Types of Policies

1. Types of Policies • Multiple-line • 1st party property • 3rd party liability • 3rd party medical expense • Multiple-peril • Fire, windstorms, theft, etc. • Named peril versus open peril policies • Standard policy forms (HO3 form most common)

2. Major Coverages Type of Coverage Amount of Coverage in HO3 Policy A. Dwelling Chosen by policyholder B. Other Structures 10 percent of dwelling coverage C. Unscheduled Personal Property 50 percent of dwelling coverage D. Loss of Use (e.g., additional living expenses if dwelling cannot be occupied) 20 percent of dwelling coverage E. Personal liability $100,000 (can be increased) F. Medical payments to others $1,000 per person*(can be increased) $25,000 aggregate limit (can be increased)

3. Excluded Perils • Intentional acts • Normal wear and tear • Changes in laws • Earthquakes • Floods • Nuclear accidents • War

4. Property Loss Settlement • Per occurrence deductible • Methods of valuing property • Like-kind replacement cost • Actual cash value • replacement cost - depreciation • Guaranteed replacement cost • Functional replacement cost

5. Pricing • Premium = (insured value) x rate • Estimation of insured value • square footage • dwelling type • construction grade • construction material • location • Factors affecting the rate • location • construction materials

6. Personal Umbrella Policies • Excess liability coverage • Limits > $1 million • Applies once losses exceed limits on other policies • auto liability • homeowners

7. Coverage of Catastrophic Perils • Earthquake • Offered by most homeowners’ insurers • required in CA • Deductible = % of home value • Flood (NFIP) • Purchased through private insurers • Risk borne by federal government (taxpayers) • Some policies are subsidized • Moral hazard • Many exposed homeowners go w/o coverage

8. Residual Market Plans • Fair Plans • Created following urban riots in 1967-68 • Subsidized coverage for urban property • CA expanded scope between 94-96 • 28 states have plans • Beach and Windstorm Plans • Subsidized coverage for coastal property • 7 states have plans

9. Policies in Beach and Windstorm Plans

10. Hurricane Andrew • $16 billion in insured losses • Insurers attempted to (1) reduce exposure and (2) increase price • FL restricted both activities • Still many homeowners could not find coverage • Beach & windstorm plan exposure increased • FL created new residual market plan in 1993 (JUA) • Merged beach & windstorm plan with JUA in 2002 • Created Hurricane Catastrophe Fund in 1993 • Investment earnings not taxed

11. Northridge Earthquake • $12.5 billion in insured losses • Insurers attempted to (1) reduce exposure to earthquakes and (2) stop selling homeowners’ coverage • CA restricted ability to cancel or fail to renew coverage • Created CA Earthquake Authority (CEA) • Insurers could satisfy its requirement to sell earthquake coverage by offering a CEA policy

12. Government Reinsurance Arrangements • FL, CA, and HA have reinsurance plans • Proposals have been introduced for federal plan • Advantages • Preferential tax treatment of investment earnings on capital set aside to fund future losses • Governments can facilitate risk pooling over time • Potential disadvantages • Inadequate pricing • Raid funds for other purposes

13. New Capital Market Instruments • Examples • Catastrophe bonds • Insurer issues bonds • If cat occurs, insurer does not have to repay interest and/or principal • Contingent equity • Insurer has option to issue new stock at pre-arranged price if a catastrophe occurs • Potential advantages: • Insurer can hold less equity capital • Lower tax and agency costs