to policyholders in the form of dividends when profits exceed business needs. These dividends might be possible because an insurer priced a product too high or because the company made more than enough money in a year to meet requirements related to its reserve and surplus accounts.

The court disagreed, concluding that the burden of proof was on the wife. If she wanted the death to be covered by an accidental death policy, she would first need to prove that the death was, indeed, an accident.

Technically, only mutual insurance companies (which share company profits with customers rather than stockholders) give out true dividends. When people use the term “dividends” in connection with policyholders at stock insurance companies, they are probably referring loosely to interest earned on permanent life insurance policies.

Misstatement of Age or Sex Clause Age and gender are important underwriting factors for life insurers. After all, on average, younger people will live longer after qualifying for coverage than older people, and women will generally live longer than men. The “misstatement of age or sex clause” allows an insurance company to adjust coverage appropriately when a client’s supposed age or gender turns out to be inaccurate. The clause forbids cancellation of a policy based on these inaccuracies, unless the policy and local laws allow an exception when the owner or an insurance

Making space on applications for a person’s age AND birthday Requiring an applicant to submit a birth certificate to the company before a policy may be issued

Mutual insurance companies calculate dividends by looking at mortality rates, interest rates, business expenses and other statistics. Due to the variable nature of those numbers from year to year, dividends are rarely guaranteed.

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INSURING MAJOR RISKS If a mutual company experiences an unfavorable investment outcome, the insurer may choose to lower dividends or to temporarily not offer them at all. Yet careful insurers have found ways to compensate for unknown economic results and have always been able to offer some dividends to policyholders, even if those dividends are lower than expected.

After two years, the man received a letter from the producer, as well as documents from the insurer’s home office, which said the financial plan had worked successfully and that the premiums had vanished. Over the next three years, the man received premium notices from the insurer, and the producer told him dividends and policy loans would continue to cover the cost of coverage.

Insurance companies give clients several options when it comes to utilizing their dividends. These options are typically as follows:

The man later learned the vanished premiums could return and that the illustrations used to demonstrate policy dividends had been based on overly optimistic investment projections. He accused the insurer and the producer of fraud, breach of contract, intentional interference with contract rights and negligent misrepresentation, and he instigated a class action lawsuit that included plaintiffs who had bought whole life or universal life policies from the company from 1982 through 1996.

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A policyholder can receive a check from the insurance company and use the money created through the dividend to pay for private expenses.  A policyholder can keep the money with the insurer and allow it to gather interest.  A policyholder can use the money to increase a policy’s death benefit on a cash-value policy.  A policyholder can exchange the dividend for a term life insurance policy.  A policyholder can repay a policy loan by giving the dividend back to the insurance company.  A policyholder can use the money to offset current or future premiums. That last option became very popular during the 1980s and relates to a life insurance feature called a “vanishing premium.” When clients pay premiums for an extended period of time, an insurer might allow premiums to “vanish” by using policy benefits to pay for coverage. Rather than billing participating policyholders directly for coverage, the carrier might take premiums out of accumulated dividends and interest.

Courts ruled the producer had no fiduciary duties to the policyholders in this case, cleared the producer of charges related to deceptive sales practices and dismissed the contract-related charges. They did not, however, dismiss fraud charges against the company. In response to the suit, the insurer offered a settlement to 240,000 policyholders that was worth $55 million in increased benefits and other compensation. As lawsuits of the real and threatened varieties became more prevalent, the insurance industry responded to the vanishing premium controversies. One insurer accused of wrongdoing stopped using the words “vanishing premium” and substituted “premium offset by policy values” in their place. The National Association of Insurance Commissioners (NAIC), which creates model industry regulations, has supported the following measures:  

Stopping the use of the term “vanishing premium” Forcing insurers to have dividend illustrations approved by a special actuary who has no connection to sales or marketing  Requiring the agent and the consumer to sign a document that says the consumer understands the illustrations and the potential benefits and consequences that could materialize based on the policy’s structure The legal disputes over dividends and vanishing premiums have lent themselves to a broader discussion about fairness and policy illustrations. Professionally constructed illustrations can help consumers visualize how permanent life insurance policies can grow in cash value over time. But because policy illustrations should ultimately serve as a buyer’s tool rather than as a salesperson’s weapon, some insurance producers have called on the industry to forbid agents and brokers from emphasizing interest rates and dividends that are not guaranteed.

When everything goes as planned, a policy with vanished premiums can create convenience for people who expect to hang onto their permanent life insurance for a long time. These policy owners might believe that they possess “paidup” coverage. Unfortunately, a vanished premium can sometimes reappear if dividends from a participating policy become too small to cover the cost of the insurance. It’s also important for insureds to know that dividends—no matter how steady they might seem at any given time—are not guaranteed to remain stable forever. When a policyholder depends on them to vanish premiums, dividends that go up or down even a single percentage point can mean the difference between the policy paying for itself and the buyer needing to pay more money to the insurance company. A few major insurance companies have been accused of overstating the probable size of future dividends to older customers in order to make policies with vanishing premiums seem attractive to retirees on fixed incomes. One company was accused of making retirees think the money they were actually paying to vanish a life insurance premium was funding an annuity. In the end, the company faced fines of up to $20 million and was forced to give millions of dollars in refunds to policyholders.

Some among this group would still allow salespersons to discuss an insurer’s past interest rates and dividends with clients but would not allow salespersons to use these numbers on illustrations or even discuss them without emphasizing that past dividends are not guarantees of future dividends. Other people suggest that an insurer should be able to use non-guaranteed interest rates and dividends in illustrations as long as the company lowers its projections by a percentage point or two.

In a real-life example from a district court in Mississippi, a man bought three $230,000 vanishing-premium policies. An insurance producer allegedly showed the man an illustration that suggested the policies would be paid up after two years if the prospect paid at least a $2,800 annual premium for each policy.

The NAIC has recommended that consumers view illustrations that represent a midpoint between current dividends and interest rates and guaranteed-minimum dividends and interest rates.

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INSURING MAJOR RISKS loan provision,” which alerts the borrower to loans that equal a certain percentage of a contract’s cash value and automatically forbids clients with variable or universal policies from investing premiums in high-risk vehicles.

Policy Loans Several reasons exist for policyholders to take advantage of a contract’s loan features. For starters, prospective borrowers are unlikely to be turned down by their insurance company as long as their policies serve as adequate collateral for a loan. Along with this privilege come fewer questions on a loan application and greater overall privacy than a person would receive from a traditional lending institution, such as a bank.

Borrowers who want to repay policy loans can do so by paying higher premiums for their life insurance, by applying dividends to debts or through some combination of those two methods.

Automatic Premium Loans

Though the federal government has tightened tax laws pertaining to life insurance loans over the past several decades, borrowing from a life insurance policy is still likely to incorporate fewer tax issues than borrowing from a person’s 401(k) or other retirement account. Also, unlike other credit situations, a loan from a life insurance company usually comes with a low-pressure obligation to pay off the debt. If a person dies or cancels a policy without paying off a loan, the company can simply take money out of the policy’s cash value.

A policy feature known as an “automatic premium loan,” permits the insurance company to use part of a permanent life insurance contract’s cash value to keep a policy in force when the owner misses a premium payment. Most insurers do not place limits on automatic premium loans in regard to either amount or frequency, as long as the policy’s cash value is large enough to cover the cost of coverage. Other companies might have rules that prevent a client from utilizing automatic premium loans too frequently. Their policies might state that owners can only take out a specific number of consecutive loans to pay premiums, or they might say owners cannot take out any more than a specific number of automatic premium loans in the same year.

Money requested from an insurer for lending purposes will usually take two weeks to six weeks to arrive in the borrower’s hands, but a company that is struggling to maintain adequate reserves may have the right to extend the waiting period to six months or more depending upon the terms of the contract and state law.

Life Insurance Premiums The cost of life insurance to the consumer will depend on several factors, including mortality rates, lapse rates, administrative expenses and an insurer’s investment performance. A person can buy a policy with one lump sum, secure the coverage permanently through a set number of premium installments or pay premiums on a steady schedule until a policy reaches its endowment date.

For a long time, policy loans were considered a great bargain for consumers because interest rates were fixed throughout the industry near 5 percent, a much lower rate than what banks were offering to borrowers at the time. By the 1970s, so many people had taken out policy loans that life insurers had become a little nervous. As an insurer passed out loans, it had to work harder to maintain adequate reserves. The strain on reserves, in turn, limited insurers’ investment options by forcing companies to keep their money in safe, low-interest bonds rather than in higher-risk and higher-growth markets like real estate. Insurers eventually gained the ability to give loans at variable interest rates.

Payment of the first premium is needed to finalize the insurance contract, so information about how and when to pay this fee is usually found on the application form and in the policy. Later premiums keep the existing insurance contract in place, so most companies will only include information about how and when to pay these fees within the policy. Clients can pay premiums at the insurer’s home office or through an agent or broker if they receive a valid receipt for their payment that has been signed by a designated company representative. If people choose to mail premiums to the insurer, their payments will usually not be marked late as long as items sent to the company have been postmarked by an acceptable date. Any person using a checking account to pay premiums should make checks payable to the insurance company rather than to an agent or broker.

Many companies give policyholders a few choices in regard to interest rates on loans. These choices relate to a concept called “direct recognition,” in which coverage and benefits will depend on a policyholder’s lending preferences and outstanding debts. Because borrowing money from an insurance company temporarily deprives the company of money it could invest, participating clients who take out policy loans might watch their dividends drop. Borrowing money could also affect the interest rates that are applied to a policy’s cash value. A client can lessen these negative consequences by agreeing to a larger interest rate on a loan. Someone who chooses higher interest rates on a loan might also have the ability to obtain more overall coverage at a cheaper price.

Insurance companies reserve the right to charge policyholders interest when premiums do not arrive on time, but many carriers are lenient and do not bother to follow through. For life insurance policyholders, the chief risk involved with not paying premiums in a timely fashion is that the insurer might revoke coverage. If an insured person dies without having paid a premium, the company will recoup the cost of coverage by deducting it from the death benefit.

A number of policy borrowers lose sight of the fact that, like most other unpaid debts, the amount of money owed to an insurer will increase if a person does not pay off a loan in a timely manner. This forgetfulness or lack of understanding can spell trouble for people who take out major loans on policies with insufficient cash values. When left unpaid, loans plus accumulated interest on those loans could amount to more than a policy’s value, and either the policyholder or the client’s estate could get a bill from the insurer rather than a death benefit.

In some unconventional cases, the policy’s beneficiary will pay the premiums. When this happens, the beneficiary will still continue to have no rights under the contract’s terms and conditions, other than the right to a death benefit.

Free-Look Periods

Some insurers have allowed clients to borrow up to 100 percent of their policy’s cash value, but policy owners might do themselves a favor by adhering to a self-imposed limit on loans that is well below that percentage A prospective buyer can also purchase a policy that includes an “over© Real Estate Institute

The initial premium paid for a life insurance policy does not automatically belong to an insurance company. A policy provision called a “free-look period” gives new policyholders a short period of time to possibly reconsider 12

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INSURING MAJOR RISKS The couple’s children argued, based on the law, that their parents’ policy should have remained in force until September 13th. Meanwhile, the insurer argued that the husband’s phone call served as adequate notice of his intent to cancel, based on company practice, and refused to pay any death benefits to beneficiaries. The insurer said the state law did not apply to the couple’s policy because the law concerned group life coverage and not group accidental death and dismemberment coverage.

their purchase, cancel the policy and receive a refund of that first premium with no questions asked. In order to receive a full return of the first premium and not face any surrender charges, the owner must return the policy to the home office or to the agent or broker before the free-look period expires. The free-look period begins on the day the policy’s owner receives the newly issued policy from the insurer. The deadline for a complete return of premium and other related fees will depend on state laws and policy language. Some insurers limit the free-look period to 10 days. Others allow for a 20-day period. In some states, people over the age of 60 have received a 30-day free-look period for life insurance policies and annuity contracts.

The insurer’s argument did not satisfy the court. State law defined “life insurance” as “insurance on human lives,” and the judiciary said it had “no reason to exclude from that definition a human life lost to an accident or by accidental means.”

Policies meant to replace previous coverage will usually feature longer free-look periods than other policies. Universal life contracts, which commonly replace other policies, tend to give consumers longer free-look periods than other life insurance products.

Cancellations and Nonforfeiture Benefits Sometimes, rather than worrying about the continuance of coverage, clients might decide that they no longer want their life insurance policy. As anti-insurer as this might sound, clients might have good reasons for getting rid of their coverage. A person might have little concern for estate planning and believe enough assets exist to leave dependents and loved ones a substantial financial cushion. People with average or modest savings might have managed to pay off debts and raise a family to a point where they no longer need to worry about dependents’ financial futures. When people grow older, they might not have potentially needy beneficiaries, and they might feel like cashing in their permanent life policy in order to fund their retirement.

Variable life policies deserve special mention in any discussion of life insurance and free-look periods. People who own these policies obviously want their cash value to grow quickly, yet a fast, negative return on an investment would complicate matters if the owner were to ask for a return of premium in accordance with a free-look provision. Perhaps this explains why initial premiums for variable life insurance are often put in money market accounts, where policyholders’ invested funds are very unlikely to decrease in value. When insurance companies decide to put an initial premium into special accounts during free-look periods, they might need to disclose this fact in the policy, so that policyholders are not surprised by early investment performances and are able to allocate their investments at their own discretion immediately after the free-look period passes.

In the past, clients could wait for their policies to endow and treat the money that would have gone toward a death benefit as a later-year retirement fund. But with most of today’s permanent life products not endowing until age 100 or later, policyholders with cash-value contracts can rarely sit back and expect their money to come to them anymore. Permanent life insurance policies feature “nonforfeiture benefits,” which give longtime policy owners some level of compensation when they either cancel or reduce their coverage. In a bit of a give and take situation, these benefits tend to increase as an in-force policy ages and as the policy’s cash value grows. This gives owners an incentive to not terminate their coverage after only a few years.

Grace Period Even if a policyholder misses a premium payment, the insurer must keep coverage intact until the policy’s “grace period” has ended. This grace period typically lasts anywhere from 30 days to 60 days.

A Grace Period Case Study A grace period can certainly ease insurance concerns for policy owners who either forget about a payment or find themselves on too tight a budget to pay a required premium. But as a case study from the U.S. Court of Appeals for the 8th Circuit proves, this policy feature can also offer unexpected comfort to life insurance beneficiaries.

Different insurers will have their own variations of nonforfeiture options, but we are at a point in history when those options, across the industry, can be narrowed down to three choices. One option involves a clean break between the insurer and the consumer and sees the policyholder surrendering coverage in exchange for its cash value. When a person asks for the cash value, the insurer will deduct unpaid premiums and outstanding loans from the total surrender value.

A married couple in Arkansas had bought a group-rate accidental death and dismemberment policy worth $150,000. On June 30, the husband talked to an insurance representative and intended to cancel the policy. The insurer gave the man two options: He could receive an immediate rebate from the company, or he could simply not pay the next premium—due August 13—and allow the policy to quietly lapse. The man opted for the latter. He and his wife died in an automobile accident on September 11 of the same year.

As good as this option might sound; it can entail a few drawbacks. Surrendering a life insurance policy could involve surrender fees, and people who cash in their policies might have to count a portion of the cash as taxable income if investment gains have pushed a policy’s cash value above the amount of money a client actually spent on premiums.

State law, at the time of the deaths, said, “The group policy, excluding an annuity policy, shall contain a provision that the policyholder is entitled to a grace period of 31 days for the payment of any premium due except the first, during which grace period the death benefit coverage shall continue in force unless the policyholder shall have given the insurer written notice of discontinuance and in accordance with the terms of the policy.” © Real Estate Institute

Other options merely modify the relationship between the insured and the insurance company and continue coverage in some form. A popular nonforfeiture benefit allows the policyholder to exchange permanent life insurance for paidup term life insurance. In a third arrangement, a client who still prefers to own at least some life insurance but worries 13

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INSURING MAJOR RISKS about outliving term coverage can trade in a policy’s cash value for a lesser amount of paid-up permanent insurance.

of Columbia Court of Appeals showcases how claims and replacement policies can breed confusion.

A policyholder often has the right to choose among these three basic nonforfeiture options upon cancellation or reduction of coverage. However, a life insurance contract may list a default nonforfeiture benefit that will go into effect if coverage is cancelled and the buyer takes no further action.

In 1979, a man purchased a $35,000 life insurance policy, which said, “In the event of suicide of the insured while sane or insane within two years from the issue date, the amount payable under this policy shall be limited to the amount of premiums paid.” By 1985, the man was considering getting rid of the policy, but the agent who handled the initial sale convinced him that the policy’s cash value and the family’s decreased insurability were decentenough reasons to maintain the coverage.

Term life insurance boasts a comparatively clean-cut cancellation process. Because term life insurance has no cash value, a policyholder who no longer desires coverage can simply ignore premium notices, take advantage of a grace period and allow a term life policy to lapse. Income tax issues should be non-existent in this case, and cancellation fees will generally be smaller than surrender charges for permanent life insurance. A person who actively cancels an annually renewable term policy might even be entitled to a partial refund of premiums.

Three years later, the agent suggested that the family increase its coverage to $50,000. The man agreed to the increase without viewing the policy or discussing anything other than premiums with the agent. The insurance company signed and issued a new policy for the man on November 8, 1988, but the man did not sign the contract. The new policy said, “For the first two full years from the date of the issue, the company will not pay if the insured commits suicide, while sane or insane. The company will terminate the policy and give back the premiums paid less any loan and any partial surrender amount [previously paid]. A like limitation applies to any increase in benefits and the effective date of such increase.”

Each policy might feature important details regarding cancellations. Consumers would benefit from consultations with unbiased financial experts before deciding whether or not to cancel their life insurance.

Reinstatement Clauses When an insurance company rescinds coverage because of unpaid premiums, the policyholder often has the right to regain coverage within a certain period of time. Conditions for this option are found in a policy’s “reinstatement clause.”

When the man killed himself 20 months later, his wife filed a claim for $35,000; the amount that would have been owed to her under the 1979 contract. The insurer denied the claim, saying the husband had died during the 1988 policy’s contestability period, and it paid back premiums that turned out to be in excess of the premiums paid for the 1988 policy.

Usually, a formerly insured person can regain coverage by paying off any outstanding premiums and answering medical questions to the insurance company’s satisfaction. The company typically gives the customer three to five years to re-qualify for old policy terms and conditions. Some companies have been known to offer 10-year reinstatement periods, and a few insurers have not put any time limits on reinstatement.

The wife sued, claiming the 1988 replacement policy should have been treated as an extension of the older policy and that only the original suicide clause applied in this case. The court ordered the insurer to honor the claim and commented on the wife’s reasoning. “By not claiming the $15,000 increase agreed to within two years of (her husband’s) suicide, (she) implicitly recognizes the reasonableness of the term of the 1988 policy…that expressly excludes payment of the amount of any increase in benefits if the insured commits suicide within two years of the effective date of the increase.”

If a former client applies for reinstatement after a stated window of opportunity has closed, the insurance company may grant or deny coverage at its discretion. A reinstatement of coverage introduces a new contestable period for the policy, but insurers can only contest information found on the reinstatement application.

Beneficiary Designations

Replacement Policies

Correctly designating a beneficiary on a life insurance policy might seem like a simple act. But because an invalid or incorrect beneficiary designation could defeat the purpose of buying the insurance in the first place, buyers and sellers must have a mutual understanding of how a policy bestows death benefits upon selected individuals and other entities. When a client’s life insurance policy does not clearly list a valid, identifiable beneficiary, death benefits will become part of the deceased’s estate, and, contrary to popular belief, a dead person’s last will and testament will often not suffice when survivors try to overrule designations made on insurance beneficiary forms.

Buyers might replace policies because their needs change, because they recognize a better policy from a different insurance company or because they feel most comfortable working with their longtime agent who has moved to another carrier. At other times, salespersons have been known to instigate policy replacements in the hope of receiving fresh and large commissions. No matter the motive behind the replacement, insurance customers and producers must understand the risks involved with swapping policies. It is almost always unwise for customers to cancel one policy before they have been approved for a replacement policy. An older, sicker person who forfeits an old policy might never again be able to find equally affordable or sufficient coverage. Even a brief gap in coverage for a younger, healthier person can put dependants at risk, given the unpredictability of death.

There are two ways in which beneficiaries can be categorized. The first set categorizes beneficiaries by their permanence. Some beneficiaries are “irrevocable beneficiaries.” No matter the policyholder’s changing wishes and no matter any assignment of ownership, these beneficiaries will remain listed on the policy unless the policyholder cancels the coverage. Other beneficiaries are “revocable beneficiaries.” No matter their own desires, these individuals can be removed from a policy at the owner’s command.

A Replacement Policy Case Study From the insurance company’s perspective, replacement policies can also create unexpected problems when someone files a claim. A case study courtesy of the District © Real Estate Institute

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INSURING MAJOR RISKS Beneficiaries are further categorized as either “primary beneficiaries” or “contingent beneficiaries.” Primary beneficiaries are first in line to receive any death benefits. If a policy lists more than one primary beneficiary, the listed individuals will share death benefits based on the percentage that the owner has designated for each party. Multiple contingent beneficiaries may also share benefits, but they can only receive compensation if no primary beneficiaries are alive at claim time. In rare cases, a policy might contain a “survivorship clause” that could permit a policy’s owner to change beneficiaries even after the insured person dies. This clause might also state that a beneficiary must outlive the insured by a specific number of days before the person can receive any money from the insurance company.

Beneficiaries and Divorce Of all the factors that contribute to beneficiary disputes, divorce seems to receive the most attention from the judiciary. Laws and insurance practices among all the states are far from uniform in regard to this topic, making it even tougher for insurance professionals and their clients to understand how a failed marriage might affect a former spouse’s right to death benefits and policy ownership. On one hand, many divorce courts force people to maintain life insurance on themselves if a former spouse or a former spouse’s child is listed as a policy’s beneficiary. Other state laws effectively remove former spouses as beneficiaries on life insurance policies.

Divorce Case Studies In a case heard by the Missouri Court of Appeals, a husband and wife divorced after having four children. The divorce settlement called for the husband to take out a $100,000 life insurance policy on himself and to list his former wife as the beneficiary until all their children came of age.

When adding or removing beneficiaries from a life insurance policy, the owner must provide written notice to the insurer and complete any additional companymandated paperwork. Some insurers will wait for owners to request these forms, but others send out change of beneficiary forms every few years in order to give their clients regular opportunities to update their policies.

Three years later, the man finally bought a policy and listed his ex-wife as a revocable primary beneficiary and his new wife as a contingent beneficiary. According to court documents, the new wife paid premiums for the policy.

A Beneficiary Case Study

A case from the U.S. Court of Appeals for the 5th Circuit shows how an understanding of beneficiary forms might help prevent legal trouble. A man purchased a $20,000 accidental death and dismemberment policy through his employer, along with $126,000 in supplemental life insurance. On the beneficiary form, the man listed his former wife in a section for primary beneficiaries and wrote “100%” by her name. Below his ex-wife’s name, but still in the space for primary beneficiaries, he listed his sister and wrote “100%” by her name, too. In a section for contingent beneficiaries, he listed his son and indicated the son should receive 100 percent of the death benefits if none of the other beneficiaries were alive at claim time.

Later, the man changed beneficiaries on the policy without alerting his ex-wife to the situation. In its revised form, the policy listed his new wife as the primary beneficiary and his stepdaughter as the contingent beneficiary. The man and his new wife eventually got divorced, but they continued to live together, and she continued to pay for the life insurance. Their divorce settlement gave the second wife control over some of their assets but did not specifically mention the policy. The man later died when the youngest child from his first marriage was 9 years old. This set up a court battle between his estate and his second wife. According to the estate, the change in beneficiaries should not have been allowed, the second wife should have lost her beneficiary status in the divorce, and the death benefits should have gone to the estate.

The policy said, “If more than one beneficiary is named and you do not designate their order or share of benefits, the beneficiaries will share equally.” It also stated, “When making a benefit determination under the summary of benefits, (the insurer) has discretionary authority to determine your eligibility of benefits and to interpret the terms and provisions of the summary of benefits.”

The court ruled initially in the second wife’s favor, saying the first wife had no power in regard to the policy because she was not married to the man when the contract was issued. The court also said evidence—such as the fact that the man and his second wife continued to live together even after their divorce—suggested the man had no intention of revoking his second wife’s beneficiary status.

When the man died from a heart ailment, his ex-wife filed a death claim and received roughly $95,000 from the insurance company. The insurer decided to hold onto the remaining death benefits and review the claim. The man’s sister insisted that her brother intended for her and his exwife to split 100% of the death benefits as primary beneficiaries. She claimed she was not specifically listed as a contingent beneficiary and that she was entitled to half of the policy’s face value. She said the insurance company should have been held responsible for making sure her brother understood how the death benefits would be disbursed.

But, just two months later, the same court withdrew its opinion and ruled in the estate’s favor. This time, the ruling centered on a state law, which said, “If after an owner makes a beneficiary designation, the owner’s marriage is dissolved or annulled, any provision of the beneficiary designation in favor of the owner’s former spouse or a relative of the owner’s former spouse is revoked on the date the marriage is dissolved or annulled, whether or not the beneficiary designation refers to marital status. The beneficiary designation shall be given effect as if the former spouse or relative of the former spouse had disclaimed the revoked provision.” This eliminated the second wife as a beneficiary and left the proceeds of the policy to the deceased man’s estate.

In response, the insurer said it could not have determined the man’s intentions ahead of time because his employer had held onto the beneficiary forms until the death claim arrived. The court ruled against the sister, concluding that the man had, indeed, put the beneficiaries in order and had listed percentages for each person. In the court’s opinion, the insurance money would have only belonged to the sister if the ex-wife had passed away before the man’s death. This case highlights the importance of clearly stated desires when listing beneficiaries.

In a case that made it all the way to the U.S. Supreme Court, a man listed his second wife as the beneficiary on a $46,000 life insurance policy bought through his employer. The couple divorced, and according to the man’s first wife, the second wife knew he intended to remove her as a 15

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INSURING MAJOR RISKS beneficiary. The man’s children from his first marriage— who would have received the death benefits under the intended change—sued the second wife when she filed a death claim.

they murdered the insured. This uniform restriction might seem cut and dry, but even murder cases can lead to ambiguity.

The children argued the second wife’s beneficiary status was invalid due to state law, which said, “If a marriage is dissolved or invalidated, a provision made prior to that event that relates to the payment or transfer at death of the decedent’s interest in a nonprobate asset in favor of granting an interest or power to the decedent’s former spouse is revoked. A provision affected by this section must be interpreted, and the nonprobate asset passes, as if the former spouse failed to survive the decedent, having died at the time of entry of the decree of dissolution or declaration of invalidity.”

An Oklahoma man bought a $100,000 accidental death and dismemberment policy with his wife listed as his beneficiary. When the man died from injuries suffered during a domestic dispute, his wife was charged with firstdegree murder. The wife was acquitted of charges in the case and proceeded to demand life insurance benefits. Although the insurer agreed the death was covered by the policy, the company resisted paying the death benefit to the wife, based on the nature of the criminal case against her. The state’s Supreme Court sided with the insurance company and based much of its decision on Oklahoma’s “slayer statute,” which said the following:

A Murder Case Study

The court ruled against the children, saying a federal law called the Employee Retirement Income Security Act conflicted with the state law and had supremacy in this case. This case again highlights the need for clarity when listing beneficiaries and keeping these provisions current.

“No person who is convicted of murder in the first degree…or manslaughter in the first degree under the laws of this state, or the laws of any other state or foreign country, of having taken, caused or procured another so to take, the life of any individual, shall inherit from such victim, or receive any interest in the estate of the victim, or take by devise or legacy or as a surviving joint tenant, or descent or distribution, from him or her, any portion of his or her estate; and no beneficiary of any policy of insurance payable upon the death or disability of any person, who in like manner takes or causes or procures to be taken, the life upon which such policy or certificate is issued, shall take the proceeds of such policy.”

In yet another example, a man bought a joint life policy and listed himself as the primary insured and his wife as the primary beneficiary. The couple later divorced, and the former spouses were allowed to keep their personal property, with no mention of the insurance policy in their divorce settlement. The husband eventually remarried, but he neither cancelled the policy nor removed his ex-wife as the primary beneficiary. When the man died, his ex-wife and his estate fought over the death benefit, with the estate claiming the former spouse nullified her beneficiary status at the time of the divorce and that the divorce settlement gave her no clear right to policy benefits.

The court cited a basic part of common law that says people who commit unlawful acts should not be rewarded with financial gain. Judges further determined that the state statute did not prevent the judiciary from applying common law in this case. According to the court, if lawmakers had wanted to exclude people from the statute, including acquitted people, they could have amended the law as they saw fit.

When the man bought the policy, state law called for the removal of former spouses as beneficiaries, but the law had changed by the time of the man’s death. Although a trial court granted the insurance money to the ex-wife, an appeals court ruled in favor of the estate. According to the appeals court, a legal agreement should be based on the laws that were in force when the agreement went into effect.

In a dissenting opinion, one judge said the legislature had amended the statute twice over the years to the point where the language specifically referenced specific degrees of murder and manslaughter. According to the dissenting opinion, “It is unsound reasoning to suppose the legislature would twice make additions which more precisely define the term ‘conviction,’ without some intent to alter its traditional meaning.”

Shared finances between spouses can also create uncertainty when divorce and beneficiary issues arise. A husband and wife in Illinois paid $50,000 each in single premiums for two universal life insurance policies. One policy insured the husband for $81,000, while the other contract insured the wife for $100,000. They listed each other as revocable beneficiaries on their respective policies and paid for both contracts with a single check.

These differing opinions of courts and judges make it extremely important for producers to encourage their policyholders to review policy beneficiaries.

LIFE INSURANCE CLAIMS

The couple divorced, and both the man and the woman altered their policies so that their respective children (all from other relationships) became beneficiaries. The man eventually died of cancer, and his ex-wife tried to collect the death benefit made available through his policy. She argued that her ex-husband’s illness might have prevented him from realizing what he was doing when he changed beneficiaries and that she was entitled to the insurance money because marital funds had paid for the two policies.

Different insurance companies have different ways of dealing with death claims. Some home offices will handle the sending and receiving of claim forms on their own. Other companies ask the agent or broker to put claim forms in the mail to beneficiaries, and many insurance professionals visit beneficiaries personally in order to deliver paperwork and answer any questions heirs might have. Agents and brokers who handle death claims have yet to arrive at a consensus regarding how this part of their job should be done. While some producers prefer to give survivors considerable breathing room by not emphasizing sales and by sticking primarily to the claim process, others view these situations as opportunities to stress the importance of financial planning and the benefits of annuities and other products offered by insurance companies.

An appellate court disagreed and pointed out that both parties had the legal right to change beneficiaries on their policies and that even the ex-wife had exercised this right.

Beneficiaries and Murder Despite unpredictability across the country in regard to beneficiary issues and marriage, every state prevents spouses (or anyone else) from collecting death benefits if © Real Estate Institute

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INSURING MAJOR RISKS According to the trade publication Best’s Review, 90 percent of beneficiaries are satisfied with the service they receive from life insurance companies and their representatives. The remaining 10 percent generally express displeasure over the time it takes to receive death benefits following a claim. Most beneficiaries will have their claim processed within 30 days, but mysterious circ*mstances or incomplete information surrounding a death can extend the claims process indefinitely.

Waiver of Premium Some experts say a “waiver of premium” is the most common and most essential rider available from life insurance companies. This feature protects disabled or terminally ill individuals by not charging the policy owner for coverage after he or she has lived with life-altering medical conditions for an extended period of time. If a policy owner suffered a debilitating stroke, for example, and could not physically pay or afford premiums because of the medical condition, the waiver of premium would likely prevent the insurance contract from lapsing. Meanwhile, the policy’s cash value would remain untouched.

Whether the action is performed during the application stage, during the claims stage or both, an insurance producer can help lower that 10 percent level of dissatisfaction by telling clients how beneficiaries might assist insurers in speeding up the payment of claims.

When consumers replace one life insurance policy with another, the new policy might automatically include a waiver of premium if the original policy had the feature. At other times, clients can request in writing that a waiver of premium rider be added to a replacement policy.

Beneficiaries who can locate a policy should be prepared to give the insurance company the policy’s identification number and the insured person’s date of death. Policy language might require that an insurer receive a copy of the death certificate, but special circ*mstances can cause insurers to waive this requirement. After the September 11, 2001 terrorist attacks on U.S. soil, for instance, most insurers allowed victims’ beneficiaries to collect death benefits without a certificate.

Living Benefits When a Canadian wing of Prudential Financial introduced a “living benefit” several years ago, this feature catered almost exclusively to terminally ill people with only a few months left to live. Today, many insurers allow policyholders to access anywhere from 25 percent to 100 percent of a life insurance policy’s face value if they are struggling with terminal or non-terminal medical problems, such as surgery, serious illnesses, doctor bills or assorted long-term care expenses. As more insurers have offered them and expanded their scope, living benefits have taken different names, including “accelerated benefits.”

If the insurance company sold multiple policies to the insured and concludes that the person has actually died, it might have an obligation to contact beneficiaries who are named in those additional contracts.

Settlement Options The manner in which a beneficiary receives policy benefits is called a “settlement option.” Many companies have a default way of paying benefits, but this does not mean beneficiaries must always accept the insurer’s preferred method.

The insured will need to prove medical hardship in order to qualify for these benefits, but the money given out by the insurance company does not necessarily need to go toward medical expenses. These benefits are different than policy loans because they do not create an interest-enhanced debt that is owed to the insurance company. Instead, living benefits are usually subtracted directly from a policy’s death benefit.

Historically, most life insurance beneficiaries have received their money in a lump sum. This settlement option is perhaps the least complex one and can be attractive to beneficiaries who have a pressing need for money. It also tends to suit people whose shares of death benefits are relatively small.

Other Riders Other popular riders over the years have included the following:

People who receive large death benefits might opt to have their money rationed and given out periodically so that they can count on a steady income that continues for several years. This option basically transforms the life insurance policy into an annuity.

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Several insurance companies allow beneficiaries to invest death benefits in money market accounts. This option gives people more time to consider what they should do with large sums of money and gives the death benefit a chance to grow in an interest-bearing environment. When a beneficiary decides that the death benefit can be put to good use, he or she can withdraw some or all of the invested funds via check-writing privileges.

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LIFE INSURANCE RIDERS

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Life insurance riders are optional policy features that may be added to a contract for an additional cost, either at the application stage or after the policy has been issued. In this portion of the text, we will examine a few of the many riders offered by life insurers. But please be aware that not all insurance companies offer these mentioned additions, and many insurance companies might include the benefits described here within their basic policies. Also, as is the case with policy terms and conditions, a rider available from one company might go by a different name at other companies.

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Cost of living rider or guaranteed insurability rider o These riders allow policyholders to increase their life insurance’s face value on a periodic basis without needing to medically qualify for the additional coverage. Paid-up additions rider o This rider attempts to create a vanishing premium by using some of today’s premiums to pay for tomorrow’s coverage. Change of insured rider o This rider allows policyholders to easily add or delete people from a life insurance policy. Accidental death rider o This rider, mentioned earlier in the text, generally pays double the death benefit if the insured dies in an accident.

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CONCLUSION

NATURAL DISASTERS

By now, you should be able to comprehend the versatility of life insurance products. From term life all the way to the latest hybrid contracts with variable life features, the insurance industry has done its best to develop fresh provisions that cater to a base of consumers who perhaps expect more from their policies than ever before. But a wide variety of products and consumer options might do little to promote lasting business relationships between insurers and the public if insurance workers forget to explain some of the complexities of these products.

INTRODUCTION Scientists and insurers often agree that it is only a matter of time before people from across the nation experience a natural disaster in their own area. The Federal Emergency Management Agency (FEMA) has estimated that threefourths of the United States is susceptible to flooding, hailstorms, hurricanes, and earthquakes, and that figure, of course, makes no mention of the wildfires, tornadoes, landslides and droughts that can also strike in a community.

When clients establish a relationship with an astute and informed insurance representative whose expertise reaches beyond sales and into policy terms and conditions, they end up with risk management assistance that can be worth far more than the size of any premium.

At its worst, nature plays no favorites when deciding where to unleash its wrath. In recent memory, a merciless hurricane season wrecked low-income communities in Louisiana and Mississippi, and nearly untamable blazes transformed luxurious homes in California into ugly ash. Some homeowners who tried to safeguard properties from fire by building with bricks or stone have realized that their favored materials don’t stand up to earthquakes. Meanwhile, people who once sang the praises of woodframed dwellings have discovered that their sturdy foundations still don’t stand much of a chance against raging flames. For the insurance industry, the business solution to the natural catastrophe problem is not as simple as merely selling various policies in presumably safe communities and ignoring the rest of the public. If an area isn’t prone to earthquakes, it may still be prone to tornadoes. If an area isn’t prone to tornadoes, it may still be prone to hurricanes. So a fearful insurer can decide that it is incapable of doing business in a particular part of the country, but an insurer who refuses to take on any kind of disaster risk will end up with a very limited base of clients. From Washington state to Maine and from California to Florida, insurers must accept that there is always the possibility of a looming “catastrophe,” which the Insurance Services Office (ISO) has defined as any event that leads to $25 million or more in insured losses. Those insured losses can involve not only structural damage but also business interruption claims, auto claims, theft claims and, unfortunately, life insurance claims. Yet compared to some developing countries, the United States is lucky in regard to natural disasters, in the sense that the catastrophes that hit its soil tend to cause widespread economic hardships rather than extremely long lists of casualties. U.S. catastrophe victims may lose precious belongings or even experience temporary homelessness, but they are at least likely to survive the ordeal. Although this generalization should not be interpreted by readers as a naïve statement that disrespects the memory of the countless men and women who have died from the effects of a natural disaster, it does explain why, from this point forward, we will ignore the life and health consequences of catastrophes and emphasize those insurance products that cover dwellings, businesses and personal property. There was a time when a solid homeowners insurance policy seemed like all the average person needed in order to protect personal assets against disasters. Decades ago, domestic insurers did excellent business in the homeowners market, aided in no small way by low-key weather conditions in America. Insurers shared some of the wealth with their customers, beefing up their policies to cover more perils and making them increasingly affordable. But as that era winded down, and as catastrophes such as quakes, windstorms and large fires arrived with greater frequency, many carriers determined that their

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INSURING MAJOR RISKS In the United States, climate conditions create an annual fire season that begins in summer and stretches through the end of fall. Within that seasonal timeframe, wildfires are at their most destructive when long-term forecasts call for hot, dry and windy weather. Lack of humidity not only helps an unattended fire spread more easily but also makes it harder for firefighters to extinguish a blaze. When fueled by a strong wind, a raging fire can move uphill, endangering people in mountain and valley communities.

homeowners policies were covering more risks than they could manage. Slowly but surely, the industry closed loopholes in policy language that had made homeowners insurance nearly an all-risk item. While coverage narrowed, new and old policyholders failed to notice how these changes affected their vulnerability to major financial loss, and many of them realized all too late that they were not adequately covered for severe damage to their home. Even people who had exhibited enough foresight to purchase a large policy sometimes admitted at a later date that it took a disaster to make them realize how little they actually knew about insurance. Much to their surprise, they sometimes learned after the fact that their homeowners insurance did not cover flood or earthquake damage or that the insurance company would not pick up the entire bill for the reconstruction of their pride-packed dream house.

As anyone who watches television news knows all too well, no one can accurately predict the next day’s weather 100 percent of the time. However, insurance professionals who worry about wildfire risks can keep an eye on the moisture content of a chosen area thanks to scientific measuring systems. Two popular measuring sticks are the KeetchBryam Drought Index and the Palmer Drought Severity Index. The Keetch-Bryam Drought Index reflects the amount of moisture in soil on a scale of 0 to 800. The index drops after rainfall and rises after a dry day. The Palmer Drought Severity Index is used to evaluate long-term climate conditions, as opposed to daily changes in moisture content, and has a base of zero. Negative numbers indicate a drought, and positive numbers indicate moisture.

A handful of disaster victims have sour stories to tell about their experiences with their insurance companies, either because they did not properly educate themselves when purchasing and evaluating coverage or because their trusted insurance professional did not clearly go over policy limitations and exclusions with them. Many of these people can now be found in town halls and other community centers near disaster areas, counseling victims on how to put their lives back together and how to get the insurance benefits that they deserve. The following course material empowers insurance producers by giving them information that can help reduce customer dissatisfaction. In addition to mentioning the typical policies that help clients manage the financial consequences of natural disasters, the text explains why these disasters occur, where they occur and perhaps most importantly, describes what insurance consumers can do to keep their property safe and their premiums manageable.

Considering the standard climatic recipe for wildfires, it is no wonder that California residents suffer more frequent and intense wildfires than citizens in any other state. The area is prone to hot and arid summers, and by the autumn months, desert winds often blow strongly toward the Pacific Ocean, helping fires overcome some of the state’s hillier topography. The state’s sometimes sky-high home values add to insurers’ wildfire worries. Even flames that cover a very small radius in California can amount to millions of dollars in insured losses if they happen to make contact with some of the prized canyon properties belonging to the rich and famous.

WILDFIRES The risk of suffering wildfire damage is small compared to the risks presented by earthquakes and hurricanes, and many insurers are more fearful of major hailstorms than of flames burning out of control. According to FEMA, homeowners have 25 percent chance of experiencing a flood over the course of a 30-year mortgage and only a 9 percent chance of having to cope with a fire.

But no matter how much attention the Golden State receives in regard to this peril, California clearly has no monopoly on wildfires in the United States. Florida, another coastal location with valuable real estate, has had its own problems with these disasters. Meanwhile, Montana, Oregon, Washington, Arkansas and even Wisconsin, which surrendered 3,800 acres to wildfires in a single incident in 2005, have sustained significant damage in recent years.

But if you try spouting those facts at the people who owned the 11,000 or so homes that have been lost to wildfires since the early 1980s, you’re bound to get an impassioned, disagreeable reaction. After more than 15 years, residents of the Oakland area are still likely to have clear memories of the East Bay fires of 1991 that scorched their hilly community. The fires, which forever changed the way insurers viewed replacement-cost homeowners policies, were responsible for $1.7 billion in insured damages. Residents of Los Alamos, New Mexico almost certainly can recall the time in 2000 when a botched burning by the federal government damaged 1,000 automobiles and forced 18,000 people out of their homes. With enough power to turn entire states into disaster areas, it is clear that the risks associated with wildfires deserve a homeowner’s respectful attention.

Controlled Burns In spite of public service announcements that encourage Americans to prevent forest fires (not to mention man’s natural fear of flames), experts argue that suppressing fires as quickly as possible is a nearly ineffectual, temporary fix to a serious problem, not unlike putting a finger-sized bandage on a wound that would be best served by several stitches. In fact, they say the occasional fire, when kept under careful watch, can do positive wonders for the environment and can actually prevent costly wildfires in the long run. Fires that are set intentionally for these beneficial purposes are known as “controlled burns.” A controlled burn acts as a housecleaning of the ecosystem. From a risk prevention standpoint, the idea is to burn away all the old, dead vegetation that might fuel a fire and to replace that vegetation with a barrier of spotless land or fresh, lessflammable plant life. Of course, performing a controlled burn in an area every 15 to 30 years does not make insurance companies entirely immune to wildfire losses, but it might mean the difference between an inconvenient number of property insurance claims and an indisputably catastrophic level of loss.

Why and Where Wildfires Occur According to the ISO, there were roughly 140,000 wildfires annually in the United States between 1916 and 1996, destroying 14.5 million acres each year. Though it’s true that major fires have sometimes been set by arsonists, most wildfires don’t require any ill will on the part of a human. They are often linked to innocent campfires that get out of hand and can also be caused by bolts of dry lightning. © Real Estate Institute

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INSURING MAJOR RISKS According to the San Francisco Chronicle, the state of California was engaged in controlled burns until the 1960s, when nervousness among the public and insurance companies helped put a temporary end to the practice, which resurfaced a few decades later. The misgivings surrounding controlled burns are still expressed by some of today’s homeowners and insurers and relate mainly to the possibility that federal and state forest officials will not be able to keep these intentional fires within safe boundaries. Though many controlled burns are executed on government land, there is always at least the small chance that a fire will find its way onto private grounds, leaving insurers exposed to property losses and liability claims. In 2000, a controlled burn in Los Alamos, New Mexico damaged 48,000 acres in four counties, destroyed approximately 200 homes and prompted the forced evacuation of 18,000 residents. Ironically enough, however, a string of wildfires in San Diego County in 2003 made local observers wonder why authorities had not been lighting controlled burns in the area prior to those fires.

Wildfires Fueled by Global Warming Another challenge to fire prevention could materialize if scientists’ predictions about climate change are accurate. As the planet grows hotter, evaporation occurs at an increasingly rapid rate, which increases the likelihood and severity of droughts in fire-prone areas. Global warming also influences the level of carbon-dioxide in the earth’s atmosphere and, therefore, could dictate the amount of brush and other plants that help small fires grow into uncontrollable disasters. Time will tell if the science behind global warning has an impact on the way property insurance is underwritten.

HURRICANES AND TORNADOES It’s not surprising that many insurance consumers are misinformed about their carrier’s approach to wind damage. Based on policy language and tradition, coverage of this peril is broad in some respects and very limited in others. The typical homeowners insurance policy’s references to wind are general enough for coverage to apply to many types of catastrophes, including major hurricanes, tropical storms and tornadoes. Yet various exclusions in the insurance contract allow companies to deny portions of catastrophic claims when destructive winds are paired with flooding.

As an alternative to the sometimes risky controlled burns, some communities have unleashed their livestock in fireprone areas and waited patiently for goats and other animals to graze their way through all of the flammable, old plants. This approach has its upsides, not the least of which is its non-reliance on man-made flames that could damage property and harm wildlife. The technique is also less reliant upon favorable weather conditions since, unlike in a controlled burn situation, it can be done safely and effectively in hot, dry or wet conditions. One obvious drawback, though, is that grazing is a slower procedure than controlled burns, even with a sizeable amount of hungry animals on hand.

Until the 1950s, wind-related disasters weren’t overly problematic for insurance companies. A smaller U.S. population in those days meant that there weren’t as many densely inhabited areas filled with valuable real estate, and a lack of residential air conditioning kept many people from settling in hot and high-risk coastal states such as Texas and Florida. In more recent years, however, shifts in population density and climate conditions have combined to make wind catastrophes a relatively common subject on the evening news. Today, roughly 50 percent of Americans live within 50 miles of a coast, and according to an assortment of trade groups quoted in National Underwriter, the property owned in coastal areas from Maine to Texas is worth upwards of $7 trillion. Meanwhile, higher sea-level temperatures may explain why the windstorms of today are frequently among the most intense weather events in our nation’s history. All told, according to a 2008 A.M. Best study, tornadoes, hurricanes and related weather conditions have been responsible for the majority of U.S. catastrophic losses, on average, since 1953.

The Urban Wildland Interface Challenges in modern wildfire prevention have been compounded by homeowners’ increased movement into the “urban wildland interface,” a term that is used to describe the buffer zone between developed land and relatively untouched forestry. Whereas wildfires from previous generations often had nothing in their paths to damage other than timber and maybe the occasional warehouse, today’s fires can burn through an increasing number of high-priced residential properties and foster more insured losses than previously imagined. Researchers at Colorado State University claimed that the population of the urban wildland interface grew by 52 percent between 1970 and 2000. In 2007, the New York Times cited a report from the University of Wisconsin that said more than 8.6 million new homes had been built in the West within 30 miles of natural forestry since 1982.

Hurricanes have been particularly damaging and have made coverage tighter and more expensive in many coastal areas. In 1992, Hurricane Andrew swept through Florida, left 11 insurers in a state of insolvency and became the costliest U.S. catastrophe the industry had ever seen. Insurers introduced predictive catastrophe models and windstorm deductibles in response to the storm, but those measures have clearly not spared carriers from hurricane losses in subsequent years. Of the 10 costliest hurricanes in American history (not counting final figures for Hurricane Ike in 2008), seven have occurred in the 21st century. Chief among them, of course, was Hurricane Katrina, which cost insurers $41 billion and necessitated more than $100 billion in government aid to residents of New Orleans and other affected places.

Unfortunately, people’s desire to live away from crowded cities and closer to nature has not always coincided with an enhanced understanding of wildfire risks. After spending most of their lifetimes in densely populated cities and suburbs where fire hydrants stood on every corner and where sidewalks and streets covered far more ground than trees, grass or bushes, many new residents of the urban wildland interface enter into the community without having been schooled in fire prevention techniques. In love with the change of scenery that sits outside their window, they often keep or even augment the brush and forestry on their property for decorative purposes, rather than realizing that such plants are extremely likely to add fuel to a fire. In some cases wildfire risk mitigation has only arrived in the wildland urban interface at the insistence of property insurance companies.

As for residents of inland states, statistics show they shouldn’t feel entirely protected from wind. Midwesterners, for example, still have to cope with the fact that the United States is more prone to tornadoes than any other country. In just the first half of 2008, there were more than 1,000 twisters, including the first two funnel clouds to touch down in northern Illinois in January since 1950. 20

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INSURING MAJOR RISKS will be covered if it is caused by the force of wind or by the weight of debris that has been blown onto the building by a storm. However, it is important to note that collapse after a hurricane is not covered when it has been aided by the force of flood waters. To insure against that kind of loss, a homeowner will need to purchase adequate flood insurance.

When viewed all at once, these various statistics suggest that wind-related risk mitigation ought to be important to producers and policyholders in any region.

Why and Where Hurricanes and Tornadoes Occur Hurricanes form at certain oceanic depths when sea temperatures are at least 80 degrees. As they move along the waterways, storm clouds absorb warm air from the lower portion of the atmosphere and release cooler air into the upper portion of the atmosphere. These storms continue to grow in strength until they hit land or are impacted by different weather conditions.

Removal of Debris and Trees Even if a hurricane or tornado does not make direct contact with a dwelling, the home can still be damaged by debris and trees that get flung about by super-strong winds. The cost of removing debris and fallen trees from the residence premises can sometimes amount to thousands of dollars. Luckily for the homeowner, this expense may be covered by insurance.

Hurricanes are created in the same general manner as other tropical storms, but they involve stronger winds and tend to push taller amounts of water onto the surface. At minimum, a hurricane is carried by a wind traveling at 74 mph and is accompanied by waves that are initially four feet high.

The most common type of homeowners insurance policy covers removal of debris after a windstorm. In general, this coverage does not increase the insurer’s limit of liability. However, when the cost of removing the debris and repairing or replacing damaged property is greater than the insurer’s limit of liability, the homeowner may receive an additional 5 percent of coverage that can be applied specifically to debris removal.

Many of the hurricanes that impact the United States come from the Atlantic Ocean and the Gulf of Mexico during a season that runs from June through November. Communities that are below or barely above sea level are particularly vulnerable to major storm damage. According to FEMA, tornadoes are basically spinning thunderstorm clouds that make contact with the ground. These clouds usually touch down at the tail end of a storm and are categorized by meteorologists based on factors such as wind speed. Mild tornadoes earn a zero on the commonly used Enhanced Fujita Scale and have winds that are slower than 86 mph. The most intense tornadoes earn a 5 on that scale and blow at speeds that are above 200 mph.

When a tree falls on the residence premises because of wind, a homeowner may be reimbursed for its removal. This free additional insurance has a cumulative limit of $1,000 per occurrence, and no more than $500 may be applied to the removal of a single tree. For removal to be covered, the tree needs to have either done damage to the homeowner’s property or blocked access to a driveway or a ramp for handicapped persons. Following a windstorm, policyholders often wonder who is responsible for removing a neighbor’s tree from their property. Regardless of where a fallen tree once stood, the party who suffers the property damage should file a claim with his or her insurance company. The neighbor would be liable for the loss only if the tree was obviously dying or was not being maintained properly by its owner.

Although a tornado can blow across a strip of land at any time of year, twister season generally runs from late winter until the middle of summer. The season begins a little earlier in southern states than in northern states. Not surprisingly, the region that is most at risk during tornado season is the one known as “Tornado Alley.” The geographical boundaries of Tornado Alley vary depending on who you ask, but it is safe to say that this area generally includes much of the South, the Midwest and the Great Plains. While Iowa, Alabama, Kansas and other states have all experienced the most intense kinds of tornadoes on multiple occasions, tornadoes are more likely to occur in Texas than in any other state.

Windstorm Deductibles In order to reduce their exposure to risk after Hurricane Andrew, many insurers in coastal states added windstorm deductibles to their homeowners insurance policies. According to the Insurance Information Institute (III), these deductibles are used in 18 states and the District of Columbia.

Covering Collapse

The amounts and triggers of these deductibles may vary significantly from one policy to the next. Whereas one insurer’s wind deductible might apply to any kind of windstorm, another carrier might only enforce the deductible after a hurricane. A report on the subject by National Underwriter showed some deductibles were triggered when winds reached a specific speed, when a windstorm lasted for a particular length of time or when winds of a particular speed were detected within a specific distance from an insured’s property.

Because hurricanes and tornadoes are sometimes strong enough to make even a sturdy house structurally unsound, we will review how the typical homeowners insurance policy treats instances of collapse. In most cases, policy language defines “collapse” to mean an instance in which all or part of a building falls down or caves in and becomes uninhabitable. The term generally does not apply when visible bulging, shrinking or cracking has merely made collapse a possibility. It also is not used to mean a situation in which a building has been broken into separate pieces but is still standing.

Windstorm deductibles are typically listed as a set percentage of a dwelling’s insured value. If a homeowner has insured a home for $100,000 and has a windstorm deductible of 5 percent, he or she will end up paying out of pocket for any portion of wind-related losses that does not exceed $5,000. The Insurance Information Institute has said insurance consumers may be eligible for flat, dollarbased wind deductibles if they pay an additional premium. Some companies might even agree to drop the windstorm deductible altogether if an insured retrofits a home in a manner that satisfies various structural requirements.

Homeowners insurance covers losses that are caused by collapse if the collapse is due to a peril listed in the personal property section of the policy. Such losses are also covered when they are brought on by hidden decay, hidden damage caused by insects or vermin, the weight of animals, people or property or the weight of rain on a roof. Collapse caused by improper construction may be covered if the collapse occurs during the construction stage. For the victim of a hurricane or tornado, these various provisions and exclusions mean that a dwelling’s collapse © Real Estate Institute

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INSURING MAJOR RISKS property. And yet, after pushing so hard for the public to purchase more insurance, carriers have a history of making decent coverage difficult to obtain in the days, weeks, months or even years after a disaster. Subsequent to a widespread loss, at least a few insurance companies are likely to institute a moratorium on sales of various products, including life, auto and homeowners insurance. Previously issued policies remain in force during these moratoriums, but new customers are not accepted, and veteran customers may be incapable of making changes to their coverage.

Windstorm Coverage From the States With windstorm disasters being so costly over the past 15 years, it’s no wonder many private carriers have been hesitant to cover homes in high-risk areas. At one time or another, homeowners in many states have found that insurance companies will either refuse to sell property insurance to them or only provide policies that do not list wind as a covered peril. For residents of these communities, these shortages have created some obvious problems. Affected property owners aren’t just unprotected against significant losses; they also may be in violation of their mortgage lending agreement, since lenders typically require borrowers to maintain all-risk insurance on their homes.

Moratoriums are sometimes a necessary form of risk management for insurance companies and will probably cause nothing more than annoyance and inconveniences for customers, as long as the freezes on sales are fair and temporary. Matters become more disruptive, however, when moratoriums continue for long stretches. Consumer groups and others point out that long-term moratoriums on homeowners insurance could harm the real estate market, with banks and mortgage companies unwilling to exempt borrowers from the insurance requirements in lending agreements. In the summer of 2002, for instance, firerelated moratoriums by several property insurers in Colorado were allegedly not only halting real estate sales but also being continued for unnecessary reasons. According to at least one local politician at the time, insurers were being detrimentally cautious by refusing to do business in communities that were at least four miles away from all previous wildfires. Similarly spirited accusations and battles have been common in other states after disasters, particularly in coastal regions, and have led to the creation of several state-sponsored insurance entities that can cover high-risk properties.

In response to such predicaments, many states have established insurers of last resort for high-risk homeowners. These state-initiated entities may provide comprehensive homeowners insurance coverage to area residents, or they might simply cover the windstorm risks that have been refused by private insurance carriers. Regardless of what specific perils they cover, these insurers of last resort usually charge consumers higher premiums than private insurers. The higher premiums reflect not only the insured property’s high risk potential but also these entities’ general desire to avoid competing with private carriers. Wind-prone states with a governmentinitiated insurer of last resort include Florida, Texas and Mississippi.

DISASTER COVERAGE FOR HOMEOWNERS Homeowners generally have some insurance protection against fire losses and wind losses. This is because various wildfire and wind damages are covered under a homeowners insurance policy, which borrowers must purchase in accordance with mortgage lending agreements. Of course, mortgage lenders do not enforce this requirement out of concern for the homeowner. Rather, they require that homeowners insurance be in place as a way to protect their own investment. The home essentially serves as the collateral in a lending agreement between the bank or mortgage company and the borrower. If the borrower defaults on the mortgage loan, the lender can get its money back by having the property sold to satisfy the debt. However, if the property were ever damaged beyond repair by fire or some other peril without any insurance money to compensate for the loss, the lender would not necessarily be able to secure a full return of the borrowed funds.

What Is Homeowners Insurance? With no moratorium in place, consumers can protect themselves financially from disasters by purchasing a homeowners insurance policy. This kind of insurance provides benefits to the policyholder when damage is done to an insured dwelling, a detached structure or personal property. It also compensates people for loss of use of a dwelling and provides some liability insurance for the homeowner. For generations, insurers have sold multiple kinds of homeowners policies, including such basic products as HO-1 policies and such deluxe products as HO-3 policies. Even the plainest policies in today’s market cover damage to insured property in the event of fire, severe wind, hail, theft, explosion or riots.

Since the minimal homeowners coverage required in lending agreements is meant to protect the lender and not the borrower, the basic insurance policy might provide insufficient benefits to disaster victims in times of crisis. For instance, the policy might cover the entirety of the lender’s investment but only a small fraction of the homeowner’s personal belongings. Displaced victims may also sadly discover that their basic policy doesn’t adequately pay for “additional living expenses,” such as the cost of staying temporarily in a hotel. The good news for cautious homeowners is that they are free to go above and beyond the terms of their lending agreement and purchase additional insurance as a way of filling in those possible gaps.

HO-1 and HO-2 policies, rarely sold these days, are known as “named peril” policies because they only provide financial protection against those dangers that are specifically mentioned in the insurance contract. The HO-3 policy is the standard product for modern homeowners and is known as an “all risk” policy because it provides financial protection against every danger that might affect a dwelling, other than those that are specifically listed as exclusions within the insurance contract. Some of the excluded perils within HO-3 contracts are listed below:  

Be Aware of Moratoriums

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Some strange things tend to happen in the insurance market following a catastrophe. After resisting solicitations for enhanced coverage for years on end, it is only after a disaster that many people actually make the effort to review their policies and seek out more protection for their © Real Estate Institute

Flood Earth movement, volcanic eruptions Wear and tear Mold Rust Rot

including

earthquakes

and

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INSURING MAJOR RISKS  

which, as its name suggests, covers the cost of replacing the home in a similar form with similar building materials, up to the policy’s dollar limit. It does not subtract for depreciation. Most mortgage lenders insist that borrowers at least cover the replacement cost of a home. Also, most insurers will not pay an entire claim for partial damage to a home unless the policyholder has insured the property for at least 80 percent of its replacement cost.

Acts of war Nuclear reactions

How Much Will Coverage Cost? The cost of homeowners insurance is usually included as part of the homeowner’s mortgage payment and is dependent upon many factors. Highly valued properties cost more to insure than low-valued properties, though homeowners premiums may differ in various states. Citizens of disaster-prone states, such as California, Louisiana, Mississippi and Florida, generally pay higher homeowners premiums than people living in places like Illinois and North Dakota, where catastrophes are not as common.

The policy’s dollar limit may be determined at the policy’s outset by looking at building costs in the area and multiplying the price, per square foot, by the dwelling size. To avoid being overly insured and paying too much for homeowners coverage, buyers should not allow uncovered land to be a part of that calculation. After all, the land will still be around after a loss. The house, garage and other structures are what might need replacing.

Cost will also be determined by the homeowner’s choice to either accept basic coverage or insure the dwelling and other property for a greater amount than a lender requires. At the very least, a mortgage lender is likely to require that a borrower insure a home up to the entire amount of the mortgage loan or up to the replacement cost of the dwelling in its current condition. But as the borrower pays down the mortgage loan and as the structure and contents of the dwelling depreciate with wear and tear, the homeowner might opt for a policy that can replace both the damaged dwelling and its contents as if they were as good as new.

Two additional levels of coverage go beyond the requirements of most mortgage agreements and were created in an effort to shield homeowners from major outof-pocket expenses after a disaster. “Guaranteed replacement coverage” is the most expensive variety of homeowners insurance but gives the policyholder more potential benefits than all the other policies that are available in the market. Like regular replacement cost coverage, guaranteed replacement coverage covers the cost of rebuilding a home in a similar form with similar materials. But unlike regular replacement coverage, guaranteed replacement coverage has no dollar limit for replacement of the dwelling. In other words, if a person’s house burns down, a guaranteed replacement policy forces the insurance company to pay for a brand-new, similarly configured home, regardless of cost. This coverage ensures that a policy will fund the construction of a new home even if the property had been improperly appraised when the insurance was purchased and even if the cost of construction and building materials soars during the course of home ownership.

Timing and competition can impact insurance costs. A calm, catastrophe-free period tends to bring homeowners insurance rates down. Conversely, people who purchase or renew homeowners insurance in the few years after a catastrophe are likely to face higher premiums. In good and bad markets, though, each insurance company might offer cost-cutting opportunities to favored customers. For example, it is very common for homeowners to receive a discount on their homeowners insurance if they buy their auto insurance from the same carrier.

What About the Deductible? Both before and after they purchase a homeowners policy, insurance consumers can influence the size of their premiums through their choice of a “deductible.” From the standpoint of homeowners insurance, the policy’s deductible is the amount of otherwise insurable losses, expressed in dollars, that will not be covered under the insurance contract. Ideally, insurance deductibles benefit policyholders by keeping premiums down. At the same time, they benefit insurance companies by making carriers less responsible for small claims.

Despite the comparatively high premiums that homeowners pay for guaranteed replacement coverage, many industry professionals believe that current prices might not be enough to compensate insurers in the event of a catastrophe. The East Bay fires near Oakland in 1991 taught property insurers a lesson and convinced many of them to stop selling limitless guaranteed replacement policies and to switch to a newer, stricter product known as an “extended replacement cost policy.” This kind of insurance entails more benefits than a regular replacement policy. Like a guaranteed replacement policy, it protects the policyholder if the cost of rebuilding a dwelling exceeds the policy’s benefit limit. However, the excess coverage is capped, usually at no more than an additional 20 percent of the policy value.

Higher deductibles correspond with lower premiums, while lower deductibles correspond with higher premiums. Deductibles for most homeowners policies start as low as $250 and are commonly increased by policyholders to $500 or $1,000. In areas that are prone to specific kinds of disasters, the insurance company might insist on a separate deductible for those specific perils. Though not commonly applicable to fire coverage, separate deductibles may exist for hail or wind damages. Unlike a policy’s main deductible, the separate deductible is usually expressed as a percentage of the policy’s value, often in the range of 3 percent to 5 percent.

As an example, let’s pretend that a client insured his home for $250,000 through an extended replacement cost policy 10 years ago. Due to a catastrophe, the house is destroyed, and contractors estimate that it will now cost $320,000 to rebuild the property. Thanks to the extended replacement cost policy, the client should receive roughly $300,000 from his insurance company ($250,000 plus 20 percent). Yet because of a 20 percent cap on excess coverage, the client will be responsible for paying the remaining $20,000.

Levels of Replacement Coverage Homeowners have at least four levels of coverage to choose from when deciding how to insure their dwelling and personal property. The cheapest and lowest brand of coverage, known as “actual cash value coverage,” is an extremely rare breed, at least within the context of insuring a dwelling. It covers the value of a home up to the policy limit but subtracts for depreciation. Perhaps the most common level of coverage is “replacement coverage,” © Real Estate Institute

The limits of extended replacement cost coverage, as well as those of actual cash value and regular replacement policies, ought to give homeowners an incentive to review their policies on a regular basis and update them as needed. 23

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INSURING MAJOR RISKS more than just the cost of replacing the home’s structure and its contents. Unless they can depend on the kindness and long-term hospitality of friends and family members, the people who are made homeless by a disaster have to bank on spending a lot of time sleeping in hotel rooms or rented apartments and eating a lot of meals in restaurants. For a family that has nowhere else to go and has to wait indefinitely for their home to be rebuilt, the bills for these unavoidable expenses could be enormous.

Covering People’s Stuff Sometimes homeowners are fortunate enough to still have a roof over their heads after a force of nature but are rocked emotionally and financially by the damage done to their dwelling’s contents. “Contents coverage” can solve part of that problem because it reimburses policyholders for the loss of various belongings. The typical homeowners policy includes contents coverage that is equal to a certain percentage of the dwelling’s insured value, often within the range of 50 percent to 75 percent. So, if a homeowner insures a dwelling for $100,000 with contents coverage that is equal to 75 percent of the dwelling’s insured value, the homeowner may receive up to $75,000 from the insurance company as compensation for damaged or lost belongings.

Luckily, a lot of these sudden costs are covered by a homeowners insurance policy. Homeowners insurance reimburses policyholders for “additional living expenses,” which may be defined as those costs that the homeowner incurs as a direct result of not being able to live in his or her dwelling. Under this definition, reimbursable expenses may include money spent on meals and room and board, but would not include any expenses that the homeowner would have incurred regardless of a disaster.

Although basing the limits of contents coverage on a dwelling’s insured value helps to keep coverage understandable for homeowners, such a simple formula is not guaranteed to favor the insurance customer at claim time. Suppose, for example, that a client owns an old, poorly maintained house but has a soft spot for cuttingedge gadgets and other expensive items. In that case, the default amount of contents coverage, based on the home’s insured value, might prove insufficient.

An insurance policy may contain a dollar limit on additional living expenses, a chronological limit or both. Dollar limits are usually no less than 20 percent or so of the damaged dwelling’s insured value. Chronological limits are usually no shorter than one year.

Regardless of a dwelling’s insured value, standard contents coverage limits the amount of money homeowners may receive for the loss of special collections and extravagant items. Valuables such as stamps, works of art, coins and boats aren’t excluded entirely in homeowners insurance policies, but coverage of these items tends to be minimal in both size and circ*mstance. Full coverage for these belongings is almost always only available at an additional cost through an add-on product called a “floater policy.”

Most policyholders don’t come close to reaching these limits, but delays during the rebuilding process sometimes make more coverage a wise buy. The probability of maxing out on a policy’s additional living expenses is greater when an event, such as a hurricane, has done tremendous damage to a wide stretch of land in a densely populated area. During such a time, builders are likely to be in high demand and short supply, meaning that a homeowner who hopes to have a dwelling rebuilt in a matter of months may instead have to wait a year or more before being able to move into a freshly constructed dwelling.

Suppose, though, that a client is a typical homeowner with standard contents coverage and no special collections to speak of. A fire breaks out in the client’s home, sparing the structure from serious damage but destroying a lot of electronic equipment, including a home theater system that the client bought for $5,000 several years ago. Leaving deductibles and policy limits out of the equation, will the client receive $5,000 from the insurance company? We have no way of knowing the answer to that question unless we know whether the person has actual cash value coverage or replacement cost coverage for the lost equipment.

Coverage During Evacuations Catastrophes can sometimes behave like unpredictable monsters, capable of taking one house as a casualty and leaving a neighboring house alone. People whose homes are left relatively unscathed amid a disaster should consider themselves very lucky, but such good fortune doesn’t necessarily mean that a person’s insurance policy will not come into play. As safety personnel try to gain control of a crisis, local authorities may call on all residents in the area to evacuate. If homeowners are forced to leave their homes but do not suffer any damage to their dwelling or contents, their homeowners insurance will often still cover the cost of hotel rooms, meals and clothing, though a thorough review of some policies may reveal otherwise. If these items are covered, the evacuated policyholder should still expect to be responsible for the policy’s deductible.

As mentioned earlier in our examination of dwelling coverage, actual cash value coverage reimburses the homeowner for replacement of property, minus depreciation. Replacement cost coverage, on the other hand, pays for brand-new property, paying no attention to depreciation. Despite rarely being used to insure a dwelling, actual cash value coverage is standard for the contents portion of a homeowners policy. Disaster victims can still use the proceeds from cash value insurance to purchase brand-new items, but they are responsible for the difference in cost between a new item and an old one.

Limits on Detached Structures and Business Property In addition to the limits and exclusions mentioned on previous pages, a standard homeowners insurance policy will not reimburse a disaster victim in full for damage to detached structures. Common detached structures include garages, sheds and barns. Coverage of damage to these structures is generally limited to 10 percent of the dwelling’s insured value, though full replacement coverage can be obtained for an additional premium. Keep in mind, however, that an insurance company can deny an entire claim for damage to a detached structure if the homeowner uses any part of the garage, shed or barn to conduct business or to store property (other than vehicles) that is used by a business. Furthermore, a homeowners policy

Replacement cost coverage is available to consumers if they are willing to pay a bit more for the insurance. When armed with replacement coverage, fire victims usually receive a monetary advance from their insurance company that is equal to the actual cash value of damaged property. They then use their own money and the advance to purchase new items and can send receipts to their insurer for reimbursem*nt beyond the advance.

Dealing With Additional Living Expenses For homeowners whose dwellings are destroyed by a fire or windstorm, the cost of the disaster amounts to much © Real Estate Institute

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INSURING MAJOR RISKS wildfires, since they block some of the winds that transport flames from one area to the next. Also, in parts of California and other states, someone who is opposed to creating defensible space may not have much choice in the matter. In recent years, property insurers have threatened to cancel customers’ coverage if, after fair warning, a homeowner ignores an order to clear brush from the land around a high-risk house. Meanwhile, ordinances in some West Coast counties make defensible space a legal requirement for residents.

provides minimal coverage of business property that is damaged or destroyed within a dwelling, and it usually includes no coverage of business data that may be lost in a fire.

Coverage for Renters When weather damages an apartment building or a rented home, structural damage should be covered by the landlord’s insurance policy. But what about damages to tenants’ belongings and the additional living expenses that a renter would incur in that situation? In nearly every case, neither landlords nor their insurers are required to indemnify a tenant for these damages and expenses.

Other life-saving and money-saving suggestions call for some major home improvement projects. For the purpose of fire protection, roofs comprised of wood shingles can be replaced with roofing made out of tile or some other noncombustible material. If the homeowner opts for a roof that is made of metal, a buffer should be placed between the metal and a dwelling’s wood frame. Otherwise, the metal might simply act as a conductor during a fire and help the frame burn. Adding a pond to the property is also a potentially smart option, especially when a home is in a secluded area, far away from a natural body of water.

If they want protection, most renters can be approved for “renters insurance,” a close relative to homeowners insurance that applies to tenants’ personal property. The perils that are covered by renters insurance are not as exhaustive as those covered by the typical homeowner’s policy. But a basic renters policy still deserves a mention in this text because it insures the policyholder against many weather-related disasters. Like homeowners insurance, renters insurance can cover a dwelling’s contents on either a replacement cost basis or an actual cash value basis, with the latter option usually available at a lower price. If a fire or windstorm makes an apartment or rented home temporarily or permanently unusable, the tenant is covered for additional living expenses until those expenses exceed a certain percentage of the policy’s value, or until a particular time frame, such as one year, has passed. For landlords, the temporary loss of rental income after a disaster might be covered under their homeowners policy if they live in one of the building’s units.

Perhaps the best way for a person to manage wildfire risks is to consider these perils before purchasing or building a home. People in fire-prone areas would be wise to avoid building or buying a log cabin and should resist any attraction they might have to wooden decks or woodburning fireplaces. When considering possible neighborhoods for their next home, people should be concerned if a property’s location might complicate matters for professional firefighters. A property’s proximity to firehouses and fire hydrants is an important underwriting factor, and few insurers are likely to jump at the chance to insure a property that cannot be accessed by fire trucks via clearly marked and easily travelable roads. In fact, members of the Laguna Beach community in California may have helped keep their homeowners premiums under control, following major fires in 1993, by reconstructing roads in a manner that improved access for emergency vehicles.

Fire Safety Tips for High-Risk Homes People from all economic backgrounds can take safety measures to reduce their exposure to disaster risks. In addition to potentially saving people’s lives and giving added protection to property, the following tips, when observed, could have a positive impact on a homeowner’s search for affordable insurance coverage. Let’s address these suggestions in order, beginning with those that are relatively easy (or cheaper) to accomplish and concluding with those that are probably only practical for people who have the opportunity to build their home from the ground up.

People with the desire and the financial resources to go the extra mile in the name of risk management can promote safety and reduce premiums from the ground up by building a “fortified home.” This kind of dwelling is built to withstand the impact of various disasters, including fire, earthquakes and windstorms. Among other characteristics, a fortified home is likely to feature an inflammable roof, reinforced doors, impact-resistant windows and an extrasecure foundation.

At the very least, a homeowner in a fire-prone area should monitor the exterior of a house and remove any hazardous plant materials that are within close proximity to the dwelling. Roofs should remain free of leaves and pine needles, and debris should be cleared regularly from gutters.

Though these homes’ appearance and cost may have kept them from capturing the public’s attention, their proponents say the homes are getting prettier and cheaper over time. Builders have been experimenting with a brand of asphalt for roofs that mirrors the look of wooden shingles while minimizing fire risks. Meanwhile, the addition of fortified features to a building is said to increase regular building costs by roughly 5 to 10 percent. At this point in time, fortified dwellings certainly aren’t cheap, but they are reportedly only a few thousand dollars more expensive than newly constructed energy-efficient homes.

A homeowner’s landscaping plans should include the creation of sufficient “defensible space,” which acts as a safe zone that separates a home from the weeds, bushes and trees that could give fuel to a fire. Fire safety experts recommend creating a defensible space in the neighborhood of 30 feet to 100 feet, depending on a dwelling’s specific location. Because fire has an easy time spreading uphill, homes that are situated on steep slopes may need more defensible space than other dwellings.

Wind Safety Tips for High-Risk Homes

If the idea of creating defensible space doesn’t appeal to the homeowner for aesthetic or financial reasons, the client should consider a few bits of information. First, the creation of defensible space doesn’t doom the homeowner to a life without lovely exterior greenery. Not every tree near a person’s home must come down for safety purposes. In fact, some well-placed trees can aid in the suppression of © Real Estate Institute

Like most other catastrophic acts of nature, major windstorms may pack a weaker punch than expected if a homeowner has taken special precautions with his or her property. In many cases, taking the precautions may also qualify a homeowner for affordable and high-quality insurance. 25

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INSURING MAJOR RISKS level. Coverage is also limited in areas that are part of the “Coast Barrier Resources System.” Parts of the United States that are part of this system are listed in the NFIP Flood Insurance Manual, which is accessible online. Buildings in this system are generally not insurable if they were built after the early 1990s.

When it comes to maintaining a home in a manner that is resistant to major wind damage, special attention should probably be paid to the dwelling’s roof. Insurers usually prefer to only cover shingled roofs that are younger than 25 years old and other roofs that are younger than 50 years old. Hip roofs, which are slanted on all sides, tend to withstand wind better than flat roofs.

A flood insurance policy can cover a residential building for as much as $250,000. Contents within a residential building can be covered for as much as $100,000. More coverage is available for non-residential buildings, with structural and contents coverage each maxing out at $500,000. Tenants can cover their contents for as much as $100,000, unless all of their belongings are stored in a basem*nt.

Roofs, though, are hardly the only part of a dwelling that should be reinforced when windstorms are in the forecast. Doors and windows should both be strong enough, by means of shutters or other materials, to withstand the impact of debris at a high speed. This recommendation also applies to the outer door of an attached garage. Very often in a windstorm, personal property that is stored in a home remains safe from harm until a damaged garage door creates an entry point for the tornado or hurricane. Specifications for doors, windows and other possible entry points might be listed within local building codes.

More information about flood insurance is available to professionals through the Federal Emergency Management Agency.

EARTHQUAKES Fictional, action-packed adventure stories tend to leave people with the impression that every earthquake is a major disaster that visibly splits the ground and rudely shakes people off their feet. However, the vast majority of earthquakes do no damage to property and pass unnoticed by anyone who is not obsessed with geology. A case in point is California, where little quakes occur just about every day but where millions of residents go about their daily lives with no noticeable bouts of motion sickness. The fact that the likelihood of a devastating earthquake is small might make homeowners feel somewhat safe, but history also shows that major, deadly quakes have occurred periodically since the dawn of civilization and that guarding against these rare events with the help of insurance may turn out to be a smart move.

When thinking about landscaping around a dwelling, remember that windstorm damage is frequently caused or worsened by projectiles from people’s yards. To reduce the probability of a flying object damaging a dwelling, homeowners may want to trim their trees on a periodic basis and replace mounds of decorative rocks with a softer sort of material.

A FEW WORDS ON FLOODS Homeowners insurance covers a policyholder against many potentially disastrous perils. But as anyone who has made a claim for losses after a hurricane knows full well, this insurance doesn’t cover flood damage. To guard against the financial consequences of a flood loss, a homeowner is likely to need a flood insurance policy from the National Flood Insurance Program (NFIP).

Earthquakes Throughout History

The premiums, terms and conditions for flood insurance policies are determined by FEMA, but the policies themselves are usually sold and serviced by private insurers. These insurers are known as “Write Your Own” companies.

References to earthquakes can be found in the literature of ancient Greece, and it is thought that the mythical story of the underwater city known as Atlantis grew out of a real temblor that wiped out an entire flourishing civilization on the island of Crete in 1400 B.C. A 16th century quake in China’s Shaanxi province failed to become the stuff of legend, but, in claiming some 830,000 lives, it did set the record for the deadliest earthquake known to man.

By being involved in the flood insurance program, the federal government hopes to achieve at least two goals. The first is to make flood coverage available to homeowners and other individuals who would not be able to obtain it in the traditional market. The second, sometimes overlooked goal is to promote the purchasing of flood insurance so that the federal government will not be overwhelmed with requests for aid after a catastrophe.

With a few exceptions, the United States has had a much luckier relationship with earth movement than the former populations of Crete and China. But scientists and insurance companies aren’t betting on that luck lasting forever. They know full well that the San Andreas fault, a 600-mile fissure running from the Gulf of California and along the coast, behaved like a crazed demon in the early 1900s and have been waiting nervously for history to repeat itself.

In order to make that second goal a reality, any person who purchases a home in a “special flood hazard area” with the help of a federally regulated lender is required to cover the home with flood insurance. A special flood hazard area is a place where there is at least a 1 percent chance of flooding each year.

San Francisco had suffered a major quake in 1868, but, with few enforceable building codes in place at that time and with city officials clamoring to get the city back on its feet as quickly as possible, the management of earthquake risks was not a major priority in the rebuilding process. As a result, few people and fewer buildings were prepared for the minute-long shake that occurred near five o’clock on the morning of April 18, 1906.

More than 20,000 U.S. communities participate in the NFIP. Participation in the program is not mandatory, but a community that chooses not to join makes its residents ineligible for federal flood insurance and might be jeopardizing its right to certain kinds of federal disaster relief. Members of the NFIP must practice flood insurance risk mitigation by enforcing certain building codes. Through its “Community Rating System,” the NFIP can give insurance discounts to communities that go above and beyond required risk mitigation by facilitating accurate insurance rating and promoting flood insurance awareness.

Countless fires reigned over the city once the ground decided to hold still. With water lines out of order, buildings were being blown up in order to create breaks in the land and to possibly suppress the flames. Elsewhere, frantic homeowners were enlarging the problem by committing arson against their own homes. Realizing that no insurance company had ever dared to cover earthquake damage, they had grimaced at their suddenly crumbled dwellings

Although most buildings that are compliant with modern building codes are eligible for federal flood insurance, a building cannot be covered if it is principally below ground © Real Estate Institute

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INSURING MAJOR RISKS and the place on the surface that is just above the focus is known as the “epicenter.”

and reasoned that their fire policy was their only hope for indemnification. After the ashes had been swept, it was estimated that half of San Francisco, what was then the seventh largest city in the nation, was homeless. The official death toll was in the hundreds, but historians later uncovered an apparently successful plot by city officials to reduce that number in an effort to aid tourism and population growth. Revelations made public in the 1980s suggested that the actual list of casualties contained 3,000 names.

Most seismologists believe we lack the tools and knowledge to predict the strength, time and location of an earthquake, though this hasn’t kept hopeful prognosticators in the United States, China and other countries from trying. Over the years, some scientifically trained soothsayers have claimed we can determine the likelihood of an earthquake by tracking elevation, water temperature, conductivity and the speed of sound in a given area. At one point, scientists in China even claimed that peculiar behavior by animals was an indicator of a coming quake.

Maybe the only silver lining to emerge from the 1906 San Francisco quake was the way in which it enhanced the image of insurance companies in the eyes of the American public. According to a report completed by insurance giant Swiss Re, the day’s fire policies often specifically excluded coverage for damages when a fire was caused by an earthquake. This exclusion, according to another report by National Underwriter, initially saw insurers employing a chimney test. Essentially, if an insurer couldn’t otherwise tell if damage to a dwelling had been caused by an earthquake or a fire, it would check to see if the chimney was still standing. If so, the damage would be ruled a fire loss, and the claim would be covered. If the chimney had been destroyed, the damage would be ruled an earthquake loss, and the claim would be denied. But the magnitude of the San Francisco disaster made the chimney test either impractical or unreasonable for many carriers. Lloyd’s of London, for one, eventually decided to pay all San Francisco claims on fire policies, regardless of any exclusionary language in its insurance contracts. Coincidentally or not, Lloyd’s went on to become the top reinsurance provider for U.S. carriers.

Instead of putting their faith in sound waves, critters and other variables to pinpoint the exact time, force and place of a future temblor, many seismologists trust the historical record and use old data and maps to make somewhat broad pronouncements about earthquake risks. For example, the scientific world is unlikely to state that a moderately sized earthquake will rattle a particular town in spring 2025, but experts may be willing to state that there is a 75 percent chance of a moderately sized quake rattling that town within the next 20 years. Most of these experts are likely to freely admit that their broad predictions, while based on historical facts, should be interpreted as estimates. They would not be entirely surprised if that moderate quake in that town didn’t happen for another 50 years or if two moderate quakes occurred in consecutive years. Based on what history and science tell them, insurance professionals who underwrite earthquake risks have come to put a tremendous amount of emphasis on a client’s proximity to fault lines. Attention to fault line proximity has made earthquake risk management extremely challenging in California, where hundreds of cracks in the earth’s crust (many of them visible to the human eye) are spread throughout the state and where, according to the California Earthquake Authority, more than two-thirds of residents live within 30 miles of a fault. In the eyes of some risk managers, places like San Francisco are additionally risky because they were built largely on landfills and because many of their buildings were constructed prior to the implementation of modern building codes.

Nearly 100 years after the 1906 quake, scientists, builders, homeowners and insurance companies had still not learned enough about earthquakes or implemented enough risk mitigation measures to avoid additional catastrophic losses on the West Coast. The death toll from a January 17, 1994 quake in the Northridge section of Los Angeles amounted to a comparatively low 57 people. But a century of population growth in the Golden State had meant that there was a lot more insurable property to be destroyed by a disaster than there had been in the Bay area of 1906. Even when the old San Francisco numbers are adjusted for inflation, the 1994 Northridge quakes still qualify as the costliest example of earth movement in U.S. history, having caused $40 billion in total losses and more than $12 billion in insured losses.

Indeed, annual earthquake losses in California greatly exceed earthquake losses in other states. In 2004, the Insurance Information Institute reported that the state was responsible for 84 percent of earthquake damage in the United States. However, many Americans who live outside of California believe they are at least slightly at risk for a major earthquake and have purchased the appropriate insurance coverage to better manage that disastrous possibility.

Why and Where Earthquakes Occur Despite centuries of study, it has only been within the past several decades that scientists have begun to gain a firm understanding of how and why earthquakes occur. In ancient times, people believed a sudden shake of the earth was a way for a god or goddess to demonstrate his or her anger. Later, people picked up on a theory by Aristotle and assumed that the shaking was caused by winds that were trapped in caverns.

In addition to being a hot topic in California, earthquake insurance is most popular in Washington, Missouri and Oregon. This makes sense since Washington and Oregon are in the West, where a large majority of all U.S. quakes occur, and because Missouri sits in a fault area known as the New Madrid Seismic Zone, along with parts of Illinois, Arkansas, Tennessee, Indiana and Kentucky. According to FEMA, earthquakes are considered a very high risk in nine states, a high risk in 10 states and a moderate risk in 22 states.

Today, most earthquakes are believed to be the byproduct of “plate tectonics,” a scientific theory that relates to the constant movement of the earth’s crust. At a basic level, modern seismologists believe that various portions of the crust sometimes get in each other’s way as they slide along their paths. This puts tremendous stress on the earth until, finally, the stress passes along a weak, cracked portion of crust, known as a “fault,” and is released in the form of seismic waves. The release of these waves is sometimes felt by humans in the form of shaking. The underground source of the shaking is known as the earthquake’s “focus,” © Real Estate Institute

Measuring Earthquakes Over the past 70-plus years, seismologists have been developing ways to mathematically represent the intensity and effects of earthquakes. The most popularly known method of measuring a quake utilizes the Richter Scale, formulated by Dr. Charles F. Richter in 1935. This scale 27

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INSURING MAJOR RISKS no significant threats to properties, policyholders reexamine their risk tolerance and usually start to let their coverage lapse.

measures the severity of an earthquake by focusing on the amount of energy that is released at the quake’s source. An increase of one whole number on the Richter scale represents an earthquake that is 10 times as strong. It also means that a quake involves roughly 32 times as much energy.

A person’s choice to spend their money on something other than an earthquake insurance policy is not always linked to a poor understanding of the geological risks that reside below their properties. Many people are well aware that their house sits near a fault line, but they look at the cost of earthquake coverage and decide that, thanks to state and federal disaster relief programs, buying quake coverage is an act reserved for fools. They might be old enough to remember how, after a 1971 California quake, victims became eligible for low-interest government loans and did not need to pay back the first $2,500 they received in governmental assistance. Or they might look at an event like Hurricane Katrina and conclude that federal and state lawmakers would be committing political suicide if they did not adequately assist the uninsured after a catastrophic event. However, the reader will note at a later point in this material that the government is not legally required to bail out citizens after a natural disaster and usually sets limits on the amount of financial relief it will give to victims.

Another popular measuring stick, the Modified Mercalli Intensity Scale, pays attention to the damage that is actually caused by a quake and represents the extent of that damage in the form of a Roman numeral. A quake ranging from I to IV is only felt by a portion of people in an area, depending on how close they are to the ground. At V, fragile items and windows might break. At VI, furniture might move and plaster might sustain some damage, and so on. According to the United States Geological Survey, the scale tops out at XII, a number associated with a totally damaged community. For reasons that are not essential to the purpose of this text, non-scientific media outlets tend to avoid these two specific scales. Instead, they just use a generally accepted measurement to represent an earthquake’s magnitude. Under this basic method, magnitudes below 2.5 are not usually felt. Some damage can be seen when magnitude reaches 4. At the top end of the basic scale, a magnitude of 8 would cause what the Associated Press has termed “tremendous damage.” The 1906 quake in San Francisco, for example, is believed to have had a magnitude of 7.9 on the media’s basic scale.

There are also several U.S. homeowners who worry about their exposure but believe that their location has effectively priced them out of the market for quake coverage. Although California has experimented with limited price controls that benefit some high-risk customers, coverage in that state has consistently been criticized for being overly basic and allegedly not worth its high cost. These criticisms help explain why only 10 to 15 percent of people in the state have purchased the insurance. Yet in Missouri, where coverage costs less, the take up rate has occasionally neared 50 percent in some years.

The Non-Popularity of Earthquake Insurance Special insurance policies that reimburse people for earthquake-related damages have been sold in the United States at least since the 1920s, but the coverage has struggled consistently to gain acceptance from most of the general population.

Though citizens of such countries as Australia and New Zealand are extremely likely to have earthquake insurance coverage, low take-up rates in other nations suggest that the people of California and other high-risk states are not just a stubborn bunch of holdouts. Japan, for one, sits on four tectonic plates and represents the biggest earthquake risk on the globe. Every September 1, the country holds a national earthquake drill that commemorates a deadly quake from 1923, and visiting journalists report that some Japanese keep their bathtubs filled regardless of use, in case a temblor disrupts water service. But in spite of all this, Japanese insurers have had little success selling earthquake insurance to their own people. At the time of a 7.2 magnitude quake in Kobe, Japan, in 1995, less than 5 percent of residents had coverage.

Nowhere is the public’s relationship with earthquake insurance stranger than in California, where noticeable earth movement is far from out of the ordinary. In 1985, the state passed a law that required all property insurers to make earthquake insurance available to all of their homeowners insurance customers. Yet the percentage of insured Californians remained surprisingly low over the next 10 years. The Northridge quakes of 1994 shot the take-up rate all the way up to roughly 30 percent for a short period of time, but that number dipped as the disaster escaped from people’s short-term memory. Despite continued earth movement in the state, not to mention state-instituted assistance for high-risk homeowners, only an estimated 12 percent of Californians were insured by an earthquake policy in 2007.

Earthquakes and Homeowners Insurance Earthquakes are obviously capable of doing tremendous damage to people’s homes. Along with the risk of structural collapse, homeowners in quake-prone communities must face the possibility that earth movement might cause floods by breaking water mains or cause fires by rupturing gas lines. Though basic logic might suggest that these perils ought to be covered under a homeowners insurance policy, the reality is that homeowners insurance generally excludes coverage of quake-related damages.

People’s reluctance to purchase earthquake insurance in high-risk areas cannot be boiled down to any single reason. Rather, insurance professionals who sell earthquake coverage need to recognize many psychological, historical and financial factors that have joined together to form a firm barrier against greater market penetration. The take-up statistics related to the Northridge quakes are a perfect example of how psychology affects people’s perception of risk. Regardless of proximity to a fault line and warnings from scientists that a quake is likely to occur in the near future, homeowners in high-risk communities fall deeper and deeper into denial the longer they go without experiencing a disaster. Conversely, a violent confrontation with Mother Nature in the recent past will often give people the extra push they need to purchase more insurance. Experts have noticed that this latter kind of behavior among insurance customers has a lifespan of approximately two years. After two years have gone by with © Real Estate Institute

Policy exclusions of “earth movement,” which collectively refers to quakes, landslides, sinking and volcanic eruptions, have been enforced in an increasingly strict manner over the past few decades. Decades ago, some courts awarded insurance payouts to policyholders if earthquake-related damage to a home could also be linked in some way to another cause. The basis for these court-mandated payouts was known as “concurrent causation” and had been practiced as early as the 1906 San Francisco quakes, 28

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INSURING MAJOR RISKS distinguishes earthquakes from the perils that are covered under a homeowners insurance policy. When a mortgaged property is damaged by fire, for example, insurers issue checks in the names of both the mortgage lender and the borrower. This allows the lender to insist that policy proceeds be used either to restore the dwelling or to pay off the outstanding balance on the home loan. If a homeowner files a claim for earthquake damage, he or she has the right to use the insurance money for other purposes without the lender’s approval.

when Lloyd’s of London and other insurers decided to pay all property claims despite exclusions for earth movement. But by the 1980s, insurance companies were getting the legal go-ahead to add “anti-concurrent causation clauses” to their contracts, effectively making it less likely that quake damage of any kind would be covered under a homeowners policy. Today’s homeowners policies might in fact cover some claims when an earthquake is responsible for a fire or a broken pipe, but that coverage is limited to damage that could have only been caused by the fire or burst pipe. Suppose, for example, that an earthquake occurs in a client’s neighborhood, causing some buildings to partially burn and then collapse from the earth movement and other buildings to simply burn to the ground. If the client’s home is one of the buildings that suffered no earthquake damage but burned down because of an ensuing fire, he or she might be able to have the home replaced in full through a homeowners insurance policy. On the other hand, if the client owns one of the buildings that suffered some fire damage and then collapsed, he or she cannot expect homeowners insurance to cover the full replacement of the dwelling.

Be Aware of Moratoriums In spite of the insurance industry’s desire to sell more earthquake policies, the coverage is not easy to obtain when it is probably most appealing to the public. For obvious reasons, the uninsured and the underinsured are more likely to inquire about earthquake insurance in the days immediately following major earth movement. Yet a property insurance company is likely to turn these potential customers away for the time being, for fear of taking on an undesirable amount of risk. Once a major quake ends, smaller quakes, called “aftershocks,” can rock the same affected area for a while. Before issuing more policies in a victimized community, carriers want to feel assured that these aftershocks have passed and that, at least in the immediate future, earth movement will not produce more damage in the same spot.

Working Around Earthquake Exclusions As a way of expanding business and compensating for the loopholes in homeowners insurance, many carriers sell special earthquake coverage that can either be added as an endorsem*nt to a homeowners policy or be sold as an independent policy. Earthquake insurance can be purchased for commercial buildings, residential buildings and even for mobile homes if people are willing to pay a little extra to insure these relatively unstable dwellings. Like a homeowners policy though, earthquake insurance contracts might still exclude some forms of earth movement, such as landslides and sinking.

In general, the uncertainty surrounding aftershocks is strong enough for an insurer to engage in a one-month or two-month moratorium, which temporarily prevents people from buying new quake policies and from updating old ones. The specifics of these potential moratoriums may differ among insurance companies and are sometimes articulated in a company’s “magnitude policy.” For instance, a company’s magnitude policy might call for a moratorium on earthquake policies within 100 miles of a quake’s epicenter if a quake has a magnitude of 4.0 or above. Sometimes though, moratoriums can be broader and arguably severe. In 1985, two quakes in Mexico were enough to stop some companies from writing new policies in San Francisco and Los Angeles.

Earthquakes and Mortgage Loans Consumers have a real choice as to whether or not to insure their dwelling and belongings with an earthquake policy. This choice contrasts greatly with the lack of options people face in regard to homeowners insurance. Though a prospective homeowner is technically not required to buy homeowners insurance in conjunction with a real estate purchase, anyone who wants a mortgage loan must do so. Since few Americans can pay out of pocket for a dwelling, insurance requirements in the mortgage industry have effectively left most homeowners with at least some financial protection against fire, vandalism, hailstorms and other perils.

How Much Will Coverage Cost? The average cost of earthquake insurance varies by state and is dependent on the area’s susceptibility to major earth movement. Reportedly, coverage is still inexpensive enough in high-risk states like Missouri for some agents to suggest that all homeowners add an earthquake endorsem*nt to their dwelling policies. But further west, where many states are considered very high risks by FEMA, it is fair to say that the insurance, no matter its positive attributes, is not cheap. From an insurer’s point of view, high premiums are often necessary because earthquake policies are most likely to be bought by people in high-risk parts of the country.

Yet lenders generally do not require borrowers to insure mortgaged properties against earthquake damages. Supposedly, this difference in insurance requirements exists because banks and other lenders consider fire risks and earthquake risks to be very different from each other. Whereas fires occur in all kinds of places, significant earthquakes are common only in a small portion of the United States. It is therefore generally believed that, as long as a bank provides mortgage loans to a geographically diverse group of borrowers, it will be able to diversify its portfolio enough to keep earthquake exposure at manageable level.

Premiums for earthquake insurance may also need to be higher than those for homeowners insurance and flood insurance because, compared to the extensive history of floods and hurricanes around the globe, there have been few major earthquakes. A resulting lack of data makes it more difficult for risk managers to estimate the frequency and potential damage that may be caused by a quake and makes it harder for insurers to offer coverage at a low price.

Lenders’ ambivalence toward earthquake insurance can create a somewhat interesting situation if a homeowner buys coverage independently and incurs a housecrumbling loss. In the judgment of some courts, a mortgage lender who does not order borrowers to purchase earthquake coverage retains no control over how a borrower uses earthquake insurance benefits. This © Real Estate Institute

What About the Deductible? Like premiums, earthquake insurance deductibles vary depending on where an insured person lives and the amount of risk associated with that area. Low-risk dwellings 29

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INSURING MAJOR RISKS coverage increasing consumers’ premiums and affecting their deductible.

may be insurable with a 2 percent to 5 percent deductible. Moderate-risk and high-risk dwellings may require a 10 percent deductible. Properties that represent a very high risk might need to be insured with a deductible of 15 percent or 20 percent.

Coverage for Renters and Condo Owners Earthquake insurance is not just for people who own houses. It can also be customized to suit the needs of renters and condo dwellers. Quake insurance for renters covers personal property within an apartment or other rented home and also helps disaster victims pay for additional living expenses. Because a renters policy entails no coverage for a dwelling’s structure, it tends to be cheaper than a typical earthquake policy and might involve a lower deductible.

The dwelling’s deductible, which represents the amount of insured losses for which the insurer is not responsible, is applied to the dwelling’s insured value, rather than to the value of an insurance claim. In other words, clients who insure their homes for $100,000 with a 10 percent deductible would need to suffer $10,000 in damage to their home before their policy benefits could kick in. If a dwelling’s insured value is particularly low, the insurer might impose a minimum deductible that is expressed in dollars. In the event of a total loss, policyholders receive the difference between their deductible and their policy’s value. They do not need to physically pay the deductible before receiving policy benefits.

Since condo ownership incorporates elements of renting and owning a house, an earthquake policy for a condo owner will be more extensive than a policy for a renter. Unlike a renters policy, insurance for condo owners can help a policyholder pay for interior repairs to the tune of several thousand dollars. However, damage to the exterior, as well as damage to such communal areas as hallways and laundry rooms, is not covered under a condo owner’s policy. It is only covered if the condo association has purchased earthquake insurance for itself.

In general, earthquake insurance involves one deductible per occurrence, not one deductible per policy period. So if the policyholders in our previous example had the unfortunate opportunity to live through two major earthquakes in the same year, they would have been looking at a combined deductible of $20,000 instead of $10,000.

If the condo association lacks insurance or is faced with a large deductible, unit owners might find themselves looking at some steep assessment fees. Luckily, many policies for condo owners will cover these costs. In some cases, this assessment coverage may be available on its own, meaning that condo owners can purchase it without also needing to insure their home’s interior or their personal property. Separate, higher deductibles for assessment coverage may apply.

However, insurance companies usually apply a single deductible to policy benefits when multiple quakes closely follow one another. All earthquakes that occur within a three-day period are usually thought of as a single event for the purpose of deductibles. Some policies have enhanced that provision to include all quakes that occur within a seven-day period.

Earthquake Insurance for Businesses

Earthquake insurance may require a separate deductible for damaged contents. If so, the deductible may be applied to the insured value of the contents. So with $50,000 of contents coverage and a 10 percent deductible, the insured would be looking at a minimum of $5,000 in nonreimbursable losses. Other policies might list a flat dollar amount as the contents deductible. Some policies have no deductible for contents coverage if the dwelling deductible has been met.

Earthquake insurance can relieve financial burdens from businesses by covering commercial properties and reimbursing companies for losses that are linked to business interruption. When insurers consider issuing earthquake coverage to a business, they may put special emphasis on a building’s contents. Whereas some offices and storefronts are likely to contain little more than standard business equipment and furniture and not seem like a major earthquake risk, an antique store located on a fault presents a problem because one good shake could mean the loss of countless fragile items.

Dealing With Additional Living Expenses Like homeowners insurance, most earthquake insurance policies include some coverage of additional living expenses (ALE), which might arise if a quake makes a home temporarily or permanently uninhabitable. Covered costs usually include those for temporary housing, clothing, meals and laundry services. As stated previously, additional living expenses do not include those expenses that a person would have incurred regardless of a disaster.

Deductibles for commercial policies might merit special attention, particularly when a policyholder wants to insure multiple structures through a single insurance contract. Suppose, for example, that a restaurant owner operates out of two locations and insures both properties with one $300,000 policy. Assuming a 10 percent deductible, that would leave the owner with at least $30,000 in out-ofpocket expenses if a quake were to destroy both properties. But what would happen if a quake were to damage one location and spare the other? Would the owner still be responsible for a $30,000 deductible, or would the insurer cut the deductible in half? The answers to those questions will depend on the policy language.

Limits and Exclusions Because the product was created in response to a major exclusion in homeowners policies, it may seem a bit ironic that earthquake insurance contains many exclusions of its own. Most policies exclude damages caused by earthquake-related fires. These damages should be insurable through a standard homeowners policy. Also, detached structures, including pools, garages, spas and greenhouses, often aren’t covered by a basic quake policy. The same might hold true for sidewalks, patios, fences and lawns.

Many issues related to business interruption pertain not only to earthquakes but also to other disasters. They will be addressed cumulatively in a later section of this material.

Earthquake Safety Tips for Homeowners For homeowners, guarding against earthquake risks is arguably more challenging than guarding against wildfire risks. Whereas wildfires can be thwarted when people remove weeds and brush from their property, earthquake risk management generally entails a major construction project or a move to a less risky part of the country.

Insurers have sometimes enforced limits and exclusions that pertain to certain kinds of building materials. On occasion, people have had to pay out of pocket for damage to plaster or concrete walls. Sometimes coverage of exterior masonry has been optional, with the additional © Real Estate Institute

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INSURING MAJOR RISKS area. Additional coverage may also be necessary when a policyholder makes major home improvements.

Effective management of earthquake risks should probably begin when prospective homeowners are shopping for a dwelling. If they want to worry less about earthquakes or at least qualify for lower insurance premiums, home buyers might want to settle on land that is at least 50 feet away from a fault, according to the Insurance Information Institute.

As a way of reducing the amount of underinsured homeowners in the United States, insurance professionals often recommend that clients review their policies at least once a year. A policy’s annual renewal period presents the opportune moment for this evaluation, since the insurer might make noteworthy changes to a policy at this time.

If moving far away from a fault is not an option, the next best thing a person can do is to pay attention to a home’s construction features. Poorly braced houses are difficult to insure in some areas because they are sensitive to lateral pressure. Their lack of horizontal stability prevents them from moving in one piece during a fierce quake and makes it easier for heavy shaking to pull pieces of the dwelling apart.

If clients follow this routine and discover that they need more insurance, they are not necessarily stuck with paying more for the additional coverage. They might be entitled to greater benefits if they agree to a higher deductible.

Minding Local Building Codes When someone buys a home, the building’s age hints at more than just the probable progression of wear and tear. It might help the owner decide how much property insurance to buy and could have an influence on the premiums for that coverage.

In general, single-story buildings have a better chance of withstanding an earthquake. “Soft-story structures,” which incorporate a parking lot or some other form of open space on the building’s first story, are especially risky due to the absence of adequate support. According to the Association of Bay Area Governments, soft-story structures accounted for two-thirds of all buildings that were made uninhabitable by the 1994 Northridge quakes.

The building’s age is important to insurance carriers because it suggests how fully a home complies with the most recent local building codes. When these safety and energy requirements are updated, they apply to new buildings but often do not require property owners to make changes to older dwellings. However, if an older home is destroyed, an owner who wants to rebuild is required to abide by the current standards.

For homeowners with the money and the drive to complete a major construction project, retrofitting is an option. In a general sense, “retrofitting” just means upgrading an old structure. From the perspective of earthquake risk management, it often involves tying a tighter knot around a dwelling and its foundation so that the building can bend a bit more under pressure without crumbling. Other kinds of retrofitting don’t do much for a building’s foundation but can help prevent the fires and floods that often follow major earth movement. Water heaters can be clamped down against walls so that they remain stationary after a good shake, and automatic shutoff valves for gas lines can prevent a bad situation from getting worse.

The insured replacement value of a damaged dwelling is likely to be enough to cover most rebuilding costs if the damaged dwelling was built only a few years ago. On the other hand, people who want to rebuild older homes would have to comply with several years’ worth of changes to the rules. Depending on where they live, these owners might need to construct a new home that boasts a fire-resistant roof, an intricate sprinkler system and several other features that they had not considered when they first bought their homeowners policy.

GENERAL DISASTER INFORMATION

If disaster victims are at all surprised by the cost of rebuilding in compliance with local codes, they are also likely to be shocked when they learn that the typical homeowners policy does not cover all of these mandatory upgrades. Concerned insurance customers might want to look into purchasing “building ordinance coverage,” which can be added to another property insurance policy to help people manage these costs.

Despite our focus on fires, windstorms and earthquakes, there are obviously many insurance issues that pertain to seemingly all kinds of disasters. The remainder of this text highlights several of these topics and concerns.

Keeping Coverage Current Buying an insurance policy to protect a home and its contents is a major step in the risk management process, but it is not the final one. No matter what kind of disaster they fear the most, policyholders put themselves in a good position when they periodically review their coverage to determine whether their insurance still meets their needs.

From an insurer’s perspective, building codes are important because they give underwriters a basic idea of how buildings in a particular area are likely to respond to a disaster. The disaster-prone states California and Florida are known to have two of the strictest building codes in the nation, which might help explain why insurance companies continue to cover properties there. Yet detailed codes, in and of themselves, will not always be enough to secure affordable coverage for local residents. After paying many disaster claims for houses that were built by people who cut regulatory corners and got away with it, insurers started paying closer attention to how strongly communities enforce their codes.

Homeowners are usually well-insured right after they purchase their dwelling. If their own risk tolerance doesn’t successfully entice them to become adequately covered against various acts of nature, their mortgage lender is nearly certain to step in and mandate proper coverage. Yet as time goes by, a well-covered home can turn into a poorly covered home, and there may be no one but the owner around to take control of the situation. According to the building consulting firm Marshall & Swift, 58 percent of homeowners in this country were underinsured in 2006 by an average of 21 percent.

Disaster Insurance for Business Owners When disasters strike, self-employed people unfortunately have much more to worry about than just the safety of their loved ones and the sturdiness of their home. They will be faced with major business concerns, including how to repair damaged offices and how to make up for lost income. A disaster’s detrimental effect on the business community has been confirmed by the San Diego Institute for Policy Research, which estimated that wildfires in the

Admittedly, many property insurance policies feature inflation guards that increase coverage by a few percentage points each year, but this protection is not always enough to minimize an owner’s out-of-pocket expenses. Building costs can easily outpace inflation and are especially likely to rise when a disaster hits a large © Real Estate Institute

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INSURING MAJOR RISKS or photos of major appliances and other electronics, for example, should include model numbers. Whether in written or photographic form, any inventory of a person’s personal belongings should be kept outside of the home. There is little point in keeping an inventory of your belongings if that inventory is likely to burn up in a fire with the rest of your stuff.

city in 2007 were responsible for $893 million in lost productivity. At least two disaster-related insurance products may appeal to business owners who would not be able to afford an unexpected halt to their productivity. “Business income insurance” is the more popular of the two. Among other things, the coverage can take care of utility bills while work is suspended, pay employees’ salaries and reimburse the business owner for lost income after a disaster.

Old receipts for major items can be helpful, too, though a client is not legally obligated to keep them. A set of house plans might prove to be invaluable if the homeowner wants to rebuild, and copies of all applicable insurance policies might turn out to be great references at a crucial moment. Like one’s property inventory, these receipts, home plans and policies belong in a secure offsite location, perhaps in a safe deposit box at a bank.

A similar product, “extra-expense insurance,” provides benefits to policyholders when they keep their business running after a disaster but incur additional expenses while doing so. For example, extra-expense insurance might cover the cost of special generators or might pay for air shipments when road conditions or other factors do not allow a company to ship products via regular mail.

Evaluating the Damage After a disaster, it will be time for the policyholder to prepare a claim and for a claims adjuster to evaluate the damage. If a disaster has only done partial damage to a dwelling and safety officials allow owners to access the property, policyholders can do themselves a favor by scouring over the building several times before filing a claim. People accumulate a lot of personal items over the course of home ownership. It will therefore be very easy for disaster victims to overlook many losses at first glance. Also, if on-the-spot repairs must be done, the homeowner ought to document them in some way so that the damage can be reported accurately to the insurance company.

Business income insurance may be cheaper and easier to find if shoppers present a “disaster recovery plan” to an insurance company. This kind of plan involves precautionary steps that ought to get a business back on its feet quickly after a catastrophic event. As part of this plan, the business owner might maintain a record of all employees’ contact information and store it in a safe place. He or she might also want to tell workers ahead of time where they ought to report for duty if the business’s building were to suddenly become uninhabitable. Finally, important computer files should be backed up on a regular basis, and backup copies should be stored in a secure location.

Today’s excellent communication systems have made it possible for claims adjusters to get on the ground and spring into action as quickly as safety permits. Often after a disaster, an insurance company will call on its top adjusters to head to the heart of the destruction as part of a “catastrophe squad.” These adjusters are paid by insurance companies to assess insured losses but are also expected to provide honest service to companies’ clients.

Avoiding Problems at Claim Time Insurance should be a source of relief for covered disaster victims, not something that amplifies someone’s stress level in an already unfortunate situation. Yet as helpful as insurance companies can be during times of crisis, it appears as though every disaster in recent memory has had its share of disgruntled policyholders.

In most cases, claims adjusters, including those who work on catastrophe squads, must be registered or licensed in the state where they perform their work. On rare occasions though, the severity of a disaster is so high that insurers are permitted to call on out-of-state adjusters to help expedite quality service to victims.

For some people, getting a disaster claim sorted out becomes akin to having a second job. For others, wildfires, earthquakes and other disasters lead to long-term legal battles between clients and carriers. Sometimes insurers win these battles, and sometimes policyholders claim victory. But no matter how each of these fights plays out, the one-sided wins are effectively in no one’s best interest. Rather than strengthening a business-minded bond between insurance providers and private citizens, they nurture a conscious and subconscious sense of distrust among those consumers and professionals who want nothing more than to be treated fairly by the other side.

Regardless of who is assigned to an area, people who have lived through catastrophes report that victims prefer to work with one adjuster throughout the claims process. If an insurer pulls its adjusters off of cases and reassigns them to other ones, a claim might get bogged down amid the transfer of responsibility, and the client might have to wait longer than expected for a fair settlement.

Indeed, it may be naïve to suggest that there is not at least a small minority of policyholders who will use disasters as an opportunity for fraud, and it may be equally naïve to suggest that there have not been a few insurance companies that have sacrificed fairness in order to satisfy greed. But it would be unfair to link all property insurance disputes to devious displays of selfishness. In fact, experience tells us there are many things clients and carriers can do to smooth out the claims process for all affected parties.

Disaster victims who believe that an insurer’s claims adjuster is not playing fairly may want to turn to a “public adjuster.” Public adjusters know how to evaluate damage, but they work for policyholders rather than for insurance companies. In return for serving as the middlemen between the client and the insurance company, they receive a percentage of the client’s insurance settlement.

Reacting to a Proposed Settlement Once a claims adjuster has evaluated the destruction that a disaster has caused, an insurance company might offer a quick settlement. The client can accept the settlement and start replacing items and rebuilding property, but acceptance of a settlement may limit the person’s ability to file related claims at a later date. As an alternative, the person can decline the offer and instigate an appeals process.

Knowing What You Own Documentation may be considered one of the keys to a pain-free insurance settlement. People who have kept track of their purchases will be able to pinpoint exactly what they have lost in a disaster and will be more likely than others to receive fair compensation quickly. Homeowners should either list or take pictures of everything they own before a disaster hits and ought to be as specific as possible. Lists © Real Estate Institute

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INSURING MAJOR RISKS to FEMA’s original purpose, as the agency found itself in charge of aiding Gulf Coast communities after Hurricane Katrina.

Earning High Marks for Quick Responses The insurance industry has learned a lot thanks to its experiences with previous disasters and has applied this cumulative knowledge to its current customer service endeavors. Though some clients still find a reason to argue with carriers over the amount of a proposed settlement, it is rare these days when policyholders voice displeasure over an insurer’s initial response to a catastrophe.

Once the president has designated a place as a federal disaster area, victims can turn to FEMA for help with their uninsured losses. Upon registering with the agency, a person will receive an application for a federal loan from the Small Business Administration (SBA) and/or an application for a federal grant from FEMA’s Individuals and Households Program (IHP).

People who live in disaster areas are likely to note that many insurers assign an array of industry professionals to hard-hit towns. Local insurance workers will typically be putting in overtime to answer clients’ questions, even as many of them worry about the status of their own homes and possessions. In addition to fielding questions, agents and adjusters at bigger companies can hand out checks or debit cards on the spot, so that the newly homeless can immediately pay for lodging, clothing, food and other essentials. In the 1990s, one insurer even went so far as to turn a 34-foot Winnebago into a claims center on wheels that traveled around the country to assist and reassure customers in catastrophic situations.

SBA Loans In spite of its name, the Small Business Administration actually distributes 80 percent of its disaster loans to homeowners and renters. These loans can only be used to pay for the disaster-related costs that are not covered in full by grants or a person’s insurance. Homeowners can receive up to $200,000 from the SBA for damages to a dwelling. Owners and renters may be eligible for up to $40,000 to replace or repair their personal belongings. Businesses and non-profit organizations may receive as much as $1.5 million as compensation for lost or damaged assets.

Dealing With Contractors Unfortunately, disasters have the power to bring out the worst in some opportunistic people. This sad reality has led to occasional law-breaking scams in which unskilled builders have presented themselves to victims as reputable contractors. Concerned policyholders may be able to avoid these frauds if they use contractors who have been recommended by their insurance companies.

SBA loans must be repaid with interest to the federal government or participating lender, with the first payment usually due after five months. However, the government puts limits on interest charges and offers long-term lending agreements to Americans in order to make the loans reasonably affordable. If a borrower has no other source of credit after a disaster, the interest rate on an SBA loan cannot exceed 4 percent. This rate restriction applies to roughly 95 percent of loan recipients. The remaining 5 percent of recipients, who can obtain credit from other sources, cannot be charged an interest rate that is higher than 8 percent. Homeowners, renters and some businesses can obtain loans with 30-year terms. A business with available credit will need to repay its loan within a minimum of three years.

Still, clients are allowed to do business with contractors who have not been chosen or recommended by a carrier. When clients go outside of their insurance company to find a contractor, industry professionals and consumer advocates recommend that they take a few preventive steps. These steps include confirming that the contractor has adequate liability coverage and checking to see if anyone has filed a complaint against the contractor through the Better Business Bureau.

The SBA is usually able to evaluate an applicant’s creditworthiness and make a decision on a potential loan within three weeks of receiving an application. The SBA says it approves approximately 50 percent of all applicants. The other 50 percent may be referred to the IHP for assistance.

Federal Assistance for Disaster Victims Though federal law does not require that the government automatically assist homeowners, renters and business after every disaster, it does grant the president of the United States the power to declare a community a “federal disaster area.” A federal disaster designation makes it possible for affected victims to apply for disaster relief from multiple federal departments.

IHP Grants If a disaster victim does not qualify for an SBA loan or has suffered uninsured losses that are too large to be covered by an SBA loan, the person may be eligible for a tax-free grant from the IHP. IHP grants, which do not need to be repaid by recipients if used as directed, can amount to roughly $25,000 or so and go to people whose homes have been rendered uninhabitable, unreachable or in need of repair. The home needs to have been situated in a federal disaster area, and the damaged or destroyed dwelling needs to have been occupied both on a regular basis and at the time of the disaster. Applicants can be turned down for a grant if the damaged property is a vacation home or if they have another unoccupied dwelling that can be used for temporary shelter.

Federal disaster relief can come from any of the numerous government departments, including the Department of Housing and Urban Development and the Department of Agriculture. Even the Department of Education can get involved from time to time by providing money for the reconstruction of schools. Still, modern disaster relief usually begins at the doorstep of the Federal Emergency Management Agency, more commonly known as “FEMA.” What began in 1979 as an agency that dealt strictly with natural disasters has moved closer and closer toward allrisk territory. During the 1980s, FEMA was seen as a valuable entity that could help the country bounce back from a potential Cold War attack. By the following decade, it had become a source of funds for victims of man-made, domestic disasters, such as the Oklahoma City bombings in 1995. After the events of September 11, 2001, the agency was consolidated into the Department of Homeland Security, making it a potentially important part of the nation’s recovery from an act of international terrorism. And, of course, the summer of 2005 brought attention back © Real Estate Institute

IHP grants must be used for specific purposes. Money applied to a damaged dwelling can only be used to make a home “safe and sanitary,” according to FEMA. This contrasts with the many insurance policies that are meant to at least restore a dwelling to its pre-disaster condition. A grant may also be used to pay for non-dwelling expenses, including medical, dental and funeral bills and the cost of clothes, tools and household items. Recipients 33

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INSURING MAJOR RISKS are only allowed to apply their grants to these goods and services if the expenses are related to preventing or recovering from a disaster. Funeral expenses, for example, will only be covered by a grant if a disaster is at least partly to blame for a person’s death. To ensure that IHP grants are used properly, the government requires that all recipients hang onto subsequent receipts for at least three years.

factored into the price of coverage, ensuring that the insurance provider will have enough reserves to handle a significant loss. Rate increases are more likely when longterm patterns suggest an increase in risk among a particular demographic of clients. So, while one wildfire might not create a lasting insurance problem for consumers, multiple fires that occur within a few years of one another might have a negative impact on homeowners.

An IHP grant pays only for expenses that are not covered by a disaster victim’s insurance company. If a person refuses insurance benefits, he or she may be deemed ineligible for a grant. However, the mere fact that a victim has some insurance should not necessarily discourage him or her from applying for IHP assistance. Insured persons may apply for an IHP grant if they have filed an insurance claim and have not been indemnified by their insurer after 30 days. If the insurer honors the claim after more than 30 days have gone by, the IHP grant will be treated like an advance of the person’s insurance benefits, and the government will get its money back.

Sometimes disaster victims worry that filing a major claim will make them uninsurable when their policy comes up for renewal. Despite declarations by the industry that only about 0.5 percent of policies are not renewed each year, insiders have asserted that filing as many as three homeowners claims within a five-year span may be enough to eventually sever the relationship between an insurer and an insured.

Catastrophe Models Risk managers at insurance companies must evaluate, to the best of their ability, the probable maximum loss that a carrier could face at any given time. However, these managers often need more than an insurer’s claims history in order to perform a proper, helpful evaluation. Because they occur so rarely in the United States compared to other perils, potential disasters are harder for underwriters to assess. This has led risk management professionals to develop and utilize multi-faceted estimation tools called “catastrophe models,” which help insurers predict the likelihood of a catastrophe and its resulting damages.

Tax Breaks for Disaster Victims The insured and the uninsured receive federal tax breaks when a disaster damages or destroys their home. Property insurance benefits that are meant to replace or repair a dwelling or personal items are tax-free. Benefits that are meant to cover living expenses are also non-taxable if they are only covering the difference between a person’s predisaster and post-disaster expenses. For instance, if a disaster forces a man to move from his $800 per-month apartment into a $900 per-month apartment, the $100 difference would be non-taxable if it were paid by the insurance company. However, the other $800 would be considered a pre-disaster expense and would be taxable under federal rules.

Catastrophe models do not ignore past insurance data, but they deemphasize that data in favor of computer simulation and widespread expert analysis. When evaluating earthquake risks, for example, an insurer utilizes information from geologists and software from a modeling organization in order to simulate a particular kind of quake and assess how a similar catastrophe might affect a particular area.

A portion of a person’s uninsured losses may be deducted on income tax returns. After subtracting an IRS-specified dollar amount from their total uninsured losses, disaster victims can deduct the portion of uninsured losses that exceeds 10 percent of their adjusted gross income.

In order to produce as accurate an estimate of potential losses as possible, underwriters provide modelers with various pieces of information. If insurers want to determine potential losses from a particular event, they will often do the following:

Additional tax benefits might be made available under special circ*mstances. In some cases, for example, the IRS may decide that people in a disaster area are entitled to a filing extension for their income taxes. In another possible scenario, the government might decide that victims deserve a quicker refund than usual and will let people work off of a previous year’s tax return instead of making them wait for the latest forms to arrive. Insurance professionals and their clients should turn to the IRS if they need specific tax information.

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Note how many of their policies are held in a particular ZIP code  Examine that area’s history of catastrophes  Study data concerning the structure of the buildings they insure in the area, reporting whether a piece of property is weather-resistant or not  Use documented losses from any similar disasters as guides  Consider the specifics of their policies, paying attention to deductibles and to what sorts of damages are actually covered through their contracts Catastrophe models had been around since the 1980s, but it took years for insurers to gain enough confidence in the tools to use them in estimating losses. In the summer of 1992, Hurricane Andrew hit Florida and caused $26 billion worth of damages. This catastrophe, the most financially disruptive one in American history prior to September 11, 2001, left 11 insurers insolvent and forced underwriters to admit that modeling was perhaps more reliable than traditional methods of risk assessment.

How Disasters Affect Affordability and Availability As if having to live through a disaster isn’t bad enough on its own, many homeowners in disaster-prone areas worry about the effect that a wildfire, hurricane, earthquake or other destructive event may have on their insurance costs. With insurers often using past claims to predict the likelihood of future claims, policyholders are left to wonder if a single catastrophe will be enough to spoil a long, spotless claims history with their carriers. Will one big fire, for example, be responsible for a rate hike, or will an insurer agree to take the bad times with the good ones, accept the fire as a rare, freakish development and resist increasing people’s premiums? For homeowners who are covered by experienced insurers, one disaster should not have a great impact on premiums. The cost of a potential catastrophe will have already been © Real Estate Institute

Still, confidence in the models varies from one insurer to the next. Different modelers can come up with different 34

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INSURING MAJOR RISKS After the events of September 11, 2001, some insurance experts theorized that catastrophe bonds would help 21st century businesses effectively insure themselves against terrorism. Indeed, according to the publication Business Insurance, issuance of catastrophe bonds hit $1.22 billion in 2002, an all-time high at that point. But the popularity of the bonds did not extend as far into the insurance industry as some people had predicted. Catastrophe bonds did, however, get international attention when FIFA, the organization in charge of the World Cup, insured the 2006 Berlin games through these unconventional financial instruments.

estimates of potential losses, prompting insurers to not always trust the findings of just one modeling service. Even when the various modeling firms are in general agreement regarding probable catastrophic losses, they can still be collectively streaky in terms of their predictions. Model estimates for the 1994 earthquake in Northridge were nearly 10 times less than the actual damage. Models related to Hurricanes George, Earl and Bonnie generally got the numbers right, but low estimates for Hurricane Katrina caused some insurers to once again question the reliability of modeling techniques. Others within the industry stress that incomplete data from insurers contributed to the poor estimations. With all of this information in mind, it is perhaps best for an insurer to keep catastrophe models within their proper perspective and view them for what they truly are: helpful tools but not infallible prognosticators.

A Federal Catastrophe Fund? The idea of a federal catastrophe fund has been floating around Washington and insurance circles for some time, with homeowners worrying about the affordability of coverage and with insurers concerned about the vast losses that a disaster might produce. To some legislators and industry professionals, the concept is a positive one. Its supporters claim that all Americans are already paying for disaster relief with their tax dollars whenever people in California, Florida or any other state receive FEMA grants. Perhaps, they say, a catastrophe fund can help the government prepare financially for disasters and prevent lawmakers from having to assemble what some taxpayers consider to be hasty bailout packages for uninsured and underinsured homeowners. It’s also hoped that a long-term federal response to catastrophe risk will alleviate some price concerns for people who want better coverage for their coastal properties but cannot afford or obtain it.

Covering Your Car While a home is almost always a person’s biggest financial asset, personal automobiles are usually very valuable, too. Drivers who want to be covered against disaster-related damage to their car, truck or van can insure their vehicle with a comprehensive auto insurance policy. They should bear in mind, however, that this kind of insurance, unlike auto liability coverage, is not required by law. Some financing agreements require drivers to purchase comprehensive insurance, but most other situations allow owners to skip the coverage at their own risk. Depending on the policy, there may be exclusions that apply to electronic accessories, such as stereo equipment, and to personal belongings that are stored inside the vehicle.

And yet the people who support greater federal involvement in risk management seem split over just how much bigger Washington’s enhanced role ought to be. While some support putting the federal government in the driver’s seat in a manner not unlike the way flood insurance is offered and underwritten in this country, others would prefer a backseat approach from Capitol Hill, with private companies still handling most claims but with the U.S. Treasury acting as a reinsurer of last resort.

Liability for Disasters On occasion, disaster victims decide that the stress and financial losses brought on by a catastrophic episode have been made needlessly worse by negligent people and irresponsible businesses. A homeowner might determine that a dwelling reacted feebly to a force of nature thanks in part to the sloppy contractor who built it. Or a community might find itself surrounded by pollution after a destructive event and place part of the blame on poor planning by a local waste management company. Professional liability insurance, directors and officers insurance and environmental insurance are all topics for another day, but risk managers should at least realize that products like these are available to help potentially liable parties cope with defense costs, court fees, settlements and monetary judgments.

On the opposite side of the aisle, opponents of these assorted proposals fear that something like a catastrophe fund could cripple parts of the private insurance market and force people in low-risk communities to subsidize insurance for people in high-risk communities. The literal and figurative mess that was Hurricane Katrina and the rising cost of property insurance in Florida have made the creation of some kind of federal catastrophe fund more likely than ever before. In November 2007, the House of Representatives passed the Homeowners’ Defense Act, marking the first time either wing of Congress had supported or even had a vote on the catastrophe fund issue. As agreed to by House members, the act would allow state catastrophe insurance programs to pool their risks all in one place and would help the pool manage these risks through the issuance of catastrophe bonds and reinsurance policies. When annual disaster losses exceed 150 percent of direct written premiums in a participating state, the applicable state insurance program would be eligible for a low-interest loan from the U.S. Treasury.

Managing Risks Through Catastrophe Bonds Problems related to insuring properties against natural disasters in the mid-‘90s led to the gradually increasing role of catastrophe bonds in the risk business. In some cases, catastrophe bonds provide insurers with a cheaper alternative to reinsurance. Insurers issue the bonds to investors, who pay for them upfront. Issuers of catastrophe bonds then invest the buyers’ money conservatively, allowing those funds to collect interest. If no catastrophe occurs, investors eventually get their money back along with accumulated cash. If, on the other hand, a catastrophe arises, the issuer of the bond can use the invested money and the interest in order to pay for damages.

CONCLUSION At the time of this writing, the Homeowners’ Defense Act was hardly guaranteed to become law. After its passage in the House, advisors to the president confirmed that they would recommend a veto if the bill ever found its way to Pennsylvania Avenue for final approval. But the act’s mere existence and its initial progress in the legislature reinforce some of this course material’s main ideas.

Insurers sometimes like catastrophe bonds because these financial mechanisms allow them to verify that a certain amount of money will be available for the payment of claims. To the benefit of investors, the bonds can be infinitely divided among various parties, thereby decreasing the burden of risk on individual buyers. © Real Estate Institute

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INSURING MAJOR RISKS Disasters, whether they are linked to wind, water, shakes or flames, are a threat to families and individuals in every region of our land. They possess the merciless power to not only threaten our safety but also demolish every material thing that serves as proof of our successes, hard work and good fortune. They incorporate nightmarish risks that cannot be managed sufficiently through luck and the average American’s often slender emergency fund.

BUSINESS INTERRUPTION INSURANCE INTRODUCTION Pretend for a moment that you are a business owner who receives a phone call earlier than usual one morning. The frantic voice on the other end of the line belongs to your office manager, who hurriedly informs you that there is a fire ripping through your premises. As you arrive on site, you’re relieved to learn no one was hurt. Your building, though, wasn’t nearly as lucky. A bustling fire crew blocks you from inspecting the damage up close, but you could tell all the way from the road this wasn’t just a small fire that relegated itself to your company’s small kitchen. Based on what you see, getting your business back to where it was will require several months of rebuilding.

Quick recovery from these perils may only be possible if victims have planned ahead by securing their dwellings. Though a property insurance policy cannot perform miracles or control the earth’s elements like a supreme deity, it might be able to influence a disaster’s psychological aftermath for the better. With adequate benefits coming their way, affected policyholders can focus on rebuilding their lives instead of dwelling on what they have lost.

Fortunately, you’ve had a property insurance policy ever since your local bank agreed to give you a startup business loan all those years ago, and you’ve been careful to update your coverage as the value of your property has increased. So the bills for all the physical repairs probably won’t break your business’s back. But as you dial your insurance agent’s phone number, you think about the possible consequences of an extended business interruption, and you start feeling sick. You wonder how you will pay your own bills if your office is closed for an extended period of time. You question whether you’ll be able to make your payroll and fear that even your most loyal employees will resign and take a steadier job with a competitor. You reason that, even if you manage to reopen in three months or so, it could take several more months for you to regain your customers and bring post-fire earnings back up to pre-fire levels. Upon discussing matters with your accountant, you determine that the multi-faceted loss of business income will be even greater than the value of your building and its contents. To put it mildly, you’ve had better days. As you return to thoughts of your real life as an insurance producer, you might think our brief introductory exercise was overdramatic in its details. However, statistics support the notion that there is nothing imaginary about the threats posed by possible business interruptions. According to a survey from the impact assessment firm Urban Environmental Research, most businesses believe a twoweek interruption would amount to a “devastating” situation. A study from the Florida-based Institute for Business and Home Safety reveals at least 25 percent of all businesses that experience an interruption are never able to open their doors again. While business owners can’t control the forces of nature or prevent all serious accidents from happening, they can cushion the financial blow of a possible shutdown by purchasing adequate “business interruption insurance.” This kind of insurance typically reimburses policyholders for lost income and any extra expenses they incur during a break in normal business operations. For a long time, business interruption coverage was bought mainly by manufacturers, but its appeal has gradually attracted a more diverse group of buyers. Major League Baseball team owners used a form of it to insure against a players strike in the early ‘80s, California eventually bought a policy to protect itself against lost toll income stemming from San Francisco’s Bay Bridge, and claims filed after the attacks of 9/11 showed that the insurance had found many takers among small service-oriented businesses. Still, the insurance’s broadened appeal is far from universal. In a U.S. study referenced in 2007 by London’s Financial Times newspaper, only 35 percent of small

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INSURING MAJOR RISKS Broader still are those coverage forms that an insurance carrier has rewritten for a particular applicant who has special interruption concerns.

businesses reported having any business interruption insurance. While startling enough on its own terms, that number is even more surprising when we consider that, compared to a study done by the insurer Safeco in 2003, it actually represented a decrease in the rate at which businesses were purchasing the insurance. Essentially, it suggests that the enormous damage caused by Hurricane Katrina in 2005 had little, if any, impact on the public’s familiarity with the coverage.

Those latter two kinds of coverage are the result of competition in the insurance market and are sometimes particularly generous in their treatment of interruptions that are caused by perils other than physical damage. For example, although perils such as labor strikes and cyberattacks are not covered under ISO language, those dangers have occasionally been covered by international insurers that use their own forms. Please keep these and other potential differences in mind when reading general statements about business interruption insurance and when making general statements about coverage to prospective clients.

By comparison, the 2003 Safeco study found that 55 percent of businesses with fewer than 100 employees lacked business income insurance, and 65 percent of respondents weren’t familiar with how the coverage worked. Those surprising numbers came out a few years after 9/11, an event that probably should have drawn more attention to business interruption losses than any other in our nation’s history. Despite all the casualties and damaged properties that were linked to the acts of terrorism at the World Trade Center and elsewhere, losses from 9/11 that were covered by business interruption insurance were larger than property insurance claims and accounted for roughly one-third of all industry payouts from those events.

The insured may find that annual premiums for business interruption insurance equal approximately two percent or so of the benefit limit, but the true cost will be different for each business and will be dependent upon many variables. The perceived ability of a business to bounce back quickly from an interruption will be a major factor in determining a fair premium. Premiums can also be influenced by location and are often higher in disaster-prone regions. Residents of Florida, for example, may discover that affordable business interruption insurance is just as scarce as cheap property coverage in their area.

These somewhat surprising statistics lead us to believe that business interruption insurance can be beneficial for many of the business owners who purchase it. But the numbers also make us question why the coverage is probably still a foreign concept to many commercial clients.

BASIC BENEFITS Having established the fact that terms and conditions can differ among carriers, we can step back and focus on some of the general contractual elements that are relevant to nearly all business interruption forms. These elements are explained in the next several sections.

Based on at least some of the extensive research that went into the creation of this material, part of what seems to keep the coverage from gaining attention is the lack of policy-oriented education among both buyers and sellers. Though most agents are likely to already understand the purpose of business interruption coverage, some of them might be too intimidated by complex policy provisions to attempt selling the coverage themselves. At other times, business owners purchase the coverage without understanding it and are therefore incapable of promoting its positive features effectively to their peers.

Kinds of Insurable Properties Although business interruption insurance reimburses policyholders for lost income and not for property damage, coverage is still usually linked to an insured’s physical place of business. In order for an interruption at a particular business property to be covered, the property often must be named in the insurance contract.

Our study of business interruption insurance strives to clarify the major elements of the coverage for a general audience of industry professionals. At the same time, the information is presented in a way that also keeps the average business owner in mind. Rather than simply summarizing business interruption clauses, we will apply those clauses to real-life examples and document how a few simple words in an insurance policy have sometimes made all the difference for real people in times of great need.

The kinds of properties that can be named in a business interruption contract are seemingly unlimited. A policy might name one building, an entire industrial complex, a rental property or a single office within a bigger building, to name only a few possibilities. A single policy form can be made to cover interruptions at one location, or it can be made to cover multiple properties regardless of their proximity to one another. Coverage is available to businesses that rent their commercial space, as well as to those who own and operate their own buildings. Business tenants can insure themselves against interruptions that are caused by damage to their section of a building or to any public area that is used to access that part of a building.

AVAILABILITY AND AFFORDABILITY Business interruption insurance is offered in one form or another by nearly every major property and casualty insurer in this country. In the past, some insurance companies were known to automatically include it as part of a standard business owners policy, which also typically includes property coverage, workers compensation insurance and liability insurance. But these days, interested businesses usually must request interruption coverage and pay an additional premium for it.

Coverage also extends to interruptions that are caused by damage to personal property. In these situations, the damaged personal property usually needs to have been within 100 feet of the named premises. ISO forms permit owners of commercial properties to choose among three kinds of business interruption coverage. Those who operate a business out of their property but do not rent out space to tenants will probably opt for “non-rental value only” coverage. Owners who rent out space to tenants but do not operate their own business out of their property will probably opt for “rental value only” coverage. Owners who operate a business out of their

The coverage usually comes in one of three varieties. Most small and midsized businesses have insurance with terms and conditions that have been defined by the Insurance Services Office (ISO). Of the three kinds of coverage, standardized coverage using the ISO’s language is generally the narrowest. A little broader are those business interruption contracts that that have been created by a carrier and offered to most of its approved applicants. © Real Estate Institute

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INSURING MAJOR RISKS property. Examples of these expenses include rent, commercial mortgage payments, commercial insurance premiums, utility bills and some taxes. If the insured wishes to lower premiums, the cost of heat, power and refrigeration can be excluded by means of an additional coverage form.

property and rent out space to tenants will probably opt for “business income with rental value” coverage. In the context of the three preceding terms, “rental value” means the amount of money that commercial tenants pay to building owners, plus any operating expenses that are normally paid by tenants but would be incurred by owners during an interruption.

A normal continuing operating expense is not covered if the interruption has eliminated it. The cost of electricity, for example, is usually considered a normal continuing operating expense, but it would not be covered if business is interrupted by a blackout. After all, the business would not be using any power during that kind of interruption.

Tenants should keep in mind that they are probably not covered by their landlord’s business interruption insurance, assuming such coverage has even been purchased by the property owner.

Business Income Insurance

Payroll Coverage

Perhaps the most significant component of business interruption insurance is its coverage of lost income. In fact, the importance of this coverage has caused some insurance producers and journalists to delete “business interruption insurance” from their working vocabulary and replace it with the term “business income insurance.”

Choosing to pay employees during a business interruption does more than create good will between labor and management. It helps the business owner by making it less likely that valuable workers will leave the company out of financial necessity. By keeping their experienced employees on the payroll during a suspension of operations, businesses set themselves up for quicker recovery. Their reopening will not be delayed by a shortage of staff, and their productivity will not be hampered by newly hired personnel with inadequate experience.

Business income insurance pays business owners the amount of money they would have earned if a covered peril had not forced them to suspend normal operations. In addition to covering the cost of continuous operating expenses (which we will study in the next section), it reimburses business owners for their lost net profits before taxes. Not surprisingly, since these insurance benefits are meant to replace lost taxable income, they must be declared as income for tax purposes.

Insurers understand how employee continuity can reduce business interruption losses, and they make it a point to list payroll as a covered continuing expense. Along with wages and salaries, business interruption insurance pays for union dues, workers compensation premiums, some employee benefits and the business’s required contributions to Social Security and Medicare under the Federal Insurance Contribution Act. Insurance benefits will be reduced appropriately if an employee is laid off during an interruption.

Business income payouts are determined by the actual loss that a business has suffered during an interruption. Essentially, benefits are calculated by estimating the profits that would have been produced without the interruption and by subtracting the company’s actual income from that hypothetical figure. Income sources that are not affected by the interruption, such as investment income, will also be deducted.

Businesses that are concerned about the size of their premiums can drop some of their payroll coverage via an “ordinary payroll limitation or exclusion endorsem*nt.” This contractual addition usually provides only a month or two of payroll coverage for nonessential employees or leaves these people with no coverage at all. It does not limit or exclude payroll costs that pertain to officers, executives, department managers or contracted workers.

By paying only for actual losses, business income insurance ensures that policyholders do not use their coverage to profit from an interruption. In practical terms, this means that if a business had already planned on shutting its doors for a few days, it could not receive business income benefits for those days. So if a business is normally closed on Sundays and is closed for seven straight days by a covered peril, it will only be reimbursed for six of those days.

Extra Expenses Most but not all forms of business interruption insurance reimburse businesses for the extra expenses they incur during a suspension of normal operations. In order to be covered by an insurer, these costs must, in some way, either reduce the duration of the interruption or help eliminate the interruption altogether. Unlike business income insurance, which usually features a three-day waiting period before coverage can begin, coverage of extra expenses starts at the very beginning of an interruption. Benefits can continue throughout the “period of restoration,” which will be the subject of the next section.

A business is not covered for any extra income it might have earned as a direct result of a covered peril’s effect on the local community. As an example, suppose your client is a builder. If a natural disaster interrupts his business and destroys several houses, he cannot make a claim for all the money he thinks he could have made if he had been able to stay open and rebuild those houses.

Continuing Expenses If a business owner plans on ever reopening after an interruption, there will be several bills and other financial obligations to take care of in the meantime. Luckily for that business owner, business interruption insurance includes coverage of “continuing normal operating expenses.”

In spite of the difference in deductibles, insurance for extra expenses and coverage of business income are linked to each other in several ways. They are often both subject to the same benefit limit, which means any claim made for an extra expense is likely to reduce the amount of money that will be available for a business income claim.

In a way, continuing normal operating expenses are the opposite of the additional living expenses that are covered under a homeowners insurance policy. Whereas a homeowner’s reimbursem*nt for additional living expenses is reserved only for those expenses that are incurred because of severe damage to named property, continuing normal operating expenses are those expenses that the insured would face regardless of damage to named © Real Estate Institute

It is also important to note that there is no difference between the perils that are covered by the business income side of a policy and the perils that are covered by the extraexpense side of a policy. Both parts of the contract require that all claims relate to physical damage at a named property. Therefore, a business will not be covered for the 38

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INSURING MAJOR RISKS lost income and extra expenses that continue into the new year.

extra expenses it incurs when it loses its lease and must relocate, and it will rarely be covered for the expenses it incurs during a strike. Expenses caused by damage at another premises, such as a supplier’s factory, will not be covered unless the business owns “contingent business interruption insurance.” We will address this product at a later point in this material.

Limits to the Period of Restoration While a business technically has the right to suspend operations and take all the time in the world to reopen, the insurance company will only pay benefits during what it believes to be a reasonable timeframe for repairs and rebuilding projects. This reasonable timeframe lasts only as long as it would take to make the property as serviceable as it was before the interruption. If business owners decide that they want to expand their property as part of their rebuilding plans, lost business income and extra expenses will not be covered during the expansion.

Each insurer may have its own idea of what constitutes a legitimate extra expense. That said, the insured could probably make a strong case for coverage of the following expenses:  

The cost of renting a temporary place of business The cost of equipping a temporary place of business with necessary machinery and supplies  The cost of making a temporary place of business physically presentable to the public and serviceable for business operations  Expedited shipping costs for necessary machinery and supplies  Moving costs  Overtime pay for employees who assist in the relocation process Although most valid extra expenses are incurred by businesses that remain open in some form while their property is being repaired or rebuilt, it is possible for a completely suspended business to make an extra-expense claim. For example, the business might be reimbursed for the cost of securing the damaged premises from looters while the property is being evaluated or restored.

The same principle applies even to projects that could reduce the risk of future interruptions. So if a business is interrupted by an earthquake, the insurer will not cover the extra time it takes to make the named property more quake-resistant. The ISO coverage form states that the insurance company will not cover some delays that are attributable to laws or ordinances. Specifically, under this form, the business is not covered for the time it takes to complete a mandatory demolition of the named premises, and it is not covered for any extra time that is spent complying with local or federal pollution requirements. A company that can or wants to continue operations during the period of restoration will have additional coverage issues to consider. For one, businesses need to understand that their failure to reasonably conduct limited operations from an alternative location (or from the damaged premises) may jeopardize their right to insurance money.

If a business has purchased extra-expense coverage but decides not to reopen after an interruption, the policyholder might receive a check for the hypothetical amount of extra expenses that would have been incurred during the period of restoration.

After the Restoration Period Once the period of restoration has concluded, coverage of lost business income and extra expenses generally ends, too. Losses that follow the restoration period are only covered if the insurance contract contains an “extended period of indemnity” provision. This feature, which is included in a limited fashion in the ISO’s coverage form, will receive special attention later in our study.

Period of Restoration Coverage of business income and extra expenses lasts until insured losses exceed the policy’s dollar limit or until the end of the “period of restoration,” whichever occurs sooner. In the case of business income, the period of restoration usually begins a few days after the start of an interruption. In the case of extra expenses, it starts at the same time as the interruption. In both cases, the period of restoration ends on the earlier of:

Treatment of New or Failing Businesses Lost income can be determined within reason when the client is a long-established business that has produced reliable amounts of revenue. But calculating fair compensation is considerably more challenging when the business is a young entity with no track record, or when it has been operating at a loss. Yet even for the company that is failing or newly established, business interruption insurance has value.

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the day when the damaged premises should have reasonably been repaired, rebuilt or restored, or  the day when the business has reopened at a different, permanent location. A business interruption coverage form may also feature a chronological limit of liability that caps the period of restoration at a year. But since interrupted businesses rarely take longer than one year to resume normal operations, the cap is often not a factor at claim time and was often absent from insurance contracts that were issued in the competitive market prior to 9/11.

A new business with no firm history of profits might be able to secure business income benefits for itself by pointing to the profits that have been generated at other local companies that offer a similar product or service. If the young company is unable to secure business income benefits, it can still look for a policy that covers continuing expenses and extra expenses. If a business was scheduled to operate at a loss at the time of an interruption, some claims for continuing expenses and extra expenses will usually still be honored. However, benefits may be reduced by the size of the probable operating loss. This practice is yet another example of how insurers prevent businesses from profiting from disasters.

You may have noticed that none of these three possible end dates for the period of restoration relate directly to the policy’s issue date or to a yearly anniversary date. In fact, a business owner can continue to receive benefits after insurance has expired, as long as the interruption began prior to the expiration date. So if a policy’s term lasts for one year beginning in January, and an interruption begins at the end of December, the business will still be eligible for © Real Estate Institute

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INSURING MAJOR RISKS amounted to a direct physical loss. The insurer countered by saying the term “direct physical loss”—which had not been defined in the policy—meant a physical injury of some kind to the business’s property.

Covered Perils and Benefit Triggers For a loss to be covered, operations usually need to have been interrupted at a covered premises by a covered peril. We already know a “covered premises” can be seemingly any building, complex or office named in the insurance policy. But we have not yet specifically explained the perils that can lead to a valid claim.

The United States Court of Appeals for the Eighth Circuit hinted that the supplier might have had a case if its beef had been contaminated, but said the facts of the situation should not have triggered insurance benefits.

The perils covered by business interruption insurance are usually identical to the perils that are covered by the business’s property insurance policy. This link between property insurance and business interruption insurance usually ensures that interruptions are covered when they are caused by fire, wind, lightning, burst pipes, vandalism, theft and explosions, among other perils. In most cases, it also ensures that interruptions are not automatically covered when they are caused by a flood or an earthquake. Still, as should be expected, an insurer might agree to cover those commonly excluded perils for an additional premium.

Waiting Periods Even if a covered peril has clearly caused an interruption, the insured will still have to endure a waiting period before coverage of business income and continuing expenses can apply. Typically, this waiting period ends when a business has been interrupted for 48 or 72 hours. Though not mentioned in all policies, it is assumed that these hours must occur consecutively. So if a business closes, briefly reopens and then shuts down again, it will probably be subjected to a new waiting period. Regardless of the length of the interruption, businesses are not reimbursed for the losses they suffer during the waiting period. If a business does not feel comfortable absorbing even a two-day or three-day loss on its own, the waiting period can often be reduced to a single day or a matter of hours at an additional cost. Dollar-based deductibles— while less popular than waiting periods—are also available.

With a few possible exceptions, an interruption will only be covered if a peril has done physical damage to a business’s premises. In practical terms, this means a restaurant would not be covered if it shut down temporarily because of a food-poisoning scare. It also means a business would not be covered if it voluntarily closed its doors in anticipation of a covered peril without sustaining any actual damage to its property.

Excluded Perils Perils that are commonly excluded from business interruption coverage include earthquakes, floods, radiation and acts of war. However, exceptions are possible. Insurers did not invoke the war exclusion after the events of 9/11, and the subsequent Terrorism Risk Insurance Act ensured that any business owner who was willing to pay a premium could be covered for similar kinds of attacks.

Court Rulings on Physical Damage Some court cases have challenged insurers’ strict treatment of physical damage as a mandatory benefit trigger. In Datatab v. St. Paul, the U.S. District Court for the Southern District of New York ruled that a data-processing company in an office building was entitled to business interruption payments, even though physical damage was limited to a portion of the building that the business did not occupy.

A few years later, Hurricane Katrina brought the longstanding flood exclusion into the congressional spotlight and prompted several lawmakers to support adding business interruption benefits to policies sold by the National Flood Insurance Program. At the time of this writing, the Senate and House of Representatives had passed competing versions of the Flood Insurance Reform and Modernization Act and were in the process of resolving their differences.

The details of the case involved problems with a water main that did damage to a basem*nt. Although the business had no equipment in the damaged area and sustained no water damage of its own, the situation forced the shutdown of the building’s air conditioning system, which, in turn, forced the shutdown of the company’s computer system.

Concurrent Causation

The carrier, which had also insured the business against the loss of physical access to its computers, refused to pay for the interruption. It claimed there was no physical damage to the business and that the damage in the basem*nt had done nothing to prevent the company from accessing its property. The business argued that its claims were valid because physical damage to the basem*nt had prevented workers from utilizing their computers.

Hurricane Katrina also provides an extreme example of why insurance clients ought to be made to understand the concept of “concurrent causation.” Concurrent causation technically occurs whenever damage is created by more than one peril, but it is almost always used to describe a situation in which one of those perils is covered by an insurance policy and another is not. After Katrina, for example, many interrupted businesses realized they were covered for wind damage but not for flood losses. Among the many policyholders whose professional lives were thrown off balance by both wind and water, the validity of business interruption claims seemed uncertain. In cases involving both of those perils, would the insurance company cover the entire loss, none of the loss or only a fraction of the loss?

In its ruling for the business, the court said the covered premises was not limited to the company’s office space and that acceptance of the insurer’s logic could lead to “bizarre” situations. For example, under the insurer’s line of reasoning, a business on the fifth floor of a building would not be covered for an interruption if a fire were to only destroy the four floors below it. Source Food v. United States Fidelity created a debate over whether a policy requiring “direct physical loss” will cover events that do not result in actual damage to property. When concern over mad cow disease put a halt to the importation of beef from Canada into the United States, a food supplier couldn’t get its hands on its product and consequently lost its biggest customer. The supplier argued its inability to receive beef shipments from Canada © Real Estate Institute

The questions brought on by concurrent causation are probably just as plentiful as the ways insurers and courts have responded to them. While some disputes will end in the insured’s favor, with the covered peril basically canceling out the excluded peril, others may come down to the judgment of an adjuster, who will itemize all damages and try to determine how each individual peril contributed 40

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INSURING MAJOR RISKS some other pest is introduced into a network or computer system. The additional coverage excludes cases in which the damage has been inflicted by an employee or by any third party who has been entrusted with the computer system.

to each individual loss. In other cases, a court might focus on the “efficient cause” of the business interruption and rule ultimately on which peril made the damage possible.

Loss-of-Market Exclusion Claims may also be denied on the basis of a “loss-ofmarket exclusion.” In general terms, this exclusion prohibits coverage when demand for a business’s goods or services is reduced or becomes non-existent. To use yet another illustration from Katrina, suppose a business avoided significant damage during the hurricane but had to close when most its customers in New Orleans evacuated. Depending on the language of the business’s insurance policy, claims for this kind of interruption may be denied.

These additional benefits may be capped at a few thousand dollars each year. If a company experiences a computer interruption and does not reach its benefit limit, any unused benefits may be applied to a second computer interruption during the same year. Unused benefits for computer interruptions cannot be carried over from one year to the next.

Power Outages and Service Interruptions

It is worth noting, however, that the loss-of-market exclusion can be one of the most ambiguous elements in a business interruption contract. To a court or even to an insurance company, the exclusion might not apply when the loss of market is caused by a covered peril.

Power outages and service interruptions used to be commonly covered under commercial insurance policies, but that has changed as businesses have become more and more dependent upon their phones, fax machines, email accounts and Web sites. An unendorsed business interruption contract offers no benefits when businesses are shut down by a failure at a utility company, a breakdown of an offsite transformer or deterioration of power lines.

Excess Clauses Conversely, an insurance contract’s “excess clause,” when present, is easy to understand and explain. It states that a loss will not be covered by the business interruption contract if it can also be covered in its entirety by a different policy in the insured’s name. Similarly, it may say benefits that are available under the business interruption form will only be available when all other avenues of coverage have been tried.

This exclusion does not prevent the policyholder from collecting some insurance money when an interruption is prompted by an outage and made worse by a covered peril. According to Newsday (which cited information from the Property Loss Research Bureau), a business owner may still be covered if a company closes during an outage and has its premises vandalized during that time. In another example, a fire that is caused or made worse by an outage is still likely to be a covered event.

Excess clauses, as well as similar sorts of exclusions, are put into insurance contracts to prevent an insured from double-dipping into benefits and receiving more money than was actually lost. In accordance with that purpose, these clauses are likely to apply when multiple policies could cover the same type of loss, but not when they merely cover the same cause of loss.

Admittedly, the effect of the outage exclusion is minimal for many clients. With business income coverage usually requiring a two-day or three-day waiting period, the majority of outages and service interruptions are probably not lengthy enough to trigger benefits in the first place. But some companies, (particularly those that deal with perishable items) might want to eliminate the exclusion by buying a Utility Service—Time Element endorsem*nt.

To clarify and illustrate this point, we can turn to a court case from Ohio. Hardrives v. Harford arose when a lightning bolt damaged circuitry at an asphalt plant and effectively shut the place down. At the time, the business owned a comprehensive property insurance policy that did not include business interruption coverage, as well as a more specialized property policy that featured a business interruption endorsem*nt. Both policies included coverage against lightning, but the business interruption endorsem*nt said it would not pay for a lightning-related interruption if the business had other coverage for that cause of loss.

The Utility Service—Time Element endorsem*nt usually gives the business several coverage options. Benefits can be made to apply to problems with power companies, telecommunication providers or water services. Coverage may also be extended to include physical damage to power lines. For coverage to be triggered, utility-related damage might need to have occurred within a specific distance from the business’s premises.

To the insurance company, this meant that because lightning was a covered peril in the comprehensive property insurance policy, it was an excluded peril in regard to business interruption. Of course, the asphalt company took an opposing view and argued that the lightning exclusion would only have been applicable if the comprehensive policy had featured duplicative coverage of business interruptions.

OPTIONAL AND ADDITIONAL COVERAGE Along with the basic elements and benefits discussed previously, business interruption contracts are likely to feature “additional coverages” that either can be added at the insured’s request or at least have their own sets of terms and conditions. Some of the most common additional coverages are explained in the next several sections.

A state appeals court affirmed part of a lower court’s ruling, saying that ambiguity in an insurance contract should be interpreted in the policyholder’s favor.

Civil Authority Clause Most business interruption insurance contracts contain a “civil authority clause,” which can trigger benefits even if an insured business suffers no damage to its own premises. In a broad sense, a civil authority clause may be invoked when a covered peril strikes an offsite location and leads to action by civil authorities, who then cause a business interruption by shutting down the surrounding area.

Computer Interruptions The basic ISO business interruption form specifically excludes coverage of computer interruptions. In this context, a computer interruption means a break in operations that is caused by “destruction or corruption of electronic data, or any loss or damage to electronic data.”

Say, for example, a business is located a few doors down from a building that has just been severely damaged by a fire. The business itself has escaped injury to its property,

Additional coverage is available that reimburses policyholders for income and expenses when a virus or © Real Estate Institute

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INSURING MAJOR RISKS offsite property to the insured’s premises. An article published in FDCC Quarterly says this became an especially pressing topic when race riots in the 1960s led to curfews in a few major cities. By the end of that decade, insurers had reacted by rewriting their policies so that the civil authority clause related to damage at properties that were “adjacent” to the insured business.

but fire officials and police have barricaded the area for safety reasons. Since this act of civil authority has caused the business to temporarily suspend its operations, the owner may be entitled to insurance benefits. The specific language of a civil authority clause, though, can be more restrictive than that. While most versions of the clause relate in some way to inaccessibility at an insured business, there can be different interpretations regarding how severe the inaccessibility must be.

This language was removed from many polices in the late 1980s, but it was still common enough to cause problems following the controversial Rodney King verdict a few years later. Rioting in the streets after that event prompted the enforcement of dawn-to-dusk curfews in Los Angeles, Las Vegas and San Francisco and consequently interrupted business at a chain of movie theaters. The theaters themselves weren’t damaged and neither were other buildings near them, but the owners believed the term “adjacent” could mean any property in the curfew area. Since there had been direct physical damage to some areas affected by the curfew, the theaters expected to receive insurance benefits.

As has already been pointed out in such insurance-related trade publications as Risk Management, some clauses in non-ISO forms only require that access be “impaired.” With that language in place, the insured may be covered if civil authorities have blocked off a business’s main entrance but have not prevented customers and employees from entering through the back or the side. ISO coverage forms, on the other hand, say coverage is only in effect when civil authorities “prohibit” access to the insured’s business. On several occasions, courts have said language like this refers to cases of seemingly absolute inaccessibility. If the premises can be reached in any reasonable way, a civil authority claim might be denied.

A court ruled that “adjacent” lacked such a broad meaning and said the theater was under a curfew rule because of the fear of damage, not because of actual damage. This kind of case helps explain why some insurers have clarified their language by naming a specific geographic limit for civil authority claims. When this limit appears in policies, it may stretch as far as a mile or so.

Among some of the more intriguing examples of how the clause might work, a hotel was not entitled to business interruption benefits when the Federal Aviation Administration (FAA) shut down all airports and air travel in the wake of 9/11 and made it more difficult for guests to reach their destination. After all, the FAA did not eliminate all possible means of reaching the hotel. It only prevented people from getting there by plane, helicopter or a similar craft.

Under the civil authority clause, coverage of business income begins three days after the act of civil authority. The date on which the physical damage occurred is irrelevant. Business income can last for three consecutive weeks, or even longer if the coverage form is not from the ISO. Under the ISO form, coverage of extra expenses begins immediately after the act of civil authority. The coverage lasts for three weeks or until coverage for business income expires.

Similarly, when a barge accident closed a bridge for nearly a month, a nearby casino was not able to collect from its business interruption insurer. Though the casino’s business dropped 80 percent during the bridge’s shutdown, the public was obviously still able to access the casino in some way, and the business was obviously still accepting patrons during that time.

Ingress/Egress Clause Ingress/egress clauses are sometimes found in non-ISO coverage forms and are very similar to civil authority clauses. The only significant difference between the two is that an ingress/egress situation can materialize without the participation of an authority figure.

The damage associated with an act of civil authority is another important factor in these kinds of claims. Most clauses require that the act of civil authority be the result of a covered peril and also state that the covered peril needs to have caused direct physical damage.

The most commonly used example of an ingress/egress situation features a powerful storm that knocks down trees and either prevents customers and suppliers from entering the business or keeps products from coming out of the business.

For an example of the first requirement (the one requiring that damage be caused by a covered peril), picture a business that has been shut down against its will by authorities due to the prevalence of flooding in the area. If flooding is excluded from regular business interruption coverage, the business will not be covered for this act of civil authority.

As would be the case with a civil authority clause, ingress/egress coverage is only applicable when inaccessibility is caused by a covered peril. Also, benefits might not be granted if access to the business is merely limited rather than fully prohibited.

To understand how direct physical damage plays into the civil authority clause, we can look at a decades-old case from Scranton, Penn. At one point in 1955, serious problems with the town’s water system meant there was no way to effectively fight fires. As a precautionary measure, the mayor ordered all businesses to close for three days, and the city was spared from fire during that time.

New Buildings and New Locations The ISO coverage form makes it possible to cover business interruptions that are brought on by damage to a new building on the insured’s premises. This extends to newly completed buildings, new buildings that are under construction and old buildings that are being renovated. When this kind of interruption delays the opening of a new business or a preexisting business that has been on hiatus, policyholders receive the amount of money they would have earned if they had been able to open on time.

A local company had insurance that listed fire as a covered peril, but it was denied benefits under the policy’s civil authority clause. A court sided with the insurance company, ruling that the policy covered acts of civil authority when there was actual damage to offsite property, but not when there was only the fear of damage to offsite property.

The ISO form can also extend $100,000 of coverage to each new location that a business acquires over the policy’s term. This insurance lasts until the end of 30 days, until the end of the policy’s term, or until the value of the

If there is indisputable, direct physical damage to offsite property, the next issue to consider is the proximity of the © Real Estate Institute

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INSURING MAJOR RISKS acquired premises has been reported to the insurance company.

The leader property is sometimes referred to as an “anchor store.”

Extended Period of Indemnity

A “manufacturing property” is basically the business that makes the products that are sold by the insured.

It is, of course, very unlikely that a company’s income will return to normal on the first day it reopens for business. The likely lag in post-interruption income may be covered under a policy provision called an “extended period of indemnity.”

A “recipient property” is the party that uses or utilizes the insured’s goods and services. It may be helpful for businesses to think of a recipient property as the property of an important client.

With an extended period of indemnity in force, business interruption benefits continue after the period of restoration and last until a date specified in the insurance contract, or until business income climbs back to pre-interruption levels, whichever comes first. Extensions on the indemnity period are usually purchased in 30-day blocks that can sometimes be stacked on top of one another to provide a year’s worth of extra coverage or more.

A “contributing property” is property belonging to a third party who delivers essential materials and services to the insured. Once regular business interruption insurance is understood, contingent business interruption insurance shouldn’t seem too complicated. Policyholders are eligible for business income benefits three days after the occurrence of direct physical damage to a dependent property. The cause of that damage usually must be a peril that is also covered under the insured’s own business interruption policy. So, if a business is not covered for floods that damage its own premises, it will not be covered for floods that damage a dependent property.

Though an extended period of indemnity can be very helpful for a business that wants to get back to work, those who opt for this extra coverage should know it has some limitations. For example, the extension might only apply to business income and not to extra expenses. When contractual language does allow for extra-expense reimbursem*nt, the business will only be covered for those expenses that are meant to reduce the size of business income claims. Similarly, a business that is not doing all it can to reopen in a timely manner will not be eligible for extended coverage.

Extra Expenses and Civil Authority Clauses Though some contingent policies only cover lost income, extra-expense coverage is often available, too. Among other things, such coverage might help pay the cost of nailing down a new supplier or manufacturer on short notice. As in regular business interruption contracts, extra expenses are often covered immediately after damage is done to property.

Contingent Business Interruption Insurance By now, the basics of business interruption insurance should be reasonably clear to you. You should know that the insurance covers lost income, continuing expenses and extra expenses when an interruption is caused by damage at an insured’s premises. You should also understand that it can be utilized when offsite damage prohibits access to a client’s office or storefront.

The events of 9/11 raised the issues of contingent business interruption insurance and civil authority clauses, as physically unharmed businesses wondered how they were going to ship products, receive inventory and make face-toface contact with customers while air travel was suspended. Some of our previously mentioned examples show that the suspension of air travel was not always enough to get insurance money into business owners’ hands, but some experts at the time envisioned scenarios in which an act of civil authority could be a contributing factor in a valid contingent business interruption claim.

But what about those losses that involve no physical damage to the insured’s property and are not related to physical inaccessibility? Suppose a client loses money because a supplier was forced to close after a hurricane. Or, in a reversal of the situation, consider how a supplier might be harmed financially if one of its best customers were to suffer property damage and close its doors. Would the physically unharmed party in either of these examples be protected by business interruption insurance?

A month after the attacks, for instance, an article in the trade publication National Underwriter said a company probably wouldn’t be covered for the shutdown at airports if it was merely unable to ship goods. However, the same source believed the shutdown could have been a covered event for airport souvenir shops and for cab companies that transported people to and from their flights.

At least as far as a standard business interruption coverage form is concerned, the answer would likely be a flat “no.” However, many property insurance companies fill in those gaps by selling “contingent business interruption insurance.” This coverage can be purchased as an add-on to the client’s business interruption contract, or, in a less common practice, it can even be bought separately by a business that does not have interruption coverage for its own premises.

Scheduled Properties or Blanket Coverage Since an insurance company is not likely to have established relationships with everyone who operates out of a dependent property, the risks associated with contingent business interruption insurance can be tough to measure.

Basic Benefits

As a safeguard, business insurers deal with dependent properties in a manner similar to the way property insurers handle homeowners’ jewelry, furs and other valuables. In order to receive full coverage for a contingent business interruption loss, the insured must have specifically scheduled the corresponding dependent property. Blanket coverage for all dependent properties is available, but this insurance can limit coverage to a pre-set percentage of the policy’s value.

Contingent business interruption insurance can relate to shutdowns at four kinds of dependent properties. These four are leader properties, manufacturing properties, recipient properties and contributing properties. A “leader property” is a property that draws customers to the insured’s business. The insured and the proprietor of the leader property might do similar kinds of business and refer customers to each other. But it’s also possible for their relationship to be based purely on proximity, like the link between a concert venue and a neighboring restaurant.

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INSURING MAJOR RISKS accountant, and the two evaluators will either agree on an appropriate dollar amount or pass the case along to an arbitrator.

BUSINESS INTERRUPTION CLAIMS Up to this point, we have addressed many of the risks that can be handled through business interruption insurance. Hopefully, with hefty doses of luck and care, your clients will not have to incur losses caused by these risks. But if disaster does occur, what will the insured be required to do when an interruption begins? And how must the insurance company go about fulfilling its obligations to policyholders?

Handling the Claim If there is no dispute regarding the severity of a business interruption loss, the insurance company must pay benefits to the policyholder within 30 days of receiving the proof of loss form. Advances on business interruption benefits are possible, but insurance lawyers say they are not as popular as advances for property damage.

Duties of the Insured When an interruption seems likely, the business owner should contact the insurance company and report the existence of damage. It is then up to the policyholder to minimize a potential claim by protecting any undamaged property. If protecting this property creates a potentially reimbursable expense, it is the insured’s responsibility to document the cost. If any crimes have been committed and are relevant to the damage, the insured must report them to the proper authorities.

BENEFIT LIMITS No matter how well a business has documented its earnings, policyholders can never know for certain how much they might lose during a suspension of their operations. Even if they could arrive at a solid figure that represents the expected loss for a typical day, they would still lack the ability to conclusively determine how long an interruption might last. While there have been plenty of cases in which businesses reopened quickly and didn’t come close to using up all their insurance benefits, events like 9/11 and Hurricane Katrina brought about instances in which businesses were closed for a year or more and lacked enough coverage to survive.

When safety permits, the insured should investigate the premises and report the loss in greater detail to the insurance company. Part of this process will involve completing and signing a “proof of loss form,” which the insurer should send upon hearing of the damage. In general, the insured must complete this form within 60 days of receiving it. However, it may be possible to extend that deadline in special situations, and claimants generally have the right to amend the form after the 60-day period has passed.

In the next several sections, we will note one method that businesses and insurance professionals have used to quantify adequate coverage. We will also explore various clauses in business interruption contracts and go into detail about how dollar limits are impacted by those clauses at claim time.

By filing a business interruption claim, the policyholder allows the insurance company to examine the business’s financial records and lets the insurer make copies of those records for its own files. At the same time, the business effectively grants the insurer access to the damaged premises as often as is necessary to evaluate the validity of a claim. Along with this access, the insurer has the right to take damaged property off the premises for the purpose of an appraisal.

Probable Maximum Loss Though buyers may choose to over-insure or underinsure themselves for various reasons, they are probably best served by a dollar limit that is at least somewhat comparable to their “probable maximum loss.” Often, this number is calculated by determining a business’s probable income for a 12-month period and then estimating the length of an interruption in a worst-case scenario.

Once an interruption has been established, any business that plans on reopening must take all reasonable steps to quickly get back on its feet. In practice, this requirement might find the business outsourcing some of its operations on a temporary basis or moving all operations to another suitable location. Failure to comply with this requirement could result in a denied claim or a reduction in benefits.

Suppose, for example, that a business expects to bring in $12 million over the next year and believes that in a worstcase scenario (usually thought of as the total destruction of the business premises), it will need no more than nine months to reopen. In this case, the probable maximum loss can be calculated by multiplying the expected yearly income by the expected length of the interruption. By multiplying $12 million by 0.75 years (or nine months), we arrive at a probable maximum loss of $9 million.

Proving Business Assets and Expenses Benefits received for lost business income will depend on the amount of money the insured would have earned if the interruption had not taken place. They will also be influenced by the size of the business’s operating expenses before and during the interruption.

To arrive at a suitable dollar limit for business interruption insurance, the business must then develop an estimate of probable extra expenses and add that number to the probable maximum loss. So, if the aforementioned business expects to incur up to $1 million in extra expenses during its nine-month interruption and wants losses to be covered in full, the dollar limit for its business interruption insurance should probably be at least somewhere around $10 million. If earnings statements later show that a business bought too much insurance, the policyholder might receive a refund under the contract’s “premium adjustment” provision.

It is therefore true that business interruption benefits are derived from a combination of real and hypothetical figures. But in spite of the estimating that’s involved, a business interruption settlement can be fair to all parties when the insured has done a careful job of documenting its profits and expenditures. At the very least, the business should provide the insurer with copies of all applicable tax forms, including federal and state returns, W-2 forms and 1099 forms. The insurer might also be helped by lists of customers and suppliers, as well as by any rental or equipment agreements that were in force at the time of the interruption.

We must state, however, that all of these calculations have been simplified. In a real-life situation that requires more than a ballpark figure, readers are strongly advised to use a more exact method of calculating probable maximum loss. Many insurers have developed a multi-page “business interruption worksheet” in order to help their producers determine probable maximum losses.

If the business and the insurance company cannot agree on a fair settlement, either party can demand an appraisal of the disputed loss. Each side will then enlist an impartial © Real Estate Institute

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INSURING MAJOR RISKS Company B purchased business interruption insurance with a $100,000 limit and an 80 percent coinsurance requirement. After a loss, the company’s expected net income and operating expenses for the year following the policy’s inception was going to equal $100,000. Since the policy’s dollar limit ($100,000) was greater than 80 percent of net income and operating expenses ($100,000 × 80% = $80,000), the coinsurance requirement was met. Therefore, after any applicable waiting period, Company B was entitled to full coverage up to the dollar limit.

It is also worth mentioning that a business can come uncomfortably close to its business interruption limit when disaster strikes a large community. Following a catastrophe, there might not be enough qualified builders to meet demand, and as a result, a company may have to wait longer than expected for a builder to start work on a damaged premises. It is sometimes advisable for clients to keep this kind of delay in mind when calculating their probable maximum loss. This is particularly encouraged when a business sits on a coastal area that is prone to major earthquakes or hurricanes.

Company C bought business interruption insurance with a $200,000 limit and a 50 percent coinsurance requirement. After a loss, the company’s expected net income and operating expenses for the year following the policy’s inception was going to equal $600,000. Since the policy’s dollar limit ($200,000) did not equal or exceed 50 percent of the expected net income and operating expenses ($600,000 × 50% = $300,000), the coinsurance requirement was not met. Therefore, Company C was only covered for a portion of all its claims.

Coinsurance Clauses Pretend a client purchased $50,000 of business interruption insurance and has lost $45,000 during a suspension of operations. Waiting periods aside, that means the client ought to be reimbursed for the entire loss, right? Well, maybe. Then again, maybe not. The answer will depend on whether the client’s contract contains a “coinsurance clause” and whether the client bought enough insurance to overcome the impact of this clause.

The following two tables list the minimum amount of coverage that a business would need to purchase if it wanted to comply with an insurer’s coinsurance requirement. The first table assumes a 50 percent coinsurance requirement. The second one assumes an 80 percent requirement.

The coinsurance clause can make a business responsible for a portion of any business interruption loss, even when the loss is far smaller than the policy’s dollar limit. The clause exists to protect the insurance company in cases when a business has underreported or underestimated its expected “net income” (net profit or loss before taxes) and operating expenses. It ensures that the insurance company will be paid fairly for absorbing risks and that a short interruption will not come close to exceeding the policy’s dollar limit.

With 50% Coinsurance Requirement

The coinsurance clause states that the insurer will not honor a claim in its entirety if the policy’s dollar limit is less than the policy’s coinsurance percentage, multiplied by the business’s expected net income and operating expenses for the 12 months following the policy’s inception. When the insurance is renewed, its anniversary date will serve as the beginning of a new 12-month period. The applicability of the coinsurance clause will be determined at the time of a loss. If, for example, insurance is purchased in January and an interruption occurs at the end of September, the insurance company will look at the business’s actual net income and operating expenses from January through September and will estimate the net income and operating expenses that would have been expected for the rest of the year. The hard numbers and the hypothetical numbers are then added together and multiplied by the coinsurance amount, which can be as low as 50 percent and as high as 125 percent. The result is then compared to the policy’s dollar limit.

Minimum Coverage Needed

$100,000

$50,000

$200,000

$100,000

$300,000

$150,000

$400,000

$200,000

$500,000

$250,000

With 80% Coinsurance Requirement

Coinsurance Examples The coinsurance clause and its corresponding formulas are probably best understood when they are accompanied by some concrete numbers. With this in mind, let’s look at three examples.

Expected Net Income and Operating Expenses

Minimum Coverage Needed

$100,000

$80,000

$200,000

$160,000

$300,000

$240,000

$400,000

$320,000

$500,000

$400,000

Figuring the Covered Portion of a Claim When a business has not satisfied its coinsurance requirement, an insurance professional can look at the coinsurance clause and—using the appropriate numbers— determine the amount that the insurer will actually pay to the policyholder.

Company A chose to purchase business interruption insurance with a $100,000 limit and a 50 percent coinsurance requirement. After a loss, it was determined that the company’s net income and operating expenses for the year following the policy’s inception was going to equal $200,000. Since the policy’s dollar limit ($100,000) was equal to 50 percent of expected net income and operating expenses ($200,000 × 50% = $100,000), the coinsurance requirement was met. Therefore, after any applicable waiting period, Company A was entitled to full coverage up to the policy’s dollar limit.

Expected Net Income and Operating Expenses

To determine the covered portion of a loss, we must first determine the size, in dollars, of the coinsurance requirement. As shown in the two preceding tables, this is accomplished by multiplying the coinsurance percentage by the business’s expected net income and operating expenses for the year following the policy’s inception. For the aforementioned Company C, we would multiply 50 percent by $600,000 and get a result of $300,000. 45

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INSURING MAJOR RISKS therefore covers Company A for up to $100,000 each month until all benefits have been used up.

In the next step, we need to divide the policy’s dollar limit by the size of the coinsurance requirement in dollars. For Company C, we would divide $200,000 by $300,000 and get a result of 0.66. That means a business like Company C would be covered for no more than 66 percent of each business interruption loss.

Let’s assume Company A goes out of business for two months, losing $120,000 in the first month and $80,000 in the second month. Following any applicable waiting period, the insurer will honor a $100,000 claim for the first month, and the remaining $20,000 for the first month will be considered an uninsured loss. However, since the $80,000 loss in the second month did not exceed the $100,000 monthly limit of indemnity, the insurer will honor the entire claim for that month.

Now all we have to do is multiply our answer from the previous step by the actual loss. If a business like Company C were to lose $30,000 due to an interruption, the insurer would multiply $30,000 by 66 percent and get a result of $20,000. This result would be the amount that the business would receive from the insurance company. The remaining $10,000 would go down as an uninsured loss.

As our example makes clear, losses that exceed the monthly limit of indemnity during one 30-day period cannot be carried over and covered during another 30-day period. Company A’s $20,000 uninsured loss for the first month will remain an uninsured loss, even though the company’s losses for the second month were $20,000 less than the monthly limit of indemnity.

If company C were to lose $100,000 due to an interruption, we would generally follow the same steps. However, instead of multiplying 66 percent by $30,000, we would multiply 66 percent by $100,000. The result ($66,000) would be covered by the insurance company, and the rest would be considered an uninsured loss.

Agreed-Value Option

No matter the actual size of a loss and a policy’s actual coinsurance requirement, the preceding steps can be summarized in the form of the following equation:

Another way to potentially eliminate the coinsurance clause is to choose the “agreed-value” coverage option. This option requires the business to submit two forms to the insurance company before coverage can begin. The first form details the business’s net income and operating expenses for the previous 12 months. The second form is a projection of the business’s net income and operating expenses for the next 12 months. After analyzing both forms, the insurance company arrives at a dollar limit that seems suitable for the business. This limit is known as the “agreed value.”

Covered Portion of Loss = [Policy Limit ÷ (Coinsurance Percentage × Expected Net Income and Operating Expenses)] × Actual Loss

Some Words for the Worried If a client feels underinsured and is worried about the possible impact of the coinsurance clause, there are a few positive things to keep in mind. First, in figuring out coinsurance requirements, the insurance company excludes several operating expenses, thereby making it more likely that the coinsurance requirement will be satisfied. Among the excluded expenses are the cost of outgoing freight, the cost of offering discounts to customers, the cost of processing returns and the value of any bad debts. Most significantly, however, is the fact that the coinsurance clause is only a factor when there is a claim for business income or continuing expenses. The clause is not a factor when the business only requests money for extra expenses.

The business can then choose the agreed value or any other value as the policy’s dollar limit. If the business opts for the agreed value or a higher number, the insurer will pay 100 percent of business income claims up to the policy’s dollar limit. If the business opts for a dollar limit that is lower than the agreed value, the covered portion of all claims will be determined by dividing the policy’s dollar limit by the agreed value. For clarity’s sake, let’s see how the agreed-value option works when some real numbers are applied to it. After evaluating Company A’s financial situation, an insurer arrived at an agreed value of $500,000. Damage to Company A’s property ultimately led to a business interruption and a $200,000 loss. Because Company A chose $500,000 for its dollar limit, it was covered for the entire loss.

Clients who are especially fearful of the coinsurance clause can have it taken out of the insurance contract. The coverage options that can replace the coinsurance clause are explained in the next few sections.

Monthly Limit of Indemnity

After evaluating Company B’s financial situation, the insurer arrived again at an agreed value of $500,000. Like Company A, Company B went through an interruption and lost $200,000. But because Company B chose $400,000 for its dollar limit instead of $500,000, it was not covered for the entire loss. Instead, the insurer divided Company B’s dollar limit ($400,000) by the agreed value ($500,000) and got a result of 80 percent. Therefore, the insurer covered 80 percent of the $200,000 loss ($160,000). The remaining 20 percent ($40,000) was ruled an uninsured loss.

More commonly, the coinsurance clause is replaced by a “monthly limit of indemnity.” This coverage option caps monthly coverage at a specific fraction of the policy’s overall dollar limit. Common fractions that are applied to the monthly limit of indemnity include one-third, one-fourth and one-sixth. The cap applies only to lost income and operating expenses. There is no cap on extra expenses.

When a business chooses the agreed-value option, the coinsurance clause can be eliminated for one year or until the insurance policy’s expiration date, whichever comes sooner. To keep this coverage option in effect, the business must submit new financial statements to the insurer every year and whenever it wants to adjust its dollar limit.

Maximum Period of Indemnity Though rarely chosen, the “maximum period of indemnity” option gets rid of the coinsurance clause and pays 100 percent of all business income losses and extra expenses that are incurred over 120 days. However, the policy’s dollar limit still applies here, so there is a chance that the business will still have some uninsured losses in the event of a very large claim.

Suppose Company A buys business interruption insurance with an overall dollar limit of $300,000 and opts for a onethird monthly limit of indemnity. The insurance contract © Real Estate Institute

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INSURING MAJOR RISKS Obviously, damage to property needs to be minimized as much as possible. However, it is important to not just view property in terms of inventory and expensive equipment. While supplies and machines can usually be replaced for a price, it is difficult, if not impossible, to put a price on the importance of key business documents and customer data. Without financial statements, a business may struggle to obtain adequate compensation from an insurer, and without customer data, a business might not be able to promote itself properly and regain its market share.

DISASTER PLANNING As helpful as insurance can sometimes be, it is only one piece of an effective risk management strategy. Whether they have adequate insurance or not, companies can help minimize business interruptions by developing a disaster plan. Businesses don’t seem to doubt the importance of planning ahead for a disaster. In a survey conducted by the Ad Council in 2005, 92 percent of small businesses said disaster planning was important. Yet in that same survey, only 39 percent of respondents claimed to have developed a plan of their own.

Simply keeping backup copies of all this information can lessen the chance of an extended interruption. Important documents can be photocopied and stored with all the aforementioned contact information in an offsite location. Scanned copies that have been saved to disk may be even better. Important computer data, meanwhile, should be backed up regularly on a server. There’s no point in saving everything to a desktop machine if that machine could be damaged with the rest of the business’s property.

The contradiction between those two statistics shouldn’t be entirely surprising. With so many other responsibilities, the small-business owner is probably busy enough without having to worry about what would need to be done in the hours and days after a natural disaster. Luckily for the already overworked owner, many components of a single disaster plan can be applied to many different kinds of catastrophes. It is even possible that some of the steps involved with developing a plan will be simpler than the business owner expects.

There’s also little point in designing a disaster plan that is doomed to poor execution. Experts in business risk management recommend that a company test its plan on a regular basis, preferably more than once each year.

A basic disaster plan addresses what to do about employees, suppliers and important property during a crisis. To ensure that disaster plans can be communicated quickly to workers, employee contact information should be kept in a place other than the business premises. When the plan calls for temporary relocation to a specific address, employees should be informed in advance in order to avoid unnecessary confusion at a critical time. Among other things, the Institute for Business and Home Safety suggests that businesses organize transportation for employees who would not otherwise be capable of reaching the new location.

CONCLUSION Business interruptions can create major problems for owners, employees and the general public. Along with other forms of risk management, business interruption insurance may minimize some of those problems. While not as popular or as widely understood as commercial property insurance, it is a product that can be useful to all kinds of companies, regardless of their size or specialty. There are, however, many important issues to consider when buying this insurance. Interested businesses need to know how various provisions and exclusions might impact them. They will also ultimately want to make sure that they have enough insurance to satisfy their objectives. With the fate of their business possibly at stake, owners and their representatives deserve to work with an insurance professional who has a thorough understanding of how this coverage works.

Preferably in the same place as their employees’ contact information, businesses should keep a copy of their suppliers’ phone numbers so that shipments can be suspended or sent promptly to a temporary location. To ensure that essential goods and services reach the business after a widespread disaster, the owner might also want to retain the name and number of alternate suppliers from other parts of the country.

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INSURING MAJOR RISKS

Below is the Final Examination for this course. Turn to page 114 to enroll and submit your exam(s). You may also enroll and complete this course online:

www.InstituteOnline.com Your certificate will be issued upon successful completion of the course.

FINAL EXAM 1. Historically, people have bought life insurance in order to ensure that a dependent or other loved one will not suffer financial hardship after a(n) _______. A. death B. disability C. economic crisis D. lawsuit 2. For many years, life insurers pounded home the idea of purchasing coverage equal to five times one’s _______. A. debts B. income C. expenses D. net worth 3. A proper _______ analyzes a customer’s death-related risks and insurance objectives. A. needs analysis B. claims adjuster C. settlement coordinator D. death benefit calculator 4. As long as a policyholder does not borrow money from or cancel a policy, life insurance proceeds are generally exempt from ________. A. state regulation B. income taxes C. federal estate taxes D. state-level estate taxes 5. On occasion, policyholders look to avoid _______ by transferring policy ownership to heirs. A. estate taxes B. property taxes C. property losses D. medical underwriting 6. _______ is sometimes called “pure insurance” because, unlike other policies, it lacks investment options and has no cash value. A. Variable life insurance B. Permanent life insurance C. Term life insurance D. Universal life insurance

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7. As their name suggests, ________ remain in effect for a contractually agreed-upon time and then expire. A. B. C. D.

variable life policies universal life policies term life policies life insurance riders

8. ________ lets policyholders maintain their term coverage at the same price for several years. A. Decreasing term life insurance B. Level term life insurance C. Variable life insurance D. Universal life insurance 9. Permanent life insurance is very different from ________. A. term life insurance B. whole life insurance C. universal life insurance D. variable life insurance 10. In addition to paying premiums for possible death benefits, people who purchase permanent life insurance are engaging in a(n) ________. A. financial investment B. annuity transaction C. policy replacement transaction D. securities swap 11. The cash surrender value is equal to the policy’s cash value minus any ________. A. interest earned B. federal surrender charges C. unearned interest D. unpaid policy loans and unpaid premiums 12. The major difference between universal and variable life insurance is that a variable life policy transfers significant ________ from the insurer to the policy’s owner. A. death benefits B. tax liability C. investment responsibilities D. dividends 13. When a customer pays a premium for ________ life insurance, any investment portions of the premium go into a separate account with the policyholder at the controls. A. term B. whole C. variable D. joint survivor 14. Though it can perform other functions, ________ is most commonly used to insure several people who work for the same employer. A. credit life insurance B. joint life insurance C. funeral insurance D. group life insurance

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15. _______ is often bought by customers who want to pay low premiums for at least some level of coverage and by travelers who are buying plane tickets. A. Variable life insurance B. Universal life insurance C. Joint life insurance D. Accidental death insurance 16. _______ is typically included in an umbrella-like policy that also covers unemployment and disability risks for people who are in debt. A. Credit life insurance B. Universal life insurance C. Whole life insurance D. Corporate life insurance 17. _______ is often called “first-to-die” coverage because the death benefit comes when the first person among the insureds passes away. A. Group life insurance B. Variable life insurance C. Funeral insurance D. Joint life insurance 18. Other than the insurance company, the ________ is the only party who controls how the policy is set up. A. policy owner B. primary beneficiary C. insurance producer D. contingent beneficiary 19. The insured individual and the owner of the life insurance policy will often be ________. A. the same person B. complete strangers C. the policy’s beneficiaries D. a trust for a minor 20. In general, a person can take out a life insurance policy on another person if the proposed owner can demonstrate a(n) ________ in the other person’s life. A. special need B. insurable interest C. needs analysis D. right of ownership 21. The owner’s option to transfer his or her rights to another entity is spelled out in a life insurance policy’s ________. A. grace period B. suicide clause C. assignment clause D. living benefits clause 22. A _______ will be made in writing and will state whether or not the lender has assumed any responsibility for paying policy premiums. A. collateral assignment agreement B. waiver of premium C. free-look period D. contestable clause

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23. In a(n) _______, the original owner transfers all rights to a different person or entity, thereby losing control of the coverage and its cash value. A. policy loan B. collateral assignment C. waiver of premium D. absolute assignment 24. Similar to the incontestable clause, the _______ usually states that an insurer will not pay death benefits when insured people kill themselves within two years of obtaining coverage. A. accidental death clause B. suicide clause C. misstatement of age clause D. wrongful death clause 25. Age and gender are important underwriting factors for ________. A. life insurers B. property insurers C. liability insurers D. private mortgage insurers 26. Mutual insurance companies calculate ________ by looking at mortality rates, interest rates, business expenses and other statistics. A. dividends B. medical loss ratios C. cash surrender values D. mortality tables 27. Unfortunately, a ________ can sometimes reappear if dividends from a participating policy become too small to cover the cost of the insurance. A. vanishing premium B. contestability period C. free-look period D. coinsurance penalty 28. A policy feature known as an “________” permits the insurance company to use part of a permanent life insurance contract’s cash value to keep a policy in force when the owner misses a premium payment. A. extended liability period B. automatic premium loan C. accelerated death benefit D. accidental death rider 29. Even if a policyholder misses a premium payment, the insurer must keep coverage intact until the policy’s ________ has ended. A. contestability period B. elimination period C. grace period D. period of restoration

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30. ________ life insurance policies feature “nonforfeiture benefits,” which give longtime policy owners some level of compensation when they either cancel or reduce their coverage. A. Term B. Credit C. Permanent D. Group 31. The manner in which a beneficiary receives policy benefits is called a(n) _______. A. accelerated death benefit B. needs analysis C. dividend D. settlement option 32. Historically, most life insurance beneficiaries have received their money in _______. A. a lump sum B. the form of a deferred annuity C. unequal payments over the course of their lifetime D. installments that are distributed by the deceased’s estate 33. Hurricanes have been particularly damaging and have made coverage tighter and more expensive in many _______. A. northern states B. coastal areas C. urban-wildland interfaces D. mountainous regions 34. _______ form at certain oceanic depths when sea temperatures are at least 80 degrees. A. Tornadoes B. Hurricanes C. Icebergs D. Hailstorms 35. According to FEMA, _______ are basically spinning thunderstorm clouds that make contact with the ground. A. tornadoes B. hurricanes C. lightning bolts D. hailstorms 36. The most common type of _______ insurance policy covers removal of debris after a windstorm. A. business interruption B. professional liability C. flood D. homeowners 37. In order to reduce their exposure to risk after Hurricane Andrew, many insurers in coastal states added windstorm _______ to their homeowners insurance policies. A. coverage B. deductibles C. penalties D. definitions

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38. HO-1 and HO-2 policies, rarely sold these days, are known as “_______” policies because they only provide financial protection against those dangers that are specifically mentioned in the insurance contract. A. all-risk B. multi-peril C. named-peril D. predetermined peril 39. When weather damages an apartment building or a rented home, structural damage should be covered by the _______ insurance policy. A. tenant’s B. landlord’s C. building association’s D. real estate agent’s 40. If they want protection, most renters can be approved for _______, a close relative to homeowners insurance that applies to tenants’ personal property. A. condominium insurance B. renters insurance C. umbrella insurance D. inland marine insurance 41. A homeowner’s landscaping plans should include the creation of sufficient _______. A. brush and trees B. defensible space C. property additions D. flood plains 42. The premiums, terms and conditions for flood insurance policies are determined by FEMA, but the policies themselves are usually sold and serviced by _______. A. state governments B. mortgage lenders C. private insurers D. unlicensed agents 43. More than 20,000 U.S. communities participate in the _______. A. SBA (Small Business Association) B. NFIP (National Flood Insurance Program) C. IHP (Interstate Housing Program) D. CEA (Community Earthquake Authority) 44. Like homeowners insurance, most earthquake insurance policies include some coverage of _______. A. pollution liability B. additional living expenses C. business income D. computer interruptions 45. As a way of reducing the amount of underinsured homeowners in the United States, insurance professionals often recommend that clients review their policies _______. A. every five years B. at least once a year C. whenever the size of mortgage payments change D. when they pay property taxes

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46. Tenants should keep in mind that they are _______ covered by their landlord’s business interruption insurance. A. probably B. probably not C. always D. partially 47. _______ insurance pays business owners the amount of money they would have earned if a covered peril had not forced them to suspend normal operations. A. Business income B. Extra-expense C. Ocean marine D. Commercial liability 48. With a few possible exceptions, an interruption will only be covered if a peril has done _______ to a business’s premises. A. fire damage B. water damage C. irreparable damage D. physical damage 49. The _______ clause can make a business responsible for a portion of any business interruption loss, even when the loss is far smaller than the policy’s dollar limit. A. coinsurance B. reinsurance C. excess D. civil authority 50. A basic _______ addresses what to do about employees, suppliers and important property during a crisis. A. commercial property policy B. disaster plan C. valuation clause D. commercial insurance pool

END OF EXAM Turn to page 114 to enroll and submit your exam(s) © Real Estate Institute

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PROTECTING CONSUMER RIGHTS

Continuing Education for Illinois Insurance Professionals

PROTECTING CONSUMER RIGHTS COPYRIGHT © 2011 BY REAL ESTATE INSTITUTE All rights reserved. No part of this book may be reproduced, stored in any retrieval system or transcribed in any form or by any means (electronic, mechanical, photocopy, recording or otherwise) without the prior written permission of the Real Estate Institute. A considerable amount of care has been taken to provide accurate and timely information. However, any ideas, suggestions, opinions, or general knowledge presented in this text are those of the authors and other contributors, and are subject to local, state and federal laws and regulations, court cases, and any revisions of the same. The reader is encouraged to consult legal counsel concerning any points of law. This book should not be used as an alternative to competent legal counsel.

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PROTECTING CONSUMER RIGHTS

TABLE OF CONTENTS ABOUT THIS COURSE ........................................................ 58 CONCEPTS OF AGENCY .................................................... 58 INTRODUCTION .......................................................... 58 INSURANCE AGENT VS. BROKER ........................... 58 CONFLICTS BETWEEN ETHICS AND LEGAL LIABILITY ..................................................................... 58 Recht v. Graves .................................................. 59 Nelson v. Davidson ............................................. 59 Chase’s Cigar Store v. Stam Agency ................. 59 Hardt v. Brink ...................................................... 59 DETERMINING LIABILITY THROUGH JOB TITLES AND RELATIONSHIPS................................... 59 Durham v. McFarland, Gay & Clay ..................... 59 EXPERTISE AND ADVISORY DUTIES ...................... 60 A CASE FOR A LEGAL AND ETHICAL BALANCE ..................................................................... 60 INSURANCE PREMIUMS............................................ 61 ETHICAL DUTIES TO THE INSURED ........................ 61 Analyzing Needs and Choosing a Policy ............ 61 Explaining Coverage and Answering Questions ............................................................ 61 Rejections and Renewals ................................... 62 Providing Company Information ......................... 62 ETHICAL DUTIES TO THE INSURER ........................ 62 CONCLUSIONS ........................................................... 63 DISCRIMINATION IN INSURANCE ..................................... 63 INTRODUCTION .......................................................... 63 REDLINING: YESTERDAY AND TODAY.................... 63 Differing Definitions of “Redlining” ...................... 64 Redlining After Riots and Disasters .................... 64 Redlining by Occupation ..................................... 64 Territorial Rating.................................................. 64 Redlining by Home Values and Age ................... 64 The Realities of Insurance .................................. 65 Is Redlining Real? ............................................... 65 Matched-Pair Studies.......................................... 66 Other Studies and Testimonials .......................... 66 Some Good News About Redlining .................... 66 Federal Views on Redlining ................................ 67 State Redlining Laws .......................................... 67 A BIGGER ETHICAL PICTURE ................................... 68 SOME WORDS ON THE WEB .................................... 68 HOW AGENTS CAN FIX THE PROBLEM .................. 69 INSURANCE AND CREDIT INFORMATION ....................... 69 INTRODUCTION .......................................................... 70 UNDERSTANDING CREDIT REPORTS AND CREDIT BUREAUS...................................................... 70 Errors in Credit Reports ...................................... 70 Personal Access to Credit Reports ..................... 71 UNDERSTANDING CREDIT SCORES ....................... 71 FICO Scores ....................................................... 71 VantageScore ..................................................... 71 Personal Access to Credit Scores ...................... 71 INSURERS AND CREDIT HISTORIES ....................... 71 THE LINK BETWEEN CREDIT HISTORY AND RESPONSIBILITY ........................................................ 72 THE LINK BETWEEN WEALTH AND EXCESSIVE CLAIMS .................................................. 72 THE LINK BETWEEN WEALTH AND FRAUD ............ 72 AIDING CONSUMERS THROUGH CREDIT REPORTS AND CREDIT SCORES ............................ 72 PROMOTING OBJECTIVITY THROUGH CREDIT-BASED UNDERWRITING ............................. 72 DISCRIMINATION BASED ON CREDIT REPORTS AND SCORES ........................................... 72 Credit Discrimination and Race .......................... 73 Credit Discrimination and Country of Origin ................................................................... 73 Credit Discrimination and Age ............................ 73 Credit Discrimination and Gender ....................... 73 OTHER NEGATIVE CONSEQUENCES OF CREDIT-BASED UNDERWRITING ............................. 73 THE PROS AND CONS OF CREDIT SCORING IN AUTO INSURANCE .............................. 73 DEFENDING CREDIT-BASED UNDERWRITING ......................................................... 74

The Study Defense ............................................. 74 The Income Defense ........................................... 74 The Legal Defense .............................................. 74 CREDIT-BASED UNDERWRITING IN PRACTICE ................................................................... 74 CREDIT-RELATED CHALLENGES FOR INSURANCE PRODUCERS ........................................ 74 CREDIT-BASED UNDERWRITING AND LAWSUITS ................................................................... 75 GOVERNMENT RESPONSES TO CREDIT REPORTS AND CREDIT SCORES IN INSURANCE ................................................................ 75 AN ASSORTMENT OF ETHICAL THEORIES ............ 78 Credit Scoring and Legalistic Theories ............... 78 Credit Scoring and Hierarchies of Responsibilities ................................................... 78 Weighing the Pros and Cons .............................. 78 CONCLUSIONS ........................................................... 79 HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996 - HIPAA ........................ 79 INTRODUCTION .......................................................... 79 Why HIPAA Exists............................................... 79 General Overview of HIPAA ............................... 79 Why Take This Course? ..................................... 80 INSURANCE PORTABILITY AND NONDISCRIMINATION RULES .................................. 80 Enrollment Rights and Nondiscrimination ........... 80 Limits on Pre-Existing Conditions ....................... 81 Voiding Limits on Pre-Existing Conditions .......... 82 Rules for Wellness Programs ............................. 83 Special Enrollment Rights ................................... 84 Plans Exempt From Portability and Nondiscrimination Rules ..................................... 86 Additional Rules for the Group Health Insurance Market ................................................ 86 Rules for the Individual Health Insurance Market ................................................................. 86 Rules for Insurers in All Markets ......................... 87 HEALTH INFORMATION PRIVACY RULES ............... 87 Kinds of Protected Health Information ................ 87 Applicability to Covered Entities.......................... 88 Applicability to Employees .................................. 89 Applicability to Business Associates ................... 90 Applicability to Plan Sponsors............................. 90 Parties Exempt From the Privacy Rule ............... 91 Required Authorization and Consent Forms .................................................................. 91 Permissible Use and Sharing of Protected Health Information ............................................... 91 The Minimum Necessary Rule ............................ 93 Right to Your Own Information............................ 94 HIPAA PRIVACY RULES IN PRACTICE ..................... 96 Sharing Information at the Doctor’s Office .......... 96 Sharing Information in an Emergency ................ 97 Adding Information to Hospital Directories ......... 98 Sharing Information in the Workplace ................. 99 Sharing Information About Minors .................... 100 Sharing Information About the Deceased ......... 100 Sharing Information About Mental Health ......... 101 Sharing Information at Pharmacies................... 101 Using Information for Marketing Purposes ....... 101 Sharing Information With Researchers ............. 102 Sharing Information With the Government, the Courts and Other Authorities ......................................................... 103 Sharing Information With the Media ................. 104 Other Assorted Privacy Requirements ............. 104 Relationship to Other Privacy Laws .................. 104 HEALTH INFORMATION SECURITY RULES .......... 104 Implementing a Security Plan ........................... 104 DEALING WITH SECURITY BREACHES ................. 106 Breach Notifications .......................................... 107 CRIMINAL AND CIVIL PENALTIES........................... 107 CONCLUSION: THE FUTURE OF HIPAA ................ 107 FINAL EXAM ....................................................................... 108

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PROTECTING CONSUMER RIGHTS brokers do not have identical job duties. In fact, agents and brokers perform importantly distinct functions with differing ultimate goals.

ABOUT THIS COURSE The decision to apply for insurance belongs to each individual, but once that decision is made, insurers and their representatives will need to live up to many ethical and legal responsibilities. Each chapter in this book addresses those duties and will remind you of how a consumer can expect to be treated in an insurance transaction.

In terms of insurance, both agents and brokers examine a consumer’s requests and serve as intermediaries who set up prospective insureds with coverage from an insurance company. The important difference between agents and brokers involves the people who they ultimately represent in an insurance transaction. Whereas a broker is ultimately a representative of the insured, an agent’s ultimate responsibility is generally to a specific insurer. Simply put, a broker is paid to act in the consumer’s best interest, while the agent is paid to act in the insurer’s best interest.

We’ll start with the basics and explore an insurance professional’s obligations when acting as an agent or as a broker. At the same time, we’ll look at how various courts have viewed the relationship between insurance applicants and insurance producers. Subsequent chapters will raise the issue of access. You’ll learn not only about blatantly illegal kinds of insurance discrimination (such as redlining), but also about situations in which the line between good underwriting and discriminatory pricing isn’t always clear. A final chapter on the Health Insurance Portability and Accountability Act explains nondiscrimination rules for group health plans and brings the right to privacy into our discussion, too.

Despite those important differences, ethical insurance producers do not simply devote themselves to the people who pay them and ignore potential responsibilities to the other parties in an insurance transaction. The majority of brokers do not deceive insurers so that policyholders can reap benefits, and most agents do not take predatory stances toward consumers in the hopes of selling deficient or unnecessary policies.

Although this course material can’t be viewed as a legal or ethical authority, we hope it at least gets you thinking about whether your dealings with the public are done in good conscience and in compliance with the law.

It is perhaps best to view agents and brokers as one might view any responsible employee of a legitimate business. For example, a consumer cannot expect a decent appliance salesperson to encourage customers to visit a competitor’s store for a better deal on a television, but the consumer should still expect to receive knowledgeable, honest and friendly service from that person.

CONCEPTS OF AGENCY INTRODUCTION Although the public sometimes views the insurance industry as an impersonal entity, dedicated insurance professionals will likely denounce that image as a major misconception and proclaim that the insurance business involves much more than working with claim forms and actuarial data. Veterans in their field have probably learned that much of an insurance producer’s job pertains to the development of relationships with the public, and that countless professionals nurture such relationships every day by assisting individuals, families, and businesses in the procurement of coverage for personal, commercial and industrial needs. Most of those professionals should agree that without those solid relationships, consumers have little incentive to trust an insurer to protect them, their loved ones or their businesses from financial risks and that one of the most reliable ways for an insurance producer to earn trust is to behave in an ethical manner toward every customer.

Like other true professionals, insurance agents and brokers endorse good-hearted attributes such as honesty and integrity. They generally agree that ethical professionals serve people other than themselves, take great care when trusted with other people’s money and avoid (or at least disclose) conflicts of interest. And yet, a deep examination of modern insurance issues and practices indicates that even though insurance producers have a common base for ethical standards, they have not necessarily had opportunities to apply ethics to many concrete aspects of their jobs. In a fast-paced, competitive environment, they might sometimes become distracted by the many other issues affecting their business and are therefore unable to act as ethically as we would otherwise expect. In some complicated cases, they may even avoid doing something that is proactively ethical in order to shield themselves from liability.

Besides the personal satisfaction that can come from treating others ethically, this sort of behavior often translates to success at work. An employer wants to trust employees and is likely to favor workers who do their jobs without being swayed by self-interest. And the average person, particularly in regard to such an essential product as insurance, is more likely to do business with an outwardly ethical carrier than with a company that seems to disregard ethical conduct.

CONFLICTS BETWEEN ETHICS AND LEGAL LIABILITY Professional insurance producers know their business and are more than likely aware of the fact that more and more people are purchasing coverage to protect themselves from lawsuits concerning “fiduciary duties,” which may be defined as activities related to upholding trust, including careful handling of funds. With consumers willing to fight in court against businesses that ignore such duties, many agents and brokers have worried about their own liability when customers or clients have sour insurance experiences. When insureds suffer losses that their policies do not cover, they sometimes cite their agents or brokers as the primary sources of fault.

INSURANCE AGENT VS. BROKER Perhaps the most visible members from the insurance world and the ones most capable of shaping the average person’s perception of the insurance industry are insurance producers, who may act as agents or brokers. The terms “agent” and “broker” are common in various parts of the professional world. One can hear those titles in conversations related to real estate and investments, to name only two examples. It must be noted, however, that the definitions of these terms can vary from one field to the next and that, contrary to popular belief, agents and © Real Estate Institute

An increasing prevalence of lawsuits against insurance producers has left many agents and brokers with legal and ethical problems. They certainly want to provide excellent service to consumers, but it sometimes seems as if purposely avoiding certain aspects of ethical service is a necessary way of fending off litigation. 58

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PROTECTING CONSUMER RIGHTS and allowed the business owner to review the policy terms, which clearly excluded employment theft and dishonesty.

Various court rulings have affected producers’ pursuit of ultimate ethical goals, and not simply because judges have been too hard on the industry. The problem for insurance producers is that there is no indisputable precedent set by a court that clearly spells out what insurance producers must do in order to fulfill their seemingly competing fiduciary obligations to policyholders and insurance companies.

Hardt v. Brink Another real-life case, Hardt v. Brink, involves a somewhat similar situation but one in which the judicial system placed greater responsibilities upon insurance producers. In this example, a plaintiff had secured insurance through the defendant agent since 1947 and had purchased, among other products, a comprehensive liability policy from the agent. In 1956, the plaintiff told the agent that he had entered into a lease agreement for a building. A year later, the building suffered severe fire damage, but the losses were not covered by the liability policy because of an exemption for rented property. The plaintiff sued the agent for not alerting him to a major liability gap and won his case in a U.S. district court in the state of Washington in 1961.

Recht v. Graves Although many courts have viewed producers as specialists with a wide range of responsibilities to customers and clients, the perceived legal duties of agents and brokers have not always been so extensive. Insurance agents (who serve the interests of insurers) probably frowned at the New York Supreme Court’s ruling in the 1939 case Recht v. Graves, in which life insurance agents claimed that, as professionals, they did not need to adhere to certain state laws regarding business taxes. But the court’s decision that agents were “engaged in the practice of a business or occupation and not in the practice of a profession” perhaps inadvertently gave agents great legal protection. As business practitioners, their obligations to their customers were no more complex than those expected from a general business. Like other businesspeople, insurance agents could not lie or steal from their clientele, but they did not need to do much more than give the people what they requested or ordered. Based on this business designation, agents presumably would not have been liable for selling a person an inferior or unnecessary form of insurance, as long as the person had requested it.

Instances such as this one show that some courts believe an insurance producer must not only help clients obtain what they ask for, but also must take on the greater duties of understanding and pointing out a customer’s or client’s insurance needs.

DETERMINING LIABILITY THROUGH JOB TITLES AND RELATIONSHIPS Unfortunately there is no clear legal guidance regarding how insurance producers should serve the public. Even courts that have agreed that agents and brokers have advisory duties to customers and clients have based their judgments on significantly different factors. Some courts have determined that the way insurance producers present themselves to the public dictates their professional obligations. For a simple example, let’s focus on job titles.

Nelson v. Davidson In a duty-specific case before the Wisconsin Supreme Court in 1990, the plaintiffs in Nelson v. Davidson alleged that their State Farm agent had an obligation to inform them that they could have purchased underinsured motorists coverage. They based their case on the fact that courts in other states had held agents responsible for advising consumers of available insurance products.

Some people believe that individuals who identify themselves as “insurance salespersons” or “agents” are merely that; company representatives who offer coverage and take applications, but who are under no legal obligation to advise anyone. Conversely, people who call themselves “investment advisers” or “risk managers” have, in many cases, been expected to perform many service-oriented tasks because those job titles are commonly associated with expertise.

In its ruling for the defense, the court wrote that the plaintiffs did not present any relevant examples of Wisconsin courts agreeing with those other decisions and stated that “the vast majority of other jurisdictions hold that the general duty of care which an insurance agent owes a client does not include the obligation to advise of available coverages.”

Many courts, when determining an insurance producer’s duties, have based rulings on the existence of what is generally referred to as a “special relationship” between the agent or broker and the customer or client. If a special relationship exists, the insurance producer’s obligations (not to mention potential liability) increase. If no such relationship exists, the producer is generally exempt from having to advise people or pursue anything more than what a consumer requests. However, different courts have considered different factors when judging the presence of a special relationship.

So, if an agent was insuring a building in a neighborhood with a history of arson, that agent might have chosen to disclose the area’s history to the property owner for ethical reasons or to entice the owner to buy more coverage, but it is unlikely that the mentioned court would have held the agent responsible for fire damages if he or she had kept quiet about the risk.

Chase’s Cigar Store v. Stam Agency

In some situations, an insurance professional’s job title and the qualifications implied by that title are enough to substantiate an insured’s special relationship claim. At other times, courts have intricately examined details of a case in order to determine whether or not agents or brokers have committed themselves to special relationships.

A 2001 appellate division case in New York, Chase’s Cigar Store, Inc. v. Stam Agency, Inc., materialized when a cigar store employee stole money from the company and the loss was not covered by the owner’s insurance policy. Allegedly, the policyholder allowed the agent to craft the details of the policy himself and did not ask for protection against employment dishonesty. The business owner filed suit against the agent for not securing the coverage, but the matter was dismissed on the grounds that the agent followed the customer’s instructions, had no obligation to include employment dishonesty protection within the policy

Durham v. McFarland, Gay & Clay In the 1988 case Durham v. McFarland, Gay & Clay, Inc., the Court of Appeal of Louisiana, Fourth Circuit ruled that an agent was liable for hurricane damages because he did not do enough to insure the plaintiff against residential flood risks. The court based parts of its decision on the fact that the plaintiff had been a customer of the defendant for 59

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PROTECTING CONSUMER RIGHTS because it involves choices that can often be debated as being both right and wrong depending on a person’s values and one’s guiding philosophies.

roughly 15 years and the fact that the defendant (who was repeatedly instructed to transfer coverage to the residence) knew for an extended period of time that the property was not adequately covered for flood risks.

A writer could fill the following pages with summaries of numerous ethical theories and examples of how each of those theories applies to the duties of insurance agents and brokers. But the insurance community might not yet have reached a time when that sort of text should be written or studied, at least not as long as insurance producers have to worry about how an inconsistent judiciary will view their actions. Rather than an abstract examination of philosophy, today’s insurance producers deserve and need something practical that will instruct them on how to protect themselves from lawsuits without compromising customer service. Yet, due to the subjectivity of ethical beliefs and the differing opinions of various courts, we will struggle to interpret truly practical guidance unless we allow ourselves to make two assumptions in regard to this topic.

EXPERTISE AND ADVISORY DUTIES Other courts seem to have ignored circ*mstantial special relationships and used broad brushes to paint all insurance agents and brokers as mandatory providers of advice and various fiduciary services. In Saylab v. Don Juan Restaurant, Inc., a broker obtained a general liability policy for a dining establishment. When drunk drivers who had become intoxicated at the restaurant killed two people, families sued. Once the general liability policyholders realized liquor liability was excluded from their coverage, they took legal action against the broker for not addressing their potential need for such insurance. In the opinion of the court, insurance brokers, regardless of any special relationship, were more than just average insurance representatives. They were professionals with expertise who should not be easily let off the hook for failing to advise clients of insurance needs or gaps in coverage.

The first assumption we will make pertains to ethics. Let us assume, for the next few pages, that insurance producers collectively subscribe to the “golden rule,” a theological concept that has gained tremendous acceptance in secular society and commands us to “do unto others as you would have them do unto you.” For insurance producers, morally subscribing to the golden rule requires agents and brokers to put themselves into the policyholder’s shoes and complete the following tasks:

Additional courts have had similar views on the obligations of insurance agents. In Riddle-Duckworth, Inc. v. Sullivan, the Supreme Court of South Carolina stated in 1969, “[T]he respective duties and obligations arising from the relationship of a principal and his agent in the procurement of insurance must be determined in the light of the fact that the agent was an expert dealing in a highly specialized business, with knowledge and means of knowledge not possessed by the average applicant for insurance.”

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Go out of their way to understand a customer’s needs  Do their best to set the customer up with products that best address those needs  Offer crucial advice (solicited or otherwise) that pertains to potential risks and overall customer satisfaction The second assumption pertains to laws and how they may be interpreted by various courts. For our purposes, let us assume that any court is capable of interpreting an insurance producer’s duties in the broadest manner possible. This would mean that agents and brokers, in every jurisdiction, could be obligated to do all of the following:

In the 1995 case Southwest Auto Painting and Body Repair, Inc. v. Binsfeld, an agent did not bring up the subject of employee theft and dishonesty coverage. In its ruling against the agent, the Court of Appeals of Arizona referred to the testimony of an insurance expert, which appears below: “The expert testified that the standard of care in the community for professional insurance agents requires agents to advise clients about the relevant types of coverage that are available and the cost of the coverage, either in a written confirmation of information given orally or in a written proposal handcrafted to the individual needs of the prospective insurer.”

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Alert consumers to their insurance gaps Do what they can to turn customers’ ultimate insurance decisions into realities  Handle other people’s money in a responsible fashion  Perform various other fiduciary functions. Let’s also pay close attention to the fact that agents and brokers ultimately serve one master. In the agent’s case, this master is the insurer. In the broker’s case, the master is the insured.

A CASE FOR A LEGAL AND ETHICAL BALANCE Because insurance producers have important business obligations, it is fair, up to a point, to apply the concept of “caveat emptor” (a Latin phrase that means, “Let the buyer beware”) to disputes between consumers and insurance producers. It is logical to expect intelligent prospective policyholders to take the time to educate themselves about their insurance needs and about the products that might best suit those needs. It is also logical for intelligent prospective policyholders to view an insurance agent or broker as a good person to learn from. After all, the insurance agent or broker has specialized, professional experience and is probably the most accessible source of insurance information for the average person.

With those assumptions and facts in mind, the information that follows is intended to help the insurance producer find a balance of ethical principles and safe, legal practices. It is for insurance agents and brokers who do not want their desire to stay out of court to overpower their desire to perform excellent, ethical services. It is also intended to be read by those professionals who do not want their serviceoriented ambitions to overpower their attention to liability risks.

Obviously, this is an ethics course, and opinions concerning which acts are ethical and which acts are unethical can differ from generation to generation, from culture to culture and from person to person. Studies of ethics are generally not structured around set-in-stone rules that firmly and universally state what is right and what is wrong. The study of ethics endures through the centuries © Real Estate Institute

Advise the public

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PROTECTING CONSUMER RIGHTS We have prepared this material in the hope that it can make the insurance producer firmly believe that legal concerns need not jeopardize one’s devotion to ethics. There is a legal world and an ethical world, and it is indeed possible to do business in both places at once.

Analyzing Needs and Choosing a Policy At some point in every transaction with the public, insurance producers must at least try to pursue what clients and customers want. If someone decides that he or she must have a term life insurance policy that costs a particular amount, the broker should search for a provider who can accommodate the client, and agents should return to their company and do what they can to obtain the requested policy for the customer. The insurance producer should not allow personal feelings to override a consumer’s decisions.

INSURANCE PREMIUMS Although courts and insurance professionals have had many differing opinions about what insurance producers must do in order to fulfill the requirements of their jobs, it is inarguable that an agent or broker must act with care when entrusted with insurance premiums. In many cases, a policyholder pays for coverage through the insurance producer, who must pass the funds along to an insurer and receives a specified commission.

That does not mean that insurance producers must never use their experience and personal instincts to influence a consumer’s thought process. In fact, doing so is ethically encouraged, as long as the producer has the person’s welfare in mind. The responsible insurance producer listens to the consumer and tries to decipher what the person needs, which may or may not be exactly the same as what the consumer requests.

Obviously, the producer’s role as a conveyer of funds requires trust from the insurer and the insured. Insurance companies want the money that they are entitled to receive in a timely fashion, and policyholders rely on the producer’s speedy delivery of those funds to ensure that payments are not marked as late or nonexistent.

What the insurance prospect needs will be different from one individual to the next. A heart surgeon is undoubtedly susceptible to risk factors that differ from those faced by a bakery owner. If a business is being insured, producers should use their own experiences, the experiences of colleagues and the statements of the insured to learn about the risks involved with that type of venture. They should study and ask about the kinds of people with whom the insured does business and determine if any agreements with third parties have exposed the owner to significant risk.

Documentation can often shield agents and brokers from allegations of illegal and unethical acts involving premiums. If producers take their agreed-upon commissions from premium payments, they should be able to quickly prove their right to do so and should confirm in writing that the insurance companies and policyholders understand that right. Examples of documentation that might serve insurance producers in this regard include copies of contracts that set forth commission obligations, bank deposit records, and notes taken during meetings and telephone conversations.

It is the producer’s ethical (and, in some jurisdictions, legal) responsibility to make clients and customers understand their insurance needs. If the producer believes, based on a consumer’s situation, that a whole life policy would serve the person better than a term life policy, the agent or broker should say so and explain why. If the insurance producer recognizes risks that would not be covered based on the consumer’s stated requests, the agent or broker should disclose the insurance gap. Specifically for agents, this might even mean making the consumer aware of insurance gaps that cannot be filled by their own carrier.

In the interim period between receiving premiums from the insured and sending the money to the appropriate insurer, producers sometimes have the opportunity to invest the funds in short-term accounts. These investments, when properly executed, allow the insurance company to obtain interest on the payments, which is typically applied to a producer’s commission as well. (Some insurers allow producers to hold onto premiums for extended periods of time in order to accumulate more interest.) Because the producer’s commission is usually affected by these investments, an agent or broker might face the temptation to put the money in ventures that have the potential for high rewards in exchange for high risks. Ethical insurance producers resist this desire and follow what has become known as the “prudent man rule” or “prudent investor rule.” Highly self-explanatory in name, this rule dictates that an insurance producer must invest premium payments in a smart, fiscally conservative fashion.

Upon being made aware of important information about the policy they are seeking, consumers must ultimately be the ones to decide on the type of coverage for the agent or broker to procure. But the obligation to track down what the consumer requests should still not be viewed by the producer as an act of blind obedience that puts the broker, agent or insurer at a financial disadvantage. Even if a consumer hopes to obtain the cheapest coverage available, the producer can make a strong ethical case for the purchase of a more expensive policy. A producer should present a consumer with the policy that is the “best value,” which is not measured in dollars and cents alone. Instead, it is measured by the quality of the coverage relative to the price. A cheap policy with big insurance gaps is not the best value for the consumer compared to a slightly more expensive policy with fewer or no gaps.

Producers should treat the premium dollars obtained from the insured and owed to the insurance company as carefully as they would treat their own life savings. Putting the money into the stock market is a serious ethical offense because of the risks involved. Bank accounts are a safe, responsible investment vehicle for premium dollars. Other modes of investment can be deemed ethical as well, under the condition that they are not likely to deprive the insurance company of the premiums it deserves.

Explaining Coverage and Answering Questions When discussing individual policies, insurance producers should make no assumptions about the consumer’s knowledge of what a policy will cover and what it excludes. Even though exclusions are documented within the policies themselves, agents and brokers should discuss these exclusions in a detailed manner with the public so that potential policyholders understand the following:

ETHICAL DUTIES TO THE INSURED Agents and brokers have different bottom-line responsibilities, but it can be argued that both types of professional insurance producers have ethical obligations to current and prospective policyholders.

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PROTECTING CONSUMER RIGHTS and comprehensive benefits that are being offered. They might admit that their company takes its time when paying claims but emphasize that the company is a financially healthy institution that has professionally served the public for decades. Through such sales presentations, the road to agency commissions can still be paved with honesty.

 What risks they are managing through insurance  What risks they are still financially exposed to Many of the ethical duties mentioned above relate to the broader issue of knowledge and competence among insurance producers. Insurance agents should be wellschooled about the products they sell. Brokers, who will lack the in-house training that an agent might receive, should also make themselves as informed as possible of the various policies that they can provide from various companies.

ETHICAL DUTIES TO THE INSURER Once the consumer has considered all relevant information and chosen a preferred policy, producers have a number of ethical duties. One of these duties is to provide insurance companies with applications that are as extensive and accurate as possible. Agents and brokers should not pursue commissions at the expense of company solvency and should not deceive a carrier into accepting undesirable risks.

Of course, no insurance producer knows the answer to every question. Competent, ethical insurance professionals admit when they do not have an answer for a consumer and then attempt to follow up on the query by diligently consulting a more knowledgeable source. However, it is not enough for the producer to merely repeat a reliable source’s answer. Assuming the agent or broker finds the answer to the question, he or she must clearly understand it and anticipate any further questions. It is also worth noting that, as in many situations in life, it is sometimes best to admit that you do not know the answer to a question and to advise the person to ask a more specialized individual. It should go without saying that a consumer will appreciate honesty more than factually shaky and potentially harmful advice.

As one can expect, the agent has many more ethical duties than the broker in regard to an insurance company. Sometimes the right and wrong actions for an agent are clearly spelled out in an agency contract, but that is not always true. Generally, though, there are several ethical practices that an agent should engage in regardless of the specifics of the contract. As a representative of the insurance company, the agent becomes the face of the insurer to the customer. The impression that a person forms of an agent is likely to represent that person’s impression of the entire company. As a result, the agent must practice acceptable etiquette when interacting with the public. Though speaking with a customer should not entail tremendous anxiety, agents might want to behave as they would when going out on a job interview. The producer’s appearance, manner of speech and general attitude should all be relative to the appropriateness of the occasion.

Rejections and Renewals An ethical insurance producer also informs clients and customers of facts relating to their insurance status as soon as possible. If consumers apply for insurance and are denied by the provider, the agent or broker must quickly inform them of the rejected application so that alternative coverage can be secured in a timely manner. The producer should never allow anyone to assume they have been approved for coverage.

Insurers expect their agents to be loyal to their company, keep the insurer apprised of customer-related situations and perform their jobs in an ethical and financially responsible way. On a more specific level, employed agents are generally not allowed to sell similar forms of insurance for competing companies. Some insurance producers, known as “independent agents,” are not permanently employed by one insurer and are allowed to sell policies from various companies at the same time. Independent agents, however, must disclose any existing or potential conflicts of interest before representing any carrier.

In a similar fashion, agents and brokers should keep a keen eye on policy expiration dates and renewal deadlines. Although a producer should not renew or apply for an alternate policy on a consumer’s behalf without authorization, the agent or broker is ethically bound to inform people of upcoming periods of potential insurance gaps.

Providing Company Information Insurance producers can do their jobs ethically and legally by giving prospective policyholders a brief description of specific insurers. Agents and brokers should mention an insurer’s rating, which relates to its ability to absorb risks and pay claims. The person paying for a prospective policy might also want to know if the insurer is well-established in the industry or if it is a relatively new organization. It will be important for the person to know how closely the company scrutinizes claims and how quickly it pays legitimate ones. Because a company’s financial health and claims procedures can vary during a policy’s lifespan, agents and brokers should convey this information to consumers not just at the application stage, but also at renewal time.

Ethical agents should also become well-versed in the internal procedures of their companies. Agents should not overstep the boundaries of their job descriptions. Unless authorized by an insurance company, agents do not have the power to make deals with customers. They cannot negotiate premiums, redefine the terms of a policy or unilaterally approve a person for coverage. They must understand that they are part of an organization and that performing the duties of another person without company approval can, at worst, lead to legal trouble, or, at best, produce role confusion and procedural disorder in the workplace.

Making potentially negative disclosures about specific carriers can be more challenging for insurance agents than for brokers. After all, agents represent the insurer in a transaction and are obviously expected to paint a positive image of their respective employers. To do otherwise could jeopardize sales, endanger employment and potentially violate the concept of agency. And yet, it is not impossible to make these ethical disclosures and still uphold one’s responsibility to an employer. For example, agents might mention that their company is a new kid on the block but also emphasize the lower costs © Real Estate Institute

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PROTECTING CONSUMER RIGHTS

CONCLUSIONS

DISCRIMINATION IN INSURANCE

This text stresses the many ethical and legal responsibilities of insurance producers. And yet, even though these responsibilities can make the producer’s job mentally, emotionally and physically challenging, those reading this material should understand that not all responsibilities are on their shoulders. Despite ethical duties owed to consumers, insurance producers need not handle every aspect of a transaction. As stated previously, the insurance producer is an adviser, not a decision maker. In the end, it is the insured, rather than the producer, who must complete the following tasks:

INTRODUCTION As people become more aware of neighbors with differing backgrounds, we may want to believe that they would become more understanding and tolerant of each other’s differences; however, instead of fading away, discrimination seems to evolve with the times and continues to be a relevant ethical concern for insurance producers. When companies or entire industries do not offer equal professional services to all groups of consumers based upon their geographic location, they engage in a discriminatory practice called “redlining.” Whereas traditional cases of redlining usually involved blatant discrimination against a few groups (particularly racial minorities), today’s insurers who redline tend to do so subtly, even unintentionally on some occasions, and often affect minorities who would not have needed to worry about these issues 40 years ago.

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Choose whether or not to purchase a particular policy  Pay premiums  Provide producers with any needed documents for coverage  Read and acknowledge an understanding of a policy’s terms Of course, no professional is immune to accusations of illegality. But insurance producers can reasonably protect themselves from liability by disclosing, at an early stage of a transaction, what they will do for a consumer and what they will not do. Smart, ethical agents and brokers do not allow the public to guess as to whether or not they represent the insurer or the insured. They document this disclosure, as well as every other act and discussion they have with a consumer, be it about a person’s wants or needs, policy exclusions, the financial stability of an insurer or any other matter.

As consumers, courts and various regulators refine their definitions of “discrimination” and “redlining” in order to combat unacceptable inequality, insurers must periodically perform a self-check to ensure that their business practices do not nurture discrimination. It is very possible that some well-meaning professionals have been illegally discriminating without even realizing it. This material alerts insurance producers to potential seeds of redlining and discrimination within their sales practices and offers suggestions on how to attack the root of the problem before it becomes a seemingly unmanageable issue.

In a perfect world, the producer would and could act in the best interests of everyone, including the consumer and the insurer. That, though, can be a difficult goal to achieve, particularly when a person is confronted with the daily grind of doing business. But even for those producers who struggle with this approach due to the pressures of making money and staying out of legal trouble, there are serious incentives to behaving ethically.

REDLINING: YESTERDAY AND TODAY Though the discriminatory practice of redlining has affected multiple classes and groups of people over the years, it will probably be forever linked to unfortunate instances of blatant racial inequality. The term got its name from the exclusionary business dealings of real estate agents, lenders and others who literally drew red lines on maps in order to highlight parts of cities and states where a significant portion of black Americans resided and where businesses would not offer service.

Adherence to ethics improves public relations, which will likely increase business. Such adherence should also lessen a producer’s legal concerns in a time when few agents and brokers are absolutely certain of their courtimposed duties. The more people feel as if they have been treated fairly, the less likely they are to take legal action against someone. And even in those situations in which litigation becomes unavoidable, demonstrations of documented ethical conduct can be an insurance producer’s best defense.

The U.S. government acted to outlaw redlining in various industries through the Fair Housing Act (one of many major pieces of civil rights legislation passed in 1968), the Home Mortgage Disclosure Act and the Community Reinvestment Act. The latter two acts mainly pertain to lenders and not to the insurance community. But in 1992, the U.S. Court of Appeals for the 7th Circuit ruled, in the case National Association for the Advancement of Colored People, et al. v. American Family Mutual Insurance Company, that the Fair Housing Act applies to insurers, as well as to real estate professionals. In its decision, the court focused on the plaintiffs’ arguments, which highlighted the link between housing and insurance and how fairness in the lending and real estate professions cannot exist without fairness in the insurance industry: “Lenders require their borrowers to secure property insurance. No insurance, no loan; no loan, no house; lack of insurance thus makes housing unavailable.” Within an insurance context, redlining is most commonly an issue for companies that sell homeowners insurance and personal auto coverage, and the unlawful discrimination can occur on many levels. Insurers might deny coverage outright or charge the discriminated party higher rates than

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PROTECTING CONSUMER RIGHTS further limits on coverage in and around South Central Los Angeles or do no business in the area at all.

they would charge a desired customer. Redlining might also occur in more subtle situations, such as when an insurer does not tell members of a particular group about policies that could save them money, or when an insurer’s marketing campaign unjustly ignores certain segments of the population.

Natural disasters like Hurricane Andrew influenced some insurers’ decision to limit or not sell property insurance for structures on both coasts as well as buildings near fault lines in the West. Similar dismay occurred among property owners in cities after September 11, 2001. Initially, most states allowed insurers to exclude coverage for terrorist attacks, but in places like New York City, where risk was obviously high and where regulators did not permit terrorism exclusions, some people suggested that insurers were essentially redlining by either denying property coverage or charging outrageously high rates for it.

Differing Definitions of “Redlining” Today, more than 40 years after the Fair Housing Act became law, few, if any, insurers publicly condone redlining. But the issue has not ceased to exist, due in large part to wide-ranging opinions about what truly is redlining and what is merely smart, selective and analytical business by insurance companies. An article published in the insurance trade publication CPCU Journal in 1996 focused on people’s varying interpretations of the term and listed 11 distinct definitions that ranged from very specific to very vague, and there are probably at least 11 additional definitions in use today.

Redlining by Occupation Despite its roots in racist behavior, redlining has affected a wide variety of social groups that includes but is not limited to people of different skin colors. Some insurers have used people’s occupations against them in insurance transactions. Liability insurers have been known to steer clear of lawyers and doctors, who are presumably more apt to be sued than the average person. When AIDS first came to the public’s attention, some health insurers allegedly tried to distance themselves from HIVpositive customers by making coverage pricey and elusive for people in stereotypically hom*osexual lines of work such as interior decorating and for people who lived in San Francisco and other parts of the country with relatively high gay populations.

Many insurers tend to view redlining in a traditional way, claiming that it involves concerted efforts to discriminate against particular groups without basing the discrimination on substantiated risk factors. These insurers would almost certainly agree that providing unequal service to people based on race or ethnicity is indeed an example of redlining. Many consumer advocates, though, say redlining occurs whenever an insurer’s underwriting criteria discriminate against people, either directly or indirectly and regardless of risk factors. For example, some insurers have been accused of redlining because they used a building’s age as a factor in offering and pricing homeowners policies. In these situations, insurers might have had statistical proof that older homes represented high risks and might have felt as though they were underwriting responsibly. Yet disagreement about redlining materialized because homes in such traditionally non-white areas as inner cities are generally older than those in predominately white communities.

According to consumer advocates and insurance agents, discrimination based on occupation does occur. But grouping that behavior in with redlining is a stretch for those people who still envision shaded maps when they think of the redlining prohibited by the Fair Housing Act.

Territorial Rating The aforementioned allegations related to insurers and San Francisco are an example of “territorial rating,” the most common situation in which insurers run the risk of modernday redlining.

Redlining After Riots and Disasters

Usually done on a ZIP-code level, territorial rating occurs when insurers price policies or offer different coverage to consumers based on geography. The practice is legal in many states and is rooted in the assumption that different locations present different risks for insurers. If, for instance, two ZIP codes feature vastly different crime rates, insurers might have the right to charge a homeowner in an unsafe neighborhood more for coverage than they would charge a homeowner in a comparatively safe neighborhood.

Although disputes related to insurance and redlining were not exactly non-existent before the 1990s, historical events beginning in and continuing after that decade have made geographically based discrimination a hot topic in professional, legal and legislative circles over the past 15 years or so. The 1992 riots in Los Angeles, which stemmed from the acquittal of white police officials who were tried for the beating of black man Rodney King, drew attention to redlining in the area. As politicians and the public tried literally and figuratively to rebuild that community, they realized the tough task was being made even more difficult by some insurers.

Redlining by Home Values and Age Whether through territorial rating or through underwriting on a case-by-case basis, property insurers have also faced redlining issues when they have based premiums and product availability on a building’s value and age.

Prior to the riots, many property owners in the area— generally non-white and working-class—struggled to find affordable coverage from major insurance companies, and some chose to purchase policies from questionable overseas providers who operated outside of state regulatory boundaries.

In many cases insurers have avoided offering replacementcost coverage to homeowners whose property has a low market value. This practice is most common in inner cities and is sometimes dictated by an insurer’s fear that replacement cost policyholders with lowly valued properties might commit arson and sacrifice their homes in order to pocket more money from an insurance company than they could obtain in the real estate market.

After the riots, policyholders discovered that some of these so-called insurers ran bogus operations, and many riot victims found themselves stuck with significant uninsured damage to their properties. Meanwhile, the riots cost legitimate insurers $775 million, and at least two insurers became insolvent due, in large part, to the destruction. Many underwriters who financially survived the riots viewed the violence as a warning sign instructing them to either put © Real Estate Institute

A building’s age comes into play during the underwriting process because older properties present a sizeable risk to an insurance company if owners do not maintain them. Although some insurers in the United States have set age 64

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PROTECTING CONSUMER RIGHTS reputable numbers via a comparison of crime rates; it can also be represented in a manner that does not necessarily judge consumers. The insurer and the customer can mutually understand that poor economic circ*mstances and other factors often force good people to live in areas with high crime rates. Denying coverage or demanding high premiums on this basis might protect the insurer’s financial interest while not pointing an accusatory finger at the applicant and suggesting that the person is irresponsible or negligent.

limits on the properties they will cover, many states have passed laws to curb this practice.

The Realities of Insurance Sometimes lost amid accusations of discriminatory behavior by insurers is the fact that insurance is not an open-door business that can thrive by treating every potential customer equally in every way. In its simplest form, insurance is a gamble for companies that write policies, a bet based on actuarial analysis that the people buying coverage will pay more to insurers in premium dollars than they will take away through valid claims.

With such risks and explanations in mind, insurers have repeatedly insisted their dealings in inner cities represent lawful, necessary discrimination in its most ethical form, as opposed to illegal, prejudicial redlining.

Agents and underwriters have an obligation to their employers to carefully examine the risk potential of insureds in order to ensure financial survival for the company. This inevitably means they cannot always grant potential customers the rates and coverage they request. A risk manager who absorbs every risk does not engage in much management at all and is likely to aid in an insurer’s financial collapse.

Is Redlining Real? Insurers deserve some leeway so they do not need to face redlining allegations whenever they work toward careful risk management. However, it is sad to realize how many insurers have abused that leeway by refusing to address the longtime civil rights violations committed by colleagues who redline.

Insurers should realize, however, that they walk a legal and ethical tightrope whenever their underwriting decisions seem to involve moral judgments or when their decisions benefit one person while penalizing another. When insurers deny coverage, it is not instinctively wrong for affected applicants to feel judged. After all, denial of insurance signifies that the person is a high risk, and being deemed a high risk can mean many things with varying degrees of insult attached to them. It can mean people are perceived as unlikely to care for their own physical health, drive safely, or properly maintain their possessions. In some cases, it can also mean people are perceived as likely to engage in illegal activity.

Within the past few decades, many insurers seem to have engaged in a cycle of inadequate responses to the problem of redlining. At one point in the cycle, insurers deny outright that redlining occurs. Then, as people begin whispering about unlawful and unethical discrimination by so-called professionals, these insurers declare they have only heard anecdotes involving wrongdoing and demand to see some concrete evidence before taking action. When the judicial system, the media or whistleblowers at last expose one insurance company as a guilty redlining proponent, some people finally concede that ethical misconduct does, in fact, exist. But they still do not go so far as to examine their own actions and solve any potential problems in their organization. They neither dare to acknowledge that they were aware of any misdeeds by their peers nor admit any personal mistakes when they, themselves, get caught giving their profession a bad name.

Consider those insurers who admit they worry about providing replacement cost coverage to someone because the person might set fire to a home for financial gain. Given the underwriting principles of those insurers, how are decent, law-abiding citizens supposed to react when they cannot secure replacement cost policies?

Many real-life cases, as well as studies, suggest redlining is far from a non-issue for the insurance community. The landmark case that resulted in the application of the Fair Housing Act to insurers, NAACP v. American Family Mutual Insurance Co., centered on the discriminatory business practiced by Wisconsin’s third-biggest insurer at the time. The smoking gun in the case, which alleged redlining against minorities in pursuit of homeowners coverage, was a memo written by an American Family manager, which instructed agents to, “Quit writing all of those blacks.”

Whether an insurer denies service for valid reasons or not, rejected individuals will likely feel as if a moral judgment has been made about them, not to mention other people who share their racial, ethnic, socio-economic or other types of characteristics. When situations such as this occur, the public cannot help but speculate about insurers’ commitment to fair, ethical customer relations. And yet, consumers must be made to understand, and insurers must not back down from the fact, that some risks are real and demand ethical and legal, yet ultimately discriminatory actions. In terms of territorial rating, insurers have decided to stick to this practice most consistently when choosing how to serve drivers and homeowners in inner cities.

Perhaps not so coincidentally, the suit also called the insurer’s hiring methods into question, particularly its employment of black agents or lack thereof. In the end, American Family settled with the NAACP for a package worth $16 million that included agreements by the insurer to open offices in racially diverse neighborhoods and to market its products and services more prominently in black communities. The settlement did not require the company to admit any wrongdoing.

When supporting their decisions to limit or charge more for coverage in specific areas, insurers often cite statistics that back up their high-risk assessments. Insurers generally do not look to cover many old buildings, and a high number of those structures tend to exist in inner cities because builders have few incentives to modernize the neighborhoods. Likewise, insurers do not jump at opportunities to provide coverage where much crime occurs, and cities have generally faced steeper levels of vandalism and theft than rural and suburban communities.

In a separate case, state regulators charged the California Insurance Group with a tremendous amount of redlining in San Francisco that turned away several minority groups, including gays, blacks and Latinos. In its examination, the California Department of Insurance obtained statements from company employees who painted a disturbing picture of blatant, unethical discrimination.

A general yet substantiated crime defense is perhaps the least controversial one insurers have made when asked why their industry limits its business with inner-city residents. Not only can crime be shown by reasonably © Real Estate Institute

According to people who cooperated with the state’s investigation, the insurance company made it clear to 65

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PROTECTING CONSUMER RIGHTS agents that, “We don’t want to write hom*osexuals or queers.” Regulators said California Insurance Group committed 252 violations, and the insurer wound up settling the case (without admitting any wrongdoing) by paying a $500,000 fine, the highest amount in state history up to that time for redlining and the third highest insurance fine paid to the state for any reason.

that effectively discourage them from doing business in inner cities. When an insurer evaluates its agents based on the number of claims that their sold policies produce, producers might think twice before offering coverage to an inner-city dweller who owns an old house, lives in a bad neighborhood or exhibits other characteristics that could hint at future filings. On other occasions, agents have said the area where they live or intend to do business can affect their chances of being hired by an insurer, with agents who aim to serve urban communities suffering negative consequences.

The American Family and California Insurance Group cases were, in a way, exceptions to the rule, in that the two insurers’ alleged attitudes toward minorities came across as harsh and clear. Presumably, most insurers who practice redlining are a bit craftier when communicating their discriminatory desires to employees.

These factors leave some consumers not only susceptible to denial of coverage but also physically distant from insurance agents. In 1995, the Massachusetts Affordable Housing Alliance reported that 14 of the top 20 insurers in the state did not have a presence in inner-city Boston, despite an insurer-funded study (conducted by Stanford Research Institute and detailed in the Los Angeles Times) that found a mere 7 percent link between a person’s geography and loss potential.

In deciding Nationwide Mutual Insurance Company, et al. v. Housing Opportunities Made Equal, Inc., the Supreme Court of Virginia in 2000 quoted an employee, who said about an employer’s alleged redlining that discriminated against people in black neighborhoods, “They didn’t tell you … not to write in those sections, but the way the rules were written up, it seems like we could not do it.”

Among other studies that give credence to redlining’s presence in insurance, the St. Louis Post-Dispatch reported in 1993 that people in the city’s poor, black neighborhoods paid 31 percent more for homeowners insurance than other customers, often regardless of their claims history. An American Insurance Association study found black consumers were three times as likely as whites to turn to a state-sponsored insurance program, highlighting the racial inequality in the open market. Back in the mid-1980s, California drivers outside Los Angeles could get 10 times the coverage available to South Central residents at one-third the cost.

Matched-Pair Studies Many alleged incidents involving racially motivated redlining have been proved through “matched-pair studies.” Traditionally in this method of checking for redlining, testers with differing racial backgrounds call insurers and inquire about homeowners policies for similar properties. General results from some matched-pair studies have allowed consumer groups to conclude the following: 

Black callers receive fewer callbacks from insurers than white callers.  Black consumers receive fewer quotes for replacement cost homeowners insurance than white consumers.  Some insurers require black consumers, but not whites ones, to provide them with a Social Security number before giving a quote.  Some insurers inform black consumers, but not white ones, about company policy that restricts coverage for old buildings.  Some insurers require more inspections for blackowned properties than for white ones. Matched-pair studies played a significant role in the previously mentioned Virginia Nationwide Mutual case. In that case, out of the 15 studies conducted by Housing Opportunities Made Equal (HOME) in the mid-1990s to test for redlining at Nationwide, seven provided evidence of supposed racial discrimination. A jury ruled in HOME’s favor in the amount of $100.5 million, an award that, according to the New York Times, allowed the case to overtake the American Family settlement as the costliest discrimination example in the history of property insurance.

Some Good News About Redlining Those facts and examples should help insurance producers realize that redlining is, indeed, a real problem that they ought not dismiss or ignore. However, the presented information should not be read as a condemnation of most insurers. Passionate statements that seem to equate redlining to a myth are misguided, but people who make those statements do have several sources at their disposal to at least prove redlining does not occur in every insurance office. A matched-pair study conducted by the Urban Institute revealed no firm evidence of redlining affecting black consumers in parts of New York state or Latinos in Phoenix. During the early 1980s, the American Insurance Association looked into redlining and reported, based on work by R.L. Associates, that 92 percent of black homeowners had comprehensive property coverage. According to National Underwriter, a state-authored report, “Status of Homeowners Insurance in Illinois,” revealed that of 13,290 complaints made to Illinois’ insurance department in 1993, only four involved property insurance redlining. In September 1994, the trade publication Best’s Review questioned 1,000 blacks and Hispanics about their insurance experiences, and 95.7 percent said no insurer had ever denied them coverage.

The Supreme Court of Virginia overruled on appeal but not because evidence failed to establish redlining. Instead, the court threw the case out because, in its opinion, HOME was not an injured party in the dispute. In a surprise development, the court later reconsidered its stance and planned to rehear the case. That plan never came to fruition because HOME accepted a $17.5 million peace offering from Nationwide.

It should also be noted that despite the disturbing results of the paired studies that probed for discrimination at insurers such as Nationwide, the number of samples in those studies (15 in Nationwide’s case) are sometimes too small to produce concretely scientific results. In order for these studies to exhibit a relatively low margin of error, they must incorporate many samples instead of single-digit or even double-digit amounts.

Other Studies and Testimonials In some situations, insurance agents have bravely put their job security and professional esteem at risk in order to expose unethical and illegal behavior at their workplaces. Some have gone on the record about company policies © Real Estate Institute

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PROTECTING CONSUMER RIGHTS Within the executive branch, HUD Secretary Henry Cisneros, who placed redlining near the top of his concerns, was not ready to concede defeat just because the legislative system had worked against his goals.

Federal Views on Redlining Redlining is illegal in America, but the states’ individual jurisdiction over the insurance industry has left the country without a uniform way of attacking the problem.. Many citizens have responded to perceived inequality in places such as South Central in Los Angeles with calls for the federal government to become more involved in the matter.

“This must stop,” Cisneros had said about redlining, as quoted in National Underwriter before the massive Washington shakeup. “Insurance is not a luxury. It is a necessity of life, and we can’t have insurance companies …pulling out when they feel like it because the numbers don’t work.”

Perhaps the closest the country came to seeing a federal law dealing exclusively with redlining was back in the early 1990s, when the L.A. riots and their aftermath were still a part of public and political consciousness. At that time, the main question for legislators did not concern whether or not the country would wind up with a federal redlining law. Instead, the uncertainty seemed to center on exactly what the contents of that law would be. The era’s two main, competing House bills did not address how an insurer should conduct business, but they aimed to give the federal government access to company data that might have allowed people to recognize and rectify potential redlining more consistently.

Insurers and declared advocates for the separation of powers in government spoke out against HUD as it worked toward exposing redliners and developing a federal regulatory plan. HUD, they said, should keep its nose out of insurance issues and should not use its funds—American tax dollars allocated to the department by Congress—in ways that contradicted the legislature’s decisions. Over the years, HUD has given millions of dollars in grant money to consumer organizations, including $1.5 million to plaintiffs in the Nationwide case, to conduct redlining studies. HUD’s continued push for redlining reform with or without Congress’s approval provoked comments published by National Underwriter in 1995 from Rep. Earl Pomeroy of North Dakota, who half-jokingly referred to HUD workers as “pointy-headed SOBs who didn’t get the message of the last election.”

The Insurance Disclosure Act, sponsored by Rep. Joseph P. Kennedy II of Massachusetts, called for insurers to present the Secretary of Housing and Urban Development (HUD) with annual data related to their customers, employees and underwriting decisions. Under the act, insurers operating in 150 parts of the country would have disclosed to HUD the total number of policies they wrote, the premiums they earned, the total policies they either cancelled or did not renew and the number of agents they employed or let go during the year, all grouped by geography. Applicants, customers, dismissed insurance representatives and current agents would have also been categorized based on their races.

Unable to cool down insurers’ boiling blood, and doing its best not to invite litigation, HUD eventually backed off from the issue, at least in its campaign to regulate parts of the insurance industry.

State Redlining Laws State redlining laws have placed varying demands on insurers. Some states do not force insurers to submit any documents to regulatory departments for anti-redlining purposes. Other states require information about service in certain ZIP codes. Some states only release cumulative data for all area insurers put together. Others make individual companies’ data available upon public request. Insurers in some states must disclose their underwriting guidelines to regulatory departments, while insurers in other states need not do so. In the early 1990s, when the redlining debate was arguably at its hottest, only a few states took a watchdog approach to redlining and required insurers to provide them with geographically categorized sales data.

Illinois’ Cardiss Collins sponsored the competing Anti Redlining in Insurance Disclosure Act, which also instructed insurers to reveal policy, premium, cancellation, non-renewal, and employee data in geographical groupings to HUD but did not specify racial disclosures and applied to 25 metropolitan areas instead of the other bill’s 150. For the most part, insurers criticized the Kennedy bill, calling it too burdensome for the industry. Professionally maintaining data costs money, and although a person might argue that federal legislation requires mortgage lenders to collect data about consumers for antidiscriminatory purposes and that insurers should be held to the same standard, insurance professionals do not see absolute parallels between the two occupations. After all, applications for insurance annually outnumber applications for mortgage loans.

Changes in statewide political power can affect how governments approach redlining prevention. This seems to have occurred in California, generally known as one of the strictest states in the country when it comes to insurance discrimination.

Perhaps believing some form of redlining legislation was bound to pass through Congress with or without their endorsem*nt, insurers begrudgingly got behind the Collins bill, which the House passed and sent to the Senate in July 1994.

During some regimes, the state’s insurance department stressed a need for extensive disclosures from insurers. Under other people’s control, however, the department did not want to require disclosure from some insurers if they presented the state with plans on how to serve highly urban communities.

Redlining legislation’s fate changed four months later thanks, in part, to Election Day returns. A newly elected Congress in 1994 claimed to support less regulation by the federal government and preferred to allow the individual states to create and enforce their own anti-discrimination laws. Despite hanging onto their seats, Collins and Kennedy lost power in committees, which play a major role in deciding which bills come up for a vote and which ones remain stuck in political limbo. The Anti Redlining in Insurance Disclosure Act never made it to the Senate floor for a vote, and the only redlining bill to come from that Senate was read twice and then eternally referred to the legislative body’s Committee on Banking. © Real Estate Institute

The state has also gone back and forth throughout political changes on the issue of territorial rating in auto insurance. California’s auto insurers have sometimes had a legal right to use ZIP codes as factors when offering and pricing coverage. At other times, they have had orders from above to base underwriting decisions on nothing more than consumers’ driving records, how long they have been behind the wheel and how many miles they drive.

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PROTECTING CONSUMER RIGHTS constituted trade secrets, and the state did not need to make the information public. But when the California Department of Insurance released ZIP-code data that State Farm said contained trade secrets, the Supreme Court of California ruled against the insurer.

Insurers have sometimes refused to embrace proposed and existing federal and state laws for reasons that go beyond the financial problems they foresaw in the previously mentioned Kennedy and Collins bills. The opposition to any federal redlining law is easily summed up by the introduction to the McCarran-Ferguson Act, which states, “Congress hereby declares that the continued regulation by the several states of the business of insurance is in the public interest.” Simply put, the authority for insurance regulation rests with the states and not with Washington D.C.

A BIGGER ETHICAL PICTURE Every professional in the industry must understand how overpriced or unavailable insurance coverage contributes negatively to society, regardless of whether or not they practice illegal redlining, legal territorial rating or any other form of discrimination that intentionally or unintentionally produces negative consequences for minorities.

Insurers are not necessarily claiming proposed federal legislation lacks benefits for consumers and the industry. They are merely pointing out that the government allocated certain powers to certain bodies long ago for a reason, and that the federal government might overstep its boundaries if it takes power away from the states.

Some people have dismissed the existence of racially discriminatory redlining by citing studies that claim 98 or 99 percent of black homeowners have property insurance. Yet it must be remembered that people from every walk of life who own homes are bound to have property insurance for the simple reason that lenders rarely provide mortgage loans without proof of insurance.

Regardless of where an anti-redlining proposal comes from, insurers have reason to wonder how legislation might affect their risk management. Any potential law could represent a slippery slope that might eventually cause insurance companies to falter if they no longer have the right to stay away from some risks. People who have trouble sympathizing with insurance companies ought to consider that if the government orders insurers to insure people and properties perceived as high risks against the insurers’ better judgment, less risky consumers will almost certainly encounter higher premiums and deductibles in order to keep the companies in stable financial condition.

As a result, writer, professor and sociologist Gregory D. Squires has said these studies must be inverted: Instead of focusing on how difficult it is for black homeowners to get insurance, they should focus on how many black consumers could not become homeowners because they could not obtain proper insurance. America touts itself as the land of opportunity, where hard work and good citizenship produce results. Due to redlining, territorial rating or other factors, many Americans do work and behave like good citizens, only to never experience the great American dream of home ownership. Senate Bank Committee member John Kerry of Massachusetts had similar thoughts on redlining in 1994, which appeared in National Underwriter:

On behalf of policyholders and themselves, insurers frequently point out privacy issues that come out of antiredlining laws and regulations. Prospective laws and regulations that aim to eradicate redlining on a racial basis usually require an insurer to collect data about consumers’ racial backgrounds. Yet, even if a law demands such an action, there is an ethical conflict in that situation because many people do not want to reveal personal information.

“When companies not only adopt the bad public policy, but the bad business policy of not doing business in whole sectors of our country, they are writing out the whole American dream. They are just writing it off. I think it’s disgusting.”

America’s long and sometimes unsatisfactory record on discrimination, particularly from a racial perspective, has made it difficult for many minorities to believe that any information they give to an insurer will go toward antidiscriminatory endeavors. Insurers who understand the pain of prejudice and the reluctance of people to disclose personal information must ask themselves a question: Is personal privacy a reasonable sacrifice for an ultimate goal of supremely fair insurance services?

Let us return to our discussion of the inner city and explore the long-term effects that redlining and unethical territorial rating can produce there. Poor people in these areas cannot afford what insurance they can get, which means they will not buy the houses of people who have left the neighborhood, which in turn means the properties will not sell and will continue to drop in value.

Privacy is particularly a worry for insurers when states require them to disclose their underwriting guidelines. For many people in the industry, such demands are unreasonable because companies’ underwriting guidelines are often viewed as their secret recipes for success. If too many trade secrets come out of legally imposed disclosures, a business might lose its competitive edge.

When a local homeowner dares to consider opening a business in the community, these low-valued homes might not be worth enough in collateral to earn the person a commercial loan. Without businesses, there are no jobs. Without jobs, there are no new homeowners or any money to pay for high insurance premiums. As Lyndon Johnson’s Kerner Commission famously said in 1968, “Communities without insurance are communities without hope.”

From a more positive perspective, though, increased disclosure by insurers might win faith from consumers who want to make certain that the industry does not engage in shady business. When used effectively by the states, these disclosures perform a priceless purpose, making legislation like the Fair Housing Act more enforceable and assuring the public that insurers uphold all applicable laws.

Insurance is not what’s wrong with inner cities, but insurers must understand that their decisions can, in some ways, either help to continue vicious cycles in these areas or aid in some life-changing solutions.

SOME WORDS ON THE WEB The internet has influenced countless aspects of modern society, and the redlining debate is no exception. Although some insurers might still find a way to practice redlining on the Web, particularly when they request an address from an online consumer before providing quotes, many people believe online insurance sales limit chances for unethical discrimination.

Sometimes courts have allowed insurers and regulators to withhold data from the public because the data reveals trade secrets, and at other times, courts have ruled the public has the right to access this information. The St. Louis Post-Dispatch went to court hoping to obtain insurers’ ZIP-code information from the Missouri Department of Insurance. In this particular case, a judge ruled the data © Real Estate Institute

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PROTECTING CONSUMER RIGHTS owners can get a better rate once they install a sprinkler system, a burglar alarm or smoke detectors, the insurance company should let them know and give those potential customers an opportunity to make those changes.

Unlike face-to-face meetings and telephone conversations, Web communication does not allow an unethical insurer to determine a consumer’s race with relative ease and practice discrimination on that basis. Also, online insurance offers can counteract the absence of agents and brokers within some geographic areas, including inner cities. Even if people in South Central cannot physically find a respectable agent to do business with them, they are potentially only a few clicks away from discovering the coverage they desire.

If nothing else, insurers must treat each customer fairly during the application process. This means not making time for white customers who come in from the street while telling black consumers on the phone that they need an appointment. It means having the same philosophy on old houses in white neighborhoods and old houses in Hispanic neighborhoods. It means taking the time and spending the money to inspect a home instead of instinctively denying coverage for it over the phone. For the truly ethical agent, it can also ultimately mean raising one’s voice, publicly if necessary, when colleagues and employers refuse to recognize or alter their discriminatory ways.

Still, the technological gap between the rich and the poor could arguably be applied to insurance and used to support claims that internet-based sales actually nurture unintentional discrimination under some conditions. If an insurance company uses the internet as a prime venue for advertising, the company might ignore members of minority groups and communities who are less likely to have computer skills or disposable income for internet access. This is especially an ethical concern when insurers offer unique deals to online consumers, while leaving the rest of the population out of the loop and paying higher premiums.

Following this advice and consciously recognizing the consequences of redlining, territorial rating and other discriminatory insurance practices could create major longterm benefits for insurers and the public. As insurers grow more knowledgeable and become more willing to carefully venture into underserved communities, they might find many new customers who will remain loyal to them for all of their insurance needs. Over time, insurers might even change the culture within the business world and, through their presence and support, convince other professionals to reinvest money, time and energy into poor communities. At the very least, they might change outsiders’ opinions of insurers and nurture a trust between the industry and the public that is never shaken by the unethical acts of the occasional bad egg.

An insurer need not sacrifice ethics in order to become a major force on the Web. In fact, online advertising and an appealing, user-friendly website are fundamental elements of any smart modern business strategy. A professional should, however, consider the consequences of any internet campaign and think about those consequences within the context of fair service to all people.

HOW AGENTS CAN FIX THE PROBLEM No insurer wants to be accused of redlining, lose business and have to cope with a public relations nightmare. Also, no agent wants to jeopardize a company by binding policies that present tremendous risk. After facing their accusers in redlining disputes, some insurance companies have loosened up a bit and taken on more types of customers than they would have in the past. But an insurance company’s standards need not drop in order to prevent potential redlining. Insurers can protect themselves and serve a variety of customers, as long as they apply the same standards to all applicants, remain as honest as possible and think openly and analytically. Statistics may tell us inner cities are generally high risk for insurers. But does that mean there are literally no insurance customers to serve in those areas? Some people within the industry have taken tours that show agents less stereotypical parts of cities that they might find attractive in a business sense. Examples of such tours include ones in St. Louis created by the NHS Missouri Insurance Initiative. If an insurance company must deny coverage or can only offer it at a high price, agents must do everything in their power to make the consumer understand exactly why the company responded that way. The public must know why insurers cannot accept all customers, why non-prejudicial discrimination is necessary and what risks insurers are generally unlikely to absorb. The more consumers understand about why insurers deny coverage at certain rates and about the insurance business in general, the less likely they are to view themselves as victims of illegal discrimination. The open-minded, analytical agent rarely shuts the door completely on a customer. It may be necessary to deny coverage to someone or to only offer someone high rates, but an agent who is trying to prevent redlining will inform a consumer about any potential solutions to the insurance problem. If a certain part of a house is too old and beat up to insure, the agent should say so and offer to take a second look at the place pending improvements. If property © Real Estate Institute

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PROTECTING CONSUMER RIGHTS employers, consumers and the industry as a whole and notes that credit-based decisions may be perceived as ethical, unethical or both depending on one’s values and the details of a given situation. As is the case with many ethics topics, two well-meaning people can examine this issue and come to very different conclusions regarding what is “right,” “wrong,” “just” or “unjust.” The information presented here allows readers to come to their own conclusions about the use of credit reports and credit scoring in insurance, but it encourages insurance producers to value ethical considerations whenever making those determinations.

INSURANCE AND CREDIT INFORMATION INTRODUCTION Anyone who has applied for a mortgage or any other kind of loan has probably had their credit history and credit score examined by a lender. Credit card companies (whether they receive actual applications for accounts or simply solicit the public via a steady flow of pre-approved offers) do credit checks on all potential customers. Even many landlords and some employers take the time to investigate the financial pasts of prospective tenants and employees. Credit reports and accompanying credit scores (typically three-digit numbers based on the contents of a credit report) can greatly affect the feasibility and conditions of a business relationship and can therefore serve as either an attractive, positive feature or a negative one for the credit applicant. Sometimes, these reports and scores are the ultimate factors that determine whether or not a person obtains that mortgage loan, credit card, apartment or job. At other times, a person is generally assured of obtaining a mortgage loan or a line of credit, but these reports and scores dictate such important details as interest rates and credit limits for the applicants.

UNDERSTANDING CREDIT REPORTS AND CREDIT BUREAUS A lender, creditor or any other person with a legitimate reason to investigate an individual’s credit history can obtain a credit report from any of the three major credit bureaus in the United States: Equifax, Experian and TransUnion. Although credit reports from each of these bureaus might differ from one to the next, they all intend to contain the same basic data. For identification purposes, a credit report will include a person’s name, address, phone number, Social Security number and other general information that may be applicable and available to the bureau. An up-to-date credit report lists existing and cancelled accounts that the person has been authorized to use, credit limits, outstanding and repaid debts, bankruptcies, tax information, overdue childsupport payments and more, depending on the individual’s financial obligations. The identities of parties who have investigated the person’s credit history through that particular bureau, such as banks and credit card companies, will also appear.

Applicants with good credit reports and high credit scores have the best chance of obtaining the money they wish to borrow or other items that they wish to secure through credit transactions. They can also expect to obtain them on favorable terms. Conversely, individuals who compile a substandard credit history are often at the mercy of a businessperson who has a professional duty to guard the lender or creditor against potential financial losses. Over the past two decades or so, insurers have been increasing their use of credit reports and credit scores to assist in flagging high-risk customers among a large number of applicants. As we will explain later, this use has increased because some insurers believe that an individual who does a poor job of managing credit will also do a poor job of managing other tasks and therefore pose a greater insurance risk.

Extensive as they can sometimes be, credit reports do not include information that relates to a person’s medical history, criminal background, ethnicity, race or gender. A creditor or lender is free to report late payments to the credit bureaus 30 days after a due date, but the creditor or lender does not always report every debt to every bureau. Therefore, a credit report from Experian, for example, might feature delinquencies and payments that a TransUnion credit report does not mention and vice versa.

Both the general public and industry professionals have begun to realize, however, that when insurers choose to base policy rates on credit histories, they are making a decision that may or may not be ethical, notwithstanding any practical benefits.

Because the consumer rarely knows which of the three bureaus a creditor, lender or other party will contact for a report, informed individuals periodically scrutinize their credit reports available from each bureau, keeping an eye out for outdated material and obvious errors.

Few insurance professionals are opposed to the overall concepts involving credit reports and credit scores. Most of them do not doubt that these sources of data are quite useful within the confines of certain businesses, particularly the lending industry. But many consumers, agents, brokers and other industry executives have pointed out that there are big differences between lending money to someone and insuring that person.

Errors in Credit Reports Unfortunately, not all obvious errors are honest mistakes made by the creditor, lender or bureau. Instead, some are instances of the increasingly common crime known as “identity theft.” Carelessness or security flaws related to one’s personal information can often assist total strangers, or even people in positions of trust, in opening accounts, taking out loans and running up bills in an unsuspecting innocent person’s name.

Insurance is not a loan that is paid off with interest over time. Instead, insurance is a product, cancelable upon nonpayment, that transfers risk from one party to another. Whereas a lender’s main concern is that a risky customer will not make proper payments, an insurance producer’s main concern is that a risky customer will have some sort of costly accident, become seriously ill, sustain damage to a home or become involved in some other type of situation that will require an insurer to pay for claims. Based on these differences, many people believe that an individual’s financial history should not play a significant role in the availability of affordable, quality insurance coverage.

Needless to say, incorrect or inaccurate information on a credit report can make a financially responsible person seem like someone with a deplorable credit history. Unless they know the truth of the situation, creditors will either reject the applicant or only grant credit at high interest rates. If consumers believe that something on one of their credit reports is incorrect, they may challenge the validity of the information by contacting the bureau that published the

The information that follows addresses how credit scoring factors into an insurance producer’s ethical obligations to © Real Estate Institute

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PROTECTING CONSUMER RIGHTS report. Credit bureaus are required to make contact with the party who submitted the disputed information and must attempt to verify the accuracy of the report’s contents. If, after that process has run its course, the consumer still contests the information, he or she may explain the alleged discrepancies in a personal statement that is added to the credit report for all inquirers to view and consider.

certain degree but deviates somewhat in the data it considers and in the way it manipulates that data. Furthermore, a person’s PLUS Score can range from 330 to 830, a slightly tighter group of numbers than the one employed by FICO. TransUnion has formulated a different scoring system that is based on somewhat different criteria than the FICO approach.

Personal Access to Credit Reports

FICO’s dominance in the credit-scoring business is understandable, given its position as the first to enter the market. In addition, a FICO score is, in many ways, a number derived from a composite of information from all of the bureaus and is, therefore, arguably a more reliable representation of a person’s creditworthiness than the contrasting scoring systems that Experian, Equifax and TransUnion have used independently of one another.

Despite the threat of identity theft and the heavy traffic of personal information that travels through the World Wide Web, U.S. residents might not need to be as concerned about unauthorized credit activity as they were at the beginning of the new millennium. The passage of the Fair and Accurate Credit Transactions Act of 2003 made the task of monitoring one’s personal credit information relatively simple and inexpensive.

VantageScore

Consumers are now legally entitled to a free copy of their credit reports from each of the three credit bureaus every year. The free report can be obtained either over the internet or by mail. Because the act does not force people to order their reports by a specific date, consumers can space out the arrivals of the three reports and give themselves a relatively frequent opportunity to monitor their records for any suspicious activity affecting their credit history. All three credit bureaus offer additional fee-based access to the reports as well.

In 2006, the bureaus unveiled VantageScore, a creditscoring method that uniformly analyzes credit report data for all three organizations. As a result of the collaborative venture, a person can receive a credit score from Experian, Equifax or TransUnion and know that the selected bureau is analyzing the same financial factors in the same way as the other bureaus. The range for scores under the VantageScore system is identical among the three bureaus, but scores might still differ if a lender or creditor reports to one bureau and not the others. Even though all three bureaus would apply the same mathematical formula, the differences between the data reported to each bureau would produce different score results.

UNDERSTANDING CREDIT SCORES Credit scores serve as reliable summaries of credit reports and are perhaps most popular as a way for banks and other lenders to initially screen applicants for home loans. Calculators of credit scores typically assign a three-digit value to a person’s credit history based on the types of accounts that the individual is authorized to use, the consistency with which the person pays bills and the existence and quantity of debts.

Personal Access to Credit Scores Although the Fair and Accurate Credit Transactions Act of 2003 allowed Americans to gain free, periodic access to their credit reports, the legislation only stipulated that a person must be given access to a credit score for a “fair and reasonable fee.” As a result, the credit bureaus and FICO usually do not disclose these scores without payment. These numbers can be purchased directly from any of those organizations.

Generally speaking, someone who has used a lot of credit and has paid off debts in a timely fashion will have a high, favorable score. In contrast, someone with minimal credit history, large debts and a pattern of late payments will generally have a low, unfavorable score.

INSURERS AND CREDIT HISTORIES

FICO Scores

Insurers have used credit reports and scores for many years when offering coverage to businesses, but it has only been within the last decade or so that credit history has played a major role in the availability and pricing of personal-line policies.

Since lenders and creditors began utilizing scores as financial evaluation tools, Fair Isaac and Co. has been the consistent leader in the field of credit scoring and is particularly dominant in the mortgage lending industry. Through the use of data compiled from the three credit bureaus, Fair Isaac formulates what is commonly known as a “FICO score,” which assesses the credit risk of a person through a “higher the better” point system.

For the prospective insured who wants to keep credit data out of the underwriting process, coverage options are becoming increasingly limited. In 1996, Best’s Review reported, through a source at FICO, that approximately 200 insurance companies were looking into applicants’ credit information. In roughly two years, according to Money magazine, that number rose by 50 percent. Despite the passage of various laws in various states that limit insurers’ use of credit histories, most property and casualty insurers at least glance at this information in one form or another.

A FICO score can range from a value of 300 to 850. People with high scores are generally considered low-risk applicants for credit and are more likely than other applicants to secure low interest rates if and when they are approved by a lender or creditor. Those individuals with lower scores are generally thought to possess an increased risk of financial delinquency. An applicant with a very low FICO score represents a high risk to creditors and may face high interest rates or a flat denial of financial assistance.

There are few guarantees, however, that any two insurers will utilize credit scores in the same way. Since consideration of credit began, some insurers have based decisions outright on an applicant’s credit score. Others have used credit scores in a slightly less strict manner, as alerts to underwriters that an applicant might represent a considerable risk, but not as grounds for immediate disqualification for coverage.

As the importance of credit scores increased in this country, the individual credit bureaus began expanding their product lines beyond reports by offering their own scores. Equifax has used a system known as Score Power, which calculates a three-digit score in a manner similar to that of Fair Isaac and Co. Experian’s scoring product, known as PLUS Score, resembles true FICO scoring to a © Real Estate Institute

Other insurers have gone a step further in their analysis of credit statistics. Instead of focusing primarily on credit 71

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PROTECTING CONSUMER RIGHTS information, they incorporate the scores and reports into a more wide-ranging formula to create an “insurance score,” which is influenced by one’s credit history to a lesser degree.

maintenance of cars and homes, which could lead to excessive claims. Plus, whereas monetarily secure policyholders might opt to pay for some insured damages out of their own pockets in order to prevent increases in their premiums, people in unfavorable financial situations might have no other choice but to file even the smallest of claims.

In other cases, which will be featured more prominently elsewhere in these pages, state governments have weighed in on the issue and passed legislation that limits the industry’s use of credit history when approving applicants for coverage and when setting rates. Some states, for example, reserve the use of credit histories solely for auto insurance companies.

THE LINK BETWEEN WEALTH AND FRAUD A few of the arguments supporting insurers’ probes into credit histories seem to treat low-income applicants in a seriously cynical manner. For example, some insurance professionals say an extremely low credit score or a heavily soiled credit report could hint at an applicant’s deviance and susceptibility to the temptations of insurance fraud.

THE LINK BETWEEN CREDIT HISTORY AND RESPONSIBILITY Whether they work as agents or brokers, insurance producers are ethically required to avoid burdening insurance companies with an overabundance of risks. To many professionals, credit histories are an excellent tool that aids them in this responsibility.

This theory applies, of course, to the few applicants who see absolutely nothing wrong in committing fraud under any circ*mstances. But it also applies to morally conflicted applicants who would not normally deceive insurers but who find themselves drowning in such a deep pool of pressure from creditors that they feel as though they must engage in fraud to remain financially afloat.

Ideally, facts found in people’s credit reports allow underwriters to gauge the behavior of prospective insureds and to assess the likelihood of those applicants filing certain claims. In a simple, concise statement printed in an article from the Boston Globe in February 1994, Gerald Fels, executive vice president and chief financial officer of Commerce Insurance Co., summarized the way in which applicants’ credit histories inform insurers.

AIDING CONSUMERS THROUGH CREDIT REPORTS AND CREDIT SCORES All of these arguments make credit reports and credit scores seem like weapons that insurers use to penalize the public. But the insurance community’s use of credit histories does create potential benefits for many insurance customers, particularly those who have struggled to obtain affordable auto and home coverage in the past.

“They’re basically going to give us the information on whether this is a good customer or a bad customer.” Within that generality, however, insurers rely on several different theories that link people’s behavior to their credit history. Many insurance professionals assert that a credit report or credit score reflects a person’s concept of responsibility and, therefore, the person’s risk potential.

Some motorists with imperfect driving records have been rewarded with lower premiums because of their impressive credit histories. Many homeowners who reside in geographic areas associated with high risk now have better insurance benefits because they pay their debts quickly and fully.

Under this rationale, someone who makes regular payments on a car loan has a good chance of being a responsible driver. Perhaps the driver makes the regular payments because he or she recognizes a moral responsibility to repay a lender. In that case, it is thought that the same sense of morality might extend to the person’s driving habits and produce few insurance claims because the driver does not want to hurt another person or damage another person’s property.

PROMOTING OBJECTIVITY THROUGH CREDITBASED UNDERWRITING A popular criticism of the insurance community is that underwriting lacks enough objectivity. This accusation may become weaker thanks to the use of credit scores and, to a greater degree, insurance scores. Although many people have angrily argued that credit scores jeopardize fairness in insurance, proponents of credit-based decisions point out that credit reports allow the industry to be more reliant upon facts when underwriting and less reliant on the biased personal and preconceived opinions of human beings. Many insurance professionals on this side of the argument are also quick to point out that credit scores have a foundation in relative objectivity because they do not take such personal attributes as one’s gender, race or ethnicity directly into account.

Or perhaps the person making regular payments on the car loan is emotionally attached to the vehicle and does not wish to damage it in an accident or through a mechanical failure. In this more materialistic situation, according to some industry veterans, the person is not only less likely to drive recklessly but also more apt to keep the automobile in good, sturdy and safe condition. Similar theories exist in regard to the credit histories of homeowners. Supposedly, people with good credit are responsible consumers who keep their household in a sturdy, safe condition and represent reduced risks for insurers. Granted, an insurance producer might not buy into the logic of all of these psychological theories related to risk potential, but as long as the producer buys into at least one of them, the credit-worthy applicant is still viewed as someone who is relatively unlikely to hurt an insurance company by filing excessive claims.

DISCRIMINATION BASED ON CREDIT REPORTS AND SCORES Despite the positive effects that credit histories have produced for many insurance customers, greater media attention seems to have been given to the vocal segment of the population that views credit-based underwriting as a despicable extension of “redlining,” an outlawed practice that has typically involved lenders and insurers denying service to various minority groups based on geographic location.

THE LINK BETWEEN WEALTH AND EXCESSIVE CLAIMS The financial difficulties associated with bad credit serve as another incentive for insurers to investigate someone’s credit report or credit score. If a person struggles with credit that might mean that money problems prevent proper © Real Estate Institute

Even though some professionals defend their preference for credit-based underwriting by pointing out that credit reports and scores do not contain information about race or 72

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PROTECTING CONSUMER RIGHTS ethnicity, critics argue that demographic data connects enough dots to prove discrimination, and that insurance producers who ignore such evidence should not be let off the hook for their allegedly unethical and possibly illegal behavior.

OTHER NEGATIVE CONSEQUENCES OF CREDITBASED UNDERWRITING The multi-faceted issue of discrimination is not alone on consumer advocates’ lists of complaints regarding creditbased insurance decisions. Even wealthy, middle-aged, American-born, white males, seemingly safe from most obvious forms of alleged discrimination, could fail to obtain the coverage they deserve due to omissions and errors in credit reports.

Credit Discrimination and Race No modern insurance company publicly admits to restricting business based on race, but some studies strongly suggest that the use of credit reports and credit scores in underwriting has indirectly made racial discrimination a greater reality.

At the time of this writing, the degree of similarity among the three bureaus’ credit scores under the VantageScore system was still unknown. But insurance insiders had confirmed that, even though the bureaus will be analyzing and scoring data in the same way, the data itself might still differ from one bureau to the next. Most times, the differences among an individual’s respective reports from Equifax, Experian and TransUnion do not jeopardize a person’s quest for credit at a reasonable interest rate, but sometimes they do. A 2002 study by the Consumer Federation of America concluded that of 1,545 combined files from the credit bureaus, 31 percent of them exhibited differences that could have potentially knocked down a person’s credit score by at least 50 points.

A December 30, 2004 report by the Texas Department of Insurance that counted drivers with the “best” credit by racial group found that 90 percent of the drivers with these high scores were white. Hispanics, meanwhile, accounted for 5 percent of those drivers, and black drivers, a mere 2 percent. In stark contrast, blacks and Hispanics accounted for 61 percent of drivers with the “worst” credit reports and credit scores.

Credit Discrimination and Country of Origin To some critics, insurance discrimination based on credit is an issue that transcends race. Immigrants, for example, tend to have limited or non-existent credit histories and might have to settle for expensive auto and home insurance, assuming that the coverage is even offered to them in the first place.

Critics further contend that underwriters might not give enough consideration to unique circ*mstances when examining credit histories. Even if prospective or existing customers admit to having bad credit, the reasons for their financial blemishes might not fit neatly into a theory that equates a good credit history with a strong sense of responsibility.

Other immigrants who do not fit that profile could still encounter similar problems if they speak little or no English and cannot decipher the contents of their credit reports in order to check for outdated information, honest instances of inaccuracy or potential identity theft. The federal government does not require credit bureaus to make reports available in foreign languages, and reports from Experian and Equifax are only available in English. A company communications executive said TransUnion limits its language options to English and Spanish.

Consider, for example, the monetary demands that come with major health scares or the loss of a job at a downsized company. Such factors can lead to personal and family crises and have the ability to spoil years of respectable credit if they remain a part of one’s life for an extended period of time. If the insurance company is unfamiliar with these private matters or does not wish to make exceptions for them, a person can be thought of as a high risk for auto and home coverage all because of temporary personal misfortune.

Credit Discrimination and Age One might also make the case that insurers’ use of credit histories results in age discrimination. Most young people have not lived long enough to establish much of a credit history, unless one counts the mounds of pre-approved credit card offers that have traditionally flooded the mailrooms of dormitories on college campuses and the hefty student loans that affect people’s finances well into adulthood.

In other cases, a person might be in the uncomfortable position of being legally responsible for someone else’s bad credit and might need to pay the price for the other party’s actions in the form of overly expensive insurance. Think again about the credit predicament of the recently divorced woman, but this time, imagine that the former husband had run up major debts on accounts that he had access to but were in her name. Until those debts are paid off or the matter is settled in some other way, the woman’s credit score will remain much lower than it probably should be, and she could face steep insurance premiums to cover her home and car.

The use of credit reports and scores could also work against elderly people who, based on conservative tradition and habit, avoid purchasing many items on credit and have low credit scores as a result.

Credit Discrimination and Gender The use of credit reports and scoring also leaves the door open, inadvertently or otherwise, for gender discrimination in insurance. Granted, financial independence among women in the United States seems to become more common with the passage of each generation. However, the country clearly has not yet achieved a goal of true equality between the sexes.

THE PROS AND CONS OF CREDIT SCORING IN AUTO INSURANCE Although credit has influenced the availability and pricing of homeowners insurance, the majority of credit-related complaints that insurers receive from customers seem to come from motorists who claim that an insurer has unfairly raised their auto premiums. Auto insurers, though, have responded on the contrary, saying that their use of credit histories actually promotes two kinds of fairness: fairness to the industry, which must carefully absorb risk, and fairness to customers, whose premiums should be measured against the rest of a company’s risk portfolio and priced accordingly.

The passage of the Equal Credit Opportunity Act three decades ago disallowed any denial of credit based on a person’s gender, and yet, some women might still have less impressive credit histories than men, particularly in the case of a recent divorcee who was not legally connected to all of an ex-husband’s accounts.

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PROTECTING CONSUMER RIGHTS Auto insurance underwriters are already at somewhat of a disadvantage because so many accidents go unreported, leaving people’s driving records incomplete and potentially allowing unsafe drivers to obtain cheap coverage. If auto insurers want to compensate for such instances of unfairness against themselves and other policyholders, they must consider additional variables that might help them assess insurability. In the eyes of some insurance professionals, credit reports and credit scores serve this very purpose.

CREDIT-BASED UNDERWRITING IN PRACTICE Some consumers and insurance professionals do not necessarily have a problem with credit being a factor in insurance rates, but they wish the industry would use the information contained in credit reports in a uniform manner. At the very least, they wish that carriers would disclose the different ways they use the data. Some insurers have used credit scores obtained from Fair Isaac or one of the three credit bureaus to judge insurability. Some have used only portions of the bureaus’ credit reports.

DEFENDING CREDIT-BASED UNDERWRITING Insurers have defended their use of credit reports and credit scores. The next few sections summarize some of their arguments.

Others have relied on a combination of credit information and other factors of their own choosing and have formulated a customized insurance score. But the general methods used and the elements that make up each insurer’s scoring formula have often been difficult to understand. This was especially the case back in the 1990s, when credit was still emerging as an underwriting tool for property insurers.

The Study Defense Many people are not opposed to some instances of creditbased underwriting and pricing, but they still criticize the industry for not putting forth enough effort to address potential discrimination.

Even among insurers who use credit in the same numerical way to determine insurability, companies often apply their numbers differently when dealing with consumers. One company might use credit data when setting policy rates, while a company across the street might use the same data strictly as a guide when making more general underwriting decisions.

As their defense, some insurance producers have claimed that a major study of discrimination would involve analyzing data that they do not have at their disposal. In keeping with various privacy and equal protection laws, insurers cannot require applicants to disclose such personal information as race and ethnicity. So, by upholding laws and professional standards designed to prevent direct discrimination, insurers have found themselves without the data that they would need to examine indirect discrimination.

The industry has debated within itself about which customers should be credit-checked. One camp has supported credit inquiries solely for new customers, while another has said credit considerations should apply to existing customers, too, and should give insurers opportunities to cancel or refuse to renew a policy.

The Income Defense When countering attacks from people who accuse the industry of discriminating against low-income applicants, some insurance professionals preach about the purpose and formulation of credit reports and credit scores.

Insurers’ secrecy regarding their use of people’s credit histories has left some consumers confused, not understanding, for example, why they obtained a mortgage loan with a relatively limited amount of hassle but are paying a bundle to insure the family station wagon. The sometimes tight-lipped approach to the use of credit information can also make it difficult for prospective insureds to shop around in search of an insurer whose views on credit will best benefit their situation.

In simplified terms, the reports and scores are not meant to show lenders, creditors and other parties how much money applicants make. Instead, they work toward a more analytical goal, helping inquirers interpret how well applicants manage the money that they earn, no matter the amount. Income is not even listed on a credit report. Nor is it a component of one’s credit score. Significant wealth does not disqualify someone from being assessed a low credit score and does not guarantee a person a high score.

CREDIT-RELATED CHALLENGES FOR INSURANCE PRODUCERS Independent insurance agents have also expressed frustration over some insurers’ credit-related practices. These agents complain about being left in the dark about how credit considerations might specifically apply to each individual customer, and some have lost potential business because they could not soothe the minds of people who worried about how their finances would affect their chances of obtaining preferred coverage.

The Legal Defense Many pro-credit insurance producers have responded to criticism with a legal defense. Credit scoring is permitted under the Fair Credit Reporting Act, and this law does not make an exception for insurance producers. Also, regulators, lawmakers and members of the judiciary have allowed the industry to engage in some forms of legal discrimination when the discrimination has been related to risk management. For example, younger drivers (who tend to be involved in more accidents than other types of drivers) can be charged more for auto insurance than middle-aged adults. Similarly, women (who have a higher life expectancy than males) can be charged less for life insurance than men.

Even agents who have been generally informed about an insurer’s underwriting guidelines have stated that the industry’s use of credit histories has made their jobs harder. When customers are confused about why an insurance company accesses their credit information, they expect the agent to explain the complex issue and the practices of various companies in an accurate, trustworthy manner.

From a purely legal perspective, many insurers contend that discrimination that results from the use of credit reports and credit scores is permissible, either because the discrimination is unintentional or because the correlation between credit and future losses is scientifically powerful enough to make discrimination acceptable.

Furthermore, some agents say the money they earn by selling credit-based policies does not compensate them enough for the administrative and legal headaches they might encounter on the job. It should be noted, however, that these internal criticisms seem to have died down in recent years as insurance 74

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PROTECTING CONSUMER RIGHTS Reporting Act. Insurers must also reevaluate policyholders’ rates whenever coverage is up for renewal.

companies have increased communication with independent agents regarding reasons for implementing credit-based underwriting.

Perhaps most significantly, the NCOIL model orders all insurers to disclose the ways in which they use credit information to state insurance departments. Insurance companies do not need to give this information to applicants, but they must inform consumers, at the application stage, that credit history may affect their coverage options. The following is a copy of the NCOIL model for your review:

CREDIT-BASED UNDERWRITING AND LAWSUITS Despite claims that the industry’s credit practices are legally permissible, history has validated agents’ fears in regard to lawsuits. Housing groups sued Citigroup’s Travelers Property Casualty Insurance, claiming that the company’s access to credit histories assisted the insurer in discriminating against people in poor communities. In a separate matter, a class action suit was filed against auto insurance giant Allstate for alleged unlawful racial discrimination when the company increased a Hispanic individual’s premiums by 25 percent, even though his insurance records contained only one claim and his only credit blemishes, as reported by Business Week, were two late payments to a gas station and hospital that added up to $131.

Model Act Regarding Use of Credit Information in Personal Insurance NATIONAL CONFERENCE OF INSURANCE LEGISLATORS MODEL ACT REGARDING USE OF CREDIT INFORMATION IN PERSONAL INSURANCE

No matter how an agent or broker feels about the use of credit information in the underwriting of insurance, these lawsuits suggest that insurers must carefully monitor how they incorporate information from credit bureaus into their underwriting guidelines. Perhaps, they also suggest that regulators must help insurers by clearly differentiating legally acceptable credit-based underwriting from illegal discrimination.

Adopted by the NCOIL Property-Casualty Insurance and Executive Committees on November 22, 2002. TABLE OF CONTENTS Section 1 Section 2 Section 3 Section 4 Section 5 Section 6

GOVERNMENT RESPONSES TO CREDIT REPORTS AND CREDIT SCORES IN INSURANCE Insurance regulation is generally a state issue, and many states have utilized their right to independence by making laws and adapting guidelines regarding credit-based insurance practices. A few states prohibit insurers from considering an applicant’s credit history under all circ*mstances. Other states have decided to walk on a middle ground and have allowed insurers to use a person’s credit history as an underwriting factor within reason. Some states have enforced, and many more have discussed, caps on rate increases that insurers may impose on policyholders based on creditworthiness.

Section 7 Section 8 Section 9 Section 10 Section 11 Section 12 Section 13

Perhaps the closest the country has come to developing a uniform position on credit-based insurance practices has been the adoption of the Model Act Regarding Use of Credit Information in Personal Insurance by more than half of the states. This model was developed by the National Conference of Insurance Legislators (NCOIL), and it states that insurers cannot cancel, deny or refuse to renew coverage because of credit without considering other underwriting factors that do not relate to credit. Insurers who wish to raise rates must adhere to those same standards. According to the model act, any adverse action taken by an insurer because of credit issues must be accompanied by a documented, clear explanation of the insurer’s reasoning.

SECTION 1. SHORT TITLE This Act may be called the Model Act Regarding Use of Credit Information in Personal Insurance. SECTION 2. PURPOSE The purpose of this Act is to regulate the use of credit information for personal insurance, so that consumers are afforded certain protections with respect to the use of such information. SECTION 3. SCOPE THIS ACT APPLIES TO PERSONAL INSURANCE AND NOT TO COMMERCIAL INSURANCE. FOR PURPOSES OF THIS ACT, “PERSONAL INSURANCE” MEANS PRIVATE PASSENGER AUTOMOBILE, HOMEOWNERS, MOTORCYCLE, MOBILE-HOMEOWNERS AND NONCOMMERCIAL DWELLING FIRE INSURANCE POLICIES [AND BOAT, PERSONAL WATERCRAFT, SNOWMOBILE AND RECREATIONAL VEHICLE POLICES]. SUCH POLICIES MUST BE INDIVIDUALLY UNDERWRITTEN FOR PERSONAL, FAMILY OR HOUSEHOLD USE. NO OTHER TYPE OF INSURANCE SHALL BE INCLUDED AS PERSONAL INSURANCE FOR THE PURPOSE OF THIS ACT.

The model specifically states that vague explanations, including “poor credit rating,” “poor credit history” and “poor insurance score” do not suffice. If an insurer utilizes an insurance scoring system, that system must not assign numerical values to applicants’ income, sex, religion, nationality or geography. Penalizing people based on the number of times their credit has been checked is also prohibited in most cases. The model recognizes the possibility of errors in credit reports and requires insurers who base rates on credit to reevaluate any wronged consumers, no later than 30 days after disputes are settled under provisions in the Fair Credit © Real Estate Institute

Short Title Purpose Scope Definitions Use of Credit Information Dispute Resolution and Error Correction Initial Notification Adverse Action Notification Filing Indemnification Sale of Information by Consumer Reporting Agency Severability Effective Date

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PROTECTING CONSUMER RIGHTS SECTION 4. DEFINITIONS

underwriting factor independent of credit information and not expressly prohibited by Section 5(A).

For the purposes of this Act, these defined words have the following meaning: A.

C. Base an insured’s renewal rates for personal insurance solely upon credit information, without consideration of any other applicable factor independent of credit information.

Adverse Action—A denial or cancellation of, an increase in any charge for, or a reduction or other adverse or unfavorable change in the terms of coverage or amount of, any insurance, existing or applied for, in connection with the underwriting of personal insurance.

D. Take an adverse action against a consumer solely because he or she does not have a credit card account, without consideration of any other applicable factor independent of credit information.

Affiliate—Any company that controls, is controlled by, or is under common control with another company.

C. Applicant—An individual who has applied to be covered by a personal insurance policy with an insurer. D. Consumer—An insured whose credit information is used or whose insurance score is calculated in the underwriting or rating of a personal insurance policy or an applicant for such a policy. E.

1. Treat the consumer as otherwise approved by the Insurance Commissioner/ Supervisor/Director, if the insurer presents information that such an absence or inability relates to the risk for the insurer.

Consumer Reporting Agency—Any person which, for monetary fees, dues, or on a cooperative nonprofit basis, regularly engages in whole or in part in the practice of assembling or evaluating consumer credit information or other information on consumers for the purpose of furnishing consumer reports to third parties.

2. Treat the consumer as if the applicant or insured had neutral credit information, as defined by the insurer. 3. Exclude the use of credit information as a factor and use only other underwriting criteria.

Credit Information—Any credit-related information derived from a credit report, found on a credit report itself, or provided on an application for personal insurance. Information that is not creditrelated shall not be considered "credit information," regardless of whether it is contained in a credit report or in an application, or is used to calculate an insurance score.

1. At annual renewal, upon the request of a consumer or the consumer's agent, the insurer shall re-underwrite and re-rate the policy based upon a current credit report or insurance score. An insurer need not recalculate the insurance score or obtain the updated credit report of a consumer more frequently than once in a twelvemonth period.

H. Insurance Score—A number or rating that is derived from an algorithm, computer application, model, or other process that is based in whole or in part on credit information for the purposes of predicting the future insurance loss exposure of an individual applicant or insured. SECTION 5. USE OF CREDIT INFORMATION

2. The insurer shall have the discretion to obtain current credit information upon any renewal before the 36 months, if consistent with its underwriting guidelines.

An insurer authorized to do business in [insert State] that uses credit information to underwrite or rate risks, shall not:

Use an insurance score that is calculated using income, gender, address, zip code, ethnic group, religion, marital status, or nationality of the consumer as a factor.

3. No insurer need obtain current credit information for an insured, despite the requirements of subsection (G)(1), if one of the following applies:

Deny, cancel or nonrenew a policy of personal insurance solely on the basis of credit information, without consideration of any other applicable

Take an adverse action against a consumer based on credit information, unless an insurer obtains and uses a credit report issued or an insurance score calculated within 90 days from the date the policy is first written or renewal is issued.

G. Use credit information unless not later than every 36 months following the last time that the insurer obtained current credit information for the insured, the insurer recalculates the insurance score or obtains an updated credit report. Regardless of the requirements of this subsection:

G. Credit Report—Any written, oral, or other communication of information by a consumer reporting agency bearing on a consumer’s credit worthiness, credit standing or credit capacity which is used or expected to be used or collected in whole or in part for the purpose of serving as a factor to determine personal insurance premiums, eligibility for coverage, or tier placement.

Consider an absence of credit information or an inability to calculate an insurance score in underwriting or rating personal insurance, unless the insurer does one of the following:

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PROTECTING CONSUMER RIGHTS insurer determines that the insured has overpaid premium, the insurer shall refund to the insured the amount of overpayment calculated back to the shorter of either the last 12 months of coverage or the actual policy period.

(a) The insurer is treating the consumer as otherwise approved by the Commissioner. (b) The insured is in the most favorably-priced tier of the insurer, within a group of affiliated insurers. However, the insurer shall have the discretion to order such report, if consistent with its underwriting guidelines.

Section 7. Initial Notification A.

If an insurer writing personal insurance uses credit information in underwriting or rating a consumer, the insurer or its agent shall disclose, either on the insurance application or at the time the insurance application is taken, that it may obtain credit information in connection with such application. Such disclosure shall be either written or provided to an applicant in the same medium as the application for insurance. The insurer need not provide the disclosure statement required under this section to any insured on a renewal policy, if such consumer has previously been provided a disclosure statement.

Use of the following example disclosure statement constitutes compliance with this section: “In connection with this application for insurance, we may review your credit report or obtain or use a credit-based insurance score based on the information contained in that credit report. We may use a third party in connection with the development of your insurance score.”

(c) Credit was not used for underwriting or rating such insured when the policy was initially written. However, the insurer shall have the discretion to use credit for underwriting or rating such insured upon renewal, if consistent with its underwriting guidelines. (d) The insurer re-evaluates the insured beginning no later than 36 months after inception and thereafter based upon other underwriting or rating factors, excluding credit information. H. Use the following as a negative factor in any insurance scoring methodology or in reviewing credit information for the purpose of underwriting or rating a policy of personal insurance:

SECTION 8. ADVERSE ACTION NOTIFICATION If an insurer takes an adverse action based upon credit information, the insurer must meet the notice requirements of both (A) and (B) of this subsection. Such insurer shall:

1. Credit inquiries not initiated by the consumer or inquiries requested by the consumer for his or her own credit information.

Provide notification to the consumer that an adverse action has been taken, in accordance with the requirements of the federal Fair Credit Reporting Act, 15 USC 1681m(a).

Provide notification to the consumer explaining the reason for the adverse action. The reasons must be provided in sufficiently clear and specific language so that a person can identify the basis for the insurer’s decision to take an adverse action. Such notification shall include a description of up to four factors that were the primary influences of the adverse action. The use of generalized terms such as “poor credit history,” “poor credit rating,” or “poor insurance score” does not meet the explanation requirements of this subsection. Standardized credit explanations provided by consumer reporting agencies or other third party vendors are deemed to comply with this section.

2. Inquiries relating to insurance coverage, if so identified on a consumer’s credit report. 3. Collection accounts with a medical industry code, if so identified on the consumer’s credit report. 4. Multiple lender inquiries, if coded by the consumer reporting agency on the consumer’s credit report as being from the home mortgage industry and made within 30 days of one another, unless only one inquiry is considered. 5. Multiple lender inquiries, if coded by the consumer reporting agency on the consumer's credit report as being from the automobile lending industry and made within 30 days of one another, unless only one inquiry is considered.

SECTION 9. FILING

SECTION 6. DISPUTE RESOLUTION AND ERROR CORRECTION If it is determined through the dispute resolution process set forth in the federal Fair Credit Reporting Act, 15 USC 1681i(a)(5), that the credit information of a current insured was incorrect or incomplete and if the insurer receives notice of such determination from either the consumer reporting agency or from the insured, the insurer shall reunderwrite and re-rate the consumer within 30 days of receiving the notice. After re-underwriting or re-rating the insured, the insurer shall make any adjustments necessary, consistent with its underwriting and rating guidelines. If an © Real Estate Institute

Insurers that use insurance scores to underwrite and rate risks must file their scoring models (or other scoring processes) with the Department of Insurance. A third party may file scoring models on behalf of insurers. A filing that includes insurance scoring may include loss experience justifying the use of credit information.

Any filing relating to credit information is considered trade secret under [cite to the appropriate state law]. www.InstituteOnline.com

PROTECTING CONSUMER RIGHTS things to consider when determining the ethical nature of an act.

SECTION 10. INDEMNIFICATION An insurer shall indemnify, defend, and hold agents harmless from and against all liability, fees, and costs arising out of or relating to the actions, errors, or omissions of [an agent / a producer] who obtains or uses credit information and/or insurance scores for an insurer, provided the [agent / producer] follows the instructions of or procedures established by the insurer and complies with any applicable law or regulation. Nothing in this section shall be construed to provide a consumer or other insured with a cause of action that does not exist in the absence of this section.

People who subscribe to this general line of moral reasoning can be divided into at least two categories. One group believes that acting ethically involves strictly upholding all laws and that acting unethically involves breaking any law in any way. People who base their decisions on this ethical philosophy are inclined to follow rules and laws even if they feel that the rules and laws are unjust. The second legalistic group believes that anything prohibited by law is unethical in all cases, and that all things allowed by law are ethical. Within the context of this course material, this second group would argue that as long as the law allows credit-conscious insurers to discriminate against some minorities (intentionally or otherwise), then engaging in that discrimination is ethical and justified. This philosophy coincides with some insurers’ defense that, because the Fair Credit Reporting Act permits credit scoring and does not make an exception for insurers, they can use credit scores with a clear conscience without worrying about how their actions might harm some consumers.

SECTION 11. SALE OF POLICY TERM INFORMATION BY CONSUMER REPORTING AGENCY A.

No consumer reporting agency shall provide or sell data or lists that include any information that in whole or in part was submitted in conjunction with an insurance inquiry about a consumer’s credit information or a request for a credit report or insurance score. Such information includes, but is not limited to, the expiration dates of an insurance policy or any other information that may identify time periods during which a consumer’s insurance may expire and the terms and conditions of the consumer’s insurance coverage.

Credit Scoring and Hierarchies of Responsibilities Ethical choices can also be made based on a hierarchy of responsibilities. Insurance producers serve the interests of clients and also the interests of insurance companies, but serving both parties equally is almost certainly impractical.

The restrictions provided in subsection (A) of this section do not apply to data or lists the consumer reporting agency supplies to the insurance [agent / producer] from whom information was received, the insurer on who’s behalf such [agent / producer] acted, or such insurer’s affiliates or holding companies.

If an agent or broker decides that relationships with customers are more important than what might be best for an insurance company (thereby subscribing to a “customer is always right” philosophy), that agent or broker might be inclined to oppose credit scoring in the industry when a client’s premiums would go up as a result of the practice.

C. Nothing in this section shall be construed to restrict any insurer from being able to obtain a claims history report or a motor vehicle report.

If an agent or broker ultimately feels responsible to the insurance company, he or she is likely to support the industry’s use of credit histories because it aids the insurer in the risk-assessment process and promotes solvency and profits.

SECTION 12. SEVERABILITY If any section, paragraph, sentence, clause, phrase, or any part of this Act passed is declared invalid due to an interpretation of or a future change in the federal Fair Credit Reporting Act, the remaining sections, paragraphs, sentences, clauses, phrases, or parts thereof shall be in no manner affected thereby but shall remain in full force and effect.

Other insurance producers might look beyond business and believe that they have an overall responsibility to society at large. In that case, they are likely to believe that all kinds of discrimination are wrong and that insurance should be affordable for people from all walks of life, regardless of credit history.

Weighing the Pros and Cons

SECTION 13. EFFECTIVE DATE

Sometimes a person’s perception of what is ethical relates to the negative consequences that are involved with a particular act. Within this ethical framework, people base their decisions on their desire to avoid the least favored outcome.

This Act shall take effect on [insert date], applying to personal insurance policies either written to be effective or renewed on or after 9 months from the effective date of the bill. © 2002 National Conference of Insurance Legislators

A major negative consequence of using credit history in insurance is that some applicants are bound to be displeased about having to pay more for coverage and might develop bitterness toward the industry. If credit histories are not considered, the major negative consequence is that insurers will lack valuable tools that could assist them in their underwriting and pricing.

AN ASSORTMENT OF ETHICAL THEORIES Figuring out what is “right” or “wrong” in regard to insurance and credit information can involve several ethics-based thought processes. Let’s end this chapter by considering a few of them.

Credit Scoring and Legalistic Theories

On other occasions, people’s views on what is ethical and what is unethical relate to the number of people who will benefit from an act or the amount of overall good that an act might produce.

All insurance professionals need to be aware of the laws that dictate proper conduct in their respective states, as well as the general contents of federal laws pertaining to credit reporting. For some people, in fact, laws are the only © Real Estate Institute

Because some studies have determined that more consumers actually benefit from credit being a factor in 78

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PROTECTING CONSUMER RIGHTS insurance than are harmed by it, an ethical choice might be to promote the use of credit information. If an insurance professional feels that ethical choices must benefit as many people as possible but not necessarily satisfy the ultimate desires of a majority, he or she might determine that permitting credit-based decision-making on a limited basis is the most ethical solution.

HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996 - HIPAA INTRODUCTION Why HIPAA Exists Not unlike the lawmakers who debated major health reforms in 2009 and 2010, elected officials in the early-tomid-1990s fought fierce battles over what role the government ought to play in the U.S. health care system. Although opponents of greater federal involvement successfully beat back the Clinton administration’s attempt at achieving universal insurance coverage, people on both sides of the argument agreed there were at least two major problems worth addressing.

CONCLUSIONS There are obviously many ways to approach and interpret the ethics involved with the use of credit scores by insurers. Yet although a person might have firm opinions about the most ethical way to deal with the issue, a reasonable professional should be able to recognize that both sides of the debate have some valid concerns and points. Unlike other debates that have gone on among insurance professionals, lawmakers and consumers, this topic and the conflicts related to it do not pit the “good guys” against the “bad guys” or lend themselves to an obvious resolution.

One of those was a predicament known as “job lock.” At a time when technological innovations were sparking many people’s desire to open new businesses, some workers still clung nervously to their same old jobs. As much as they may have wanted to pursue opportunities at different companies, workers with pre-existing health problems had no guarantee that they would be eligible for coverage through a new employer’s insurance plan. Likewise, even if a healthy employee could count on getting coverage for himself through a new job, he couldn’t bet that his cancersurviving wife or his diabetic child would be eligible too. Rather than risk losing essential health benefits for themselves and their families, these workers would often play it safe and stay in unfulfilling careers.

With that in mind, agents and brokers might be tempted to merely throw up their arms in a sign of frustrated resignation and convince themselves that the abundant ethical gray areas will never allow the insurance industry to discover a uniformly acceptable approach to credit-based underwriting. However, it may still be premature to jump to such an open-ended conclusion. No matter which side of the credit scoring issue an agent or broker is on, it is perhaps helpful to remember that one reason why professional insurance producers care about ethics in the first place is that they want their industry to reach certain ideal heights.

The two sides also generally agreed health care needed to be administered more efficiently and that delivering it would be simpler if there was a set of national standards for doctors and insurers to follow when handling electronic transactions. But just imposing those standards and encouraging greater utilization of electronic health records wouldn’t be enough to please patients and providers.

Of course, these great expectations for their business relate, in some ways, to financial gain. But for the true professional, they also involve gaining public trust and improving people’s sometimes unfavorable perceptions of the typical agent, broker and insurance company.

The concept of the internet was still relatively new to many Americans, and even those who were fine with sending some data through computer networks weren’t entirely comfortable with the possibility of their medical information being intercepted by hackers and identity thieves. If the government wanted sensitive information to be shared in new ways, it would need to ensure that people’s privacy would remain intact.

With these ideals in mind, the industry owes it to itself and to its customers to recognize those situations in which discrimination disguised as credit-based underwriting is clearly evident. Over time, observant professionals might notice patterns that could strongly support, refute or refine the results of the studies that have already been done on the subject of credit-based underwriting. Insurers could then incorporate these patterns into their business practices and perform the immeasurably important task of educating the public about how the industry treats credit information, and about how insurance professionals base that treatment on their ethical obligations.

Congress tackled those basic concerns on a bipartisan basis by passing the Health Insurance Portability and Accountability Act of 1996, known more simply as “HIPAA.” Full implementation of HIPAA was delayed at first by a rush of public comments about the law and then by changes in the leadership at the Department of Health and Human Services after Clinton left office. But by the middle of the first decade in the 21st century, anyone who was providing or receiving medical services was feeling the effects of one our country’s most significant health care laws.

General Overview of HIPAA So, what exactly did HIPAA do? A detailed answer to that question is what this course is all about. But as a starting point, here are some of the areas in which HIPAA has had the greatest impact:

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Thanks to HIPAA, new employees and their dependents have the right to join an employer’s group health plan regardless of their health status.

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Thanks to HIPAA, people who are insured through a group health plan can be covered for preexisting medical conditions after a special waiting period has passed. www.InstituteOnline.com

PROTECTING CONSUMER RIGHTS exist in the actual law and regulations. If you’re working with clients and have access to their health information, we strongly suggest you review HIPAA thoroughly on your own or at least consult an expert who is familiar with your specific situation.

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Thanks to HIPAA, doctors and health plans generally can’t disclose a patient’s medical information without the person’s consent.  Thanks to HIPAA, most doctors and health plans are required to take security-related measures to keep medical information safe.  Thanks to HIPAA, there are uniform procedures for doctors to follow when billing electronically for treatment.  Thanks to HIPAA, purchasers of long-term care insurance can receive federal tax breaks. Our focus will be on the first four of those points.

INSURANCE PORTABILITY AND NONDISCRIMINATION RULES Enrollment Rights and Nondiscrimination HIPAA attacked the problem of job lock by making it illegal for a group health plan to discriminate against someone on the basis of health. As simple as that prohibition may seem, we won’t be able to fully grasp its importance unless we know what is meant by words like “discrimination” and “health.”

Why Take This Course?

At least as far as HIPAA is concerned, a group health plan would be discriminating against you in all of the following cases:

Although HIPAA was passed more than a decade ago, the government’s incremental approach to implementing it has meant that the full range of protections within the law has only been available to the public for a few years. Add on the law’s amount of detail and complexity, and it shouldn’t surprise you to learn that people often are unaware of some of HIPAA’s most important features and misinformed about some of its requirements. At their worst, these misunderstandings have left consumers without valuable insurance coverage and exposed some well-meaning professionals to liability.

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You are denied membership into the group plan. You are required to pay higher premiums than other group members.  You are provided fewer insurance benefits than other group members.  You are required to make higher co-payments than other group members.  You are required to pay higher deductibles than other group members.  You are required to wait longer for coverage to begin than other group members. Though there are some factors that could cause you to be treated differently than other enrollees in a group plan, your health can’t be one of them. Therefore, you can’t be treated differently because of:

The consequences of not understanding HIPAA’s insurance portability provisions have been amplified by the country’s recent economic troubles. Out of the millions of Americans who lost their jobs due to the recession, how many of them were aware of the option to immediately become covered under a spouse’s plan? How many unemployed workers with pre-existing health problems were worried about exhausting their COBRA benefits and didn’t realize some insurance would still be available to them? Even among families who got through an unemployment crisis without facing a medical emergency, being made aware of these and other HIPAA-mandated protections could’ve resulted in one less thing to worry about.

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A physical or mental condition you currently have A physical or mental condition you previously had Your history of making health insurance claims Genetic information that suggests you are susceptible to medical problems  Behavioral, lifestyle or environmental factors that suggest you might file health insurance claims (such as playing extreme sports, being in a physically abusive relationship or having made a suicide attempt) One thing you’ll realize quickly about HIPAA, though, is that there are plenty of exceptions to its rules and plenty of particulars to keep in mind. We can see this right away in the nondiscrimination rules.

Noncompliance with HIPAA’s privacy rules has created unfortunate situations involving either one of two extremes. On one hand, there have been examples of medical personnel being completely ignorant of the rules by posting people’s x-rays on social networking websites and selling celebrities’ medical information to gossip publications. However, there have also been instances in which a doctor or nurse has leaned too heavily on the law and prevented a patient’s loved ones from receiving important information in an emergency. In between those extremes, there are countless cases of professionals who have wanted to do the right thing but have been unsure about what HIPAA allows or prohibits.

Does Everyone Get Covered?

If you and your clients want to get the most out of HIPAA, you’ll have to learn about the law prior to losing your insurance and before being faced with a health crisis. Throughout this course, we’ll try to give you a strong background in your rights and responsibilities under the law in a wide variety of common situations. In some cases, you might be surprised to read about protections you didn’t know existed. Alternatively, you might discover that some broad exceptions to these rules leave you with fewer protections than you expected.

Although HIPAA prohibits discrimination on the basis of health, it doesn’t force employers to offer coverage to all their employees. It only prevents them from denying participation in a group plan for medical reasons. So, for example, the law doesn’t force an employer to have a health plan, and it doesn’t stop the health plan from discriminating against people for non-health reasons. A plan that covers full-time employees but excludes part-time workers isn’t violating HIPAA.

Can You Reward Healthy People?

Either way, please be advised that the totality of all HIPAArelated rules could fill several hundred pages. So while you’ll find plenty of information here, a course like this can’t possibly address all the details and all the nuances that © Real Estate Institute

Many group health plans reward people who have healthy lifestyles. It’s not uncommon for employees to pay less for 80

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PROTECTING CONSUMER RIGHTS their insurance if they maintain a good weight or don’t smoke.

words, some of things an insurer can’t do to one person are permissible if they are done to everyone in the plan.

There are obvious benefits to having a healthy workforce, but employers and group plans need to understand that a person’s weight and smoking habits are considered health factors. Therefore, giving preferential treatment to nonsmokers or thinner people can amount to a HIPAA violation if special rules aren’t followed.

While HIPAA doesn’t let insurers charge individual group members more for coverage because of their health, it lets insurers base premiums for the entire group on the collective health of its members. For instance, a plan covering a mix of healthy and unhealthy people can charge its members more than a plan that has nothing but healthy members in it. Since the two groups represent a different amount of risk, there can be a difference in price.

Plans that reward healthier people are allowed if they give unhealthy people an alternative way of qualifying for the same reward. For instance, a plan rewarding non-smokers might also opt to reward smokers who enroll in a smoking cessation program. A plan rewarding physically fit employees might also opt to reward overweight employees who agree to follow an exercise regimen. We’ll go over the exact rules for these kinds of plans in another part of the course.

Charging one group more than another because of health reasons is allowed if the cost is shared equally among group members. If an employee’s cancer treatments cause a company’s health insurance premiums to rise, everyone in the company’s plan will have to pay the same additional amount. The employee with cancer can’t be singled out and asked to pay more.

Can You Exclude Pre-Existing Conditions?

Limits on Pre-Existing Conditions Under HIPAA, group health plans are allowed to temporarily exclude coverage of pre-existing conditions. A pre-existing condition is any physical or mental health problem that you were treated for or diagnosed with within the six months prior to enrolling in your health plan.

In spite of HIPAA’s nondiscrimination rules, you can still be denied coverage for a medical condition that predates your enrollment in a group health plan. However, this kind of exclusion can only last for a limited time, and it can’t be applied differently to other people in the plan on the basis of their health. A plan that immediately covers pre-existing cases of cancer but has a six-month waiting period for preexisting cases of heart disease is not compliant with HIPAA.

Suppose you were treated for asthma three months ago and have just enrolled in a group health plan with your new employer. Since you were treated within six months prior to enrolling, your new plan can refuse to pay for asthma treatment for a limited time.

Pre-existing conditions are another topic we’ll discuss again later in more detail.

A plan’s ability to exclude pre-existing conditions can seem scary, particularly to people who have serious health problems and can’t afford a break in benefits. But group participants can take comfort in knowing there are some consumer protections built into these exclusions. Let’s address them by answering some common HIPAA-related questions.

Does a Plan Need to Cover My Particular Condition? Some state and federal laws have created minimum standards regarding what kinds of treatment must be part of a health plan or individual policy. HIPAA generally isn’t part of that group.

Do Pre-Existing Conditions Affect Coverage of New Ailments

Under HIPAA, health plans aren’t prohibited from excluding coverage of specific medical problems or putting limits on coverage of specific treatments. Theoretically, for example, the law doesn’t stop a plan from refusing to cover any kind of treatment related to kidney failure or from putting a dollar-based cap on coverage of that treatment.

A pre-existing condition doesn’t prevent you from being covered for any new medical problem you encounter after enrolling in a plan. Even if the asthma patient in our previous example is forced to wait three months before asthma treatment will be covered, there won’t be a threemonth wait for other kinds of benefits.

On the other hand, HIPAA does force group plans to apply those kinds of limits or exclusions equally among participants. So if there is a limit for treatment related to kidney failure, the limit can’t only apply to people who already have kidney problems. Similarly, even if a plan excludes coverage for kidney problems, you still can’t be excluded from the plan altogether due to a kidney problem. For better or worse, you are entitled to the same benefits as your peers.

Don’t confuse this kind of waiting period with one that applies to all new group members. Some plans require new enrollees to wait a certain amount of time (often two or three months) before they can be eligible for any health coverage at all. This kind of waiting period is allowed by HIPAA. It just can’t be lengthened or shortened depending on a new applicant’s health status. If a healthy person and an unhealthy person enroll at the same time, coverage of non-pre-existing conditions needs to begin for both of them at the same time.

Can a Plan Still Require Medical Information From Enrollees? In effect, HIPAA’s nondiscrimination rules mean you don’t have to pass a physical examination to enroll in a group health plan. The key word there is “pass.” A plan is still allowed to require an exam, and it can still make you complete a medical questionnaire. But the results can’t be used to treat you differently than everyone else in your group.

What About Old Injuries? Something is only a pre-existing condition if you were treated for it or diagnosed with it within six months prior to joining your group plan. If your last treatment for something was administered before those six months, you don’t have a pre-existing condition. To demonstrate this point, let’s imagine a woman with a history of back problems. If she receives treatment for her back, goes at least six months without further treatment and then enrolls in a group health plan, she won’t have to wait to be covered for back problems.

Must All Groups Be Treated Equally? Other than a few exceptions that we’ll cover later, HIPAA’s nondiscrimination rules are meant to protect individuals within a group plan, not the group as a whole. In other © Real Estate Institute

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PROTECTING CONSUMER RIGHTS Regardless of the plan’s chosen waiting period, it must be applied equally to all enrollees. You can’t extend someone’s waiting period because they have a particular health problem.

Do Treatment and Pre-Existing Conditions Need to Be Closely Related? A waiting period for pre-existing conditions only applies to treatment that is directly related to one of those conditions. Treatment that is only indirectly related to a pre-existing condition is supposed to be covered right away.

Do Group Members Need to Be Told About Their Rights?

Think of a person who is diagnosed with a terminal illness and then applies for group coverage a week later. Treatment for the illness could be temporarily excluded because the illness is a pre-existing condition. But if the illness makes the person weak and the person falls after enrolling and breaks their hip, the hip injury shouldn’t be considered a pre-existing condition. Treatment for the hip ought to be covered because the relationship between it and the illness is only indirect.

When a health plan gives you enrollment forms, you also need to receive a notice about pre-existing conditions and the possibility of a temporary exclusion. While processing your enrollment, the plan will apply “creditable coverage” to the exclusion, which can reduce your waiting period. (We’ll explain creditable coverage shortly.) Once creditable coverage is applied, you will receive another notice explaining the exact duration of the exclusion. If a plan doesn’t provide these notices in a timely fashion, it won’t be allowed to enforce a waiting period.

Is Pregnancy a Pre-Existing Condition? Group health plans aren’t allowed to treat pregnancy as a pre-existing condition. Despite this parent-friendly feature, HIPAA doesn’t guarantee a plan will cover the entire cost of pregnancy or childbirth, and it doesn’t force a company’s employee-only plan to cover children or other dependents.

The plan doesn’t need to give you the second notice if you won’t be subjected to a waiting period. A notice doesn’t need to state which specific conditions will be excluded.

Are Genetic Conditions Pre-Existing Conditions?

HIPAA’s rules regarding nondiscrimination and pre-existing conditions need to be followed by any health plan that has at least two participants at the start of a plan year. Those two participants must be employees of the plan’s sponsor. (In general, a business that institutes a health plan for its employees is that plan’s sponsor.) If a plan starts with two participants but drops down to one participant, the remaining person will retain HIPAA rights for the rest of the plan year.

Do All Health Plans Need to Follow the Rules Regarding Pre-Existing Conditions?

Whether a genetic condition is a pre-existing condition depends on when you were diagnosed or treated. If you were diagnosed with the condition or treated for it within the six months prior to your enrollment in the plan, it’s a preexisting condition. If not, it isn’t a pre-existing condition. Consider a man with a genetic heart defect. If his condition is unknown to him when he enrolls in a group plan, the plan wouldn’t be able to treat the defect as a pre-existing condition. But if he happened to be diagnosed with the defect a week before enrolling, he’d be subjected to a waiting period.

If you are applying for insurance outside of a group, HIPAA’s rules about nondiscrimination and waiting periods might not protect you. Much will depend on whether your previous insurance was provided through a group. Details on this subject will be mentioned later.

How Long Can a Plan Exclude Pre-Existing Conditions?

Voiding Limits on Pre-Existing Conditions

If you have a pre-existing condition and enroll in a group plan, the plan can refuse to cover treatment of that condition for 12 months. If you are considered a “late enrollee,” the exclusion can be extended to 18 months. (Late enrollees are people who didn’t enroll in a plan when they first had the chance but enrolled when given another opportunity.)

If you were recently covered by other health insurance and are now enrolling in a group plan, you can use your old insurance to help reduce or even eliminate the waiting period for pre-existing conditions. The waiting period in your new plan will be shortened by the amount of time you were previously covered. For example, if you switch jobs and were covered under your old employer’s plan for 12 months, those 12 months would be subtracted from your new waiting period for preexisting conditions. In this case, coverage of pre-existing conditions under your new plan would begin immediately.

Let’s say a company has just hired two employees named Matt and Marta. Matt has a pre-existing condition and enrolls in the company’s health plan right away. Since he isn’t considered a late enrollee, the plan can impose a 12month waiting period for coverage of his condition. Marta decides not to enroll immediately but is given another chance to enroll a year later. Marta chooses to enroll at that time but has just been diagnosed with a medical problem. Since she is considered a late enrollee, the plan can make her wait 18 months before it will cover her condition.

Now let’s modify the situation a bit and pretend you were only covered at your old job for nine months. The nine months would be subtracted from your new waiting period for pre-existing conditions, giving you a new waiting period of three months. (Of course, both of these examples assume you aren’t a late enrollee. If you were a late enrollee, your prior coverage would be subtracted from 18 months instead of 12.)

If a plan has a waiting period that applies to all new members regardless of health, the waiting period for preexisting conditions must begin at the same time. So if all new employees at Matt’s company are required to wait three months before they can be covered by a plan, coverage for Matt’s pre-existing condition would need to begin no later than nine months after that three-month waiting period is over. (12 months – 3 months = 9 months.)

Old coverage that reduces your new waiting period is called “creditable coverage.” The use of creditable coverage has kept many sick people away from financial disaster, but it has its limits. If you allow yourself to go uninsured for more than 62 consecutive days, your old insurance can’t be used anymore as creditable coverage.

The 12-month and 18-month waiting periods set by HIPAA are maximum standards. A health plan has the option of imposing shorter waiting periods or even no waiting periods at all. © Real Estate Institute

Pretend you worked for a company and were covered by the company’s plan for a year. Then, after being laid off, you chose not to purchase any health insurance. After being unemployed for six months, you’ve been hired by 82

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PROTECTING CONSUMER RIGHTS opt for COBRA benefits and they expire, you will get another certificate when they end.

another company and have enrolled in a new plan. Since you went more than 62 days without insurance, you won’t be able to reduce the waiting period for pre-existing conditions.

If you aren’t eligible for COBRA continuation coverage, the certificate should be given to you within a reasonable time. You can also ask for a free certificate at any time within 24 months of losing coverage.

To become more fully acquainted with creditable coverage, let’s answer a few key questions.

If something prevents you from receiving a certificate, you can prove you have creditable coverage in other ways. Instead of giving your new plan a certificate, you might provide billing statements from your previous insurer or old pay stubs showing payroll deductions for insurance.

What Can Count As Creditable Coverage? Nearly any kind of health insurance can be counted as creditable coverage, including:          

Group coverage Individual coverage COBRA coverage Medicare coverage Medicaid coverage Coverage from a military health plan Coverage obtained through the Peace Corps Coverage obtained through a state high-risk pool Coverage from the Indian Health Service Coverage under another country’s public health plan

Health plans can’t have a deadline for you to prove creditable coverage. But if you get into a dispute about a pre-existing condition, keep in mind that other laws may give you a deadline for appealing a denied clam.

Rules for Wellness Programs Researchers have concluded that a significant amount of health care costs can be attributed to preventable ailments. With premiums rising on a seemingly never-ending basis, it’s no wonder plan sponsors are taking steps to encourage healthier living among their employees. Programs that promote health to group members are known as “wellness plans” or “wellness programs.” Companies have found that the best way to increase participation in a wellness program is to offer direct financial incentives to their employees. These incentives might include cheaper health insurance, a waiver of certain deductibles or the chance to receive gifts. (For a few examples of wellness programs, see the section “Can You Reward Healthy People?” from earlier in this course.)

Does the 62-Day Rule Still Apply While People Are Going Through Waiting Periods? If you’ve enrolled in a plan but are required to go through a waiting period before any coverage can go into effect, the waiting period can’t have a negative impact on your creditable coverage. For example, assume you were unemployed and uninsured for 60 days and have just enrolled in your new employer’s plan. The plan forces all new employees to wait 30 days before their coverage can go into effect. Even though you technically will end up being uninsured for 90 days, only the first 60 of those days will be used to determine your right to creditable coverage. From HIPAA’s perspective, you were only uninsured for 60 days, and your previous coverage can still be used to reduce any waiting period for preexisting conditions.

If a company is planning on offering employees incentives as part of a wellness plan, the incentives can’t be given on a discriminatory basis. Rewarding employees for simply participating in a wellness program isn’t discriminatory. But tying those incentives to an employee’s personal health can be against the law. To be compliant with HIPAA, a wellness plan that rewards anyone for their health must adhere to several rules. Let’s go over them one by one.

In cases where an individual health insurance policy must comply with HIPAA, the rules about creditable coverage must be obeyed. If you submit an application for an individual policy and are not immediately approved, your waiting period for approval won’t be counted toward your 62 days.

Design of the Plan The wellness plan must be designed to promote health in a reasonable way. It is illegal to design something with the intent of discriminating against someone and then try to pass it off as a wellness plan.

Chances to Qualify

Are the Rules About Creditable Coverage the Same for All Group Plans?

Employees must be given the chance to qualify for the wellness plan at least once a year.

The consumer protections in HIPAA are minimum standards. If it wants, a health plan can use a longer cutoff point for creditable coverage than 62 days. It can also expand the list of previous insurance that qualifies as creditable coverage.

Size of Rewards No matter the kind of reward a wellness plan offers, the value of the reward can’t be greater than 20 percent of the cost of covering the individual. The cost of coverage includes the portion paid by the employee and the portion paid by the employer. It can also include the cost of insuring the employee’s dependents if they are eligible to participate in the wellness plan.

How Do You Prove You Have Creditable Coverage? When you leave a health plan, either the plan itself or the insurer behind it is required to give you a “certificate of creditable coverage.” This document proves you were covered by the plan.

Reasonable Alternatives If a wellness plan is going to reward people for being in good health, there needs to be a reasonable alternative way for unhealthy people to qualify for the same reward. The alternative is reserved for cases in which adhering to the plan’s regular standards would be unreasonable for a particular employee or would put the employee’s health at risk.

The certificate of creditable coverage should be given to you no later than when you receive a notice about COBRA continuation coverage. (COBRA is a law that allows many unemployed people to keep their group coverage for a limited time if they pay for it entirely out of pocket.) If you © Real Estate Institute

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PROTECTING CONSUMER RIGHTS enrollment.” Special enrollment occurs when you aren’t a new employee but are allowed to immediately enroll in a group health plan. Depending on the circ*mstances, special enrollment rights can also extend to your dependents, such as your spouse and children.

For a few examples, let’s think back to plans that reward people for not being overweight or not smoking. Since it would not be reasonable or medically advisable for a grossly overweight employee to slim down dramatically over a very brief period of time, the employee might have the alternative option of enrolling in an exercise program. Since it would be unreasonable to expect a lifelong smoker to suddenly quit the habit, an employee might be given the alternative option of enrolling in a smoking cessation program.

Under normal conditions, the option to enroll in a group plan is only available for a limited time. Employees typically can enroll when they are hired, but if they decline this option, they won’t have the chance to enroll again until the plan’s “open enrollment period.” The open enrollment period tends to last for one month each year, and anyone who enrolls during that timeframe might be subjected to an 18-month waiting period for pre-existing conditions (rather than the usual 12-month wait). Employees who decline coverage when they’re hired but opt to enroll during a later open enrollment period are known as “late enrollees.”

Reasonable alternatives for wellness plans can’t force employees to achieve a particular health-related outcome. For the employee enrolled in the exercise program, this means the plan can’t require that the person slim down to a certain weight or body-mass index. For the employee in the smoking cessation program, it means the person still can’t be forced to quit. In both examples, simply participating in the program would need to be enough for the employee to be rewarded.

Insurers believe restrictions on open enrollment are necessary to prevent people from gaming the system. If people were allowed to enroll in group plans at any time, some of them would not choose to do so until they got sick and were in a position to actually use their benefits.

Though plans need an alternative for their wellness programs, they have some leeway in deciding what the alternative should be. As long as it is reasonable for all employees, a single alternative can be used for everyone in the group. On the other hand, a plan has the option of tailoring the alternative to an employee’s individual needs. So if a disability prevents an employee from enrolling in an exercise program, the plan can work with the person to come up with another way of qualifying for the reward.

But prior to HIPAA, these restrictions were occasionally detrimental to people who had declined insurance from their employer because they were already covered under another plan. If a husband and wife both worked but were only covered under the husband’s plan, the family would have had few insurance options if the husband had lost his job.

If a reasonable alternative can’t be found for a particular employee, the plan might simply waive eligibility requirements for that person. In any case, the plan can require a doctor’s note in order for you to be eligible for a reasonable alternative.

Notice of Alternatives

HIPAA makes it possible for employees, spouses and dependents to enroll in a group plan outside of the plan’s open enrollment period. In this kind of “special enrollment,” a person is not treated as a late enrollee and, therefore, is entitled to coverage for pre-existing conditions after no more than 12 months.

All materials that describe a wellness plan to employees must mention the existence of a reasonable alternative. They do not need to mention what the alternative is. That can be worked out between the plan and the employee.

Special enrollees can’t be charged more than other members of a group and can’t be subjected to different exclusions. In other words, they need to be treated as if they had enrolled when they were first hired.

The U.S. Department of Labor has suggested using the following language in a wellness plan’s materials:

Special enrollment can only be done in certain situations. It can’t be done just because you’re unhappy with the cost of your current coverage, and it can’t be done just because you’ve become ill. Let’s go over the times when it would be possible.

If it is unreasonably difficult due to a medical condition for you to achieve the standards for the reward under this program, call us at (insert plan’s telephone number) and we will work with you to develop another way to qualify for the reward.

Lost Coverage You, your spouse and your dependents can enroll in your plan as special enrollees when any of you lose other health insurance. Circ*mstances that might cause you to lose your insurance and become eligible for special enrollment include:

Applicability of Rules for Wellness Plans The rules we’ve just mentioned don’t apply to all kinds of wellness plans or all kinds of rewards. They are only for plans that base rewards on a health factor. A plan that merely requires that employees attend seminars about healthy lifestyles wouldn’t need to abide by these specific rules.

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A plan that promotes wellness by reducing or eliminating co-payments for preventive care usually doesn’t need to follow the rules either. As long as the effect on copayments is applied to preventive care for all enrollees, the plan is not discriminating on the basis of health.

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Still, like the rest of HIPAA's nondiscrimination rules, these consumer protections don’t extend beyond the health plan. So even though the health plan can’t discriminate against you for smoking, HIPAA doesn’t stop an employer from imposing a no-smoking policy in the workplace.

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You were covered by a spouse or dependent’s plan, and the spouse or dependent has become unemployed. You were covered by a spouse or dependent’s plan, and the spouse or dependent’s employer has discontinued the plan. You were covered by a spouse or dependent’s plan, but your spouse or dependent’s employer has shifted the cost of the plan entirely to its employees. You were covered by a spouse or dependent’s plan and reached your lifetime benefit limit.

Special Enrollment Rights Some of the most important yet unpublicized rights available to you through HIPAA pertain to “special © Real Estate Institute

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PROTECTING CONSUMER RIGHTS regained their special enrollment rights at that point. Since they eventually opted against enrolling because they were covered by a different plan, they can enroll in the wife’s plan if they lose their insurance. Their reason for declining it the first time won’t have any effect on them anymore.

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You were covered by a spouse or dependent’s plan, but the spouse or dependent has lost coverage due to a reduction in work hours.  You were covered by a spouse or dependent who has died.  You were a spouse or dependent on someone else’s insurance but aren’t a spouse or dependent anymore. (This includes cases of spouses getting divorced and children reaching adulthood.) Your special enrollment rights extend to your spouse, and your spouse’s special enrollment rights extend to you. So if you lose your insurance, you can immediately enroll in your spouse’s health plan. And if your spouse loses his or her insurance, your spouse can immediately enroll in your plan.

Finally, although you can go without insurance for yourself and still have special enrollment rights in regard to your employer’s plan when your spouse loses his or her coverage, your spouse and other dependents generally can’t specially enroll in your plan unless they’ve lost coverage of their own. (There are a few exceptions that we’ll address in the next two sections.) Let’s imagine that two parents each have coverage through their own employer but chose not to insure their child. If the mother loses her insurance, she can enroll in the father’s plan, but their child will not be able to join at the same time. Since the child was not the one who lost coverage, coverage for the child can only be obtained during an open enrollment period.

As long as one spouse loses coverage, both spouses have special enrollment rights. So if a husband loses coverage and his wife works but chose not be covered by her company’s plan, both the husband and the wife can enroll in the wife’s plan, and so can their children.

Marriage

Still, there are some important exceptions to the rules about special enrollment. For one, someone who loses coverage still can’t enroll in a spouse’s plan if the plan isn’t designed to cover spouses. The same scenario would apply to dependent children too. If a parent’s plan doesn’t cover children, an employee’s child doesn’t have special enrollment rights in regard to that plan.

Marriage is one of the few events that let a member of your family join your plan without needing to have lost other coverage. When you get married, HIPAA gives your spouse 30 days to enroll in your plan. If you aren’t already enrolled in your company’s plan, you can join within those 30 days too. When special enrollment is allowed due to marriage, coverage for the newly enrolled person will begin no later than the first day of the next month after you request enrollment. If you request to join the plan on June 12, your coverage would begin no later than July 1.

Second, you and your dependents don’t have special enrollment rights if you lost your insurance because you stopped paying premiums or because of fraud. Again, you can’t specially enroll in a different plan just because your premiums are too high.

Birth or Adoption

Third, in order for you to specially enroll in your plan, your reason for declining coverage the last time it was offered to you must have been because you were covered by other insurance. (Two exceptions to this would be when you get married or have a child.) To better understand this rule, let’s look at two opposing examples.

The birth or adoption of children is another event that gives family members the option of joining your plan even if they haven’t lost other coverage. Children can join your health plan within 30 days after being born or adopted. When they do, their coverage is retroactive and dates back to the day of the birth or adoption.

In the first example, a husband and wife had the chance to enroll in plans from either one of their employers. They chose to enroll in the husband’s plan, and since one plan was enough for them, they declined coverage from the wife’s plan. Then the husband lost his job, and the couple lost their insurance. Since their reason for declining coverage from the wife’s plan was because they already had insurance, they are now both allowed to specially enroll in the wife’s plan.

If you or your spouse aren’t insured under your company’s plan when you add a child to your family, both of you can specially enroll at this time too. But keep in mind that a spouse or other dependent can’t join your plan if the plan is only meant to cover a company’s employees. In addition, realize that your plan might require you to enroll if you want your spouse or another dependent to join. As you can probably tell, the rules for special enrollment are more than a bit complicated. We’ll try to tie up some of their confusing loose ends by answering a few questions.

In our second example, a husband and wife had the chance to enroll in the wife’s health plan but opted to go without any insurance at all. Three months later, the husband changed jobs and enrolled both of them in his new plan. He lost that job two months later, leaving himself and his wife without insurance. Since their reason for declining coverage from the wife’s plan had nothing to do with them already being covered, they don’t have the right to specially enroll in her plan. They will have to wait for her plan’s next open enrollment period.

Do Special Enrollments Only Apply to Health Insurance? Your special enrollment rights give you the right to join a health plan. They do not entitle you to other insurancerelated benefits. If your company offers group disability insurance, group life insurance or a separate dental and vision plan, you might have to wait until open enrollment to become eligible for that coverage.

This doesn’t mean your special enrollment rights will be gone forever if you decide you don’t want any health insurance when it’s first offered to you. Let’s modify our second example by pretending the husband and wife first declined to join the wife’s plan because they preferred to go uninsured but then had another chance to enroll during an open enrollment period. If the husband and wife declined the insurance during the open enrollment period because they were both covered under the husband’s plan, they © Real Estate Institute

What If an Employer Has More Than One Health Plan? Your special enrollment rights let you join any health plan that is available to your peers. If you’ve already enrolled in one plan and your dependents have the chance to specially enroll, you can switch to whatever plan they choose for themselves.

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PROTECTING CONSUMER RIGHTS and an employee’s stay-at-home spouse wouldn’t be enough.

What If You’re Eligible for COBRA? If you’re eligible for COBRA continuation coverage, you can choose to take it or use your special enrollment rights. You generally can’t do both.

Group plans that aren’t health plans are also not part of HIPAA. This is true even when benefits are triggered by a person’s medical problems. For example, the rules generally don’t apply to:

If your COBRA coverage expires, it’ll be treated as a loss of coverage, and you’ll have special enrollment rights again.

   

Workers compensation Group disability insurance Group life insurance Group accidental death and dismemberment insurance  Group auto insurance Dental, vision and long-term care insurance offered through a group aren’t subject to HIPAA’s portability and nondiscrimination rules if either of the following is true:

Is There a Deadline for Exercising My Rights? In order to specially enroll in a plan, you need to contact the plan within 30 days after the triggering event. The triggering event can be the loss of other coverage, marriage or a child’s birth or adoption. The 30-day deadline will be extended to 60 days if you’ve lost coverage from Medicaid or SCHIP (State Children’s Health Insurance Program). Plans can have longer deadlines if they wish.

Do Employees Need to Be Notified About Their Rights?

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You must be notified of your special enrollment rights no later than when you first get the chance to enroll in a plan. The notice must be given to you whether you enroll or not.

They’re offered under a different contract, certificate or policy than other health insurance.  They’re provided to employees for an additional cost, and employees can choose not to take them. Supplemental health insurance plans might not have to follow all of HIPAA’s rules, particularly if they are offered by a separate entity than the main health plan and don’t do anything accept fill in the main plan’s gaps. However, the government has ruled that these group plans still can’t discriminate against people on the basis of health. Health savings accounts (HSAs) and flexible spending accounts (FSAs) are often exempt from HIPAA’s rules too.

Can I Specially Enroll in My Plan Even If My Dependents Remain Uninsured? Even if your special enrollment rights are triggered by marriage, the birth of a child or a spouse’s loss of coverage, you can choose to be the only one to specially enroll in your plan. So if you were covered by your spouse’s plan and your spouse loses coverage, you can enroll in your plan while your spouse opts for COBRA. However, other than in cases of marriage or new children, your spouse and other dependents can’t specially enroll in your plan without having lost coverage of their own.

The rules for supplemental health insurance, HSAs and FSAs are very situational and won’t be explained any further here. If you have questions about how these insurance arrangements must comply with HIPAA, please review the rules on your own or seek out an expert opinion.

What If My Special Enrollment Occurs During the Plan’s Open Enrollment Period? If you happen to specially enroll during a plan’s open enrollment period, you won’t be treated as a late enrollee. The longest you can go without coverage for pre-existing conditions is 12 months, not 18.

Additional Rules for the Group Health Insurance Market In addition to its rules protecting an individual’s right to insurance, HIPAA includes requirements that ensure the availability of coverage for small businesses.

Plans Exempt From Portability and Nondiscrimination Rules Despite the many positive effects they’ve had on insurance consumers, the HIPAA rules we’ve mentioned don’t apply to all kinds of insurance or even all kinds of health insurance.

If a health insurer offers coverage to a small business, it must offer to cover all other small businesses in the state too. Under HIPAA, a small business (or “small employer”) is a business with two to 50 employees.

Perhaps most significantly, the nondiscrimination and portability rules don’t need to be followed in all cases when you shop for health insurance in the individual market. In general, a policy that covers just you does not need to incorporate HIPAA’s consumer protections unless you’re transitioning from a group plan and haven’t had a significant break in coverage.

This market requirement doesn’t mean all small groups will be offered good coverage at a good price. Although insurance must be offered to a small group, the law doesn’t put restrictions on the cost of the insurance. The law also doesn’t stop a health insurer from refusing to accept all new applicants for group insurance. Once an insurer has agreed to cover a group (small or otherwise), the insurance needs to be “guaranteed renewable.” In other words, the insurer can’t cancel or refuse to renew the coverage unless there has been fraud, nonpayment of premiums or some other violation of the plan’s rules. The insurer can also refuse to renew the group if it is getting out of the state’s group market entirely.

So if you lose insurance from your employer and immediately apply for an individual policy, you might be able to take advantage of HIPAA’s rules. But if you’re looking to replace one individual policy with another (or are buying an individual policy after going without any insurance), the law is unlikely to protect you. If you are unhealthy and are buying insurance in the individual market, you may have trouble finding any coverage for preexisting conditions.

Rules for the Individual Health Insurance Market HIPAA is mainly concerned with the portability of group health insurance, yet it still sets a few important requirements for insurers in the individual market.

As we’ve already mentioned, HIPAA’s portability and nondiscrimination rules generally aren’t applicable to group plans unless there were at least two group participants at the start of the plan year. Both of those participants need to have been employed by the plan’s sponsor. An employee © Real Estate Institute

For example, as you already know, coverage from the individual market is still considered creditable coverage. Therefore, if you cancel your individual health insurance, your insurer must give you a certificate of creditable 86

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PROTECTING CONSUMER RIGHTS coverage. You can use the certificate to reduce waiting periods for pre-existing conditions in a group plan.

your state has different rules that are more consumerfriendly, the state’s rules must be followed.

Under limited circ*mstances, HIPAA guarantees that a person who loses group coverage will be offered an individual policy as a last resort. You are guaranteed a policy in the individual market if you are a “HIPAA eligible individual.”

HEALTH INFORMATION PRIVACY RULES To provide and pay for health care in relatively simple ways, certain people need access to your medical information. If you don’t tell your doctor about your medical history, you might end up being misdiagnosed. If your doctor doesn’t share information about you with your insurer, he or she might not be compensated for treatment.

To be a HIPAA-eligible individual, you must meet all of the following requirements:

Still, most patients seem to agree that details about your health are your own business and should only be disclosed on a need-to-know basis. Since you probably wouldn’t want everyone in the world to know what surgeries you’ve had and what medications you’ve taken, you expect your physicians to protect your privacy as much as possible.

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You have at least 18 months of creditable coverage.  Your most-recent insurance was through a group plan.  You are not eligible for COBRA continuation coverage (or you’ve used up all your COBRA coverage).  You aren’t eligible for any kind of group health insurance, including a government plan.  The loss of your group coverage wasn’t due to fraud or nonpayment of premiums. If you are a HIPAA-eligible individual, an insurer in the individual market must offer you a policy that immediately covers pre-existing conditions. In many parts of the country, the policy is provided through a state-implemented high-risk pool. (In a high-risk pool, several insurance companies share the financial risk of giving coverage to unhealthy people.)

Laws regarding medical privacy existed before HIPAA, but they were mainly enacted on a state-by-state basis. Through a collection of regulations known as the “Privacy Rule,” HIPAA created national standards that dictate what doctors, insurers and other collectors of medical data can do with your information. Those standards also determine your right to access your own medical records, as well as your right to correct errors in them. The authors of the Privacy Rule attempted to promote a balance of confidentiality and efficiency in the health care system. On one hand, they recognized that patients put a lot of trust in their doctors and expect their personal records to be guarded with care. Yet they also knew putting too many restrictions on the sharing of information could slow the system down and prevent patients from getting treatment in a timely fashion.

In states without a high-risk pool, each health insurer in the individual market must offer HIPAA-eligible individuals the choice between at least two policies. These two policies generally need to be similar to the two most popular policies that the insurer issues in the state.

Whether the authors ultimately succeeded in finding that balance has been a source of heated debate in the medical community. But no matter which side of the debate you’re on, you’ll probably agree that complying fully with the Privacy Rule isn’t easy. If you aren’t careful and wellinformed when medical information is being shared, someone’s rights could be at risk. Those rights, of course, can include your own.

Even for people who aren’t HIPAA-eligible individuals, all policies purchased in the individual market must be guaranteed renewable. In effect, this means a policy can’t be cancelled or not renewed unless the policyholder has committed fraud or failed to pay premiums.

Kinds of Protected Health Information

But like the rules for group plans, the requirements for insurers in the individual market don’t restrict the price for insurance. They also don’t stop an insurer from refusing to accept all new customers or from getting out of the individual market.

HIPAA doesn’t allow certain entities (mainly health care providers and health insurance plans) to use or disclose specific medical information about you unless you give your consent or unless the use or disclosure is allowed by the Privacy Rule. This specific medical information is called “protected health information.”

Insurers in the individual market can refuse to cover HIPAA-eligible individuals because they believe they are already insuring too many people. However, they can’t do it because of an individual’s health status, and they’ll have to stop accepting new customers in the individual market for at least 180 days.

One of trickiest parts of HIPAA compliance is figuring out what exactly qualifies as protected health information. The Privacy Rule and HIPAA itself can make this task difficult because they contain many similar terms and definitions. For example, along with the term “protected health information,” the Privacy Rule also has separate definitions of “health information” and “individually identifiable health information.” We can’t understand HIPAA’s requirements unless we know what those terms really mean.

Rules for Insurers in All Markets Health insurers can get entirely out of the large-group, small-group or individual market in a state if they give their policyholders at least 180 days’ notice. Once they leave that market, they can’t reenter it for another five years.

To be considered “health information,” the information must have all of the following traits:

Health insurers can choose to stop offering a particular kind of coverage in a market if they give their policyholders at least 90 days’ notice and give them the option to purchase other coverage. Any reduction in coverage after insurance has already been purchased must be applied to everyone in the market. It can’t be applied specifically to you because of your personal health status.

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This concludes our study of HIPAA’s portability and nondiscrimination rules. Be aware that these rules are mainly minimum standards from the federal government. If © Real Estate Institute

It is created by or given to a health care provider, a health plan, a public health authority, an employer, a life insurance company, a school or university or a health care clearinghouse. It relates to a person’s past present or future medical condition, health care provided to a

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PROTECTING CONSUMER RIGHTS Now that you know that “protected health information” is basically “individually identifiable health information” with a few exceptions, let’s go over some important details by answering some questions:

person, or the past, present or future payment of health care for a person. That definition, though, is just a starting point. Health information, in and of itself, is not the kind of information that can’t be used or disclosed without your consent. In fact, some of the entities mentioned in that definition (such as life insurance companies and schools), generally don’t need to follow the Privacy Rule.

Does it Matter How Information Is Transmitted or Recorded? An important element of HIPAA known as the “Security Rule” only applies to information that is stored electronically. However, the Privacy Rule applies to individually identifiable health information in all its forms. The information can be stored electronically, written by hand or spoken.

Health information isn’t protected by the Privacy Rule unless it is considered “individually identifiable health information.” To be considered “individually identifiable health information,” the information must have all of the following traits:

What Are Some Basic Kinds of Information That Are Protected?

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It is created by or given to a health care provider, a health plan, an employer or a health care clearinghouse. (Note the absence of life insurers, schools and public health authorities from the definition.)  It relates to a person’s past, present or future medical condition, health care provided to a person, or the past, present or future payment of health care for a person. (Note that this trait is also part of “health information.”)  It either identifies the person or could reasonably be used to identify the person. That last point is key to HIPAA compliance. A doctor who says something like, “I once treated someone for tuberculosis,” wouldn’t necessarily be violating the Privacy Rule. But a doctor who clarified that statement by saying, “I once treated Jane Smith for tuberculosis,” could be in some legal trouble. With this in mind, information that would normally not seem medical in nature (such as your name, your Social Security number and your address) can be “individually identifiable health information” if it is disclosed along with information about your health, your treatment or your payment for treatment.

Examples of information protected by the Privacy Rule include:     

Is Information About Relatives Protected? Information doesn’t have to be about you in order to be protected. If you give your doctor some details about your parents’ medical history, the doctor needs to treat those details as protected health information. The doctor generally can’t disclose them without your consent.

What About Information That Predates HIPAA? HIPAA’s Privacy Rule is retroactive, meaning it protects information that doctors and health insurers currently possesses but obtained prior to the law’s passage. It doesn’t matter if you were treated for leukemia way back in 1960. The information is still protected.

The same standard would apply in regard to information about payments for health care. While a health insurer wouldn’t be breaking the law by telling a reporter that, “We’ve paid over $5 million in claims this year,” it might be a violation of HIPAA to say, “The policyholder at 123 Main St. has made a $5,000 claim.”

Even the dead retain some HIPAA rights. We’ll have more on that topic later.

When Can Protected Health Information Be Shared?

But even then, the information might not be considered “protected health information” and, therefore, might not be subject to the Privacy Rule. In general, “protected health information” is “individually identifiable health information” that is transmitted or stored in any way. However, “protected health information” typically doesn’t include information from school records or employment records.

Someone who must follow the Privacy Rule can’t share protected health information unless the law provides an exception or you give your consent.

Applicability to Covered Entities With just a few important exceptions, the only people or other entities who need to follow the Privacy Rule and keep your information confidential are “covered entities.” A covered entity can mean any of the following:

So, why is there a distinction between “individually identifiable health information” and “protected health information”? The short answer is it helps clarify how employers need to follow the law. If you haven’t already, you’ll soon understand that certain entities need to comply with the Privacy Rule while others don’t. Someone who is exempt from the Privacy Rule doesn’t need to keep your protected health information confidential.

 A health care provider  A health plan  A health care clearinghouse As you can see, that’s a relatively limited list. If you are concerned about your privacy in general, keep the brevity of this list in mind when discussing your medical information with anyone. Though it wouldn’t be the nicest thing to do, your neighbor can gossip with others about your medical history and not be in violation of HIPAA. Businesses that get a hold of your medical information might not be obligated to keep it private if they aren’t involved in providing or paying for health care.

Employers are in a unique position in that they are generally exempt from the Privacy Rule when acting strictly as your boss but not necessarily exempt when they are acting as the sponsor of your group health plan. Don’t be too concerned if this sounds confusing at first. We’ll elaborate on the distinction between employers and plan sponsors in a little while. © Real Estate Institute

Information you discuss with your doctor, a nurse or other health care provider Information in your medical files Information about health insurance claims Information about medical bills Non-medical information (such as your name, address and phone number) if it can reasonably be used to identify you and help people learn something about your health.

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PROTECTING CONSUMER RIGHTS Still, each item on the list deserves clarification.

Are There Major Exemptions for Health Plans

Health Care Providers

Some self-insured health plans are not covered entities and generally don’t have to worry about the Privacy Rule. In a self-insured plan, an employer sets up a mechanism whereby it is responsible for paying employees’ medical bills. In a true self-insured plan, coverage for employees is not purchased from an insurance company.

We tend to associate the phrase “health care provider” with doctors. But the true definition of the word is a bit broader and incorporates many other people. According to the Department of Health and Human Services, a provider might be any of the following:

A self-insured health plan is not a covered entity if it has fewer than 50 participants.

 A doctor  A hospital  A clinic  A pharmacy  A dentist  A psychologist  A chiropractor  A mental health center  A nursing home Providing medical services to patients doesn’t necessarily make a person a covered entity. A health care provider is exempt from the Privacy Rule if it never shares health information electronically. Examples of providers who might be exempt from the Privacy Rule include those who don’t do electronic billing, don’t electronically inquire about patients’ insurance coverage and don’t electronically authorize referrals. But since most providers do these things (and since there is still no exemption if a provider relies on a third party to do them), there are very few providers who can ignore the Privacy Rule.

What If an Insurer Doesn’t Share or Receive Information Electronically? In the rare event that a health insurance company doesn’t share or receive information electronically, it still must obey the Privacy Rule. The exemption regarding electronic information and providers doesn’t extend to health plans.

What About Other Kinds of Insurance Companies? A common misconception about HIPAA is that life insurance companies are covered entities and need to follow the Privacy Rule. The Department of Health and Human Services has concluded that life insurance companies and workers compensation insurers generally aren’t governed by the rule. The confusion regarding this issue is understandable because life insurers and other non-health insurers often collect medical information about their customers. Still, don’t assume the Privacy Rule doesn’t factor into the way these insurers do business. When a life insurance company decides that it will only sell you a policy after reviewing your medical records, those records typically can’t be shared with the company unless you have signed a HIPAA-compliant authorization form. Though the insurer technically still wouldn’t be a covered entity at that point, the authorization form might put contractual restrictions on how the company can use your information.

Although the electronic transmission of information helps determine if a provider has to follow the Privacy Rule in the first place, it doesn’t change the kind of information that is protected. Once it has been established that a provider is a covered entity, that provider must keep all protected health information confidential, including information found on paper and information revealed in conversation. The information doesn’t need to be stored electronically for it to be covered by the Privacy Rule.

Keep in mind, too, that many life insurance companies have branched out into the health insurance market by offering traditional health insurance, long-term care insurance and other health-related coverage. In its role as a provider of this coverage, an entity calling itself a “life insurance company” might actually be a health plan under the law.

Again, be careful not to confuse HIPAA’s Privacy Rule with HIPAA’s Security Rule. Unlike the Privacy Rule, the Security Rule only pertains to electronic information. You’ll read about the Security Rule later in this course.

Health Care Clearinghouses

Health Plans

According to the Department of Health and Human Services, health care clearinghouses are entities that take health information in a non-standard format and put it in a standard format or vice versa. Health care clearinghouses rarely have direct relationships with patients, but they play important roles during the health-care billing process.

A health plan is basically defined as an individual plan or group plan that pays for health care. Common examples include the following:    

Health insurance companies Health maintenance organizations (HMOs) Company health plans Government health plans, including Medicare and Medicaid As usual, there are some important details to consider when trying to figure out exactly which health plans need to follow the Privacy Rule.

Applicability to Employees You may have noticed that most examples of covered entities (with the exception of some health care providers) technically aren’t individuals. With this in mind, you might wonder how employees of covered entities fit into the Privacy Rule. If a doctor improperly discloses protected health information but is employed by a hospital and isn’t involved at all in things like electronic billing or insurance inquiries, who is at fault? Would the covered entity (the hospital) be liable for the disclosure, or would the employee (the doctor) be the one in trouble?

Is the Privacy Rule Only for Group Plans? No matter if it sells insurance in the group market or the individual market, a health insurer is a covered entity under the Privacy Rule. This is a big difference compared to HIPAA’s rules about portability and nondiscrimination, which often don’t apply to the individual market.

How about a customer service representative at an insurance company? Since the representative isn’t a health plan on his own, would the representative be in legal trouble if he didn’t keep a customer’s information confidential? 89

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PROTECTING CONSUMER RIGHTS associates if they are aware of violations by covered entities.

Those questions weren’t clearly addressed in HIPAA’s original form, and the officials in charge of enforcing the law sometimes couldn’t agree on the answers.

Do Covered Entities Need to Have Agreements With All Third Parties?

Congress tried to clear up some of the uncertainty by passing the HITECH Act in 2009. Under the act, an employee who takes or discloses personal health information from a covered entity without proper authorization has violated HIPAA.

Business associate agreements are only for third parties who receive or access protected health information from a covered entity. If a covered entity deals with a vendor who doesn’t receive or access protected health information, the vendor doesn’t need to sign a business associate agreement.

Applicability to Business Associates Whether they realize it or not, some businesses and individuals aren’t covered entities but are still indirectly expected to uphold the Privacy Rule. Many of these businesses and individuals are known as “business associates.”

There’s also no need for a business associate agreement if it is technically possible for a third party to access protected health information but very unlikely for it to occur. For example, a shipping company or post office can accept a package containing protected health information without having to sign an agreement.

Business associates are third parties that are given protected health information in order to provide services to a covered entity. They aren’t members of a covered entity’s workforce, but they might find themselves acting on a covered entity’s behalf.

What Happens When Agreements Expire? If a business associate agreement expires or is terminated, the business associate must do one of the following:

Examples of potential business associates include:

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    

Lawyers for covered entities Health insurance agents and brokers Transcription companies for health care providers Third-party administrators for health plans Third-party billing companies for health care providers or health plans  Accountants for covered entities Business associates are impacted by the Privacy Rule through “business associate agreements.” A business associate agreement is a contract between a business associate and a covered entity. It explains what the business associate can and can’t do with protected health information. The agreement can’t allow the business associate to do anything that the covered entity wouldn’t be able to do under the Privacy Rule. It can even force the associate to agree to rules that a covered entity wouldn’t have to follow.

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Do Covered Entities Need Agreements When Sharing Information With One Another? Covered entities generally don’t need to sign business associate agreements when they share information with one another for the purpose of billing or treating people. If your doctor decides to get the opinion of a colleague about your health, your information can be shared with the other doctor without the need for an agreement. Your doctor is also free to share your information with your insurer in order to be paid for medical services. If information is shared among covered entities for other reasons, a business associate agreement might be required. According to the Department of Health and Human Services, an outside physician who is hired to train hospital employees would need to sign a business associate agreement before accessing patients’ information as part of the training.

Until 2010, business associates were only indirectly regulated by HIPAA. Though they couldn’t do anything that violated the Privacy Rule, they technically couldn’t be charged with HIPAA violations. If you were a business associate and improperly disclosed someone’s health information, the victim might’ve taken legal action against the covered entity who gave you the information. Then, the covered entity might’ve responded by suing you for violating your business associate agreement. But in the end, the federal government wouldn’t have subjected you to any HIPAA-specific penalties.

Applicability to Plan Sponsors “Plan sponsors” are indirectly required to follow parts of the Privacy Rule in certain situations. A plan sponsor is the entity that arranges for people to join a group health plan. In the majority of cases, it’s an employer who decides to have a health plan for employees or a union that decides to have a health plan for its members.

Like it did for employees of covered entities, the HITECH Act expanded liability under HIPAA to include business associates. If you are a business associate and violate a business associate agreement, you can face the same legal consequences as a covered entity.

HIPAA affects plan sponsors because it puts limits on the kind of information they can receive from their health plans. It also restricts what sponsors can do with the information once they receive it.

Here’s some additional guidance to help you understand the relationship between covered entities and business associates.

A sponsor usually can’t receive protected health information from a health plan unless it signs a special agreement. The agreement will state what the sponsor can and can’t do with the information, and it can’t let the sponsor do anything that would otherwise be a violation of the Privacy Rule. The agreement will also forbid the sponsor from using the information to make employmentrelated decisions. (Decisions regarding whether to change or discontinue a group plan are allowed.)

What If a Business Associate Violates the Law? Upon becoming aware of a possible HIPAA violation, the covered entity is required to notify the business associate. At that point, depending on the severity and the continuance of the violation, the covered entity might need to help fix the problem or terminate the business associate agreement. The same actions must be taken by business © Real Estate Institute

Return the protected health information to the covered entity. Destroy the protected health information. If the information can’t be returned or destroyed, agree to keep the protected health information private.

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PROTECTING CONSUMER RIGHTS You’ll read more about plan sponsors in the section “Sharing Information in the Workplace.”

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The deadline for the receiving entity to receive or access the information  Information about your right to cancel the authorization and how to exercise that right  Whether allowing the use or disclosure will affect your right to treatment or insurance benefits  Disclosure of the fact that the information might not be protected by the Privacy Rule once it has been shared  A place for the date and your signature Let’s go over some common questions about authorization forms.

Parties Exempt From the Privacy Rule Since we’ve spent so much time going over who is a covered entity and who isn’t, it’s worth revisiting the basics before moving on to our next topic. Again, with a few exceptions, the Privacy Rule only needs to be followed by covered entities. The list of covered entities is limited to the following: 

Health care providers who engage in certain electronic activities  Health plans  Health care clearinghouses Since HIPAA was enacted, many people have incorrectly assumed that the number of covered entities is larger than those three. Even though they may receive health information on a regular basis, the following entities generally aren’t covered entities:

Does the Form Need an Exact Expiration Date Authorization forms need to mention how long the receiving party can access or receive your protected health information. They don’t need to contain an exact date. For example, if access or disclosure will be allowed on a continuing basis, the form can mention this in place of a deadline. It’s also acceptable to use a particular event (such as the end of a medical research study) instead of a specific date.

   

Life insurers Workers compensation insurers Property and casualty insurers Schools (assuming they don’t provide health care on a regular basis and don’t engage in certain electronic transactions)  Law enforcement officials But don’t forget the main point of the Privacy Rule: A covered entity can’t share your protected health information with a non-covered entity unless you or the rule allow it. So while non-covered entities aren’t necessarily limited in the ways they can share your information, they may be limited in the ways they can receive it.

Does the Government Require the Use of Specific Language in the Form? The language in an authorization form can be written entirely by the covered entity. The government only requires that it contain the required information and be understandable.

How Do Consumers Remember What’s in the Form? When you sign an authorization form, you are supposed to receive a copy from the covered entity.

Required Authorization and Consent Forms

Can a Form Allow Covered Entities to Disclose Future Information?

HIPAA allows covered entities to use or disclose protected health information without your permission in any of the following circ*mstances:

Authorizations can be made ahead of time. If you want someone to receive copies of all your future medical records, you can authorize it by signing a single form.

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The use or disclosure is designed to help treat you.  The use or disclosure is designed to ensure payment for medical services.  The use or disclosure is part of “health care operations.” (Health care operations are an assortment of tasks that are integral to running a reasonably efficient covered entity. An example would be training employees at covered entities to use computer systems.) Using or sharing information for other reasons generally can’t be done without your consent. The Privacy Rule requires that consent be provided through the use of an authorization form. The form has several mandatory elements to it, and it must be used even if you are the one asking that information be shared with someone.

Is This the Same Form That I Sign at the Doctor’s Office? When you have your first appointment with a health care provider, you receive and sign a form that explains your basic HIPAA privacy rights. That form isn’t an authorization form, and it doesn’t give the doctor the right to disclose your information for reasons other than treatment, billing or health care operations. Information about this privacy form appears in the section “HIPAA Privacy Notices.”

Permissible Use and Sharing of Protected Health Information Covered entities can use or share protected health information without your authorization if the use or sharing is done to facilitate treatment, payment or health care operations.

Among other things, a HIPAA-compliant authorization form needs to contain all of the following items:   

Early drafts of HIPAA regulations didn’t allow this to happen, but it was ultimately decided that requiring authorization in these situations would be impractical and potentially harmful to patients. If you were to become very sick and needed immediate medical attention, you’d probably want medical professionals to have easy access to your past and present health records. If you were having important tests done, you’d probably want your doctor to be able to access those tests and report back to you as soon

The kind of information that will be used or shared The person or entity that will be using or disclosing the information The person or entity that will be receiving the information

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PROTECTING CONSUMER RIGHTS as possible without having to get your signature on something.

One would also be allowed if it relates to payment or health care operations.

You can request that a covered entity not share your information for the purpose of treatment, payment or health care operations, but the covered entity doesn’t have to grant your request. Still, if you make the request and the covered entity agrees to it, the entity needs to stick to the agreement.

It might be impossible for the doctor to avoid disclosing some protected health information in the message (such as your name and the fact that you’re a patient), but that’s not a HIPAA-related problem if the disclosure is as limited as possible. So, if the message is meant to confirm an appointment, the doctor might say the scheduled time but not disclose the reason for the visit. If the doctor is trying to reach you to discuss a medical issue, the message might simply say to call the provider’s office.

Suppose you’re concerned about identity theft and don’t want your Social Security number shared with anyone. You might ask your doctor to keep the number private, but the doctor might need the number to receive payment from your insurance company. Since this kind of sharing relates to payment, the doctor can refuse your request and disclose the information to your insurer.

If you’re concerned about communication from a covered entity falling into the wrong hands, you can request that covered entities only contact you in certain ways (such as only by phone or only at a certain number). As long as your preference is reasonable, the covered entity needs to honor it.

These exceptions to the rules about authorization can be very helpful to covered entities, but it’s important not to read things into the exceptions that aren’t really there. For example, a doctor’s right to share information with a business associate for treatment purposes doesn’t mean a business associate agreement isn’t required.

Payment Covered entities can use or disclose your protected health information to ensure they are properly paid for their services. This allows doctors to send your information to your health plan and vice versa. If someone else is responsible for paying your medical bills, your information can be given to them, too.

Also, keep in mind that the exceptions about authorization relate to the covered entity’s right to use the information on its own or share the information with a third party. They technically don’t give the third party a right to obtain the information, even when treatment, payment and health care operations are involved.

The HITECH Act created some new restrictions in regard to payment-related disclosures. To properly understand them, we should briefly recall some basics about disclosures to covered entities.

As an example, if your new doctor contacts your old doctor and requests protected health information for treatment purposes, your old doctor isn’t required to share it. If he or she wants, the old doctor can refuse to disclose the information until you’ve signed an authorization form.

In general, a covered entity can share information with another covered entity without authorization if the sharing is done for reasons of treatment or payment or health care operations. Even if you ask a covered entity not to engage in this kind of sharing, it doesn’t need to honor your request.

In most situations, the only person who can’t be denied access to your personal health information is you.

Treatment Covered entities don’t need your authorization to use or share your information for treatment purposes. This allows a health care provider to go through your medical records in order to give you appropriate medical advice. It also lets one provider share your information with another provider so you can get the best care possible.

As of 2010, you can ask your doctor not to share information with your health plan for purposes of payment or health care operations, and the doctor must agree if you pay for treatment entirely out-of-pocket. This relatively new consumer protection is expected to be utilized by patients receiving particularly personal kinds of care, such as abortion services and treatment for sexually transmitted diseases.

Disclosures for treatment purposes can sometimes be made to people who aren’t medical professionals. Perhaps the most common example of this would be a disclosure of your health status to a friend or family member in an emergency situation. Another would involve allowing a pharmacist to give medicinal information to someone who picks up a prescription for you. In both examples, the relative, friend or other person can be thought of as being involved in your treatment or responsible for it. (There are, however, many restrictions on situations like these. We’ll analyze these scenarios again later.)

Health Care Operations Covered entities can use and disclose protected health information while conducting health care operations. The term “health care operations” is probably one of the most difficult HIPAA concepts to grasp. It’s an admittedly vague phrase but is generally used to describe reasonable activities that would be expected to be done at a covered entity. Some major examples include employee training and the underwriting of health insurance (by an insurance company).

Treatment can also include contacting patients about appointments and care. But since emails and voicemails can sometimes be accessed by someone other than the intended recipient, many providers are hesitant to leave messages. After all, a statement as simple as “My name is Dr. Smith, and Mary Jones is one of my patients” could be a HIPAA violation, depending on the reason for saying it.

For clarity’s sake, here’s the exact definition from the Privacy Rule: Health care operations means any of the following activities of the covered entity to the extent that the activities are related to covered functions:

HIPAA doesn’t prevent your doctor from leaving you a message, even if the message is left with another person. What matters are what is said and why. If the intent is treatment-related (such as to confirm an appointment or go over your test results), a message of some kind is allowed. © Real Estate Institute

(1) Conducting quality assessment and improvement activities, including outcomes evaluation and development of clinical guidelines, provided that the obtaining of generalizable knowledge is not the primary purpose of any studies resulting from such activities; population-based activities relating to improving health or reducing health 92

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PROTECTING CONSUMER RIGHTS doctor leaves you a message on your answering machine and you play it when someone else is in the room, the disclosure of your health information to the other person is considered incidental. If your doctor or insurer communicates with you via email, the covered entity wouldn’t be in trouble if you open up a message and the text is seen by someone looking over your shoulder.

care costs, protocol development, case management and care coordination, contacting of health care providers and patients with information about treatment alternatives; and related functions that do not include treatment; (2) Reviewing the competence or qualifications of health care professionals, evaluating practitioner and provider performance, health plan performance, conducting training programs in which students, trainees, or practitioners in areas of health care learn under supervision to practice or improve their skills as health care providers, training of non-health care professionals, accreditation, certification, licensing, or credentialing activities;

Other incidental disclosures commonly occur at hospitals and medical offices. A provider can call out your name in a waiting room without violating HIPAA, and your doctor can discuss your health with you even if you’re sharing a hospital room with another patient. In another example, a nursing home or hospital can choose to put your name by the door to your room. The fact that visitors can see it is outweighed by the way it makes treatment and health care operations simpler for the covered entity.

(3) Underwriting, premium rating, and other activities relating to the creation, renewal or replacement of a contract of health insurance or health benefits, and ceding, securing, or placing a contract for reinsurance of risk relating to claims for health care (including stop-loss insurance and excess of loss insurance), provided that the requirements of §164.514(g) are met, if applicable;

The Minimum Necessary Rule HIPAA sometimes grants covered entities the power to use and disclose protected health information without consent, but that power is far from absolute. Even in cases where use or disclosure is allowed, the covered entity needs to follow the “minimum necessary” standard.

(4) Conducting or arranging for medical review, legal services, and auditing functions, including fraud and abuse detection and compliance programs; (5) Business planning and development, such as conducting cost-management and planning-related analyses related to managing and operating the entity, including formulary development and administration, development or improvement of methods of payment or coverage policies; and

Under the minimum necessary standard, protected health information can only be used or disclosed to the extent that the information is needed to complete a task allowed by HIPAA. In other words, if only a portion of your information is needed to do a particular act, a covered entity should only share that portion and keep the rest confidential.

(6) Business management and general administrative activities of the entity, including, but not limited to:

The minimum necessary standard might be best understood by considering how providers share information with health plans. If you visit your doctor for a broken leg, the doctor can send protected health information to your insurance company for billing purposes. This disclosure is allowed without your authorization since it relates to payment. But since things like your weight, your blood pressure and your family’s medical history probably aren’t needed for the insurer to make payments for a broken leg, your doctor isn’t supposed to share them.

(i) Management activities relating to implementation of and compliance with the requirements of this subchapter; (ii) Customer service, including the provision of data analyses for policy holders, plan sponsors, or other customers, provided that protected health information is not disclosed to such policy holder, plan sponsor, or customer. (iii) Resolution of internal grievances; (iv) The sale, transfer, merger, or consolidation of all or part of the covered entity with another covered entity, or an entity that following such activity will become a covered entity and due diligence related to such activity; and

Similarly, while a psychologist might need to share a general diagnosis of your mental health with your health plan, disclosing the specifics of what you discuss in therapy would probably violate the minimum necessary standard.

(v) Consistent with the applicable requirements of §164.514, creating de-identified health information or a limited data set, and fundraising for the benefit of the covered entity.

The minimum necessary standard is about more than just disclosures to outside individuals. It also controls how information can be accessed or shared within a single covered entity. To comply with the standard, a covered entity needs to identify all of the following:

Incidental Disclosures The authors of the Privacy Rule understood that preventing every single kind of unauthorized disclosure would be impossible. Whether patients and policyholders like it or not, some protected health information is inevitably going to be available to complete strangers.

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The people within the organization who will have access to protected health information  The kinds of personal health information that those people will be able to access  The circ*mstances under which those people will be allowed to access the information To demonstrate how this might work, let’s think of a family doctor working out of a small office. The doctor might determine that her office assistant (but not her office’s janitorial and maintenance staff) ought to have access to patients’ protected health information. Then she might decide that the assistant should only be able to access patients’ contact information, basic insurance information and their general reason for making appointments. Finally, the doctor might believe that the assistant should only be allowed to access the limited amount of protected health

Covered entities aren’t expected to prevent this sharing from happening at all costs. They just need to protect it in reasonable ways and implement common-sense safeguards. Minor disclosures that occur despite reasonable actions by covered entities are known as “incidental disclosures.” These disclosures are either accidental or practically necessary to facilitate treatment, payment or health care operations. They’re bound to happen from time to time, and they aren’t examples of HIPAA violations. Our previous discussion of phone messages and email ought to help you understand incidental disclosures. If your © Real Estate Institute

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PROTECTING CONSUMER RIGHTS information in order to make appointments, make insurance inquiries and prepare visitors for examinations.

(iii) Used, in whole or in part, by or for the covered entity to make decisions about individuals.

Based on the doctor’s decisions, the assistant would be following the minimum necessary standard if he accessed a patient’s general information to confirm an appointment. But let’s assume one of the assistant’s close friends came in for treatment, and the assistant accessed the friend’s health records out of personal curiosity and concern. In that case, the assistant wouldn’t be abiding by the standard.

Covered entities are required to give you a copy of your protected health information if you request one. Even if you have unpaid bills from the covered entity, you still have a right to the information. A covered entity can’t charge you anything for the copy, other than the reasonable cost of labor and supplies that are associated with the copying. The rules about cost apply to you and a person known as your “personal representative,” but some covered entities have been known to charge more when information requests come from third parties, such as attorneys and insurance companies. (We’ll go into detail about personal representatives later.)

In its original form, the minimum necessary standard was general in nature and allowed each covered entity to decide what kinds of access and disclosures were compliant with it. Through the HITECH Act, Congress ordered the Department of Health and Human Services to create more specifics about the standard by August 2010. At the time this course was being written, the department’s guidelines hadn’t been finalized.

The timeframe for giving you copies of your records can depend on where the information is stored. In general, you’re supposed to receive a copy within 30 days after making a request. But if the information is stored offsite, the records might not be available for 60 days.

One thing HIPAA made clear from the beginning was that the minimum necessary standard doesn’t need to be obeyed when sharing is done among covered entities for treatment purposes. So even though your asthma probably has nothing to do with your arthritis, your primary care physician can share the asthma information with your bone specialist. Presumably, the exemption for treatment purposes is designed to help physicians make wellinformed medical decisions.

You can have your records given to you in any form that is reasonable for you and the covered entity. For example, you might receive them in the mail, via fax or in an electronic format if the covered entity is set up to provide them in those ways. There are very few occasions when a covered entity can turn down your request for your records. An example would be a request for copies of psychotherapy notes. These notes don’t need to be shared if a therapist doesn’t store them in your medical records.

Right to Your Own Information A law mandating privacy of your information wouldn’t be very significant if you didn’t have a way of knowing what your information actually contained. For all its focus on disclosures to third parties, HIPAA still gives you several rights involving access to your own records. These rights include:

If a covered entity is refusing a request for your records, it might be because the request is coming from your personal representative rather than from you. Your personal representative is very similar to someone who has medical power of attorney and is often a family member who is responsible for your health care.

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The option to receive copies of your medical records  The option to correct errors in your records  The option to know if your information is being shared without your authorization  The option to let a friend or family member control access to your records Let’s take a closer look at each of those rights.

Your personal representative has the general right to access your protected health information in the same way you do, but a covered entity might determine that disclosing certain information to the person isn’t in your best interest. This sometimes occurs when a physician suspects spousal or child abuse and the personal representative is the one who is probably inflicting it. If a covered entity denies you or your personal representative access to your information, you can appeal the entity’s decision. In this case, the decision to share your records or keep them confidential will often be made by an impartial health care provider.

Obtaining Copies of Medical Records You have a right to know what pieces of information a covered entity has about you. Probably the easiest way to find out is to contact the entity and request a copy of your protected health information.

Making Changes to Medical Records

You can receive a copy of any protected health information that has been recorded by the covered entity and included in a “designated record set.” (Keep in mind that information you convey in conversations might not be recorded and, therefore, might not apply to this portion of the Privacy Rule.) The Privacy Rule defines “designated record set” in the following manner:

If you access your protected health information within a designated record set and notice an error, the covered entity who gave you the information is responsible for correcting it. Errors usually need to be fixed within 60 days after a request, but covered entities can get a 30-day extension if they give notice to the consumer. After a covered entity has corrected the records in its possession, it may be required to send the changed data to other companies and individuals. At the consumer’s request, corrected information must be given to anyone who has received the person’s protected health information from the covered entity and who would reasonably benefit from knowing about the correction.

Designated record set means: (1) A group of records maintained by or for a covered entity that is: (i) The medical records and billing records about individuals maintained by or for a covered health care provider; (ii) The enrollment, payment, claims adjudication, and case or medical management record systems maintained by or for a health plan; or

Sometimes, a consumer and a covered entity will disagree about whether information is accurate and whether a change should be made. If a covered entity doesn’t believe an error exists, it can refuse to make a correction. The 94

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PROTECTING CONSUMER RIGHTS operations will still not be required when disclosures are made orally or on paper.

denial must be stated in writing, along with the reason for the denial and an explanation of how the consumer can file a complaint. At your request, the fact that you are disputing the accuracy of the information must be added to your records.

The requirement to retain information about disclosures that are made for treatment, payment or health care operations was originally scheduled to go into effect on January 1, 2011. At the time this course was being written, HHS was still in the process of developing rules related to the requirement. The department was also proposing changes that could impact a person’s ability to learn about other kinds of disclosures.

Accountings of Disclosures When covered entities disclose your protected health information, they are required to keep records of the disclosure. These records must be made available to you if you request them.

Key changes that were proposed in the May 31, 2011, edition of the Federal Register are summarized below:

At your request, you can receive information about these recorded disclosures if they were made in the previous six years. The information must be given to you within 60 days after your request and generally needs to include the following:

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Upon request, covered entities would be required to provide two kinds of disclosure reports: an accounting of disclosures and an access report. The accounting of disclosures would mention disclosures that were made electronically or on paper but would not need to contain information about disclosures that were made for treatment, payment or health care operations. An access report would only mention disclosures that were made electronically (including those made for treatment, payment or health care operations) and would contain slightly less information than an accounting of disclosures.  People would be able to request information about recorded disclosures that were made within the past three years (rather than six).  Information about recorded disclosures would need to be provided within 30 days of a request instead of 60.  Exemptions regarding the kinds of disclosures that need to be recorded would be changed and expanded.  Disclosures would only need to be recorded if the disclosed information is maintained in a designated record set. Keep in mind that these proposed changes wouldn’t change the kinds of information that can or cannot be disclosed. They would merely change the rules for keeping records of disclosures.

 Who received your disclosed information  What information was disclosed  When the disclosure occurred  Why the disclosure was made Let’s answer a few questions about the tracking of disclosures.

Is Information About Disclosures Free to Consumers? You can request a free accounting of disclosures once each year. If you make additional requests, you might have to pay a reasonable fee.

Are Covered Entities Required to Maintain Protected Health Information for a Set Period of Time? HIPAA doesn’t force covered entities to keep your protected health information for any length of time. It only requires that they keep records of disclosures.

Are There Disclosures That Don’t Need to Be Tracked? Covered entities typically don’t have to keep records about the following kinds of disclosures:   

 

Disclosures about a person that are authorized by that person Disclosures about a person that are made to that person (or the person’s personal representative) Disclosures that are incidental (For examples, please see the section “Incidental Disclosures” from earlier in this course.) Disclosures for treatment, payment and health care operations Disclosures of “limited data sets” (You’ll read about these later in the section “Limited Data Sets.”)

The proposed changes relating to access reports would not go into effect until 2013 or 2014. The proposed changes relating to the accounting of disclosures would go into effect approximately six months after their approval. Since this course material was printed prior to the finalization of the rules, we advise that you check for updates from HHS.

Rights of Your Personal Representative The same rights that you have under HIPAA (including the right to receive your information, correct errors in it and authorize disclosures of it) also belong to your “personal representative.” Your personal representative is anyone who has the legal right to make health care decisions on your behalf.

Are There Any New Recordkeeping Requirements As a Result of the HITECH Act? As a result of the HITECH Act, covered entities will also eventually need to retain (and you will be able to receive) information about disclosures for treatment, payment and health care operations. Records about these disclosures will need to be maintained if personal health information is disclosed electronically from a designated record set. (For a review of designated record sets, see the section “Obtaining Copies of Medical Records.”) You will be able to request information about these electronic disclosures within three years after they are made. Records of disclosures for treatment, payment or health care © Real Estate Institute

By default, the person who can make medical decisions on your behalf is determined by state law. For most children, the person would be a parent. For most married adults, it would be a spouse, and for most unmarried adults, it might be a parent, a sibling or a grown son or daughter. By signing power-of-attorney documents, you can designate someone as your representative regardless of state law. The rights given to personal representatives can be extremely important because they can be used to give loved ones critical information in serious situations. 95

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PROTECTING CONSUMER RIGHTS An exception to this rule allows parents to access a child’s protected health information even if the child can think and communicate. Since there are other special guidelines for the use and disclosure of children’s information, we’ll address this issue in another section.

For example, if you are your elderly mother’s personal representative and she goes in for emergency surgery, you can access her medical records before making difficult treatment decisions for her. If you are the one in serious condition and are incapacitated, you can rest assured that timely and informed choices about your health can still be made by someone close to you.

Do Non-Medical Powers of Attorney Make People a Representative?

Since they tend to be utilized in emergency situations, the rights of personal representatives should be made clear to patients and providers sooner rather than later. Answers to the following questions might come in handy at the right time.

You can arrange for someone to make financial decisions on your behalf, but that alone doesn’t make the person your personal representative. Unless the person has the power to make health decisions for you, a covered entity isn’t required to give the person your information without your consent.

Can a Covered Entity Refuse to Give Information to a Personal Representative?

You’ll recall, however, that covered entities have the option (not the obligation) to share your information without consent for the purpose of payment. If you are responsible for paying your father’s bills, his insurance company can send you his financial statements without violating HIPAA.

As you’ll note later in this course, covered entities have the option to share your information with your family and friends without your authorization, but they aren’t required to do it. The opposite is true regarding your personal representative.

HIPAA PRIVACY RULES IN PRACTICE

Because your personal representative is acting in your place, a covered entity generally can’t refuse to give a representative access to your protected health information. The only exception would be a case in which the entity believes giving information to your representative would reasonably result in harm to you. In practice, the exception is used when you are in danger of being physically abused or neglected by your representative.

We’ve covered all the basics and most of the important details of HIPAA’s Privacy Rule. We’ve even touched on some examples that show how the legislative requirements are followed in the real world. Still, if you’ve been reading this while thinking about how health care is provided in your own life, some of the privacy requirements might seem unclear or impractical. As a patient, you might still be wondering how the Privacy Rule adapts to emergency situations. As an employee, you might still be confused about what information is supposed to kept away from your boss.

However, depending on the law and various agreements that you may have entered into, someone can be your personal representative in one situation but not in others. If the specifics of a situation mean that the person doesn’t have the right to make a particular medical decision for you, the person isn’t your representative and can’t control or use your information. This point is clarified in answers to the next few questions.

Those sorts of issues deserve special attention here for two reasons. First, they tend to involve situations that anyone, regardless of their profession, might encounter. Second, the requirements that relate to them don’t always fit into the generalities we’ve already mentioned.

Is the Same Person My Representative Whenever I’m Incapacitated?

Over the next several pages, we’ll look at the Privacy Rule within some fairly specific contexts. All the while, you should be able to see how the law tries to strike a balance between the privacy of your information and a commonsense approach to health care.

Whether someone’s role as a personal representative applies to all cases of incapacitation will depend on what state law says and what extra legal protections you’ve put in place. If you’ve gone beyond state law and delegated medical decision-making to another person in limited situations, that person is only your personal representative in those limited situations.

Sharing Information at the Doctor’s Office The average person’s first exposure to HIPAA usually occurs at a doctor’s office. Since they are almost always covered entities, these offices usually need to guard your information in accordance with the Privacy Rule.

For a practical example, imagine you have gone beyond state law and given your best friend the power to make decisions about life support. Your other medical decisions will be made on your behalf by your sister.

If you recall our earlier discussion of incidental disclosures, you’ll probably realize that a doctor’s office isn’t forced to take extreme measures for privacy’s sake. Your doctor can’t broadcast the contents of your medical records to everyone in the office, but she doesn’t have to treat you in a soundproof room. Your name can be protected health information in some cases, but someone working at the office is still allowed to call it out in a waiting room. (As an extra precaution and courtesy, many offices will call out your first or last name, but not both.)

In this example, your best friend would only be your personal representative if a decision needs to be made about your life support. If you aren’t on life support but are otherwise incapacitated, your friend wouldn’t be your representative and wouldn’t be able to access your information. On the other hand, your sister would be able to access your information in the second case but not the first.

Can Someone Be My Personal Representative If I’m Not Incapacitated?

HIPAA Privacy Notices When you have your first appointment with a health care provider, you will be asked to sign a HIPAA-related form. This form isn’t the authorization form that you read about earlier. Rather, it is used to confirm that you‘ve received the provider’s “notice of privacy practices.”

Someone is your personal representative when they have the legal right to make health care decisions for you. Unless you or a court makes some unconventional arrangements, this right is only given to someone if you are physically or mentally incapable of making your own choices. If you want someone to receive your information but aren’t incapacitated, you might need to sign an authorization form first. © Real Estate Institute

By signing the form, you aren’t giving your doctors any more rights than they already have. Doctors don’t need your signature to share information for purposes of 96

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PROTECTING CONSUMER RIGHTS copy. If you are covered along with dependents, all privacy notices can be sent to you instead of to those dependents.

treatment, payment or health care operations, and your signature on the form doesn’t allow them to use or share your information in ways that would otherwise require your authorization. The only reason doctors ask you to sign is so they can prove you’re aware of your HIPAA rights.

The Privacy Rule also excludes the following entities from the notice requirements: 

Entities or individuals in their roles as business associates  Group health plans that are fully insured and don’t receive protected health information other than enrollment and summary health information (Fully insured plans aren’t self-insured and arrange coverage for members entirely through a health insurance company or HMO. Summary health information is cumulative information about the plan and its claims history that can’t be traced back to a particular enrollee, with the possible exception of ZIP codes.) Health plans that are considered fully insured but receive personal health information besides enrollment and summary health information need to have a privacy notice of their own. However, they only need to provide it upon a member’s request. A similar exception applies to health care providers that are involved in your treatment but don’t treat you directly. An example would be a laboratory that receives samples or test results from your doctor but doesn’t communicate with you about your health.

The notice of privacy practices (which might or might not be on the same page as the signature we’ve been talking about) must contain several elements, including the following: 

An explanation and examples of how your information can be used or shared without your written authorization (including but not limited to uses and disclosures for treatment, payment and health care operations)  Disclosure of the fact that other kinds of uses and disclosures won’t be allowed without your written authorization  Disclosure of your right to request restrictions on the use or disclosure of your information, but that the covered entity isn’t required to grant your request  Disclosure of your right to receive copies of your information, amend your records and receive an accounting of disclosures of your information  Disclosure of your right to receive a copy of the privacy notice  Disclosure of the covered entity’s obligation to keep your information private  Disclosure of your right to file a privacy complaint and an explanation of how to do it  The effective date of the covered entity’s privacy practices Your doctor needs to give you the notice of privacy practices before your first treatment and has to display a copy of it in plain view at the office or treatment facility. In an emergency situation, the doctor doesn’t have to give you the notice before treating you, but you are required to receive it when the emergency has ended.

Sharing Information in an Emergency There’s hardly a more important time to understand HIPAA than in an emergency. Suppose you’re with your brother who suddenly collapses. You rush to the emergency room and are told to wait outside by yourself while the medical staff tries to revive him. An hour later, you finally track down a doctor. But when you ask the physician about your brother, she refuses to give you any information. She tells you that since you aren’t your brother’s personal representative, she can’t tell you anything about his condition, including where he is or how he’s feeling. After all, she says, giving you that kind of information without your brother’s authorization would violate HIPAA. The doctor in our example is wrong, and so are the real-life medical personnel who have consistently said such things to patients’ families and friends. Though a health care provider might have an internal policy that prevents employees from giving information to a patient’s loved ones, HIPAA doesn’t prohibit this form of sharing.

Health care providers need to make good-faith efforts to confirm their patients’ receipt of the privacy notice. If you refuse to sign an acknowledgment form, the doctor needs to take note of the situation, but you can’t be penalized for your decision. The doctor still has to treat you. You don’t need to receive the doctor’s notice of privacy practices again unless you request a copy or unless the practices change. If privacy practices change, you are supposed to receive a revised version of the notice in a timely manner. The doctor doesn’t have to confirm your receipt of a revised notice.

If you are not available to give your consent or if you are incapacitated, a covered entity can share some of your protected health information with family members and close friends. Covered entities are allowed to disclose information under these circ*mstances if they believe doing so is in your best interest and that you probably wouldn’t object to it. Based on their professional judgment, they can share information in these situations to the extent that the recipient is involved in your care.

Health care providers who operate Web sites are also required to post their privacy practices online in an easily accessible place.

So getting back to our example, it is reasonable to assume that giving you information about your brother’s condition would be in his best interest. (Even if you aren’t the one who can make medical decisions for him, you might be in charge of contacting the person who fits that description.) And since you were the one who made sure he got to the hospital in the first place, you’ve become involved in his care. While the doctor would be out of line if she were to tell you information that didn’t relate to your brother’s collapse, HIPAA still allows her to give you some information about his current condition.

Privacy Notices for Other Covered Entities Other covered entities need to maintain privacy policies and make them available to consumers, but the rules are a little different for people who aren’t health care providers. A health plan needs to give you its notice of privacy practices when you enroll and within 60 days of a change. This may be done through the mail or through your plan sponsor (often your employer). The plan doesn’t need to verify that you’ve received the notice, but it needs to remind you (at least every three years) of your right to receive a © Real Estate Institute

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PROTECTING CONSUMER RIGHTS to give information to your representative is when there is a reasonable chance that the representative will abuse you.

The same standards apply to information shared over the phone. If you have an accident and aren’t capable of telling medical personnel who to contact, your doctor or your hospital can use professional judgment to contact a friend or family member on your behalf. The covered entity doesn’t need to worry about whether the contacted person is your personal representative.

Other friends and family members don’t have any rights to your information under HIPAA. Without your authorization, they can’t access your information unless a covered entity believes disclosing it would be beneficial to you. The covered entity can pick and choose what to tell these people about your health status, and unless they’re your personal representative, they can’t amend your records or authorize disclosures. They can’t make medical decisions for you.

If you are available to your health care provider, your information can be shared with friends or family if the provider believes doing it would be in your best interest and you don’t object. So if you are in the emergency room but are still competent and able to communicate, your doctor can simply say something like, “I’ll go tell your son what’s going on.” By saying nothing to stop the doctor, you would be giving him consent to share at least some of your information with your son. You don’t need to sign an authorization form for this kind of sharing to be legal.

Do Patients Need to Sign a Blanket Authorization Form Before Their Information Can Be Shared With Friends and Family? If you don’t want a covered entity to use its own judgment when deciding whether to disclose information to certain people, you can opt out of this kind of sharing. If you don’t mind the entity using its professional judgment to share information, you don’t need to sign anything ahead of time.

Sometimes your consent can be implied. For example, if you invite someone into a treatment area while you are being examined, your provider can infer that talking about your condition in front of that person is acceptable.

Adding Information to Hospital Directories Pretend your coworker is in the hospital. You aren’t involved in his care at all, but you decide visiting him would be a friendly gesture. You don’t know his room number, so you ask someone in the hospital lobby. If the person there discloses your colleague’s location, has the person violated HIPAA?

Here are some other situations in which a covered entity might be able to use professional judgment and disclose some of your protected health information without your consent to friends or family. 

Someone is picking you up from treatment and would benefit from knowing how to transport you safely.  Someone is going to be looking after you while you are sick or injured and would benefit from knowing how to keep you safe or provide basic treatment.  Someone is helping you pay your medical bills and needs protected health information for financial reasons.  Someone is picking up medication for you and would benefit from knowing about dosages, side effects and other drug-related matters. Because this aspect of the Privacy Rule is so important yet so misunderstood, we’d be foolish if we didn’t explore it in greater detail.

People who visit or call a health care facility can receive basic information about you from a patient directory. Anyone who asks for you by name can be told your location in the facility and your general condition (fair condition, stable condition, etc.). Those same details and your name and religious affiliation can be disclosed to members of the clergy. When you’re admitted to a hospital or other care facility, you are supposed to be told about the information that will be listed in the facility’s directory and who may receive it. If you don’t want the information to be given to callers and visitors, you can order that the facility keep it private. You don’t need to sign anything in order for it to be disclosed. If you’re incapacitated or in the middle of an emergency, you’re supposed to be told about the directory information at the next reasonable time. Until then, the facility can give out the information to people based on its professional judgment.

Are Covered Entities Required to Share Information With Friends or Family Members in Emergencies?

Here are some specifics about how this part of the Privacy Rule is enforced.

HIPAA gives covered entities the option of sharing your information with these people without your authorization. However, covered entities aren’t obligated to share your information with anyone other than you or your personal representative.

What Happens If I Opt Out of the Directory? If you aren’t in the facility’s directory, you might not be able to receive visitors, phone calls or gifts. Anyone trying to contact you would need to already know where you are and how to do it.

Health care providers might have internal policies that prevent your friends and family members from receiving any protected health information under any circ*mstances. These policies are generally allowed, but they aren’t required by HIPAA.

If I’m Not in the Directory, Will a Member of My Religious Community Find Me? Patients often take comfort in their religious beliefs when they are in the hospital. Still, if you decline to have your information available in the facility directory, you’ll have to make a special request if you want to see a priest, rabbi or other spiritual leader. Even if you are near death and your local priest insists you’d want to see him, he won’t be able to obtain any information about you from the directory.

How Is My Personal Representative Different From Other Friends and Family Members? Your personal representative can act on your behalf to make medical decisions and take several actions in regard to your protected health information. This person can access all of your protected health information, request amendments to it and authorize disclosures of it on your behalf. Practically the only time a covered entity can refuse © Real Estate Institute

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What Will Visitors and Callers Be Told If I’m Not in the Directory?

Fully Insured Plans vs. Self-Insured Plans HIPAA compliance can be relatively simple for employers when they sponsor a fully insured plan. A fully insured plan is a group health plan in which coverage is secured entirely through an insurance company or HMO. The opposite of a fully insured plan is a self-insured plan, in which the employer pays members’ medical bills partially or entirely on its own. In general, self-insured plans are more popular among large employers than among small employers.

Ideally, they will just be told that there’s no one in the directory with your name. If they’re told you’ve opted to keep your information private, they’ve confirmed that you’re a patient. This might be a violation of your privacy.

What Happens If I’m in the Directory But I End Up Leaving the Hospital or Dying There? Your departure or death can be disclosed to people who ask for you by name.

Since employers are usually the ones who sponsor health plans, it’s easy to assume that they are responsible for keeping their plans HIPAA-compliant. But if an employer sponsors a fully insured plan and its insurer doesn’t give the employer any information about employees other than enrollment information and “summary health information,” most of HIPAA’s administrative responsibilities will be handled by the insurance company.

Sharing Information in the Workplace Despite not being covered entities, employers deal with HIPAA indirectly when they act as “plan sponsors.” A plan sponsor is essentially any entity that decides to create a group health plan for itself. A sponsor can choose to fund its group’s health care independently (in an arrangement known as self-insuring), or it might decide to purchase coverage for the group from a health insurance company.

Summary health information is health information about the benefits provided under the employer’s plan, including the plan’s claims history. This information may disclose the kinds and costs of treatment that group members have received, but it won’t include data that can be used to identify a particular employee, other than five-digit ZIP codes. A plan sponsor can only receive summary health information (without members’ consent) for limited purposes, such as shopping around for lower premiums and making changes to its health plan.

A plan sponsor’s involvement in HIPAA compliance will depend on how its plan is structured and what information the sponsor receives from the plan. If an employer offers its plan entirely through an insurance company and only receives a limited amount of health information from its insurer, its participation in HIPAA compliance won’t be particularly complicated. (In this case, the employer’s insurance company will probably be charged with handling HIPAA’s administrative requirements.) But if the employer is self-insuring, it will be at least partially responsible for ensuring that its plan is following HIPAA’s many privacy requirements.

Fully insured plans that don’t let employers access other information generally just need to ensure that their plan doesn’t retaliate against people for exercising their HIPAA rights and doesn’t force members to waive any of those rights. Other administrative duties can be handled by the employer’s insurance company.

Before going into too many specifics about different kinds of health plans, we need to emphasize that there are plenty of situations in which medical information provided at work has nothing to do with HIPAA. Even as the Privacy Rule regulates the instances in which your health plan can give information to your employer, it doesn’t always stop your employer from getting your information from other sources and using it inappropriately.

To keep this straight in your mind, you might find it helpful to view these kinds of plans as two separate plans. One plan is at the employer level and is the employer’s responsibility. Another plan is at the insurer’s level and is the insurer’s responsibility. For the fully insured arrangements that we’ve been discussing, the administrative requirements for the plan at the employer’s level are minimal.

In general, HIPAA has little or no power over information that companies obtain in their role as employers. For example, when you request a medical leave of absence, your employer can require that you give a reason for your request. When you attempt to take a sick day, your supervisor can still demand to know why you won’t be in the office.

If a plan is self-insured or lets the plan sponsor receive protected health information other than enrollment and summary health information, the sponsor will have more responsibilities. Even though the employer would still technically not be a covered entity, the portion of its business that is administering the health plan would be acting as one. As a covered entity, this portion of the employer’s business needs to do the following:

Since medical information in those situations would be coming from you rather than from the health plan, your company would be receiving it as an employer, not as a plan sponsor. Nothing in HIPAA would force your employer to keep your medical information private in either of those examples. (Of course, your employer might be required to follow other laws that restrict the use or disclosure of your information. For simplicity’s sake, we’ll only concern ourselves with HIPAA requirements here.)

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Similarly, since it would need the information for payroll purposes, your employer can receive information about whether you are enrolled in its plan and how much of your paycheck is supposed to be earmarked for premiums. And though your doctor might not be allowed to disclose the results of a drug test to your employer without your consent, you can still be turned down for a job if you don’t let your employer access the information.

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Not retaliate against employees for exercising their HIPAA rights. Not force people to waive their HIPAA rights. Create and maintain a privacy notice. Provide the privacy notice to group members in the manner described in the section “HIPAA Privacy Notices.” (If the plan is fully insured but receives or creates protected health information besides enrollment and summary health information, the notice only needs to be provided upon a member’s request.) Appoint a privacy officer who will be in charge of keeping the health plan compliant with the Privacy Rule.

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PROTECTING CONSUMER RIGHTS recall, a personal representative is entitled to your information when he or she has the legal right to make medical decisions for you. If you are an adult, someone generally can’t make your medical decisions for you unless you are incapacitated. But if you are under 18, your medical decisions can often be made by your parents even if you are of sound mind and capable of communicating your wishes. Whenever an adult has the power to make a treatment decision for a minor, the adult also has the power to control access and disclosure of the minor’s information.

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Create internal privacy policies that address who can access or use protected health information, what information they can use or access, and the circ*mstances under which use or disclosure will be allowed.  Have a written or electronic copy of its internal privacy policies.  Establish a process for members to file privacy complaints.  Implement safeguards to prevent unauthorized or unintentional uses and disclosures.  Train employees to follow privacy practices and procedures.  Require third-party administrators and other service providers to sign business associate agreements before obtaining protected health information from the plan. If a health plan is going to be sharing information with its sponsor besides enrollment and summary health information, the legal documents establishing the plan must be amended. Among other things, the following points must be made clear in the amended documents:

HIPAA provides for a few exceptions that let minors keep information away from their legal guardians. In cases where laws allow a minor to receive treatment without an adult’s consent, the minor’s rights will be the same as an adult’s’ rights. So if state law lets a teenager be tested for a disease without parental consent, the teenager’s parent can’t use his or her rights as the child’s personal representative to find out about the test. The doctor administering the test can only disclose it to the parent if the teenager provides authorization or if the disclosure is done for treatment, payment or health care operations. A parent’s rights as a personal representative are also waived in cases where the parent and the provider agree ahead of time that certain information will remain confidential between the child and the physician. For instance, if a parent agrees to leave the room during an office visit, the information shared between the child and the doctor during that time isn’t necessarily any of the parent’s business.

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The sponsor can’t use or disclose protected health information in ways that are prohibited by the plan documents.  Any agent acting on the sponsor’s behalf must follow the same privacy rules as the sponsor.  The sponsor needs to contact the plan if it knows of any improper use or disclosure of protected health information.  If possible, the sponsor needs to get rid of or return protected health information when the information is no longer needed.  The sponsor can’t use protected health information to make employment-related decisions.  The sponsor will only allow certain people to access protected health information on its behalf. (These people must be identified in the plan documents.) Understand that this is only a summary of a plan’s main requirements at the employer level. For additional requirements impacting employers and other plan sponsors, see the Privacy Rule.

Like all personal representatives, parents can be denied access to information if a covered entity believes disclosing the information to them would put someone in danger. HIPAA is careful, however, not to overstep the boundaries of a state’s own parental notification and parental access laws. If a state lets a child receive care without parental consent but still gives parents the right to receive information about that care, the state law must be followed. Likewise if parental access to information is allowed by HIPAA but prohibited by state law, the access isn’t allowed. When state or federal law makes parental notification or parental access optional, the decision to give information to parents must be made by a licensed medical professional. Parents lose control over a son or daughter’s health information when their child becomes an adult. This includes information that was compiled by a covered entity when the son or daughter was still a minor. An adult child who isn’t financially independent from the parent has the same privacy rights as one who receives no parental support. Once you’re an adult, your parents generally can’t access or receive your protected health information, other than in one of the following scenarios:

Exemptions for Some Group Plans Though HIPAA’s rules about insurance portability and nondiscrimination still need to be followed, the Privacy Rule doesn’t apply to self-insured health plans with fewer than 50 participants. Group plans that only offer life insurance, disability insurance or some other non-health kind of coverage are also exempt.

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Sharing Information About Minors Children are a bit of an oddity in HIPAA terms because their information can be accessed by a legal guardian without their authorization. Even if the parent’s reason for wanting a child’s information is not related to treatment, payment or protected health information, a covered entity usually must honor a request.

Sharing Information About the Deceased Believe it or not, many of your HIPAA privacy rights will remain in force after you die. But before we mention what rights will outlive you, we should touch on the occasions when covered entities are allowed to share information about the deceased.

You authorize the disclosure. Disclosure is made for the purpose of treatment, payment or health care operations. You’re in a situation in which your parents have the legal authority to make your medical decisions.

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PROTECTING CONSUMER RIGHTS Some of the permissible disclosures follow common sense. For example, covered entities can share your information under any of the following circ*mstances:

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The notes are being disclosed to comply with a law or an order from the Department of Health and Human Services.  The notes are being disclosed to a coroner or medical examiner to identify someone or determine a cause of death.  The notes are used or disclosed to prevent an imminent threat to someone’s health or safety. Extra restrictions on psychotherapy notes also impact your access to your own records. While you have the right to access your protected health information from a covered entity, psychotherapy notes do not need to be disclosed to you. They don’t need to be disclosed to your personal representative either.

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The information is shared with authorities for identification purposes.  The information is shared with authorities to determine cause of death.  The information is shared to facilitate proper organ donation.  The information is shared by a covered entity exercising its professional judgment. A covered entity also has the ability to share a deceased person’s information with researchers who request it. However, a researcher needs to agree to only use the information for research purposes, and the information needs to be an essential part of the research. At the covered entity’s request, the researcher needs to confirm that the person has passed away. (You’ll find more about HIPAA’s rules for research in the section “Sharing Information With Researchers.”)

Sharing Information at Pharmacies HIPAA doesn’t prevent a friend or family member from picking up a prescription for someone else, and it doesn’t stop a pharmacist from giving drug-related information to the person picking up the prescription.

Using Information for Marketing Purposes

In addition, a deceased person’s information can be shared for the purpose of treating a living person. Your doctor can receive information from your deceased parents’ doctors to properly diagnose you.

Covered entities can’t use or disclose your protected health information for marketing purposes without consent. A covered entity is marketing to you if it is communicating with you about a product or service and encouraging you to purchase or use the product or service. A covered entity is also generally forbidden from selling your information to a third party, including situations in which the third party just wants to market to you.

In most other cases, though, the protected health information of deceased individuals can only be shared with the person in charge of their estate. The person running the estate is otherwise treated as the deceased’s personal representative.

There are, however, some cases in which a covered entity can promote goods and services and not be marketing to you. For instance, no marketing is going on (and no authorization is required) if a covered entity is promoting a product or service as part of legitimate treatment. If you phone your doctor and complain of certain symptoms, your doctor generally can recommend a particular drug to you as a way of relieving those symptoms. Also under HIPAA, marketing is not necessarily going on when a covered entity is using your information to promote a health-related product or service that it provides.

Sharing Information About Mental Health Confidentiality tends to be even more of an issue for people who receive mental health care. Since the topics addressed in a counseling session can be particularly personal, patients usually don’t want the details of their therapy disclosed to anyone. If special privacy requirements didn’t exist among mental health practitioners, some people who need help would be less inclined to receive it. With this in mind, the writers of the Privacy Rule put special restrictions on “psychotherapy notes.” These notes are records maintained by a mental health care provider that are not kept in a person’s medical records. They might include the specifics of what was discussed in a counseling session, but they don’t include things like a general diagnosis, prescription information and a session’s starting and ending times.

A covered entity doesn’t need your authorization before marketing products and services to you in a face-to-face conversation or when giving you a small promotional gift.

Marketing Rules Under the HITECH Act Through the HITECH Act, Congress tightened and clarified the HIPAA marketing rules for covered entities and their business associates. Among other things, the law added the following rules:

If your therapist’s notes aren’t kept with your medical records and are considered “psychotherapy notes,” they can rarely ever be used or disclosed without your consent. Your provider can’t even share them for treatment, payment or health care operations unless you give your permission.

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Proving again that there are exceptions to every rule, HIPAA allows health care providers to use or disclose psychotherapy notes without your authorization under a few circ*mstances, including the following:   

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The notes are used only by the person who made them and are being used to treat you. The notes are being used for training purposes by your health care provider. The notes are being used by your mental health practitioner as part of a legal proceeding.

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If a covered entity or business associate is disclosing your protected health information in exchange for compensation, the authorization form that you sign must state whether the party receiving the information can resell it. If you receive communication from a covered entity for the purpose of fundraising, you need to have a way to opt out of future fundraising communications. Even if a covered entity is marketing products or services to you that are provided by that entity, your authorization might still be required. Much will depend on whether a third party is paying the covered entity to do the marketing. (As an example, think of a health plan that’s being paid to www.InstituteOnline.com

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advertise a particular benefit, or a doctor who’s being paid by an equipment manufacturer to market certain procedures to all patients.)

Sharing Information With Researchers At its best, medical research finds cures for serious ailments and helps professionals find ways to make health care cheaper and more efficient. So it’s no surprise that the Privacy Rule makes special mention of studies that involve the use of protected health information. Since research generally doesn’t fall into the categories of treatment, payment or health care operations, it can’t entail the use or disclosure of your information unless some conditions are met. A covered entity doesn’t have blanket authority to give your records to a researcher and can’t even give your contact information to a researcher without your consent.

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Some researchers have expressed frustration over the way HIPAA has impacted their work or may impact it in the future. They claim, on occasion, that HIPAA requirements might discourage people from conducting research and make essential pieces of medical data tougher to find.

Limited Data Sets If researchers can’t get what they need through deidentification, they can ask covered entities for a “limited data set.” A limited data set is similar to de-identified information, but it can contain dates and more geographic information.

Still, the Privacy Rule contains at least four ways for researchers to obtain health information from covered entities. Let’s go over each of them, starting with the one that is probably the simplest to understand.

Unlike de-identified information, limited data sets are still protected health information. If a covered entity is going to use or disclose them without authorization, the use or disclosure can only be for the following purposes:

Authorization Covered entities can share your protected health information with researchers if you sign an authorization form. Details about this form can be found in the earlier section “Required Authorization and Consent Forms.”

 Research  Health care operations  Public health Even when they are going to be used for one of those three purposes, limited data sets can’t be disclosed unless the sender and the recipient enter into a “data use agreement.” Similar to a business associate agreement, the data use agreement must state:

De-Identification Earlier in this course, you learned that your medical information is only protected if it can be used to identify you. Information that is about you but can’t reasonably be used to identify you isn’t governed by the Privacy Rule. That reminder can help you understand the concept of “deidentified” information. De-identified information is health information that doesn’t take away a person’s anonymity. It can include information about treatment received by a particular patient, but it can’t include anything that tells people who that patient is.

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Since de-identified information doesn’t directly or indirectly disclose your identity, covered entities can use and share it without your authorization. This lack of restrictions can be especially helpful to researchers.

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That the recipient can’t use the information to identify individuals  That the recipients can’t use the information to contact individuals  That any third party who is allowed to use or disclose the information for the recipient must abide by the data use agreement A limited data set can’t contain any of the following information about you, your relatives, your employer or anyone living with you:

Names Location (such as home address) if it is expressed as something smaller than a state (The first three numbers of a ZIP code are occasionally permissible.) Dates (such as birthdays and treatment dates) other than years Ages above 89 (All individuals above 89 can still be grouped together and identified as “90 or above.”) Telephone numbers Fax numbers

What the recipient can and can’t do with the information Who can use or receive the information That the recipient must implement appropriate safeguards to prevent unauthorized uses and disclosures That the recipient must report unauthorized uses and disclosures to the covered entity

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Under the Privacy Rule, your information can be considered “de-identified” if it doesn’t contain any of the following facts about you, your relatives, your employer or anyone living with you:  

Email addresses Social Security numbers Medicaid record numbers Health plan identification numbers Vehicle serial numbers and license plate numbers Account numbers Certificate or license numbers Website addresses Device identification and serial numbers Biometric identifiers (such as fingerprints and voiceprints) Full facial images Any other information that could reasonably be used to identify you

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Names Addresses (other than cities, states and ZIP codes) Phone numbers Fax numbers Email addresses www.InstituteOnline.com

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Sharing Information With the Government, the Courts and Other Authorities

Social Security numbers Medicaid record numbers Health plan identification numbers Vehicle serial numbers and license plate numbers Account numbers Certificate or license numbers Website addresses Device identification and serial numbers Biometric identifiers (such as fingerprints and voiceprints) Full facial images

There are plenty of times when government authorities and courts could benefit from having protected health information. The information might help the government detect illegal activity, assist people in defending themselves, or assist local health officials in the containment of infectious diseases. Covered entities can disclose your information to the government, the courts and other authorities without your authorization. We’ll summarize how these disclosures are allowed, but be aware that the Privacy Rule has many specific requirements that will depend on a given situation. If you find yourself in a position where you feel obligated to give health information to a lawyer, a government representative or a police officer, you’ll probably want to review the Privacy Rule first.

Authorization Waivers Sometimes, contacting you for permission to use or disclose your information is impractical or impossible. In these kinds of situations, covered entities can share your information with a researcher if the researcher has obtained a “waiver of authorization.”

The Government Covered entities can give your protected health information to the government if the information is required by law. They might also share your information as a way of cooperating with regulatory investigations.

Waivers of authorization can be issued by either an Institutional Review Board or a Privacy Board. According to the Journal of Health Care Compliance, Institutional Review Boards existed prior to HIPAA. Privacy Boards, on the other hand, were created specifically in response to the Privacy Rule. They are designed to evaluate researchers’ compliance with HIPAA and have the following characteristics:

The Courts Whether information can be shared as part of a lawsuit will depend on who’s involved in the suit and who’s asking for the data. Covered entities can disclose protected health information if they are a plaintiff or defendant and the information relates to their case. If you are suing your doctor for malpractice, the doctor doesn’t need your permission to use your medical records as part of a defense. If your health plan has taken legal action against you for nonpayment, your payment information can be used against you without your consent.

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They are comprised of at least two people with different backgrounds, both of whom have an appropriate understanding of privacy issues.  At least one member isn’t affiliated with or related to people doing the research.  None of the members have a conflict of interest that could influence their decisions about authorization waivers. Institutional Review Boards and Privacy Boards can only issue a waiver of authorization after they’ve made three important determinations:

When they aren’t plaintiffs or defendants, covered entities can share information without your consent in accordance with a judge’s order. When a judicial request is made by a party other than a judge, covered entities can share your information without your consent in either of the following situations:

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The requested information is necessary to conduct the research.  It would be impractical or impossible for a researcher to contact individuals and ask to use their information.  Disclosing or using the requested information would only create a minimal risk to people’s privacy. That last determination will be based on whether a researcher has done all of the following:

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Law Enforcement Law enforcement entities occasionally use protected health information to prevent and solve crimes. Here are a few instances in which sharing information with law enforcement would generally be allowed:

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Agreed to protect the requested information Agreed to get rid of the requested information when it is no longer needed  Agreed to not use or disclose the requested information in ways that haven’t been explained to the board There are no specific bits of information that can’t be disclosed to someone with a waiver of authorization. The board issuing the waiver will decide what can and can’t be shared.

The covered entity or the person requesting the information has made a reasonable attempt to contact you and given you a reasonable chance to object to the disclosure. A court has issued a protective order that sets privacy restrictions on your information.

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The sharing is required by law. The sharing is done to protect someone from immediate harm. The sharing is requested by law enforcement to help identify or locate a criminal. (The Privacy Rule has special limits on the kind of information that can be shared in this scenario.)

Public Health Authorities Covered entities can share your information with a health authority if the disclosure is made with the intent of protecting the public. Like most other kinds of disclosures, 103

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PROTECTING CONSUMER RIGHTS this sharing still needs to be compliant with the minimum necessary rule. If a piece of information isn’t needed to fulfill a particular purpose, it’s supposed to be kept confidential.

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Relationship to Other Privacy Laws

Sharing Information With the Media

We’re just about ready to turn away from the Privacy Rule. But before we do, we ought to reiterate that HIPAA’s privacy requirements are minimal standards and aren’t the only medical privacy rules in existence.

Members of the media have been known to argue with their sources over the availability of health information. A reporter’s ability or inability to receive this information as part of a news story has even been the central issue in a few lawsuits.

People who aren’t covered entities need to understand that being exempt from HIPAA requirements doesn’t exempt them from other laws regarding health information. Covered entities need to know that uses and disclosures that HIPAA allows might be prohibited by other laws. In general, if a law provides greater privacy protection than HIPAA, that law must be obeyed.

By going over how HIPAA impacts the media, we can actually review some of the Privacy Rule’s key features. For example: 



A reporter can be given health information that isn’t individually identifiable. After all, information that doesn’t identify an individual isn’t protected by the Privacy Rule. Reporters can receive a patient’s general condition and location in a care facility if they ask for the person by name. After all, anyone can obtain this information through a facility directory. Law enforcement can share information with reporters without violating HIPAA. After all, the Privacy Rule only regulates health care providers, health plans and health care clearinghouses. Reporters might be able to obtain some health information if a state’s open records laws give them the right to receive it. After all, protected health information can be used or disclosed to comply with other laws.

HEALTH INFORMATION SECURITY RULES The Privacy Rule isn’t the only collection of standards that covered entities need to follow. A covered entity and its business associates also need to comply with HIPAA’s Security Rule. Whereas the Privacy Rule deals mainly with how protected health information can be used or disclosed, the Security Rule addresses how the information needs to be guarded. It contains a number of administrative, physical and technical safeguards that need to be implemented whenever protected health information is stored or transmitted in an electronic format. Information stored on a server or on a desktop computer is considered to be in an electronic format, and so is data that’s stored on a removable disk. Information that’s transmitted over the phone or via fax generally isn’t in an electronic format.

Other Assorted Privacy Requirements

When it was enacted, the Security Rule was applicable only to covered entities (health care providers, health plans and health care clearinghouses). Because of the HITECH Act, business associates are now required to obey it too.

Regardless of whether any protected health information has been shared yet, covered entities need to comply with the Privacy Rule’s administrative requirements. You already read about some of these requirements in the section “Fully Insured Plans vs. Self-Insured Plans.”

A business associate’s obligation to follow the Security Rule’s requirements needs to be part of a business associate agreement. If a plan sponsor wants to receive protected health information in an electronic format, the sponsor must agree to implement a security plan of its own.

Other than some fully insured plans at the employer level, all covered entities must follow the Privacy Rule by doing the following:          

Appointing a privacy officer to oversee compliance with the Privacy Rule Providing appropriate privacy-related training to employees Applying sanctions against employees and business associates who violate privacy rules Documenting any sanctions against employees and business associates who violate privacy rules Implementing appropriate safeguards to keep protected health information private Creating a process that allows the public to file privacy complaints Documenting any privacy complaints Creating procedures that minimize the harmful effects of privacy violations Not intimidating, threatening or discriminating against people for exercising their HIPAA rights Not forcing people to waive their HIPAA rights for the purpose of treatment, payment, eligibility for benefits or enrollment in a health plan

Keeping a written or electronic copy of privacy practices (for at least six years after they are no longer in effect).

Implementing a Security Plan Ever since it was proposed, the Security Rule has made some covered entities nervous. Under the impression that the rule’s requirements are too complicated and costly, many providers and plans remain noncompliant with this part of HIPAA. In reality, the Security Rule was written with flexibility in mind. The people drafting it understood that no two covered entities are exactly the same and that they all have different amounts of technical and financial resources available to them. The rule is intended to be used as a general set of standards that can be followed at all levels of the health care industry without becoming outdated. So before diving into too many details, we should clarify some basics about what the Security Rule requires and what it doesn’t. Contrary to popular belief, it doesn’t force anyone to utilize any particular kinds of software or other computer-related technology. It doesn’t even force covered entities or business associates to encrypt electronic health information. Instead, the Security Rule sets several broad securityrelated goals and expects covered entities to achieve them in whatever way seems reasonable. In return for being able 104

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PROTECTING CONSUMER RIGHTS to choose the specifics of their security plan, covered entities are required to reevaluate that plan if their exposure to security risks ever changes.



When deciding how to implement the standards set by the Security Rule, covered entities are allowed to take the following factors into consideration:   

The covered entity’s exposure to security risks The cost of implementing particular security measures The covered entity’s existing security measures and how they accomplish the goals of the Security Rule

Required Safeguards and Alternative Safeguards The specific safeguards mentioned in the Security Rule are either “required” or “addressable.” If a safeguard is required, covered entities must implement security measures that satisfy it. If a safeguard is addressable, covered entities need to at least determine whether the safeguard is reasonable or appropriate for them.



When covered entities believe a Security Rule safeguard is reasonable and appropriate, they need to implement it. When a safeguard isn’t reasonable and appropriate, covered entities can ignore it by doing all of the following: 

Documenting that the safeguard isn’t reasonable and appropriate  Documenting why the safeguard isn’t reasonable and appropriate  Implementing an alternative safeguard that is reasonable and appropriate The required and addressable safeguards are divided broadly into three categories: Administrative safeguards, physical safeguards and technical safeguards. Within those broad categories, you’ll often see subgroups of safeguards. These subgroups are known as “standards.”



In the next three sections, we’ve summarized the standards and safeguards and identified which ones are required and which ones are addressable.

Administrative Safeguards 



Standard: Security Management Process (Create and implement procedures to protect information, detect security problems and fix security problems.)  Safeguard: Risk Analysis (Identify the risks to your electronic data and the size of those risks.) REQUIRED  Safeguard: Risk Management (Take steps to bring your identified security risks down to a reasonable level.) REQUIRED  Safeguard: Sanction Policy (Create penalties for employees who violate security rules.) REQUIRED  Safeguard: Information System Activity Review (Regularly monitor the security of information systems.) REQUIRED Standard: Assigned Security Responsibility (Choose someone who will be responsible for picking and implementing security measures.) required



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Standard: Workforce Security (Take steps to ensure that authorized employees can access information and unauthorized employees can’t.)  Safeguard: Authorization and/or Supervision (Implement procedures to determine if people should have access to information and how they should be supervised.) ADDRESSABLE  Safeguard: Workforce Clearance Procedure (Implement procedures to prevent unauthorized people from accessing information.) ADDRESSABLE  Safeguard: Termination Procedure (Implement procedures to ensure that once people lose access, it stays lost.) ADDRESSABLE Standard: Information Access Management (Determine how access to information should be achieved.)  Safeguard: Isolating Health Care Clearinghouse Functions (If you have a department that acts as a health care clearinghouse, take steps so that information from that department isn’t shared improperly with other departments.) REQUIRED  Safeguard: Access Authorization (Determine how people should be able to access information.) ADDRESSABLE  Safeguard: Access Establishment and Modification (Document, review and modify [if needed] how access to information is allowed and achieved. ADDRESSABLE Standard: Security Awareness and Training (Create training for people within the organization.)  Safeguard: Security Reminders (Keep the workforce appraised of security procedures.) ADDRESSABLE  Safeguard: Protection From Malicious Software (Protect your system from viruses and similar problems, and train employees about this risk.) ADDRESSABLE  Safeguard: Log-in-Monitoring (Take steps to monitor situations in which people attempt to access information but don’t succeed.) ADDRESSABLE  Safeguard: Password Management (Make procedures for creating, changing and safeguarding passwords, and communicate password policies to employees.) ADDRESSABLE Standard: Security Incident Procedures (Decide what should be done when there’s an issue with information security.)  Safeguard: Response and Reporting (Implement procedures for identifying security problems when they occur and minimizing their impact.) REQUIRED

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

received, handled and disposed of on hard drives or portable storage devices.)  Safeguard: Disposal (Implement procedures regarding how to dispose of information and the items on which it’s stored.) REQUIRED  Safeguard: Media Reuse (Require that media storage devices can’t be reused unless old information is deleted from them.) REQUIRED  Safeguard: Accountability (Document cases in which information is moved from place to place.) ADDRESSABLE  Safeguard: Media Backup and Storage (Ensure that information has been copied before moving the equipment that stores it. ADDRESSABLE

Standard: Contingency Plan (Have a plan for situations in which normal access to information is lost.)  Safeguard: Data Backup Plan (Make copies of electronic information for emergency access.) REQUIRED  Safeguard: Disaster Recovery Plan (Have a plan for restoring lost access to information.) REQUIRED  Safeguard: Emergency Mode Operation Plan (Make sure an emergency doesn’t jeopardize the security of information.) REQUIRED  Safeguard: Testing and Revision Procedures (Periodically test contingency plans, and revise them as needed.) ADDRESSABLE  Safeguard: Applications and Data Criticality Analysis (Determine which computer programs are most important to the handling of protected health information.) ADDRESSABLE Standard: Evaluation (Evaluate all security plans periodically to address risks and compliance with the Security Rule.) REQUIRED Standard: Business Associate Contracts and Other Arrangements (Don’t share information with business associates unless you believe they’ll keep it protected.)  Safeguard: Written Contract or Other Agreements (Document a business associate’s obligation to keep information safe.) REQUIRED

Technical Safeguards 

Physical Safeguards 



Standard: Facility Access Controls (Implement procedures that limit access to information and to the facility housing the information.)  Safeguard: Contingency Access Controls (Have a way to make information secure and/or adequately accessible when a contingency plan is underway. ADDRESSABLE  Safeguard: Contingency Security Plan (Take steps to address theft, tampering or unauthorized access of electronic information at the facility.) ADDRESSABLE  Safeguard: Access Control and Validation Procedures (Determine who at the facility should have access to areas where information is accessible.) ADDRESSABLE  Safeguard: Maintenance Records (Document any repairs and modifications that relate to the physical security of the facility.) ADDRESSABLE Standard: Workstation Use (Implement policies explaining how devices related to electronic information are to be used, including devices used outside of the facility.) REQUIRED Standard: Device and Media Controls (Develop policies regarding how information should be

 



Standard: Access Control (Create methods and controls to ensure that information is only accessible to authorized personnel.  Safeguard: Unique User Identifier (Be able to track users of information systems by name or identification number.) REQUIRED  Safeguard: Emergency Access Procedure (Implement ways for information to be accessible in emergency situations.) REQUIRED  Safeguard: Automatic Logoff (Use a system that logs people off after an extended period of inactivity.) ADDRESSABLE  Safeguard: Encryption and Decryption (Figure out how to encrypt and decrypt information.) ADDRESSABLE Standard: Audit Controls (Implement procedures for recording activity on systems.) REQUIRED Standard: Integrity (Take steps to ensure information can’t be improperly changed or deleted.)  Safeguard: Mechanism to Authenticate Electronic Protected Health Information (Monitor whether information has been inappropriately altered or destroyed.) ADDRESSABLE Standard: Person or Entity Authentication (Take steps to ensure that people trying to access information are who they say they are.) REQUIRED Standard: Transmission Security (Take measures to prevent unauthorized access while information is being transported through a network.)  Safeguard: Integrity Controls (Make sure information isn’t modified or destroyed during transmission.) ADDRESSABLE  Safeguard: Encryption (Use a system that encrypts data when appropriate.) ADDRESSABLE

DEALING WITH SECURITY BREACHES The Privacy Rule and Security Rule made covered entities responsible for the proper use and disclosure of protected health information. But until 2009, nothing in HIPAA or its 106

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PROTECTING CONSUMER RIGHTS agent of a covered entity knew about a breach but didn’t report it.

related statutes guaranteed that a victim of a serious privacy breach would ever be alerted to the situation. While some states had laws requiring breach notifications, many others didn’t address the issue and let covered entities make up their own minds about whether contacting affected persons was appropriate.

Covered entities can delay notifications if they receive a request from law enforcement. If the request is made orally, an entity can delay notification for 30 days. When the request is in writing, the entity can wait until the time specified in the request. The law allows these delays in order to keep notifications from compromising criminal investigations.

One of the most significant changes brought on by the HITECH Act was the requirement that covered entities notify individuals of security breaches. The law also forces business associates to alert covered entities when protected health information has been used or shared in unauthorized ways.

Breach notifications should be made via first-class mail and sent to the individual’s last known address. A covered entity can notify people by email if they have already agreed to be reached that way, or by phone if other forms of communication are too slow to prevent harm. If an affected individual has died, the covered entity can send the notice to the person’s personal representative or next of kin.

Breach notifications only need to be made when the wrongfully used or disclosed information was “unsecured.” For data that is stored electronically, information generally is unsecured when it has not been destroyed or encrypted. For data stored on paper, information generally is unsecured when it has not been destroyed or shredded.

When a breach involves 10 or more people whose contact information is unknown, the covered entity has two options. Notification of the breach to those people can be made on the home page of the entity’s website for 90 days, or it can be made through a toll-free telephone number that is active for 90 days. The entity is required to advertise the phone number in the local print and broadcast media.

Under the law, breach notifications are required when the unauthorized use or disclosure of protected health information is likely to cause financial, reputational or some other kind of harm. If a disclosure is technically a HIPAA violation but isn’t likely to harm anyone, a covered entity isn’t obligated to contact the victim.

Breaches that require notifications also need to be reported to the Department of Health and Human Services. Breaches involving less than 500 people in a state or other jurisdiction need to be reported to the government in annual reports within 60 days after each calendar year. For larger breaches, a covered entity needs to notify the government at the same time that affected individuals are given notice, and advertising must be done in print and broadcast media.

When deciding whether actual harm is involved, covered entities are advised to consider both the kind of information that has been breached and the person who gained access to the information. If covered entities determine that notification isn’t necessary, they still need to document the unauthorized use or disclosure and their reason for not notifying anyone. The government has determined that some unauthorized disclosures aren’t considered breaches. For example, a breach hasn’t occurred when there was no reasonable way for unauthorized people to retain a person’s protected health information. (Think of a health record that appears on a computer screen for only a few seconds.) There also hasn’t been a breach if an employee of a covered entity has accidentally accessed information in good faith and hasn’t done anything unlawful with it. (Think of an employee who receives a misdirected email, sends it to the right person and then deletes it.)

CRIMINAL AND CIVIL PENALTIES The HITECH Act increased the size of penalties for HIPAA violations and made them applicable to covered entities, business associates and employees. The severity of a penalty will depend on the violator’s history of compliance, the violator’s knowledge of the law and the violator’s intent. Civil monetary penalties range from $100 for a single mistake to $1.5 million for repeated serious offences. Criminal offences can land a violator in jail for as long as 10 years if the person broke the law with malicious intent or for financial gain.

There doesn’t need to be proof of a breach for the notification requirement to go into effect. If a situation suggests there might have been a breach, it needs to be treated as though one actually occurred.

CONCLUSION: THE FUTURE OF HIPAA The passage of health care reform in 2010 means there are bound to be major changes to HIPAA in the years to come. Unless Congress takes further action, health insurers will not be allowed to discriminate against people on the basis of pre-existing conditions by 2014. This prohibition went into effect specifically for children in September 2010.

Breach Notifications A notice to an affected individual must contain the following:  

The date when the breach occurred (if known) The date when the covered entity became aware of the breach  The steps that have been taken to minimize harm to the individual  The steps the individual can take to minimize harm  Contact information that can be used to find out more about the breach Breach notifications need to be made to affected individuals no later than 60 days after a covered entity either knows of a breach or reasonably should have known about one. This includes any time when an employee or

As a result of those reforms, much of the material in this course about insurance portability and pre-existing conditions is likely to become obsolete in 2014. However, there will undoubtedly be new regulations to replace the old ones, and the issue of portability will continue to be important to consumers. Meanwhile, HIPAA’s rules regarding privacy and security might receive even more attention as millions of new customers enter the health insurance market. Students who are interested in potential changes to HIPAA should periodically contact the Department of Health and Human Services or visit the department online. 107

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Below is the Final Examination for this course. Turn to page 114 to enroll and submit your exam(s). You may also enroll and complete this course online:

www.InstituteOnline.com Your certificate will be issued upon successful completion of the course.

FINAL EXAM 1. The important difference between agents and brokers involves the people who they ultimately ________ in an insurance transaction. A. represent B. employ C. pay D. satisfy

2. Upon being made aware of important information about the policy they are seeking, ________ must ultimately be the ones to decide on the type of coverage for the agent or broker to procure. A. consumers B. producers C. financial advisers D. regulatory authorities

3. Insurers expect their agents to be loyal to their company, keep the insurer apprised of customer-related situations and ________. A. invest premiums in high-return accounts B. sign and initial all documents on the consumer’s behalf C. provide comprehensive legal advice to the public D. perform their jobs in an ethical and financially responsible way

4. Adherence to ethics improves public relations, which will likely ________ business. A. B. C. D.

slow decrease overcomplicate increase

5. Though the discriminatory practice of redlining has affected multiple classes and groups of people over the years, it will probably be forever linked to unfortunate instances of blatant ________. A. gender inequality B. age bias C. employment discrimination D. racial inequality

6. The U.S. government acted to outlaw redlining in various industries through the ________. A. B. C. D.

Fair Housing Act Redlining Deterrent Act Illinois Human Rights Act Fair Redlining Act

7. Within an insurance context, ________ is most commonly an issue for companies that sell homeowners insurance and personal auto coverage. A. life expectancy B. steering C. medical underwriting D. redlining

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8. Usually done on a ZIP-code level, ________ occurs when insurers price policies or offer different coverage to consumers based on geography. A. rebating B. territorial rating C. post-claims underwriting D. bait-and-switch

9. Sometimes courts have allowed insurers and regulators to withhold data from the public because the data reveals ________. A. discrimination B. illegal activity C. overcharging D. trade secrets

10. Anyone who has applied for a mortgage or any other kind of loan has probably had their credit history and credit score ________ by a lender. A. altered B. improved C. damaged D. examined

11. Applicants with good credit reports and ________ credit scores have the best chance of obtaining the money they wish to borrow. A. high B. medium C. low D. incalculable

12. A lender, creditor or any other person with a legitimate reason to investigate an individual’s credit history can obtain a credit report from ________. A. HUD B. a state insurance department C. a private investigative agency D. any of the three major credit bureaus in the United States

13. For ________ purposes, a credit report will include a person’s name, address, phone number, Social Security number and other general information that may be applicable and available to the bureau. A. discriminatory B. marketing C. research-related D. identification

14. Extensive as they can sometimes be, credit reports do not include information that relates to a person’s medical history, criminal background, ethnicity, race or ________. A. residency B. current mortgage C. number of open accounts D. gender

15. If consumers believe that something on one of their credit reports is incorrect, they may challenge the validity of the information by ________. A. submitting an affidavit to state regulators B. contacting the bureau that published the report C. asking their local bank to intervene D. filing a complaint with HUD

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16. Consumers are now legally entitled to a free copy of their credit reports from each of the three credit bureaus every _______. A. month B. time they request one C. year D. 90 days

17. Generally speaking, someone who has used a lot of credit and has paid off debts in a timely fashion will have a ________ score. A. low, favorable B. high, favorable C. high, unfavorable D. low, unfavorable

18. Although the Fair and Accurate Credit Transactions Act of 2003 allowed Americans to gain free, periodic access to their credit reports, the legislation only stipulated that a person must be given access to a credit score ________. A. once each year B. upon receiving written authorization from a creditor C. when applying for a mortgage loan D. for a “fair and reasonable fee”

19. The passage of the Equal Credit Opportunity Act three decades ago disallowed any denial of credit based on a person’s ________. A. gender B. credit history C. credit score D. ownership history

20. HIPAA attacked the problem of job lock by making it illegal for a group health plan to discriminate against someone on the basis of _______. A. age B. gender C. health D. number of hours worked

21. Although HIPAA prohibits discrimination on the basis of health, it doesn’t force employers to offer coverage to ______. A. B. C. D.

smokers cancer survivors overweight employees all of their employees

22. Plans that reward healthier people are allowed if they ______. A. B. C. D.

are only offered at companies with more than 100 employees do not discriminate against smokers are offered in addition to another health plan give unhealthy people an alternative way of qualifying for the same reward

23. In effect, HIPAA’s nondiscrimination rules mean you don’t have to pass a physical examination to ______. A. B. C. D.

purchase term life insurance receive long-term care enroll in a group health plan qualify for disability income benefits

24. Charging one group more than another because of health reasons is allowed if the cost is ______. A. B. C. D.

paid only by the plan sponsor no more than twice the average for small businesses absorbed only by unhealthy group members shared equally among group members

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25. If you have a pre-existing condition and enroll in a group plan, the plan can refuse to cover treatment of that condition for _______. A. 12 months B. 20 months C. 24 months D. 30 months

26. If you are applying for insurance outside of a group, HIPAA’s rules about nondiscrimination and waiting periods ______. A. will still protect you B. might not protect you C. will be even more consumer-friendly than in a group situation D. will only protect you if you don’t have creditable coverage

27. When you leave a health plan, either the plan itself or the insurer behind it is required to give you a ______. A. B. C. D.

copy of all of your protected health information chance to rejoin at a lower premium discount on future insurance certificate of creditable coverage

28. Programs that promote health to group members are known as “______.” A. B. C. D.

self-insured programs health-care operations HIPAA-eligible groups wellness plans

29. HIPAA makes it possible for employees, spouses and dependents to enroll in a group plan outside of the plan’s ______. A. provider network B. service area C. open enrollment period D. early enrollment period

30. Laws regarding medical privacy existed before HIPAA, but they were mainly enacted ______. A. B. C. D.

at the federal level on a state-by-state basis to protect insurers from liability with no specific penalties attached to them

31. Health information isn’t protected by the Privacy Rule unless it is considered ______. A. B. C. D.

individually identifiable potentially embarrassing financially harmful mental health information

32. An important element of HIPAA known as the “______” only applies to information that is stored electronically. A. B. C. D.

Privacy Rule Security Rule Minimum Necessary Rule Pretexting Provisions

33. With just a few important exceptions, the only people who need to follow the Privacy Rule and keep your information confidential are “______.” A. health plan sponsors B. life insurance companies C. covered entities D. doctors who don’t store information electronically

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34. A common misconception about HIPAA is that ______ are covered entities and need to follow the Privacy Rule. A. B. C. D.

health care providers health plans health care clearinghouses life insurance companies

35. According to the Department of Health and Human Services, ______ are entities that take health information in a non-standard format and put it in a standard format or vice versa. A. health care providers B. health plans C. health care clearinghouses D. life insurance companies

36. ______ are third parties that are given protected health information in order to provide services to a covered entity. A. B. C. D.

Business associates Personal representatives Plan sponsors Fully insured plans

37. When you have your first appointment with a health care provider, you receive and sign a form that explains your ______. A. right to a referral B. COBRA insurance options C. eligibility for insurance subsidies D. basic HIPAA privacy rights

38. Covered entities can use or share protected health information without your authorization if the use or sharing is done to facilitate ______. A. treatment, security or health care operations B. fundraising, marketing or health care operations C. D.

treatment, payment or marketing treatment, payment or health care operations

39. In most situations, the only person who can’t be denied access to your personal health information is ______. A. B. C. D.

you your doctor your child your health plan’s administrator

40. Under the ______, protected health information can only be used or disclosed to the extent that the information is needed to complete a task allowed by HIPAA. A. Security Rule B. limited data set standard C. self-insured rule D. minimum necessary standard

41. Someone is your ______ when they have the legal right to make health care decisions for you. A. B. C. D.

health care provider personal representative privacy officer plan sponsor

42. Health care providers need to make good-faith efforts to confirm their patients’ receipt of ______. A. B. C. D.

the privacy notice their security plans medical bills marketing materials

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43. Health care providers who operate Web sites are also required to ______. A. B. C. D.

answer patients’ questions via email follow Web accessibility standards list charges for all available procedures post their privacy practices online

44. Your ______ can act on your behalf to make medical decisions and take several actions in regard to your protected health information. A. insurance beneficiary B. financial adviser C. family attorney D. personal representative

45. In general, HIPAA has little or no power over information that companies obtain in their role as ______. A. B. C. D.

employers health plan administrators health care providers business associates

46. Parents lose control over a son or daughter’s health information when their child ______. A. B. C. D.

moves away becomes an adult becomes incapacitated is injured at the workplace

47. HIPAA doesn’t prevent a friend or family member from ______. A. B. C. D.

accessing information about a former spouse picking up a prescription for someone else being denied group health insurance for health reasons being charged more for group health insurance than their colleagues in the same plan

48. Covered entities can’t use or disclose your protected health information for ______ without consent. A. B. C. D.

treatment purposes payment purposes marketing purposes health care operation purposes

49. Whereas the Privacy Rule deals mainly with how protected health information can be used or disclosed, the Security Rule addresses how the information needs to be ______. A. pre-identified B. guarded C. sold D. updated

50. When covered entities believe a Security Rule safeguard is reasonable and appropriate, they ______. A. B. C. D.

can give consumers the option of extra protection need to implement it must file an updated security plan with the federal government need to mention the safeguard in their privacy notice

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INSTRUCTIONS FOR OPEN-BOOK EXAMINATION To receive continuing education credit for one or both of the courses in this book, you must complete the corresponding exam for each course.

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MAIL or FAX: 1. The answer sheet for both exams is on the next page. A duplicate copy is on the back cover of the book. 2. Remove the answer sheet from the book. 3. The exam questions appear at the end of each course. 4. Complete the answer sheet and return it to the REAL ESTATE INSTITUTE.

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 Check or Money Order made payable to REAL ESTATE INSTITUTE  MasterCard  Visa  Discover  American Express  I have pre-paid - I am only submitting my exam(s) for scoring

CARD # ________________________________________ EXPIRATION _______/____________ CARD VERIFICATION # _________ NAME ON CARD ___________________________________________ SIGNATURE ________________________________________

[PDF] INSURANCE CONTINUING EDUCATION Earn Credit in 3 EASY STEPS: Hours $49.00 * 21 Hours $69.00 * - Free Download PDF (2024)

FAQs

Is better CE legit? ›

BetterCE is a Fully Licensed Continuing Education provider in every State where courses are offered.

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What is the CE requirement for an insurance license in NJ? ›

REQUIRED HOURS

New Jersey licensed producers are required to take 24 hours of CE, including 3 hours of Ethics, every 2-year license term. One credit hour of professional Ethics can be substituted with one credit hour related to insurance fraud.

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How do I check my CE credits in CA? ›

To check your continuing education hours, you may visit our License Status Inquiry Web page, for on-line license status information. The continuing education provider has 30 days from the course completion date to submit the student roster to the department.

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How do I check my CE credits in Michigan? ›

CE Marketplace is your one-stop destination for viewing your certified continuing education course completions to meet the Michigan real estate license renewal requirements set forth by the Michigan Department of Licensing and Regulatory Affairs. Simply register to create a profile and login to view your CE history.

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Is CE credits online legit? ›

Online CE Credits maintains CE sponsorship approval with national professional associations at the provider level which covers all CE-granting courses, curated by a team of highly experienced experts in clinical mental health treatment.

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Is my free CE legit? ›

All MyFreeCE courses are approved for California. MyFreeCE is approved by the California Board of Registered Nursing.

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How many CE credits do you need for a PA insurance license? ›

Producers licensed in Pennsylvania must complete 24 hours of CE every 2-year license term. Ethics credits are not required for successful completion of PA continuing education. Producers must renew and have met all their CE requirements either before or on the expiration day of their license.

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What does CE mean in licensing? ›

Continuing Education Requirement

CE will be required once the license has been in effect for more than 2 years and for every subsequent renewal or relicensing. Credits must be accumulated during the licensing period, which begins with the effective date of the license.

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How much does it cost to get your insurance license in New Jersey? ›

In New Jersey, applications are submitted online through the National Insurance Producer Registry. This costs $170 for major line licenses (e.g., Life, Accident, & Health or Sickness, Variable Life, and Variable Annuity) or $95 for limited lines licenses (e.g., Car Rental, Group Mortgage Cancellation, or Bail Bond).

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What do you use CE credits for? ›

CEUs allow you to renew your credentials and optimize your career management without taking additional time from your personal or work life. Advancing your career: You can use CEUs to earn new and more specialized certifications.

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How do I check my IRS CE credits? ›

Login to your PTIN account. On the Main Menu, click the Continuing Education Credits tile. Select the year of the CE you wish to view from the drop down menu.

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What does CE mean for credits? ›

Continuing Education (CE) Credit Tips for Brokers:

Your GA and/or health underwriter associations may offer qualifying courses. A one-hour course offers one CE Credit. Hours earned have to be relevant to your business and your selected license type.

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How many CE credits do I need in California? ›

California requires 24 hours of continuing education including 3 hours of ethics every two-year license term, regardless of how long you have been a licensed producer.

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Is CEU a credit? ›

A Continuing Education Unit (CEU), also known as Continuing Education Credit (CEC), is a vital measure in ongoing education programs, helping professionals maintain their licenses.

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What is APA CE credits? ›

APA provides continuing education (CE) programs for psychologists and other mental health professionals. These programs provide the opportunity for professional development opportunities while earning CE credits.

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Is CE leaders legitimate? ›

We are also an approved provider by the Florida Board of Nursing, and a registered provider with the Arkansas State Board of Nursing, District of Columbia Board of Nursing, Georgia Board of Nursing, Kentucky Board of Nursing, New Mexico Board of Nursing, South Carolina Board of Nursing, and West Virginia Board of ...

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Is Noble CE legit? ›

NobleCE boasts a compliance check system to ensure that you're taking the right courses. It also carries out daily certification reporting, so you can avoid the penalties from delayed completion.

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Is CE app free? ›

CE Broker has free mobile apps for both iPhone and Android to keep up with your busy life. It's now easier than ever to track and report your CE on-the-go. In addition to checking your compliance, you can also report course completions directly from your phone.

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Is the CE shop accredited in Florida? ›

Florida Continuing Education Individual Courses

The date you renew depends on when you took your licensing exam. The CE Shop is an approved provider in Florida.

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[PDF] INSURANCE CONTINUING EDUCATION Earn Credit in 3 EASY STEPS: Hours $49.00 * 21 Hours $69.00 * - Free Download PDF (2024)

FAQs

Is better CE legit? ›

How do I check my IRS CE credits? ›

References