AIG

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEpolicy. Rental reimbursement typically pays a weekly rate for you to rent a medium-pricedcar.Auto Service Contracts Another type of “insurance” contract increasingly offered to car buyers is the auto servicecontract from the auto dealer. Auto service contracts extend the manufacturer’s warranty,which can be good for at least one year or 12,000 miles. Auto service contracts for new carsrun from three to five years and from 36,000 to 100,000 miles. Generally speaking, it doesnot make much sense to buy a service contract in the first year you own a new car, becauseit merely duplicates the warranty you already have with the manufacturer.Towing If you are not a member of an automobile club, you may want this benefit, which will payup to $50 for the cost of towing your car from the scene of an accident. If you are a memberof an auto club, you already have paid for this benefit and you do not need to purchaseduplicate coverage.No-Fault Insurance States that have no-fault laws typically require that you buy personal injury protection (PIP).No-fault is a system in which your own coverage pays for your injuries, regardless of whocaused the accident. In states that do not have no-fault laws, the insurer of the person whowas at fault is the company that pays for injuries. If you didn’t cause the accident, it’s the otherdriver’s coverage that pays you, which means that to collect, you’ll sometimes have to suethe other driver and establish in court that the accident was his or her fault. In states with no-fault liability insurance, an insured cannot sue for general damages until special damagesincluding medical expenses exceed the minimum amount. The basic idea of no-fault is to get accident victims’ bills paid promptly, regardless of whocaused the damage; to lower the cost of auto insurance by reducing the number of lawsuits;and to channel more of the premium dollar toward paying for losses, rather than litigationexpenses. No-fault is also an attempt to solve a dilemma at the heart of the auto insurance system.As a responsible person, you spend money for coverage to make sure that anybody you injurewill be compensated—without causing you bankruptcy. Your life savings are at the mercy ofless responsible drivers. Your savings could be wiped out paying your own medical bills asa result of an accident caused by a person who has no coverage. No-fault lets your ownpremiums work to pay for your injuries.Umbrella Coverage If you have assets with a total value that greatly exceeds $300,000, you should considerbuying additional liability insurance in the form of an umbrella policy. This is a policy you carryin addition to other liability insurance, and it comes into use only when the other coveragesare exhausted. Most standard policies go up to a $300,000 limit, but $400,000 or $500,000limits can be purchased. If you purchased, for example, $1,000,000 of umbrella coverageand your standard policy limit was $300,000, for an accident that cost $500,000 of liability 101

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEclaims, your regular auto policy would pay the first $300,000 and the umbrella would takeover to pay the remaining $200,000. Most companies require that you insure both your home and auto with them before they’llsell you umbrella coverage.The Personal Auto Policy When making application for a personal auto policy, be aware of your rights. Yourinsurance company or agent cannot make untrue, misleading or deceptive statements to yourelating to insurance. You have the right to be told in writing if you are being denied coverageor being denied access to less expensive coverage offered by other insurance companiesrepresented by your agent. However, you must request this explanation. Insurance can be an expensive necessity, so it is something you want to shop around forto avoid spending more money than you have to. If you’re like most people, you have no ideahow much coverage you need, let alone how to compare one policy with another. And, unlikenecessities like food and lodging, it’s not immediately obvious where to buy it. The key word in buying auto insurance is not price, but service. You will want a companythat gives fast, fair and efficient service wherever you are. If you wreck your car, you are surelyinterested in knowing it will not sit waiting for an adjuster. If you’re buying insurance for the first time, an obvious first step is to ask your friends,relatives and your colleagues at work where they bought their insurance and what kind ofservice they’ve had. In fact, even if you own insurance policies, it cannot hurt to consult friends,neighbors and associates when you’re in the market for more. Some very good insurancecompanies rely more on word-of-mouth to attract new customers than on expensiveadvertising campaigns. Some of the money they save this way is passed on to theirpolicyholders in the form of lower premiums. Another important source of information is your state insurance department or commis-sion—the government agency that regulates insurance companies, agents and brokers in yourstate. Many state insurance departments publish consumer guides and cost comparisonsurveys on automobile and homeowner’s insurance. It’s well worth finding out if yours is oneof them. But, if you don’t have the resources to consult with others about insurance, or your stateregulatory agency does not publish a consumer guide, consider this information aboutinsurance agents and companies before you buy: Independent local agents write manypolicies, but they may not be very helpful if you have an accident away from home. The agentmay also write you a policy with a company that earns him or her the best commission.Companies that sell indirectly are called agency companies. Despite its name, an agencycompany does not have its own sales force of insurance agents. Instead, agency companiessell their policies through independent, self-employed agents and brokers. They get a salescommission, just as the company agents do. Independent agents typically represent severalinsurance companies. Your other choices are agents selling for just one company, or the mail order, supermarketor department store types of agencies. An agent that sells for just one company is oftenpreferred, because this type of agent has a stake in the company, knows its personnel and 102

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEproducts, yet still offers the advantage of a personal acquaintance. These companies thatsell directly are called direct writers. You might buy insurance from a direct writer by telephoneor mail, or from a company representative or company agent. The person who sells you thepolicy might be salaried or work on commission, or both. In all cases, however, you will bedealing with a full-time employee of the insurance company. The bigger company is usuallythe better choice. Unless you never travel beyond a 50-mile radius from home, you shouldbe insured with a company that can give claim service anywhere in the United States. Thereshould also be a 24-hour emergency toll-free number on your insurance ID card. Brokers generally deal more with commercial than personal insurance, and they representthe insurance buyer rather than the seller. The broker buying on a client’s behalf makespurchases directly from companies, or indirectly through agents. Some independent agentsare also licensed as brokers. Price is still a definite consideration in purchasing auto insurance, and it can vary widelyfor the same coverages. After you narrow your choices to a few whose service and scope seemsatisfactory, begin your comparison price shopping. This will involve submitting yourrequirements to several agents for quotes. In addition to a good price, you’ll naturally want to feel some confidence that you are buyingfrom a financially sound, reputable company. A low premium would be worthless if thecompany is known for its refusal to pay out seven out of ten claims, or that it is on the brinkof bankruptcy. A.M. Best & Company is a company that rates insurers for their financialstability. Best’s ratings are published yearly in two large volumes called Best’s InsuranceReports, Property Casualty and Best’s Insurance Reports, Life-Health. You should be able tofind both books in the reference section of your local public library. Best’s Insurance Reportswill give the address and telephone number of the company, the names of its officers andthe states in which it’s licensed to do business, as well as a summary of financial data. Theratings range from the superior rating of A+ to a fair rating of C-. These ratings are for financialstability, not service.Personal Auto Liability Underwriting and Ratemaking The big question from most people about auto insurance is how much it will cost. Theanswer depends on many factors—some of them within your own control (your driving record),and others that are not within your control (where you live, how old you are). To determinethe best available coverage at the best price, you will have to compare quotes from at leastthree insurance companies or agents. You may want to use the sample form on the next page as a model to make out the listof coverages legally required in your state. This list can be used to comparison shop for autoinsurance.Discounts Take a look at the following checklist, and include any discounts for which you may qualifyin your worksheet calculations. These discounts usually apply only to one or two of thepremiums that make up the full cost of your auto policy. Installing an anti-theft device willget you a discount on the comprehensive portion of your policy, but it will not lower the costof your liability coverage. Not all discounts are available from all companies, so be sure to 103

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEask whether or not each company you get a quote from offers the discounts for which youqualify:1) Good Driver—Many insurers give a discount to drivers with accident and/or violation-free records.2) Mature Driver—If you are 50 or 55 years old or more, some companies will knock 10 to 20 percent off your premium, depending on how many miles a year you drive. There is also a discount for drivers 65 and older.3) Car-Pool Driver—You and your fellow car-pool drivers might qualify for discounts of 10 to 20 percent from some insurance companies.4) Multicar Household—If your family owns more than one car, putting them all on one policy might be good for a 15 to 20 percent discount.5) Multipolicy Discount—Some insurance companies offer a discount when you insure your house (or apartment) with them, as well as your car, where permitted by state law.6) Antitheft Device—If you make it more difficult for someone to steal your car, by installing an ignition cutoff system, an alarm, or a hood and wheel-locking device, you could qualify for a 5 to 15 percent discount.7) Seatbelts and Air Bags—Some insurers reduce the premium for your medical coverages by as much as 30 percent for automatic seat belts or air bags.8) Nonsmoking Driver—Nonsmokers sometimes qualify for lower rates for liability, no-fault (that is, medical benefits coverage) and collision insurance.9) For completing high school or senior citizen driver education courses.10) If your teenager listed in your automobile policy attends school 100 miles or more away from home and does not have a car.Auto Liability Claims You should be aware that there are people who try to get all they can from an insuranceclaim. Fraudulent claims end up costing you, the policyholder, with higher premiums. In themodern marketplace, auto insurance is like a public utility, and the claim payments comeright out of premiums. Every exaggerated claim comes from the pockets of policyholders. Withthat in mind, in order to protect yourself, you should become knowledgeable about automobilelaw and auto liability claims. Loss History—The Accident Record Your claim will be more quickly and more easily filed if you act properly while you are stillat the accident scene. For example, don’t panic. If at all possible, keep calm, and make everyeffort to protect your passengers and property. Call for assistance for those injured and donot leave the scene. Do not discuss whose fault the accident was with the other party. Try notto apologize unless you are absolutely sure the accident was your fault. Do not volunteer asto how much insurance coverage you have. Show the other driver your license, registrationand the name of your insurance company, along with your name, address and the name ofthe registered owner of the car. Secure from the driver of the other car his name, address,driving license number, date of birth, state of license, and residential and business telephonenumbers, along with his vehicle registration number and insurance company. If the driver is 104

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEnot the owner, make sure to determine the name of the car owner and his address andtelephone numbers, if possible. If people are injured, note their names, addresses, home and business telephone numbersand the extent of their injuries. Make the necessary reports to the police. Write down badgenumbers and names of the police and emergency personnel at the scene. Seek out witnessesto the accident, and take down their names, addresses and telephone numbers. Be certainto check all cars for damage, and write down areas damaged, as well as car description, make,color and license number. Record location, date and time of accident, and weather conditions.If possible, move your car to a safer place to prevent any more accidents. If this is not possible,ask the police to set up flares. As soon as you can, write down your own account of whathappened and how it happened. It is important to do this while the information is fresh in yourmemory. Report the accident to your broker or agent immediately. If the accident involvesinjury or significant property damage, report it promptly to the police department. If possible,obtain a police report as soon as it is ready. (Your agent or insurance company may haveforms available that will give you instructions in the event of a collision. You can keep themin your glove compartment.) The kind of service you get when you file a collision claim is a good way of evaluating yourauto insurance company. Some people prefer dealing with a local agent or insurance brokerrather than with a company directly, so they can rely on the same person for on-the-spotservice and advice. The sooner the claim is filed, with detailed and accurate information, the faster you willbe reimbursed. If you are at fault in the accident, having the facts straight is especiallyimportant in presenting your case, since it’s important to your future insurance rates that anydamage be assessed accurately and fairly. Remember, it is your right to contact a lawyer, atany time, for information and guidance. Be sure that your insurance payments are alwaysup-to-date and your coverage is in full effect.How Rates Are Set The insurance company decides what to charge (your premium), based on your ratemultiplied by the number of units—the amount of insurance you buy. An insurance rate is thecost for one unit of insurance. A unit of insurance is usually $1,000 of coverage. Each insurer has literally thousands of auto insurance rates in every state in which it doesbusiness—rates for every type of car and driver and for each geographical area in the state.Each company also has a variety of surcharges and discounts that modify these rates. Theseare essentially penalties and rewards.All insurers set their rates with three basic goals in mind.1) They want to make enough money to cover all their policyholder’s claims and pay the company’s overhead expenses and staff salaries, and if they are publicly held, still have a profit for their shareholders.2) They want to charge higher rates to drivers who file more costly claims, and lower ones to those whose claims are smaller and less frequent.3) They want to stay competitive with other insurers in markets they think will be more profitable. 105

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE How your insurance rates are set also depends in part on which state you live in, becauserates are regulated on a state-by-state basis. The insurer has to follow the regulations of thestate you live in.Are You a Good Risk? The first thing affecting your rate is the overall risk you represent to the insurance company.In other words, what are the chances that you will have a lot of accidents and file expensiveclaims? The underwriter is the person at the insurance company who decides what risk yourepresent and how much you should be charged for insurance. Insurance rates are based ona wealth of statistical experience. Most insurance companies divide auto risks into three basictypes: preferred or low risk, standard (average risk) and nonstandard (high risk). The kind of risk the underwriter sees when he or she looks at you depends on factors likeyour driving record and the make and model of your car because some cars cost more to fixthan others.Your Insurance Profile: Age, Sex and Marital Status Even though underwriting criteria differ, insurers use the same basic factors in setting theirrates. Your age, sex and marital status are used to sketch your profile. Rates run highest for single males under 25. Long-established and undisputed evidenceshows that young drivers are worse insurance risks than older ones. Nearly 52 percent of alldrivers in 2005 were men, and they were involved in almost 70 percent more accidents thanwomen drivers. National Safety Council data show that male drivers were involved in morethan three times as many fatal accidents as female. Men drive more frequently than women,which automatically increases their chances of being in an accident. They also tend to drivemore aggressively and they’re more likely than women to get behind the wheel when theyare intoxicated. Similarly, the statistics show that married drivers have fewer accidents thansingle ones. The emotional commitments and responsibilities of a marriage tend to makepeople more careful drivers. As a result, insurers charge young drivers higher rates than older ones, young males higherrates than young females and young, unmarried males more than those who are married.A woman between the ages of 30 and 65 qualifies for special discounts from many companiesif she is the only driver in a household.Your Driving Record Insurers typically consider your driving record for the past three years. There are differentsurcharges applied from company to company. These surcharges are applied if you receivea ticket or have an accident. Each company has its own idea of what constitutes a standarddriver, but clearly, an accident in which you were at fault is going to weigh more heavily againstyou than a traffic violation. A conviction for drunk driving will get you rejected by most insurers. Standard risk drivers generally pay a premium that is about 20 percent higher than forpreferred risk drivers. Some companies will not sell insurance to people they deem 106

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEnonstandard. A few specialize in high-risk drivers. Every state mandates an insurance poolor facility that must provide coverage to all applicants. If you have not owned a car in three years, many insurers will rate you as if you have neverdriven before. Others are ready to take on new drivers, but may charge you more than if you’dbeen covered by another insurer during the past three years.The Records of the Family Members Who Live With You Your insurance rate takes into account not just your own age, sex and driving record, butalso those of other licensed drivers in your family who live with you. (Remember, the insurancecompany will be covering the car when family members drive it, too.) If you’re all good driversand each of you has a car, putting them all on one policy will get you a multicar discount fromsome insurers.Your Car Cars that cost less to repair and are better able to withstand a crash qualify for discountsfrom the standard collision and comprehensive coverage rates. Those that are more expensiveto fix, more easily damaged and statistically likelier to be in an accident are surcharged. According to statistics maintained by the Highway Loss Data Institute (HLDI), the safestcars are big, four-door models, station wagons, passenger vans and cars equipped with airbags and other passive restraint systems. Not all insurers surcharge or discount for all makes and models of cars. Discounts andsurcharges from insurers that do can range from 10 to 30 percent.Bodily Injury Hazard The most important element in your automobile policy is the one pertaining to bodily injury.This coverage deals with your legal liability to third parties—people you might injure whileyou are driving your car. It is extremely difficult to measure the amount of liability that could be assessed to youtomorrow in an accident that might occur today. Most states require you to maintain suchcoverage. It is even more important to you than insuring yourself against physical damageto the automobile. You can measure the maximum amount of money you might lose if you have a total lossto your car. You can significantly reduce the cost of your physical damage insurance—thatis, for fire, theft, collision and burglary—by increasing the deductible.The Claim Handling Process When you call your insurance agent or company representative, he or she will tell you whatkind of documents you’ll need to support your claim. Typical requirements are medical bills,auto repair bills and a copy of the police report. Your agent or company will send you a claim form to fill out. Take your time in filling itout, as you do not want to omit an important loss or send incomplete documentation of yourlosses. Thoroughly assess the damage and collect all the documents you need. These aresome of the questions you may want to ask your agent: 107

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE1) Am I covered for these losses?2) What is my deductible? (The deductible is the amount of loss you will have to pay out of your own pocket.)3) How long will it take to process my claim?4) Does my policy contain a time limit in which I must file a claim? Is there a time limit during which claims must be resolved after they are filed? If so, what are these time limits?5) Will I have to get repair estimates for the damage to my car?6) What does my policy pay toward the cost of renting a car while my own car is being repaired?Keep a Written Record After reporting the accident on the telephone to your agent or company representative,you might sit down and write him or her a letter describing it. The letter should repeateverything you said in your telephone conversation. You can put in additional information,too, if there were any details you forgot to mention on the phone. Writing down what happenedwill help you organize the information for your insurance claim, which you must make inwriting. A phone call is not the same as making a claim. Be sure that you send copies of documents to your insurance company, such as receiptsfor repair work on your car or medical bills—and keep the originals yourself. You do not wantto risk that original documents may be misplaced or lost, and you can be sure that will nothappen if they remain in your care. You should keep records of all expenses you have as aresult of the accident. This means not only your doctor’s bills and auto repair bills, but anylost wages or increased expenses—like hiring a temporary housekeeper—if you cannotperform your normal household tasks because of injuries sustained in the accident. Also keeptrack of the cost of duplicating papers. If you live in a no-fault state, your policy may cover at least part of your lost wages andadditional housekeeping expenses, as well as medical and hospital bills. You will need todocument the expenses in order to collect reimbursement, however.Processing a Claim The first thing your insurer does on receiving your claim is to confirm that the policy is ineffect and that the accident is covered. Then, the company will assign your claim to a claimsadjuster. This may be someone who works exclusively for one insurer or an independentadjuster who represents more than one company. It is the adjuster’s job to verify the loss anddetermine the amount you are entitled to claim under your policy. Most often, an adjusterwill be sent to look at the damage you sustained. His or her estimate can serve as a goodmeasure in which to compare your own shop’s estimate. No good adjuster will expect you to sign an agreement accepting the insurer’s estimateas the total claim payment until you’ve established to your satisfaction that it will cover athorough repair. Do not allow yourself to be pressured into accepting the insurer’s estimateof repair costs without getting at least one other estimate. 108

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE You may accept an advance of some cash to have repairs done, without forfeiting yourright to more money for repairs, unless you sign an agreement releasing the insurancecompany from further obligation. Your insurance company cannot require you to have repairs done at a particular shop.However, it can insist that you get more than one estimate for the work to be done on yourcar. Just as you want to be sure that your car is adequately repaired, the insurer wants tobe sure that it does not pay a grossly inflated repair bill. (Keeping repair bills down is in yourinterest, too, because inflated bills force insurance costs up.) Do not be surprised if your insurance company opts to pay for the lowest bid, but do notautomatically accept such a settlement if you believe that the low bid will not pay for anadequate repair job. Get an estimate at a shop you trust, and do not hesitate to argue withthe insurance adjuster if you really believe his or her repair estimate is too low. One thing that could reduce the amount of your claim for a repair job is what insurancecompanies call betterment. If your old car was repaired with brand-new parts, for example,the insurance company might argue that the repairs actually enhanced the car’s value andreduce your claim by the difference between a used part and a new one. Satisfy yourself thatthis is, in fact, the case by getting a second opinion (from a used-car dealer, for example) beforeaccepting a reduction in the amount of your claim. Declaration of Total Loss It is up to the insurer to decide whether to pay for repairing your car or to declare it a totalloss and pay you its book value. Your standard auto policy will not pay to repair a vehicle ifthe repairs cost more than the cash value the company assigns to the car. The insurerdetermines the value of your car by consulting standard references on used cars, such as the“blue book” published by the National Automobile Dealer’s Association, and sometimes alsoby consulting used car dealers in your area. It will take more than your unsupported word to get you a higher settlement, if you believeyour car was worth more than the value those references put on cars of the same make, modeland year. But if you have good reason for believing that the resale value of your car was higherand can substantiate your contention with evidence (like mileage records, service history oraffidavits from mechanics), you should certainly do so. You are entitled to the market priceof the car you lost.The Other Person’s Insurer If you live in a no-fault state, you always file personal injury auto claims with your owninsurance company. If your policy includes medical payments coverage, your own companywill respond to your medical bills, whether or not you live in a no-fault jurisdiction. If you live in a fault state and have been hurt in an accident that was the other driver’sfault, you will have to collect from his or her insurance company. To do that, you may haveto go to court to prove it was the other driver’s fault. If you have a very clear-cut case, the other driver’s insurer may offer to pay youimmediately, without going to court. You should establish the severity of your injuries beforesigning any agreement accepting full payment. You will want to consult a doctor, and you may 109

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEwant to speak to a lawyer, as well. It is often the case that the fault is not clear-cut. Whenit’s not so easy to figure out who was at fault, it then depends on state law.Negligence Laws There are three types of negligence laws. In states that have pure comparative negligence,what you can collect in damages depends on how much at fault you were in the accident. Instates that have modified comparative negligence, you can collect from the other driver’sinsurer only if you’re at fault less than a specified percentage, usually 49 or 50 percent. Adriver who was 20 percent at fault could collect damages. A driver who was 55 percent atfault could not. In states that have contributory negligence, you cannot collect at all againstthe other party’s insurance if you are as much as 1 percent at fault. Your own insurancecompany will pay your collision claim. Unless you have medical payments coverage, and ifyou do not live in a no-fault state, you are not legally required to carry it—you will not haveany auto insurance for your physical injuries or those of any passengers in your car. Even if you do not live in a no-fault state, you could find yourself the defendant or theclaimant in an insurance claim that goes to court. No-fault laws only cover personal injuries.(Michigan is an exception. Some property damage is covered, also.) All liability insurance iscovered by tort laws, since liability coverage only pays claims for which the policyholder islegally responsible—a determination typically made by a judge or jury.Property Damage Claims There are cases in which you could file a claim with your own insurer or with the otherdriver’s company. If you car is damaged in a collision in which the other driver was at fault,for example, you could make a claim against his or her liability insurance or against your owncollision coverage.Among the things to consider:1) If you file a claim on your collision coverage with your own company, you will get paid without having to establish who was at fault. Therefore, you most likely would be paid more promptly.2) However, you will have to pay your deductible. And if it is determined that the accident was partly your fault, the claim may hurt your record with your own insurer, possibly causing your premiums to be raised. If you file a claim with the other driver’s company and you are not at fault, you will not have to pay a deductible as you would with your own coverage and your driving record with your own insurer will be unaffected. But if you are at fault, the other driver’s insurer will come back to your insurer.3) If you file and collect on your policy and the other driver was at fault, your insurance company will turn to the other driver’s insurer to recover the money (your insurer) paid to you. Your company should also recover your deductible and refund it to you. Do not forget to ask your agent or company representative if you are entitled to get your deductible back in this situation. 110

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEThe Innocent Passenger If you are a passenger in a car accident, you should get the names, addresses and otherpertinent information about the drivers of the cars involved. The amount of coverage you areentitled to is going to depend, in large part, on how well-insured those drivers are. You could collect under their medical payments coverage. You might also be able to collectfor a claim against their liability coverage. Your own health and hospitalization insurance will also cover you. The quickestcompensation is probably through your health insurance company—which may later recoverthe damages from the auto insurance companies of the drivers. If so, you may be entitledto get your health insurance deductible back. Do not forget to ask your health insurance carrieror employee benefits department (if you’re insured through your job) about this.Commercial Auto Liability InsuranceAuto Liability Insurance You or your company can be vicariously liable for injuries caused by negligent operationof a car, truck or other motor vehicle. Failure of a small business owner to recognize the dangerhe or she faces by not carrying liability insurance can be one of the most serious errors inbusiness management. One liability judgment could easily wipe out the entire assets of yourfirm and cause its liquidation. Liability insurance protects your company if someone is injuredas a result of your business operations. Be sure you are covered for injuries that arise out ofthe operation of cars and other vehicles. Liability insurance protects the assets of a businesswhen it is sued for something the business did (or failed to do) that caused injury or propertydamage to someone else. A business’s liability loss exposure includes not only payingdamages and perhaps a penalty as the result of a successful lawsuit against it, but it alsoincludes attorneys’ fees and other costs involved in defending a company against a liabilityclaim. You and your insurance agent should carefully analyze the circumstances under whichyour company may be sued. You should then develop an insurance program that adequately protects your companyfrom judgments that may be entered against it. Keep in mind that in the case of personalinjury lawsuits, it’s becoming increasingly common for juries to return verdicts of over $1million, where injuries are serious. Your insurance policy should cover liability you have toinjured parties. Adequate coverage is essential. A well-designed insurance program canprotect your business from two types of risks. The first is the risk of loss, such as when a firestrikes your business premises. The second is the risk of liability, such as when someone ishurt by the negligent operation of a business vehicle. The basic principles of liability insurance apply to the liability the business person may incurin owning and maintaining automobiles. Business firms are often legally liable for the useof trucks and passenger cars, even though they do not own any. Be sure your company vehicles are covered by insurance—but go even further. Buycoverage for cars used on company business, even if they are not owned by your company.This happens when an employee or a subcontractor uses his or her own car on behalf of theemployer. You are usually liable for an accident that occurs when your employees use rented 111

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEor leased vehicles, or when an employee is operating a car belonging to customers. Thevarious kinds of automobile liability policies provide protection for specific business uses.Commercial Auto Insurance Coverages Coverage for liability loss exposures related to operating automobiles and trucks is partof the business auto coverage. The liability portion of the policy obligates the insurancecompany to pay all damages the business owner is legally obligated to pay because of bodilyinjury or property damage caused by an accident and resulting from the ownership,maintenance or use of a covered auto—up to the policy limits. The starting point is a knowledgeable insurance agent—one who takes the time to analyzeyour particular business operations. Steer clear of an agent who, without learning the specificsof your business, tries to sell you a package policy, without exploring other options. Theinsurance industry has developed some excellent packages that cover the basic needs ofvarious businesses. The agent should ask a lot of questions and thoroughly understand yourbusiness. Insist that your insurance agent tailor your coverage to your particular business. You want an agent who’s not locked in to one insurance company. The agent should bewilling to obtain quotes from several companies so that you do not pay more than is necessary.Have a clear understanding of exactly what your insurance policy covers and what is excluded.The higher the deductible, the lower your premium. In a number of states, the auto policy is not permitted to cover punitive damage awards.Even in states where coverage for punitive damages is permitted, the policy may excludethem. Punitive damages are sometimes imposed when the driver was drunk or was operatinga vehicle recklessly. When there is an auto liability lawsuit against the insured business, where the loss iscovered by the policy, the insurance company is obligated to defend the business owner orto settle the lawsuit. The policy leaves the decision entirely up to the insurance company aboutwhether to defend or settle a given claim. The insurance company’s duty to defend or settleends when the insurance policy limits have been exhausted by the payment of judgments orsettlements. If, for example, three people are injured in an accident, and the insurancecompany uses up the policy limits in judgments or out-of-court settlements on the first two,the business will have to pay the cost of the judgment, if any, to the third injured party.Automobile Physical Damage Insurance Most automobile owners carry insurance for damages from collision, fire, theft and otherphysical perils. There are several kinds of insurance for physical damage. You can usuallyinsure collision damage separately from other types of losses. Collision insurance does notcover glass breakage and damages from falling objects, flying missiles, windstorm, hail,malicious mischief and vandalism. You can insure all types of physical automobile loss, exceptcollision by taking out a “comprehensive” policy. It excludes only the following:1) Losses from wear and tear.2) Loss to tires (unless owing to fire, malicious mischief or vandalism, or arising from a collision).3) Loss from radioactive contamination. 112

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE4) Loss from freezing or from mechanical or electrical breakdown. However, if any of these losses, except radioactive contamination, result from theft, youare covered. If you do not want to buy automobile comprehensive insurance, you can cover separateperils. For example, you can buy fire and theft insurance at rates somewhat below those forcomprehensive insurance. Theft insurance not only covers loss of your car by theft, includingall damage done by thieves if the car is later recovered, but also pays you $10 per day forloss of use, subject to an aggregate limit of $300. Coverage for loss of use begins after athree-day waiting period and ceases when the insurer offers to settle with you for the lostvehicle. Physical Damage Rates Rates on automobile physical damage insurance vary widely, depending on territory,distance traveled, type of vehicle, age of vehicle and sometimes age of driver. If your firmoperates a fleet of cars, you will be able to get “experience” rates. These give individualtreatment (for better or worse) based upon loss experience over a period of several years.If not eligible for fleet rates, you as an individual owner may qualify for the “safe driver plan”or “merit rate” available in most states. Buying a policy with a deductible-amount clause willbring you a considerable saving in collision coverage. Coverage for Truckers A number of insurance agents specialize in handling insurance for truckers and truckingfirms. Specialized agents know the many different rules in each state that relate to the kindsof filings and insurance requirements. First-time truckers can expect premiums to be higherduring the first three years of operations. Agents can also help with the financing of premiums.Truck insurance is relatively expensive, and most policies are financed. Specialized agentsusually either finance the policies themselves or have a close working relationship with a bankor finance company that helps provide financing of the premiums. To operate in any state,an insurance company must be recognized by the state’s insurance authority. One of the jobsan insurance agent performs for a trucker is making sure that coverage is placed with aninsurance company that is recognized by all the states in which the trucker operates. If a filingis made from an insurance company that is not recognized by the state, that filing will berejected. The Interstate Commerce Commission (ICC) operates somewhat differently with regardto insurance companies. It basically recognizes all insurance companies, unless and until itreceives a report that something is wrong with the company. Even when the ICC learns thatan insurance company is bogus or corrupt, it may be a year or more before the company isplaced on the ICC’s list of nonapproved insurance companies. Age Considerations Drivers under 25 and over 65 have a harder time getting insurance. This is because lossexperience has shown drivers under 25 and over 65 have more insurance losses. For truckersover 65, the insurance company underwriter will want to see copies of U.S. Department of113

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDETransportation (DOT) medical statements, which are medical exams truckers are required tohave every two years. Some insurance companies require them of any driver over 60.Vehicle Maintenance and Safety Insurance companies look very closely at the maintenance of vehicles and, also for largercompanies, at whether good safety programs are in force. Insurance companies have found that many accidents and insurance claims can be tracedto poor maintenance of equipment. When applying for insurance, truckers have to answera number of questions about maintenance of their equipment: How often are the air brakesbled? Are pretrip inspections done? How often is the truck serviced? If the insurance companyis not satisfied that the rig is maintained properly, it may not want to issue a policy. For the larger trucking firms, insurance companies want to see evidence that the firm’smanagement is committed to safety. Are there incentives for safe driving, such as bonusesor awards to drivers who go a certain number of miles without any accidents? Are trip logsmaintained? Is the maintenance of the equipment done on a scheduled basis? Qualityinsurance companies will not insure a trucking firm that does not have a safety program.Where there is a good safety program, good safety record and low claim history, someinsurance companies will give premium reductions.Motor Vehicle Records Insurance companies will definitely check motor vehicle records before insuring a trucker.Usually, the agent will run a check on a trucker’s driving record before submitting theapplication to the company. If there is something on the record that the insurance companywill have a problem with, the agent will attach a summary to the application, explaining exactlywhat happened and why the violation is there. Unpaid fines can be a problem when applying for insurance, because they can show upon the motor vehicle record. Also, truckers who do not pay fines may have their driver’s licensesuspended. Insurance companies may not cover a trucker with a suspended license.Types of Insurance Truckers Need Insurance for trucking is divided into two categories: mandatory and voluntary. The federalgovernment and state governments require the majority of truckers to have liability insurance,and sometimes cargo insurance, before granting them legal authority to operate. Further,a firm shipping goods may require a trucker to have insurance on cargo as a condition of beinggiven the job. Similarly, truckers usually are required by lienholders on equipment to carryinsurance for physical destruction of that equipment. Truckers voluntarily may purchase insurance to protect their assets so that if they are inan accident, they can recover at least some of the expense of repairing or replacing damagedequipment.Business Owner Liability Coverage Form, Garage Coverage Form and TruckerCoverage Form These “forms” are actually the policies for each of these quite specific areas. Thesecoverages include medical expense coverage and detail all of the exclusions of the policy. The 114

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEactual form or policy made up by the insurance company will vary according to the specificcoverages desired and may cover 10-20 pages or more of detailed information.Federal Insurance Requirements The federal government requires all carriers regulated by the ICC to have liabilityinsurance. Basically, all interstate truckers are subject to ICC regulation, except those thathaul only farm products in their raw commodity state. The DOT has been mandated to auditevery interstate trucker. One of the documents DOT auditors look for in a trucker’s files isa form known as “MCS 90,” which is issued with every truck liability insurance policy. If theform is not in the trucker’s files, the trucker will automatically fail the audit, which meanspossible suspension from driving a truck. The required amount of liability coverage varies. A regular interstate trucker haulingnonhazardous commodities is currently required to have $750,000 in liability coverage pervehicle. The required coverage can go as high as $5 million per vehicle for truckers that carryhazardous items. For items that are considered hazardous, but not the most hazardous, therequired coverage is $1 million.Interstate Insurance Requirements If traveling in many different states, truckers must conform to the insurance requirementsof each state in which they operate. Each state makes its own rules, which can differconsiderably from the rules of bordering states. Most, but not all, states require that a trucker carry a certain amount of liability insurancewhile operating in that state. Some states also require provisions of cargo insurance. A goodinsurance agent should be current on the various liability insurance requirements for eachstate.In some states, an interstate trucker is required only to show proof of insurance, but in manystates, a state agency must give permission for an interstate trucker to operate. The usualprocedure is that after the trucker makes an application for authority to operate in a state,the insurance company files a form with the state showing that the required insurance is inforce. When the state gets the filing from the insurance company, the trucker receivesoperating authority. This procedure is referred to as a filing made. A “Form E” filing is requiredin all states that require liability insurance. Cargo insurance requires a “Form H” filing.Passengers Insurance companies increasingly do not want any passengers in trucks, because they donot want to insure the potential loss of injuries or death to passengers. Many policies excludeany coverage for passengers. Even with the exclusion, however, the insurance company canend up paying claims on an injured passenger if there is a lawsuit and a jury finds the truckingcompany liable. If this does happen, the company will probably not renew the policy. Insurance companies do not even want any family members traveling with truckers, unlessthe family member is part of an actual driving team. They have had too many claims involvinga relative, often a father or a grandfather, who takes a child out on the road and gets intoan accident in which the child is hurt. Then, some other family member, such as the ex-wifeor grandparents, sues the driver, because no one has the money for the medical bills, and 115

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEthe only way the relatives can obtain that money is by trying to collect insurance money ina lawsuit against the individual who was driving the truck.Commercial Auto Liability Underwriting and Ratemaking Insurance companies—even the best ones—profit by not paying out claims. And evenwhen they must pay, it’s in their best interest to settle claims as cheaply as possible. Essentially,insurance companies save money in two ways: they raise the amount they charge inpremiums, and they build a lot of exclusions into the policies they sell. It is especially importantto pay attention to the parts of a policy that deal with definitions and exclusions. Businesses need to be aware of how insurance policies are written for a fleet of vehicles.Some provide fleet coverage, which means the business does not have to notify the insurancecompany when a new vehicle is added; it is covered as part of the fleet. Other policies dorequire notice to the insurance company of a new vehicle. If the notice is not given, the newvehicle is not insured. To protect business vehicles from vandalism and fire to those left overnight at a business,some businesses let employees drive vehicles home at night. This, however, increases therisk that these individual vehicles will be involved in an accident. If vehicles are parked onthe business premises overnight, coverage can be added to the property policy to cover onlythe overnight premises exposure. Covered AutosWhat autos it wants to cover for liability is up to the business. The three options are:1) Autos owned by the business.2) All autos owned, hired or leased.3) All autos, including those that are not owned, hired or leased. Most businesses should buy the third type of coverage to protect themselves from liabilitywhen an employee or principal is driving a personal auto on company business.State Requirements Every state has automobile liability insurance laws that state the minimum amount ofcoverage a vehicle must have for bodily injury and property damage. Most states have splitlimits with separate minimum coverage amounts for bodily injury to each person hurt in anaccident, bodily injury for all people hurt in the accident and property damage. These lawsapply to vehicles owned by businesses, as well as individuals. To protect their assets, mostbusinesses will need to purchase higher limits of liability than those mandated by the state. An out-of-state endorsement to the business auto policy will automatically adjust the policylimits to conform to state requirements when a vehicle is driven in another state. Many states have some form of no-fault automobile liability law. Such laws provide thatfor less severe bodily injuries, lawsuits are not permitted. 116

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDESECTION II — AUTOMOBILE INSURANCE RATING Each year, more than 25 million automobile accidents occur in the United States. As a directresult of these accidents, approximately 5 million people are injured. More than 45,000 die. Another shocking statistic—since 1900, more than 2 million people have died in autoaccidents—more than the number of U.S. casualties suffered in all wars since the Civil War. The major reasons for these statistics? Statisticians tell us that drinking and driving is thedirect cause of more than 50 percent of the automobile accidents in the U.S. today, but thereare other reasons as well, such as speeding, carelessness or failure to observe traffic laws. The National Safety Council has compiled other information on automobile accidents anddeath on the American highway. The council’s findings may not be stunning to most drivers,but could be of interest to those interested in saving money on insurance premiums orimproving their current driving records. The council found the following:1) Death occurs on rural highways more often than on city streets.2) 41 out of every 100 fatalities are the result of single-car crashes.3) Approximately 45 percent of today’s traffic fatalities occur during daylight hours.4) Saturday is the most dangerous day of the week and August is the most dangerous month of the year. In the United States, an average of 200 people are killed each Saturday of the year. In a recent year, 4,760 people were killed in accidents occurring in August. The safest month? February, with less than 2,940 deaths. Whatever the data, automobile accidents occur frequently and have become increasinglycostly to society. As a result, the automobile insurance industry is a high-visibility matter ofconcern to every automobile owner and operator in the country. Of equal concern are therates charged to the consumer for automobile insurance. According to data collected by the U.S. government, the cost of automobile insurance ofall kinds averages more than 10 percent of the total cost of operating an automobile overa 10-year period. Some owners or drivers pay as little as $500 annually. Others pay morethan $3,000 for the same, or similar, protection. From the insurer’s perspective, over the past several years, the average cost per claimhas risen dramatically. The reason is the sharp increases in costs for what insurance covers—medical care and automobile repair. And, veteran industry watchers see no end in sight forthese increases. As a result, automobile insurance premiums will continue to increaseproportionately. Under the umbrella of Personal Auto Policy Protection (PAP), there are four parts:1) Part A—Liability—Protects the operator/owner and compensates the injured and owners of damaged property.2) Part B—Medical Payments—Pays for injuries to owner/operators and others.3) Part C—Uninsured Motorists—Pays owner/operators for injuries or property damaged by uninsured motorists.4) Part D—Damage to Your Auto—Pays for damages to the owner/operator’s car.117

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE The automobile insurance industry, as costs have increased, is constantly evaluating andre-evaluating its system of establishing rates and its ability to maintain a price that is profitableto the industry while, at the same time, affordable to the automobile owner. The following information will offer a brief history of the industry, an overview of the variousrisks covered by automobile insurance, the differences between commercial and personalcoverages, and how automobile insurance rates are calculated and regulated by the insuranceindustry. It is the purpose of this information to provide an understanding of the rating processand its application to providers and consumers of automobile insurance.A Brief History of Automobile Insurance While various companies in the United States may want to claim the title of having writtenthe first automobile liability policy, it is a little known fact that the first automobile insurancepolicy was actually written in England in the year 1895. Three years later, in 1898, theTravelers issued the first automobile insurance policy in the U.S. to Dr. Truman J. Martin. Theform used for this first policy had been previously derived to insure mule teams and horsesin rural America, but with a few modifications, it looked good enough to insure Dr. Martin’sautomobile against any bodily injury that could result. As more “horseless carriages” crowded onto the rutted wagon roads that would laterbecome America’s highway system, the possibility of an accident seemed likely, and toaccommodate this purpose, the U.S. insurance industry developed an auto collision policy,first written in 1899. Soon thereafter, the first automobile property damage liability policywas written in the U.S., and by 1904, U.S. insurers had begun paying on these policies whenWilliam Wallace, vice-president of the Boston Insurance, filed the first liability claim. It seems that he was on his way from Boston to neighboring Worcester when the gasolinetank on his auto exploded, rendering him without transportation. It is not known whether thepaid claim purchased an entire new automobile or simply replaced the gasoline tank andrepaired the associated damage. Since that first claim—less than a century ago —automobile insurance has grown to beone of the most widely held insurance coverages in this country, and is one that is purchasedby individuals, as well as businesses. Liability coverage is required in most states and isnecessary for anyone owning or operating an automobile. There is another story—probably more mythical than fact—about the president of a largeU.S. insurance company around the turn of the century. It seems that someone sent him arequest to insure one of the new-fangled automobiles that were beginning to be seen alongthe wagon paths of America. His response: “This company wouldn’t insure a railroad trainoperated by a veteran engineer. Why—we’d be idiots to insure an automobile, traveling atbreakneck speed, through the center of town, over railroad crossings and operated byanybody who had the money to buy one of those contraptions, whether or not they had thebrains to operate it properly.” Today, there are abundantly more automobiles than trains in America, just as there arecountless other developments enjoyed by this generation. Fortunately, most of these newdevelopments—vehicles, computer systems, objects of entertainment or convenience—can 118

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEbe insured and to be sure, the coverage is being made available by insurers who are milesahead of that company president in 1900 who refused to insure that first automobile.Why Is Automobile Insurance Mandated? To understand the reasons for automobile insurance rates, an initial step would be to lookat the concept of “risk.” One definition of risk is “... the uncertainty of the future; the inabilityto look into a crystal ball and predict loss when it occurs or the size of a loss.” Because oursis a world of risk, losses occur at anytime and usually without warning.Two Kinds of Risks Within the insurance industry, there are two classifications of risk—pure risk results onlyin loss or in the absence of loss. As an example, we can say that a barn will have a fire orit will not have a fire. A bicycle will be stolen or it will not be stolen. Speculative risk is the type of risk that results in loss or gain. If an individual goes to therace track and bets on a certain horse, he or she either wins money or leaves the track withempty pockets. When a new business is begun, the owner is taking a speculative risk: thebusiness will either make a profit, or it will lose money and eventually go under. It is important to understand the difference between these two types of risks, because onlypure risks—risks where there can be no profit, only loss—are the only risks that are insurable.Think about it. The possibility of gain cannot be insured. Consider the following example. On a recent trip to Europe, Edmund purchases an expensive painting and is told that thepainting will eventually double in value. Once home, the painting is hung in a place of honorin his mansion, only to be stolen by an infamous cat burglar. Edmund, fortunately, had insuredthe painting for what he had paid for it. That makes the painting a pure risk, because whenit was stolen, Edmund suffered a loss. But, there is also an aspect of this painting that makesit a speculative risk. What the gallery owner did not tell Edmund was that as the painterproduced more paintings, there is a possibility that the painting he bought could decline invalue. However, because the painter is very much in demand, there is an equal possibilitythat the painting’s value could increase tenfold. The pure risk—the risk of theft (loss)—is insurable. But the speculative risk—that thepainting could decline in value—is not insurable, and the owner could, indeed, suffer a losson the painting’s initial price, particularly if he tried to sell it and the market was flooded withpaintings by the same artist. Types of Loss Before going forward with the study of automobile insurance, there are also a fewcommonly used terms that should be discussed: loss, peril and hazard. A “loss” is anunexpected decline or disappearance of the economic value assigned to a car or property.The loss resulting from the theft of an heirloom wedding band would be the economic valueassigned to that ring. The fact that it was an individual’s great-grandmother’s, minted fromher father’s musket, would be sentimental value, not economic value—which is not insurableand not compensated by any insurance policy. 119

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEIn the world of insurance, there are four distinct types of losses:1) Loss of property.2) Loss of income (or the ability to earn an income).3) Loss associated with legal liability claims.For example: If an accident occurs, the owner will be responsible for the legal costs of defending himself against a lawsuit, and may end up paying the party bringing the law suit.4) Loss due to expenses that are unexpected, such as the cost of a long-term hospitalization, nursing home care or rehabilitation.What Is Peril? A situation of peril is simply the cause of a loss. For example, if a pipeline explodes anddestroys an entire neighborhood of single-family dwellings, the peril is the explosion.Insurance policies generally cover perils such as fire, theft, explosions or illness. In some partsof the country, policies also cover floods, earthquakes and hurricanes.Kinds of Hazards A hazard is a situation or condition that increases the possibility of loss due to a particulartype of peril. When an operator doesn’t keep his automobile in good condition and the brakesgo out, the brakes become the hazard that increases the possibility of a loss due to automobileaccident. According to most insurance experts, there are three types of hazard with which oneshould be familiar: physical, moral and morale.1) Physical hazards are those things that can be seen, touched or smelled that can cause a loss—bad brakes, poor ventilation, water spills on already slippery floors.2) Moral hazards occur when someone with insurance may be totally dishonest or may make a loss seem larger than it was. A known arsonist, for example, would be considered a moral hazard if he attempted to buy fire insurance.3) Morale hazards developed when the ability to buy insurance makes the insured indifferent to loss. For example, if Sam buys insurance for his car and then uses no judgment as to where the car is parked, whether or not it is locked, etc., this careless attitude becomes a “morale” hazard.The Chance of Loss Sometimes called “probability,” the chance of loss is the number of losses out of a givennumber of loss exposures. Take the simple act of betting on the flip of a coin as an example.In this case, there is a 50 percent chance of winning and a 50 percent chance of losing.Therefore, the chance of loss is one out of two. Because insurance companies usually haveto calculate the chance of loss based on their experiences in the past, large data banks of thesestatistics are amassed over the years and it is upon this information that rates are based. The Degree of Risk It is not difficult to confuse the concept of chance of loss with “degree of risk.” For usehere, the “degree of risk” is the area of uncertainty that looms over future losses. It is an 120

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEarea that cannot be precisely predicted. Following is an example of “degree of risk.” If thereis a definite certainty that losses will not occur, the degree of risk is zero, because there isabsolutely no uncertainty. If there is a certainty that a particular number of losses will occur,again the degree of risk is zero, because there, again, is absolutely no uncertainty. However,if the number of losses cannot be predicted with certainty, then the degree of risk increaseswith the degree of uncertainty present.The Concept of Insurance Before discussing automobile insurance rates, one more basic concept should bediscussed—the concept of “insurance.” Insurance is often defined as a system of combiningmany loss exposures with the costs of the losses being shared by all the participants. “Lossexposures” are simply objects that are subject to loss. In automobile insurance, the lossexposures, of course, are automobiles. To illustrate how automobile insurance works, assume that there is a group of 100 peoplewho each own an automobile. To make this illustration simple, let’s say that each of these100 automobiles are worth $1,000 each. These owners understand that these automobilescould be wrecked or stolen, so each of them buys an insurance policy to eliminate the riskof loss. The insurance policy is a contract under which an insurance company states that it will payfor stated losses. The insurance policies purchased by the auto owners in this example coverthe cars against the perils of collision or theft, for a term of one year. The price paid for thesepolicies—called premiums—is $25. So, the insurance company collects $25 from each of the100 auto owners. This particular company has insured cars against collision or theft for manyyears, and their statistics show that about two out of every 100 cars will be stolen or wreckedevery year. Since the insurer has charged a premium of $25 for each of the 100 policies, the companygathers in approximately $2,500 (or 100 x $25 = $2,500). If the auto owners suffer the samelosses that the company has experienced in the past, the company will pay out $2,000 thisyear, or 2 x $1,000—which leaves $500 for the insurance company to use to pay operatingexpenses, sales commissions, taxes, etc. If anything is left over, the company calls it a profit. So, what has been achieved? First of all, the owners have been relieved of risk to theirproperty, which was covered by the insurance policy. Secondly, the losses experienced by two of the auto owners are shared by all 100 owners,in that all of them pay. Finally, because the insurance company can determine with a highamount of accuracy how much loss will occur each year, the premium can be calculated sothat the owners will know how much they must pay to cover their share of the total cost—and, at the same time, be assured that if they themselves suffer the loss, their cars will beeither repaired or replaced.Rates If the acceptable definition of insurance is, “... combining the loss exposures of manyproperties so that the costs of the losses that do occur are shared by all policyholders,” thenext step is to understand the reason for buying insurance. 121

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE The primary reason anyone purchases an insurance policy is to get rid of the risk of financialloss. This is accomplished when the purchaser transfers the risk (the uncertainty) of damageor loss of property to the insurance company. The insurer, in exchange for premiums, promisesto pay the policyholder if damage or loss occurs. The formula is an easy one to remember—risk is handled by combining exposures to loss and sharing the costs, should loss occur. Returning to the topic of liability, it can be defined as damage to property or injury topersons resulting from ownership, maintenance or use of an automobile. Liability insuranceprovides protection for the insured against claims from others of bodily injury or propertydamage that has resulted through negligence or has been imposed by law. With liabilityinsurance, the insured is protected from unexpected and intentional damages or losses(exposures). Within the insurance industry, there are two areas of private insurance—life insurance andproperty/liability insurance. Coverages available through property and liability insuranceinclude the following five types:1) Physical damage or physical loss.2) Loss of income and additional expenses resulting from damage to property.3) Liability.4) Health.5) Surety.Liability and Negligence Within the definition of liability, there are two specific types—absolute liability (also calledliability without fault) and strict liability.Absolute Liability Absolute liability occurs when laws or public policy direct that a person be held responsiblefor injury to others, although that injury may not have been intentional or the result ofnegligence. According to the truest definitions of absolute liability, when activities are verydangerous and where loss is almost certain, the loss is then shifted to those who can bestcontrol it. Strict Liability Strict liability is most commonly found to occur in areas of product liability. Using theconcept of strict liability, the manufacturer and seller of a defective product that causes injuryare held liable, regardless of fault or negligence. In this case, strict liability is distinguishedfrom absolute liability, because the person filing the claim must prove that the product wasdefective and was, therefore, dangerous. SECTION III—PERSONAL AUTO INSURANCE AND COVERAGES AVAILABLE Automobile insurance has traditionally included two types of coverages—liability insur-ance, which includes medical payments and related coverages, as well as uninsured motoristinsurance, and direct physical damage insurance, which includes collision, comprehensive,fire, theft, etc. 122

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE In the early days of the automobile insurance industry, the person seeking insurance wouldhave to deal with two different insurers. What resulted, eventually, for the convenience ofthe insured, was a combination policy, in which liability coverage and direct physical damagecoverage were presented in a single contract. Two different insurers (the casualty and thefire insurers) were involved. Today, these two coverages can be obtained by a single insurer—due to multiple-line charter powers and license authority.Differences Between Commercial and Personal Automobile Coverage Automobile insurance coverage is classified according to the types of exposure to thevarious hazards. The two major coverages are “personal” and “commercial.” Both of thesecoverages require liability and physical damage insurance, but these two types of policiesinvolve different needs for coverage and different hazards.Personal (Private) Coverage Personal automobiles are vehicles used for both family and business reasons. Specifically,a personal passenger vehicle is:1) A motor vehicle that is not used to convey commercial passengers and is not rented to others without a driver.2) A pickup or van owned by an individual (or family, e.g., husband and wife, partners, etc.) and is not used for business other than in the course of driving to and from work. If it is a pickup, it may be used in the operation of a farm. Notably, a passenger car or van need not be owned by an individual to qualify as a private passenger vehicle, but a pickup owned by a corporation would not be qualified as a private passenger vehicle. There are three types of policies that can be used to cover the private passenger vehicle.These include the following:1) Family Automobile Policy.2) Special Automobile Policy.3) Basic Automobile Policy.Coverage for Public Automobiles A public automobile is considered “...an automobile of any type used for public conveyanceand includes taxicabs, public and private livery automobiles, general passenger buses, specialpurpose buses and cars rented by automobile rental agencies.” These are covered under theBasic Automobile Policy, covering both liability and direct physical damage losses, underwrittenby a single insurer. Commercial automobiles are vehicles, such as trucks, which are not used as public orpassenger vehicles, and include tractors, delivery sedans, panel trucks and automobiles withpickup bodies used in the business of the insured person. This category also includesautomobiles rented to others, commercial trailers and semitrailers, construction andmaintenance vehicles, and special equipment used by municipalities and contractors. Thesevehicles are typically covered by the basic automobile policy or the ComprehensiveAutomobile Policy. 123

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEComprehensive Auto Policy The Comprehensive Automobile Policy offers complete liability coverage “... arising outof the ownership, maintenance or use of any automobile.” There is also coverage availableon all automobiles and trailers, including those owned by the insured at the time of the contractand those that are purchased during the contractual period. Automobiles used by independentcontractors while working for the insured and all hired cars are also covered. This contractmay be sold separately or in combination with the Comprehensive General Liability policy.Automobile Insurance Rating Plans Automobile insurance is the largest classification in property/liability insurance today, witha total written premium value of more than $50 billion. The personal automobile insurancepremium is divided into two classifications—two thirds for liability and one third for physicaldamage insurance—which breaks down to collision coverage (66-2/3 percent) and one thirdfor fire, theft and comprehensive. The “rate” paid for insurance is actually “... the price per unit of exposure charged to aparticular party for a particular contract of insurance.” The “unit of exposure” is, simply, a unitof measure used in insurance, similar to “pounds” when measuring sugar or “feet” whenmeasuring carpet. In most cases, the “rate” charged for insurance is the cost per unit ofexposure, multiplied by the number of units of exposure (determined by an actuary). The resultis the “premium” or the total price paid for insurance. In the insurance industry, there are two major rate classifications—the “manual,” whichis sometimes referred to as the “class” or “classification rates,” and the “individual-insured.”Manual or “class” rates usually divide insureds into rate groups, based on characteristics ofterritory or hazard characteristics that would be peculiar to that individual. People in the sameclassification group normally pay the same rates. The important aspect of the manual rate is that it is the projection of the anticipated averageloss per insured and the costs associated with that loss. This projection would also include costsfor underwriting and a built-in profitability for the insurance carrier. The second major rateclassification, the “individual-insured” rate, is usually the manual rate, plus modifications,based on a composite data base of experience, prospective experience, schedule andretrospective experience. When defined as “a modification of manual rates,” the individual-insured rates assume that the provisions of the insurance contract are similar to those offeredunder the manual rate structure. For insureds who want unusual or special coverage (excess liability in addition to primarycoverage, as an example), and for speciality lines, the rate charged will be unique, dependingon the circumstances or situation involved in that special setting. As is the case with many businesses, the pricing of the product is the most important, yetoften most difficult task of the business cycle. Prices are generally set according to anticipatedcosts and demand for the product. Insurance pricing is much the same. It is the responsibilityof the insurance actuary to develop rates that will assist the insurance company in meetingthe losses and expenses that accompany these losses, plus cover the costs of offering thiscoverage. The actuary must understand the insurance industry, must be skilled in 124

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEmathematics and statistical analysis, and must have a broad knowledge of trends in territoriesas well as throughout the country.Personal Automobile Physical Damage Automobile physical damage insurance divides frequency exposures into high- and low-loss frequency exposures. Damage that occurs infrequently, such as damage due to fire andflood, is generally insured on a full-coverage basis. Damage that has more frequent exposureand could result in many small losses are written into an insurance policy, using a deductible.By handling physical damage in this way, the usual scratches, scrapes and dings that occurto automobiles of every price range are a maintenance cost to the insured and not a recurringclaim problem for insurance companies. For private automobile owners, physical damage insurance uses one of three policyforms—the basic automobile policy, the family automobile policy and the special automobilepolicy. There are also some nonbureau policies that are filed by individual companies, butthese policies are very similar to the other types of policies. The Basic Automobile Policy is used to insure most automobiles used for business. It is alsoused for automobiles that may be ineligible for the standard contracts due to:1) Joint ownership by persons other than a husband or wife.2) Ownership by an insured that is subject to an assigned risk plan.3) Coverage to be written on a fleet policy by the owner of the business.4) The vehicle does not meet basic descriptions, such as those with less than four wheels, e.g., golf carts or motorcycles. When the basic form is used, the coverage is almost the same as that provided forbusinesses, except that businesses receive automatic coverage for any newly acquired fleetautomobiles. The Family Automobile Policy delineates between “owned” and “nonowned” vehicles.“Owned automobiles” are those covered by a policy for which a premium is charged, and anysimilar automobile the insured purchases during the policy period, if it replaces an insuredautomobile, or the insurer provides coverage on all vehicles owned by the insured and theowner notifies the insurance of the new vehicle within 30 days of purchase. These policiesalso cover substitute vehicles over a temporary period of time. “Nonowned” automobiles are those private passenger cars or trailers not owned by theinsured or relative and used only temporarily by the insured or in the custody of the insured.The “Insured” The “insured” referred to in a Family Automobile Policy is (1) the person named as insuredand (2) any person who is using, maintaining or having custody of the named automobile withthe permission of the insured, except those who are involved in the automobile business.Liability policies usually exclude these situations. People employed in the automobile sales/service business usually have a special kind of coverage giving physical damage liabilitycoverage to automobiles owned by others that are left in their care. 125

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE Nonowned automobiles that are used by the person named as the insured, a spouse andany other relative living with the named insured, are covered if the automobile is being usedwith the owner’s permission.Insuring an Automobile—Commercial or Private Automobiles are generally exposed to two types of loss—direct physical damage, whichincludes loss of use, and legal liability. In the insurance industry, the automobile has the largestpremium classification in the property/liability business. The premium, which representsapproximately $50 billion, is divided into two thirds of the premium for liability coverage andone third for physical damage insurance. The following is a discussion of coverage regardingphysical damage or loss. Physical Damage Automobile insurance for physical damage is designed to delineate between high-loss andlow-loss frequencies of exposure. Perils with low frequency in automobile insurance, such asfire or flood, are usually written with full coverage. Collision and upset, which are morefrequent and which comprise many smaller losses, are almost always written as a deductible. Comprehensive coverage is comprised of two parts. The first part of the coverage insuresowned or nonowned vehicles against loss resulting from situations other than collision. Thiscoverage covers losses due to fire, malicious mischief, if the automobile is stolen, or if thedamage is coincident with and from the same cause as other losses that are covered by thepolicy. The condition called “Payment of Loss” says that if a stolen car is recovered somedistance from where it was stolen, the insuring company will pay for the return of the car toits owner. The Basic Policy As stated before, automobile insurance is written in three policy forms. These are:1) Basic.2) Family.3) Special. The Basic Policy insures most business automobiles in this country, although it does insurepersonal vehicles not qualified for one of the other types of insurance. Reasons for this includejoint ownership of the vehicle by husband and wife, coverage through a fleet plan or that thevehicle has less than four wheels, such as a golf cart. If the insured chooses the basic plan,coverage will be much like that of a policy written to cover vehicles owned by a business. The Family Policy The Family Automobile Policy’s section on physical damage explains that “loss” is a directand accidental loss of or damage to the automobile (and equipment) or other coveredproperty. Equipment means those mechanisms required for the operation of the vehicle.Because of the rising popularity of tape players, CD players and portable computers, unlessthis type of equipment is specifically mentioned as being covered, it is usually excluded.126

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE The second part of the physical damage coverage insures the personal property of theinsured, a spouse or relative, against damage caused by fire or lightning. There is usually amaximum recovery amount. Any losses of personal property arising from theft of the entireautomobile are usually reimbursed within 48 hours, with small installment payments up toa maximum or until the automobile is recovered and returned to use or the insured has settledwith the company regarding the value of the stolen automobile. Collision coverage is very similar to the collision coverage offered through the Basic Policy.One condition is that the deductible does not apply in a collision involving two vehicles insuredby the same company. Any damage resulting from collision with animals and birds is notcovered by standard collision coverage. Regarding trailers, since trailers are used by large numbers of people, a separate summarystatement is used to note that trailers are not automatically covered by automobile insurance.Trailers purchased during the policy term are usually considered an additional automobile ifnotice is given 30 days after purchase.Special Package Automobile Policy The Special Package Automobile Policy serves as an alternative to the Family AutomobilePolicy and has much the same eligibility requirements, although the two types of policies differregarding liability coverage. One area of difference is the physical damage coverage. Though relatively minor, theSpecial Package Policy will automatically cover newly purchased and eligible vehicles for 30days from the day of purchase. The Family Policy, on the other hand, has no limitation forautomatic coverage. Another difference in the Special Package Policy is that it offers broader coverage for perilinvolving personal property. The maximum limit of coverage is higher than the Family Policyand includes such mishaps as flood, falling objects, earthquake, theft of the entire vehicle andpersonal luggage. The Family Policy covers only “personal effects.” Because of the loss and expense experience of automobile insurers over the years,profitability has been somewhat limited, which has caused a number of revisions of the ratestructure as a result. The rating bureau for automobile physical damage is the NationalAutomobile Underwriters Associations. This organization provides rates for all but indepen-dent or nonbureau companies. For commercial vehicles, rates are normally developed according to several factors. Onefactor is the original cost of the vehicle when it was new. Other factors include age groups,territory, weight of the vehicle, purposes for use of the vehicle and whether it is regularly usedfor local or long-distance transportation. The “age groups” factor is actually the age of the vehicle. “Territory” refers to the statein which the vehicle will be operating. Regarding weight, vehicles are divided into two weightclasses—those having a gross weight of 19,500 pounds or more. The other weight class wouldinclude all other vehicles. The purposes of use will classify the type of “exposures” the vehicle has in its daily useroutine. For example, delivery trucks and other similar vehicles, such as vans, would normally 127

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEhave a high exposure rate. Larger, commercial vehicles would typically be classified in regardto whether they were operated in a local, intermediate or long-distance capacity. To economize, many commercial vehicles are classified under fleet rating plans forcomprehensive, fire, theft and collision coverage. A “fleet” is considered to be five or morevehicles. Base manual rates are then modified, depending on the past experience of theinsured, including the rate of loss in the past. Private automobiles—for setting rates on physical damage coverage—are usuallyclassified regarding the territory (state) of operation, the original cost of the vehicle, and theage group (based on current model year). Other rating factors include the age of the operator,the gender and whether or not the insured qualifies for a multicar discount.SAVING MONEY ON YOUR INSURANCEGAP insurance: Specialty policies help protect new car buyers While that new car smell may last a few weeks, the second you drive your new automobileoff the dealer´s lot, it begins to depreciate. It immediately becomes a used vehicle. Dependingon the amount financed, your once new car may be worth considerably less than what youowe the lender who is financing it. If your car is stolen or “totaled” in an accident, you may end up owing much more thanthe “actual cash value” for which the vehicle is insured. Actual cash value may be very differentfrom the actual cost to replace the vehicle, especially if you are early in a long-term loan. Inother words, you may owe the lender more than you receive from your insurance company. That´s where a product called “GAP insurance” may help. GAP stands for: “GuaranteedAuto Protection.” And as the name implies, the typical GAP policy covers the gap betweenthe actual cash value settlement from your insurance company and the outstanding balanceon your vehicle loan. Many GAP policies will also cover the deductibles on your standard autoinsurance policy. The two most common types of GAP insurance are commercial and personal. But a thirdvariety of GAP coverage, offered as an auto insurance policy add-on, has just recently becomeavailable. You can check with your auto insurance agent or a sales representative to see ifthe coverage is offered. Policy language and rates for GAP policies available from authorizedinsurers must be approved by the Department of Insurance. Commercial GAP insurance protects state and national banks and credit unions from losseson financed vehicles due to thefts or accidents. When you finance a new car, the bank or creditunion may offer you a debt cancellation agreement, which may be insured by a commercialGAP policy. It covers the outstanding balance of your loan if the car is lost or totaled. GAP insurance is a relatively new concept. The commercial version for lenders was firstauthorized by a Finance Code change. It wasn´t until 1997 however, that commercial GAPpolicies were approved to be marketed by banks and credit unions. Only over the past coupleof years, after auto dealers began selling the product, have personal GAP policies becamewidely available to new car buyers.128

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE We´ll focus on personal GAP insurance because that´s the product that most consumerswill likely encounter, especially if they finance their car at a dealership. Many auto dealersare now licensed to offer GAP insurance. The policies have become one of the optionsconsumers must consider as they negotiate for a new car. If your car is stolen or totaled, GAP insurance will be much more important than the pin-stripes or rust protectant coating the dealer may be pushing. If GAP insurance is somethingyou´re interested in, it´s important to stay focused during the negotiation process and askif the dealer offers GAP insurance and if so, what it covers. GAP insurance is typically purchased for a one-time premium at the time of your vehiclepurchase, or it may be rolled into the amount of your loan. Like any other insurance product,prices can vary greatly. Dealerships and other lenders offer premium rates based on the valueof the vehicle and the length of the loan. GAP insurance will cost you anywhere from $100to 4-or-5 percent of the vehicle´s sticker-price. That can be a big difference when trying toreach a bottom-line price on a new car and stay within a budget. Still GAP insurance should at least be a consideration for new car buyers, especially givenwhat you could lose in a worst case scenario. SECTION IV—LIABILITY The difference between damage loss and liability loss is that damage loss may neverexceed the value of the property, while liability loss is virtually unlimited. Liability risks, over the years, have become important to the insurance industry for threereasons: First, people are more apt to file a lawsuit or press claims against the other party;second, the awards for property damage, personal injury and the perceived loss of earningpower have increased considerably. Finally, there is also a factor called the “jury problem,”which means attorneys have become increasingly skilled in maneuvering juries to awardsettlements that are increasingly higher. Another aspect that has contributed to the close scrutiny of the liability risk is that ofexaggerated or falsified claims. Unique to the characteristics of liability risk is the fact that the full potential exposure ofany vehicle cannot be truly and accurately measured. Because both individual vehicleoperators, as well as businesses, have rather high liability risks, it is important to understandthose elements that create risk so as to identify various sources of exposure that affect potentialloss from a vehicle.Personal Automobile Liability There are various risks involved in owning a motor vehicle. When an automobile accidentoccurs, people may sustain a financial loss to pay for one or more of the following: (1) Liabilitydamages for injury to persons and property; (2) Medical expenses and other loss sustainedas a motorist, passenger, or pedestrian; (3) Repairing or replacing an owned or non-ownedauto which has been damaged or destroyed; and (4) Providing substitute transportation untilrepair or replacement is completed. 129

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE An automobile liability insurance policy assumes the risk of financial loss arising fromliability for bodily injury or property damage to third parties caused by automobile accidents,as well as providing various first party coverages to policyholders and other insureds. Thispaper is written to provide an overview of personal automobile liability laws and coveragewith an accompanying chart setting forth a fifty-state survey on auto law.Automobile loss exposures Liability to others. Auto liability exposures for bodily injury and property damage ariseout of the ownership, maintenance, use, or operation of an owned or non-owned vehicle. Suchliability can be of either a personal or a vicarious nature, and can stem from common law,statute, or contract. Personal liability for damages to pedestrians and other motorists can arisewhen a person negligently operates an automobile. Examples of negligent operation of avehicle include:· falling asleep at the wheel,· unattention to the road (e.g., using a cellular telephone while driving),· speeding,· disregard for traffic safety signals, and· following a vehicle too closely. Vicarious liability may be imputed to the owner of a vehicle because of certaincircumstances. For instance, the family purpose doctrine, accepted at one time by about halfof all American courts and now by a relatively small minority of courts, provides that a carowner who lets members of his or her household drive his or her car for their own personaluse has done so in order to further a “family purpose” or family objective, and is thereforevicariously liable if a family member uses the vehicle and negligently causes damage to a thirdparty. Injury or death to owners and operators. Exposures to injury or death of the ownersand operators themselves are first party exposures created by the ownership, operation, oruse of autos. Potential financial losses include: hospital, surgical, and rehabilitation expenses;temporary permanent loss of income; and costs incurred for partial or total disability of atemporary or permanent nature. Injury or death to passengers. Operators owe a duty of care to their passengers, andwill be found liable for injuries sustained by his or her passenger should the operator breachthis duty. Guest statutes place constraints on passengers’ ability to hold operators liable fordamages. A minority of states still have “automobile guest statutes” on their books. Thesestatutes generally provide that an owner-driver is not liable for injuries sustained by his orher non-paying passenger, unless the driver was grossly negligent or reckless. Physical damage to autos-first party coverage. Physical damage loss exposures arefaced by individuals and families who own, borrow, rent, or lease autos. Such exposures mayresult in a direct loss, where property itself is damaged, destroyed, or lost because of someperil (cause of loss) resulting in a decrease in the value of the property. Additionally, an indirectloss can occur as a consequence of a direct loss. Loss of use of an auto following its damageor destruction by the peril of collision is an example of an indirect loss. 130

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEThe personal auto policy (PAP) The personal auto policy is designed for individuals and families who own or lease privatepassenger autos. The basic contract, which can be modified by endorsement to tailor coverageto specific needs, contains three essential preliminary sections:· a declarations page that contains the policy number, the insured’s name and address, period of coverage, description of covered autos, limits that apply to the coverage selected, and any deductible amounts;· a general agreement that serves as a preface to the policy as a whole and makes the insurer’s obligations contingent on the insured’s payment of premium; and· a definitions section which defines commonly used terms. Following these preliminaries, the policy includes the following six coverage parts: Liability. This section indemnifies the insured for bodily injury and property damage thepolicyholder causes to a third party, as a result of operating his or her vehicle and for whichthe policyholder is held legally responsible. Medical payments, Personal Injury Protection (PIP) and no-fault coverages.Medpay will pay for you and your passengers’ medical expenses incurred, as a result of anautomobile accident, while you are driving your car or someone else’s car (with theirpermission), and injuries you and your family members sustain when you are pedestrians.This first party coverage will pay regardless of who is at fault, but if someone else is liable,the insured’s insurer may seek to recoup the expenses from them. PIP and broader “no fault”coverages are expanded forms of medical payments protection that are required in severalstates. Expanded features include lost wages and childcare expenses. Uninsured/underinsured motorists’ coverages. Uninsured motorists (UM) coveragepays for your injuries if you are struck by a hit-and-run driver or someone who does not haveauto insurance. This coverage is required in many states. An uninsured motor vehicle isdefined as one of the following:· a vehicle that does not have a bodily injury liability policy or a bond filed with his or her state of residency;· a vehicle which has an insurance policy or a bond for bodily injury liability at the time of an accident, but with a limit of liability that is less than the minimum specified for bodily injury under the financial responsibility law of the state where a victim’s covered auto is principally garaged; or· a hit and run vehicle, whose owner or operator cannot be identified, that hits (a) the named insured or family member, (b) the named insured’s covered auto, or (c) a vehicle which the named insured or family member is occupying. An underinsured motor vehicle is defined as one to which insurance or a bodily injury bondapplies for a limit which is equal to or greater than the minimum amount required by the statebut less than the limit of a person’s underinsured motorist’s coverage. (The criterion here isthat the liability limits of the other party’s policy is less than the insured’s underinsuredmotorist’s limits.) Broader form underinsured motorist coverage comes into play when theliability limits of the at fault party’s policy are less than the insured’s actual damages ratherthan being less than the limits of underinsured motorist coverage. In other words, an insured 131

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEwould be entitled to underinsured motorist coverage even when his or her underinsured limitsare less than or equal to the at fault party’s liability limits. Damage to your auto. These optional coverages compensate the policyholder when hisor her auto is damaged. There are two types: Collision: Pays for damage to the policyholder’s vehicle from a collision with anothervehicle or fixed object (e.g. telephone pole) Comprehensive:: Pays for damage to the policyholder’s vehicle that was not caused byan automobile accident (e.g. damages from theft, fire, vandalism, natural disasters, or hittinga deer). Duties after an accident or loss. The duties following any accident or loss are as follows:· In general, immediately following any loss, the insured is obligated to notify the insurance company of all the particulars concerning a loss and to submit a proof of loss when required. The insured is also expected to cooperate with the insurer in the investigation, defense, or settlement of any claim or suit.· An insured who makes a claim for uninsured motorists coverage must, in addition to the above, notify the police as promptly as possible following a hit and run accident.· In addition to the above-stated general duties, an insured making a claim for loss to the covered auto must take necessary steps after the loss to protect the auto from further loss (mitigate damages). The insurer will pay any necessary cost incurred in mitigating the insured’s damages. Additionally, the insured is required to notify the police promptly in the event the covered auto is stolen. General provisions. The policy contains provisions regarding bankruptcy, legal actionagainst the insurer, subrogation, policy period, territory, and termination. Each policy shouldbe read closely, and additional policy provisions may apply to specific policies.The Necessity of Liability Insurance When a person buys liability insurance, the insuring company agrees to pay for damagethat the insured is legally liable to pay. Throughout the history of the insurance industry, the question of transferring liability froman individual to the insurer has been fully discussed. The courts have examined this questionon numerous occasions, and the result is that the primary purpose of legal liability is todiscourage carelessness and wrongful acts by the insured. The courts have also pointed outthat liability insurance does not release the negligent driver from direct liability for the insured. Liability insurance promises to “pay on the behalf of” the insured, and the latter part ofthe basic coverage of liability insurance states that the insurer will pay sums required whenthe insured becomes legally liable. This does not imply that the insurer will foot the bill forlosses caused by the insured. What it means is that the insurance company will consider payingfor damages if the insured is charged, found guilty and a settlement is determined.132

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE Further, in addition to paying for judgments rendered against the person holding theliability policy, liability insurance promises to defend the insured against groundless or falseclaims, and also says they will bear the expenses to defend the insured. Liability insurance is a major part of the casualty insurance classification. The first liabilitypolicies were written in the 1880s, and they protected employers against claims from injuredemployees. Liability insurance protecting businesses came into being in the late nineteenthcentury and products liability insurance was introduced in the early 1900s. In comparison with the rest of the industry, liability insurance is a newer part of theinsurance business. It has grown with the movement of the American family from the farmto the city, and from the city to the suburbs. It has also expanded because of the growth ofAmerican business, and the growth of both the private and public sectors of our transportationnetwork.Beyond the Statutes In some sectors, it would appear that by passing compulsory automobile liability insurancelaws, all persons would be protected. However, being able to compensate auto accidentvictims is not just a matter of passing a law. There are some states, such as Texas, that havecompulsory insurance laws with built-in enforcement provisions, e.g., annual automobileinspections require proof of insurance and all drivers should have this proof available if theyare stopped at any time by law enforcement officers. However, much like any enforcementsystem, there are “cracks,” and there are individuals who manage to fall through these cracks. Because of the history of compulsory insurance in this country, there are few people whobelieve that it is totally effective; however, many states have subscribed to this system,beginning with Massachusetts in 1927, New York in 1957 and others. In most cases, stateshave enacted mandatory liability programs when no-fault insurance laws have been adopted. Except when mandatory insurance is enacted in connection with no-fault insurance,insurance companies do not generally favor compulsory liability laws. While this is somewhatsurprising, as one would assume that compulsory laws would mean more business forinsurers, the insurance companies believe that there are serious drawbacks associated withcompulsory liability laws. Liability rates for automobile liability insurance are class rates. This means they areobtained from a rating manual from each state by the National Bureau of CasualtyUnderwriters or the Mutual Insurance Rating Bureau. Independent or nonbureau companiesoften deviate from the bureau rates and are allowed to do so. Whether the rate is developed by the bureau or an independent insurer, the basic approachis much the same. Automobiles are divided into four separate groups:1) Private passenger cars.2) Commercial vehicles.3) Public vehicles.4) Garage vehicles. 133

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE Within each of these classifications, there are many special details to consider when writingliability insurance. Liability rates for the private passenger car will depend on the state in whicha majority of its operation takes place, the municipality where the policy is written, the driverof the vehicle and the major uses of the vehicle. There are numerous rating classifications used in the liability insurance industry today. Theappropriate class will be determined by such details as age, marital status and whether thedriver has had formalized driver training or not. The primary use of the vehicle will also beconsidered, as will the area in which the vehicle is used, e.g., city driving vs. farm-to-marketroads. Other considerations when developing rates include whether or not the policy is insuringonly one vehicle or several vehicles owned by the same family. There is a discount for this,as there is also for compact cars and safe driving records (over the previous three years). Theseclassifications and rate modifications also carry a manual rate factor, which means that whenall rating factors are added together, the result is then applied to the territory’s base rate todetermine the rate and final premium.SECTION V—INSURANCE RATING LAWS In all insurance “jurisdictions,” rates are regulated by the states, with the consent ofCongress. Therefore, rates charged for insurance coverage of any type must be filed withthe state’s insurance department prior to being used, and any changes must be immediatelyreported prior to going into use. Most regulations covering insurance rates require that the filing of rates with the stateindicate the character and extent of the coverage contemplated. To be effective, rateregulations require that changes to the rates may not be made without first being filed andapproved. The laws regulating insurance rates were established with the intent of preservingcompetition, and in doing so, the laws make room for some flexibility in ratemaking proceduresin response to the highly dynamic nature of the industry and the needs of the insured. Within the industry, there are variations in rating laws and variations, too, in theinterpretations of these laws. Therefore, for the large insurer, it is difficult and often expensiveto justify and defend the filing of new rates. Actuaries are often required to justify thesechanges statistically where, in some cases, filings were approved based on logic and intuition.Now, a process that is often challenging to all involved is required to set a new insurance rate. Statutes used in rate regulation usually provide standards to be followed by the actuarywho makes the rate and the supervisory authorities who judge the filing for a new rate. Inmost cases, the new filing must be approved if it is not excessive, too low or discriminatory.These standards have been set to insure protection of all parties involved—the insurer andthe insured party. The specific definitions of these standards are not usually available, butstatutes regulating rates are followed to insure fairness. The following is a discussion of thesegeneral standards.134

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEGeneral StandardsAdequacy Adequacy means that the rate used to price insurance coverage should produce enoughfunds to cover total losses and expenses for the insurer. There should also be monies forunderwriting profits and any contingencies. In some territories, the statutory definition of“adequacy” may note that the rate structure is not inadequate if the insurance company makesa profit or if the rates charged do not endanger the solvency of that company, if it does notdo away with competition, or if it does not create a business monopoly. There is a test for adequacy that, primarily, refers to the whole rate structure for one typeof insurance in the smallest territory possible. However, as rate groupings are more refinedand based on stronger statistical data, the test of adequacy is applied to rates for specificgroupings within the rate structure for a particular type of insurance. Because of this evolution,the test for adequacy and the test of fair discrimination have become similar. It is important to note that bureau rate filings are usually based upon the experience ofall insurers submitting data to a bureau, and the rates become “averages.” Thus, even thoughthe rate structure may be adequate as measured by the experience of all contributing insurers,it may not be adequate for a particular insurer. The bottom line of rate adequacy is probably the most difficult objective to achieve. In somestates, the insurance board or commissioner may not approve, as requested, an increase inrates because of socioeconomic reasons or pressures from lobbyists. Rate bureaus or insurersmay fail to request adequate rates. And, as in all cases, competition has had exceedinglyimportant impact on the rate, or requested change. Especially in automobile insurance andhome insurance (mass market lines), insureds feel a need for protection, but most fail torecognize product coverage differences. Therefore, competition in the industry usually centerson price. Reasonableness is another important general statute in the regulation of rates, and state,generally and specifically, that rates should not be excessive in producing an underwritingprofit. Like the “standard of adequacy,” there is also a standard of reasonableness that appliesboth to the expense and loss portion of the insurance premium. A good portion of the totalcost of insurance consists of operating expenses. The standard of reasonableness requiresthat these costs be legitimate. The existence of this standard makes the insurer aware thatexcessive or unnecessary expenses should not be passed along to the consumer in the formof higher rates. Traditionally, however, “reasonableness” applies to the whole rate structure of the insurerfiling the rates for a type of coverage in the smallest possible territory. An average bureaurate may be excessive for efficiently operated companies, but it may be inadequate for others. Competition, there is no doubt, tends to enforce the requirement that rates be reasonable.Therefore, an insurer with a high rate structure cannot exist long without also offering arecognizably superior product. Fairness statutes require rates to recognize significant differences in the anticipated costsor hazard exposures of a certain class of insureds. Developing a rate structure with this 135

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEobjective as a goal is also an increasingly difficult task. This task is further complicated becausemost statutes do not clearly define the ground rules regarding the meaning of “fairness.”Suffice it to say that the objective of fairness regarding rates and rate structures must beinterpreted from the viewpoint of the insured. Some other objectives should be discussed as fundamental to insurer solvency andcompetitiveness. These objectives include responsiveness, stability and hazard and lossreduction.Responsiveness Responsiveness of rates simply means that the rates should be responsive (shouldrecognize) any changes in hazard exposures, also called loss costs, and the expenses involvedin writing insurance. Responsiveness within this particular context means that there shouldbe only a minimum time lag from the recognition of a need for change and the time thenecessary change is reflected in new rates. It is often difficult to achieve responsiveness,because manual rates are based, specifically, on past experiences that have been analyzedand projected for future protection. Actuaries and underwriters attempt to set a price basedon a “best guess” supported by past experience. To achieve responsiveness, rates arecurrently determined by trending factors, shortened experience periods, shortened contractlengths and credibility factors. Other techniques to achieve responsiveness include statisticalsampling techniques, more refined rating groups and definitions of these groups that reflectcurrent hazard characteristics.Stability Stability implies that even though rate structures are responsive, they should also bestable. While this may sound contradictory, it is a necessity for the industry. Except for thevery largest group, if individual insureds with relatively high loss frequency relative to severity,rates perfectly responsive to this hazard exposure would not be insurance. Instead, each ofthe insureds would be paying his own loss costs, plus the expenses incurred by the insurerhanding this business. In much the same way, the experience data base of many rate groupings (specificallyclassifications) may be so small that the actuary modifies indications from the raw data withcredibility factors, strictly for the purpose of stability. Longer experience periods, the use ofonly “basic limits” data in liability insurance, and catastrophe limitations in workers’compensation insurance are examples of some of the techniques used to insure stability inrates. The insurance industry is aware that stability is desirable by the very nature of its products.Stability is also desirable relative to political expediency and public relations. Rates thatfluctuate do not build consumer confidence. Additionally, and from a practical viewpoint, whencosts rise, rates tend to lag behind experience, which often leads to loss for the underwriter.A balance between responsiveness and stability in the rate structure often helps the insurerrecoup losses in the down leg of a cycle.Rate Structure One other objective also should be mentioned here. The rate structure, or rating plan,should be designed in a way that is simple to operate and explain. In the case of individual- 136

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEinsured ratings, it should be easy for the insured to grasp the operation of the plan and theinteraction of their business affairs with the rating system.section vI—The Process of MANUAL RATEMAKINGHow Rates Are Determined In the process of making rates, the actuary must develop a charge for the individual seekingto be insured that, when combined with the charges for other insured individuals, will createa pool that will pay for any losses sustained by the group, will underwrite the overheadexpenses of the insurer and will provide a reasonable profit while building a reserve for futurecatastrophes. The most problematic ratemaking is that of creating rates that will reflect the varying lossesand quantitative exposures of the insured group. To be fair, it is necessary to set up classesand territories, so that the risks of essentially the same loss exposure will pay equal rates forinsurance coverage. The actuary also wants to develop a system of measurement for a particular risk, orexposure, so that from a quantitative standpoint, the insured will pay a proportional shareof the total cost of being insured. To arrive at this figure, the actuary will take the numberof units of exposure assigned to the insured and multiply these by the appropriate rate forthe classification and territory of the insured. This will determine the amount of the premiumdue from the person seeking coverage. The following is an example:If the annual rate for automobile liability insurance (a unit = one car for one year) is$58 for that classification and that territory, then the premium for one year is $58. The exposure basis varies widely according to the line of insurance. To create equity, theexposure basis should be conveniently ascertainable, not subject to manipulation andreflective of the true scope of risk assumed by the insurer. There are several other problems relative to ratemaking once statistics have beengathered. One is the expertise to interpret the meaning of the statistics that have beencompiled. Another is the ability to determine the credibility of the statistics. Still anotherchallenge is to identify trends, to determine expense loadings and profit margins, and todetermine methods through which the interpretation of the data may be presented. It is important to understand the meaning of the two elements that comprise the manualrate—losses and expenses/profits, and contingencies. The first element is often called the“pure premium” and anticipates the payment of losses agreed upon in the policy. Anothername is the “expected loss ratio.” The expenses, profits and contingencies aspect of themanual rate usually are referred to as the “loading element.” This element is expressed as the expected expense ratio. When added together, theexpected expense ratio and the expected loss ratio should equal 100 percent of the rate. Practically speaking, expense experience is usually more stable than loss experience, andthe expected loss ratio is sometimes determined as the complement to the expense ratio.Therefore, if you assume an expense ratio of 42 percent—which means $.42 of every 137

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEpremium dollar paid will be applied to expense, then 58 percent of the premium dollar canbe made available to pay for losses incurred by the insureds. If experience indicates that more losses and expenses occur, then the rates will be adjustedto reflect this situation. To determine the variations represented by the different types of hazards in the liabilitylines, it is necessary to examine and analyze past experience statistics in minute detail. Theactuary’s major task, however, is to study the experience statistics continually and implementa pricing policy which results in rates that are adequate to cover costs, reasonable for theconsumer and nondiscriminatory. The rate structure formulated by the actuary must also bereflective of the changing conditions and yet reasonably stable. As classifications are redefinedand refined, new rates must be calculated and added into the rating structure.A Review of Classifications To establish classifications, the system should be based on judgment considerations ofcommon loss-producing characteristics. Much of the information used to formulate thesecharacteristics comes from the experience of insurers over a number of years. As thesestatistics are accumulated and analyzed, and as knowledge and understanding grows,classifications are updated and redefined. Classifications that are established serve as a balance between the need to minimize thenumber of classifications and the need to have a sufficient number of classifications to producereasonable equity. Any classification should, based on the data and past experience of the industry, ascertainthe specific pattern of loss development. Because past experience and trends are vehicles fromwhich future predictions may be made, the volume must be great enough to establish a patternfor underlying loss occurrences. The classifications that result should represent a homogenous grouping of risks to achievereasonable equity. If average loss costs are substituted for an individual risk’s own patternof losses, a broad classification will result. This, in turn, will lead to the situation of someinsureds paying too high a premium and some paying a premium that is too low. It is the job of the actuary to use clear terminology to avoid misclassification of certaincharacteristics. Finding a reasonable balance between the various objectives of this procedureregarding expense considerations is the goal. The establishment of classifications in theinsurance industry is an ongoing process, because conditions and situations within our societychange constantly. As more data is gained from these varying experiences, weaknesses areusually found within the classification system and revisions are made. The computerization of the industry has lessened the burden of recordkeeping, and assuch, has led to greater number of classifications. This has allowed the industry to have agreater ability to price its coverages more accurately than ever before.Rating Methods As mentioned earlier, there are two specific approaches to ratemaking for automobiles.These approaches are the “pure premium approach” and the “loss ratio method.” 138

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE Loss Ratio Method The loss ratio method of rate review is the oldest method, historically speaking, and it basesrate revisions on comparisons of actual and expected loss ratios. This method takes its namefrom the fact that the comparison is used in the determination of the statewide rate level and,to the extent that credible data is available, in determining rates for rate groups as well. In the determination of an average for statewide rate level change, the formula is asfollows: The Actual Rate Modification Factor is determined by dividing the Expected Loss Ratio into the Actual Loss Ratio. In this case, the Actual Loss Ratio will be equal to the Experience- Period Statewide Losses and Loss Adjustment Expenses Incurred, divided by Experience- Period Statewide Premiums earned at the present rate level. When one assumes that the actual and expected loss ratios are .70 and .655 respectively, then the Average Rate Modification factor is the result of .70 divided by .655, or 1.069. With this calculation, the actuary has determined that a rate increase of 6.9 percent is indicated, and the product of the average rate modification (1.069) and the old average rate will equal the new average rate (1.069 x $40 = $42.76). In any loss ratio calculation, such as the one carried out above, the objective is to reviewthe experience at the current rate level. Since the experience-period may extend beyond 12months, for the purpose of insuring credibility, rate levels may have been adjusted during theexperience period. The earned premium at the present rate level reflects changes in the actualearned premium. This, in turn, reflects the premium that would have been earned during theentire experience-period, had the current rate been in effect for the entire length of the period. To summarize, use of the loss ratio technique, or a system combining both the loss ratioand pure premium techniques for ratemaking, is determined in large part by the nature ofthe hazard and the nature of the data available. Pure Premium Method The pure premium method of rate review is named for the fact that the statewide rate leveladjustment factor and the territorial and classification relatives are determined through ananalysis of pure premium data. The pure premium method of rate review involves threemethods of presentation—the pure premium rate calculation, the pure premium ratemodification factor, and the loss ratio at present rates rate modification factor. Each of thesemethods of presentation should yield identical results (with few exceptions). In the first presentation—called the pure premium rate calculation—the first step is todetermine the dollar amount for losses per unit of exposure. Then, load this proposed purepremium for expenses and underwriting profit and contingencies. In this presentation, thereare two calculations. In essence, the pure premium is equal to the number of units of exposure divided into thelosses incurred. The second calculation finds the expected expense ratio by dividing theproportion of the premium dollar by underwriting profit and contingencies. The next step isto subtract the expense ratio from 1.00 to determine the expected loss ratio, which is thendivided into the pure premium to find the gross premium rate.139

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE Here are the steps in summary:1) Pure premium = losses incurred divided by the number of units of exposure.2) Expected expense ratio = proportion of premium dollar divided by the underwriting profit and contingencies.3) 1.00 - expense ratio = expected loss ratio.4) Gross premium rate = pure premium divided by the expected loss rate. In calculating the pure premium rate modification factor, the presentation is characterizedby the fact that the rate modification factor is determined by a comparison of the experienceor indicated pure premium with the underlying pure premium in the present rate structure.Assuming that all values have full credibility, the rate modification factor, multiplied by theold rate, equals the new rate. For example, the statewide level for automobile bodily injury insurance could bedetermined by using the following process:1) To calculate the average pure premium rate modification factor, divide the underlying pure premium into the indicated statewide average pure premium.a. In determining the indicated statewide average pure premium, divide the experience- period, statewide exposure units earned into the experience-period statewide losses and loss adjustment expenses incurred. This will provide the costs per car year.b. In determining the underlying pure premium, multiply the percentage statewide average rate by the expected loss ratio.2) The indicated statewide average, then, would be the result of multiplying the present statewide average rate by the rate modification factor. If more than one year of experience is involved, particularly with a large number ofclassifications or territories, the use of pure premiums prior to the final stage of ratedevelopment may create distortions arising out of shifts in the distribution of premium writingsfrom year to year. To avoid this difficulty, base the review upon loss ratios at present rates. Like the pure premium rate modification factor method of presentation, the loss ratio atpresent rates modification factor method of presentation gives the advantage of being easilyunderstood. This is because the concept of loss ratio is more easily understood than the conceptof pure premium. The pure premium rate modification factor method of presentation is used in automobileliability insurance. The process is as follows: Average Statewide Actual Loss and Loss Adjustment Expense Ratio is determined by dividing the Experience-Period Earned Premium at Present Rates into the Experience- Period Statewide Losses and Loss Adjustment Expenses Incurred. It is important to note that the pure premium method of rate review, regardless of themethod of presentation chosen, involves (through analysis) the separating of the variouselements of the rating structure. The actuary may prefer this rate because of the relativelyplentiful rate materials and the frequency of opportunity to check and correct both thematerials and the results.140

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE The advantages of this method are inherent in the available data which permits a detailedanalysis of loss and exposure data and their interaction. This makes it possible for the actuaryto achieve fairly objective standards of rate relativity among the rate groups. The purepremium method of rate review is generally used in every stage of the ratemaking processin liability insurance. However, the method of presentation may vary by line and by each stepwithin a given filing.Rating Statistics As mentioned above, there are two broad classifications of experience data consideredin ratemaking. Assigning losses to a certain risk in a given territory is not difficult, but expenseitems cannot be assigned to individual risks or even territories, except through the use ofassumptions that are, at best, arbitrary. This is not actually a difficulty, since expense itemsdo not usually vary by classification or territory. Loss Statistics The statistics used to analyze losses are recorded according to standardized statistical planssetting forth definitions of terms and detailed coding systems. These plans usually include areport to the central statistical agency of premiums, exposures, losses and the number ofclaims. The agency then tabulates the combined data from a number of insurers. Characteristics of insurance statistics that may give some idea as to the difficulty of theactuary’s job of compiling data are:1) Every insured belongs to a class of insureds. However, every insured differs from every other insured person in that particular class.2) All classes of insureds are capable of multiple subdivisions.3) Nearly all loss statistics are expressed in monetary terms.4) For many kinds of insurance, the class with large amounts subject to loss may be possessed of too few insureds to produce reliable data.5) All results are influenced by human actions.6) Many insureds are classified on the basis of representations, not observed fact. Most statistical data in insurance are based on second- or third-hand information.7) Most statistics for a specific class may be compared with statistics for a related class, or a somewhat related coverage, on what is otherwise the same class.8) Often, insurance data is used before claim information is fully available.9) Insurance classes are different from population classes because of the actions of the insureds in a specific class, the response of the insurer and because people who buy certain insurance coverages are usually different from those who do not buy that kind of insurance. Once this data is made available to the actuaries, it is normally analyzed by calculatingcertain ratios for comparison with data from existing rate schedules. In addition to the lossratio, expense ratio and pure premium, it is also common to calculate claim frequency andaverage claim cost for this category. Ratemaking data is maintained on a variety of bases because of the needs andcharacteristics of each line of insurance. Statistics for the rate review include the reporting141

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEof losses, number of claims, premiums, units of exposure and dates of contract beginning orending. Claim frequency is calculated by dividing the number of claims by the number of units ofexposure. This measures the frequency of occurrence. Average claim cost is calculated bydividing the dollars of losses by the number of claims. This tells the severity of occurrences.The product should be equal to the pure premium. Loss stats are maintained upon a variety of bases, including the calendar-year basis,accident-year basis and policy-year basis. These are usually expressed in running accounts.For example, the calendar-year data, as a rule, reports only paid losses, although some linesalso report incurred losses. Premiums are usually reported on a written basis, rather than anearned basis. However, during periods when business experiences marked increases ordecreases, the use of written premiums distorts experience indications. In accident-year data, losses incurred for all accidents occurring during the year arecompared with calendar-year earned premiums for the year. This statistical basis, which ismost often used for calculating automobile accident year data, is called the “calendar-accidentyear” basis. For liability insurance, the delay in settling claims affects the results of the data sosignificantly that a completely different statistical basis is used. This is called the policy-yearbasis. Through this approach, the total experience from policies written with an effective datein a given year is brought together for analysis. Yet, even by using this method, the recordis not complete because of audits of exposures, and premiums will come in after that. Further,some losses may be adjusted over a several-year period. To take loss trends into account, which include inflationary influences, the calendar-year-record of average claim costs or frequencies is used. This helps determine trends or projectionfactors relative to the policy-year experience. This more responsive calendar-year data, alongwith the estimating earn factor, has resulted in a more user-friendly policy year database.Determining Expense Data Expense data is reported on a calendar-year basis, and premiums on both written andearned basis, and expenses on an incurred basis, are included. The complexities resulting fromexpense data center around the problems usually incurred when allocating expenses. For thisreason, special expense studies are periodically conducted to support the allocation basis andboth expense-constant and graded-expense programs, which are used in liability, compen-sation and other lines of insurance coverage. Without question, the entire rating process is due for state regulation and “watch-dogging.” These laws—sometimes called “model rating laws”—require that rates areadequate, reasonably affordable and not discriminatory.Formalizing Ratemaking Procedures With state regulation impacting nearly all forms of nonlife insurance, there has been a needto maintain consistency from state to state. Note that the uniformity pertains to the procedureand not to the rate. The tendency has been toward more uniformity from year to year acrossthe nation. This uniformity was a natural evolution, arising for a variety of reasons including: 142

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE1) The need to maintain consistency from one state to the next to avoid charges of discrimination.2) Uniform statistical plans and systems of classification.3) The need to simplify presentations because so many filings must be made.4) The need to maintain a system familiar to and approved by state regulatory authorities. Formalization means more than uniform procedures, however. The development ofratemaking formulas and credibility techniques are all based on the need for consistency,stability and responsiveness to the rate structure. Rating bureaus use increasingly quantitativemethods to secure approval of needed rate increases, and these methods impart reasonablyobjective standards to a subjective analysis. Their methods have been made possible by theincreasing mathematical and statistical sophistication in the field of nonlife actuarial science. While the overall purpose of formalization is to facilitate approval of rate filings, it has alsocreated some problems. Some supervisory authorities and some citizens have misconceptionsabout the meaning of “actuarial certainty,” and some pressures have developed againstmodifying statistical indications when they seemed to be contrary to sound underwritingjudgment. In reality, actuarial certainty is actually based on the mathematical theory ofprobabilities, and in that field, a range of answers or a comparison is more usual than adefinitive and single answer. Presently, there can be no permanent and inflexible rating formula from one year to thenext. Flexibility is vital in the determination of overall rate levels, as well as assuring fairnessto insurance consumers. Therefore, the actuary uses “judgment” in every step of ratemaking.To simplify, premiums are not made by a purely mechanical or mathematical method. Instead,the actuary will use judgments and other noninductive ingredients in order to create the finalresult—which will vary according to the quality of the underlying data, the competitivesituation, the economic state of the nation and other factors. Naturally, no system of ratemaking is perfect or permanent. The objective of the actuary,then, is to compile, analyze and then calculate rates in a setting where there is no uniquesolution to the rating problem. SECTION VII—REGULATION OF RATES For more than 75 years, following the Paul vs. Virginia ruling in 1869, it was the acceptedpractice within the insurance industry to place all forms of jurisdiction over insurance withinthe various state governments. On June 4, 1944, the U.S. Supreme Court ruled (in U.S. vs.the South-Eastern Underwriters Association, et al.) that insurance was commerce andtherefore the subject of federal regulation as determined in the commerce clause of theConstitution. Therefore, Public Law 15 (known as the McCarran-Ferguson Act) was soonthereafter passed by Congress. This law allowed Congress to assume control over thedistribution of authority over the insurance industry. In this law, Congress redefined theauthority of the states over the regulation of insurance and developed a plan where regulationwould become a cooperative effort between federal and state governments. According to the McCarran-Ferguson Act, the federal government controls certain areasof the industry, such as rates and unfair practices.143

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE After passage of Public Law 15, regulation of premium rates began. For the most part,laws for this area of regulation were based on laws approved by the National Association ofInsurance Commissioners. The purpose of these regulations on rates was to enforce therequirement that rates be adequate, reasonable and nondiscriminatory. For most lines ofinsurance, the rates were set by rating bureaus. However, the rating bureaus are subject tosupervision by the state’s insurance commissioner.The Legal Basis for Regulation of Rates Some of the earlier methods of insurance regulation were modeled after parallel publicutility statutes derived from the common law. Today, however, the insurance industry is notregarded as a public utility, but instead as one affected with a public interest. Therefore, ifa federal or state legislative body does not act, there is no regulation of insurance. The industry and its “public” quality justifies the use of a state’s police power to regulateautomobile insurance rates. Historically, fire insurance rates were the first to be regulated in the United States. Thefirst device for regulation was the antitrust law, sometimes specifically covering and/orinterpreted to include combinations of insurers for ratemaking. The purpose of this regulationwas to keep rates as low as possible, through enforced competition. The antitrust law failed as a regulatory measure for insurance, because it could be evadedby fire insurance advisory bureau rates. The main result was discrimination in favor of largerrisks. A few of these early laws remain on the statute books in several states, but most of themhave been canceled by laws recognizing or compelling rating bureaus. The second phase of development of rate regulation also originated with fire insurance.This was the antidiscrimination statute. This law prohibited unfair discrimination among risksin the same class. There may be discrimination in rate application, as well as in ratemaking. The purpose of early antidiscrimination laws was to assure fair treatment to individualswithin the same classification, rather than unfair treatment differences between risks indifferent classifications. The antidiscrimination law failed as a rate-regulatory device, because the concept ofinsurance underlying the law was too simple. In fact, it is not possible to know whether risksare of the same class, until general classification criteria are set up. Adding to theantidiscrimination law, the requirement of the filing of classifications, rating rules and ratescorrects this weakness, to some extent. There remains, however, no method of controllingrate level as a whole, over rate differentials and on classification equities. The last qualitative development in casualty rate regulation was the addition of a secondoverall standard to which the entire rate structure must conform. Rates should be reasonable.Adequacy is a minimum standard and above this, rates may go to any height. The standardof reasonableness was developed to protect against the dangers of excessive profits andmonopolies. Today, the regulation of rates in casualty insurance is a relatively new development, withthe first laws passed in 1946. At that time, not more than ten states required either filing or 144

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEpreapproval of automobile insurance rates, and only one state required preapproval ofaccident and health rates. Today, every state, plus the District of Columbia and Puerto Rico,has a casualty rating law. Despite of the U.S. Supreme Court’s approval of the legality of uniform rating laws, thecurrent trend is toward more permissive rating laws. Under the prior approval laws, the commissioner must be on record as approving eachincrease in rates. This approval generally produces disapproval from the voting public.Consequently, politically adept commissioners are reluctant to approve rate increases. As anexample, Louisiana did not grant one increase in automobile liability insurance rates from1958 to 1965. The loss ratios during that period were consistently above permissible lossratios. These ratios, of course, were unpopular with insurers, and some stopped writingautomobile insurance in the state. The modified prior approval law was seen as the bestsolution for both insurers and state officials. It enabled insurers to get the higher rates theyneeded, and commissioners were relieved of pressure from the public, since they would nothave to give formal approval for such rate increases. There has been much controversy over the most effective type of rate regulatory law. Thosefavoring the uniform rate laws rely on the dangers of restrictive underwriting and companyinsolvency due to competition to give credence to their cause. Others point to the poorinsolvency record in Texas, often regarded as the epitome of uniformity, saying that uniformityis more likely to cause, than prevent, insolvency problems. It is well-known among opponentsthat uniformity of rates neither prevented these insolvencies or caused them. The problemin Texas, according to analysts, is derived from past regulation, and in some cases, lack ofhonest regulation, two situations rating laws cannot overcome. Those opposing uniform rate laws say that these laws do not comply with the McCarrenAct (under which state regulation continues to operate). This argument, however, has beendenied by the United States Supreme Court. Finally, there has been some controversy regarding the interpretation of the expensestandards of the rate laws. And while the controversy generated several approaches in severalstates, the insurance industry has been surprisingly accepting toward the concept of uniformaccounting and more accurate expense allocation by function and by line. The argument for federal regulation is a continuing one. The weaknesses of stateregulation most often brought up by those favoring federal regulation are:1) State supervision tends to vary from one state to another. When state standards are different, sometimes inconsistent and often contradictory, the results for the insurance business translate into friction, uncertainty, waste and inequity to policyholders.2) State supervision of a business essentially means, at some point, duplication of supervisory and insurer personnel and organization. Insurers have often objected to the need for excessive administrative costs and the other disadvantages that come from duplication, particularly in making rates, reporting insurer condition, licensing insurers and agents, and policy approval.145

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE3) State supervision means supervision primarily from a local and sometimes a parochial point-of-view—and therefore, incomplete, inadequate and ineffective supervision. The states admitted that unless the federal government comes to their assistance, they can hardly cope with the problem of unauthorized insurers. They have also admitted that there were too many insurers and too many agents, and that a system of licensing under multifold state standards did not seem to provide a solution. One side of the argument emphasizes the admitted weakness of state regulation of anational and international business. The other side of the argument contends that theseweaknesses are being remedied, even though political and social issues are at stake. Theearliest campaign for federal regulation, which began in the 1860s, was based on theargument of simplicity and efficiency. The leaders of the campaign were life insurers and afew insurance commissioners. This campaign ended partly because of public opinion on thereforms that followed the Armstrong investigation, and mostly because of the rapid expansionof insurance volumes over the next decades. Remarkably, there is no significant group for federal regulation, and insurers—bothofficially and individually—are solidly against it.Alternative Plans The insurance industry and others are currently experimenting with alternatives to thetraditional automobile liability insurance system. Several states, in an effort to makeautomobile insurance available to high-risk drivers, have formed joint underwriting associa-tions. Within these associations, a few of the larger insurance companies have been selectedto write the policies and provide services to high-risk drivers. Losses coming from the jointunderwriting associations are then shared by every auto insurer in the state. This method isin contrast with the Automobile Insurance Plans (AIP), where there is no pool and no sharingof losses by other companies. Some states, such as Massachusetts, New Hampshire and the Carolinas, have tried whatis often called “reinsurance facility.” Those drivers that a company believes to be high-riskare put in a reinsurance pool. That company writes the coverage and provides policyholderservices. The premiums, however, are paid into a pool, which pays out losses on high-riskdrivers in the pool. Maryland has also used another method, called “The Maryland Automobile InsuranceFund.” This is a state agency, and the agency writes policies and pays losses on high-riskdrivers. There are no insurance companies involved in this method.What Is an AIP? An Automobile Insurance Plan is a way to make automobile liability insurance availableto those motorists who are unable to purchase insurance in a normal situation. These driversare usually “high-risk” drivers—drivers who have had so many accidents or tickets that theyare viewed as “probable” exposures. Most states have AIPs, so when high-risk drivers are signed up, they will be assigned toa participating insurance firm. 146

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDE When the high-risk driver makes an AIP application to the state, the application is assignedto a specific insurer, who writes the insurance. These risks are usually assigned on aproportional basis. Here is the formula: If an insurer writes 5 percent of the insurance in thestate, he or she will insure 5 percent of the high-risk drivers in the state. There are two types of high-risk drivers who are able to receive coverage from AIPs. Thefirst group is comprised of those whose record of tickets and accidents causes them to berejected for normal coverage. The second group is made up of drivers called “clean risks.”These drivers are considered high risk. This group may include older drivers, drivers with amedical history that may interfere with safe driving practices and drivers who are youngerthan 25 years of age. It is the current concept among insurance companies that young drivers are high-risk,based on their record as a group. In 2005, drivers under age 30 made up more than onethird of all motorists in this country. This same group was involved in over half of the accidentsin the U.S. during that same time period. While higher premiums are generally charged tothis age group, underwriters believe that even with higher premiums, the funds are notenough to cover the losses produced by this group. The AIP in any state will provide high-risk drivers with the limits of coverage required bythe state’s individual financial responsibility law. A majority of the AIPs offer limits higherthan required by state law, have medical payments coverage, and make comprehensive andcollision coverages available. Clean-risk drivers covered by the AIPs are charged regular standard rates. High-riskdrivers normally pay higher (sometimes extremely high) rates. There are some drivers who are not eligible for coverage under AIP. These usually includethose who have been involved in illegal activities or those who have a record of frequentaccidents or ticketed violations. These individuals have few alternatives: either give up driving(which few choose to do), drive without insurance or pay high rates for coverage fromcompanies who can insure such risks. Automobile Insurance Plans were established so that the state would not have to create“in-house” agencies to insure high-risk drivers. AIPs would be a way for private insurers,instead of state governments, to provide coverage for high-risk drivers. But, just as mostpeople would rather insure their property with a private carrier instead of the stategovernment, the question still remains of how to cover high-risk drivers at a reasonable cost.To this point, there is a question as to whether it can be successfully done at all.AUTOMOBILE INSURANCE MADE EASY Texas law requires you to have auto liability insurance, and if you still owe money on yourcar, your lender requires that you also carry collision and comprehensive coverage. Autoinsurance pays for damages, injuries, and other losses specifically covered by your policy.Read your policy carefully to know exactly what it covers. Pay special attention to the exclusionssection, which lists the things your policy doesn’t cover. The front page of your policy is calledthe declarations page. It contains useful information such as the exact name of your insurancecompany, your policy number, and the amount of each of your coverages and deductibles.147

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEProof of Financial Responsibility You must show that you can pay for accidents you cause. Most drivers do this by buyingauto liability insurance. The law requires minimum coverage of $20,000 per injured person,up to a total of $40,000 for everyone hurt in an accident, and $15,000 for property damage.This basic coverage is called 20/40/15 coverage. However, basic coverage might not beenough if you are held liable for an accident. You should consider buying more than the basiclimits. When you buy an auto policy, your insurance company will send you a proof-of-insurance card. You will have to show proof of insurance when you· are asked for it by a law enforcement officer· have an accident· register your car or renew its registration· obtain or renew your driver’s license· get your car inspected.Auto Insurance Coverages The Personal Automobile Policy offers eight types of coverage. The law requires you tohave basic liability coverage. The other coverages are optional, but if you still owe money onyour car, your lender will require you to have collision and comprehensive coverage. Thefollowing describes the eight types of coverage available in the Personal Automobile Policy.Auto insurers may offer alternative policies if approved in advance. Read your policy carefully,as your coverages and policy terms could differ from those listed below.Liability Coverage Pays: Other people’s expenses for accidents caused by drivers covered under your policy,up to your policy’s dollar limits. These may include the other person’s· medical and funeral costs, lost wages, and compensation for pain and suffering· car repair or replacement costs· auto rental while their car is being repaired· punitive damages awarded by a court. Liability insurance also pays attorney fees if you are sued and bail up to $250 if you arearrested. Covers: You, your family members, and other people driving your car with yourpermission, even if they don’t have their own liability insurance and are not named on yourpolicy. You and your family members also are covered when driving someone else’sautomobile - including a rental car - but not a car that you don’t own but have regular accessto, such as a company car.Who qualifies as a family member? Your auto policy covers your spouse, blood relatives, in-laws, adopted children, wards,and foster children living in your home, even if not named on the policy. Family membersattending school away from home and a spouse living elsewhere during a marital separationalso are covered. 148

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDEMedical Payments Coverage Pays: Medical and funeral bills arising from accidents, including those in which the victimwas a pedestrian or a bicyclist. Covers: You, your family members, and passengers in your car, regardless of who causedthe accident.Personal Injury Protection (PIP) Coverage Pays: Same as medical payments coverage, plus 80 percent of lost income and the costof hiring a caregiver for an injured person. Covers: You, your family members, and passengers in your car, regardless of who causedthe accident. An insurance company must offer you $2,500 in PIP, but you can buy more. If you don’twant PIP, you must reject it in writing.Uninsured/Underinsured Motorist (UM/UIM) Coverage Pays: Your expenses from an accident caused by an uninsured motorist or if the otherdriver did not have enough insurance to cover your bills, up to your policy’s dollar limits. Alsopays for accidents caused by a hit-and-run driver if you reported the accident promptly to thepolice.· Bodily injury UM/UIM pays without deductibles for medical bills, lost wages, pain and suffering, disfigurement, and permanent or partial disability.· Property damage UM/UIM pays for auto repairs, a rental car, and damage to items carried in your car. There is an automatic $250 deductible. This means you must pay up to $250 of the repairs yourself. Covers: You, your family members, passengers in your car, and others driving your carwith your permission.Insurers must offer UM/UIM coverage, but you can reject it in writing.Collision (Damage to Your Car) Coverage Pays: The cost of repairing or replacing your car after an accident, regardless of who wasdriving or who was at fault. Payment is limited to your car’s actual cash value, minus yourdeductible. Actual cash value is the market value of a car like yours before it was damaged.Comprehensive (Physical Damage Other than Collision) Coverage Pays: The cost of replacing or repairing your car if it is stolen or damaged by fire, vandalism,hail, or another cause other than collision. Comprehensive coverage also pays for a rentalcar or other temporary transportation if your car is stolen. Your policy won’t pay for an autotheft unless you report it to the police. Payment is limited to your car’s actual cash value, minusyour deductible. 149

Noble Continuing Education All rights reserved. AUTO INSURANCE GUIDETowing and Labor Coverage Pays: Towing charges when your car can’t be driven. Also pays labor charges, such aschanging a tire, at the place where your car broke down.Rental Reimbursement Coverage Pays: A set daily amount for a rental car if your car is stolen or is being repaired becauseof damage covered by your policy.Coverage for Stereo Equipment Your policy won’t pay for tapes, compact discs, cellular phones, citizen band radios, orstereo equipment not permanently installed in your car. However, you can buy endorsementsto your policy that provide separate coverage for these items for an additional premium.Insurance Coverage When Renting a Car Auto rental agencies offer collision damage waivers as well as liability policies. The collisiondamage waiver is not insurance. It is an agreement that the rental company will waive its rightto recover the costs of the damage to the auto from the renter with certain exceptions,regardless of who is at fault. If you have an auto liability policy, your policy already coversdamage to a rental car. Your coverage limit, however, might be less than the value of a rentalcar. If you rent cars often, it might cost less to raise the liability limit on your auto policy ratherthan buying collision damage waivers each time you rent. The Automobile Rental LiabilityPolicy provides liability insurance for renters who do not have a personal auto policy. If you don’t own a car, but borrow or rent cars often, you can buy a non-owner liabilitypolicy. A non-owner policy pays for damages and injuries you cause when driving a borrowedor rented car but not for damage to the auto you are driving.Coverage When Driving in Other States, Canada, and Mexico Your policy automatically meets the financial responsibility requirements of other U.S.states and Canada. Mexico, however, does not recognize U.S. auto liability policies. Mexico does not require drivers to have automobile liability insurance. However, driverscan be held criminally and financially responsible for any auto accidents they cause. If you’rein an accident that results in an injury, police in Mexico may detain you until they determinewho is at fault. You will have to show that you either have insurance recognized by the Mexicangovernment or the financial ability to pay any judgment against you. You can buy Mexican liability insurance from agents who specialize in it. Some U.S.companies provide a free endorsement extending your policy’s coverage to infrequent tripsof up to 10 days and as far as 25 miles into Mexico. You can buy coverage for longer stays,but it is valid only within 25 miles of the border. Telephone books in border towns list insuranceagents that specialize in car insurance for travel in Mexico. Your local agent also might be ableto help you find coverage with a licensed Mexican company. You also may be able to buy a limited Mexico “tourist” endorsement that extends yourliability coverage to pay expenses exceeding those covered by a Mexican liability policy. This 150