Protect Yourself!: Using Insurance, Personal Security and Common Sense to Keep Your Family, Things and Body Safe

Protect Yourself USING INSURANCE, SECURITY TECHNIQUES AND COMMON SENSE TO KEEP YOURSELF, YOUR FAMILY AND YOUR THINGS SAFE

SILVER LAKE PUBLISHING LOS ANGELES, CA
ABERDEEN, WA

Protect Yourself Using Insurance, Security Techniques and Common Sense to Keep Yourself, Your Family and Your Things Safe First edition, second printing 2004 Copyright © 2004 Silver Lake Publishing Silver Lake Publishing 101 West Tenth Street Aberdeen, WA 98520 For a list of other publications or for more information from Silver Lake Publishing, please call 1.360.532.5758. All rights reserved. No part of this book may be reproduced, stored in a retrieval system or transcribed in any form or by any means (electronic, mechanical, photocopy, recording or otherwise) without the prior written permission of Silver Lake Publishing. Library of Congress Catalog Number: Pending Silver Lake Editors Protect Yourself Using Insurance, Security Techniques and Common Sense to Keep Yourself, Your Family and Your Things Safe Includes index. Pages: 327 ISBN: 1-56343-765-1 Printed in the United States of America.

Acknowledgments

Silver Lake Publishing had been planning this book before the September 11, 2001, terrorist attacks on New York City and Washington, D.C. The goal then was to make a book that would help people think about how to protect themselves at the stage before they buy insurance…to think like the risk managers who have become prominent in corporate circles. The 9/11 attacks have only made the need for this book even more evident. Through most of the post-World War II era, Americans drifted into an unusual sense of personal security. They believed that, if they wrote their monthly checks to the insurance company, they would be protected against just about anything. The insurance industry encouraged this impression. Now, most Americans realize that they need to take a more assertive position in regard to their own security. This book offers some help in that effort. The Silver Lake Editors who worked on this book include Kristin Loberg, Steve Son, Megan Thorpe and James Walsh. Christina B. Schlank and Valli K. Thornton also helped with reporting and editing. We’d also like to thank Sander Alvarez, Esq., and Professor David T. Russell of California State University, Northridge, for their input and assistance. Some parts of the chapters dealing with the psychology or risk and disasters are based on material that appears in two earlier Silver Lake Publishing books—True Odds: How Risk Affects Your Ev-

Protect Yourself

eryday Life and It’s a Disaster: The Money and Politics that Follow Earthquakes, Hurricanes and Other Catastrophic Losses. Some of the checklists and other information in this book are based on material that appears in the Silver Lake Publishing books The Insurance Buying Guide and How to Insure Your Income. For more information on those or other Silver Lake Publishing books and publications, please visit our Internet Web site at www.silverlakepub.com or call our customer service line at 1.360.532.5758 during regular business hours, Pacific time.

Introduction INTRODUCTION

Table of Contents

Introduction...................................................................... 1 Part One: Protecting Your Body and Health Chapter 1: Travel and Activities......................................... 5 Chapter 2: Health, Diet and Risk...................................... 23 Chapter 3: Crime Risks..................................................... 39 Chapter 4: Insuring Your Health....................................... 53 Part Two: Protecting Your Family Chapter 5: Life Insurance Protects Many Things................. 73 Chapter 6: Your Family’s Health........................................ 95 Chapter 7: Disasters........................................................... 109 Chapter 8: Risks Posed by Your Family.............................. 127 Part Three: Protecting Your Things Chapter 9: Protecting Your House…and Yourself............... 141 Chapter 10: Renters, Condo Owners and Others................ 161 Chapter 11: Special Situations............................................ 173 Part Four: Protecting Your Finances Chapter 12: Disability Insurance & Social Security.............. 195 Chapter 13: Personal Liability............................................ 219 Chapter 14: Scams and Swindles........................................ 239

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Chapter 15: Inheritance and Tax........................................ 257 Chapter 16: Small Business Risks....................................... 273 Chapter 17: Lending Money............................................... 295 Chapter 18: Bankruptcy As Protection............................... 307 Conclusion.........................................................................319 Index................................................................................. 323

Introduction INTRODUCTION

Introduction

In a world where hijacked jets crash into skyscrapers, anthrax circulates through the mail, money moves at the speed of light and identities are as easy to steal as bicycles, traditional notions of safety and security are as obsolete as dictaphones and three-martini lunches. Yet people cling to obsolete notions. This book aims to open your eyes to how risk works…and to give you tools for minimizing the dangers that threaten your self, your family and your things. These are tools that people need, regardless of how many political fanatics are trying to hijack planes. • In the post-industrial world, people are free agents—in their work lives and their personal lives. •

The odds are increasingly large that you don’t have a corporate employer or big family living under your roof to help you absorb a personal loss.

•

You have to fend for yourself, which means you have to be able to identify, assess and manage risk for yourself.

Americans are used to having large institutions—corporate employers, immigrant communities, the government—manage risk for them. In the wake of the September 2001 terrorist attacks on New York and Washington, D.C., many people talked about wanting to return to the comfort of traditional values. This traditional comfort really means going back to having institutions handling risk for us. But the economic and cultural tides can’t be turned back, however comforting that idea might be. Our world grows more decentral-

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Protect Yourself ized every day; and every person is increasingly responsible for himself. This is an opportunity for great freedom and liberty…but it’s also a potential threat. The threat doesn’t come from terrorists. It comes from our own bad judgments about what’s dangerous and what’s safe. As we recoil from the risks posed by a dangerous world, we surrender our ability to handle…and to manage…circumstances in ways that work for us. Despite great access to data, a shocking number of people have a bad sense of risk. Americans often ignore serious risks (driving recklessly, smoking, handing their life savings to swindlers) and obsess about trivial ones (terrorism, pesticides, breast implants, flesh-eating bacteria).

By underestimating common risks while exaggerating exotic ones, we end up protecting ourselves against the unlikely perils while failing to take precautions against those most likely to do us in. Most media coverage of risk to health and well-being focus on shock and outrage. The media pays attention to issues and situations that frighten—and therefore interest—readers and viewers. The shock-and-outrage approach creates interesting stories but warps people’s sense of risk. As a result, we’re scared—and often scared by the wrong things.

Some experts in risk analysis call this response statistical homicide—the triumph of long odds over common sense. In other words, the risks that kill people and the risks that scare people are different. A smart person doesn’t worry about what’s scary; she worries about what’s deadly. Businesses, government agencies and people who understand risk are able to make smart decisions and respond to news effec2

Introduction tively. To some extent, they even manipulate risk to their advantage. For example: • Insurance companies structure policy premiums to cover their costs and exclude situations they don’t like to face because they understand risk. •

Government agencies propose rules and regulations that assure their own importance because they understand risk.

•

Industry groups and consumer groups publicize friendly research because they understand risk.

And all of this affects you. So you need to understand risk and how various interest parties use it.

What Is Risk Management? Throughout this book, we will deal with real-world examples of risk management. And we’ll drill into the details of how risk management can help you in matters as basic as where you live and what you eat. But what precisely is risk management? It’s a broad term that refers to a variety of analytical tools, including: • risk characterization, •

comparative risk assessment,

•

risk ranking,

•

risk-benefit analysis; and

•

cost-benefit analysis.

You don’t have to be Stephen Hawking to understand the basics of risk management and apply them to your everyday life. Each chapter in this book offers practical examples. Risk management isn’t exact—and, as we’ll see, it can be manipulated by people with agendas. Still, it offers the best way to minimize loss of life and limb. And its basic tenets can help you live a good life.

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Protect Yourself These tenets include: • Relative risk and odds ratios compare the odds that something will happen to a specific group with the odds that the same thing will happen to an entire population. Relative risks are expressed in positive numbers—like 0.8 or 5.3—that mean the specific group is that many times more or less likely than the entire population to experience some event. •

Correlation is not the same as causation. To some people, a newspaper headline that reads “Bottled water linked to healthier babies” might seem to mean that bottled water actually makes kids healthy. But it doesn’t. A more likely explanation: Wealthy parents are more likely to drink bottled water and have healthier kids because they can afford better care.

•

The law of large numbers provides a key connection between theoretical probability and observed results of random processes. It follows from the law of large numbers that if you repeatedly take bad risks—or play unfavorable games—though you’re uncertain of the results of any given outcome, in the long run you’ll be a loser.

It may be inevitable that a book about protecting yourself in a dangerous world ends up talking a lot about insurance. But this book isn’t intended to be a buyers guide to life, home and auto coverage (we’ve already done that book). The reason that we talk a lot about insurance here is to show you how insurance companies think about and handle risks. In some cases, you may want to buy their products to protect yourself; in others, it may make more sense to copy their behavior. It usually makes senses to model your behavior after people or companies that have a lot of experience in their fields. This book will show you how these companies and people deal with risk; this should give you the information you need to protect yourself. 4

Chapter 1: Travel and Activities CHAPTER

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Travel and Activities

If you’re thinking about the best ways to protect yourself from harm or loss, the first thing to consider is that there are two risk factors you can control: the things you do and the places you go. Other risk factors—your age, the value of your possessions, the actions of other people—are either long-term factors that take years to change or are entirely beyond your control. This chapter explains the basic concepts of risk and how your travel habits, the things you do, the places you go and how you get there impact your well-being. The ways people perceive risk also affects the chance of a loss occurring as much as hard numbers can. For example, a one in a million risk of mortality is so small it can barely be measured. However, it can have a big impact. After the terrorist attacks of September 2001, for example, many Americans changed their travel plans. In reality, most of these people could have done a lot more to enhance their life expectancies by losing 10 pounds than they could by cancelling a trip to Europe. But they simply perceived the risk as being high, which in turn, affected the chance of a loss resulting from travel. Conventional risk estimates downplay the kinds of catastrophic risks that fill the post-9/11 nightmares of some Americans. Disasters cased by terrorist attacks, radioactive waste spills or genetic technology run amok occur rarely. Most of the problems people face have to do with common risk. The chances of suffering some ill effect are tied more to simple issues like the amount of alcohol you drink, how you drive a vehicle and what you do for recreation.

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Travel Risk Most people think of travel risk in terms of the odds that their plane will crash, their train will derail or their boat will sink. This reflects the general trend in popular risk assessment to telescope risk perception, or focus on a few dramatic losses rather than many mundane losses. The many mundane losses often pose a greater risk to the average person than the few dramatic ones. Many people stress over being victims of terrorists or dying in a plane crash more than drowning in their pools or burning in a simple house fire. You’re more likely to suffer a loss close to home—or even at home—than you are to fall from the sky the next time you go home for the holidays.

Driving or riding in a privately-owned car is one of the most dangerous things that most ordinary Americans do on a regular basis. The statistics tell the story: • In 2000, 37,409 Americans died from traffic injuries. (This is the equivalent of a jetliner going down every day.) •

About 45 percent of those fatalities—16,653 deaths—involved alcohol or controlled substances.

•

According to the National Highway Traffic Safety Administration (NHTSA), on an 800-mile automobile trip your chances of being killed in an accident in any given year are about one in 100,000.

And, placed in the context of daily driving, auto-related risks become even more real: • If you drive 10,000 miles a year, the annual odds of being killed in an accident that year are about one in 4,000. •

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Drive 10,000 miles every year, and the odds of dying in an accident over the course of your lifetime are one in 60.

Chapter 1: Travel and Activities

When…and How…Are Odds Relevant? So, is it safe to get in your car and drive to work? Groups like the NHTSA rightly say that it’s safer than ever. But what does that mean? This gets back to an old conflict. Scientists talk about group risk, while most people want to know about individual risk. Statistics for automobile fatalities may show a lifetime risk of one death in a car wreck for each 100 Americans—but this doesn’t mean that a particular person’s chances of dying in a car accident are one in 100. Why? Numerous variables affect a particular risk—including: •

driving skills,

•

location,

•

time spent on the road, and

•

driving schedule.

Efforts taken to control behavioral risk factors have started— slowly—to pay off. The NHTSA estimates suggest that through the 1990s around 5,000 lives were saved each year by safety-belts, 300 by child seats, 600 by motorcycle helmets and 800 by stricter limits on alcohol use. Essentially, the issue of safety in travel focuses on relative risks— the odds of a mishap or accident in one mode of travel (say, a plane crash) versus another (say, an auto accident). This is the context in which the fear of terrorist attacks pales in comparison to the risks of getting in a crash with a drunk driver on a Friday night.

Demographics Travel risks—and especially car-related risks—have a strong connection to the demographics of the people involved. In other words, who and where you are when you get in a car has a big impact on the risk that something bad will happen. For example, people in low income areas have a greater risk of car accidents. Perhaps because of

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Protect Yourself poorer roads, older cars, different driving practices, differences in alcohol use, lower seat-belt use or inadequate emergency and medical care, motor vehicle death rates generally go down as the income in a given area goes up. Driving experience is another key factor in controlling driving risks. Adolescents and young adults are at the highest risk for both fatal and nonfatal injuries related to motor vehicles. Injuries from motor vehicle crashes are the leading cause of death for Americans ages six to 33, according to the NHTSA. Motor vehicle deaths account for more than 40 percent of all mortality among those in their late teens.

A 2002 study from the Virginia-based Insurance Institute for Highway Safety—based on 1,078 fatal crashes—isolated 16-year-olds from other teens, and found that 16-year-olds are: • involved in one fatal crash for every 6 million miles they drive, more than twice the accident frequency of other teens and 10 times the average for all drivers; •

involved in more single-car crashes, which account for 44 percent of fatal crashes involving 16-year-old drivers; and

•

more likely to be speeding than other drivers. One in three 16-year-old drivers in fatal crashes were speeding.

Should you be concerned about your neighbor’s 16-year-old who’s about to take his driver’s test? Yes. But the concerns don’t end with your neighbor’s 16-year-old. If that neighbor’s 75-year-old father is still driving, you need to be concerned about him, too. The rate of fatal accidents per mile driven is higher for drivers over 75 than it is for teenagers. Some auto safety experts assign the high per-mile-driven fatality rate to the number of older drivers taking some form of prescription medication that may dull reflexes.

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Chapter 1: Travel and Activities Seniors die even as a result of low-speed side crashes; at speeds under 33 m.p.h., 86 percent of occupants over 60 died, compared with almost no one under 40, according to a study published by the Society for Automotive Engineers. Nationwide, more than 40 percent of fatal crashes involving drivers over age 80 are side-impact crashes—which auto engineers consider an accident most often caused by inattentiveness. This number is more than double the percentage for drivers between 25 and 50. The risk posed by older drivers will be on the rise in the United States in the future. The number of licensed drivers over the age of 75 is expected to double by 2020.

But teens and seniors out on the road aren’t the only ones who raise your risk. Youngsters, oldsters, aggressive drivers, drunks and fatigued people all raise your risk of being in accident when you’re on the road. And it doesn’t stop there. Drivers who use cell phones, PDAs or fancy computerized navigation systems also pose a risk to your safety. In driving—unlike other modes of travel—other drivers’ behavior can have a direct and mortal impact on you.

Vehicle Safety Ratings Another key factor that influences your chances of being killed behind the wheel is the vehicle itself. Different kinds of vehicle pose different levels of risk to drivers—and people in other cars. If you drive a safer car, you can improve your odds of long-term survival. Of course, determining which car models are safe—and which aren’t—is a hotly contested business. The Insurance Institute for Highway Safety (IIHS), which is funded by insurance companies, issues vehicle rankings based on injury and damage claims. After studying fatalities involving 168 vehicles over a five-year period, the Institute reported that 27 people died in accidents involving the Chevrolet Corvette but no one died in an accident 9

Protect Yourself involving the Volvo 240 sedan. But were these differences due to the cars? Or their drivers? Several groups challenged the breadth and depth of the Institute’s studies—arguing that it didn’t mean much to say a fiberglass sports car was more dangerous than a steel sedan. Put another way, the Insurance Institute ratings based on insurance claims couldn’t distinguish adequately between vehicles that are safe by design and vehicles that tend to attract safe drivers (a distinction relevant to auto buyers but not necessarily to insurance underwriters). Minivans, for example, always show up well in insurance loss statistics, although they handle less well than passenger cars and, with some exceptions, perform poorly in crash tests. But minivans are more likely to be driven by conservative drivers, including parents transporting children.

NHTSA crash tests performed on new cars sold in the U.S. use a key measurement called the “head injury criteria.” It’s an index that includes the severity and duration of crash forces on a person’s head. A score of 1,000 or more indicates the likelihood of severe injury or death; a score lower than 300 suggests minimal chance of fatal injury. The NHTSA tests involve crashing cars into a fixed barrier at 35 m.p.h. (Although some auto safety specialists argue that this is a much higher speed than the average crash in the real world.) Auto safety experts reluctantly conclude that the NHTSA’s test is the best way to judge the safety of a car. It’s the only objective standard that submits all models to the same test. You can obtain information pertaining to everything from side crash test results, risk of roll over and probability of femur fracture to probability of head, chest or severe thoracic injury from the NHTSA’s Web site at www.nhtsa.dot.gov.

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Chapter 1: Travel and Activities

Drunk Driving Another major risk factor that boosts your odds of being killed in a car wreck is drunk driving. Alcohol is responsible for a large percentage of traffic fatalities. The number of licensed drivers arrested each year for drunk driving are at a greater risk of being involved in a fatal crash. In fact, drivers arrested for driving while intoxicated (DWI) are “at a substantially greater risk” of dying in an accident that involves alcohol, according to the Center for Disease Control and Prevention’s Morbidity and Mortality Weekly Report. That risk increases in tandem with the number of DWI arrests, and drivers convicted of DWI are at greater risk of being involved in a fatal crash, “regardless of whether they are killed,” the journal said. Less publicized, however, is the fact that alcohol remains a significant risk factor in auto and other accidents when consumed in amounts below legal measures of intoxication. Even small amounts interfere with the cognitive and physical skills needed to drive an automobile.

The best that anyone can do when it comes to managing the risks posed by drunk driving is: • avoiding driving after having even a few drinks; •

don’t get into a car with someone who’s been drinking any alcohol;

•

use extra caution when driving on weekend nights or during holidays;

•

steer away from cars that are weaving, changing speed or using their brakes a lot; and

•

don’t rush into intersections (where drunk drivers often make their most fatal mistakes).

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Fatigue Another risk factor that doesn’t get enough attention is fatigue. A study of the “Impact of Fatigue on Driving,” conducted by New York State task force, found from a series of statewide surveys that of 1,000 drivers surveyed, 55 percent “have driven drowsy within the past year,” 3 percent had fallen asleep at the wheel and crashed and 23 percent had fallen asleep but avoided a crash. Most sleep-related accidents occur between midnight and 6 A.M. or at midday. And, more than 20 percent of the 1.3 million singlevehicle crashes each year occur between midnight and 6 A.M., according to federal figures. Things you can do to avoid risks related to fatigued drivers: • don’t drive when you’re tired, just as you shouldn’t when you’ve been drinking; •

take breaks at least every two hours during long drives;

•

eat and drink (nonalcoholic beverages) steadily while on long driving trips; and

•

avoid peak fatigue hours, if possible.

Fatigue and sleep deprivation have a cumulative effect. If you slept eight hours last night, but only two hours the night before, you shouldn’t get behind the wheel of a car for a long drive.

Auto Insurance: The Best Way to Protect Yourself Because private autos are the main mode of travel that Americans use, auto insurance is the main form of financial protection that most Americans buy. In fact, it’s the most common form of insurance sold in North America. Knowing the basic mechanics of how policies work, allows you to get the right coverage for the kind of car you drive. Of course, auto

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Chapter 1: Travel and Activities insurance can’t prevent accidents from happening. Its main purpose is to offset some of the financial loss that results from an accident. The key to buying the right kind of auto insurance and using it cost-effectively is understanding how the coverage works. So, let’s consider the various kinds of auto insurance coverage according to how important each one is.

Necessary Coverage •

Bodily Injury Liability. If you injure someone in a car accident, this coverage pays medical and rehabilitation expenses. In most states, you must buy coverage of at least $15,000/$30,000 (the $15,000 pays for injuries to one person; the $30,000 is the total available per accident).

•

Property Damage Liability. If you damage someone’s property in an accident for which you are at fault, this coverage pays to fix it. In most states, you must buy $5,000 worth of coverage. Many standard policies include a higher limit—often $25,000.

•

Medical Benefits. This coverage pays medical bills for you and others covered on your policy, no matter who was at fault. Coverage also applies to you and your family members while riding in other vehicles. These payments are offset against any payments made to an injured person under liability or other sections of a standard auto policy.

Almost Necessary Coverage •

Collision. This coverage pays to repair any damage to your car in an accident. Like medical benefits, it’s no-fault coverage. If you’re financing a car purchase, most lenders require you to buy collision coverage.

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Comprehensive. This coverage pays for theft or damage to your car resulting from hazards including fire, flood,

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Protect Yourself vandalism or roadkill. Again, most lenders require you to buy this coverage if you’re financing your car. •

Uninsured/Underinsured Motorist. This coverage pays for losses and damages you suffer, if you’re hit by a person who doesn’t have any or enough insurance. The details of this coverage vary from state to state, so read and understand your policy’s specific provisions.

Optional Coverage •

Extraordinary Medical Benefits. This coverage pays when your medical and rehabilitation expenses exceed the limits in your policy.

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Income Loss. This coverage pays a prearranged percentage of your take-home pay when injuries from an accident keep you from working. Payments are made without regard to whether you have other disability insurance.

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Rental Car Replacement. This coverage pays a set amount per day for a rental car if your car is being repaired because of an accident.

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Towing and Labor Costs. This coverage pays for road service, such as jump-starting your car or changing a flat tire, and towing, which can be used anytime your car breaks down, not just when it’s involved in an accident.

Rental Coverage When you rent a car, you’ll usually be offered a collision damage waiver or CDW. (Some rental companies use the term loss damage waiver or LDW. The coverage is the same.) This waiver releases you from responsibility for damage to the rental car, provided you comply with the rental contract terms. If you decline the coverage and have an accident, you may be held responsible for the entire value of the car.

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Chapter 1: Travel and Activities CDW is usually overpriced, adding about $11 to $15 a day to the cost of renting a car. In Illinois and New York—two states where rental companies have to bundle collision coverage into the advertised rental rate—average rates are only about $2.50 a day higher than in the rest of the country. That gives you an idea of what the coverage really costs. Before you turn down rental coverage, however, know what kind of coverage you already have. Your own auto policy should cover liability exposures for you and your passengers in a rented car; but check your collision coverage carefully. Decline the CDW if your own policy includes collision insurance for non-owned vehicles—and if a nonowned vehicle includes rentals. Coverage may also depend on whether you use the car for business or pleasure or whether your car at home is being used in your absence. Some policies limit the number of rental days covered each year. Others apply deductibles and lower liability limits to collision coverage—and therefore rental car coverage.

CDW isn’t the only additional insurance rental companies try to sell you. Other kinds include: • Supplemental Liability Insurance. This protects the renter against property-damage or personal-injury claims beyond the basic limits provided in the rental agreement. •

Personal-Effects Coverage. This provides limited reimbursement to the renter for loss of baggage and other personal property during the rental period.

•

Personal Accident Insurance. This provides limited accidental-death benefits for the renter and—in some cases— passengers.

In some states, major car rental companies are shifting primary liability responsibility to renters who have personal insurance. 15

Protect Yourself If you need extra accident insurance, you need it full time—not just when you’re in a rental. Increase the coverage offered by your main auto insurance policy.

Flying vs. Driving All this talk about auto insurance and the risks related to driving may make you think it’s the most dangerous way to travel. Well…it is more dangerous than most people realize. One classic misperception about travel is that driving a car is safer than flying in an airplane. In the months after the September 2001 attacks—and particularly during the following summer—many Americans chose to drive to vacation destinations. But, on mediumlength trips, commercial flights—even factoring in the attacks of September 2001—are as safe as driving a car. Over longer distances, commercial flights are safer. Some additional statistics: • For a trip of more than 1,000 miles, flying on a commercial airplane is generally safer than driving a car. •

Since most plane accidents occur on takeoff or landing, the shorter the trip, the greater the risk per mile.

•

On a trip of up to 1,000 miles, you’re probably as safe in your car as in a jetliner.

•

On a per-mile-travelled basis, U.S. commercial airlines are the world’s safest form of mass transportation.

•

Depending on where you live, the drive home from the airport may be more dangerous than the commercial flight.

The terrorist attacks of September 2001 did cause an upward spike in the total number of deaths caused by airline crashes. But not that many people die each year in plane crashes. When you’re dealing with small base numbers, it doesn’t take much to increase odds ratios sharply. Any risk assessment you do is going to be volatile. 16

Chapter 1: Travel and Activities Nearly 600 people died in the four jet crashes related to the September 2001 terrorist attacks. By comparison, an extra 100,000 Americans would have to die in car wrecks to have the same impact on auto safety numbers.

What Do Flying Risks Mean? Nervous airline passengers don’t understand that all travel is risky and safety is a matter of relative risk. In other words, an activity is usually considered safe only as contrasted with some other activity. Absolute standards of safety are hard to establish…and are often more arbitrary than most people realize. A few basic measures can improve your odds of surviving an airplane flight. These include: • stick with commercial airlines; •

make your trips long ones;

•

don’t fly in bad weather;

•

avoid high-traffic or high-risk airports; and

•

pay attention to instructions you get on the plane.

Of course, none of these guarantees you a perfectly safe flight; and it’s hard to follow a set of “basic measures” when you plan a trip and have to rely on others to get you there. When you have to get from Point A to Point B, you rarely set out to do so with a set of precautionary guidelines. You simply try to get to point B the quickest and cheapest easiest way you can. Think about driving to work; if you have to be there by 9 A.M., you drive during the riskiest time of the day—when everyone else is commuting to work. So, flying on commercial airlines—and even on commuter airlines—is safer than most people think. And it’s safer in many cases than driving the same distance. But how do you protect yourself against even this relatively reasonable risk? Life insurance. 17

Protect Yourself When losses occur in airline travel, they tend to be catastrophic. Even if the loss results from pilot error or mechanical failure (instead of terrorist attack), the end is usually the same: few, if any, survive. In these cases, health insurance or disability insurance—both worthwhile concerns when it comes to car risks—aren’t important. Life insurance can serve many purposes; the simplest is to replace the earning power that you offer your family or other interested parties (business partners, etc.). In this context, life insurance protects against precisely the sort of catastrophic loss that an airplane wreck poses.

There are many formulas for calculating how much life insurance a person needs. But, from the income-replacement perspective, there are two calculations that work for most people: • replace five years of the insured person’s earned income; or •

pay off mortgages, car loans, consumer debt and other debts related to daily living.

Basic term life insurance will usually cover these needs. Term is the least expensive form of life insurance in most situations. Some people are tempted to increase their life insurance coverage or buy special insurance if they know they are going to be flying a lot—for business or pleasure—during a given period of time. However, travel life insurance (often marketed through airport kiosks or some on-line travel services) is usually not a very good bargain. It’s usually smarter to increase the basic term life insurance you carry than to buy the short-term policies. If you need more life insurance, you probably need it all the time.

Travel life insurance is different than trip insurance (sometimes called “travel insurance”) offered by some travel agents. Trip insur18

Chapter 1: Travel and Activities ance protects the cost of your travel and accommodations against illness, disability, mechanical problems or other interferences. If you are mugged in a foreign country while on vacation, travel insurance will help cover your loss.

Boats and Other Nautical Perils We have considered the risks of driving and flying—and some ways to protect yourself from each. Next, we’ll consider the other main mode of travel: boating. Boating is different from driving and flying in that most people who sail look at the activity as recreation in its own right. From a risk perspective, this is an important distinction. It means that boating is even more dangerous than driving and flying.

According to BOAT/U.S., the largest boat owners association in the United States, the national average for nautical mortality is 3.9 deaths a year per 100,000 boats registered. While this statistic is useful for tracking the relative safety of boating over several years, it tells you little about the odds of dying during a given boat trip. U.S. Coast Guard statistics serve that purpose better. They indicate more than 75 million Americans go boating each year on more than 20 million pleasure crafts. On average, almost 1,000 fatalities result each year from 7,000 accidents involving 9,000 boats. So, generally, your odds of dying when you’re out on a boat are something like one in 75,000. This is, plainly, far more dangerous than driving or flying. Of course, several factors raise or lower nautical risks. The Coast Guard reports that most boating accidents involve three situations: • capsizing, •

someone falling overboard, or

•

collision.

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Protect Yourself The majority of boating deaths are caused by drowning—which can result from any of the three most common accident situations. This explains the fact that most fatal accidents involve a single vessel. Whatever the situation, smaller boats get into more accidents than large ones do. Seven out of 10 fatalities occur on boats less than 21 feet long.

The simplest nautical risk factors relate to the number of boats on the water at a given time. These factors include: • Weather. Most accidents occur in calm waters with light winds and good visibility. •

Calendar. The calendar has something to do with odds of a boating accident. Half of all boating deaths occur in warm weather months: May, June and July.

•

Traffic and Location. Generally, places with more boats have more accidents and fatalities per accident than others.

Another familiar problem recurs in boating fatality rates: intoxicated drivers. According to the U.S. Coast Guard, alcohol is involved in roughly 50 percent of the boating fatalities nationwide. The reasons for this are simple: • Alcohol consumption remains an accepted social aspect of recreational boating. •

Drinking at sea can result in delayed reaction time in sudden, high-demand situations—such as navigating through stormy weather, rough currents or boat-clogged waterways.

•

Drinking passengers run a greater risk of losing their balance and falling overboard.

Of course, responsible boating involves a great deal more than simply avoiding alcohol. Since the Federal Boating Safety Act of 1971

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Chapter 1: Travel and Activities was instituted, annual boating fatalities have fallen from 20 deaths per 100,000 boats to less than four per 100,000. Life jackets can make a big difference. According to BOAT/ U.S., 80 percent of the people who die in boating accidents each year aren’t wearing life jackets. But an explosion in watercraft numbers and variety during the 1980s and 1990s means that boats are moving at more varied speeds, over more congested waters and in places they could not go before. Some recreational activities are inherently unsafe. Frequently that’s part of their appeal. And while it’s true that they can be made safer by education or regulation, risks can’t ever be completely eliminated.

In the mid-1990s, so-called “squirt boats” came onto the boating scene. Almost all of the boats are propelled by a jet pump that forces water out the back through a nozzle; because there is no external propeller, they can operate in water as shallow as five inches. These smaller craft are usually not regulated by rules laid down for other personal watercraft. In addition, lack of required on-water certification or licensing—and the lack of knowledge or experience—often leads to bad decisions. So, boating is considerably more dangerous than flying or driving. But you can improve your odds by taking a handful of precautions, including the following: • avoid crowds; •

keep to boats at least 21 feet long;

•

make sure there’s a working radio (or, at least, a working cell phone) in any boat you use;

•

don’t drink or ride with someone who drinks at sea;

•

take a Coast Guard-approved boating course;

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Protect Yourself •

keep away from squirt boats; and

•

wear a life jacket.

Conclusion Does this mean you should walk everywhere? Of course not. It would be too time consuming. And there are risks involved in being a pedestrian, too, including: L.A. drivers, unruly bicyclists, street athletes such as rollerbladers, skateboarders and unicyclists, faulty traffic signals, kidnappers, rabid dogs, psychotic winos and trespasser-wary neighbors. More importantly, is there a safe way to get from one place to another? Not entirely. One key to assessing relative risks is not giving in to the sensationalized biases of media coverage. This sensationalism reflects the instinctual biases most people have about travel. Driving is more dangerous than most people realize. People feel in charge of their cars, so they think driving is safe. They feel impotent in the coach section of a 737, so they think flying is dangerous. What these people don’t acknowledge is that a highway or the Inland Waterway offers little protection from all the bad—or drunk— operators cluttering scene…or that the pilot flying a 737 is usually pretty good at what he or she does. Unless he throws back a few with his copilot before they show up for a shift…

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Chapter 2: Health, Diet and Risk CHAPTER

2

Health, Diet and Risk

Americans, like most people in the developed world, worry a lot about their diets. While dieting to lose weight may still be more common among middle class women than other groups, just about everyone thinks in some way about what he or she eats. The appeal of fad diets cuts across just about all demographic categories. The popularity of organic foods has spread to such a degree that even mainstream grocery stores are stocking organic products. But the basic health effects of diet are simple. In 1992, the United States Department of Agriculture (USDA) and the United States Department of Health and Human Services (DHHS) devised a Food Guide Pyramid that specifies the number of servings of each type of food Americans should ingest each day, including: 1) bread, cereal, rice and pasta; 2) vegetables; 3) fruit; 4) meat, poultry, fish, dried beans, eggs and nuts; 5) milk, yogurt and cheese; and 6) fats and sugars. (See the following page for a graphic of the USDA’s Food Guide Pyramid.) The USDA suggests that each food group provides most—not all—of the nutrients a person needs each day to remain in good health.

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Protect Yourself

But there has been much debate since the USDA came out with its dietary guidelines about whether or not its serving allotments are the best for overall health. For instance, some argue that the six to 11 servings of bread, rice and pasta a day is too high. Others suggest that the Food Guide Pyramid’s guidelines for types and amounts of food are not right for people of different ages and sexes. In this chapter, we’ll consider the various ways that foods are analyzed for safety and nutritional value. We’ll also consider how different groups—pregnant women, people with particular health conditions, the elderly— respond to these analyses. Finally, we’ll make some conclusions about what an average, smart person can do to improve his or her health.

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Chapter 2: Health, Diet and Risk

Some Background on Dieting People diet for two basic reasons: To avoid dangerous foods and to lose weight. But what is a dangerous food? Determining what constitutes a dangerous food can be difficult. Poison can be defined as too much of anything. But how much is too much? Is there a threshold at which small amounts of foods that cause cancer or heart disease are not harmful? In most cases, no one can answer these questions with certainty.

Dietary risks, like others, are usually described in the odds of causing a fatal illness or in the average number of days or years by which they shorten your life. Consider these fluky factoids: • Drinking milk every other day adds a one in 7,200 chance of getting liver cancer from a mold that produces aflatoxin— a naturally-occurring carcinogen. •

Three pats of butter on a slice of toast takes a half hour off your life.

•

A steak dinner, complete with a snifter of brandy afterward, will cut 20 minutes off your life (though this sounds like a bargain compared to the three pats of butter).

All of these statistics are of questionable value, though. They’re usually based on one of two methods—both of which have flaws. First, some of these numbers are based on aggressive extrapolation from standard dietary impact charts, which lose their effectiveness the farther they move from empirical numbers. In the case of the three pats of butter on toast, that figure is taken from an American Heart Association statistic on daily fat intake over a lifetime. To extrapolate such a small number out of a lifetime measure makes it meaningless. Furthermore, cancer statistics are often based on animal tests, which have an important flaw: animal experiments necessarily involve large

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Protect Yourself doses. Thus, to pinpoint a risk of one in a million, you’d have to perform a million tests, involving as many as 1,000 animals each. The cost would be prohibitive. The best scientists can do is experiment with large doses, adjust for the weight and metabolic activity of the animals compared with humans…and project the possible results of small doses on people. A lot of guesswork is involved. Take, for example, the synthetic sweeteners Nutra-Sweet and Equal. Large doses of those cause cancer in mice—but you’d have to consume an unrealistic amount to be at the same risk at those mice. An yet, you are forewarned on the label “May cause cancer.” Of course, not everyone diets to avoid cancer or strokes. Many people diet because they want to lose weight. This involves one main risk: That you’ll regain whatever weight you lose. Begin a denial-based diet and you’ll probably lose weight. For how long is an entirely different question. Losing weight at the rate of two to three pounds per week produces the best long-range effects. Many experts say this means making realistic changes to your life-style in the way you eat and how much you exercise.

Diet and Nutrition…and Super-Nutrition Through the early 1990s, an intense debate took place in scientific circles over whether some nutrients, such as Vitamins C & E, calcium, coenzyme Q10 and Zinc—taken at levels well above the federal government’s recommended daily allowance (RDA)—provide benefits beyond their traditionally defined “essential functions.” The use of foods for medical purposes dates back many centuries. But advocates of super-nutrition base their position on modern science—specifically, anecdotal evidence that certain nutrients, taken in huge doses, can reverse things like early-stage cancer tumors.

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Chapter 2: Health, Diet and Risk Scientists argue that cancer is not an on-off switch. It’s more like a gradual deterioration with built-in stops. These stops are biological mechanisms: DNA repairs, cell-to-cell communications and other mechanisms in the body that check the spread of cancer. The super-nutrition theory holds that you can “feed” these stops so that the body can participate more effectively in the recovery and illness protection process. Nutrition and exercise ought to be protective factors. Unfortunately, for most, they are not. On any given day, only 18 percent of Americans eat cruciferous vegetables (i.e., broccoli, radishes, watercress and brussels sprouts) and only 16 percent eat whole grains. The rest of us are eating junk food. The relationship between nutrition and immune function has been recognized for many years. Malnutrition can impair the human body’s defense mechanisms, decreasing resistance to infection. While the immune function has been associated with AIDS research, it also plays an important role in the health status of people, including the elderly, who have high incidences of infectious disease. The changes that occur with aging are partly due to changes in nutritional status. By manipulating the diet appropriately, you may able to reverse or delay these changes.

For example, vitamin E is one of the few nutrients that has been shown to enhance immune functions and blood flow when taken in doses above the RDA. Vitamin E may help prevent coronary heart disease; as an antioxidant, it also prevents the oxidation of LDL (lowdensity lipoprotein) cholesterol and the formation of blood clots. Tests done on animals receiving various doses of vitamin E have indicated increased resistance to infectious diseases. So, vitamin E may help reduce the risk of infectious disease in the elderly—and anyone else for that matter—when taken in high doses.

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Protect Yourself Dieting does the most good by what it prevents. Being overweight increases your risk of diabetes, cardiovascular problems and several kinds of cancer. So, it’s good not to be overweight.

So, losing weight and lowering your cholesterol will not make you healthy. These things will simply make you less unhealthy. As we mentioned in the previous chapter, risk is relative. Being lean and in-shape doesn’t make you healthy per se, but it makes you healthier as compared to if you were overweight and lethargic.

Watch Out for Fat and Salt The U.S. Surgeon General’s Office has noted that in the 2000s, some 61 percent of Americans are overweight—up from 46 percent in the 1970s. More than ever, Americans enjoy cheap and convenient food…from McDonalds, KFC and Pizza Hut. But along with this convenience come empty calories, refined sugars and artery-clogging fats. This isn’t good. As a society—and as individuals—Americans need to reverse that trend. Why? Because epidemic obesity will lead to a health crisis as serious as AIDS, tuberculosis or anything else we’ve experienced. Obesity leads to diabetes, heart disease and other health problems. It causes or contributes to 300,000 deaths in America each year…and costs $117 billion in health care. And both of those numbers are going up. Following current trends, obesity will overpass smoking as the number one preventable cause of death in America by 2020. People are responding. One-quarter of all men and almost half of all women are trying to lose weight, according to the American Journal of Public Health. And Americans spent upwards of $33 billion a year on weight-control products and services. But other, troubling signs remain. In the 1990s, the Department of Agriculture and the Department of Health and Human Services boosted their guidelines for what a person’s normal weight should

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Chapter 2: Health, Diet and Risk be. The feds said that a “normal” 5-foot-6-inch woman under 34 could weigh 118 to 155 pounds; over 35, she could weigh 130 to 167. This upward adjustment is a dietary version of the phenomenon economists call bracket creep (when inflation raises the incomes of middleclass people into upper-class tax brackets). In this case, overweight people are reclassified as not overweight. Reclassifying guidelines to include heavier people in a “normal” category may make people feel better about themselves, but it hints at long-term trouble. Overweight people are two to six times more likely to develop hypertension; when they lose weight, there is a notable reduction in this risk (and others).

American Heart Association dietary guidelines emphasize reducing total fat (not just cholesterol) and keeping a balanced diet. In 1995, the AHA reduced its recommendation of no more than 30 percent of fat in the daily diet to no more than 20 to 25 percent. Less than 10 percent of the fat in the daily diet should come from saturated-fat (animal) sources. AHA dietitians insist that simple adjustments to the average balanced diet can achieve these goals. Lowering fat intake can also reduce your risk of getting colon cancer. Fat is a factor that promotes colon cancer; the problem occurs when most calories are derived from fat. Colon cancer is the second leading cause of cancer deaths in men in America (lung cancer is first). The risk of colon cancer increases significantly over the age of 50. And then there’s salt. Research indicates that reducing sodium intake actually can prevent hypertension from developing. About 80 percent of consumed sodium comes from processed foods; 20 percent is added during preparation or at the table. With fat and salt parameters set, you have considerable flexibility in choosing a healthy diet. But a few points are worth remembering: • Potassium-rich foods, such as bananas, may play a role in the prevention of high blood pressure. The National Acad-

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Protect Yourself emy of Sciences estimates 1,600 milligrams a day to be a minimum goal. One banana provides about 450 milligrams of potassium. Other potassium-rich foods are cantaloupe, dairy products, orange juice, beans, broccoli and potatoes; •

You can still drink coffee in the morning—even with caffeine—without worrying about hypertension, as long as you drink it in moderation.

•

Onions and garlic contain quercetin, which many scientists believe has a preventive role in heart disease linked to free-radical tissue damage, and S-allyl cysteine, which has been shown to lower levels of LDL.

•

A USDA study found that as the substance homocysteine increases in older people, so does the risk of artery narrowing. Fortunately, folic acid can correct elevated homocysteine—and it’s easy to get folic acid through your diet. Green vegetables and citrus are excellent sources.

An important caveat on dietary standards: Too little fat in the diet may be as risky as too much. Below 20 percent, key fat-soluble vitamins (A, D and E) may not be absorbed, and the body does not produce these essential fatty acids.

Essential fatty acids are necessary to prevent hardening of the arteries, increased risk of clot formation, high blood pressure and heart disease.

Alcohol Risk Factors Among dietary items, alcohol is a risk factor of unparalleled proportions. The complication: Some health experts say light or even moderate alcohol use may be good for you. Other statistics argue against this theory, though:

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Chapter 2: Health, Diet and Risk •

A light drinker (who quaffs one pint of beer a day) faces a one in 50,000 chance of getting usually fatal cirrhosis of the liver in any single year. Over a drinking lifetime of 50 years, the odds narrow to one in 1,000.

•

Heavy drinkers obviously face starker odds. Their odds of dying from the habit are one in 100.

And both of these projections only calculate disease. They don’t count the even greater risk of accidents—in a car or on foot. Despite the statistics, other researchers still claim moderate drinking can lower death rates from other diseases—particularly coronary artery disease. The National Institute for Alcoholism and Alcohol Abuse (NIAAA) took a long look at this theory. The NIAAA studied the alcohol and the heart “trade-offs” in a paper that asked the obvious question: “Will the cardioprotective effects of drinking outweigh the risks associated with alcohol use?” The study described the mechanisms by which alcohol is thought to protect against cardiac illness, explored the potential risks and benefits of alcohol use and recommended a method by which people could determine the benefits and risks of alcohol use. The study found that several plausible mechanisms support the possibility that drinking some alcohol protects against coronary artery disease. Of these, the best documented is protection by raising the high-density lipoprotein (HDL) or so-called “good” cholesterol, and decreasing the low-density lipoprotein (LDL) or “bad” cholesterol that we mentioned earlier. LDL may be involved in at least two later steps of heart disease: 1) the gathering of cellular debris in fibrous plaque; and 2) defects in the integrity of the layer of cells lining the inside of blood vessels of the heart. The human body produces antioxidants to protect itself from the effects of toxic molecules such as LDL. But it may need some help

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Protect Yourself from compounds such as flavonoids, a group of compounds found in plants, that are able to prevent LDL from developing or “oxidating.” The potent antioxidant activity of phenolic substances in red wine has been offered as an explanation of the French Paradox (the apparent incompatibility of a high-fat diet with a low incidence of coronary heart disease among French people).

The rest of alcohol’s healthy impacts have to do with its anticlotting effects: Alcohol increases the body’s release of plasminogen activator, an enzyme involved in clot degradation. An anti-clotting effect would explain the apparent protective effect provided by relatively small amounts of alcoholic beverages. For some people, moderate alcohol consumption appears to decrease risk of ischemic stroke, caused by blockage of blood flow in blood vessels. However, due to the anti-clotting effects of alcohol and the effect of alcohol on blood pressure, moderate drinking also increases the risk of hemorrhagic stroke—caused by the loss of blood through the walls of a blood vessel. Age is an important factor in weighing the risk versus benefit of moderate alcohol consumption. Coronary heart disease impacts primarily on men age 45 and older and women age 55 and older. Thus, the older you are the more you drink each day, the more likely you are to move from the healthy effects to the dangerous ones.

Diet and Cancer The American Cancer Society has issued several dietary recommendations to improve your odds in cancer prevention. While the Cancer Society has bent risk analysis in some cases, its diet suggestions make basic sense. • Avoid obesity. This isn’t just the five extra pounds that many people carry around, but being more than 10 percent overweight. Just because McDonald’s opens a new

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Chapter 2: Health, Diet and Risk restaurant somewhere every eight hours, doesn’t mean you should eat there every day. •

Cut down on total fat intake. Keep saturated fat to a minimum; saturated fats come mostly from animal products, but also come disguised in many processed foods in the form of coconut oil and palm oil. So-called “trans-fatty acids” are a also something to avoid. Foods high in fat may increase cancers of the colon, breast and prostate.

•

Eat more high fiber foods. Most Americans consume eight to 12 grams of fiber a day. The Cancer Society recommends at least twice that amount.

•

Add cruciferous (cabbage, cauliflower and broccoli) vegetables to your diet. These are good sources of cancerpreventing vitamins A and C. They are also naturally low in fat and contain fair amounts of fiber.

•

Cut down on salt-cured, smoked and nitrite-cured foods. Foods are preserved to protect them from rapid spoilage. Unfortunately, some methods of preservation have been found to be cancer-causing.

•

Keep alcohol consumption moderate. The Cancer Society cites studies that show an increased risk of certain cancers in persons drinking as little as an average of two drinks daily. The risk tends to go up the more you drink.

Diet and Pregnancy For more than a generation, doctors have recommended that women eat carefully when they are pregnant. Starting in the mid1990s, prenatal health specialists began urging women planning a pregnancy to start eating carefully. The reason? The developing fetus is most vulnerable between days 17 and 56 after conception when critical organs such as the brain and heart are being formed—and

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Protect Yourself when most women don’t know they are pregnant. Prepping for pregnancy can be the foundation for a baby’s growth and development. Several studies have confirmed that women who consume moderate amounts of folic acid every day for at least a month before conceiving cut their baby’s risk of neural-tube defects, such as spina bifida, in half. The evidence is less clear on the role of caffeine consumption. Some studies suggest caffeine may increase the risk of miscarriage and low-birth weight babies; most doctors advise women to avoid or limit caffeine intake to two cups or less a day. The debate over caffeine heated up when researchers at Canada’s McGill University published a study that found that women who continued to consume caffeine during pregnancies had a higher rate of miscarriage. But not everyone agreed with its conclusions. Soon after the results were published in the Journal of the American Medical Association, the International Food Additive Council issued a report citing research which said that moderate caffeine consumption during pregnancy causes no adverse health effects to a mother or her children.

Specialized Insurance and Other Protections Obviously, the main insurance mechanism for protecting yourself against dietary risks is a good health plan. We will consider the mechanics of that later in this book. For now, we’ll take a look at some of the specialized forms of insurance that protect against cancer and particular health risks. In the heated debate between managed care and traditional indemnity insurance, some of these smaller but equally important health coverage issues are lost. These smaller issues are often related to specialty health insurance policies—matters that are not broad enough to become political debates…but which can be devastating when they impact an individual person or family. If insurance companies consider you uninsurable due to your health or medical history, or if you are in the market for more than just your typical medical and hospitalization coverage, you might want

34

Chapter 2: Health, Diet and Risk to explore the options of other, less commonly used forms of healthrelated benefits or policies—on a stand-alone basis or combined with each other—including some of the following: • health insurance that covers specific diseases, •

dental coverage,

•

vision coverage,

•

a separate prescription plan, or

•

even long-term care coverage.

Of course, people look for these kinds of coverage precisely because they suspect they will have a particular kind of need. On the other hand, some people choose these coverages for financial reasons (i.e., their employers offer the insurance for free…or for a discounted fee via a tax-advantaged cafeteria plan). Whatever the reason people choose specialty coverages, the plans will likely grow in importance as technology and financial sophistication advance. Some risk experts predict that soon health insurance will be a collection of specialty coverages for specific conditions. This would allow maximum flexibility for the policyholder—and maximum precision for the insurance company.

In the meantime, specialty coverages remain…a specialty. But one that’s worth considering in detail. Cancer insurance is sometimes referred to as a limited risk policy or the even older name dread disease policy, reflecting the basic truth of the coverage: It only provides benefits for a single category of health risks—cancer. Cancer insurance provides a daily benefit (such as $50, $75, $100, etc.) if you or a family member is hospitalized for cancer or is receiving regular cancer treatment on an inpatient or outpatient basis.

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Protect Yourself However, a specific insurance company or particular policy may limit coverage even more, providing daily benefits only for inpatient treatment of cancer with outpatient expenses excluded. If you have a cancer policy and are hospitalized for cancer-related treatment or surgery, over and above any other benefits, the policy will indemnify you at a specified amount ($100 per day is common) for as long as the treatment or hospital confinement continues. Of course, if you’re hospitalized due to a broken leg, the cancer policy will pay nothing. A basic medical expense policy or major medical plan will cover cancer like any other illness would be covered—on an expense-incurred basis. The cancer policy covers you on a daily basis without regard to expenses incurred. However, cancer policies usually contain limitations in terms of the daily benefit, a policy maximum or a time limitation. For example, a plan may pay $100 per day for up to 30 days of confinement, 90 days of treatment, etc. In most cases, cancer insurance makes sense for people who can’t qualify for standard health coverage because of other problems they’ve had. In other words, a person with a history of heart disease may choose cancer insurance because it’s the only coverage she can get.

If you already have hospitalization insurance do you need an additional policy for cancer insurance? The answer depends upon your ability to pay extra premium, awareness of the risk of cancer, etc. Because cancer is one of the leading causes of death, most people are aware of its risks and costs. However, this awareness may not create any urgency for “extra protection” by means of a cancer policy. For example, almost everyone is aware of the relationship between smoking and lung cancer; yet, many continue to smoke because they don’t care or don’t believe the cancer will happen to them. Or, even

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Chapter 2: Health, Diet and Risk more unfortunately, they simply can’t quit. Can smokers buy cancer insurance? Probably not. Before they issue a policy, most insurance companies that write cancer coverage will ask you if you smoke. If you answer “yes,” the premiums are very high. In most other cases, the premiums for cancer insurance are relatively low—just a few dollars in annual premium per thousand dollars of coverage for a healthy person in his or her thirties. So, why don’t more people buy the insurance? Several reasons stand out: 1) many people don’t see a reason to buy extra coverage when they already have regular health insurance. 2) most consumers don’t like to think about their health in terms of contracting specific, deadly diseases. 3) most insurance companies would rather focus on broad coverages sold to large audiences…so they don’t encourage their agents to sell specialty policies.

Conclusion The best way to control the odds of diet-related risks is to take moderate steps toward a balanced mix of foods and substances like vitamins and minerals. The key dietary rule: Lower the fat content of what you eat.

After that, you should lower the amount of sodium you consume and raise the amount of fiber. Other suggestions offered by the American Dietary Association include: • Examine nutrition labels. On individual foods with a nutrition label, check to see there are no more than 3 grams of fat for every 100 calories in a serving. When this is the case, the food contains no more than 27 percent of its calo-

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Protect Yourself ries from fat—just below the recommended level. This usually works regardless of serving size. •

Know the recommended level of dietary fat for the amount of calories you consume. To estimate a recommended level of dietary fat (in grams) for any day, take your daily calories and divide by 30. If you’re eating 2,100 daily calories, your daily fat allowance would be 70 grams.

•

Avoid any kind of extremism in your diet. Some dietary fat is necessary. And some rigorous diets can create undesired risks.

•

Maintain weight and exercise. Trying to maintain an ideal weight by keeping the perfect diet isn’t the smartest way to go. Exercise regularly and you can enjoy more kinds of food and still lower your risks.

Don’t expect dramatic health impacts from your diet. Diet is a long-term, gradual protection. Your best bet is to shave at mortality and life-span odds by eating a balanced, low-fat diet—including lots of mineral-rich fruits and vegetables…and engage in some form of physical activity to increase your heart rate. Obviously, your weight has a lot to do with what you eat. But diet also affects your chances of contracting several types of cancer and fatal illnesses. As useful as specialized cancer insurance may be if you contract the disease…you’ve still contracted the disease. Dietary health factors are the best example of the importance of prevention that you’re likely to experience in your life. Bottom line: It’s no mystery that a good diet will improve your chances for living a longer, healthier life. But a good diet is significant largely because it reflects a balanced, generally healthy approach to living. In this way, it’s the opposite of fad diets designed to help someone look good by means of drugs or strange eating habits.

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Chapter 3: Crime Risks CHAPTER

3

Crime Risks

Of all the risks that ordinary people have to consider in the course of their daily lives, crime was most affected by the terrorist attacks on New York and Washington in September 2001. Those attacks heightened sensitivities toward crime and victimization—leading in some cases to a fascination with violent acts. The media’s exaggerated interest in kidnappings during the summer of 2002 can be thought of as a result of the fears stirred up by the 9/11 attacks.

In reality, kidnappings had gone down in numbers over the years—but you’d think the opposite if you were keeping up with the news. This focus on victimization is surely one of the goals of terrorism. Terrorists clearly intend to make target populations fearful; one way to do this is to convince the population it’s a victim. For these psychological reasons and others, crime statistics are hugely misunderstood. For most Americans, the odds of being the victim of a violent crime dropped between the late 1980s and the early 2000s. Even before the 9/11 attacks, people believed they were at greater risk of violent crime. For example: A poll commissioned by Parenting magazine revealed that 54 percent of parents feared their children might be kidnapped at some point. But, according to federal government statistics, a child’s odds of being kidnapped are one in 300,000.

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Protect Yourself According to criminologists, even though violent crimes touch very few lives, they are a key to people’s sense of safety. Does homicide make you fearful? Probably. Does white collar crime make you fearful? Probably not. But white collar crime is more likely to affect you (as an employee or an investor) than homicide. The odds of the average American becoming a victim of violent crime in a given year are about one in 135 (an incidence rate of 746 per 100,000 people).

It’s easy to blame the popular media for exaggerating the importance of violent crime risk. Unlike other risk issues, crime reporting has a long, sensationalized history in popular media. In fact, figures collected by the Bureau of Justice Statistics (BJS) suggest that more than 90 percent of Americans are safer today than they were during much of the 1980s and 1990s. The drop in crime was—and remains—consistently underreported by the media. In 2002, the BJS reported that: • the violent crime rate fell 10 percent between 2000 and 2001, due primarily to a significant decrease in the rate of simple assault; •

the overall property crime rate fell 6 percent between 2002 and 2001, because of decreases in theft and household burglary rates; and

•

males and females were victims of simple assault at similar rates.

And, despite what the media implies, you have some control over your odds of being a victim, particularly when it comes to your behavior. Behavior has something to do with your chances of being the victim of a violent crime—if you’re a drug dealer, the odds you’ll be shot increase.

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Chapter 3: Crime Risks Other factors—especially who you are and where you are at a given time—also influence crime statistics. For this reason, the sociological and demographic patterns that emerge from crime numbers are important to the odds that you’ll be mugged, raped or killed in the coming year.

Interpreting the Statistics The various influences on crime statistics are explored in a series of studies done each year by the FBI and the Justice Department. The largest and most sophisticated study from victims is the National Crime Victimization Survey (NCVS). Every six months, NCVS interviewers contact a national sample of more than 65,000 households. More than 100,000 individuals age 12 years or older are interviewed and asked to report their experience with crime. The NCVS has been progressively refined over the past 20 years, and it is widely considered to be the best source of information about rates of crime and violence in the United States. Some of its conclusions include: • Generally speaking, the crime rate is contingent upon the number of young men in the population. The more young men there are, the more crime there is. •

According to the FBI and the Justice Department, more than 80 percent of those arrested are male. And men age 15 to 34 years account for 70 percent.

•

Selective sampling can be made to produce almost any result, but the demographic influence on crime rates is a historical trend.

Demographers predict the most violent-prone segment of the population (15- to 19-year-olds) will grow nearly twice as fast as the overall U.S. population through the year 2010. And, according to the BJS, “In general, the younger the person, the more likely they [a]re to experience a violent crime.”

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Protect Yourself One of the common mistakes people make about crime is that it’s motivated by poverty. There is no causal connection between poverty and crime. At best, there is only a correlative link. Being poor doesn’t make you a criminal; being rich doesn’t make you a victim. But hanging around in high-crime areas is more likely to make you one or the other. Or both.

Violent criminals tend to be spontaneous and opportunistic. They prey on whoever is nearby. The best way to avoid violent crime is to stay away from violent criminals—no matter who you are. According to the Justice Department, your risk of being a victim does not increase as you make more money—it actually declines. Your odds of being victimized are two to three times lower if you make $50,000 or more a year than if you earn less than $10,000. That’s because the wealthier you are, the more likely you are to stay away from criminal activities.

Crime and Race Race is another correlative factor when it comes to violent crime. The archetypal image—present in so many sensational media stories, cynical political ads and racist fantasies—of a young black male threatening elderly whites is not supported by the numbers. But, as we’ve seen before, misperceptions can stubborn things. Race doesn’t make someone more likely to be a criminal. But the correlation between race and violent crime means devastating things for many Americans. Leaving politics as far out of this discussion as possible, the fact is that people allow misperceptions to make them scared when they shouldn’t be. In the United States, young black men are convicted of committing crimes more than other demographic groups; but they are also disproportionately the victims of violent crime. The rate of homi-

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Chapter 3: Crime Risks cide among young black men, age 15 to 35, grew two-and-one-half times worse between the mid-1980s and mid-1990s. The chances of a white woman 65 or older becoming a victim of serious violent crime are just one-seventieth the odds a black male teen faces. But older women worry about crime more than any other group.

In absolute terms, white people commit more violent crimes than black people—54 percent to 45 percent, according to FBI arrest statistics. But, because there are fewer black people, the impact of the numbers is much more dramatic for their communities. Every 1 percent of black Americans accounts for 3.5 percent of all violent crimes, while every 1 percent of other Americans accounts for about 0.8 percent of these crimes. But the most important conclusion: People are most often victimized by someone of their own race. Your chances of being attacked vary tremendously according to your age, race, sex and neighborhood. The risk of becoming a victim of violent crime is: • nearly four times higher if you’re 16 to 19 years old than if you’re 35 to 49; •

almost three times higher if you’re black instead of white;

•

two times higher if you’re male rather than female; and

•

two times higher if you live in a city rather than in a suburb or in the country.

So, what can you do to reduce your chances of becoming the victim of a violent crime? Obviously, you can’t change your age, race or gender. But you can do something about how close you are—physically—to problems, either immediately or over the long term. More specifically, you can:

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Protect Yourself •

do everything possible to get out of densely-populated city neighborhoods, especially if you are (or are the parent of) a young black male;

•

stay away from public spaces where young people gather, after school or at night; and

•

remember that you’re most likely to be attacked by someone of your race and age group—so don’t assume you’re “safe” because the people on the street look like you.

Crime and Criminals Are Opportunistic Street criminals are not masterminds. Criminals act opportunistically: They aren’t usually in the mental condition to plan complex crimes. According to The Sentencing Project, a Washington, D.C.based criminal justice policy group, “Half of all violent offenses are committed by people intoxicated on alcohol or other drugs.” In most cases, violent criminals tend to be young because few people make a career out of crime. Most criminals realize that crime poses enough risks to life and liberty that a straight job— even one near minimum wage—is usually a better deal.

Larceny is a risky and low-profit line of work. If a thief nets 50 percent of what he or—less likely—she steals, he or she would have to commit six or eight crimes a month just to live at a subsistence level. Law enforcement officials and politicians often refer to crime as a pathology or disease. This rhetoric usually has little bearing on the odds an average person will be a victim of crime in a given period. However, in the June 14, 1995, issue of the Journal of the American Medical Association, academics from Emory University in Atlanta and the city’s Police Chief performed an epidemiological study of home invasions during a three-month period in 1994. The results support the characterization of crime as an opportunistic phenomenon.

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Chapter 3: Crime Risks A total of 198 cases were identified during the study interval (cases of sexual assault and incidents that involved cohabitants were excluded). A few key distinctions emerged: • the ethnic makeup of victims closely resembled the demographic composition of the city; •

the victim and offender were acquainted in nearly onethird of the cases;

•

a firearm was carried by one or more offenders in 32 cases— fewer than 1 in 8; seven offenders carried knives;

•

stealth was the most common method of entry (80 cases), followed by force (59 cases); offenders used deception (for example, knocking on the front door) followed by force in 12 cases;

•

15 percent of the intruders entered through the front door of the house; 24 percent, through a back or side door; almost all of the rest gained entry through a ground floor window; and

•

47 percent of the crimes occurred between midnight and 6 A.M.; 17 percent occurred between 6:01 A.M. and noon; 16 percent, between noon and 6 P.M.; and 20 percent, between 6:01 P.M. and midnight.

Property Crime vs. Violent Crime The cases studied in the Atlanta report combined violent crimes and property crimes. This combination reflects a key bit of confusion that most people have about crime: They confuse violent and property crimes. This confusion is important for several reasons. First, property crimes are more common than violent crimes. According to the BJS, “more than nine in 10 crimes against the elderly [in 2001]…were property crimes.” Yet, most elderly people state that they are most worried about being attacked violently.

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Protect Yourself Second, the most effective responses to each type of crime are different. The Atlanta report found that resistance to thieves can be effective, while resistance to violent crime may only cause more and greater violence. In the Atlanta report, the sequence of events in each crime fit one of three general patterns: • No confrontation occurred in 42 percent of cases because the intruder either entered and left silently or fled the moment he or she was detected. •

Forty-nine victims (25 percent of the total) confronted the offender but did not attempt to resist.

•

Sixty-two victims (31 percent) resisted the offender.

Some resisted passively by running away, locking a door or holding on to their property; most resisted actively by fighting back, screaming or calling 911.

Victims who avoided confrontation were more likely to lose property but much less likely to be injured than those who confronted the offender. Consider this data: • Resistance was attempted in 62 cases (31 percent). •

Forty cases resulted in one or more victims being injured, including six who were shot.

•

No one died.

•

Three victims (1.5 percent) used a gun in self-defense. All three escaped injury, but one lost property.

•

The odds of injury were not significantly affected by the method of resistance.

The main conclusions of the study reflects basic common sense. The best way to prevent a home invasion crime is to make your dwell-

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Chapter 3: Crime Risks ing hard for the opportunistic criminal to enter. In other words, lock your windows and doors. And keep some lights on. Confronting an intruder is likely to get you hurt. And having a gun doesn’t improve your chances of confronting a criminal without getting injured.

Crime tends to be a geographically-sensitive risk. Robert Figlio, a University of California, Riverside, sociology professor, says, “It’s where you are even more than who you are that determines whether you will be a victim.” So avoid the occasion of trouble.

Statistical Questions Criminologists complain that annual crime rankings of cities are inaccurate, and nothing more than a creation of headline-hungry journalists who oversimplify surveys that were never intended to produce comparisons among cities and states. Local law enforcement authorities have wide discretion in the way crimes are reported and classified. This is an important point because: • The FBI counts only crimes reported to the police—just a fraction of actual crime. •

The Justice Department, which surveys victims, concludes that nearly two-thirds of all crime goes unreported nationally.

•

So, even a small difference in willingness to report crimes can have a big effect on the actual “crime rate.”

When it releases its report each December, the FBI assigns no rankings and does no calculations to compare different cities or states. It even warns against doing so because there are too many other factors that come into play. Among those factors:

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Protect Yourself •

population density,

•

degree of urbanization,

•

high concentrations of youths or transients,

•

poverty,

•

unemployment,

•

family stability, and

•

climate.

Crime numbers can vary dramatically—even within a single metropolitan area. And the FBI report considers metropolitan areas, not individual cities. So, the cities with the highest crime rates sometimes are in metro areas farther down the list. For example, in 1993, Washington, D.C. had one of the highest violent crime rates in the country at 2,922 offenses per 100,000 residents. But its metro area included northern Virginia and parts of suburban Maryland—thus pulling it way down on the violent-crime list with a rate of 771 per 100,000.

Terrorism When the commercial airliners hijacked by members of the alQaida terrorist organization attacked the World Trade Center in New York and the Pentagon near Washington, D.C., approximately 3,017 people were killed or declared missing—including 147 on the two hijacked planes and another 224 in the attack on the Pentagon and in the hijacked plane that crashed in Pennsylvania. Hundreds were injured seriously enough to seek medical care. It’s likely that many more were injured but didn’t seek medical treatment. And this doesn’t include the rash of anthrax cases that followed in the weeks after the incident. The financial impact of the attacks is so large that it’s hard to quantify. Even if you leave aside the impact the attacks had on the

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Chapter 3: Crime Risks financial markets—and focus only on direct costs—the losses were in the tens of billions. Insurance paid for a lot of the financial loss (and the effect that these payments have had on the insurance and financial services industries has caused a second-hand ripple in the broader economy). But the effects of 9/11 go beyond the dollars…and they probably shouldn’t go as far as they do. Terrorism counts on misdirected fears and exaggerated response. In the days after the bombing of the Alfred J. Murrah Building in Oklahoma City, telephone bomb threats led authorities to evacuate government buildings in New York, Detroit, Dallas, Cincinnati and various cities in California Some people expected that the perpetrators of the Oklahoma City bombing to be agents of some foreign political group. However, the people responsible turned out to be native sons. Timothy McVeigh, a former soldier with right-wing leanings, and a handful of accomplices planned and executed the crime. Just as the initial ideas about who committed the crime were wrong, the ideas about terrorist attacks impacting most Americans were wrong. America is a big place with a lot of people living in it—the overwhelming majority of whom will not be affected directly by terrorism in their lifetimes.

Despite the fears caused by the Oklahoma City and World Trade Center bombings, the greatest risk of terrorism loss occurs for most Americans when they travel abroad. Everyone fears the most rare and tragic of circumstances when they travel abroad: the fatal terrorist attack. However, despite reports of terrorism, random crime and assaults pose the greatest threats to Americans abroad. • Travelers tend to be most at risk at airports and in the vicinity of hotels, restaurants and tourist sites.

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Protect Yourself •

Kidnappings of executives and their families have soared in several nations—mainly Colombia, Mexico, Brazil and the Philippines. Most of these incidents ensnare well-to-do and middle-class locals, such as business owners, politicians, land owners and bankers. Usually, they end safely once a ransom has been paid.

•

Cigna is one of several U.S. insurance companies that provides insurance coverage against the criminal calamities that may befall traveling executives.

•

Other providers are Fireman’s Fund, American International Group and Chubb. Lloyd’s of London, the venerable British institution, underwrites three-fourths of the world’s kidnapping and ransom coverage.

But, when it comes to terrorism risks, insurance is merely a backstop when preventive measures fail. Political risk experts acknowledge that the lines between political terrorism, organized crime and drug and arms dealers are becoming increasingly blurred and hard to discern. As a result, identifying the source of threats to international companies and their employees is becoming more complicated. Security experts say it’s difficult to tell what kind of group is threatening who and why. The standard guidelines to identify these groups have gone; since the end of the Cold War, the ideological basis and state backing (for terrorism) has gone. Many groups are involved with drugs or weapons dealing.

What steps can you take to protect yourself from terrorists? This question is more difficult to answer, because the best precautions are things that require government-level regulation of public spaces. So, you can press your local government to take effective measures. What are these? 50

Chapter 3: Crime Risks In April 2002, New York governor George Pataki proposed a plan to sharpen security at New York City’s area airports. This plan went beyond federal requirements—and it serves as a good example of a thorough response. The plan included: • installing fingerprint scanners quickly to control access for all airport employees and do away with simple plastic passes; •

installing more sophisticated cameras, motion detectors and other devices around the perimeters of the facilities, including ground-based radar and a new array of low-light and infrared closed-circuit cameras;

•

requiring detailed background checks for security guards and people working on the aircraft or handling baggage;

•

requiring the same checks—including criminal reports— for vendors, food service workers and other employees of companies doing business within the facilities; and

•

providing counterterrorism training for the state and local police.

The most important piece of the plan in the eyes of security officials was the investigation of the people working in shops and restaurants. A terrorist might not be able to smuggle explosives through a checkpoint; but a confederate at one of the shops could do so easily. Even a knife used to cut meat at a restaurant might be passed on to a potential hijacker.

Finally, though, the important thing to remember about terrorism: If you become the victim of a crime, the crime is much more likely to be a theft or burglary…a crime against your property. You can protect yourself most effectively by taking actions to prevent that kind of crime. Because terrorism is a public crime, it requires public (usually governmental) prevention.

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Protect Yourself

Conclusion According to the Insurance Information Network of California (IINC), light, time and noise are a burglar’s three worst enemies. Research shows that if it takes more than four or five minutes to break into your home, the burglar will go elsewhere. According to the IINC, nine out of 10 break-ins could be prevented if homeowners took steps to “burglar proof” their homes. The organization recommended the following tips for homeowners to help protect their homes: • “Case” your home the way a burglar might and look for easy entrance points. •

Protect your doors with solid locks. If you have sliding glass doors, secure them deadbolts. Eighty percent of breakins are though a door.

•

Consider a home security system that will sound an alarm if triggered.

•

Leave blinds and curtains in their normal positions.

•

Don’t allow trees and shrubs to conceal doors.

•

Never hide your keys outside; burglars know where to look.

•

Use automatic timers for lights, radios and televisions to make the home appear “lived in.”

•

Lower the sound on your telephone ringer and answering machine.

To encourage these precautions, many insurance companies offer a discount for devices like deadbolt locks, smoke/fire alarms and burglar alarms that make a home safer. These companies will usually offer their own checklists for securing your property.

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Chapter 4: Insuring Your Health CHAPTER

4

Insuring Your Health

No matter what the cause—extreme recreation, reckless diet, armed robbery, terrorist attack or simple age—risks to your health are your greatest concern. Insurance is the best way to protect your health. If you’ve ever been sick or injured, you know that it’s important to have the right kind of health insurance. It pays for the pain to be abated…and the damage to be repaired. But, if your employer offers you a choice of health plans, how do you make the right choice? Do you need any other kind of insurance, in addition to medical expense coverage? What will happen if you are too sick to work? If you are over 65, will Medicare pay for all your health care expenses? If you’re confused, you’re not alone. Health insurance is the most complex form of coverage; and more than 40 million Americans don’t have any form of it. You need to have some understanding of how it works. This chapter should help you review the basic forms of health coverage and compare plans, to help you make the right decision for you and your family. Health coverage generally refers to a collection of insurance policies and government programs that pay for a range of costs including: • doctor care, •

hospital stays, and

•

certain long-term care expenses.

When most people refer to health insurance, they usually mean group insurance offered by employers—insurance that covers such

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Protect Yourself things as medical bills, surgery and hospital expenses. Insurance companies call this comprehensive or major medical coverage because of the broad protection it offers. The following are some words that you will come across, and their definitions, if you choose a standard group plan. • Fee-for-Service. This coverage generally assumes that a medical provider (usually a doctor or hospital) will be paid a fee for services rendered. The term refers to the way doctors are paid…regardless of who pays.

Paying cash—that is, unreimbursed out-of-pocket expenses— for medical treatment is a form of fee-for-service arrangement. However, most people don’t pay cash for their medical care.

•

Indemnity Coverage. The term used by insurance companies to mean traditional health insurance—is a fee-forservice arrangement.

•

Reasonable Service Charge. With some variation, feefor-service policies reimburse bills for a percentage of a reasonable service charge. (This amount is derived by the prevailing cost of a service in a geographic area.)

•

Coinsurance. The portion of the covered medical expenses that you pay. Sometimes a doctor will charge more than a reasonable amount for a service. If this is the case, you’ll end up paying the difference out of your own pocket.

Many fee-for-service plans pay hospital expenses in full, so be sure to check with your plan provider before you fork over the extra cash.

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Chapter 4: Insuring Your Health •

Deductibles. In health insurance, as with any other type of insurance, deductibles are the amount of the covered expenses that you must pay each year before your insurer will reimburse you. Deductibles range from as little as $100 to $300 per year per person to $500 or more per family. Generally, the higher the deductible, the lower the premiums, which are the monthly, quarterly or annual payments for insurance.

•

Out-of-pocket Maximum. Most policies have this. When your covered expenses reach a certain amount in a given calendar year, a reasonable fee for the benefits that are covered on your plan will be paid in full by your insurer and you no longer pay the coinsurance. However, if your doctor bills you more than the reasonable charge, you may still have to pick up some of the tab.

•

Lifetime Limits. In addition to the out-of-pocket maximum, many policies place lifetime limits on benefits. When shopping for a plan, it’s smart to look for a policy whose lifetime limit is at least $1 million. If the limit is much lower than this, you could run through the coverage if you have major health problems for several years.

How Traditional Indemnity Insurance Works Until the early 1980s, most people received health coverage through either a traditional indemnity or a fee-for-service plan. Under these plans: • the insurance company pays all or part of the bill for any doctor, hospital or other care provider that you choose; •

you are free to visit the doctor of your choice;

•

you can change to another doctor at any time for any reason; and

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Protect Yourself •

you can use any hospital or licensed medical facility you choose.

Indemnity plans existed long before HMOs, PPOs and other types of managed care plans. However, indemnity plans—with their focus on flexibility—aren’t very effective at controlling costs. When insurance people talk about indemnity insurance, the party that’s being indemnified is you, the policyholder. Indemnity insurance puts most of the decisions about health care and treatment on the shoulders of the policyholders, who usually defer to the suggestions that their doctors make.

Other points to remember: • An indemnity insurance contract states that the insurance company will pay your medical bills. •

In some cases, indemnity insurance will reimburse you for bills paid out-of-pocket; in other cases, it will pay bills directly to the doctor or hospital providing services. In either case, it pays for services after they are provided.

As we mentioned above, with the service provider (the doctor) strongly influencing decisions about how much and what kind of service you need, one truth emerges about indemnity coverage: It’s not very effective for containing costs. Insurance companies realized that doctors and hospitals were making a lot of money. So, the companies started to limit how much an indemnification contract would…well…indemnify.

Limits on Indemnity Insurance The first limit—the deductible—works this way: Under an indemnity policy, the insurance company will pay the doctors and hospitals bills—after you pay a small amount (the deductible) first. This

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Chapter 4: Insuring Your Health fee is defined at the start of the policy period; and it’s usually structured to spread over the whole period. An example: the insurance company might indemnify you for all medical costs after the first $500 each year…or the first $50 each month.

The point isn’t so much to get you to pay part of the cost as it is to make sure you only go to the doctor when you’re really sick. Said another way: The insurance company figures that if you have to pay $50, you’re less likely to go to the hospital with a low-grade fever or a simple bellyache. As with most kinds of insurance, up-front fees are very effective at reducing bills generated by policyholders. Another limit on how much an indemnification contract can indemnify is coinsurance. In a policy containing a coinsurance clause, the insurance company agrees to pay a certain portion (80 percent is common) of your medical bills. You pay the other 20 percent. This shared burden applies from the first dollar of coverage to the policy’s absolute limit. This is a major compromise on the concept of full indemnification. Insurance companies usually make it financially appealing to take the lesser coverage. It’s easy to calculate how much the insurance company wants you to pay. Simply compare the annual premium for full indemnity coverage with the annual premium for indemnity coverage with an 80/20 coinsurance split. (Most companies sell both.) Generally, full indemnity coverage is about 25 percent more expensive. If it’s much less, the company doesn’t mind the risk—and you should buy the full coverage. On the other hand, if it’s more than 25 percent more—and most will be—you may be better off with the cheaper coverage.

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Protect Yourself Many indemnity policies have both a deductible and a coinsurance clause. In these cases, you’ll probably want to focus your negotiating efforts on lowering the coinsurance. The deductible doesn’t usually impact the policy price as much as the coinsurance clause.

Another limit insurers place on indemnity policies: They don’t cover specifically-named medical therapies, treatments or services. A common example: Many individual indemnity policies exclude coverage for things such as pregnancy and childbirth (companies see this as an optional condition that has more complexities—and hidden costs—than most people realize) or prescription drugs or routine doctor visits. Another cost-saving trick that insurance companies wield to limit coverage: usual, customary and reasonable (UCR) fees. This trick relies on lists of UCR fees that the company will pay for specific kinds of medical treatments. Under this limit, approved providers (a group slightly less rigidly defined than network providers in a managed care plan) agree to accept these fees as full payment for each service provided—within the policy’s limits, of course. UCR fees are a big reason that the distinctions between indemnity insurance and managed care have started to blur. If your indemnity insurance company uses a UCR fee schedule—and if you don’t use a participating provider—you may be responsible for the difference in the cost.

Even if you adhere to the UCR fee schedule, you’ll also be subject to deductibles and coinsurance requirements. As you can see, taken together, these coverage limitations begin to erode the impression of blanket coverage that indemnity plans have 58

Chapter 4: Insuring Your Health for most people. They are the tools that even indemnity plans use to deny or only partially pay claims.

Managed Care If you want lower premiums, managed care will work better than an indemnity plan. Unlike indemnity plans, managed care plans impose controls (and cut costs) on the use of health care services and the providers of health care services, usually through: • health maintenance organizations (HMOs); •

preferred provider organizations (PPOs); or

•

point-of-service (POS) plans.

Managed care plans can be organized as for-profit (commercial) corporations or nonprofit corporations. In most cases, however, a managed care plan is a for-profit with responsibilities to stockholders that take precedence over responsibilities to you. Managed care plans provide comprehensive health services to their members and offer financial incentives for patients to use providers under contract with the plan. That’s how managed care plans keep their costs low and control the amount of health care that doctors are allowed to provide to you. (In recent years, though, even this tactic has had a diminishing effect.) Instead of paying for each service that you receive separately, the plans pay providers in advance.

How an HMO Works An HMO is an entity that contracts with medical facilities, physicians, employers and sometimes individual patients to provide medical care to a group of individuals. This care is usually paid for by a company or other group at a fixed price per patient. The principal objective of an HMO is to reduce medical expenses by: • stressing preventive medicine—physical exams and diagnostic procedures;

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Protect Yourself •

reducing the number of unnecessary hospital admissions;

•

reducing the average number of days per hospital visit;

•

reducing duplication of benefits; and

•

saving on administrative costs.

Other features of an HMO include: • Most managed care plans require you to choose a primary care doctor from their list of doctors. The primary care doctor, or gatekeeper, controls your access to medical care. •

If you switch from an indemnity to a managed care plan and your physician isn’t in the plan’s network, you probably can’t continue to go to the same doctor. And, even if he or she is a member, your office visits still may be restricted—particularly if your doctor is a specialist.

•

Unless your primary care doctor decides your medical problem is outside his or her own realm of expertise, you can’t see a specialist.

•

While most specialists are participating providers in the HMO, there are circumstances in which patients enrolled in an HMO may be referred to providers outside the HMO network and still receive coverage.

Co-Payments HMOs generally do not require any significant “out-of-pocket” expenses. In fact, they generally don’t require you to pay deductibles or coinsurance. But, many HMOs and other managed care plans require members to make a co-payment when they get treatment. A co-payment is a specific dollar amount, or percentage of the cost of a service that you must pay in order to receive a basic health care service (i.e., $10 for an office visit or $5 for a prescription). This is one way in which the plans adjust for people who use services heavily.

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Chapter 4: Insuring Your Health Co-payments usually range from $5 to $50—but they are due every time you visit a health care provider. On the other hand, some HMOs don’t require any co-payment for a considerable number of their services.

HMO Exclusions and Limitations Under an HMO, exclusions or limitations are used to either limit a benefit provided or specifically exclude a type of coverage, benefit, medical procedure, etc. HMOs may not exclude and limit benefits as readily as commercial insurance companies, but they may exclude coverage for the following: • eyeglasses or contact lenses; •

prescription drugs (other than those administered in a hospital);

•

long-term physical therapy (over 90 days); and

•

out-of-area benefits (other than emergency services).

HMOs are required to have a complaint system, often called a grievance procedure, to resolve complaints. The HMO will provide you with a complaint form (complaints must be written) and must notify you of any time limits applying to a complaint. Typically, complaints must be resolved within 180 days of being filed with the HMO (with a few exceptions). They may be resolved through binding arbitration if so specified by the HMO. While HMO benefits are generally more comprehensive than those of traditional fee-for-service plans, no health plan will cover every medical expense. For example: • Very few indemnity or managed care plans cover elective cosmetic surgery, except to correct damage caused by a covered accidental injury.

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Protect Yourself •

Some fee-for-service plans don’t cover checkups.

•

Some plans cover complications arising from pregnancy but not normal pregnancy or childbirth.

•

Plans generally won’t cover any type of experimental procedure.

•

Insurers will not pay duplicate benefits. (So, if you and your spouse are each covered under a health insurance plan at work, under what is called a coordination of benefits provision, the total you can receive under both plans for a covered medical expense cannot exceed 100 percent of the allowable cost.

Pre-Existing Conditions If you or a family member covered under your policy has a preexisting condition you won’t have to worry about whether or not your coverage will transfer when you change jobs thanks to a recent change in federal law. Insurance companies can impose only one 12-month waiting period for any pre-existing condition treated or diagnosed in the previous six months. So, as long as you have maintained coverage without a break for more than 62 days, your prior health insurance coverage will be credited toward the pre-existing condition exclusion period. This doesn’t include pregnancy, but the 12-month waiting period is waived for any newborns or adopted children who are covered within 30 days. If you’ve had group coverage for two years, switch jobs and move to another plan, the new health plan can’t impose another pre-existing condition exclusion period. Federal law also makes it easier for you to get individual insurance under certain situations. If you aren’t covered under a group plan and can’t get insurance on your own,

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Chapter 4: Insuring Your Health check with your state insurance department to see if it has a risk pool. Like risk pools for automobile insurance, these can provide health insurance if you can’t get it elsewhere. But they can get expensive.

HMO Benefits HMO benefits are not limited to treatment resulting from illness or injury, but include preventative measures like routine physical examinations and programs for quitting smoking, losing weight and managing blood pressure. Your HMO must provide you with a list of the basic services that are covered under the plan. The following are just a few: • Inpatient hospital and physician services for at least 90 days per calendar year for treatment of injury and illness. If inpatient treatment is for mental, emotional or nervous disorders—including alcohol and drug rehabilitation—services may be limited to 30 days per year. Treatment for alcohol and drug rehabilitation may be restricted to a 90-day lifetime limit; •

Outpatient medical services when prescribed by a physician and rendered in a non-hospital health care facility, such as a physician’s office, member’s home, etc. These include diagnostic services, treatment services, short-term physical therapy and rehabilitation services, laboratory and x-ray services and outpatient surgery;

•

Preventative health services, including child care from birth, eye and ear examinations for children under age 18 and periodic health evaluations and immunizations; and

•

In- and out-of-area emergency services, including medically necessary ambulance services, available on an inpatient or an outpatient basis 24 hours per day, seven days per week.

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Protect Yourself In addition, supplemental health care services may take the form of additional coverages over and above those provided as basic, or additional amounts of the basic benefits already provided.

Guidelines Plans Must Follow HMOs, like traditional indemnity insurance companies, cannot engage in certain types of business practices, policies, etc. In addition to being prohibited from excluding you-r preexisting conditions from coverage, your HMO is prohibited from unfairly discriminating against you based on age, sex, health status, race, color, creed, national origin or marital status. Your HMO is also prohibited from terminating your coverage for reasons other than: • nonpayment of any premiums or co-payments; •

fraud or deception;

•

a violation of contract terms;

•

failure to meet or continue to meet eligibility requirements; or

•

a termination of the group contract under which you are covered.

Because HMOs provide service benefits rather than reimbursement benefits, they must follow guidelines prescribed by the Insurance Department to assure quality service to members. These guidelines specify the requirements for reasonable hours of operation and standards to insure that sufficient personnel are available. They also require arrangements to provide inpatient hospital services for basic health care, including the services of specialists.

PPOs and POSs Unlike HMOs, PPOs and POSs do not utilize primary care gatekeepers. This means that a single physician does not manage your

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Chapter 4: Insuring Your Health health care services. PPOs—a cross between regular fee-for-service plans and HMOs—are designed to provide you with increased benefits if you use doctors and hospitals within its network. A PPO or POS is often a good option if you don’t want to pay for traditionally expensive fee-for-service coverage, but want more choice than an HMO offers.

Characteristics of these plans include some of the following: • they combine the features of fee-for-service plans and HMOs; •

they provide choice regarding physician, hospital, etc.;

•

they offer more flexibility than HMOs;

•

they have somewhat higher premiums;

•

they offer some reimbursement if you receive a covered service from a provider who is not in the plan;

• they cost you more if you choose a provider outside the plan’s network; and •

they act like fee-for-service plans and charge you coinsurance when you go outside the network.

Under a PPO, as they do in HMOs, your insurance company contracts with certain physicians and provides a “preferred provider” network of doctors and specialists that you can choose to go to. However, unlike HMOs, you don’t have to go to a doctor in the network, and you don’t have to get referrals from a primary care physician to see a specialist. Of course, you’ll be encouraged to use the network to keep costs down for both you and your insurance company. And, if you use the network, you’ll pay for services with co-payments or a much lower coinsurance fee than you would if you go outside the network.

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Protect Yourself A PPO allows you to choose between cost savings and freedom of choice in selecting a health care provider and services.

Generally, deductibles for PPO coverage range between $150 and $300 per year. If you don’t use the PPO network often, you might only have 70 percent coinsurance and a higher deductible. That would mean that you’d pay a higher deductible (somewhere between $300 and $500 per year per individual) and 30 percent of costs after that. PPOs are considered to be closer to indemnity plans than managed care, since the insurance company pays discounted rates for medical services without becoming overly involved in health care decisions about the treatments rendered.

As we mentioned earlier in the chapter, PPOs are a better choice than fee-for-service plans if you don’t make a lot of money but you want to have some flexibility in your choice of a physician. They are also good if you see a physician outside the network and want to continue that relationship. You can still use preferred providers for other services and keep seeing your specialist. PPOs are also good when you know you will exceed the deductible amount. If you don’t exceed the deductible, you will be getting no value out of the insurance because you have to pay the deductible amount before the insurance company starts paying.

Other Options Exclusive Provider Organizations (EPOs) are a type of PPO in which you can use a particular provider, instead of choosing from a list of preferred providers. Under these plans, providers are not paid a salary but are paid on a fee-for-service basis.

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Chapter 4: Insuring Your Health EPOs are characterized by a primary physician who monitors care and makes referrals to a network of providers, strong utilization management, experience rating and simplified claims processing. EPOs can serve as an alternative to or companion to HMOs and PPOs. Another managed care alternative to an HMO, is an open ended HMO (also known as a “leaky HMO” or “point-of-service HMO”) or a hybrid arrangement whereby you can use non-HMO providers at any time and receive indemnity benefits that are subject to higher deductible and coinsurance amounts. The out-of-pocket cost to you (and probably your employer, too) is higher, but the arrangement allows you to remain in control when choosing a health care provider. A Multiple Option Plan is an integrated health plan that includes services of an HMO, PPO, EPO and a traditional indemnity plan—all of which are administered by a single vendor (usually a traditional insurance company). There are many variations of the multiple option plan, including: point of service plans (POSs), physician hospital organizations (PHOs), practice management organizations (PMOs) and provider-owned networks. Most of these alternatives combine the mechanical controls of HMOs, the flexibility of PPOs and some kind of provider (that is, physician) ownership. Most alternative plans try to reap the benefits of cost control while keeping doctors in on the decision-making process.

Traditional Insurance vs. Managed Care If you want to share in the decision-making, have greater flexibility and direct access to providers, you’ll probably want an indemnity plan. If you want lower premiums, managed care usually works better. Most people know this much about health insurance. But how do these two main versions of health coverage compare in a more detailed way? Here are some quick comparisons:

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Protect Yourself Indemnity Insurance

Managed Care

Choice

You can select any doctor, hospital or other health care provider.

You can select any health care provider in the network. If you use a provider outside of the network, you pay some or all of the bill.

Specialists

You can use any specialist. However, some plans require pre-approval for certain procedures performed by specialists.

Your primary care doctor determines if and when you see a specialist. (Sometimes you can see a specialist who is in the network without permission.) If you use a specialist without approval (or outside the network), you will have to pay the entire bill.

Out-of-Pocket You may have to pay an anCosts nual deductible of $200 to $1,000. You also may be responsible for co-insurance payments of something like 20 percent of your medical bills, up to a certain limit (the stop-loss amount) each year. Sometimes, you pay for routine doctor visits and prescription drugs.

You may have to pay co-payments (usually $5 to $50) for network doctor visits and prescription drugs. When you use a provider outside of the network, you may have to pay a deductible—after which the plan will pay part of the total charges.

In short, an indemnity plan—even with its limitations—offers you the freedom of choice but usually requires you to pay more outof-pocket expenses than you would with an HMO or PPO. The indemnity plan may not cover you for any routine care— annual checkups and other preventative treatments—either. Some of these preventative treatments include: • blood tests, prostate exams,

•

genetic trait tests,

•

hearing and sight loss,

•

electrocardiogram (stress tests),

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•

Chapter 4: Insuring Your Health •

mammograms, and

•

CAT scans (if you have a history of problems).

In an age of heavily-touted preventive medicine, the fact that these treatments aren’t covered may seem strange. Of course, you can get these services under an indemnity plan. You just have to be willing to absorb the related costs—at least large parts of them—by yourself.

Other Coverages Various kinds of insurance—most tied to some form of life insurance or related coverages—can provide health coverage for people or groups who can’t get the protection they want from standard policies. On a stand-alone basis…or combined with each other…these alternative coverages can work for people whose health or medical history makes traditional health insurance difficult. We’ll take a quick look at a few of the important ones: • Medical expense insurance. Commonly referred to as hospitalization insurance, this coverage provides benefits for expenses incurred for hospital medical treatment/ surgery as well as certain outpatient expenses like doctor’s visits, lab tests and diagnostics. The policy can be issued as an individual policy covering all family members or as a group insurance policy provided through an employersponsored program. •

Dental expense benefits. Generally sold as part of group hospitalization coverage, dental benefits are provided for preventive maintenance (cleanings and x-rays), repair (fillings, root canals, etc.) and replacement of teeth. Most insurers do not provide individual dental coverage.

•

Long-term care (LTC) insurance. Pays for the care of persons with chronic diseases or disabilities. The coverage may include a wide range of health and social services pro69

Protect Yourself vided under the supervision of medical professionals. LTC often covers nursing home care, home-based care and respite care.

Specialized Health Insurance There are a variety of special health insurance policies providing limited coverage. To ensure that you have sufficient notice that your coverage is limited, your policy, by law, should state plainly that it is a limited policy. • Travel accident insurance. Provides coverage for death or injury resulting from accidents occurring while the insured is a fare-paying passenger on a common carrier. •

Specified disease or dread disease insurance. Provides a variety of benefits for only certain diseases, usually cancer or heart disease. This coverage is especially important for people with a history of a particular illness—because this is how they can insure against other problems. For example, a person who has survived cancer may have trouble finding standard health coverage but may be able to get coverage for heart trouble.

•

Hospital income insurance. Pays a specified sum on a daily, weekly or monthly basis while the insured is confined to a hospital. The amount of the benefit is not related to expenses incurred or to wages lost while the insured is hospitalized.

•

Accident only insurance. Provides coverage for injury from accident—but excludes sickness. Benefits may be paid for all or any of the following: death, disability, dismemberment or hospital expenses.

•

Blanket insurance. A form of group coverage. Often the individual’s name is not known because the individuals

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Chapter 4: Insuring Your Health come and go. These groups include students, campers, passengers of a common carrier, volunteer groups and sports teams. Individuals are automatically covered under the blanket policy, and they do not receive certificates of insurance.

Prescription Coverage Prescription coverage has been a hot political topic for most of the 1990s and 2000s—though the political debate focuses on prescription coverage as part of Medicare and Medicaid. Traditionally, these federal government programs have not included coverage for prescription drugs. Prescription medication coverage is normally provided as an optional benefit under a group medical expense policy. The key characteristics of this coverage include: • the insured and eligible dependents are provided with a stated cost for any prescription medication required (usually, two, three, or five dollars per prescription). •

regardless of the cost of the medication, the insured only pays the stated amount and the balance of the prescription cost is paid by the insurance company.

The Limbo of Young Adulthood If you’re a recent graduate and you haven’t found a good job yet…or if you’re on hiatus for a while until you figure out what you want to do…you probably don’t have health insurance. You can’t get it from school anymore and you’ve probably reached the age when you aren’t covered by your parents’ plan. So, what can you do—besides going without any insurance because you’re at a “safe” age. Basically, you have two options: • short-term policies, and •

standard individual policies.

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Protect Yourself A short-term policy will cover you for a fixed number of weeks or months but it comes with no right of renewal. At the end of the period, you have to reapply for coverage if you want it. The policies are relatively inexpensive but come with high deductibles and copayments. If you don’t expect to be sick but want coverage for catastrophic expenses, this policy is a good choice. A standard individual policy is a lot more expensive but offers indemnity or HMO-type coverage and can be renewed automatically. This is important if you become injured or come down with a longterm illness.

Conclusion Finding the right kind of health insurance at the right price always requires a lot of attention. Historically, people didn’t have to think too much about these issues because they simply accepted whatever their employers offered. That’s a luxury few people can afford anymore. Whether you buy insurance for yourself or get coverage through your job, the trend in the industry is toward you making more decisions about your coverage. Even if you live a healthy life and eat a pristine diet, you’ll need to see a doctor or go to the hospital at some point. And, then, you’ll realize how essential the right health insurance is to your personal protection.

An HMO or short-term policy may not provide the most luxurious health care available; but either one will assure you basic coverage in a crisis. And basic is much better than the coverage you’ll get if you’re uninsured.

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Chapter 5: Life Insurance Protects Many Things CHAPTER

5

Life Insurance Protects Many Things

Life insurance plays an important role in securing the finances of many families. In the purest sense, life insurance is something that protects against the risk of you dying too soon. It pays a death benefit to someone when you die. Your premature death would expose your family or business to certain financial risks, such as: • burial expenses; •

paying off debts;

•

loss of family income;

•

loss of business profits;

•

paying estate taxes; and

•

a lack of or a limited college fund for your children.

If you don’t have dependents, you probably don’t need life insurance. But if you have a spouse, children or elderly parents who rely on your income, you’ll want life insurance to pay expenses for them in the event of your premature death. You also may even want to consider insuring the life of your spouse if he or she is not earning money—particularly if he or she cares for your children. (If your spouse were to die unexpectedly, not only would you have funeral expenses, but you’d have to start paying for child care.) Life insurance guarantees a specific sum of money will be available at exactly the time it is needed. Savings accounts, mutual funds, stocks, bonds and other investments do not offer such protection—and, in fact, they can be tied up in probate at the time of your death. Life

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Protect Yourself insurance, however, will be available immediately—and it creates, in essence, an estate that did not previously exist. Life insurance policies are complex and often include numerous types of benefits and features. Over the years, life insurance companies have been particularly creative, introducing new combination products at a remarkable rate. Many of these are designed to serve a particular type of client—or in response to changing economic conditions and consumer preferences. This trend is expected to continue, making it even more difficult to choose the right policy for the amount of protection you’ll need.

The Basics With life insurance, you get what you pay for. You pay the policy’s face amount—the amount the life insurance company will pay when you die. Since this amount is payable upon the death of the insured, the element of risk to the insurance company is much different than it is for an automobile or homeowners policy. When an insurance company issues an auto policy, for example, it hopes you will be a safe driver, never have an accident and never file a claim. When an insurance company issues a life policy, it knows it will be called upon to pay a claim someday—because everyone dies. The only unknown is whether the claim will be made in one year or in 50. This is why, not surprisingly, life insurance costs vary based on your age, health and the amount of insurance you buy.

Individual Life Insurance There are three broad types of individual or ordinary life insurance: • whole life,

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•

term life, and

•

endowment policies.

Chapter 5: Life Insurance Protects Many Things There are no standard policies in life insurance, as there are for homeowners or automobile insurance. This makes it tough to comparison shop among companies.

Death benefits are the one thing that all types of life insurance have in common. If your policy doesn’t pay a death benefit, it isn’t life insurance. The death benefit is the pure life insurance protection. You could argue that anyone who knew for certain he or she would live to an old age would be foolish to spend money on life insurance. The premiums could be put to better use over the course of a long life—and it would only be necessary to set aside a small sum for the funeral. None of us can be certain that we’ll live for a long time, even if our ancestors are long-lived. There’s always the possibility that a disease or accident will result in early death. Anyone can become a victim of a natural disaster or an act of violence.

Term Life vs. Whole Life The two most common forms of life insurance policies are term life and whole life. The names are remarkably apt, in that: • a term life policy lasts for a set period, say 10 years. If you die during that 10-year term, the policy will pay. If you don’t, it expires and that’s that; and •

a whole life policy lasts for your whole life. You absolutely will die during the policy period for a whole life insurance policy (although most will pay you the benefit before you die, if you live to be 100).

Typically, a term life policy provides protection for a period of one to 20 years. The best way to think of term life is as temporary insurance. A whole life policy, on the other hand, is permanent insurance. 75

Protect Yourself Term policies usually are used when you have a temporary need, such as: • a mortgage; •

business obligations; or

•

a particular need for income when your children are young.

Whole life products are effective when you have a permanent need, such as to: • supplement your surviving spouse’s income; •

cover funeral costs, pay capital gains taxes;

•

make charitable donations; or

•

pass a family business from one generation to the next.

A term policy does not build any cash, loan or surrender values. It essentially provides a death benefit only. For this reason, it is usually the least expensive form of life insurance. Its low cost allows you to buy higher levels of coverage at a younger age, when your need for protection is often greatest. Of course, it would be simple if there were only one kind of term life policy to consider. Instead, there are three: 1) Level term. Provides a consistent amount of insurance throughout the policy period. 2) Decreasing term. Good for shrinking debt obligations (such as a mortgage), and starts with a specified face amount, which decreases annually until it reaches zero when the policy expires. 3) Increasing term. Provides a growing amount of insurance, but the need for this type of protection is rare. Many term policies are also convertible, which means they may be exchanged for another type of life insurance. Choosing a convertible term life policy is one way to make sure you will be able to get

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Chapter 5: Life Insurance Protects Many Things permanent coverage at a later time, without having to prove that you are still insurable. You won’t want to stick with term life insurance for your entire life (assuming that you live a long time). By the time you reach 70 or 80 years of age, the premiums for a term policy usually approach the face amount of the insurance, because the insurance company figures you’re going to die soon.

Whole Life Insurance A whole life policy, sometimes called straight life or permanent life, is protection that can be kept as long as you live. It enables you to pay the same premium over the years—averaging the cost of the policy over your lifetime. Some characteristics of a whole life policy include the following: • Whole life insurance builds a cash value—a sum that grows over the years, tax-deferred. •

If you cancel the policy, you receive a lump sum equal to this amount (and you pay taxes on it if the cash value plus any dividends exceeds the sum of the premiums you paid).

•

If you need to stop paying premiums due to a temporary financial crisis, you can use the cash value in the policy to pay those premiums for a period of time.

•

You also can withdraw part of the cash value in the form of a policy loan. (If you die before repaying it, the loan and any interest due is repaid from the death benefit amount.)

•

The face amount in a whole life policy is constant, and this amount is paid if you die at any time while the policy is in effect.

•

The policy is designed to mature when you reach 100. If you live to be 100, you won’t have to pay any more premiums, and the policy’s cash value will be equal to the face

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Protect Yourself amount. So, the insurance company usually will pay you the face amount—even though you’re still alive. Most people do not plan on paying premiums until age 100. More commonly, whole life insurance is used as a form of level protection during the income-producing years. At retirement, many people then start to use the accumulated cash value to supplement their retirement income. Whole life plays an important role in financial planning for many families. In addition to the death benefit or eventual return of cash value, a whole life policy has some other significant features. For example, it may pay dividends. Whether or not it does is the primary difference between: • a participating (par) policy, issued by a mutual life insurance company, is one in which the policyholders receive dividends (if a dividend is declared); and •

a nonparticipating (non-par) policy, issued by a stock life insurance company.

Many people use the dividends in a participating policy to buy additional amounts of insurance, instead of taking the cash. This is really no different than taking a few extra dollars out of your pocket and making a separate purchase. Still, dividends are often a successful sales tool because some people like the idea of getting something extra back—even though they’ve paid more initially. Another significant feature of the whole life policy is that it guarantees the interest rate on any loans you take out against the cash value of the policy. (You also can get a bank loan using the cash value of the policy as collateral, but the guaranteed interest rate in the policy may be much lower than that available from a bank.)

Universal Life Insurance Another common form of life insurance is universal life. With this kind of policy:

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Chapter 5: Life Insurance Protects Many Things •

You may pay premiums at any time, of virtually any amount, subject to minimums.

•

The amount of cash value the policy builds is based both on the premiums paid and on the interest earned.

•

The insurance company subtracts money from the fund each month to cover the cost of the insurance and expenses.

•

They offer standard rates that can be substantially cheaper— as much as 30 percent or more—than standard rates charged by insurance companies for comparable term coverage.

Some universal life policies feature progressive underwriting (which means it’s easier to get coverage). These policies usually are structured so that if you pay the minimum annual premiums, coverage won’t lapse for 15 or 20 years. Another form of this insurance is variable universal life. It provides death benefits and cash values that vary according to the investment returns of stock and bond funds managed by the life insurance company. The premiums that you have to pay can also change a lot. Variable universal life is as much an investment tool as a true protection tool.

Target premiums are fixed in the first year—but policyholders, because of the flexible nature of the products, are not contractually entitled to those fixed payments afterward. The cost of variable universal life is too uncertain for some people because of the open-ended method of premium payment.

Troubles with Term The most important right you have when it comes to a life insurance policy is the right to keep the policy in force without restrictions or dramatic premium increases.

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Protect Yourself Some term policies, however, are guaranteed renewable and some are not. Some may even require a physical at the end of the term. If the company requires you to pass a medical examination to avoid a premium increase in the future, you have assumed a big risk. You get a discount for taking the risk, but is it worth it? Some critics argue that term insurance companies reduce the premium for a few years so that they can coerce you into a physical in the future. Many consumers are seduced by the low premiums on policies that require medical requalification to maintain a reasonable premium. To avoid this kind of problem, ask the following questions about any term policy you’re considering: •

If I don’t pass the medical requalification, what will the premiums be?

•

Are they written in the contract? Are they guaranteed?

•

If you’re required to take and pass a medical exam in order to avoid dramatic increases, how extensive is the exam?

•

What standards of underwriting will be applied at that time?

•

Will the underwriting standards be the same for requalification as for new applicants?

•

Will there only be a “pass” or “no-pass” standard, or will there be a range of ratings?

If the answers to these questions aren’t in writing in the policy, get another policy that does have them in writing. It’ll be worth it in long-run—for both you and your family.

Making a Decision You don’t have to have an in-depth understanding of life insurance to eliminate some options and make your final choice. Here are a few scenarios that may help you to decide which kind of coverage is right for you. 80

Chapter 5: Life Insurance Protects Many Things •

Are you young, with a family and broke? You might want to start out with a term policy. Are you trying to save money but having a tough time at it? A mix of term and cash value insurance might be ideal.

•

Are you divorced and need to (or are required to) maintain life insurance until your children are grown? A level term policy for the number of years necessary best fulfills this need.

•

Do you need life insurance for fewer than 10 years? Go with a term policy. Do you need it for more than 15 years? Try a whole life or cash value policy. Ten to 15 years? It’s a toss-up.

•

Are you over 60? Term is rarely useful because premiums quickly become unaffordable. Do you need life insurance to pay estate taxes? Try a cash-accumulating plan.

•

Are you in a high tax bracket? The higher your tax bracket, the more valuable whole life or other cash-accumulating insurance will be—if you properly understand it.

•

Are you in your forties and want to increase your retirement savings? In this scenario, several types of cash-accumulating policies make sense.

•

Are you an active investor under 50 and want to accumulate cash for retirement? A variable universal life plan will allow you to control the investment.

•

Are you an equity investor? You can use cash-value life insurance as the liquid part of your total portfolio.

Whatever you do, don’t buy a policy that you are afraid you can’t continue. Remember: Cash-value insurance only makes sense if maintained for more than 10 years. Why? The costs of operations, marketing,

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Protect Yourself etc., are loaded into the first few years of the policy. Therefore, the cash accumulates slowly at first. Cash-value is a good long-term investment because the cash accumulates tax-free. Therefore, for people in higher tax brackets who need the insurance for more than 15 years, cash-accumulating policies are the most cost-effective. The following chart will help you compare costs for three kinds of policies: term, whole life and a blend of term/whole life. Term vs. Whole Life Term vs. Whole Life Financial Comparison for 30 Years Financial Comparison for 30 Years Insurance Alternatives for a 40-Year-Old Male Insurance Alternatives for a 40-Year-Old Male Insurance Benefit: $100,000 Insurance Benefit: $100,000

Term (Plan A)

Blended Term/Whole Life (Plan B)

Whole Life (Plan C)

Year 1

$159

$1,287

$1,884

Year 10

194

1,287

1,884

Year 11

249

1,287

0

Year 20

525

1,287

0

$16,111

$46,314

$18,840

Ongoing Insurance

$0

$238,713

$160,303

Cash Value

$0

$174,257

$110,038

Annual Lifetime Income

$0

$17,406

$11,038

Annual Outlay

Total Outlay (Age 40-76)

Plan A: Premium increases annually. Insurance ends at age 70. Plan B: Level premium payments. Plan C: Level premium payments for only 10 years. (These figures are for illustration purposes only.)

A Few of the Hybrids If the decision to buy term or whole life seems complicated, then you’re not going to like what comes next. Not only are there combi-

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Chapter 5: Life Insurance Protects Many Things nations of the two, there is a plethora of derivative or hybrid policies on the market now, since insurance companies have been scrambling to create products that will meet particular needs or market niches. Some of these policies offer additional insurance benefits. Others offer additional non-insurance benefits. Some will be appropriate for first-time insurance buyers—but most will not. We can’t discuss all the different kinds of life insurance products here. (It sometimes seems as if every life insurance company has at least one unique policy.) But we will consider some of the most common combination and derivative products.

Family Income Policy One of the most popular, and perhaps most useful, of the combination life insurance contracts is the family income policy, which combines whole life insurance with decreasing term coverage. Under the term portion of the policy, monthly income benefits are paid to your family; the whole life portion provides a lump sum payment. Some family income policies split the lump sum into two parts. In this case, half of the policy’s face amount would be paid upon your death to cover the funeral expenses and the costs of the last illness. This would then be followed by income payments to your designated beneficiary (or beneficiaries) for a period of years—assuming the term part of the coverage had not expired. At the end of the payment period, there would be another lump sum payment equal to one-half the face amount of the policy. So, a family income policy has two time elements. The family income portion of the policy corresponds to the decreasing term time period. The base, or lump sum, part of the policy is usually whole life—thus, some degree of protection is provided for your whole life. The family income policy fulfills the need for higher amounts of coverage during the initial child-rearing years. When your children become self-supporting, the need for protection and coverage reduces (unless you begin caring for elderly parents at that point).

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Protect Yourself

Joint Life Policy A joint life policy is a whole life contract written with two or more persons as named insureds. For example, you and your spouse might decide to purchase a joint life policy. Most commonly, the policy is issued in this way—with the insured amount payable on the death of the first insured only. However, some policies pay on both deaths; others pay on the first death and then increase the amount of coverage on the remaining insured or insureds, so that the total coverage remains the same (usually for business insurance purposes). A variation on the joint life policy is the last survivor policy, which pays the insured amount not to the beneficiaries of the first insured to die, but to the beneficiaries of the last.

Modified Life Policy Modified life is typically a whole life product that is purchased at a very low premium for a short period of time (usually three to five years)—followed by a higher premium for the life of the policy. The policy may be a combination—with term for the modified period, converting to a whole life premium. In this way, premiums are lower than average during the modified period—and slightly higher than average (to make up for the early deficit) thereafter. Generally, a modified life policy is sold to people who want whole life but, for the next few years, will be unable to pay the typical premium.

Graded Premium Whole Life Graded premium whole life is similar to modified whole life in that, initially, the premium is low. Unlike modified life, which increases to a higher-level premium for the life of the contract, graded

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Chapter 5: Life Insurance Protects Many Things premium policies provide for an increase in premium each year for the first five to 10 years of the policy’s term. After this step rated premium period, the premium remains level. Graded premium and modified life policies do build cash value— but the amount is usually less than for a straight whole life policy, because of the smaller outlay of premium up front. Typically, a graded premium policy will have very little, if any, cash value during the graded premium period.

Split-Life Policy The split-life policy is a combination of a whole life or a term life insurance contract and an annuity contract, which provides a savings feature. This savings feature is a retirement annuity to age 65, and the life insurance feature is usually yearly renewable term insurance. If you do not purchase an annuity along with the life insurance, you do not receive the same low cost benefits as those who do. The insurance contract may be renewed as long as the annuity premium continues to be paid. The most common amount of coverage is $10,000 of term insurance for each $10 of annuity premium.

Adjustable Life Insurance An adjustable life policy allows you to adjust the policy’s face amount, premium and length of protection—without having to complete a new application or have another policy issued. This kind of insurance introduces the flexibility to convert to any form of insurance (such as from term to whole life) without adding, dropping or exchanging policies. This type of policy is based on a money purchase concept. The question, then, is not so much which type of policy you buy, but rather how much money you will spend. Adjustable life is flexible, but if an adjustment results in a higher death benefit, proof of insurability (determined by a physical) may be required for the additional coverage.

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Credit Life Insurance If you’re paying off a loan (or two…or six) or have some credit card debt, your unexpected death could create serious financial problems for your family. The solution: credit life insurance. This coverage, written on a group basis or in individual credit life policies, provides that, in the event of your death, the outstanding balances will be paid in full. It usually is written as a decreasing term type of coverage, so the amount of insurance shrinks as the amount of the debt shrinks. Level term insurance also may be written, which would remain level for the term of the policy (appropriate, for example, if you typically live with a certain amount of credit card debt). With this sort of insurance, you pay the premium. If you die, the benefits are paid to your creditor—to reduce or extinguish your debt. These policies are often added to the finance contract for a major purchase—so that, in effect, the insurance premium is being financed along with the item being purchased.

Riders and Other Modifications One mechanism that consumers use to tailor insurance policies to their needs is the use of riders and other modifications. This allows you to buy a more basic policy and customize it yourself, rather than having to take some benefits you’d rather not pay for. Riders can be used to enhance or add benefits to the policy, or they can be used to take away benefits from the policy. Riders usually require the payment of a relatively small additional premium for the benefits provided. Among the most common kinds of riders: • Accidental Death (Double Indemnity). The accidental death benefit, also called the principal sum (the rider’s face amount), provides an additional death benefit and a dismemberment benefit for loss of certain body parts, if the cause of death or loss is due to an accident as defined by the

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Chapter 5: Life Insurance Protects Many Things policy. Usually, death must occur within 90 days of the accident for the benefit to be paid.

If a death claim is submitted, it must comply with the policy’s definition if the additional accidental death benefit is to be paid. The definition of accidental death can vary, so be sure to clear this up before you purchase the rider.

•

Waiver of Premium. In the event of total disability as defined by the policy, this rider provides that premiums for the policy will be waived for the duration of the disability. The rider is temporary, in that it usually expires at age 65. There is usually a six-month waiting period before the rider’s benefits are payable. In other words, you must be totally disabled for six months (sometimes it’s only three months), and then future premiums will be waived for the duration of the total disability. A variation on this rider is Waiver of Premium with Disability Income. The same concept applies, but this rider also pays a weekly or monthly disability income benefit.

•

Guaranteed Insurability. Guarantees that at specified dates (option dates) in the future (or at specified ages or upon the event of specified occurrences, such as marriage and the birth of a child when you are between the ages of 25 and 40 or policy anniversary nearest your birthday at ages 25, 28, 31, 34, 37 and 40), you may purchase additional insurance without evidence of insurability. The rate for any additional coverage purchased is based on your attained age, not the age at which the policy was issued. The amount of insurance on the option dates usually is limited to the amount and type of the base policy.

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Protect Yourself The biggest advantage offered by this rider is the opportunity to buy additional amounts of insurance as your needs change, without proof of insurability. •

Return of Premium. This rider is simply an increasing amount of term insurance that always equals the total of premiums paid at any point during the effective years. Technically, it does not return premiums, but pays an additional amount equal to premiums paid to date of death. The policy owner who purchases the rider is simply buying additional term insurance.

•

Return of Cash Value. Seldom-used, this rider is similar to the return of premium rider, in that it is merely an additional amount of term insurance that is equal to the cash value at any point while effective. If you buy it, you are simply getting additional term insurance.

•

Cost of Living Adjustment. This rider changes the face amount of the policy each year by a stated percentage, such as 5 percent. This amount is compounded annually. This rider can be used to increase and decrease the face amount of the policy, depending on the cost of living—though there are limits on how much the amount can be decreased.

•

Additional Insureds. These riders are commonly attached to life insurance policies to provide coverage on the lives of one or more additional people. Often, these are term insurance riders covering a spouse, one or more children or all family members in addition to the named insured. Most companies issue additional insured riders on request. Some actively market combination coverage policies for family members as a family protection policy.

•

Living Need. This rider allows a terminally ill individual to obtain part of the insurance proceeds prior to death.

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Chapter 5: Life Insurance Protects Many Things However, you must you must have medical proof of a terminal illness. Most companies offering this benefit will limit the amount of the insurance proceeds paid in this manner. Companies usually do not charge an additional premium for this rider, because it is an advance against the death proceeds for which you are already paying premiums.

Some companies offer a variety of riders and options as sales tools—to allow a salesperson to focus on the riders and distract your attention from the poor quality of the basic product. Beware of agents pushing the unique benefits and riders as compelling reasons to buy a life insurance policy.

Accelerated Benefits and Viatical Settlements If you have a terminal illness, life insurance benefits may be made available for medical expenses and living expenses prior to death through accelerated benefit provisions or viatical settlement agreements. A key point to remember: Any accelerated benefits that are paid out reduce the remaining death benefit. The government does not currently consider accelerated death payments to be taxable income, thus the policy owner can get between 50 and 95 percent of the policy’s face value. A viatical settlement allows the policyholder to sell all his rights to the life policy to a viatical settlement company, which advances a percentage (usually 60 percent to 80 percent) of the eventual death benefit. When the insured person dies, the viatical settlement company receives the death benefit. Unlike accelerated benefits, proceeds from viatical settlements are considered taxable income by the government. Are they for you? That depends. Accelerated death benefits require a life expectancy of

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Protect Yourself one year or less. Viatical settlements are available for a person who has up to five years to live.

Exclusions and Limitations Life insurance policies also contain certain exclusions or restrictions. The main exclusions are: •

Suicide Exclusion. Initially, life insurance contracts excluded suicide entirely. But this exclusion left dependents without protection, which defeated the purpose of purchasing the coverage. Also, it was incorrect to exclude suicide completely, because death by suicide is included in the mortality tables upon which premiums are based. So, the majority of life insurance policies issued today contain a time provision (usually two years) that restricts liability in the event of suicide. Although, occasionally, it is only one year or less. A typical provision is that in the event of suicide within this period, the liability of the company shall be restricted to an amount equal to the total of premiums paid, without interest, less any indebtedness.

•

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Aviation Exclusion. Aviation exclusions are rarely found in life insurance policies, but among the types of aviation restrictions still in existence are: 1) exclusion of all aviationcaused or -related deaths, except those of fare-paying passengers on regularly scheduled airlines; 2) exclusion of deaths in military aircraft only or death while on military maneuvers; and 3) exclusion of pilots, crew members, student pilots and (sometimes) anyone with duties in flight or while descending from an aircraft (for example, parachuting). Companies that use these restrictions will usually cover you in the event of a civil aviation death for an extra premium. The exclusions or restrictions apply only to those unwilling to pay the extra premium.

Chapter 5: Life Insurance Protects Many Things •

War and Military Service Exclusion. In wartime, it’s common for companies to limit the death benefit paid to a refund of premium, plus interest—or possibly an amount equal to the policy’s cash value. Also, the policy’s benefits often are suspended during a war or an act of war. There are two types of restrictions or clauses that may be used: 1) the status clause, which excludes the payment of the death benefit while you are serving in the military; and 2) the results clause, which excludes the payment of the death benefit if you are killed as a result of war.

•

Hazardous Occupations and Avocations Exclusion. By today’s underwriting standards, few applicants are declined life insurance because of their occupations. Much of the underwriting attention in this area focuses on avocations or hobbies. If you participate in a hazardous hobby— such as auto racing, sky diving, scuba diving, etc.—then the amount of insurance you can get may be limited, or you may have to pay an extra premium. And the death benefit may be excluded if your death is a result of the hazardous avocation.

Some Basic Definitions By now, you should know that the insured is the person whose life is insured. A death benefit will be paid if this person dies while the insurance is in effect. The owner of a policy is the person who applies for the insurance, agrees to pay the premiums, and has certain ownership rights. Generally, the policy owner has the right to: • elect or change the beneficiary, •

elect settlement options, and

•

assign ownership to another person.

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Protect Yourself A beneficiary is someone who is entitled to death benefits if the insured person dies. There may be one or more designated beneficiaries: • primary beneficiaries who are entitled to the proceeds if they are living; and •

contingent beneficiaries who are entitled to the proceeds if there is no surviving primary beneficiary when an insured dies.

The owner of a policy may or may not be the insured person, and may or may not be the beneficiary. The same person cannot be both the insured and the beneficiary, but the insured’s estate can.

The owner of a life insurance policy is entitled to certain valuable rights. These include: • the right to assign or transfer the policy; •

the right to select and change the payment schedule, beneficiary and settlement option;

•

the right to receive cash values or dividends; and

•

the right to borrow from the cash value.

Insurable Interest You can’t purchase life insurance on the lives of anybody. In order to purchase life insurance, you must have a legitimate insurable interest in the subject of the insurance. There must be a personal risk of emotional or financial loss, and a legitimate interest in preserving and protecting the life being insured. Every person is presumed to have an insurable interest in his or her own life. You also have an insurable interest in the lives of close

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Chapter 5: Life Insurance Protects Many Things relatives through blood or marriage. Usually this extends to those who could be considered immediate family members—such as your spouse, children, parents and perhaps brothers and sisters. The requirement for insurable interest becomes more difficult to justify when insurance is sought on the lives of more distant relatives, such as uncles, aunts, nephews, nieces and cousins, but insurable interest certainly may exist in these cases—especially when these relatives live in the same household as the insured person. In the life insurance business, insurable interest must exist at the time of application and inception of the policy and not necessarily at the time of death. If a policy is valid when it is issued, the death benefit is payable even if insurable interest no longer exists at the time of the insured person’s death. The requirement for insurable interest applies only to the owner of a policy. There is a greater flexibility allowed when it comes to the proposed insured’s selection of a beneficiary.

Conclusion In spite of all the choices, the basics of life insurance are pretty simple. Its key purpose is to pay a death benefit—and a death benefit is the one feature that all forms of life insurance have in common. These benefits cover final expenses, pay outstanding debts and provide income and security for your family in the event of your premature death. And, they also can be used to pay estate taxes and set up an education fund for your children. Life insurance products have evolved in response to changing economic conditions and consumer preferences. Despite these changes, all life insurance policies include some form of true life insurance protection. And, many policies also include other types of insurance benefits and non-insurance elements. Remember: If you don’t have any dependents and you don’t own a business, you probably don’t need life insurance.

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Protect Yourself And even if you do have people who are counting on you for financial support, it is important to insure only what you need to insure. Before making a final decision on your policy, ask yourself some of the following questions. • Do you want to purchase a family income policy? •

Do you want to purchase a joint life policy?

•

Do you need a policy that allows you to pay less money now and more in the future, such as a modified life policy?

•

Would you prefer to pay more money now and less in the future, such as for a deposit term insurance policy?

•

Are you interested in a policy that combines life insurance and an annuity?

•

Would you like any of the following riders: Accidental death? Waiver of premium? Guaranteed insurability? Return of premium? Return of cash value? Cost of living adjustment? Additional insureds? Living need?

When you’ve answered these questions for yourself, you should be in good shape to buy the insurance…either from an agent or directly from a company, over the telephone or the Internet. The direct channels are usually the most cost-effective way to secure this essential financial protection.

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Chapter 6: Your Family’s Health CHAPTER

6

Your Family’s Health

Protecting your own health is important. Protecting the health of your family may be even more important to you. In Chapter 4, we looked at insurance, prevention and the other steps you can take to look after your own physical well-being. In this chapter, we’ll take a look at the best ways to protect the health of those dear to you. What are the differences? Obviously, you will have a harder time controlling…or even influencing…the behavior of family members than yourself. A spouse may your dietary advice. Children will follow your lead when they are small. But when they reach their teens… . And diet is probably the easiest health factor to influence. There isn’t much you can do about driving (when you’re not in the car), things that happen on the athletic field or random crimes. And this doesn’t even touch on your rebellious 16-year-old’s penchant for smoking cigarettes—which may be the safest thing she smokes. The best protective measure that most people can take for their family’s physical well-being is to buy the best health insurance available. And, with the early 2000s pointing toward a harder insurance market, it’s key to do the research and find the right coverage for the right price—removing the risk of you and your family suffering a catastrophic financial loss. Health coverage is packaged in two ways: for individuals and for groups. Like most people in the United States, you probably get your coverage in a group package offered by your employer. Often, health insurance is the most important benefit to working.

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Protect Yourself Although group and individual health insurance policies share many of the same policy provisions, there are significant differences. • In an individual policy, the contract is between you and your insurance company. •

In a group policy, the contract is between the company and your employer, union, trust or other sponsoring organization.

A caveat: Your family members may be covered under both group and individual policies. But you should determine how they will be covered before signing on to either kind of policy.

•

While group policies may have fewer limitations, they do have one important drawback. If you change jobs, you may no longer be covered under your last employer’s group policy.

•

However, individual health insurance contracts continue regardless of change of employment.

•

Group medical coverage may cost less than individual policies depending on the ages and dependent status of the participants.

The Group Insurance Contract A group insurance policy, or master policy is issued to the policyowner—usually your employer, association, union, or trust, etc. If you are covered under the group policy you are issued a certificate of insurance. • The certificate lists what the policy covers, and explains such things as how to file a claim, the term of insurance and the right to convert from group coverage to an individual policy.

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Chapter 6: Your Family’s Health •

Group health insurance is generally subject to experience rating, under which the premium modification factor is determined by the experience of the group as a whole.

•

In contrast, individual policies may be subject to community rating, under which the insurance company’s overall experience is adjusted in different areas to reflect variations in local costs for doctor and hospital services.

Employee, Association and Trustee Groups A group policy may be issued to an employer (or to the trustee of a fund established by an employer) where insurance is secured for the benefit of the employees, or for persons other than the employer. • The employer is the policyowner and establishes eligible employees to be covered under the group policy. •

Usually, this classification will include all full-time employees (including the employer).

•

The classification can also specify full-time, salaried, nonunion employees.

•

By classifying the employee group in this manner, the employer is legally able to exclude certain groups of employees (part-time, union, etc.) from the eligible class of covered employees.

•

The eligible class of employees may also include retired employees.

An association, including an industry trade group or a labor union, must have the following characteristics to be considered an authorized group: • have a constitution and bylaws; •

be organized and maintained for purposes other than obtaining insurance; and

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have insurance for the purpose of covering members or employees for the benefit of persons other than the association or its officers or trustees (in this context, the term “employee” may include retired employees).

Finally, a group policy may also be issued to the trustees of a “trust group” if the fund has been: • established by two or more employers in the same or related field; or •

established by one or more labor unions or associations (this is also known as a “Taft-Hartley Trust”).

The trustees are the policyholders under the plan, which covers the eligible employees. The plan can’t be for the benefit of the employer, union or association; the individuals who may be considered “employees” as defined by this section are the same as those previously listed under Employee Group. Group health coverages track closely with benefits available under individual coverages. We will discuss them under the headings of disability income and medical expense benefits.

Disability Income Group disability income coverage provides for loss of income benefits due to a disability caused by an accident or sickness. • The amount of benefits paid is usually a percentage of your weekly or monthly compensation, such as 60 percent or 70 percent. This is intended to encourage you—the disabled employee—to recover and return to work.

•

If 100 percent of compensation were provided, there would be no incentive for you to return to work.

•

Benefits are payable following the policy’s elimination period (EP).

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Chapter 6: Your Family’s Health •

The EP is a waiting period during which you must be totally disabled as defined by the policy. An EP can be 7, 15, 30 days or longer.

Group disability benefits may be short-term or long-term. Short-term benefits are usually payable for up to one or two years—though usually one year. Short-term policies usually have short elimination periods such as 15 or 30 days. Long-term disability (LTD) benefits are usually paid out for periods such as five years or until you turn 65. Generally, LTD policies will have longer elimination periods, such as 90 or 180 days. (For more detailed information on disability protection, please see Chapter 12: Disability Insurance and Social Security.)

Medical Expense Basic Group Medical Expense policies usually provide benefits for inpatient services such as hospital room and board costs, surgical expenses and miscellaneous charges. Outpatient (out-of-the-hospital) expenses are usually not covered. Basic group plans have limitations. Among them: • Usually, benefits are limited to a specified amount. •

Room and board charges may be limited to $300 or $400 per day for example. Surgical benefits are usually factors of a surgical schedule that specifies the maximum surgical benefit to be paid.

•

Miscellaneous benefits (private duty nurses, bandages, medication, in-hospital x-rays, lab work, etc.) are usually limited by an amount equal to 10 or 20 times the daily room and board rate.

•

Basic plans are also limited in terms of time. Most plans will specify that policy benefits will be paid for 30 days or possibly up to 365 days.

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Because of these limitations, basic medical expense plans usually do not cover medical expenses in full. As a result, you’re responsible for certain out-of-pocket expenses.

Group Major Medical In contrast to basic group medical plans, group major medical policies provide more comprehensive benefits. Group major medical will “limit” benefits normally to what is reasonable and customary as opposed to a specific dollar amount. In essence, you are provided with a sum of money to cover medical expenses. • Most insurers require 75 percent or more of the eligible members to participate. •

Under a noncontributory plan, the employer pays the entire premium. The insurance companies in this case require 100 percent participation.

•

The minimum participation requirement is to help guard against adverse selection. If a free choice were given, many people in good health might not choose the insurance, whereas many in poor health most certainly would.

•

If you are single, you can usually purchase individual coverage for less premium than if comparable coverage was obtained under a group policy.

When a group policy is rated, the premium may be higher or lower than individual coverage because everyone in the group is paying for every other group member. If the ages of the participants are relatively high, the premiums will be high. A single person, age 21, will consequently pay a relatively higher premium (due to the age of the group) than he or she might pay on an individual policy basis.

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Chapter 6: Your Family’s Health •

An individual policy is rated on the age and insurability of the applicant, not an entire group.

•

A married person with several children would probably find that the group premium would be less than an individual family premium.

•

A married person with several children would usually pay a family rate regardless of the number of dependents he or she has. This is a good deal for people with families.

Self-Insured Plans If claim costs are fairly consistent, your employer may consider a self-funded health care plan. • With a self-funded plan, your employer—not an insurance company—provides the funds to make claim payments for company employees and their dependents. •

In the event that claims are higher than predicted, a selffunded health insurance plan can be backed-up by a stoploss contract. The stop-loss contract is designed to limit your employer’s liability for claims.

Generally, there are two variations of this coverage: 1) Specific stop-loss coverage applies after your medical expenses exceed a predetermined threshold such as $5,000. 2) Aggregate stop-loss coverage applies when your employer’s liability for group insurance claims exceeds a specified amount. The insurance company will pay all claims once the specified amount is reached. An employer self-funded plan may be an indemnity program, which reimburses you for the medical care you have received. Or, your employer may provide benefits through the service plan offered under an HMO, or through the insurance company’s PPO network.

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Protect Yourself An insurance company may also be used for a self-funded employer to help out with needed administrative services. Government allows anyone who is self-employed to deduct a portion of his or her health insurance premiums.

Third-Party Administrators A third-party administrator is a firm that provides administrative services for your employer or other associations having group insurance policies. • The third-party administrator acts as a liaison between the insurance company and your employer in matters such as certifying eligibility, preparing reports required by the state and processing claims. •

Use of third-party administrators became common in the 1990s, as larger employers self-funded health plans.

Small Employers Small employers (those with fewer than 25 employees) have been especially hard hit by increases in health insurance premiums. Because many group plans are experience rated, small employers see an immediate premium increase whenever claims are high. If the average age of the participants is high, or if claims experience is high, or if there has been even one long or catastrophic illness in a small employer plan, it can make insurance unaffordable for the whole group. Recent surveys by the Health Insurance Association of America (HIAA) indicate a substantial decline in the number of small firms that are able to offer health coverage to their employees. Some states have acted to ensure that health insurance coverage is available at a reasonable cost and under reasonable conditions for small employers. Under the programs, insurance companies are required:

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Chapter 6: Your Family’s Health •

to offer standard benefit plans that must be offered to small employers;

•

to limit waiting periods for preexisting conditions;

•

not to exclude particular individuals or medical conditions from coverage; and

•

not to cancel small employer plans for reasons other than nonpayment of premium, fraud, misrepresentation or noncompliance with plan provisions.

Cafeteria Plans and Other Variations Another response to the higher medical costs of the last 20 years has been an explosion in the number of alternative plans available for small companies and their employees. These plans vary widely from the basic HMO/PPO choices that most people have when it comes to buying health protection for their families. In some cases, the plans are mostly busywork for HR departments…but, in some cases, they can add a lot of value to family health. Under a cafeteria plan, you select health benefits from a variety of options, based on your individual and family needs. • Cafeteria plans tend to be more complex (and more expensive) than traditional plans, especially with regard to plan administration—the fees that either you or your employer pay are usually pretty steep. For this reason, the plans often make the most sense for larger companies. •

Benefits are elected in advance of the year in which they will be used. For example, benefits to be used in 2003 are budgeted at the end of 2002.

Medical Savings Account (MSA) A medical savings account (MSA) is an employer-funded account linked to a high deductible medical indemnity plan.

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Usually, your employer raises the existing plan deductible (usually by 300 percent to 400 percent) and in turn returns a portion of the premium savings to you as contributions to the medical savings account.

•

You can use these contributions to pay for health care expenses throughout the year, and at the end of the year, you may withdraw whatever remains in the account as (taxable) cash or “roll it over” to be added to the amount you can use in the following year.

Multiple Employer Trusts (METs) Multiple employer trusts provide health insurance benefits to small businesses through a series of trusts usually established based on specific industries such as manufacturing, printing, real estate, etc. Most states have group size eligibility requirements for employer groups to qualify for group insurance. • Generally, states may require a minimum of five to 10 participants for a group to be eligible for group benefits. METs typically have no such requirements and in reality a group of one could be eligible for group benefits. •

METs are formed by insurance companies or third-party administrators called sponsors. The sponsor develops the plan, sets the underwriting rules and administers the plan.

To help prevent the possibility of adverse selection, the underwriter must make sure that the sponsor’s underwriting rules are adequate and that he or she adheres to them. This is necessary because an employer with only two, three or five employees could elect to join a MET because they know of the poor health condition of one of the employees. These standards must be able to prevent this from happening.

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Chapter 6: Your Family’s Health If state law allows, METs may be noninsured. A noninsured plan is a self-funded plan; that is, a plan that operates without the services and funds of an insurance company. The trustee has charge of the funds and the policies and all financial activities occur through the trust. As with a traditional group insurance plan, a master policy is issued to a trustee who is operating under a trust agreement. • The master contract has its own effective date and renewal dates that the insurance company may use for changing rates on the MET’s entire block of business. •

Also, every employer under the MET has its own effective dates and anniversary dates.

•

Rates are generally changed on an employer’s anniversary date, but usually not more than once a year.

Multiple Employer Welfare Arrangements (MEWA) Multiple employer welfare arrangements (MEWAs) are employer funds and trusts providing health care benefits (among other benefits) to employees of two or more employers. ERISA, the federal Employee Retirement Income Security Act, is designed to protect you if you are in a group health insurance plan. It restricts a state’s ability to regulate employee benefit plans while preserving state insurance laws on reserve requirements. A state may regulate insurance—but may or may not consider an employee benefit plan “insurance” for the purpose of regulation. Some self-funded MEWAs claim they are not subject to state insurance regulation and operate under a supposed preemption under ERISA. As a result, many have gone unregulated, and have fraudulently collected premiums from small business only to fold and leave millions of dollars of unpaid claims. Regulators are attempting to resolve the issue of jurisdiction.

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Protect Yourself Meanwhile, in most states MEWAs need to obtain a Certificate of Authority in order to transact insurance business, and must be fully insured by a licensed insurance company. Usually, agents and brokers are prohibited from assisting MEWAs to transact insurance until and unless the agent or broker files a report with the Department of Insurance outlining the MEWA’s organization, insurance contracts, benefit plan description and the designated third-party administrator.

Dental, Vision and Prescription Drug Plans Dental care is usually considered a budgetable expense, so it’s usually not included in group health plans. However, you can usually obtain dental care from your employer in the form of employee benefits. • Some health plans do include dental coverage as part of the medical plan; others include it as a separate add-on plan. •

Many plans do provide coverage for noncosmetic dental work resulting from an accident.

•

Your employer may also offer direct reimbursement for dental care—this is a noninsured dental coverage plan typically used by smaller employers—in which your employer agrees to pay for a percentage or amount of the expenses.

•

Small employers usually go with direct reimbursement to avoid both the costs associated with an insured plan and the administrative complexity of going through an insurance company.

The risk is considerably smaller because dental expenses, unlike medical expenses, tend to be more predictable and seldom involve catastrophic expenses.

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Chapter 6: Your Family’s Health Vision coverage is similar to dental, in that it is a relatively new benefit, usually offered by employers that can afford to add certain fringe benefits typically considered budgetable. • Most health plans provide coverage for medical care related to eye injury or disease, but not for costs associated with periodic eye examinations or corrective lenses. •

Vision care is typically covered on a scheduled basis that pays a fixed dollar amount for examinations, lenses and frames.

Most often, only prescription drugs that are for treatment of an illness or injury are covered by a health plan—subject to applicable deductibles and coinsurance. • Your insurance company might not cover your contraceptive prescription drugs or the nicotine chewing gum you need to help you quit smoking. •

Different insurance companies offer different types of drug plans, but the basic types of prescription medication plans include open panel, closed panel, mail order and prescription drug card plans.

Conclusion Group health insurance dominates the market because it receives a number of critical subsidies from the federal government. Most of the subsidies come in the form of tax breaks. Medical expense benefits are generally considered to be reimbursements for medical expenses already incurred, and therefore are not taxable as income. Disability and long-term care insurance provided on a group basis enjoys the same tax status as group life and health insurance, meaning premiums paid by the employer are tax deductible and benefits are received tax free up to specified limits.

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Protect Yourself With all of these tax breaks, it’s little wonder that so many people get their health coverage through group policies at work. The main question that you should consider as an informed consumer: Will the federal government ever end the subsidies it gives employers—as part of some larger health insurance reform plan or otherwise? For anyone who gets health insurance under a group plan—which includes most American families—the answer is no.

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Chapter 7: Disasters CHAPTER

7

Disasters

Some lucky people can buy exactly the kind and amount of property insurance they need off the shelf. All they need to do is pick up a phone, call an insurance agent and buy the standard homeowners, renters or auto policies. But, for many people—and you may be among them—life’s risks are more complicated. You may fit in this less-than-lucky number if you live in a hurricane or flood region, earthquake zone, fire corridor or even a simple hillside. In these cases, the insurance agents may not want to take your call. In 2001, according to the Insurance Service Office (ISO), insurance companies paid out $24 billion in insured property damage, the highest figure ever for catastrophe losses (property losses related to the World Trade Center attack weren’t included in these numbers). This record was set even though the number of catastrophic events was the lowest for any year since 1969. Some regional property insurance markets grapple continually with severe problems in financing disaster or catastrophe risk. In the end, many catastrophe risks are simply too difficult to insure. The result is diminished availability and high price of property coverage in areas subject to natural disasters. There are two main causes of these insurance problems: 1) constantly-revised estimates for the actuarial cost of catastrophe risk. This is the estimated annual average loss from catastrophes. During the 1980s and 1990s, actuarial estimates of the potential catastrophes skyrocketed; and

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Protect Yourself 2) perhaps more important, the greater severity of the disasters observed in recent years. Both of these trends were in place before the 9/11/01 terrorist attacks on New York and Washington, D.C. Insurance claims related to the collapse of the World Trade Center in New York are estimated to reach $40 billion. And insurance companies agree that the risks posed by terrorists remain small, compared to the risks posed by natural disasters. Given the magnitude of the 9/11/01 losses, the sums required to fund catastrophic claims can’t be obtained easily at reasonable cost or accumulated over time (for tax reasons). These conditions make insurance a product that is costly and difficult to supply in at-risk areas. For many insurers, the heightened severity of the next disaster is compounded by the concentration of insurance policies in high-risk areas. An insurer facing such a situation has only two alternatives. It can either: 1) reduce its exposure in high-risk areas, or 2) increase its reinsurance to cover a greater portion of its losses. In the 1980s and 1990s, when the big risks facing the insurance industry were natural disasters like Hurricane Andrew or the Northridge (California) earthquake, reinsurance looked like the right solution. This “insurance for insurance companies” was written by a number of small, low-profile speciality firms—often controlled by financial experts like Warren Buffett or the teams of MBAs at outfits like GE Capital. A number of these reinsurance companies (called “Re companies” in insurance jargon) used aggressive accounting practices and complex investment strategies to manage risks that they were taking.

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Chapter 7: Disasters The terrorist attacks of 9/11/01 and the financial accounting scandals that plagued the U.S. during the year following have taken some of the luster away from the Re companies. As a result, the insurance industry has focused on protecting itself rather than offering the best protection to people who live in disaster-prone areas. This plays to some lazy tendencies: • Many homeowners fail to upgrade their policies regularly to reflect such physical improvements as porches and decks, kitchen and bathroom enhancements and finished basements that would affect home replacement costs. •

Often, the insurance valuation problem arises because many insurers still rely on antiquated, quick and easy squarefootage methods of calculation compared with new, more sophisticated methods of estimating based on advanced technology and computerization.

The consequences? Policyholders underpay or insurance companies pay to replace improvements for which they never charged sufficient premiums. This may seem like a good thing for consumers; but it creates market imbalances that limit coverage over the long run. Some insurance experts estimate that up to 75 percent of all homeowners have inadequate protection because their coverage is based on mortgage balances or square footage.

Rather than adjusting policy terms incrementally, conducting inspections and carrying out relatively small rate increases spread across the entire population, the industry has raised prices drastically and beaten a hasty retreat from places like Florida and other coastal areas. This may address the fairness issue by not penalizing policyholders in lower risk areas; but it creates acute problems in high-risk areas. What can you do if you live in one of these high-risk areas? In this chapter, we’ll consider the options.

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Loss Mitigation One way to “prefund” catastrophe costs is to prevent them in the first place through loss mitigation—in other words, avoiding risks in the first place. Unfortunately, the failure of market forces and government policy to encourage loss mitigation has increased the potential severity of catastrophic losses. People like living near water, on hillsides and in urban areas, no matter how risky these places may be. More than 68 million people now live in hurricane-vulnerable coastal areas of the U.S., up from 52 million in 1970—a 31 percent increase over 30 years. And, 55 percent of the U.S. population now lives within 50 miles of the East or West Coast.

Many owners do not see it in their interest to reduce the vulnerability of their property to damage from natural disasters. There are many reasons for this failure, including: • lack of knowledge or underestimation of the exposure to loss and the benefits of mitigation; •

lack of insurance premium discounts for mitigation because of screwy “consumer protection” regulations on rates;

•

tax deductions for unmitigated and uninsured disaster losses;

•

inadequate enforcement of building codes;

•

lack of financing for mitigation expenditures; and

•

expectations of government financial assistance in the event of a disaster.

The lack of mitigation makes it more difficult and expensive for insurers, reinsurance companies and financial markets to assume catastrophe risk. Though laws and tax codes encourage risky real estate decisions, there are some steps that anyone can take to reduce catastrophe losses.

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Chapter 7: Disasters The simplest thing is probably making sure your property is up to code. For example, roofing construction and building materials may determine windstorm losses more than any other single factor. Mitigation doesn’t have to be complex. It can be as simple as putting away lawn furniture that can become projectiles in high winds, trimming trees and spending about $200 to tie down roofs. More complex methods of mitigation would include states implementing stricter building codes and offering tax or premium incentives for retrofitting structures to withstand the storms.

Earthquakes, Floods and Fires Some perils are generally not covered—or not covered sufficiently—by standard homeowners insurance policies. Chief among these: earthquakes, floods and fires. In this section, we will consider how homeowners can deal with each of these disasters. But, first, some background. • Residents of areas prone to crime, fires and windstorms may also find insurance companies unwilling or unable to sell them policies. Most commercial insurance companies simply don’t write flood insurance; many won’t write any insurance for homes in flood plains. •

The easiest way for homeowners in these areas to buy insurance is through one of several federally-administered flood insurance programs.

•

While this may not make sense from a broad, governmental or budgetary perspective, it’s a great deal for those who live dangerously.

So, if you live in a high-risk area, you should consider buying any of the following government-subsidized protections: • flood insurance, •

windstorm insurance,

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high-risk homeowners or renters policies, or

•

earthquake insurance.

Generally, these kinds of insurance are a bad deal for the country as a whole…but a good deal for anyone who qualifies for them.

Earthquake Coverage Standard property insurance does not cover losses caused by an earthquake—but earthquake coverage for the residence, other structures and personal property may be attached by endorsement. • Several earthquake-prone states—most notably California— require any insurance company that writes homeowners coverage to write earthquake coverage. •

This doesn’t mean these companies have to publicize earthquake coverage. Most stay quiet about it. But they have to give you information, if you ask.

•

When earthquake coverage is purchased, an additional charge is made for the coverage. And this can be expensive—sometimes as much as the underlying basic homeowners coverage.

The type of construction of the structure is a significant factor in earthquake rates. Different rates apply to frame buildings (wood, or stucco-covered wood structures) and to those classified as masonry (brick, stone, adobe or concrete block). For earthquake coverage, masonry rates are usually higher than frame rates. For ordinary property coverages, the reverse is true—masonry rates are lower than frame rates. This situation exists because of the nature of the exposure: wooden buildings are more vulnerable to fire than stone or brick buildings are; but stone or brick buildings are more vulnerable to earthquakes than wooden buildings are.

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Chapter 7: Disasters Because it’s so expensive, earthquake insurance is usually sold with high deductibles—making it, appropriately, a catastrophic coverage. Anything short of major damage to your house won’t be covered. If you don’t have earthquake insurance and suffer substantial losses when the Big One hits, you can claim a so-called casualty loss on your taxes—but only if you have unreimbursed damage in excess of 10 percent of your annual income plus $100. So, if you earn $50,000 a year, you can write off damages only in excess of $5,100. Once an area has been officially designated a federal disaster area in the wake of an earthquake, FEMA and other agencies make various forms of low-interest and no-interest loans available for rebuilding. Many people simply count on these subsidized loans as their earthquake insurance. A final point: Earthquakes are ongoing disasters. They require some even-tempered management. If you have substantial damage to your home, including exposure to outdoor weather, your insurance company will expect you to seal it off—so rain will not cause more damage. • If you do have earthquake coverage, you may well end up making repairs two or three times—because aftershocks can damage the repairs in process. The insurance company will usually pay for these multiple repairs. •

The best strategy for buying earthquake insurance is to take the coverage with a deductible equal to 20 to 50 percent of the cost of rebuilding. That will keep the premiums low—and, if things get shaken up, you can usually get a cheap FEMA loan for the high deductible.

This is the opposite of the best plan for flood insurance—which is, simply, buy as much of the subsidized FEMA coverage as the Feds will sell you.

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Protect Yourself Insurance companies will often try to classify any damage caused by water—which often comes after an earthquake—as “flood-related” and, therefore, not covered. This can be an issue on which you have to press hard for your rights. In California, some homeowners may qualify for a so-called “minipolicy” offered directly from the state through its California Earthquake Authority. The advantage of the mini-policy is that it’s cheap; the disadvantage is that it doesn’t offer as much coverage as an endorsement from your insurance company. In either case, most people count on FEMA loans as key part of earthquake protection.

Flood Coverage Ninety percent of all natural disasters in this country involve flooding, according to the National Flood Insurance Program. Between 25 and 30 percent of flood insurance claims are for damage in areas designated low risk because the severity of rainstorms is growing and federal officials have not yet redrawn existing flood plain maps to reflect additional areas at risk of flooding. This is a big reason to consider flood insurance. Many people don’t think about flood insurance. Floods, however, are the most common natural disaster. They occur so often, most of them are not declared disasters by the president and, therefore, victims don’t get federal financial assistance. Flood insurance pays even if a disaster is not declared. Only one in five Americans who live in flood zones have flood insurance, and the percentage of people who live elsewhere is substantially lower. But one third of all flood claims come from outside the high-risk areas.

How do you get flood coverage? The easiest way is to go through the National Flood Insurance Program (NFIP), which is part of the Federal Emergency Management Agency. The NFIP is the pri-

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Chapter 7: Disasters mary provider of flood insurance in this country. You can also buy NFIP flood insurance from your private insurance company or agent; coverage is financially backed by the U.S. government. You must apply for flood coverage at least 30 days in advance. You cannot watch the weather report and then expect to have a policy effective at midnight. You are probably more at risk for flooding than you think. You may not live in Houston or near the flood plains of the Mississippi, but severe snow, overflowing rivers, heavy rains (El Niño), levy or dam failures can cause flooding. If your community does not participate in the NFIP, ask your insurance company or agent what you can do to acquire coverage. But everyone should beware of certain contents that are not insurable under a flood policy: • animals and livestock; •

licensed vehicles;

•

jewelry, artwork, furs and similar items valued at more than $250;

•

money or valuable papers; and

•

items in a structure that does not qualify as an “insurable building” such as garden tools stored in an open carport.

If you need these items covered, ask your insurance company or agent. There may be supplemental insurance available to you. There are major differences between flood damage and water damage. Standard property insurance protects you and your possessions against damage caused by water…but not by floods. Sometimes, it takes a legal genius—or several—to determine whether a loss is related to water damage or a flood. If your family has some flooding in your basement on various dates over several months, you might make a claim under your standard homeowners policy. But your insurance company might deny

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Protect Yourself coverage—as many have done—issuing a disclaimer letter based on standard policy provisions that exclude coverage for water damage due specifically to: 1) “flood, surface water, waves, tidal water, overflow of a body of water, or spray from any of these, whether or not driven by wind”; and 2) “water below the surface of the ground, including water which exerts pressure on or seeps or leaks through a building, sidewalk, driveway, foundation, swimming pool or other structure.” Let’s say you point out that the story was more complicated than that. The basement flooding was due to a town water main break underneath your street. You offer evidence that debris from the water main break clogged a town storm drain pipe connected to your subsurface drainage system. It was after this episode that your basement started flooding every time it rained. Better still, you can prove that you complained to the town government and, after several months, the highway department cleaned out the drain pipe—and the flooding stopped. What’s likely to happen? Legal precedents suggest a court would back up your version of things. The original cause of the flooding was a covered loss, so the insurance company would have to pay. But remember, the legal precedents only suggest this conclusion. The distinction between water damage and flooding remains fuzzy.

Fire Coverage Flood and earthquake insurance both remain specialized enough that their terms and conditions don’t apply to most circumstances. The one catastrophe to which everyone can relate: Fire. Here’s what a standard homeowners policy does and does not cover when it comes to fire damage:

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Structure. The house is covered to the limits of the policy. Fire insurance covers replacement of the exact structure of your house, including walls, roofs, plumbing, wiring, wallto-wall carpeting, molding, windows, etc.

•

Valuables. Fine things are usually covered for a maximum of a couple of thousand dollars. If you have jewelry, furs, cameras and guns worth more, you need an insurance rider to cover them separately.

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Landscaping. Brushes and shrubs are usually covered to set limits, usually 5 percent of the structure coverage. Some insurers limit this coverage to a specific dollar amount.

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Contents. As we’ve seen elsewhere, this coverage is usually limited to 50 percent of the structure amount. Furniture, appliances, clothes and dishes are all covered.

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Temporary living expenses. Your hotel room, rent on a house or apartment, meals and all other extraordinary expenses caused by displacement are reimbursable. These expenses are generally limited by a dollar amount or time.

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Code upgrades. Rebuilding your house to meet current rules and regs is usually not covered. If rebuilding according to current building codes is more expensive than it would have been under codes existing when your house was built, you may have to pay for the upgrades.

If there are specific aspects of your homeowners policy that you want to adjust, it’s usually most cost-effective to do this with specific endorsements that raise or change fire coverages. In many circumstances, people buy fire insurance instead of homeowners insurance. This is possible because there are enough standalone dwelling and fire policies to create a separate market. Historically, the New York Standard Fire Policy (SFP) has been one of the

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Protect Yourself most widely used fire insurance contracts. Standard provisions and exclusions from the SFP are included in many other policies. With the introduction of modern commercial property forms, the SFP has largely been replaced. However, because of its historical significance, the SFP remains a useful document—it has influenced the language of so many property insurance policies. • The SFP was never a complete contract. It is always issued with attachments that describe the property covered and shape the coverage. Different versions were used to insure dwellings, mercantile buildings, warehouses and other types of property. •

Endorsements were used to alter the coverage, by adding insurance against loss by additional perils and providing coverage for different types of losses.

•

The conditions and exclusions were contained in 165 numbered lines found on the second page of the form.

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The declarations section made each policy unique. Information found in the declarations identified start and end dates, the parties to the contract and insurance amounts.

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Although the SFP identifies covered property, it does not define the property. This is why at least one additional form defining the type of property (such as a dwelling form) must be attached to complete the contract.

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Certain kinds of personal property—including bullion or manuscripts—may be covered only if specifically named on the policy in writing. In other words, these special items cannot automatically be covered as part of a general property class, such as a building’s contents or a policy owner’s personal property.

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Chapter 7: Disasters •

The SFP excludes coverage for accounts, bills, currency, deeds, evidences of debt, money or securities. These items are easily concealed or removed, and their value may be difficult to determine, so they are not considered to be suitable subjects for ordinary fire insurance.

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The SFP is a named perils contract, and it only covers the perils specified in the policy. Also, it only covers direct losses caused by the named perils.

“Direct loss” means actual physical damage to, or destruction of, the insured property.

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The insuring agreement states that the policy covers direct loss resulting from any of three causes—fire, lightning and removal from premises.

When a specific peril is the proximate cause of a loss, courts have held that the peril in question caused the loss. Loss from water damage, chemicals, firefighters breaking down a door or smoke may be a direct loss caused by fire if an uninterrupted chain of events existed between the fire and the loss.

•

The policy requires the insured person to make all reasonable efforts to save and preserve covered property at the time of loss and following a loss.

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Since it would be illogical to penalize an insured person for trying to minimize a loss, the removal coverage is extremely broad—it is, in effect, all risk coverage. If an insured person removes covered furniture from a burning building and some of it is stolen or damaged by rain, the SFP will cover

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Protect Yourself the furniture loss as a removal loss—even though the policy excludes theft and does not cover rain damage. •

Whenever fire or lightning threaten covered property, removal coverage applies automatically for five days. After that time, any extension of coverage would have to be arranged with the insurance company.

Because the SFP is a named perils contract, it does not cover any perils other than those named in the insuring agreement. Various forms and endorsements may be added to increase the number of perils covered.

Forms Increasing Covered Losses The SFP and many of its attachments provide insurance against direct property losses caused by covered perils. • Some types of direct loss, such as sprinkler leakage damage, are excluded by basic policy forms. Coverage for sprinkler leakage damage and other indirect losses can be provided by attachments to the SFP. •

On the other hand, indirect losses—such as the loss of earnings resulting from business interruption—are not covered by fire insurance. Many of these coverages can also be written under separate policies.

Forms Increasing Covered Perils Attachments that increase the number of perils insured against do not increase the amount of insurance, but broaden the coverage. An extended coverage (commonly abbreviated as EC) is a package of additional covered perils which are insured as a group. It is a relatively inexpensive package and it is the most common addition to fire policies. • Windstorm and hail damage to building exteriors is covered, but loss caused by frost, snow or sleet is not covered.

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Chapter 7: Disasters Damage to building interiors and contents is covered only when wind or hail first creates an opening in the walls or roof, or cause sprinklers or pipes to leak or burst. Once wind or hail create an opening, damage caused by rain, snow, sand or dust entering the building is covered. •

Explosion damage is covered, including direct loss resulting from explosion of accumulated gases or unconsumed fuel within the fire box or combustion chamber of any fired vessel. Explosions within the flues or passages that conduct gases from a combustion chamber are also covered. However, the explosion peril does not cover steam-related explosions of pipes or equipment that the insured person owns, leases or operates; nor does it cover sonic booms, electric arcing, rupture of rotating machine parts or bursting of water pipes.

•

Riot, riot attending a strike, and civil commotion coverage provides riot insurance for direct physical damage. Looting and pillage during a riot is covered.

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Sudden and accidental damage from smoke is covered, but not from smoke resulting from agricultural smudging or industrial operations.

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Aircraft damage resulting from actual physical contact with an aircraft, or an object falling from an aircraft, is covered.

The EC endorsement has some general exclusions, which eliminate coverage for war risks, nuclear risks, floods and other types of water damage. These are common exclusions; on forms where EC perils are listed as an option, the exclusions usually appear elsewhere. A Vandalism and Malicious Mischief (commonly abbreviated VMM) endorsement broadens certain EC coverages and is only sold when EC has been purchased.

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A separate VMM endorsement may be added to the Standard Fire Policy, or the VMM section of a form that also includes EC may be activated.

•

In either case, VMM coverage applies only when premiums for both EC and VMM are shown on the policy.

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VMM covers the insured against willful and malicious damage to or destruction of the covered property, and that is the extent of the coverage statement.

Most of the VMM endorsement is dedicated to what it does not cover: • glass (other than glass building blocks) parts of a building, structure or sign; •

pilferage, theft, burglary or larceny (but damage caused by burglars while entering or leaving is covered);

•

explosion of steam pipes or steam equipment owned, leased, or operated by the insured, the rupture of moving machine parts, and losses resulting from a change in temperature or humidity, or deterioration.

The VMM coverage is suspended if a dwelling has been vacant for more than 30 days. Vacant means a building has neither occupants nor contents. (Buildings under construction are not deemed to be vacant or unoccupied.)

Terrorism and Acts of War One of the most important issues that came up in the wake of the 9/11/01 terrorist attacks was whether insurance companies would attempt to deny coverage for property claims on the basis that the alQaida attacks were acts of war. Obviously, the collision of commercial jet liners into office buildings would be covered under the EC language we’ve described earlier (although probably under a Commercial Property policy).

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Chapter 7: Disasters But what about the additional fact that those jets had been hijacked and were being used as missiles by an organization dedicated to the destruction of the United States government? In the early stages of the 9/11/01 aftermath, some pundits who knew something about insurance and risk issues noted that the acts of war exclusion or similar language might come into play. Ultimately, this did not happen…for several reasons. One reason was that, strictly speaking, the attacks were not acts of war. Despite the warlike rhetoric that followed 9/11, the attacks were not undertaken by an other country in a declared war against the U.S. Some property insurance policies add exclusions for acts of terrorism to the acts of war exclusions. But even these didn’t end up having much effect.

Another—and perhaps larger—reason this didn’t happen was that the political cost of denying these claims would have been so high. Insurance companies are keenly aware that they operate in heavilyregulated markets…and that the cost of bad political decisions can be even higher than paying claims. The insurance companies agreed to pay claims as quickly as possible—often as one part of larger, government-coordinated disaster response programs. Behind the scenes or through bureaucratic channels, insurance industry lobbyists pressed for government support of the companies and subsidized loans to people who’d suffered losses. (This is like the approach most take to earthquakes.) The response recalls an old saying in disaster insurance circles: “Uncle Sam is the reinsurer of last resort.”

The willingness of property insurers to pay 9/11 claims also highlights another important point about terrorism as a disaster: Even

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Protect Yourself though it gets a lot of attention in the media, terrorism—even when as effective as the 9/11 attacks—doesn’t do as much damage as a large series of natural disasters. As horrible as the 9/11 attacks were, they affected fewer households than Hurricane Andrew or the Northridge earthquake. This may seem counterintuitive at first. But it’s an economic reality that may hold the ultimate promise of defeating terrorists and terrorism. It makes a lot of media noise, but it doesn’t hurt as many people as badly as a natural disaster.

Conclusion Disaster or catastrophe risks don’t always follow the guidelines of intuitive sense. The most dangerous elements of disaster risks are fueled by seemingly simple things like federal flood insurance and coastal developments. And the things that seem hugely dangerous—like terrorists attacking the World Trade Center—end up not influencing economics as much as they appear to. At the end of the day, the important point to remember is that loss mitigation can be simple…and can be the most effective form of protection from catastrophic risks. Make sure your structures are built to code. Keep your property in good, clean shape. Think twice about the basic risks posed by living near a levee or a beach. And make sure you have some insurance in place for the what-ifs. FEMA loans by themselves are usually not enough.

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Chapter 8: Risks Posed by Your Family CHAPTER

8

Risks Posed by Your Family

In the earlier chapters dealing with car safety and medical coverage, we talked about how you can protect your children—however imperfectly—from the dangers of the world. But the dangers flow both ways. Children, especially as they grow into their teens and early twenties, pose particular risks. If you have them (children), you’re likely to face them (risks). Just as you think about protecting toddlers and small children from the outside world, you need to think about protecting yourself from the havoc these same children can create before they head out into that world on their own. In essence, children pose two kinds of risks, related to: • driving cars, and •

creating legal liabilities through their actions.

In this chapter, we will review each of these risks and offer some suggestions about what you—as a parent—can do to protect your family as a whole. And establish some peace of mind.

Risks Posed by Vehicles One of the most dangerous activities anyone can undertake is driving a motorized vehicle—be it a car, a golf cart or a boat. And the dangers posed aren’t just personal; vehicle accidents are the most common cause of liability claims. Auto insurance covers some of these liabilities; but others are excluded from standard auto coverage. In those cases, homeowners insurance may be your best protection.

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Protect Yourself Homeowners insurance does not apply to any exposure—even liability—created by driving a vehicle that is registered with a state motor vehicle agency. There is also no coverage for liability arising out of vehicles that you own, operate, rent or borrow. These vehicles should be covered by your auto policy. However, there is coverage for the vicarious liability created when a member of your household drives someone else’s vehicle. Vicarious liability is a nasty proposition. It can make something all your fault…even when it’s not—strictly speaking—your fault.

There are several reasons why young drivers are expensive. But the most important is the most simple: Auto accidents are the most frequent cause of death among people ages 6 to 33 years old. Through the 1990s and early 2000s, more than 5,400 teenagers died on American roads each year. (And half of these deaths were alcohol-related.) As an auto insurance consumer, your choice of which coverage to purchase will be influenced by the following questions: • What coverage do you have to buy because of state law? •

What additional coverage do you need or want?

•

How much will the required and optional coverages cost? (The more coverages being purchased, the higher the premium, of course.)

Managing Kid-and-Car Risks In most situations, a parent is going to have to self-insure certain risks of having a child who drives the family car (or, making matters worse, cars). In other words, you’ll inevitably have to shell out cash at some point if Junior takes out the minivan. This self-insurance may take the form of speeding tickets you pay for your child. It may take the form of higher insurance deductibles,

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Chapter 8: Risks Posed by Your Family which your insurance company requires or you choose. Or it may take the form of really high monthly premiums. With that warning, here are some ways to save money on family auto insurance: • Stay with one company. The longer you’re a good customer, the better the rates. •

Make sure your kids take driver’s ed. Adding a teenager to a two-car policy can boost a family’s premiums by 50 percent. However, most insurance carriers reduce premiums for drivers up to age 21 if they take a certified course.

•

Encourage your kids to get good grades. Most insurance companies provide a discount for students with a B average or better—or with a 3.0 grade point average in college. The typical discount is 10 percent. (Some companies ask for copies of report cards each time you renew.)

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Talk your teen into driving a nice, big, safe station wagon. Intermediate-size cars, sedans and other “low-profile” vehicles will carry lower premiums than high-performance cars, sport utility vehicles and sports cars.

If your teenager drives a sports car, you’ll probably have to go to a company specializing in high-risk policies. The premium can be double the normal rates. Ignore whatever status issues this matter raises for you or your kid. Warren Buffett wouldn’t pay double premiums; and he’s got more money than you do. You probably shouldn’t pay this, either.

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Raise the deductible amounts—or drop—collision, fire and theft coverage for the cars the teenager drives. Many agents suggest getting a deductible of $500 for collision and $250 for theft and other damage, and dropping tow-

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Protect Yourself ing and labor coverage. This approach is especially appropriate if your child drives an older car. •

Put your teenage driver on your policy. This usually is cheaper than buying separate insurance. Even if your son has his own car, including his coverage on the family policy will help get the multi-car discount.

A caveat: If a teenage driver is in an accident that is not the other driver’s fault, the cost of your policy will rise—often dramatically. In this case, you may want to put your teenager on a separate policy. Also, if your teenager has his own car and doesn’t qualify for a good student or driver education discount, it may be better for him to have his own policy.

What Is a Safe Driver? Safe drivers typically save as much as 20 percent off insurance companies’ standard rates. Different insurance companies will have slightly different definitions of a safe driver. But, speaking generally, the programs look for drivers with: • No more than one minor violation or at-fault accident in the last three years per household. •

No more than one comprehensive loss or not-at-fault accident in the last three years per household.

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No major violations, such as driving while intoxicated, in the last five years (three years in some states).

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No revocation or suspension of driver’s license(s).

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No Financial Responsibility Filings required in the last three years.

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Five years’ driving experience in the United States for principal drivers.

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No lapse in insurance coverage.

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No accidents or tickets if under age 21.

In addition, some high-performance cars will disqualify you from the discount program. Classic, antique and customized vehicles typically are not eligible, and neither are commercial vehicles. Again, it usually makes the most sense for your teen or young adult driver to stick to the occasional use of family cars.

Negligent Entrustment Negligent entrustment relates particularly to the insurance issues raised when you lend someone your car. For example, your son borrows your car to go out. He has a few beers at a party, so he does what he thinks is the smart thing and allows a friend to drive home. On their way out, the friend accidentally hits another teen, seriously injuring her. The friend turns out not to have a valid driver’s license. And his parents recently declared personal bankruptcy. The friend will probably not be included under the liability or medical payments coverage of your auto policy. But, if you are found to have negligently entrusted the car to your son…and your son to the friend…you might be held liable. And your homeowners insurance might have to pay. Still, negligent entrustment is tough to prove. As one Louisiana court wrote: [Most state laws] establish that persons are responsible for the damage caused by the things within their custody. To be responsible for negligently entrusting that which is in your custody to one who is incompetent to use it requires the knowledge that the person is incompetent. So, a person making a claim against you has to establish “reasonable foreseeability.” The burden of proving that you knew your son would get drunk and ask a non-licensed driver to get him home would be difficult.

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Protect Yourself However, some courts stick to more liberal extensions of auto liability—ruling that after you give “initial consent” to someone to use your car, just about any situation has to be assumed as foreseeable. So, be careful to whom you lend your car.

What if Your Kid Is Really Trouble? Some people worry about the trouble mischievous—or downright troubled—kids can cause. If your child does something awful, can you be held liable? If your son or daughter was a legal adult living on his or her own—No. If your child is still a child, liability issues usually go differently. What happens when your impressionable teenage son starts hanging around with punk skateboarders who convince him that vandalizing your neighborhood will be cool? You may be responsible for the costs of his bad judgment. This is another example of what we’re talking about when we mention vicarious liability. Most states now hold parents responsible for at least some of the damage their minor children cause. This is in large part due to a handful of high-profile cases—like the Columbine, Colorado, high school shootings—and an overall increase in violent acts by juveniles.

A side note: Because of the parental liability claims that followed the Columbine tragedy, the parents of Dylan Klebold blamed authorities for failing to prevent their teen’s murderous rampage. The Klebolds threatened to sue the Jefferson County sheriff’s department and school district. In a bizarre twist, the Klebolds argued that if investigators had told them about their son’s Internet rantings and his friend’s violent tendencies, they would have kept the two boys apart and prevented the murders.

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Chapter 8: Risks Posed by Your Family Sound ludicrous? Well, it’s merely a product of the human condition. As evidenced by other cases, when something bad happens, people jump to hold someone else liable—before taking a good look at themselves and acknowledging their own negligence. Parental liability laws generally require parents to pay for damages caused by their kids—whether damage to property or person. However, the specifics vary by state; some states hold parents liable for property damage and bodily injury—in others, parents are only liable for the criminal acts of their children. Typically, parents are sued in civil court.

Intentional or criminal acts are, as usual, excluded from insurance coverage. So, if your kid gets involved in some kind of mischief—even of the prankish sort—you are going to have to settle legal claims out of your grocery money. (Or, as in the Klebold case, you can try to blame other authorities in your child’s life. Good luck.) Parental negligence is a more serious charge. In these instances, a court decides a parent (or even a teacher or counselor) should have known of the damage a child was about to inflict. Juries have found parents guilty of civil negligence and ordered them to pay up to $500,000 because of bad things their children have done. However, it’s often difficult to collect civil damages in cases seeking to prove parental negligence. Though state law may allow the claims, juries are often split on what constitutes appropriate behavior on the part of the parents. Plus, it’s usually difficult to collect from the at-fault family—often a struggling, middle-class type. Lawyers say these cases are used to make a point, not money.

The Mechanics of Parental Liability If you think about parent/child cases at all, you’re probably looking for a more typical parental liability case involving a genuine, minor child and his liable or negligent parents. Here’s one for the ages:

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Protect Yourself A 14-year-old boy drives the family lawn mower on a public road to the church and collides with and injures another boy on a bicycle. The court hearing the resulting lawsuit offered a list of the five points1 that explain when parents may be held liable for the torts of their children: 1) where the relationship of master and servant exists and the child acts within authority accorded by the parent; 2) where a parent is negligent in entrusting to the child an instrument which, because of its nature and purpose, is so dangerous as to constitute, in the child’s hands, an unreasonable risk; 3) where a parent is negligent in entrusting to a child an instrumentality which, though not necessarily a dangerous thing of itself, is likely to be put to a dangerous use because of the known propensities of the child; 4) where the parent’s negligence consists entirely of his failure to reasonably restrain the child from vicious conduct imperiling others, when the parent has knowledge of the child’s propensity toward such conduct; and 5) where the parent participates in the child’s act by consenting to it or by ratifying it and accepting the fruits.

A Key Term: Household Members The liability coverage offered by standard property insurance is designed to protect the value of your property—against even your own ill-advised actions. And this protection extends to your children, as well as other blood relatives who are your dependents (on your tax returns) and live in your house. It also extends to non-relative minors who are your dependents and live in your house. 1

The case is Stronger v. Riggs (Missouri Appeals Court, Western District, May 2000.)

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Chapter 8: Risks Posed by Your Family In insurance jargon, the standard homeowners or umbrella liability policy extends to members of your household. In most cases, the definition of household member is pretty common-sensical. In a few cases, it has fueled disputes. Who’s insured is an important definition. In a standard policy, the insurance company promises to pay any damages and provide legal defense for any insured. These are key benefits.

The insurance company has plenty of incentive to avoid lawsuits. Under the standard homeowners policy, it will provide a legal defense against claims—even if the claims are groundless, false or fraudulent. The company may also make any investigation or settlement deemed appropriate. All obligations of the insurance company end when it pays damages equal to the policy limit for any one occurrence. But legal costs can add up quickly in the meantime. Personal liability insurance applies separately to each insured person, but total liability coverage resulting from any one occurrence may not exceed the limit stated in the policy. A key issue in liability coverage is the insurance company’s duty to defend a policyholder. This means that if an insured person is sued by a third party, the insurance company must cover the cost of a defense—even though there’s been no determination about whether the insured person is guilty or liable. If damage to the property of others is caused by an insured person, the policy will provide replacement cost coverage on a per occurrence limit. This additional coverage won’t pay for: • damage caused intentionally by an insured person who is at least 13 years of age (there has to be some cutoff age— otherwise, this could cover the intentional acts of adults);

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property owned by you, because this coverage is designed to cover property owned by others; or

•

property owned or rented to a tenant or a person who is resident in your household.

Example: Your daughter borrows a camera from your neighbor and accidentally drops it in your swimming pool while taking pictures. Standard homeowners (or renters) insurance will provide up to $500 to replace the camera.

Another key issue: Injury to members of the insured household. Lawsuits between people covered by the same policy aren’t covered by standard property insurance policies. A homeowners policy is not meant to be a substitute for health insurance—and this exclusion makes it clear that there is no coverage for an injury suffered by the named insured or other family members who reside in the same household.

A third key issue: Intentional acts of an insured person or acts that can be expected to produce bodily injury or property damage. If you or your children meant to hurt someone, standard insurance won’t cover the resulting damages. In addition to these major issues, there are a number of less important circumstances in which homeowners insurance does not cover liabilities. Standard property insurance also won’t cover you or your children against liability claims involving: • rendering or failure to render professional services; •

transmission of a communicable disease by an insured;

•

sexual molestation, corporal punishment, or physical or mental abuse;

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the use, sale, manufacture, delivery, transfer or possession by any person of controlled substances (illegal drugs), other than legitimate use of prescription drugs ordered by a physician; and

•

entrustment by an insured person of an excluded vehicle, watercraft or aircraft to any person, or vicarious parental liability (whether or not required by law) for the actions of a minor using any of these items.

So, keep in mind that your minor child is most likely to cause risks for you and the rest of your family with a vehicle. Make sure your auto insurance covers your driving-age kids. If it doesn’t…and you can’t afford to make it so…make sure the kids don’t drive. Beyond auto risks, most of the dumb or dangerous things kids do that cause vicarious or parental liability will be covered by homeowners or renters insurance. Also, if you carry separate and additional umbrella liability insurance, this coverage will usually apply to family liabilities the same way the property coverage does.

Innocent Spouse Doctrine Of course, kids aren’t the only people who can cause problems for you and your family. Sometimes your spouse or boyfriend/girlfriend can cause problems. Leaving deep psychology and cheap melodrama aside, it is fair to say that you can never know another person completely. Even if you’ve lived with that person for years. Trouble with spouses can take several forms. Common problems include alcohol abuse or an emotional crisis that leads to lost jobs or unpaid bills. Destructive behaviors like adultery, physical abuse, compulsive gambling and drug use are also common…and often more damaging. Less common—but most damaging—problems include malfeasant or criminal behavior that your spouse hides until arrest, foreclosure or some other point of dramatic breaking.

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Protect Yourself When the worst of this happens, you can be faced with bankruptcy or other major reckoning—even though you’ve been loyally keeping up your end of the legal and emotional bargain. Unfortunately, there’s no insurance to protect you from an alcoholic, abusive or adulterous spouse. A wise strategy is to maintain a separate financial identity—no matter how happy your home life is. If you have joint bank accounts and credit accounts with a spouse or partner, it’s still a good idea to keep at least one bank account and a couple of credit accounts separately, in your name. That way, you’re less likely to be wiped out completely if your significant other suffers some breakdown…or meltdown.

When the worst happens—sheriffs show up to lead your spouse away in handcuffs—you may need to take a strong line with banks, mortgage companies and insurance companies. In these dire circumstances, your best protection is the innocent spouse doctrine. Simply said, the innocent spouse doctrine holds that a person who wasn’t aware of and didn’t profit from criminal or illegal behavior can’t be held financially liable for the wrongdoing of his or her spouse. It comes out of the insurance industry, with regard to property or liability claims made by innocent people whose significant others go berserk and burn down the family house…or do something equally damaging. Courts have held that these innocent people have a right to some or all of the protection their insurance offers. Increasingly, though, the insurance industry’s rules are stretching out into other areas. In the late 1980s, Washington-based Safeco Insurance agreed to settle a coverage dispute involving a claim filed by a homeowner whose ex-husband allegedly abused her and intentionally set fire to her home. The settlement ended a long legal fight in which Safeco had sought to deny the claim of policyholder Kittis Bolduc, because of exclusions

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Chapter 8: Risks Posed by Your Family written into her policy for losses caused by the intentional acts of co-insureds. Although divorced, Ms. Bolduc had an ex-husband who was technically still a co-insured under her homeowners policy when he set fire to her home. The dispute had to be settled outside the contract because a court had upheld the insurance company’s denial of the claim based on the co-insured and intentional acts exclusions. Safeco had pressed the dispute in the courts in order to clarify whether the policies offered coverage in cases involving domestic violence—but a spokesman said the company was uncomfortable with the result, even though it had won the legal case. Insurance regulators in Washington state had encouraged the company to resolve the case, which was likely headed for legal appeals. During the announcement of the settlement, Insurance Commissioner Deborah Senn said: …the public exposure of Kittis’ case has moved this issue forward. We are encouraged that victims, advocates, legislators and officials, and, now, insurance companies, will be standing together to make insurance discrimination illegal. Senn was active in developing laws to protect innocent spouses. She had led the National Association of Insurance Commissioners’ effort to draft a model law to deal with the problem of discrimination against victims of domestic abuse by insurance companies. The model barred insurance companies from the following practices in cases involving domestic abuse: • refusing to issue, renew or reissue insurance policies; •

cancelling or otherwise terminating coverage;

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restricting or excluding coverage; or

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adding a premium differential to a property or casualty insurance policy on the basis of the abuse status of the applicant or insured person.

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Protect Yourself The model also barred companies from using the co-insured and intentional acts exclusions to deny claims in cases involving alleged domestic abuse.

The model act has yet to pass at the federal level, which suggests that this level of protection won’t become law in the near future. In the meantime, you need to be doubly cautious about creating—or tolerating—abusive behavior.

Conclusion In truth, there are limits to what you can do to protect yourself against losses caused by the members of your family. The best prevention is the most difficult to explain briefly: Choose mates and raise children who understand that their actions have consequences…and that it hurts everyone when they cause harm to themselves or others. Beyond this broad goal, your best protections are to: • get the best insurance you can afford for teenage drivers; •

keep close enough tabs on them that they don’t feel free to drive recklessly;

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make sure that the liability coverage offered by your homeowners, renters or umbrella policies offer protection for vicarious or parental liability; and

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maintain some personal banking and credit accounts that are yours, personally.

It’s true that you can choose your friends but you can’t choose your family. If family members are prone to trouble, your best move is to draw clear financial lines between you—without abandoning the trouble-prone person entirely. In fact, clear financial lines may allow you to offer emotional support and other kinds of assistance.

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Chapter 9: Protecting Your House…and Yourself CHAPTER

9

Protecting Your House…and Yourself

Buying a home is probably the biggest investment you’ll ever make. You’ve heard this old chestnut from your uncle or father-in-law or boss. Probably in a slightly condescending tone…and after a couple of drinks. But, unlike much conventional wisdom, this chestnut is true. Buying a house is a rite of financial passage; it changes how you think about money and life. And it changes how people think about you. Most people focus on getting into their first house—how to choose the place, how to save or assemble the down payment, how to qualify for the mortgage. Everything that comes after—taxes, insurance, maintenance—comes, well, after. But there’s more to owning real estate that just qualifying for a loan. It changes the sort of things you need to protect. The most common way to protect your big investment is by purchasing homeowners insurance. And homeowners insurance covers a lot more than just roofs and walls; but it can be confusing—full of jargon about covered perils, uncovered perils and exclusions. For most people, the right solution is one of three standard homeowners policies that offer basic, broad and special coverage. These policies are relatively complete packages. They cover you and your home from the personal and property exposures that most people encounter—fire, theft and liability.

In this chapter, we’ll consider the most common kinds of risk that face people who own real estate and the most common kinds of insur-

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Protect Yourself ance that protect against these risks. We’ll look at what’s covered, who’s covered and…maybe most important…what’s not covered. First, a few general points: • A homeowners policy is a complete package of personal property and liability coverages designed to cover the average residential and personal exposures that most individuals and families encounter. •

Under a homeowners policy, personal property doesn’t just mean real estate. It means just about any household possession that’s financially valuable—from the smallest earring to the largest refrigerator.

•

A policy can be issued to cover a premises used principally for private residential purposes (some incidental business uses, such as a home office, are permitted) and that contains no more than two units (so, single family homes and duplexes are eligible).

Separate policies are available for tenants of apartments and condominium unit owners, who have personal property and liability exposures but do not need to insure the dwelling.

Homeowners insurance covers the value of the home or homes in which you live—not just the physical property. In other words, the insurance should cover risks and liabilities that might encumber the value of your property. The fact that you have a $200,000 policy doesn’t mean that’s all you get if your home is destroyed. The $200,000 limit usually applies to the cost of replacing the physical structure. Typically, a policy will pay up to $100,000 more—half of the face amount of the policy—to replace the home’s contents, including valuables. And it will also cover legal costs related to a liability lawsuit.

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Chapter 9: Protecting Your House…and Yourself If you have a separate structure on the property—a garage or guest house—that’s usually covered in addition to the face amount. There are also several other additional coverages. A homeowner with a $200,000 policy can get $200,000 to rebuild, $100,000 for personal effects, $10,000 to relandscape, $10,000 to rebuild the garage and $25,000 to cover temporary living expenses. That’s a total coverage of nearly $350,000 on a $200,000 face value. And the cost of defending the homeowner in a liability lawsuit could add another $50,000 to $100,000 of coverage.

The Standard Types of Homeowners Policy The standard types of homeowners coverage that insurance companies offer are: • HO-1 (The Basic Form) •

HO-2 (The Broad Form)

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HO-3 (The Special Form)

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HO-6 (The Condo Unit Owner Form)

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HO-8 (The Modified Basic Form)

We’ll consider each of these. The Basic Form (HO-1) covers the dwelling, other structures on premises and property of the policyholder against 11 named perils—mostly having to do with fire and water damage. It’s not enough coverage for most homeowners. Few insurance companies sell it. The Broad Form (HO-2) insures the dwelling, other structures and personal property against loss by all basic form perils plus six additional perils. The additional perils are: • Damage caused by falling objects (but damage to a building’s interior or its contents is covered only if the falling object first damages the roof or an exterior wall).

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Damage to a building or its contents caused by the weight of ice, snow or sleet (this peril does not cover damage to an awning, fence, patio, pavement, swimming pool, foundation, retaining wall, bulkhead, pier, wharf or dock).

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Accidental discharge or overflow of water or steam from a plumbing, heating, air conditioning system or automatic fire protection sprinkler system, or from a household appliance (this peril does not include loss caused by freezing).

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Sudden and accidental tearing apart, cracking, burning, or bulging of a steam or hot water heating system, an air conditioning system or automatic fire protection sprinkler system or an appliance for heating water.

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Freezing of plumbing, heating, or air conditioning system or automatic fire protection sprinkler system, or of a household appliance.

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Sudden and accidental damage from artificially generated electrical current (but not damage to a tube, transistor or similar electrical component).

The Broad Form is the most limited kind of homeowners insurance that works for most people. Most insurance companies sell it—or some slight variation on it. The Special Form (HO-3) insures personal property against loss by the same perils included on HO-2 but adds more coverage. HO-3 provides the most complete coverage for the dwelling and other structures. It insures the dwelling and other structures against “risk of direct physical loss” except to the extent that named exclusions and limitations apply. It covers risks like vehicle damage to a fence, driveway or walk—even when caused by a resident. The policy does not cover any of the following: • Any loss involving collapse, other than as provided under the additional coverages section.

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Freezing of a plumbing, heating, air conditioning system, sprinkler system or household appliance, or discharge, leakage or overflow due to freezing while the dwelling is vacant, unoccupied or being constructed (such damage by freezing of an occupied premises is covered).

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Freezing, thawing, pressure, or weight of water or ice to a fence, pavement, patio, swimming pool, foundation, retaining wall, bulkhead, pier, wharf or dock.

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Theft in or to a dwelling or structure under construction, or theft of any property that is not actually part of a covered building or structure.

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Vandalism and malicious mischief if the dwelling has been vacant for more than 30 consecutive days.

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Gradual, preventable, or expected losses including: wear and tear, latent defect, rust, mold, wet or dry rot, contamination, smoke from agricultural smudging or industrial operations, birds, vermin, insects, domestic animals, or the settling, cracking, shrinking or expansion of pavements, foundations, walls, floors, roofs or ceilings.

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Losses caused by weather conditions to the extent that weather contributes to causes found in the general exclusions (i.e., power failure, flood, etc.).

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Losses caused by faulty, inadequate or defective planning, zoning, surveying, siting, design, workmanship, repair, construction, renovation, remodeling, grading, repair or construction materials used, or maintenance.

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Losses caused by acts, decisions or the failure to act or decide by any person, organization or government body.

The Condo Unit Owner Form (HO-6) insures personal property against all of the perils found on the Broad Form. Coverage against

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Protect Yourself perils also applies to the limited dwelling coverage for alterations and other owned building items. (We consider the protection and insurance issues related to renters and condo owners in greater detail in the next chapter.) In some states, a Modified Basic Homeowners Policy (HO-8) may be issued. Eligibility, minimum coverage requirements, policy conditions and exclusions, and certain coverages are identical on HO-1 and HO-8. Modifications occur only in terms of property coverage, and HO-8 departs from basic coverage in three ways: • actual cash value (ACV) settlement on the dwelling; •

miscellaneous coverage restrictions; and

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elimination of optional property coverages.

Other policies provide replacement cost coverage on buildings if insured for at least 80 percent of the current replacement cost. For owners of older homes, replacement cost coverage is often not practical; it ends up costing much more than ACV coverage. And it’s not just older homes. Elaborate homes and those with detailed designs or decorative architecture might have a replacement cost far in excess of the ACV or market value. The premium for replacement cost coverage might be prohibitive and, in the event of a major or total loss, the owner would be likely to replace the building with one of simpler construction and modern building materials. HO-8 has no replacement cost provision, and all partial losses are paid on an ACV basis. A caveat: Several coverage modifications restrict coverage usually provided by homeowners insurance. HO-8 provides limited theft coverage. Aggregate theft losses are limited to $1,000 on a per occurrence basis, and the separate limits for theft of certain personal property items (silverware, guns, etc.) are deleted from the policy. The full coverage limit for personal property applies only on the residence premises.

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Chapter 9: Protecting Your House…and Yourself Through the rest of this chapter, when we cite policy language, we’ll refer to the standard HO-3 policy. If you have another version, you can still use the discussion as it applies to the language that’s common—which is most of the language.

Coverage Sections and Conditions Homeowners policies are divided into two sections. Section One provides coverage for the insured person’s: • dwelling; •

other structures on the grounds;

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personal property owned by family members; and

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certain types of loss of use, such as rental value or additional living expenses.

Section Two provides personal liability coverage, and medical payments coverage for people injured while on your premises. Knowing how an insurance company defines what your personal property is gives you helpful information about any additional coverage that you may need to purchase. Personal property includes everything that is not real property, such as: • indoor and outdoor furniture, •

linens,

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drapes,

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clothing,

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most appliances (but not built-ins), and

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all other kinds of household goods and equipment used for the maintenance of the dwelling.

Unlike your house and other structures, which are insured to cover all losses not specifically excluded, personal property is insured on

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Protect Yourself a named perils basis. All of the named perils are subject to exclusions—and each individual named peril may have restrictions or exclusions that apply to it. These technical definitions and exclusions are a major reason that you need homeowners insurance—and that you need to be careful about what kind of insurance you buy.

Who Can Buy Homeowners Insurance Homeowners forms HO-1, HO-2 and HO-3 may be issued to any of the following: • an owner-occupant of a dwelling; •

the intended owner-occupant of a dwelling in the course of construction;

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one co-owner, when each distinct portion of a two-family dwelling is occupied by separate co-owners;

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a purchaser-occupant when the seller retains title under a contract until payments are completed; and

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an occupant of a dwelling under a life estate arrangement when dwelling coverage is at least 80 percent of the current replacement cost.

In cases where a homeowners policy is sold to a co-owner, purchaser-occupant or an occupant under a life estate, the owner or remaining co-owner will have an insurable interest in the dwelling, other structures, premises liability and medical payments coverage. A co-owner’s insurable interest can be insured by attaching an additional insured endorsement to the policy. In the case of coowners, the remaining co-owner-occupant would have to purchase a separate policy to cover any personal property exposure.

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Who Is an Insured? A major reason that you may need homeowners insurance is that you have a family to protect from property loss or liability claims. The definitions page of a homeowners policy identifies the person insured by the policy (called the named insured) and other people insured. This part of the policy may include the following language: • Insurance on the dwelling and any other structures is provided for the named insured and the insured’s spouse if the spouse lives in the same household. •

Personal property coverage and personal liability insurance are provided for the named insured and all residents of the same household who are relatives of the insured or who are under age 21 and in the care of any member of the insured’s family.

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If the named insured or the spouse dies, coverage continues for legal representatives.

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Until a legal representative is appointed, a temporary custodian of the named insured’s property is also covered.

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All household members who are insured at the time of the named insured’s death will continue to be covered while they continue to live at the residence premises.

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The personal property of others may be covered while on the residence premises, and the personal property of guests or a residence employee may be covered while in any residence occupied by an insured person.

A residence employee is an employee who performs duties related to maintenance of the residence or who performs household, domestic or similar duties elsewhere—as long as they are not connected to the business of an insured person.

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Property and Losses Not Covered Homeowners insurance covers a lot—but it can’t cover everything you own or everything you do. The following types of property and losses are not covered by most homeowners policies—and they serve as a kind of anti-checklist: • land, including that under an insured residence; •

structures used solely for business purposes;

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structures rented or held for rental to any person who is not a tenant of the insured dwelling;

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aircraft and parts, other than model or hobby aircraft;

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property of roomers, boarders, and other tenants who are not related to any insured;

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accounts, drawings, paper records, electronic data processing tapes, wires, records, discs, or other software media containing business data (blank disks are covered);

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losses caused by perils having catastrophic potential— these include the nuclear and war risk exclusions;

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losses caused by the common power failure and ordinance or law exclusions;

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losses caused by the neglect of an insured person to use all reasonable means to save and preserve property;

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any intentional loss arising out of an act committed by or at the direction of an insured;

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losses caused by, resulting from, contributed to, or aggravated by earth movement; and

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losses to a motor vehicle and any electronic apparatus designed to be operated solely by use of the power from the motor vehicle. (However, homeowners policies do cover

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Chapter 9: Protecting Your House…and Yourself vehicles that are not subject to motor vehicle registration and are used to service an insured person’s residence or assist the handicapped.) If you’re hoping to insure any of these items or activities with homeowners coverage, you’ll be out of luck. Again, the operating assumption here is that the insurance company will provide coverage against losses that are likely to occur in a person’s ordinary experience.

Homeowners vs. Dwelling Many residences are insured by homeowner policies—but standalone dwelling policies are still issued for a variety of reasons. • Some dwellings are ineligible for homeowners coverage because of the structure’s age, location or value. •

Other dwellings are ineligible because of the number of living units involved—a homeowners policy covers one- or two-unit residential property, while dwelling forms may cover a structure containing up to four living units.

Dwelling policies are primarily issued to cover non-owner occupied buildings—like rental properties and vacation homes.

Homeowners coverage is broader than stand-alone dwelling coverage in a number of important ways: • The most important distinction is that homeowners covers liability and dwelling does not. •

Unlike dwelling insurance, all homeowner insurance—even the most basic policies—include coverage for theft of personal property.

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It includes coverage for the loss of property from a known location when it is likely that the property has been stolen.

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A homeowners policy will usually cover outdoor property, such as awnings and antennas—a dwelling policy does not.

Finally, coverage for vehicle damage is also broader. Unlike dwelling coverage, homeowners coverage covers vehicle damage to fences, driveways, walks and outside lawns, shrubs, trees and plants—as long as it’s not caused by someone in your household. Like homeowners insurance, dwelling insurance comes in various forms—including basic, named perils (also called broad) and all risk (also called special). • In addition to providing broader coverage, an all risk form shifts the burden of proof from the person making a claim to the insurance company. •

With named peril coverage, the person making the claim has to prove that a covered peril caused the loss.

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With all coverage, the insurance company has to prove that an exclusion applied in order to deny coverage.

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With some recent policy revisions, the gap between dwelling and homeowner coverages has begun to close.

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Personal liability insurance and other coverages associated with homeowners policies have become options under dwelling policies—at least in the majority of states.

If You Have a Mortgage If you have a mortgage on your house, the finance company will usually be included on a homeowners policy as an insured party or co-payee. If an insured loss occurs—but the company denies the claim because you haven’t complied with some condition or requirement— payment would still be made to the mortgage company up to its insurable interest. This usually means the balance of whatever you owe on your mortgage.

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If you have a mortgage, you should double-check that language—to make sure the loan would be repaid.

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If the limit of your homeowners coverage is based on your mortgage, make sure that it is enough to cover the current cost of rebuilding.

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To determine the rebuilding cost, calculate the current cost of construction for a house like yours or hire a professional appraiser to do it.

Replacement Value and Replacement Cost You should have enough insurance to cover the cost of rebuilding your home. That may bear little relation to its market value. If the limit of your homeowners coverage is based on your mortgage, make sure that it is enough to cover the current cost of rebuilding. • In most situations, you should buy insurance for at least 80 percent of your home’s replacement value. •

If you buy less, you forfeit the right to collect the full replacement value of the insured property, even for a partial loss.

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After determining rebuilding costs, you have to determine how much insurance you need.

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If you’re insured for less than 80 percent, the insurance company will make two estimates and pay whichever is larger.

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This significant risk is called implied coinsurance.

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If you are cautious, get a homeowners policy that will pay for 100 percent of the rebuilding costs. Say you have a $100,000 home that suffers $90,000 in damage. With a 100 percent replacement policy, the insurance company would pay $90,000.

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If you are willing to take on a some risk, buy a policy that pays 80 percent of the rebuilding costs. If your $100,000 home is insured for 80 percent, the maximum value of the policy is $80,000. So if your home suffered $90,000 in damage, the insurance company would pay $80,000.

The surest way to arrange full coverage is to buy a guaranteed replacement cost policy, which will pay up to 50 percent more than the face value of the policy to rebuild your home. (A few companies offer unlimited coverage.) • With a guaranteed replacement cost policy, the insurance company automatically adjusts the amount of insurance each year to keep up with rising construction costs. •

The policy also protects you against the unexpected, such as a sudden increase in construction costs due to a shortage of building supplies.

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Companies that offer guaranteed coverage usually require that you insure your house for 100 percent of its replacement cost to begin with.

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Owners of high-risk or older homes may not be eligible for this type of policy.

Placing a Value on Things Many insurance policies have a valuation clause, which describes how the value of different types of property will be determined in the event of a claim. The valuation clause may use such terms as actual cash value and replacement cost. • Actual cash value (ACV) is the basis for recovery under many property and liability contracts, regardless of the policy amount. •

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ACV generally means “the replacement cost of damaged or destroyed property at the time of loss, less depreciation.”

Chapter 9: Protecting Your House…and Yourself It is better to purchase a policy that will give you the full replacement cost for your personal property, without deducting for depreciation. This can be done, for an additional premium, by adding an endorsement to guarantee payment of the replacement cost. If you own an older home, you may not be able to get guaranteed replacement cost coverage, because many building techniques used in decades past are more expensive than techniques used today. So, you may have to settle for a modified replacement cost policy. With this sort of coverage, instead of repairing or replacing plaster walls with similar materials, for instance, the policy would pay for repairs using wallboard. • Complete replacement cost coverage may be difficult to obtain if you have extensive ceiling moldings and other fine craftsmanship that would be difficult to replace today. •

Homeowners policies also will pay you the full replacement cost for your house and other insured buildings only if you maintain a minimum amount of insurance—usually 80 percent.

If it will cost $200,000 to rebuild your home and you only have $100,000 worth of insurance, no insurance company is going to pay you the full replacement cost.

•

For this reason, most insurers require that your insurance be equal to at least 80 percent of the replacement cost at the time of loss.

Insurance companies don’t want to encourage you to file a claim and pocket the money. So, for both building and contents losses, most policies state that full replacement costs will be paid only if the property is actually repaired or replaced. If it is not, claims will be paid on an ACV basis.

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Protect Yourself An important issue in many property insurance policies is the pair and set clause. This is written in because a set can be worth more than the sum of its pieces. For instance, an antique pair of candelabras might be worth $1,000. But if one is lost or destroyed, the remaining candelabra might be worth only $200. In this situation, the value of the loss of one part of a pair is not equal to 50 percent of the value of the complete pair.

For this reason, many property insurance policies give the insurer the option of repairing or replacing any part of a pair or set to restore its value, or of paying the difference between the ACV of the property before and after the loss. In the above example, the insurance company might be able to replace the lost item—or obtain a complete pair of equal value to exchange for the remaining item—at a lesser cost than making a cash settlement. Or the insurer might pay the difference in ACV before and after the loss ($800), if replacement was not possible. An important part of any policy—and something you should always check—is how disputes are handled. • If you and the company can’t agree on the value of something—like your house—you may be able to take advantage of an appraisal condition, if your policy has one. •

Either you or the insurance company may make a written demand for an appraisal.

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No matter who makes the request, each side is allowed to bring in an impartial appraiser (at its own expense), and the two appraisers select an umpire.

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The appraisers separately state the value of the property or amount of loss.

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If they don’t agree, the differences are submitted to the umpire.

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You and your insurer then must abide by the valuation set either by the two appraisers—if they agree—or by the umpire.

Insuring Against Theft People often assume they have theft coverage when they don’t. If you purchased dwelling coverage to save some money, you probably don’t have any theft coverage for your personal property. In some cases, even broad homeowners policies don’t offer theft coverage that’s broad enough or deep enough to satisfy your specific needs. However, in either case, theft coverage may be added to an insurance policy by endorsement. There are two variations of theft coverage: 1) Broad theft coverage endorsement, which is available for owner occupants of a dwelling. •

Broad theft coverage applies to more types of property, offers optional off-premises coverage and insures other members of the insured’s family who are members of the same household.

2) Limited theft coverage endorsement, which is available for renters and other nonowner occupants. •

Limited theft coverage, when repackaged slightly and sold as stand-alone insurance, is sometimes called renters insurance.

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Limited theft coverage applies only on the insured premises, and doesn’t provide any coverage for your family.

If a theft occurs on your property, a limit of liability may apply to your coverage for the incident.

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Generally, insurers will pay for any one covered loss at the described location.

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On-premises coverage applies to property owned or used by you, and to property owned by a residence employee. It also applies away from the described location if property has been placed for safekeeping in a described place.

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Off-premises coverage is not required, but it is only available when on-premises coverage is purchased.

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This coverage applies away from the described location, but not to property at a newly acquired principal residence. If you move, you will have up to 30 days at a newly acquired principal residence to contact your insurer.

Home Warranties In the late 1990s, a growing trend in home insurance has been the home warranty. This form of protection—which is a separate contract from traditional homeowners insurance—covers repair or replacement costs related to the structure, systems and appliances of your home. If you have a home warranty, you can call on the issuing company when your air conditioning goes out, your pipes leak or your foundation cracks.

Warranties are often written and sold by companies that aren’t traditional insurers. The contracts were first offered by big housing developers as an incentive for people to buy their subdivisions. The people who liked them then looked for similar contracts when they moved on to their next homes. Today, the market is made up of developers, insurance companies and companies that specialize in home warranties. And any of these players will offer warranties on new homes

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Chapter 9: Protecting Your House…and Yourself or existing ones—although finding a warranty on a home that’s more than 50 years old can be difficult. Like the warranties available on electronics, appliances or cars, home warranties are of greatest value to people who don’t want to deal directly with home repairs…and are willing to pay for that convenience. (Like those other plans, home warranties are expensive.) If a home warranty sounds like something you want, consider these points: • the plans usually include deductibles, which range from $25 to $100 per service visit; •

multiple visits to repair the same problem may require multiple deductibles;

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warranty companies work with specific service providers, so you won’t have much choice in who does the work; and

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the response time on a service call may be slow.

The annual premium for a home warranty contract will depend on the size of the house and its location. Generally, the price starts at $400 a year…and can go up to several thousand dollars. The best use of a home warranty is for a house that’s between 10 and 50 years old. A house that’s newer shouldn’t need a warranty; a house that’s older will be prohibitively expensive to protect.

Liability Coverage The coverage that standard homeowners policies offer against personal liability are one of the most critical parts of this protection. The policy will protect you against liabilities up to the value of the house itself—but most people use their homeowners policy as their main protection from civil lawsuits.

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Most homeowners policies pay up to $100,000 each time someone makes a legitimate liability claim against you.

•

If the liability claim against you is more than $100,000, you would have to pay the difference.

Remember: Anyone can sue you—an angry neighbor, the guy who bought your ’69 Plymouth, the parents of a kid on the Little League team you coach. If the person suing you wins a judgment in court, you either have to reach a cash settlement or face the court placing a lien against whatever equity you have in your house. The claims against you don’t even have to hold up in court to hurt you financially. The cost of hiring an attorney to defend you in a civil lawsuit can easily reach $10,000. This is another reason liability insurance is valuable—it covers the costs of mounting your legal defense.

Liability risks in this litigious world really are a topic until themselves. We consider personal liability risks—and protections—in greater detail in Chapter 13.

Conclusion It is important to compare and contrast policies in order to find the coverage that individually suits you and obtain that coverage at premiums that you can afford. It is important to compare not only insurance companies but the prices and limits within each insurance company as well. If you follow the guidelines provided throughout this book, with some shopping around and just a few adjustments you will be able to find coverage in a package that suits you and your needs.

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Chapter 10: Renters, Condo Owners and Others CHAPTER

10

Renters, Condo Owners and Others

Not everyone owns a single-family house. Especially in big cities, common living arrangements include rented apartments, condominiums (rented or owned) or co-ops and other variations. As we noted in the previous chapter, home ownership is important to protecting yourself—financially—because homeowners insurance is the main mechanism that people use to protect themselves and their possessions and against liability claims. So, how do you protect yourself against these risks if you rent an apartment or own a condo? You buy other kinds of insurance (variations on the basic homeowners policy). In this chapter, we look at the insurance coverages that apply to the various living arrangements available.

Condominium Coverage Owning a condominium or a town house is not the same as renting—and it’s certainly different from owning a house. • You don’t have to worry about mowing the lawn, mending the roof or fixing a broken gate when you own a condo. Clearly, you have less to maintain. •

You also have less to insure than someone who owns a house—but more than someone who is only renting.

• If you own a condominium, your primary interest should be in insuring yourself and your unit. •

The condominium association should take care of the rest— everything from purchasing insurance for the common areas to fixing a leaky roof. 161

Protect Yourself •

The condo association maintains the facility—including the upkeep of the building (or buildings) and attached grounds.

Condominium ownership is a common alternative to traditional home ownership—and therefore traditional homeowners insurance needs. In some cases, your insurance needs may not be as broad as the coverages that the standard homeowners insurance package offers. You may not need liability or personal property insurance—especially if you are insuring a second home or certain kinds of investment real estate. In these situations, you may prefer to buy the more limited but less expensive dwelling insurance. The condo owners policy (form HO-6) covers many of the same things as a standard homeowners policy—only it offers far less coverage for the dwelling itself. The basic coverages include: • Coverage A—Dwelling; •

Coverage C—Personal property;

•

Coverage D—Loss of use;

•

Coverage E—Personal liability; and

•

Coverage F—Medical payments.

Covered perils include fire, lightning, removal of debris, windstorm, hail, explosion, riot, civil commotion, aircraft, vehicles, smoke, vandalism, glass breakage, theft, bursting of a steam or hot water heating system, falling objects, collapse, weight of ice, snow or sleet, freezing pipes, damage to appliances by artificially generated electricity and leakage of a plumbing or heating system. When condominiums first became popular in the late 1960s and early 1970s, insurance companies wrote policies for condominium associations with wide-ranging coverage because claims were few and far between. But recently, as lawsuits between condo associations and

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Chapter 10: Renters, Condo Owners and Others individual unit owners have become common, insurance companies define coverage more narrowly to reduce their exposure. A condo owner should keep in mind the following points: • Because condo associations make decisions by committee, they often underinsure liability and other risks. •

Most condos carry fire and casualty coverage for the association’s real property and liability coverage on the common areas of the condominium—as well as for their boards of directors, officers and employees.

•

This liability is important in the event that someone— particularly any of the unit owners—sues the association for failing to perform its duties properly.

The HO-6 policy works best as a layer of insurance above what your condo association has. It automatically provides only a few thousand dollars of building coverage. But most condo owners will want more protection than that—and they will usually get this through the association.

The HO-6 policy takes into account that: • condominium owners own only a portion of the building in which their units are located; •

as a member of the association of unit owners, each individual unit owner has shared ownership in the building structure; and

•

disputes over shared liability can result in large legal judgments against individual owners.

Owners of other common-interest communities—i.e., town houses and cluster homes—depend on articles, bylaws and regulations set by residents’ associations. This can leave room for a lot of problems.

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Protect Yourself If a fire started by your neighbor damaged your condo, your neighbor’s insurance company might refuse to pay for your damage, claiming that your insurance should pay. The result could be that you and your neighbor, both insurance companies and a couple of attorneys square off in court.

To avoid these problems, bylaws often require individual condo owners buy insurance to cover the contents of their unit and condominium associations to buy coverage on the real property. Condo policies often don’t include broad water damage coverage—for problems like sewer and drain backup. High-rise buildings also have problems with wind-driven rain—though most condo associations aren’t covered for that. Unless your association has coverage for water damage, you may not be insured. Claims made against underinsured condo associations are a big issue between associations and their insurance companies. If problems occur and the association finds it doesn’t have adequate coverage for the damage, unit owners often will sue the board of the association for neglecting its fiduciary duty to protect members. Condo owners living in buildings that don’t have blanket coverage against liability and property damage usually have to provide their own coverage. This isn’t a good idea.

Insurance Issues for Renters Even if you’re just renting your first apartment out of school, you may have things you need to protect—computers, TVs and VCRs, stereo equipment, sports equipment and so on. These things can be worth thousands—or tens of thousands—of dollars. So, it’s surprising that less than half of all renters in the United States bother to protect their personal belongings and furnishings with

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Chapter 10: Renters, Condo Owners and Others insurance. People under 40 are particularly remiss—even though renters insurance is relatively cheap and easy to get. • The HO-4 insurance policy form—called the tenant broad form in the insurance industry—is available from most property and casualty insurance companies. •

The coverage is called different things by different companies—the contents broad form, broad theft coverage or tenants insurance—but, whatever it’s called, the coverage is inexpensive enough to be worth a look from just about any renter.

•

All personal property is insured against loss by the broad form perils under an HO-4 policy.

Who Should Buy Renters Insurance? An HO-4 policy may be issued to any of the following: • a tenant nonowner of a dwelling or apartment, •

a tenant nonowner of a mobile home,

•

an owner-occupant of a condominium unit, or

•

an owner-occupant of a dwelling or apartment when not eligible for coverage under one of the combined building and contents homeowner forms.

A renter doesn’t usually need to insure the building in which he or she lives. And renters who don’t want to pay for liability protection can opt for a policy that covers only personal property. Landlords will sometimes require that tenants carry some form of renters insurance. (This usually applies to luxury apartments or, conversely, rent-controlled units.) In states with large urban centers, insurance and housing regulators have outlawed these requirements in the name of consumer protection. Unfortunately, these prohibitions send the message to many

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Protect Yourself people that renters insurance is a rip-off. That’s unfortunate because renters policies can be a bargain. Renters insurance can either be written in a comprehensive form for all risks that aren’t explicitly excluded or for named perils only. Named perils coverage averages about 20 percent less expensive, because the losses it covers are more limited. Renters insurance usually covers a pretty broad mix of risks. Generally, the perils covered on the renters policy are the same as those covered on a condo owners policy—namely: • ire or lightning, •

broken glass,

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volcanic eruption,

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windstorm or hail,

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explosion,

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riot or civil commotion,

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aircraft,

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vehicles,

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smoke,

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vandalism or malicious mischief,

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theft,

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accidental discharge or overflow of water,

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falling objects,

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collapse from weight of ice, snow or sleet,

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freezing pipes,

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sudden and accidental tearing apart, and

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artificially generated electrical charge.

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Chapter 10: Renters, Condo Owners and Others Although it doesn’t cover the building itself, an HO-4 policy does provide a limited amount of coverage for building additions and alterations. (This coverage is also known as leasehold improvement insurance.) How much renters coverage you need depends, of course, on the value of your belongings. Once you’ve calculated the value of the things you own, you simply have to ask yourself how much of this you could stand to lose. If you only own a few hundred dollars of any specific kind of personal property, you probably don’t need renters insurance. But, if you care enough about a hobby, activity or other experience to invest thousands of dollars in related equipment, you probably do want to protect those things.

Protecting Against Theft One reason that renters insurance is so attractive is that it protects personal property against theft. By comparison, basic dwelling policies don’t provide any theft coverage. A broad theft coverage endorsement has to be added to a dwelling policy—at additional premium—to provide such coverage. For many insurance companies, the broad theft coverage endorsement—sold in a slightly different version as stand-alone insurance—is renters insurance. Theft coverage provides insurance against loss by the following two perils: • theft, including attempted theft, and •

vandalism and malicious mischief as a result of theft or attempted theft.

A caveat: The vandalism coverage won’t apply if your residence has been vacant for more than 30 days immediately before the loss. In most cases, though, this limit won’t be an issue for renters.

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The Limits of Renters Coverage Renters insurance limits coverage either with one general dollar limit or a range of dollar limits applicable to different types of personal property. • In the first case, a policy would insure all your property— regardless of type—to a limit of $30,000. •

In the second, a policy would insure computer equipment up to $5,000, stereo equipment to $2,000, sports equipment to $1,500, etc.

Although limits of liability are shown for the maximum amount of insurance for any one loss, special sub-limits of liability usually apply to specific categories of insured property. Examples of the special limits of liability might include: • $200 for money, bank notes, bullion, coins and medals; •

$1,000 for securities, accounts, deeds, evidences of debt, letters of credit, notes other than bank notes, manuscripts, passports, tickets and stamps;

•

$1,000 for watercraft including their trailers, furnishings, equipment and outboard motors;

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$1,000 for jewelry, watches, furs, precious and semiprecious stones; and

•

$2,500 for silverware, silver plated ware, goldware, gold plated ware, and pewterware, including flatware, hollowware, tea sets, trays, and trophies.

Broad theft coverage does not apply to the following types of property: • aircraft and parts, other than model or hobby aircraft; •

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animals, birds, or fish;

Chapter 10: Renters, Condo Owners and Others •

business property of an insured person or residence employee on or away from the described location;

•

motor vehicles, other than motorized equipment which is not subject to motor vehicle registration and which is used to service the described location, or is designed to assist the handicapped;

•

property of tenants, roomers and boarders not related to an insured person;

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property while at any other location owned, rented to or occupied by any insured person, except while an insured person is temporarily residing there;

•

property while in the custody of any laundry, cleaner or tailor except for loss by burglary or robbery; and

•

property while in the mail.

The broad theft form adds two conditions that can influence whether or not property (which would otherwise be covered) is covered. First, in addition to standard duties after loss, theft coverage requires the insured person specifically to notify the police when a theft loss occurs. Second, if a theft loss is covered by other insurance, the insurance company is only obligated to pay the proportion of the loss that the limit of liability under the theft endorsement bears to the total amount of insurance covering the loss.

When You’re the Landlord Of course, renters aren’t the only people who may need insurance in a rental situation. If you’re renting out an apartment or house you own, you have significant exposures to financial loss. However, you may find yourself in an awkward place—lost between the limits of a standard homeowners policy and the technical complexity of commercial landlord coverage.

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Protect Yourself Fortunately, you can protect yourself against some rental losses. With some modifications, a combination of dwelling insurance and broad theft coverage should meet your needs. Even in a case where you feel that you know the renters well, there’s the possibility that some of your possessions might disappear during their stay. If so, the chances are good that you won’t collect on a basic dwelling policy. You’ll need the same theft coverage that the renters themselves should have. There can also be problems if a renter’s lack of concern about your property leads him to forget to double-latch the door or secure a window—making things easy for a burglar. If your insurance company learns about this, it might resist paying for stolen items—on the grounds that its premium rates were based on the assumption that you’d be around to help keep the home and contents safe. So, you need to look again at your homeowners or dwelling policy before you accept a renter’s deposit check. In particular, you need to look in the exclusions or conditions section for a clause that reads something like: peril of theft does not include any part of loss when the property is rented by the insured to another party. If your policy has language like this, you may want to convert to an all-risk homeowners policy or buy an endorsement broadening your theft coverage. If you rent your home frequently, you may need an even costlier special multi-peril policy. This kind of insurance—which is actually a commercial policy—is designed for professional landlords. It covers just about every exposure a landlord faces—and can be modified to insure against various particular risks. If you’re just renting one house or apartment, you’ll probably do best to use endorsements to make a standard homeowners or dwelling policy work.

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Chapter 10: Renters, Condo Owners and Others Some part-time landlords may be tempted to avoid the extra insurance and, if there’s an insurable loss, simply fail to mention to the insurance company that the incident occurred while the property was rented. This may work. The fact that insurance companies don’t like to talk about it suggests it does happen. But this kind of claim can progress quickly from white lie to outright fraud. For most people who have enough assets to insure, it’s better to tell the whole truth and pay a slightly higher premium. The minimum coverage you can buy on a renters insurance policy usually is $6,000 worth of personal property coverage. A basic renters policy also includes: • loss of use coverage (in case your residence is rendered uninhabitable), at 20 percent of the amount of personal property coverage; •

personal liability coverage, with a $100,000 minimum; and

•

medical payments coverage, with a $1,000 minimum.

As ever, for an extra premium, you can raise these limits as necessary to suit your needs. The liability component is important. If you’re like many people, you may believe that the landlord is responsible if someone trips in your apartment and is hurt. But the landlord’s policy may specifically exclude liability for injury to another person or damage to another person’s property if the incident occurred within your apartment. And that means you could be held liable.

Conclusion Whether you’re looking forward to owning your dream house or you’re happy in your apartment, your current risks of loss related to personal property or liability are something you need to keep in mind.

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Protect Yourself You may not think that homeowners insurance can do much for you; but—in its condo and renters forms—it can. If you own a unit in a condominium or co-op building, don’t assume that your assets are protected by the general insurance that the condo association or co-op board buys. This usually won’t work for you. Besides, the most common legal disputes involving these associations are against individual residents or members. Make sure you get your own insurance. And pay attention to your bylaws.

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Chapter 11: Special Situations CHAPTER

11

Special Situations

People lead more complex lives than they did in the early part of the 20th Century—when most of the standard terms and conditions of property insurance were established. Simply said, things are harder to value than they used to be. One example: The growth of “collectibles” trading on Internet sites like eBay means things that seem like so much junk can be sold for thousands of dollars. Adding to the complexity: Some of these “special” things are difficult to protect. Rare baseball cards or comic books can be stored in plastic holders; but they’re still at risk if your house catches fire. You can lock them away in a safe or at a bank—but, for most people, part of the pleasure of owning collectibles is being able to hold them and look them over whenever they like. Short of building an elaborate vault or panic room in your home, the best bet for protecting valuables is to make sure you have insurance that will pay to replace them if they are stolen or destroyed. And, in most cases, insurance companies do a pretty good job of offering this protection at a reasonable cost. But you have to know what questions to ask when you talk to an insurance company or agent. This chapter is about those questions.

Indecent Exposure People tend to err in thinking that their standard insurance will protect their unusual assets. So, knowing what’s not covered under standard policies may be as important as knowing what is.

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Protect Yourself We saw a version of this list before, but let’s review some of the property losses which are not covered by standard insurance and, therefore, may require you to purchase a customized or specialty policy: • animals, birds or fish; •

accounts, drawings, paper records, electronic data processing tapes, wires, records, discs, or other software media containing business data;

•

losses caused by the common power failure and ordinance law exclusions;

•

losses caused by the neglect of an insured person to use all reasonable means to save and preserve the property;

•

any intentional loss arising out of an act committed by, or at the direction of an insured person; and

•

losses caused by or resulting from, contributed to, or aggravated by earth movement.

If you have valuable things that fit under one of these categories, you probably need some sort of speciality policy. Another way to think about this need: Pay attention to the wording of your standard policies—particularly to the exclusions sections of most standard forms. Here are a few examples, taken from actual policies, which may leave holes in your coverage: ...personal property and structures that are not buildings (e.g., a TV antenna tower) are valued at actual cash value (replacement cost less depreciation) or the necessary cost of repair. ...awnings, carpeting, etc., might be considered as building items but are to be valued at actual cash value and not replacement cost, which is the usual settlement basis for buildings. And, even if there is some coverage, standard types of insurance don’t always cover full replacement value of personal possessions. So, be wary of promises or assurances that agents give you about poli174

Chapter 11: Special Situations cies that cover full replacement value. This term is used freely—but it only applies in a relatively few policies. The terms “replacement value” or “full replacement value” as used in property insurance usually refer to the structures (house, garage, etc.) covered in a standard policy. They don’t usually apply to the personal property inside the structure.

Unscheduled Property Unscheduled personal property refers to things you own but don’t specifically list or name in an insurance policy. Insurance for these things typically requires a deductible for each separate loss, but, if you want to reduce your premium, a higher deductible is also available. An unendorsed homeowners policy will cover your unscheduled personal property on a named perils basis. But, you may own some valuable personal property that would be better covered if it were scheduled and specifically insured under a floater policy. High-valued property such as jewelry, fur coats, etc. generally fall into this category. If you own any of the following items, you may want to consider purchasing a floater policy: • unique objects, including works of art, antiques, paintings and collections of unusual property (such as a valuable stamp or coin collection); •

portable property, including cameras and camera equipment, musical instruments or sports equipment;

•

fragile articles, with a high value such as glassware (china, crystal, etc.), scientific instruments or computers; and

•

business or professional equipment, whose value exceeds the limited amounts covered by a standard property insurance policy.

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Protect Yourself Be sure to establish the value of all property in advance—by doing this, you will avoid having to prove its value later. It’s a good idea to inventory all of your possessions, have the most valuable things appraised and document everything on paper and with photographs or videotape. The inventory doesn’t have to be technical; it can take the form of a handwritten list in an academic composition notebook. The photographs or videotape can be made in an afternoon or two.

Having physical documentation and description of the things you own will help a lot when and if you need to make an insurance claim. And, in the case of particularly valuable possessions, these documents will support descriptions in the floater. The floater will describe the insured item and may include information about its purchase, history of ownership, etc. Floaters are sometimes written as separate policies…but are usually written as endorsements (additions to a standard policy that expand its coverage).

A personal property floater (PPF), covers personal property owned or used by you that is normally kept at your home. The PPF also offers worldwide coverage on the same property when it is temporarily away from your home and it is insured on an all-risks basis— meaning that all direct losses will be covered unless they are specifically excluded.

Personal Effects Floater If you are planning on taking a trip, you may want to consider a personal effects floater (PEF), designed for people who want to cover their personal possessions while travelling.

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Chapter 11: Special Situations A PEF provides “all-risk” coverage for your property anywhere in the world—but only while the covered property is away from the residence premises and only for you, your spouse and any unmarried children who live with you. Personal effects refers to any personal property that you would normally wear or carry. It is designed to cover items such as luggage, clothes, cameras, and sports equipment, while you are travelling or on vacation. A PEF excludes coverage for: • automobiles, motorcycles, bicycles, boats and other conveyances and their accessories; •

accounts, bills, currency, deeds, evidence of debt and letters or credit;

•

passports, documents, money, notes, securities and transportation or other tickets;

•

household furniture and animals;

•

automobile equipment, sales peoples’ samples and medical equipment (including contact lenses and artificial teeth or limbs); and

•

merchandise for sale or exhibition, theatrical property and property specifically insured.

Property covered under a PEF must be used or worn by you and it must belong to you. If you borrow property from anyone other than another insured person, you will not be covered for its loss.

Individual Articles Floater In addition to the personal effects floater, a number of individual articles floaters can insure specific types of personal property for scheduled amounts. Usually issued as inland marine forms, separate floaters are available to insure: • bicycles,

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Protect Yourself •

cameras,

•

fine art,

•

golfer’s equipment,

•

jewelry and furs,

•

musical instruments,

•

stamp and coin collections,

•

silverware, and more.

When you are taking the time to insure your personal property for scheduled amounts, be sure to know the exact value of your property. This may cost you time and money—but it will save you a bundle of money in a lawsuit.

You can purchase an individual floater when you need to insure personal property that is concentrated in one or two classes of property. When there is a need to insure multiple classes of property, it is more practical to use a personal articles floater.

Newly Acquired Property If you have newly acquired property, check your PAF. You may find automatic coverage. • For coverage to apply, an amount of insurance must already be scheduled for the property class. •

You must report the acquisition of property to your insurance company.

•

If you don’t report it, there may be no coverage.

•

If you acquire any new jewelry, furs, cameras or musical instruments, the personal articles floater will usually cover you for the actual cash value of your property up to $30,000

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Chapter 11: Special Situations or 25 percent of the amount of insurance already scheduled—whichever is less. •

If you bought a mink coat, you have 30 days from the date of purchase to report the purchase to your insurer, in order for coverage to apply.

•

Your PAF also will only cover you for the actual cash value up to 25 percent of the amount of insurance already scheduled for newly acquired fine art.

•

However, make sure that you report the item to your insurance company within 90 days.

•

If fine art is insured, the coverage applies only within the United States and Canada.

Collectibles and Fine Art We live in a society with a thriving subculture that treasures and collects things like lunch boxes, comic books and doll wardrobes. We may not know what drives people to collect Hot Wheels cars or “Donny and Marie” dolls. But we do know that these items are some of today’s most valuable collectibles—and they aren’t in museums, but in the closets of ordinary people with not-so-ordinary insurance needs. • With conventions built around the sale and trade of these items, insurers are responding and writing out policies for this property. •

Insurance companies usually offer coverage for collections of all values on an all-risk basis, including flood, earthquake, fire, theft and breakage.

•

Generally, collectibles coverage is specifically tailored for collectors and described based on recent price guides, recently documented sales, auction offerings or by experts in the field of your collection.

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Protect Yourself •

Today, coverage for these items is pretty easy to get—many insurers even solicit pop collectibles and insurance riders.

Depending on the value of your collection, you may be required to take certain measures to secure the premises at which your collection is stored. You may have to photograph or otherwise document your collection—especially items of high value. If you’re looking to insure the collection of blues albums that your homeowners insurance won’t cover, you may want to look into specialty coverage for the collection.

Under a fine art collection policy you will be covered for loss due to breakage of items but this is limited for fragile articles such as glassware, statuary, marble, etc. A fine art collection policy will insure you against all risks of physical loss to the covered property, not including coverage for typical wear and tear, deterioration, insects, etc. • Perils insured against include fire, lightning, aircraft, windstorm, malicious damage, theft, explosion, earthquake, flood, collision, derailment or overturn of conveyance. •

If you are having art restored or repaired, you won’t be covered for any damages during the process.

•

Any newly acquired art will be covered for its actual cash value, up to 25 percent of the amount of the existing insurance—but only for 90 days.

•

Unless the premises at which you are displaying your art has insurance, you won’t be covered for any loss while your property is on exhibition.

•

If there is a loss to a pair or set of your collection, your insurance company will pay the full scheduled amount for

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Chapter 11: Special Situations the value of the pair or set as long as you turn over the undamaged portion to the company. For people who collect fine art, the value of an individual item or the total value scheduled for all items may exceed the amount of coverage that standard property insurers are willing or able to provide. • A number of excess and surplus lines brokerage houses provide coverage for these larger needs. •

A vital consideration when considering miscellaneous floaters is whether or not it provides an agreed amount of coverage. Many of the specialty policies do provide coverage on this basis.

All scheduled property other than fine art is covered on an actual-cash-value basis. But the policy won’t pay more than the stated amount of insurance, or the amount for which you could be expected to repair or replace the property. • If you experience a loss to a pair or a set for property other than fine art, your insurance company has the option to repair or replace any part of the pair or set, or pay the difference between actual cash value before and after the loss. •

Breakage of glass objects, statuary marble, porcelain and similar fragile items is covered when caused by fire, explosion, collision, windstorm, earthquake, flood, malicious damage, theft or derailment or overturn of conveyance.

•

All-risk glass coverage may be purchased, too.

Unscheduled stamps or coins that are covered on a blanket basis (multiple types of property at a single location) are usually insured for their market value. • However, coverage for any single stamp or coin is usually limited to $250 and coverage for any one coin collection is limited to $1,000.

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Losses to your stamp or coin collections are not covered if caused by fading, creasing, denting, scratching, tearing, thinning, transfer of colors, inherent defect, dampness, extremes of temperature, depreciation, theft from an unattended automobile and damage from being handled.

•

Stamps and coins also aren’t covered while they are in the custody of transportation companies or during the process of shipment by any form of nonregistered mail.

•

And they won’t be covered for disappearance unless each item is described in the policy and scheduled with a specific amount of insurance.

•

All stamps or coins covered by a personal articles floater must be part of a collection.

With a few exceptions, the amount paid for a covered loss is the lowest of the following: 1) the actual cash value at the time of loss or damage; 2) the amount for which you could reasonably be expected to have property repaired to its condition before the loss; 3) the amount for which you could reasonably be expected to replace the property with property most identical to the item lost or damaged; or 4) the amount of insurance stated in the policy. Other issues that shape the coverage available for collectibles and fine art include: • Loss to a Pair, Set or Parts. In the event of property damage or loss to a pair or set, the amount paid is not based on a total loss—the insurer may choose to: repair or replace any part to restore the set to its value before loss; or pay the difference between the actual cash value of the property before and after the loss.

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Chapter 11: Special Situations •

Claim Against Others. If a loss occurs and your insurer believes that it can recover the loss payment from the person or parties responsible, a payment of loss to you would be considered a loan. This means that any recovery you would receive from others after you have received your loan would have to be paid to the insurance company.

•

Insurance Not to Benefit Others. This provision states that no other person or organization that has custody of the property and is paid for services can benefit from the property’s insurance. A third party who was responsible for the loss would not be able to deny liability for payment because the property is insured.

•

Other Insurance. If you have any other insurance that applies to the property at a time of loss, the insurance would be considered excess over the other insurance.

Coin and stamp collectors often take their collections to exhibitions to trade and sell items. And the growth of online communication and commerce only seems to have increased collectors’ interest in shows.

The most customized coverage that the serious collector can obtain is through membership in either the American Philatelic Society (stamps), or the American Numismatic Society (coins). Group coverage is also available through these organizations.

Sports Memorabilia and Sporting Goods Growing in popularity, sports collectibles and memorabilia is often insured under a floater designed especially for it. This floater is used to insure all sorts of sport-related items (not just trading cards). • Many insurers don’t have a filed policy to cover these, sometimes extensive, collections.

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The excess and surplus lines market directories contain listings of brokers who provide coverage on either a blanket or a scheduled basis, and can cover the items even while in transit or off premises.

•

You may want to check with the sports memorabilia store where you do most of your business. Usually, dealers know of brokers who handle such items.

Separately, sporting goods and sports equipment is a category of possessions that can present significant exposures. Large gun collections and their auxiliary equipment, as well as equipment used in other types of sport (archery, fishing, etc.) can be worth a significant amount of money. A typical personal articles floater will only cover the guns themselves and none of the related equipment (nor will it cover sports equipment of any other nature—archery or the like).

How Inland Marine Insurance Works The contents coverage provided by homeowners or renters insurance is meant to cover average personal property exposures that don’t have special value. This includes such things as furnishings, clothing, household appliances and many other personal possessions found in a typical home. Some property, (such as jewelry and furs, and items that are made of gold or silver) however, can have special value due to intrinsic factors. And other property (such as antiques and collectibles) can have special value due to market value factors. Both kinds of property may move around a lot—it may go with you when you travel, etc. Standard insurance policies won’t cover this type of property, or will, at very low limits. So, such special property is usually protected by inland marine insurance. The term “inland marine” relates to property that has special coverage needs for one or both of the following reasons:

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Chapter 11: Special Situations 1) it is mobile; and 2) its value is intrinsic or market-driven. Inland marine forms may provide coverage in three formats to cover the gaps in a standard insurance policy: 1) scheduled coverage—individually declared items and values; 2) blanket coverage—a stated value to cover everything in a given class; or 3) a combination of scheduled and blanket coverage. Jewelry, fine art, and cameras are examples of property usually covered on a scheduled basis. In contrast, floaters covering personal effects or wedding presents are typically written on a blanket basis. Stamp and coin floaters can be a combination of both (a blanket amount for the entire collection, with scheduled amounts for individual items). Inland marine floaters usually have the following features: • coverage on a risks-of-direct-loss approach (“all-risk” instead of named perils); •

“floating” nature of coverage (coverage applies anywhere within the stated policy territory, which is typically worldwide, except that fine art is limited to the U.S. and Canada);

•

versatility of coverage (policyholders may select only those classes of property for which they desire coverage, and also select a predetermined limit for each coverage).

Due to the special nature of some classes of personal property in an inland marine policy, a few special provisions apply: 1) Sports or golf equipment Here we find a slight broadening of this coverage stating that it is extended to include the clothes you store in a locker while you are playing golf. There is coverage for the

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Protect Yourself loss of golf balls by the perils of fire and burglary. For a burglary loss to be covered there must be visible evidence of forcible entry into a building, room or locker. 2) Fine Art This is the only class of property for which agreed amount coverage applies. •

If there is a total loss of any scheduled item, the insurer will pay the amount shown as the scheduled value in the declarations section of the policy.

•

If partial loss occurs to a pair or set, the total declared value will be paid and the insured must surrender the remaining part of the set to the insurer.

•

Competent packers—Some types of fine art are very fragile and may be easily damaged. Therefore, a condition stipulates that when and if you transport such items, they will be handled by competent packers.

3) Stamp and Coin Collections The postage stamps class includes various types of stamps and other philatelic property owned by you or in your custody. This class includes property such as books, mounting pages, etc. Rare coins include medals, paper money, bank notes, tokens and other numismatic property, including albums, containers, frames and display cases. •

In the case of items that are insured for scheduled amounts, losses will be paid in accordance with the provisions that apply to “other property.”

•

In the case of items covered on a blanket basis (unscheduled items), the insurer will pay up to the market value at the time of loss.

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Chapter 11: Special Situations If the property is underinsured, the insurer will not pay more than the proportion that the blanket amount bears to the market value at the time of loss. So, if you have $10,000 of blanket coverage for a coin collection with a market value of $20,000, your insurance company will only pay half of any loss.

4) Other Property For all other property, the value is not an agreed amount, but will be determined at the time of loss. Despite the fact that a scheduled amount is shown, the insurance will not pay more than the lesser of the following amounts: •

the actual cash value;

•

the cost to repair the property to its prior condition;

•

the reasonable cost to replace property with substantially identical property; or

•

the scheduled amount of insurance. This means that a scheduled amount is not necessarily the amount that will be paid for a total loss, but that it could be paid if it is less than the alternative amounts.

Computers and Related Risks The need for personal computer insurance has increased in direct proportion to the rising popularity of home computers. Today, there are tens of millions of personal computers in use in the United States, and sales continue to increase each year. • Computer equipment is expensive, and it is relatively easy to transport. •

Although desktop systems are not as easily moved around as the portable laptop PCs, any thief who could steal a TV could make off with computer equipment.

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Protect Yourself •

Theft is the leading cause of computer losses.

•

Computers are susceptible to loss by many of the same perils as other property (such as fire, lightning and theft), but they are also susceptible to loss or damage by some unique perils.

Standard policies provide some coverage for personal computers, but do not cover any disks or media containing business data, and do not cover any damage caused by power surge. The limitations on covered perils and business exposures create a need for special personal computer coverage. • If a personal computer is used for any business purposes, a standard homeowners policy limits coverage to $2,500 while on the premises. •

Some policies don’t cover home computers at all if they are used for business.

Many home computers are used for some business purposes, which means that business data inside the computer is not protected by a homeowners policy.

•

The dollar limitations are easily exceeded if you own a highend personal computer, an expensive laser printer and commercial software programs.

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Even if you don’t have any business exposures, you may desire computer coverage beyond what is provided by a homeowners policy.

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Extensive computer coverage is available under stand-alone policies issued by specialty carriers as well as endorsements to standard homeowners policies.

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Chapter 11: Special Situations •

Many of these forms are considered to be inland marine policies.

Coverage is normally provided on an all-risk basis, but some exclusions specifically address computer-related exposures. Here are some features of the policy: • Coverage is provided for business property (business use does not invalidate the insurance). •

Scheduled computer hardware is covered (this means the computer itself and related equipment, such as printers, modems and connecting cables).

•

Scheduled media is covered (this means the material on that data is stored, such as hard disks, floppy disks and tape backup systems).

•

Scheduled data is covered (this means data stored on media that is available from a commercial source, such as commercial software programs; coverage for any other noncommercial data, including any programs developed by the insured, is limited to $250).

•

Coverage is provided for newly acquired computer equipment, subject to a limit of 25 percent of the amount of insurance shown for the class of property or $1,000, whichever is less. (The insured must report this new property within 30 days and pay an additional premium.)

Besides the exclusions for earthquakes, floods, war and nuclear hazards, the coverage is narrowed by computer-specific exclusions: • mechanical breakdown or failure; •

damage caused by any repair process;

•

erasure of data, unless caused by lightning; and

•

computer fraud.

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Protect Yourself Mechanical breakdown coverage is available through the specialty market. (These policies may be thought of as “extended warranty” or “repair and maintenance” contracts.) Earthquake coverage for computers is also available through the specialty market. Specialty coverages that apply to personal property: • Mysterious disappearance/theft is a coverage essential for portable computer equipment in case of a claim, usually supported by a police report, of theft or disappearance. For example, such a claim may follow accidentally leaving a portable computer in a taxi and being unable to retrieve it. •

Valuable papers and records/cost of research coverage. Unless specified otherwise in a policy, coverage for magnetic media is limited to the value of replacement of the physical media, not the inherent value of the magnetic content. In your computer policy you may want to include coverage for research and replacement cost of information lost on the media for which duplicates do not exist.

•

Utility interruption is the coverage for electrical surges and usually includes lightning that accesses equipment through electrical lines. Policies limit coverage for surges due to a power fluctuation within a specified distance from the premises. Lightning is still covered with no distance limit.

•

The typical computer policy specifically excludes “data processing equipment installed in motor vehicles licensed for highway use.” With the expanded use of wireless terminal technologies used in delivery trucks and other motor vehicles, such coverage may be appropriate.

•

Policies do typically cover property “in transit or off-premises at a temporary location.” The coverage is sometimes subject to interpretation with portables and company-

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Chapter 11: Special Situations owned desktop computers permanently located in an employee’s home office. These items may be “permanently temporary,” so “floater coverage” may be advisable. •

Programming errors exclusion coverage. Most policies exclude programming errors. So, you should ask programming vendors for a certificate of insurance to confirm errors and omissions coverage (malpractice insurance).

Special Protection: Personal Watercraft We considered the risks posed by boating in an earlier chapter. But watercraft also create liability and other risks, not covered by standard insurance. They also expose you to an entirely new element, with no boundaries on operation (other than the shorelines) and little in the way of regulatory constraints on operation. The term watercraft includes everything from small outboard flatboats used for fishing to large cabin cruisers and yachts. It also includes the rapidly growing ranks of jet skis, squirt boats and other socalled personal watercraft. An unendorsed homeowners policy provides very little in the way of coverage for your watercraft, either from a physical damage or a liability standpoint: • A homeowners policy limits personal property coverage for watercraft, including their trailers, furnishings, equipment and motors to only $1,500. Not only is this a relatively small dollar amount, the coverage is also subject to the applicable “perils insured against” named in the homeowners policy (and this would never include “perils of the seas” such as wave action, stranding, sinking or capsizing). •

Usually, a homeowners policy will only cover watercraft and related equipment when it is inside a fully enclosed building. Since many boat owners store their boats outside (for example, on a trailer parked behind the garage), this

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Protect Yourself eliminates coverage for an exposure to which the boat would be very susceptible to damage. •

Additionally, theft coverage for your watercraft is severely restricted under your homeowners policy. It applies only to theft that occurs on the residence premises. So, there would be no theft coverage if your boat and/or its trailer were stolen from a lakeside vacation location, from a parking lot in Yellowstone, or anywhere else away from the insured premises.

Boatowners face some of the same exposures to loss as do auto operators regarding the ownership, maintenance or use of watercraft, including: 1) Bodily injury and property damage to others, such as injury to passengers, skiers, swimmers, occupants of other craft, damage to other craft, etc. 2) Physical damage to the craft because of collision with other boats or objects, fire, theft, and “perils of the seas”—including wave action, stranding, sinking or capsizing. 3) Injury to the boat operator and other guests onboard the craft due to the actions of a boater who’s uninsured. 4) Liability imposed because of a responsibility for removing a wrecked craft from the waterway. Whether a boat is eligible for homeowners liability coverage depends upon the ownership, use, power and length characteristics that apply to the boat and the particular situation. If you own or use a boat that exceeds the power or length limitations, you will have to look elsewhere for liability coverage. And even if you own a small boat that falls within the permitted range for liability coverage, you’re likely to be motivated to look elsewhere for coverage, due to limitations on property coverage.

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Chapter 11: Special Situations The maximum amount of personal property coverage for any kind of watercraft—including all related motors, equipment and trailers—under a homeowners policy is still about $1,500. In many cases, this would represent only a small fraction of your actual exposure to a loss.

A personal watercraft policy is an independently filed specialty policy. The benefit of such a policy is that instead of trying to adapt an existing policy to meet only some of your needs, your insurer can craft a policy to meet your special needs. Generally, this includes physical damage coverage on an agreedvalue or replacement-cost basis (instead of ACV), coverage for all risks of loss (instead of a limited package of perils), broader liability coverage, fewer restrictions on the types of eligible vessels, and coverage for injuries caused by uninsured boaters. Typically, these policies have coverage for equipment on shore, repairs, replacement for a prescribed list of property items, salvage charges, and commercial towing and assistance.

Conclusion The purpose of this chapter has been to consider various special situations—either special kinds of possessions or special insurance policies that protect possessions. The main point to remember from this chapter is that standard insurance policies will usually offer some protection for hard-to-value or portable belongings. But they don’t offer very much. Many people are lulled into a false sense of security because standard homeowners or renters policies “cover” possessions like jewelry, sporting equipment or collectibles. They shouldn’t feel so safe. The amount of coverage for these things is usually quite small— from a few hundred dollars to a few thousand. And these amounts are often a mere fraction of what special assets are really worth.

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Protect Yourself Your best bet for protecting special assets is to increase the coverage limits offered by your standard insurance policies or to buy separate insurance designed especially for the possessions. As we’ve seen, the choice between those options is usually decided by the nature of the possession being insured. You have to decide whether your special possessions are worth the additional cost of separate, stand-alone insurance. In most situations, if you feel strongly enough about something to collect it, you will want to spend the money on the special insurance.

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Chapter 12: Disability Insurance & Social Security CHAPTER

12

Disability Insurance & Social Security

If you have a family, you probably have life insurance to protect them in case you die. But what if you don’t die…immediately? What if you suffer a stroke or are injured on the job tomorrow and can no longer work? What if you are diagnosed with a debilitating illness? If you live and you can no longer earn a living, what will happen? How will the bills get paid? Will your family suffer? You may live for many years totally disabled—and, therefore, unable to generate an income to pay for the higher medical and living expenses caused by the disability. Thirty-something workers are three to four times more likely to become disabled than they are to die. And the vast majority of disabilities are temporary, spanning a year or two, so Social Security and pension benefits never kick in.

The chart on the next page shows that the risk of becoming disabled during peak earning years is substantial—especially for people age 50 and younger. And, as you get older, the length of the average disability increases, as do the chances that you’ll never totally recover. By the time you’re 50, if you’ve got a disability that has lasted more than 90 days, odds are it will take you more than six years to recover. For most people, who work for a living, this kind of downtime is catastrophic. In this chapter, we’ll look at the various kinds of insurance, government benefits and other tools that you can use to protect yourself and your family if you are disabled during your working life.

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Protect Yourself The Probability of Disability Compared to Death at Specific Ages Number per Age 1,000 Disabled 32 6.87

Number per 1,000 Dying 1.74

Probability of Disability vs. Death 4 to 1

37

7.75

2.27

3.5 to 1

42

9.46

3.39

2.8 to 1

47

12.00

5.00

2.4 to 1

52

15.78

7.36

2 to 1

Source: Commissioner’s Individual Disability Table and Commissioner’s Standard Ordinary Mortality Table

Do you really need to worry about protecting your income? You bet. Considering how much you could earn between now and age 65, your ability to earn an income is your financial security and survival. Disability is usually a financial blow even when you have disability coverage. Most policies make you wait up to six months before drawing benefits. Then they replace half to three-fourths of your former income. And, if you to deal with a drawn out, long-term disability claim dispute, it can make matters even worse. So it’s important to make sure you have enough cash to carry you from the end of sick pay to the start of disability. Adjusting for the wait is important.

What Exactly Is Disability Insurance? Disability income insurance is a form of health insurance that provides a weekly or monthly benefit to replace a portion of the earnings lost when you’re unable to work because of an injury or illness. If you don’t have disability insurance, you have to rely on other resources to offset the effects of a disability. These usually include:

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Chapter 12: Disability Insurance & Social Security •

cash savings,

•

investments,

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business assets,

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government programs, and

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borrowing.

How long will your savings last? And how liquid are your investments or business assets? If you have an art collection or a car collection, it might take months or years to find the right buyer at the right price—and the same goes for a business. What are you going to live on in the meantime? Most people cannot rely on any of the other kinds of insurance that they may have—or their savings or collections—to help them through a prolonged disability. Fortunately, disability income insurance is designed to do just that. Disability income policies are issued on an individual basis—or on a group basis, through an employer-sponsored plan, labor union or association. Benefits paid are in accordance with the policy’s provisions and, to a degree, your loss of income. One problem: Disabilities often aren’t self-evident. Insurance companies may challenge your claim, and they may dispute the severity of an injury or illness.

Disability policies are typically among the most difficult policies to manage, for you and for the insurance company. The language in disability policies can be very important, and specific, as to how they define disability. This is why it’s important to know—and understand— the language of your policy. Does it protect the ability to perform your job, or the ability to perform any job for which you are qualified? Any job coverage is more valuable.

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Protect Yourself Other, optional policy provisions are designed to enhance the overall benefits of the disability income policy. The most common optional provisions include the following: • Presumptive disability. This provides for total disability benefits with little claims hassle if the disability results in the loss of speech, hearing, vision or use of two limbs. •

Rehabilitation benefit. This enables you to undergo vocational rehabilitation, during which time total disability benefits will be paid—as long as you remain totally disabled during the training period.

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Future increase option. This protects your future insurability by providing birthday, marriage and birth of children option dates on which additional amounts of disability benefits can be added to the policy without proof of insurability on your part.

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Cost of living benefit. This option provides increases in benefit payments once you are on a claim, so that disability benefits can keep pace with inflation and the cost of living.

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Lifetime benefit. This optional benefit provides lifetime disability income benefits—usually if the disability commences prior to a certain age. Otherwise, coverage may end at age 65 or be limited in other ways.

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Additional indemnity riders. These riders provide additional payments for short periods of time, such as six or 12 months. The purpose is to coordinate with other disability benefits, such as Social Security or group plans.

Group Plans at Work If you’re an employee, there may be some work-related benefits available from a group disability plan, a salary continuation plan, employee stock plan, workers’ compensation, etc.

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Chapter 12: Disability Insurance & Social Security But group disability benefits are of short duration—a year or less—and cover only a percentage of lost income. These capped benefits also tend to discriminate against higher-paid employees. A group plan might provide benefits equal to 60 percent of your pay, up to a maximum benefit of $2,000 per month ($24,000 annually). This may prove to be an adequate benefit if you earn $40,000 or less per year. But for people earning more, the disability benefit is still limited to $24,000 a year. If you earn $60,000 annually, then your disability benefit would cover only 40 percent of your ordinary pay.

Also, under most group plans, you merely “rent” coverage. In other words, benefits are available on the condition that you continue to be an employee. If you terminate employment, your disability benefits also are terminated. If a disability strikes between jobs, no workrelated benefits are provided. Most group short-term disability (STD) policies provide for short elimination periods (usually 30 days or less) and short benefit periods. The benefit period is usually between six months and one year. The benefit amount is limited to a percentage of your pre-disability earned income—such as 60 or 70 percent. The claims process for STD benefits is fairly simple. You need an attending doctor’s affidavit that you are injured seriously enough that you can’t work. You also need to fill out a claims form—mostly attesting to the fact that workers’ comp or other coverages don’t apply. One of the rationales for STD has been that if you are injured you should be eligible for Social Security disability benefits after the fivemonth Social Security waiting period. In reality, this may or may not be true—depending on whether you can meet the strict definition of Social Security disability. Yet another form of coverage that could kick in is Accidental Death and Dismemberment (AD&D) coverage, which frequently

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Protect Yourself is provided as part of a group insurance contract. AD&D coverage pays a “principal sum” (basically, the policy’s face amount) for accidental death in accordance with the policy’s provisions and definition of accidental death. This same amount is paid if you lose use of both arms or both legs, or if you lose vision in two eyes due to an accident. This amount usually is identified as the capital sum if the policy is paying an accidental dismemberment benefit. Long-term disability (LTD) policies provide for longer elimination and benefit periods than short-term. Typically, the elimination period will be 90 days or six months. Usually, LTD policies provide benefits to age 65. The amount of the long-term benefit is also limited to a percentage of your pre-disability earned income—from 60 to 75 percent, depending on the policy and insurance company. The claims process for LTD benefits is more complicated than for STD benefits. Normally, you and a physician must complete a claims form periodically— every month, once a quarter, etc.—for the duration of the claim. This will be in addition to the initial claim form you complete when you first notify the company that you’ve been injured. A caveat: Make sure that you inform the disability insurance company as soon as possible when you’ve suffered a disabling sickness or injury. In many cases, the company won’t begin the elimination period until it has been informed—so benefits don’t start until six months or a year after that.

Insurance companies paying LTD benefits may also look more carefully into the status of the claim. (They are supposed to use the elimination period to do this, though many don’t start their investigations until they’ve started paying benefits.) Your insurance company will look for anything about the claim that might disqualify it under the exclusions section of your policy. Common objections include:

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•

a claim has arisen from or occurred in the course of work— and should be covered by workers’ comp;

• •

you did not inform the company in a timely manner;

•

other insurance reduces the benefits available.

you are not totally disabled—as this term is defined in the policy; and

This last issue can raise all kinds of problems. The LTD benefit may be offset by any of the following: • any benefits provided by another formal employer plan;

•

benefits payable under workers’ compensation or any similar statutory program; and

•

any benefits payable under Social Security.

The claims process is usually simplified with presumptive disabilities—like loss of vision or a limb. For this kind of claim, there is a single claims form completed at the onset of the claim. Due to the severity of the disability, no further claims forms are usually needed.

Association Disability Plans Professional associations—such as the American Medical Association or the American Bar Association—offer association disability income coverage to their members. Association disability plans function very much like group plans. However, there are some differences. Technically, association coverage is individual coverage. As a member of a professional association, you complete an application for insurance; an individual policy is then issued through the association. Association plans are packaged plans, in that only certain elimination periods, benefit periods and benefit amounts are offered to members. Premiums for association coverage usually are banded. That means they are grouped based on increments of age. For example, everyone between the ages of 25 and 30 pays the same premium; other bands of five (or 10) years continue to age 55 or 60.

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Protect Yourself Typically, the amounts of coverage also are predetermined—such as a $1,000 benefit or a $2,000 plan. This makes sense because all members have the same occupational classification and job duties— i.e., physicians, lawyers, etc. Also, association plans may offer a minimum guaranteed issue policy without regard to the insurability of the member. This is an advantage for the uninsurable individual. Through the association, you can get disability income insurance regardless of your health history. Disadvantages of association coverage include the fact that the policy may be cancelled by the insurer or the association. Also, you can lose the coverage if you don’t keep your membership in the association. A final disadvantage: Premiums are not guaranteed. The insurer can raise the premium for the entire plan.

Occupational vs. Non-Occupational Benefits Generally, individual disability insurance plans offer better coverage than group plans. But even the individual plans can be pretty complicated. There are two basic types of individual disability income insurance—traditional your occupation type coverage and residual policies. Both short-term and long-term disability income policies may be occupational or non-occupational. • Occupational coverage provides payment for disability arising out of accidents occurring on or off the job.

•

Non-occupational coverage provides payment only for disability that is not work-related.

Traditional disability income policies define total disability in terms of job duties or functions. The claims process is triggered by the inability to perform duties of a job. With these policies, benefits end when you return to work, even on a part-time basis. • Residual disability income benefits are triggered by a loss of pre-disability income. So, they offer an incentive for

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Chapter 12: Disability Insurance & Social Security the insured person to return to work, because benefits will continue in proportion to his or her loss of income.

An occupational policy pays benefits whether or not the disability is covered under workers’ comp; a non-occupational policy does not pay if workers’ comp pays.

Under traditional your occupation disability coverage, when benefits are triggered by the inability to perform functions of a job, you must be totally unable to work. There is little incentive for you to return to work on a part-time basis, unless the policy contains a partial disability income benefit. Frequently, the traditional disability income policy will contain a limited partial disability benefit, which will pay you 50 percent of your total disability benefit for up to six months. Generally, the definition of partial disability is the ability to perform some, but not all, of the duties of your occupation. Without a partial benefit, you may be unable to return to work financially until you can do so on a full-time basis. This will tend to prolong the claim, which is not good for either you or the insurance company. Yet, for decades, this was the only type of disability income insurance sold; today, it’s still sold, mostly to people in high-risk occupations.

Applicants for disability income insurance are classified according to the risks inherent in their occupations. For example, a dentist or a doctor works in a safer environment than a truck driver or a factory worker. Generally, most insurers will offer all occupational classes the your occupation type of coverage. Non-occupational or residual disability income benefits are triggered by simple loss of income. In the technical language of the policy:

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Protect Yourself loss of pre-disability income due to a disability caused by accident or sickness. The question becomes: Has the insured person suffered a loss of income? as opposed to Is the insured person unable to perform the duties of his or her job? If the answer is yes, then the person is entitled to a benefit in proportion to the loss of pre-disability income. In essence, the residual benefit is a long-term partial disability benefit. It can be defined as: the ability to perform some, but not all, the duties of one’s occupation and, as a result of disability, the insured’s earned income is reduced by at least 20 percent of pre-disability income. Under this kind of policy, as long as you are partially disabled, you receive a benefit in proportion to lost income. And this partial payment lasts throughout the policy’s benefit period—even if that benefit period is to age 65. This proportionate benefit is a percentage of your total disability income benefit. In other words, if you suffer a 30 percent loss of pre-disability compensation, you are entitled to 30 percent of your total disability benefit.

Many companies offer residual policies without qualification periods. Thus, when a residual policy has a zero-day qualification period, satisfying the elimination period makes the insured eligible for total or residual benefits. When a policy has no qualification period, days of total disability and/or residual disability will satisfy the elimination period. If you have a residual disability policy, your pre-disability income will be used in the calculation of residual benefits. This figure normally will be based on average income for a specified period of time, such as one, two or three years. So, the policy may define predisability income as: the average monthly income earned by the insured during the 12 months prior to the onset of total disability.

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Injury and Sickness Benefits Disability income benefits are paid for disabilities caused by accidental injury or sickness. While the benefit amount is usually the same for either cause of disability, the primary difference between coverage for accidents and sickness lies in the elimination period. Elimination periods for sickness may range from seven days to one year. Frequently, accident coverage has a reduced elimination period or no elimination period.

Of the different definitions given to the term accident, there are two major ones: accidental bodily injury and accidental means. • Accidental bodily injury is defined as an injury (the result of an accident) that is unintentional and unforeseen. •

Accidental means is an injury whose cause is unintentional and unforeseen. That is, the accident was not caused by any action taken by the injured person or by any activity performed by the injured person.

Sickness or illness may not be defined in any manner that is more restrictive than sickness or disease that first manifests itself after the effective date of the policy. However, if a disability policy provides nonoccupational coverage only, the definition of sickness may exclude work-related disabilities.

Workers’ Compensation Workers’ compensation provides another source of disability income benefits—but only if your accident or sickness is job-related. Falling out of bed in the morning and breaking your arm doesn’t constitute a workers’ comp claim. Slipping on a wet floor at the job site and breaking your arm is a workers’ comp claim.

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Protect Yourself The intent of the workers’ comp system is to make the employer liable for occupational disabilities without you having to prove that the company was at fault. Your employer either will cover such claims out of company funds or elect (as almost all do) to cover this risk by means of workers’ comp insurance. The laws—and the benefits provided—vary somewhat from state to state. But benefits are usually low—around $300 a week. Employers provide workers’ comp coverage to their employees in one of several ways. The most common ways include: • an insurance policy paid for by the employer and naming employees as beneficiaries; •

membership in a state-approved employers’ group designed to process and pay claims; and

•

a bond or other financial device that shows the employer has enough money to pay any claims directly (this is another example of self-insurance).

Workers’ comp coverage applies to bodily injuries and diseases that occur arising out of or in the course of employment. Besides that, the following circumstances must be in place: • Covered losses must be work-related (losses that are not work-related are not covered by workers’ comp). •

Any covered bodily injury must be accidental—and can include death resulting from the accident.

•

Only occupational diseases that are unique to a particular job are covered.

•

A cause-and-effect relationship must exist between the job and the disease. Ordinary diseases suffered by the general public are not covered.

So, what’s the difference between a health insurance plan and workers’ comp? Your employer may offer health insurance only to a

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Chapter 12: Disability Insurance & Social Security certain class of employees, such as all salaried employees or employees who have worked one year or more for the firm. With workers’ compensation, singling out classes of employees for coverage is not permitted. All employees have to be covered. Workers’ compensation laws provide for the payment of four types of benefits: • medical benefits, •

income benefits,

•

death benefits, and

•

rehabilitation benefits.

Disability Benefits Under a workers’ comp program, if you are injured, disability income benefits compensate you for lost or reduced earning capacity that results from a compensable injury or occupational disease. Such benefits are paid when you are unable to perform all or part of your regular duties. Compensation is paid in four designated classes of disability, as follows: • permanent total, •

temporary total,

•

permanent partial, and

•

temporary partial.

Under most workers’ comp plans, income benefits are paid to employees with work-related disabilities. A waiting period (usually three to seven days) applies before benefits for loss of wages begin. If the disability continues beyond a longer period (usually two to four weeks), retroactive benefits are paid for the initial waiting period. For permanent total disability or temporary total disability, the benefit is a percentage of the your weekly wages before the injury.

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Protect Yourself This figure is subject to stated minimum and maximum dollar amounts. Within each state, the percentage is the same for either type of total disability (67 percent is most common). However, for permanent total disability, the dollar maximum and the benefit period are usually greater. Benefits for permanent total disability often continue until you are 65, while benefits for a temporary total disability may be limited to a maximum number of weeks. If you have a partial disability and are able to perform some work, the laws provide a benefit equal to a percentage of your wage loss (difference between earnings before and after the accident). In addition to benefits for lost wages, the state provides scheduled benefits for specific permanent partial disabilities, such as loss of limbs, sight or hearing. Usually, these benefits are paid in addition to any other income benefits. Like Social Security and commercial disability income insurance, workers’ comp plans include rehabilitation benefits designed to reduce costs by incentivizing your return to work. These benefits can include the following: • physical or mental rehabilitation, intended to help the injured or ill worker achieve maximum recovery from the disability effects of the accident or disease; •

vocational rehabilitation, intended to give the worker new job skills, since the disability prevents the worker from pursuing the job he or she had prior to the disability;

•

maintenance allowance, which can include board, lodging and travel during rehabilitation; and

•

rehabilitation devices, such as wheelchairs.

Rehabilitation also aids the insurance company. It helps to restore the injured worker to his former earning capacity. Today, insurance companies are among the leaders in providing rehabilitation for the industrially injured.

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Chapter 12: Disability Insurance & Social Security Rehabilitation benefits are provided by all states. Some states have set up a special fund to provide these benefits, while others have not. Various states impose weekly limits, maximum limits and special limits for specific types of rehabilitation. A disabled worker is entitled to receive all necessary medical and surgical treatment to cure or relieve a work-related condition. However, maximums or limits may apply to specific types of treatment. Two types of payments are provided under workers’ comp death benefits. A certain amount is provided as a burial allowance, and income payments for a surviving spouse or children are provided. Death benefits are usually a percentage of wages, subject to minimum and maximum dollar amounts. A surviving spouse may receive benefits for life, or until remarriage. Surviving children generally receive benefits until age 18—or age 22, if they are still in school.

Social Security Coverage You also might think you can count on Social Security disability income benefits. But it’s not easy to get Social Security benefits—and they’re pretty puny when they do come. The Social Security System, more properly called Old Age Survivors and Disability Insurance (OASDI), was enacted in 1935 to provide retirement benefits for covered workers. By 1939, it also provided survivors benefits to the families of covered workers. The program pays four types of benefits: • disability benefits to workers, •

Medicare benefits,

•

retirement benefits to workers and their dependents, and

•

survivors benefits to a worker’s family.

The disability benefit paid to you under Social Security is equal to your primary insurance amount (PIA), which is based on your earnings history and the taxes you’ve paid. This benefit may be reduced by monies paid to you under workers’ comp or other statutory plans.

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Protect Yourself Sadly, the disability benefits of Social Security are all that many people have to replace their income if they’re unable to continue working due to illness or injury. Benefits are modest. At most earnings levels, benefits amount to less than half of prior earnings. In 2002, the average monthly benefit received by approximately 5 million disabled workers in the United States was…$815. Still, Social Security is a key part of most Americans’ total package of income insurance—so its mechanics are worth considering. Just about everyone is eligible for Social Security, including: • Common law employers and employees. Corporate officers and working owners of companies are considered employees for Social Security tax purposes; •

Most self-employed persons. A self-employed person means an individual (or individuals) operating a business or engaged in a profession as a non-incorporated venture. The business may be a sole proprietorship or a partnership, or the person may operate as an independent contractor. Professionals—CPAs, doctors, dentists, lawyers, real estate agents, etc.—usually are self-employed;

•

Armed forces personnel; and

•

Employees of nonprofit organizations. Since January 1984, all employees of nonprofit organizations—school systems, hospitals, churches, etc.—have been covered by Social Security. Nonprofit organizations are those identified in section 501(c)(3) of the Internal Revenue Code.

Other occupations eligible for coverage include: • Independent contractors and free-lance workers. A person who is an independent contractor or free-lance worker will have no Social Security taxes paid on his or her behalf by an employer. Most pay Social Security taxes as self-employed persons.

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Chapter 12: Disability Insurance & Social Security •

Family members employed in the family business. As a general rule, if a family member works for the family business, Social Security coverage and taxes are applicable. An exception: a minor child (under the age of 18) employed by the parent.

•

Government employees. Government employees were not covered by Social Security during its early years. However, in the 1980s, a series of reforms moved these workers from various programs into the Social Security system.

•

Ministers, priests, rabbis and members of religious orders. Since 1967, these people have been covered by Social Security. Members of religious orders must pay Social Security taxes—however, they may claim exemption. They will still be able to claim disability benefits.

Eligibility Isn’t Everything Participation in the program and payment of Social Security taxes is mandatory, unless your occupation is exempt. But—even though almost everyone pays the taxes—only about one in three claimants collects benefits. This is true for several reasons. Qualification for disability income benefits from Social Security requires the following: • you have fully insured and disability insured status; •

you are under age 65; and

•

you have satisfied a five-month elimination period followed by submission of an application for benefits.

The under age 65 requirement is due to the fact that, at age 65, any disability benefits being paid become retirement benefits. When a recipient turns 65, disability benefits cease and retirement benefits begin.

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Protect Yourself In addition to the age and status requirements, a worker must also satisfy the Social Security definition of total disability. This may be the toughest part. Total disability is defined as: The inability to engage in any substantial gainful activity by reason of any medically determined physical or mental impairment which can be expected to result in death or last for at least 12 months. This definition is very restrictive. It obviously eliminates benefits for any short-term disability or a relatively insignificant, non-life threatening disability. Generally, you should file an application for benefits sometime during the fifth month of disability, because of the five-month elimination or waiting period. Claims applications may be submitted retroactively up to 12 months after the onset of the disability.

Who Else Qualifies? A spouse of a disabled worker is eligible for benefits if: • the worker achieves eligibility; •

the spouse is not eligible for another disability benefit equal to or larger than the worker’s PIA; and

•

the spouse is under age 62 or has a minor child under the age of 16.

In addition, the spouse must have been married to the disabled worker for at least one year prior to the submission of the disability claim and/or be the biological mother of the minor child. A divorced spouse is eligible for benefits relative to a disabled worker. Essentially, the divorced spouse must have been married to the disabled worker for at least 10 years prior to the date on which the divorce became final and must be single. The spouse’s (or divorced spouse’s) benefit is equal to one-half of the worker’s PIA and subject to the family maximum. Dependent

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Chapter 12: Disability Insurance & Social Security children of a disabled worker may be eligible for benefits if certain requirements are satisfied. These requirements include the following: • the child is dependent on the disabled worker—which generally means that the child is under age 18;

• •

the child is not married; and an application for a child’s benefit has been submitted.

A disabled child of a disabled parent may receive benefits past age 22 if the child’s disability began prior to age 22. These same eligibility requirements apply to grandchildren or stepchildren. The disability benefit for a child of a disabled parent is equal to one-half of the parent’s PIA and subject to the family maximum benefit. Also, a child will lose benefits due to excess earnings—as is true with survivor or retirement benefits. The following chart reviews the Social Security benefits in relation to the worker’s PIA. Social Security Benefit

Equal to

Worker’s Retirement

100% of the PIA

Widow’s Benefit

71.5% of the PIA

Worker’s Disability Benefit

100% of the PIA

Dependent Spouse

50% of the PIA

Dependent Child(ren)

50% of the PIA

All dependent benefits are subject to a family maximum—which is approximately 20 percent greater than the benefit equal to the PIA. All benefits are subject to periodic increases due to changes in the cost of living. The worker’s benefit, as well as dependent benefits, may be increased annually in accordance with the Consumer Price Index for Urban Wage Earners and Clerical Workers, which is prepared by the Department of Labor each year. In certain cases, non-family third parties may receive Social Security disability benefits. For example: You have an established his-

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Protect Yourself tory of substance abuse problems. In fact, they are the cause of your disability. The Social Security Administration may choose to send your benefit checks to a trustee or custodian. If it does this, it must notify you that benefits will be paid in the indirect manner. Social Security prefers to pay these benefits to a local social services agency or governmental body, which will manage the benefits for you. In some cases, though, it will allow a privatesector organization or another person to receive the check.

Figuring Out How Much Disability You Need Social Security doesn’t pay much. So, how much other disability insurance do you need? To figure this out, you will need to gather some information and calculate some numbers. In financial planning circles, this process is called needs analysis. Usually, it’s best to use a worksheet when conducting a needs analysis. This helps you consider problems, needs and objectives consistently. It also helps you avoid the main problem that plagues needs analysis: overlooking something. What you make is fairly simple to calculate. It’s the amount of earned income you expect to have during a specific period of time. In most cases, insurance companies calculate this number by asking what you make in salary and other earned income. A good insurance company will ask for some kind of proof of income—like an IRS W2 form or other tax document. Don’t fudge these numbers. If you do, the insurance company will not have to pay you anything in the event of a claim. You’d be amazed how many people blatantly lie on their applications and then sue their insurance companies when they won’t pay. The insurance companies usually win.

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Chapter 12: Disability Insurance & Social Security You also need to calculate what you need to protect, including: educational objectives for dependent children, other family needs, business objectives and retirement goals. The following will impact your disability needs most directly: • Fixed Obligations. Such expenses as mortgage or rent, car payments, utilities, food, installment purchases, insurance premiums, etc., must be itemized.

•

Variable Expenses. These are the unexpected, non-fixed expenses that occur from month-to-month, such as car repairs, medical expenses, prescriptions, home repairs, etc.

•

Added Expenses. There are added expenses that result from a disability—additional medication, doctors’ bills, prosthetic devices or appliances, the rental of special equipment (i.e., beds or wheelchairs), hospital expenses not fully covered by insurance, etc.

Charting Your Needs The worksheet on the next page will help you add up your expenses, such as mortgage or rent, utilities, food, auto or transportation expenses, tuition or education expenses, clothing, outstanding consumer loans or installment purchases, insurance premiums, medical or dental care costs, taxes and miscellaneous expenses. Then it will help you look at your other sources of funds in the event of a disability, and consider your potential needs, should you become disabled. If the final income figure is negative, check your numbers—with an eye toward making sure that your expenses are all covered and that the non-earned income is absolutely reliable. If your final number is still negative, you don’t need to worry about disability insurance—you should be thinking about retiring. For most people, the final income figure will be positive—and probably disturbingly large. And remember, this is only a monthly number.

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Protect Yourself Disability Income Needs Assessment Worksheet PART 1 Enter your monthly expenses related to each of these items and add them for Subtotal 1. If possible, average what you spent during each of the last six months. Mortgage or rent Utilities Phone Food Auto expenses/transportation Tuition/education expenses Clothing Loans and installment purchases Insurance premiums Medical/dental care costs Miscellaneous expenses Taxes Subtotal 1

__________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________

PART 2 Enter your monthly income provided by each of the following sources of “non-earned income.” For the insurance items, check each policy’s maximum benefit. For the other items, average your costs over the last six months, if you can. Add them to come up with Subtotal 2. Group disability insurance benefits Other insurance benefits Interest income Dividends Rental income Deferred compensation, residuals, etc.

__________________ __________________ __________________ __________________ __________________ __________________

Subtotal 2

__________________

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Chapter 12: Disability Insurance & Social Security PART 3 Subtract Subtotal 2 from Subtotal 1. This will provide you with the monthly income figure that you need to insure against disability. Subtotal 1 minus Subtotal 2 equals Total monthly income to be insured

__________________ __________________ __________________

In order to estimate the likely total loss from a disability, refer to the disability duration chart below. The Average Duration of a Disability that Lasts for More Than 90 Days Age at Onset

Duration

30

4.7 years

35

5.1 years

40

5.5 years

45

5.8 years

50

6.2 years

55

6.6 years

Source: Journal of the American Society of Certified Life Underwriters

Finally, multiply the total monthly income you need to insure by the average duration of a disability that lasts at least 90 days. Total monthly income to be insured

__________________

multiplied by Average duration of a disability that lasts at least 90 days equals

__________________

Average long-term disability loss

__________________

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Conclusion The key to staying in good financial shape, even while you are disabled, is covering that monthly figure. Now you know the three numbers you need to tell your insurance company or agent when you’re shopping for disability coverage: the total monthly income to be insured, your current monthly earned income and the average long-term disability loss. These numbers provide a range within which your income coverage (whether it’s disability insurance, Social Security or simple cash savings) should fall. This chapter considered the mechanics of disability income insurance and what you should be aware of when purchasing a policy. The process can get even more difficult if you’re relying on one of the statutory programs—workers’ comp, state unemployment insurance or Social Security—for coverage. These programs are even more bureaucratic. And they offer even smaller benefits. Make sure your policy spells out how to appeal decisions with which you disagree. Policyholders almost always have the right to an independent medical examination. And, some insurance companies are more forthcoming than others. Stay on top of things if you need your disability coverage. In some cases, doctors who can’t keep track of the paperwork cause the disability problems.

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Chapter 13: Personal Liability CHAPTER

13

Personal Liability

We live in a litigious society. Much of society believes that an injured party has the right to sue anyone (including you) he or she can and collect as much money as possible—whether or not the payment is justified by actual damages or by your actual liability for the loss. Even if you’re a reasonable, hard-working citizen, everyday life is a risk in this environment. What can you do to protect yourself from some eccentric judge deciding that a ludicrous situation is all your fault? Be smart about any contracts you sign and buy insurance. This chapter is about how you can be found liable for some terrible loss situation. And it’s about how you can protect yourself— both legally and financially—from the consequences of a lawsuit.

Torts vs. Crimes When you break a law, you have committed a crime. When you violate the rights of another person, you have committed a tort. The person committing a tort is known as the tortfeasor. It’s important to remember that liability insurance applies only to the financial consequences of torts. There is no insurance that covers liabilities related to crimes.

Most personal liability cases involve unintentional torts: your dog barks all night, keeping you neighbors awake; you accidentally hit a bicyclist with your car. The basis for legal claims related to unin-

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Protect Yourself tentional torts is usually negligence. In order for negligence to exist, the following elements must be present: • Duty to act. The duty to act in a reasonably prudent manner toward another (such as driving safely, in a manner that avoids hitting cars or pedestrians). •

Breach of the duty to act. The tortfeasor does not act in the prudent manner described above.

•

Occurrence of injury or damage. Another party actually must suffer an injury or damage.

•

Negligence is the proximate cause of the injury or damage. The tortfeasor’s breach of duty is actually what caused the injury or damage.

If all four elements are present in a situation that involves a loss, the injured party usually has a valid claim for damages. In any discussion of liability, it is important to understand the term damages. If you are held liable for injury or property damage to another, you can be required to pay compensation to the injured parties. For these types of claims, two broad types of damages apply: • Compensatory damages—this simply means compensation for the loss incurred. These may include specific damages (the actual expenses incurred by the injured party, such as medical bills and property replacement costs) and general damages (more subjective aspects of the loss, such as pain and suffering or loss of consortium). •

Punitive damages—these are damages that courts order a tortfeasor to pay in addition to the compensatory damages as punishment for outrageous or intentional conduct.

Of course, there are many examples of intentional torts—you see them in the civil lawsuits that often follow criminal ones. Wrongful death is an intentional tort…so is assault, fraud and trespass. But unintentional torts are more often the results of normal life. 220

Chapter 13: Personal Liability

Key Liability Points Vehicle-related liability is the most common source of personal liability. More specifically, vehicle liability can arise from: • property damage to other people’s cars; •

injury to pedestrians or people occupying other cars; and

•

damage to property other than cars (such as a fence).

Injuries and damages related to vehicle use also may be caused or aggravated by various risk factors, such as: • excessive speed; •

disobedience of traffic laws (such as running a stop sign);

•

intoxication (use of drugs or alcohol); or

• simple carelessness brought on by inattention. Auto insurance protects against many of these damages and factors. But it may not offer enough coverage to protect you completely. That’s why the additional coverage is important. The second largest source of personal liability is residence-related liability. Whether you own or rent your home, you may be personally liable for injury or damage to others, including: • trip and fall incidents due to ice and snow, debris, etc.; •

accidents related to swimming pools or other attractive nuisances, such as jungle gyms and trampolines;

•

injuries sustained by maids, gardeners, etc.; and

•

injury caused by an overly protective dog.

Umbrella Coverage In most cases, if you are a middle-class…or wealthier…person, you will need a personal liability or umbrella policy to cover the legalistic garbage that infects daily living in the modern world.

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Protect Yourself An umbrella liability insurance policy sits over other liability coverages and pays claims in excess of the underlying policies. It will also cover liabilities that existing policies do not. Generally, the policy is issued by your current homeowners, renters or automobile insurance company. The insurance isn’t terribly expensive. If you have homeowners and auto policies with liability maximums of $300,000, an insurance company will usually issue you a $1 million umbrella policy for around $200 a year. The price sounds too good to be true? It really isn’t. Umbrella liability companies require that you already have at least $300,000 insurance on your home and on your car. The umbrella liability company now has a $300,000 deductible on your house and, more important, on your car.

Typically, personal umbrella liability coverage comes in increments of $1 million, starting at $1 million and going up to $5 million. It’s possible to get even higher limits; some insurance companies write $10 million policies. Umbrella liability policies serve two major functions: •

they provide so-called “high limits of coverage” that protect against catastrophic losses not covered by standard insurance; and

•

they provide broader coverage than underlying policies.

Your premium will depend on the limits you select; the number of cars, homes, boats, etc., that you own; and the area in which you live. To figure out how much umbrella liability insurance you need, you will need to determine your current net worth (assets minus liabilities). Do you expect this amount to increase in the near future? Because of the relatively low cost of this type of insurance, you might consider buying enough coverage to protect your net worth for several years. 222

Chapter 13: Personal Liability If you are thinking about buying a personal umbrella liability policy, it’s best to place it with the same insurance company that writes your homeowners and auto coverage. Not only are you likely to get a discount for having multiple policies with the same company, but you are more likely to avoid gaps in coverage if one company is handling all your overlapping insurance needs. Besides, most companies tailor their excess liability coverage provisions around their auto and homeowners policies. What do umbrella policies cover? • These policies cover all vehicles that you own or rent, excluding recreational vehicles and aircraft. •

They cover personal injury to others but have restrictions for communicable diseases.

•

They cover legal expenses. A personal liability policy can come in handy if you’re being sued for physical damages or nonphysical damages—like libel or slander—in a nonbusiness situation.

Umbrella policies pay legal defense costs, even if a suit made against you is groundless, false or fraudulent. This is important because some lawsuits are designed to hurt you by forcing you to pay steep legal fees to defend yourself. Typically, umbrella policies will cover you and your relatives, including anyone related to you by blood, adoption or marriage. Spouses, to be covered, must be in your household. Umbrellas are not standardized forms (like homeowners or auto policies), which means they can differ from one another—and from company to company—in significant ways. Most personal umbrella policies on the market can be organized into two categories: • Following form excess policies. These provide high limits over the exact same perils, coverages and exclusions found in the underlying policies.

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Protect Yourself •

True umbrella policies. In addition to high limits of liability coverage, these policies provide broader coverage than underlying coverages.

Early umbrella policies were extremely broad and contained few exclusions. However, insurance companies soon learned that they’d need to narrow the coverage by creating more specific insuring agreements and exclusions.

Broader Protection One of the most important functions of a true umbrella is that it provides broader coverage than the underlying policies. The term dropdown coverages is often used to name the coverages provided by the personal umbrella that are not provided by the underlying liability policies. Some of these include: • Personal injury coverage. The typical underlying homeowners policy provides liability coverage for accidental bodily injury (meaning physical injury or death), but not for events involving libel, slander, false arrest and the like. The personal umbrella does cover you for liability arising out of these events. • Regularly furnished autos. The standard Personal Auto Policy contains language that precludes liability coverage for the use of vehicles that you do not own but that are made available for your regular use (such as a company car). The personal umbrella does not exclude such coverage. • Contractual liability. The standard homeowners policy severely limits coverage for liability assumed by contract. So, if you sign an easement agreement to build a shared access road with your neighbor—and he sues you because the road is never completed—the umbrella will cover you. • Damage to property of others. The standard homeowners policy excludes coverage for damage to property of others left in your care, custody or control. The personal umbrella does not exclude coverage for damage to such property.

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Chapter 13: Personal Liability An important concept that comes into play when a personal umbrella covers a loss that is not covered by an underlying policy is termed a self-insured retention or SIR. (It’s called a retained limit in some policies.) When the umbrella alone provides coverage for a loss, you pay what amounts to a deductible by “retaining” the first small portion of the loss (typically $250). Loss payment is administered somewhat differently than with traditional deductibles. In this case, you write a check to your insurance company for the amount of the SIR, and it pays the injured party the entire amount for which it is liable.

Intentional Torts So, what about intentional torts? Intentional torts can involve infringement of property and privacy rights. Property rights also can be violated by nuisance-type activities that interrupt a property owner’s ability to use the property (for example, you test your 2500watt stereo early Sunday morning while your neighbor is trying to sleep). Other intentional torts can involve personal injury, which includes bodily injury and damage to reputation through untrue statements, libel or slander. Most liability policies exclude coverage for bodily injury or property damage that could reasonably be expected to result from “the intentional or criminal acts of an insured person or which are intended by an insured person.” Some policies exclude coverage for criminal acts not resulting in criminal charges and acts committed while an insured person lacked the capacity to form the intent to commit the act. Even if the intentional or criminal acts exclusion does not apply, coverage may still not be available because some umbrella policies cover only accidental loss. An accident is never present when a deliberate act is performed unless some additional unexpected, independent and unforeseen happening occurs that produces or brings about injury or death.

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Protect Yourself Regardless of any mental instability you suffer from, if you engaged in deliberate acts, chances are your policy won’t protect you.

Swimming Pool Liabilities But, in fact, most liability disputes never touch on criminal issues. They turn on simpler matters. The main item in most backyards that causes liability problems is a swimming pool. Two important liability terms to know when it comes to swimming pool liabilities: open and obvious and duty to warn. If your neighbor dived head-first into the shallow end of your swimming pool at night, hit his head, broke his neck and blamed you—who wasn’t there at the time—are you negligent? One of the pivotal questions is whether or not you owed him a duty of care. An owner or possessor of land owes a duty of reasonable care to all persons lawfully on the premises. This includes an obligation to maintain property in a reasonably safe condition in view of all the circumstances, including the likelihood of injury to others, the seriousness of the injury and the burden of avoiding the risk. However, this duty to protect lawful visitors does not extend to dangers that would be obvious to persons of average intelligence. The open and obvious danger doctrine presumes a person’s exercising reasonable care for his own safety. The open and obvious danger rule concerns the existence of a landowners’s duty of care, which the injured party must establish as part of his prima facie case before any comparative analysis of fault may be performed.

The legal duty owed by the landowner to any visitor includes an obligation to maintain property in a reasonably safe condition; it also includes a duty to warn visitors about any “unreasonable dangers of which the landowner is aware or reasonably should be aware.”

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Chapter 13: Personal Liability However, the various duties do not extend to dangers that would be obvious to persons of average intelligence. A landowner is not obliged to supply a place of maximum safety, but only one which would be safe to a person who exercises such minimum care as the circumstances reasonably indicate. A person of average intelligence would recognize that diving head first into shallow water posed a risk of injury by striking the bottom of the pool. And because the danger of diving into the shallow end of a swimming pool—at night—is open and obvious to a person of average intelligence, you would not be found liable for your neighbor’s injuries.

Open and obvious can cancel a duty to warn—especially when it comes to the risky, stupid acts of seemingly competent adults. You may wonder how a court decides whether an adult is competent or not; and that, of course, is also determined on a case-by-case basis.

Is Slippery Snow Your Fault? Slip-and-fall claims are some of the most bogus liability issues in the American legal system. From New York judges who sue the state as a kind of additional pension benefit to California insurance scammers who fabricate claims against friends and family, slip-and-fall claims often involve absurd circumstances. Insurance companies know that these claims are often shady; they often investigate the claims carefully. This can make problems for you, if you are the policyholder facing a lawsuit. The best approach to take if you’re facing a slip-and-fall claim may be to follow the practice of the insurance companies: Investigate the claim fully. And, generally, the courts give property owners some good tools for battling iffy claims. When someone knows of a hazardous condition on his premises caused by a natural accumulation of ice and snow and expressly in-

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Protect Yourself vites someone to visit the premises, he owes a duty to the guest to take reasonable steps to remove the hazard and to warn the guest of the dangerous condition. However (this is where it gets tricky), an owner of land ordinarily owes no duty to business invitees to remove natural accumulations of ice and snow from the private sidewalks on the premises, or to warn the invitee of the dangers associated with such natural accumulations. The dangers from natural accumulations of ice and snow are ordinarily so obvious and apparent that an occupier of premises may reasonably expect that a business invitee on his premises will discover those dangers and protect himself against them.

The underlying rationale: Everyone is assumed to understand the risks associated with natural accumulations of ice and snow and, therefore, everyone is responsible to protect himself or herself against the inherent risks presented by them. Even if the case involves the duty of a homeowner to a social guest, rather than a business to a customer, most courts say there isn’t much of a difference. Most states assume that people should be smart enough to deal with obvious risks—and that you can’t anticipate every possible thing that can go wrong on your property. Legitimate slip-and-fall claims usually need to find some sort of negligence or greater responsibility on the your part. Most insurance companies treat shaky slip-and-fall claims with the skepticism they deserve.

Fido Bites the Neighbor’s Kid It might sound like a cliché, but dog bites are a major source of personal liability claims. If you have pets, you are responsible for any harm they do to people. According to the Centers for Disease Control and Prevention, there are approximately 4.7 million dog bites per year. They cost around $1 billion each year in medical costs, pain-

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Chapter 13: Personal Liability and-suffering payments, lost earnings…and even psychotherapy costs for post-bite trauma. Dog owners can be held liable for these costs; insurance companies pay out about $310 million each year in dogrelated liability claims. You may be thinking, “My dog doesn’t bite. He loves children. Nothing could ever happen.” Or, you may think you’re safe because you put up a precautionary sign that reads “Beware of Dog” on the front gate. But trouble can still come. Dog owner liability is determined by state law where the bite occurred. In most states, the dog owner is responsible for damages caused by a dog. Many states impose strict liability if a dog bites someone when it is loose or if the person bitten was in a public place or was invited on the owner’s property.

The three most common bases of dog-bite lawsuits are: a specific dog bite statute, common law rule and ordinary negligence. Each affects liability: 1) Dog Bite Statutes. Laws in numerous states impose “strict liability”; that means you, the owner, are held responsible regardless of whether you were at fault. The effect of these statutes, however, may be mitigated by the conduct of the victims—i.e., if they were trespassing, or teasing, tormenting or provoking the animal. 2) Common Law Rule. In addition to statutes, the courts have developed a system of rules called the “common law.” The common law imposes liability on you if you knew the dog was inclined to be dangerous. 3 ) Negligence. Under the negligence theory, the victim must prove that your careless behavior in handling or controlling your dog directly caused the injury. Also, that the incident occurred when the victim used reasonable care to

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Protect Yourself prevent the injury. Unlike strict liability, which does not consider your conduct as it does in negligence, strict liability requires proof of your knowledge of your pooch’s dangerous propensity. In personal injury lawsuits, the victim may be compensated for: • medical bills; •

lost wages (if relevant);

•

damage to property;

•

punitive damages (if your conduct was outrageous or your dog had injured someone previously); and

•

damages for pain and suffering, although more difficult to assess (the extent and value of the damages must be proven by the bite victim).

As a dog owner, you may have some defenses, which also vary from state to state. You may successfully defend such a lawsuit if you can prove that: • the bite victim was trespassing; •

the victim’s own negligence contributed to his injures;

•

the victim provoked the dog into attacking; or

•

the victim knew there was a risk of being injured by the dog, had an opportunity to avoid the injury and did not.

If a dog-bite injury occurs in a car, is it covered by an auto policy or a homeowners policy? Because an injury caused by a dog sitting in the back of a vehicle does not arise out of a “use of the automobile,” it doesn’t trigger coverage under an automobile policy. Thus, a homeowners policy usually provides coverage. Most homeowners policies exclude coverage for bodily injury arising out of the “maintenance, operation, ownership, or use…of any…motor vehicle…owned or operated by…any insured.”

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Chapter 13: Personal Liability There must be a “substantial nexus” between the injury and the use of the car in order for the obligation to provide coverage to arise. Under the substantial nexus test, auto coverage applies if the negligent act, which caused the injury, was a natural and reasonable consequence of the use of the automobile. In other words, a clear connection must exist between the legitimate use of a car and an incident arising out of that legitimate use.

Some states have reached different conclusions about whether a dog bite can arise out of the use of a vehicle. However, auto liability coverage should cover the injury caused by a dog bite occurring while the dog is in the open cargo area of a pickup truck because it arises out of the use of the vehicle—to transport the dog. The bottom line: As a dog owner, you are indisputably liable for your pet’s behavior, whether or not your auto policy has to cover the damages.

Social Host Liability If you host a New Year’s Eve party, serve spiked eggnog and bottles of André Rosé, there may be laws that govern your responsibility as a dispenser of liquor (if not your taste in sparkling wine). Technically, you are considered a social host and in some states social host liability applies to you. In at least 21 states, statutory liability extends to noncommercial servers. In 10 other states, similar liability has been established by common law. A social host’s responsibility for the actions of drunk guests was first addressed in a 1984 New Jersey State Supreme Court ruling that a private host serving liquor could be held liable for a drunken guest’s subsequent motor vehicle accident. The court’s decision did not apply, however, to situations when there are parties with many guests, when guests serve each other, or when a host is busy with other responsibilities and is not serving liquor or when the host is drunk.

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Protect Yourself Subsequent rulings—particularly one in 1988—tempered that law even further, limiting social host liability. And courts in some states have ruled that social hosts are not liable. • In 1993, a Texas court ruled that the drinker, not the social host, is responsible for the drinker’s behavior. •

In at least three states—Missouri, Washington and Colorado—courts have decided that social hosts cannot be treated under the law the same way as those who sell drinks for a living.

•

In two states—California and Iowa—laws were passed that abolished earlier, court-imposed social host liability precedents.

•

In Michigan, social hosts of a party where minors consume alcohol are not liable for criminal acts of their guests other than alcohol-related auto accidents.

•

In 1999, the Vermont Supreme Court rejected a case that sought to make property owners liable for injuries resulting from unauthorized drinking on their property. The ruling stated that social host liability would not apply if the land owners are neither present nor furnish the alcohol.

However, a Massachusetts Appeals Court decision in late 1995 expanded social host liability in that state. The court said that bar patrons who “pick up the tab” can be held liable if the people for whom they buy drinks injure others by negligently operating cars. The case concerned an uncle who paid for his nephew’s drinks at a bar. The nephew then drove home; en route, he was stopped by police for speeding and received a warning. Soon after, his car drifted into oncoming traffic and collided head-on with another car. The driver of that car won a $1.2 million verdict against the nephew, uncle, the bar and the Commonwealth of Massachusetts; all but the nephew appealed. The appeals court reversed the judgments against the bar

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Chapter 13: Personal Liability and the Commonwealth but ruled that the uncle, by paying for the nephew’s drinks, made liquor available to him and he therefore could be liable as a social host. Does a standard homeowners or umbrella policy cover this kind of liability? The jury—quite literally—is still out. However, there is little doubt that cases of social host liability—especially stretched to the limit of claims against someone who picked up a tab in a bar— would fall within the duty to defend…and probably the general liability coverage…of a standard property policy. Until Congress enacts a federal law to define and govern social host liability, you must look toward your state’s laws for such guidance. This much is clear: Social host liability remains the best argument for buying umbrella liability insurance.

Legal Defense Costs Another major benefit of personal umbrella coverage—which we have discussed before, but not in detail—is that the policy provides for payment of defense costs. When you’re accused of harming someone else, you’ll incur legal fees, even if the suit is groundless. Actually, the insurance company does much more than simply pay defense costs when a suit is brought against you. It steps in and provides the defense and does so at its own expense. However, the insurance company’s duty to defend ends when it has paid or offered to pay its maximum limit of liability. For example, you have a homeowners policy providing $100,000 of personal liability coverage, and you also have $1 million of personal umbrella coverage. One day, your pit bull bites and severely injures a visiting child—and the child’s parents sue for $500,000. If the underlying insurer believes a defense may be successful, it may defend the claim to conclusion, regardless of the outcome. (There may be no liability, the liability awarded may be less than the

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Protect Yourself homeowners policy limit, or the award may exceed that limit.) The umbrella insurer observes but does not participate in the defense. It will, however, pay its share of any award in excess of the $100,000 homeowners limit. However, the underlying insurer might not have to provide a defense. If it believes a successful defense is doubtful and that any settlement is going to exceed its policy limit, it might immediately offer to pay its $100,000 limit and avoid defense costs (its obligation ends when it exhausts its limit). In this case, you no longer have the underlying insurer defending its claim. The personal umbrella becomes very valuable at this point for two reasons: First, the company will defend the remainder of the claim; second, the umbrella’s liability limit can make up the remaining $400,000 if the child’s parents win their case.

An umbrella policy’s duty to defend clause is also important when there is no underlying coverage for a particular suit. In this situation, the personal umbrella company will step in and provide a defense, pay the defense costs and provide drop-down coverage for damages that may be awarded in addition to the defense costs. Even if you have umbrella coverage, you need to be careful about defense costs. Many policies do cover defense costs in addition to the limit of liability. But be aware that under the terms of some personal umbrellas, defense costs are included in the policy limit and are not additional coverage.

Hold Harmless Agreements Every insurance policy is a contract. But there are other contracts you can use to protect yourself from personal liability. The most common of these is a contract between people or corporations stating that one side will not make or pass on legal claims or judgments to the other. This is known generally as a hold harmless agreement.

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Chapter 13: Personal Liability The terms hold harmless agreement and release are often used together and sometimes interchangeably. The terms do not mean exactly the same thing. Generally, a hold harmless agreement is more particularly tailored to protecting you from a personal liability.

Few people think about hold harmless agreements in the daily routine of their lives. Asking the manager of the grocery store, your visiting college friends and the people at your work to sign legal documents promising not to sue you is unrealistic. However, you can focus on a few activities or situations…work-related or not…that pose risks to your financial well-being and press for such agreements there. Example: A hot-shot executive who wants to coach his son’s Little League team may ask the local Little League chapter to sign a hold harmless agreement protecting him from any complaints (the legal kind) about how he manages the team.

Be very careful before signing any hold harmless agreement. Make sure you understand—clearly–the following key points: • the true names and identities of all of the parties (people or companies) covered in the agreement; •

the intended goal of the agreement (who’s being protected and who’s doing the protecting);

•

the specific activities or affiliations covered by the agreement;

•

the circumstances, situations or events in which the activities take place;

•

the terms (locations and/or time limits) that apply to the agreement; and

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the specific exclusions and exceptions that apply to the agreement.

If you’re thinking of signing—or drafting—a hold harmless agreement to protect yourself against liabilities related to a personal or business activity, you should check with any existing insurance policies you have. Insurance policies will sometimes have conflicts with hold harmless agreements. In many cases, a policy will specifically exclude coverage for liabilities that you assume in a hold harmless agreement. So, if you plan to extend your coverage to someone else, it may not work. Even if your policy covers a liability assumed under a hold harmless agreement, it will usually count any settlements against its limits. Make sure those limits are high enough to absorb any claims under the hold harmless agreement.

Although they can take any sort of exotic shape, most hold harmless agreements fall into one of four categories: 1) someone else holds you harmless for things he or she does; 2) someone else holds you harmless for things you do; 3) you hold someone else harmless for things you do; or 4) you hold someone else harmless for things he or she does. A rule of thumb: The first two categories are agreements you want to sign. The third is one you want to sign only after examining the agreement carefully. The fourth is one you don’t want to sign. You may have already signed hold harmless agreements without realizing what you were doing. If you use the Internet a lot, you have probably clicked “I agree” to a few pages of text that include such language.

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Chapter 13: Personal Liability An important point to make about hold harmless agreements: Because they don’t follow any particular form, they can be written to do all kinds of things. They can protect you from a liability related to some activity or affiliation—but they can also create exposures that you wouldn’t otherwise face. On the following page, you’ll find an example of a hold harmless agreements taken from an actual event.

Conclusion While common personal liability policies (such as a homeowners or auto policy) do provide coverage for relevant liabilities, the limits often aren’t high enough to pay the damages that could be awarded in a severe case. What if you have a $250,000 limit for automobile bodily injury and a court enters a judgment of $500,000 against you? If a court hands down a liability judgment that exhausts the limits of your homeowners or car insurance policy, you are responsible for the balance. If your assets are exhausted and a judgment is not fully satisfied, a court may do something like attach future earnings. A major liability loss can wipe out assets that took a lifetime to build. Is anyone exempt from personal liability exposures? Except for minors, the legally incompetent and the indigent (who have no assets at risk), most of us have exposures. Umbrella coverage can protect your present and future income streams. It provides three essential things: • excess limits over underlying policies; •

broader coverage than the underlying policies; and

•

defense costs in addition to the limit of insurance.

And finally: It’s important to remember that liability insurance applies only to the financial consequences of torts. Liability insurance will not protect you against the consequences of crimes. So, you can’t publicly defame someone or shoplift meds from the neighborhood pharmacy and expect insurance to bail you out.

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Protect Yourself RELEASE AND HOLD HARMLESS AGREEMENT The undersigned desires to use [COMPANY PRODUCTS] in the [COVERED EVENT], an event sponsored by [SPONSORING PARTIES] and other as yet unnamed sanctioning bodies, or sub-divisions thereof, during the calendar year 200_. The undersigned desires to do so all the while understanding and acknowledging that [ACTIVITY] is potentially dangerous and poses a risk to life and limb. With this understanding, for himself (or herself), his (her) personal representatives, heirs, and next of kin, the undersigned: 1.Hereby releases and discharges for all time [SPONSORING PARTIES], their officers, directors, agents and/or employees, from all liability to the undersigned, or anyone representing the undersigned, for any loss or damage, on account of injury or damage or loss sustained by the undersigned, including his (her) death as a result of the participation by the undersigned in the [COVERED EVENT], whether caused by the negligence of [SPONSORING PARTIES] and whether on or off [ACTIVITY] premises, while the undersigned is participating in any [COVERED EVENT]. 2.Hereby assumes full responsibility for, and risk of, bodily injury, death and/ or property damage while participating in any [COVERED EVENT]. 3.Hereby waives any claims, and does covenant not to sue [SPONSORING PARTIES], for any claim which he (or she) may now have or may acquire against said entities or against any of their agents, representatives or employees by reason of any injury or damage or loss sustained by the undersigned, including his (her) death, as a result of the performance of his (her) services hereunder whether on or off activity premises, regardless of the cause thereof. 4.Hereby agrees that this release and hold harmless agreement is intended to be as broad and inclusive as is permitted by the law of the state in which any of its activities are located, and if any portion of it is determined by a court of law to be invalid, the balance shall continue in full force and effect. 5.Hereby understands that [RELEVANT STATE LAW] may provide that a general release does not extend to claims which the undersigned does not know or suspect to exist in his favor at the time of signing the release, which if he (she) knew or suspected such claims, would have materially affected his (her) willingness to sign the release. 6.Hereby waives his (her) rights under [RELEVANT STATE LAW] and any similar law of any state, and acknowledges that this waiver is an essential term of this release without which he (she) would not have signed this release. THE UNDERSIGNED REPRESENTS THAT HE (SHE) HAS READ, UNDERSTANDS, AND IS VOLUNTARILY SIGNING THIS RELEASE AND HOLD HARMLESS AGREEMENT and, further, represents that no verbal statements have been made to the undersigned to induce him (her) to sign this Agreement.

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Chapter 14: Scams and Swindles CHAPTER

14

Scams and Swindles

Just about everyone has something to sell. Whether on the Internet, through the mail, over the telephone…or even at your church…you’re likely to hear pitches about cheap credit, easy weight loss or can’tmiss investments. Many of these excited proposals are scams—financial swindles designed to take your money. The Internet has increased the efficiency with which scams can be promoted. In some cases, the scams are online variations of old-fashioned swindles (“old wine in new casks,” as one law enforcement official said). In other cases, the scams are designed particularly for the online environment. Throughout this book, we’ve suggested various kinds of insurance as the best (or at least simplest) form of protection against life’s risks. But there’s no such thing as insurance against getting scammed. Your credit card company may offer you some recourse against a bogus charge; some Internet commercial sites may offer precautions. But only you can protect yourself against being ripped off. In this chapter, we’ll look at several of the most common kinds of swindle. We’ll suggest ways to recognize a crooked scheme before you put money into it. Finally, we’ll suggest some things that you can do if you’ve already been scammed. And we’ll try to do all of this without making you so paranoid that you’re blind to the legitimate bargains and genuine business opportunities that do exist.

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Internet Auction Frauds Buying things—from obscure collectibles to concert tickets— through auctions on the Internet has been one of the biggest successes in e-commerce. But the most common form of Internet scam is the online auction fraud. Most auction frauds are simple variations on the classic “bust out” scheme. In these schemes, a crook opens a business or offers goods for sale online. He then accepts payments for the goods (and, sometimes, credit for supplies) but never makes any products or pays any bills. He stays in contact with customers and creditors as long as possible— without honoring any commitments. Finally, he disappears, leaving customers and creditors empty-handed. In 2001, almost 14,000 cases of online auction fraud—representing nearly $15 million in losses—were reported to the Internet Fraud Crime Center (IFCC). The IFCC is an agency formed in 2000 by the Federal Bureau of Investigation and the White Collar Crime Center. It works as a clearinghouse for Internet fraud complaints, gathering complaints from consumers and coordinating information with federal and local law enforcement agencies.

Internet auctions are a good environment for crooks because they are administered—but not really controlled—by large, well-known large companies. You’ve probably heard of eBay and amazon.com; and you may be aware that both have auction services. But you may not realize that actual business being done on these sites is between unregulated (and loosely identified) individuals. Crooks are often drawn to circumstances that allow people to be confused about identity. The auction services don’t make any promises about the people selling things on their sites. If you’re planning to buy something online,

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Chapter 14: Scams and Swindles the auction company will make the bidding easy and relatively fair. It will offer some payment options, once the deal is done. And it may take a small fee for these services. But it’s only a middleman— you’re doing business with someone you’ve never met…and probably never will. That’s inherently risky. Most auction sites offer some form of seller ratings. These are programs that invite buyers to rate the seller and the deal on various scales, all designed to give other buyers some idea of what they can expect from the individual sellers.

However, to protect yourself from getting scammed, you need to take a few extra steps. These include: • Look beyond rating scores. Read through the detailed comments that back up ratings—look for clues in even mild complaints. Comments like “frustration” and “delay” even in positive feedback can be signs for problems. •

Look at the seller’s history. Again, this means more than just ratings. Has the seller ever sold the kind of product you’re buying? Ideally, he or she has sold at least a few products like the one you’re buying. The more expensive the product, the more important this becomes.

•

Know how you got to a site. One of the trickiest aspects of the Internet is the cloudy connection that exists among many Web sites. Many times, you may not even be aware which site you’re on when you see something you want to buy. And many sites like it that way.

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Avoid off-site auctions. Some crooked outfits will pressure you to move off of a recognized auction site and do business privately. This way, the seller can avoid that level of scrutiny.

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Ask for contact information. Even though the Internet ethic is steeped in anonymity, there are many secure ways to exchange contact information. You’re in your rights to ask for names and phone numbers.

Another smart protection may seem to run against the spirit of online commerce: Keep a paper trail. More specifically: • print a hard copy of the Web site’s main page; •

print a hard copy of the product detail page;

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print hard copies of all e-mails between you and the seller;

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investigate the public information related to the registry of the Web site (internic.net and networksolutions.com are the best sites for this); and

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print hard copies of all exchanges with the Web site’s Internet service provider (ISP).

Again, your biggest risk from doing business on the Internet is that you pay for something and the seller never delivers. Several of the larger auction sites (including eBay and amazon.com) offer some kind of protection against nondelivery of goods sold on their sites. In most cases, you will have to absorb a deductible equal to 10 percent of the purchase price of the non-delivered goods. You’ll also have to fill out various forms stating that you’ve been scammed. Also, if you paid by credit card, you may have some success going to your card company. Most offer some form of “customer protection”—which will usually mean refunding part of all of the charges on your card. A caveat: Credit card companies may require considerable documentation—including various sworn statements—from you. And their response time can be quite slow. They take a long time to refund disputed charges as a form of protection against the chance that your complaint is bogus.

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Chapter 14: Scams and Swindles There’s another payment option that can be even more secure than a credit card. A number of escrow companies have cropped up on the Internet. These companies will hold your payment on behalf of the seller until you have reported that the goods have been received. Once you indicate receipt, the funds are released. Online escrow services are particularly valuable for larger transactions. If you’re planning to spend more than $500 on a purchase, an escrow service is worth whatever fee it charges.

There are other things that you can do to improve your chances of getting money back if you think you’ve been scammed online: • Confirm that a fraud has been committed. Some problems turn out to be basic disputes between buyers and sellers. •

Make sure to stay in contact with the seller. State clearly that you will make a formal complaint if you don’t get satisfaction.

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Keep a paper trail of all communication. Especially in an age of e-mail, it may be tempting to avoid paper—but nothing supports a claimed fraud better than hard copy.

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Take advantage of complaint channels. Many online auction services invite buyer feedback; bad reports about specific sellers can pressure them to improve their behavior…or stop selling.

Chasing the Crooks If you’re dealing with a hardened crook, threatening formal complaint may not do much good. But it will keep the pressure on the crook to make good on some part of promises made. You may not have much success suing a crook yourself. In many cases, the crook will be in another state…if not another country. Plus,

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Protect Yourself smart crooks keep each individual theft to a relatively small amount— and count on human laziness to prevent discovery. You can do some investigation on your own. A number of the largest Internet search engines (including Yahoo!, Google and others) include reverse e-mail services, which can track down the origins of e-mails you’ve received. But, ultimately, you’ll need to count on law-enforcement agencies to take action. Although the Internet values secrecy and anonymity, law enforcement agencies usually have the authority to get personal information from credit card processing services, wire-transfer services and banks. In cases where your relatively small loss is part of a larger fraud, law enforcement agencies may have a keen interest in tracking down the identity and location of the scammer.

Diet Schemes The Internet is still relatively new. Another of the most common scams is one of the oldest—promising people weight loss without effort or self-denial. More than 60 percent of American adults are overweight. A smaller, but still disturbing, number of American children are also overweight. In 2000, Americans spent more than $35 billion on diet books, supplements, exercise equipment and other weight-loss items. It’s little wonder that weight loss scams remain stubbornly common.

In 2002, the Federal Trade Commission released the results of a survey it had taken of diet ads in major media outlets around the U.S. About 40 percent of the 300 ads surveyed made at least one “blatantly false” claim. More than half made claims that were unsubstantiated. Some ads promised rapid weight loss without surgery, diet or exercise; others claimed that their products allow users to “eat all [they] want and still lose weight.”

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Chapter 14: Scams and Swindles Interestingly, the FTC reported that the promises made in ads were strangely specific. Boasts included things like “lose 10 pounds in 48 hours” and “lose weight without exercise or diet.” Usually with lots of exclamation points!!! Many of the products are dietary supplements that purport to block the body’s ability to digest fat or carbohydrates. The products may not been illegal. But false advertising is. The FTC is limited in what it can do. It took legal action against 81 weight-loss advertisers in 2001. This had little effect against the waves of ridiculous ads. Most Common Advertising Claims in Weight Loss Ads Consumer Testimonials Fast Results Guaranteed Results All Natural Before and After Safe/No Side Effects No Diet or Exercise Permanent Weight Loss Clinically Proven No More Failure Medically Approved

65 percent 57 percent 52 percent 44 percent 42 percent 42 percent 42 percent 41 percent 40 percent 34 percent 25 percent

Source: Federal Trade Commission

Most doctors paid little attention to the dietary supplement market until 1993, when a Harvard Medical School researcher reported that 34 percent of American consumers used some form of unconventional medicine—including everything from herbal remedies to spiritual healing. This report made alternative medicine and diet supplements a bigger deal for physicians. Celebrity doctors like An-

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Protect Yourself drew Weil and Robert Atkins who advocated diet supplements, hastened the trend. A number of doctors have taken to suggesting diet supplements—and selling them directly in their offices. Some diet supplements may alter, slightly, how your body processes food. This may help you lose weight. However, generally, there are no shortcuts to permanent weight loss. If you want to lose weight, you need to commit to a regimen of a low-fat diet, limited snacking and regular exercise.

Investment Swindles The dot.com bubble of the 1990s struck many people as a big, economy-wide swindle. In truth, the investment mania gave cover to real crooks. (Again, crooks like confusion.) There was an increase in the number of financial scams reported all around the United States—and that boom lasted after the dot.com bubble had burst. The most common investment swindle of the 1990s and 2000s was the Ponzi scheme—another old-fashioned fraud. A Ponzi scheme isn’t complicated, mechanically. The perpetrator collects money from investors, promising huge returns in a matter of months or weeks. Then, he has to do one of two things: 1) return a portion of the money as profit while convincing investors to keep their principle (which is dwindling fast) invested; or 2) recruit new investors, whose money is used to produce the promised windfall to the earlier ones. Even if the crook does the first thing, he’ll eventually have to do the second. Finding the second level of investors is usually the hardest part of the scheme. Once they are recruited, the scheme often drives its own growth. This is why a certain level of word-of-mouth public-

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Chapter 14: Scams and Swindles ity is essential to a scheme’s success. When word of early profits and ritzy investors spreads, new investors pour in, allowing the crook to pay off more people. Basically, a lot of cash is moving around but none…or very little…actually goes to anything that turns a real profit. The crook can maintain the charade and skim off money for himself as long as new suckers are found. When this cash flow dwindles—even slightly—the whole scheme collapses.

The schemes may yield returns for those who start them or join early on. As long as there are enough people to support the next level of the scheme, people above are safe. In financial circles, this is known as the “greater fool” theory. As long as you find someone willing to take your place in the scheme—a greater fool—the fact that you were a fool to invest doesn’t matter. The greater fool theory applies to more than just crooked schemes. Paying $40 million for a French Impressionist painting, $500,000 for a baseball card or a year’s salary for a tulip bulb might make sense if there is someone willing to pay even more. But it’s absolute folly if there’s not. This fiscal relativism blurs many people’s judgment about all investments.

Numbers Never Add Up Like a chain letter, investment swindles are dependent on each new level of participants securing more persons to join. The new participant makes payment to the person on top of the list or pyramid, who then is removed and replaced by those at the next level. In a four-level scheme, for all of the first group of new participants to be paid, 64 people need to join. After 20 levels of new participants, 8,388,608 additional investors would be needed. And there would be a total of 16,777,200 people in the scheme. These numbers are a practical impossibility.

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Protect Yourself Investment swindles rely on trust. Of the key factors that allow Ponzi schemes to flourish, misplaced trust is most important. It’s the point on which burned investors—once they learn they’ve lost money—most often blame themselves. Invariably, the person will offer some version of “I can’t believe I trusted that crook... .” Telephones, television, computers and the Internet have shattered the traditional sense of social proportion and created an encouraging environment for swindlers. People don’t trust their neighbors but believe they have a personal relationship with Oprah Winfrey or Hillary Clinton.

The perfect Ponzi investor is a person who buys a lot of stuff from QVC. Engaging in business with QVC requires an abstract level of trust that most people didn’t have a generation ago. Many Americans are conditioned to send money to a person they don’t know. They’ll put bars on their windows and lock all the deadbolts, but let a crook waltz right in, over the phone. Swindlers thrive on the inability of some investors to tell the difference between a friend and an acquaintance. This is particularly true in business circles, where the networking mentality that lingers from the 1980s and 1990s often confuses business cards in a Rolodex with time-tested relationships. One federal appeals court dealing with the fallout of a collapsed Ponzi scheme noted: Often there is a component of misplaced trust inherent in the concept of fraud. One must hold a position of trust before it can be abused, however. Fraudulently inducing trust in an investor is not the same as abusing a bona fide relationship of trust with that investor. The most effective crooks—the ones who can keep their schemes going for the longest time—are usually people who have built a track

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Chapter 14: Scams and Swindles record of trust with the people from whom they’re stealing. This level of trust also gives the crook the option of skimming a little money at a time from the scheme, rather than stealing a big piece right away.

Recognizing a Crook Most swindlers set up legitimate businesses to camouflage their schemes. Then, when the schemes collapse, investigators and burned investors are left wondering why someone who could build a real business resorts to theft. The crooks may actually put a lot of work into their schemes. They’re smart and make a good impression. They know they have to build at least a pretense of trust with their investors. Most tell stories or use tricks that, in retrospect, seem plainly dubious. In these cases, the best practice for avoiding a loss is to keep your eye on the traditional signs of a Ponzi scheme—exceptionally high returns combined with anything resembling a guarantee or no risk offer. No legitimate investment generates guaranteed returns. And no real business opportunity is risk-free. When you invest money, there’s always risk…which is why there’s sometimes return.

Many smart investment swindlers have the same characteristics and tricks of the basic telephone scammer, including: • they’re courteous, •

they sound concerned about your well-being,

•

they listen to your complaints,

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they flatter you,

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they try to be the surrogate son or friend you seldom see,

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they tout their financial successes,

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they offer some financial advice, and

•

they tell you they can get a better return on your money.

Then they take your money. Of course, these characteristics describe many legitimate business people, as well as crooks. The thing to watch for is the combination of the friendly soft-sell and promises of big investment returns without much or any risk.

Personal Charisma Personal charisma is one of a crook’s keenest tools. Sometimes, the details of the supposed business opportunity aren’t logical at all. Details may be hazy. But the size of the operation…or the posh location…or the glamorous friends and investors…make you to think that the guy must know what he’s doing. There are some recurring signs that a crook is hoping that you’ll bank on his personal charisma: • the crook talks about you a lot—but in general and psychological terms (you’re being decisive, you’re taking control of your life, you’re investing in yourself); •

if you ask financial questions about the investment, the crook responds in philosophical or psychological generalities;

•

the crook describes himself as an “idea man” or “visionary”—anyone to whom you give money needs to be a detail person;

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the crook talks a lot about emotional matters, such as fear, joy, happiness and love;

•

the crook talks about talking, saying that he doesn’t understand what you mean…or asks if you understand what he’s saying; and

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the crook answers questions with questions (“What are you saying?” “How can I make you happy?” or “Are you saying you want your money back?”).

Charismatic crooks will often try to turn facts on their heads. In some cases, crooks at the center of crumbling schemes— and under investigation by the SEC or the FBI—are able to convince investors that the Feds are the villains.

Crooks will often talk a lot about themselves in a detached manner: They embody integrity and perseverance; they are dedicated husbands, fathers or friends; they admire gurus like Tom Peters, Paul Hawken or—more literally—the Dalai Lama. Other characteristics that crooks often volunteer about themselves include: • They are the rural farm boys that are too ambitious to spend their lives plowing fields. •

They always base deals on a foundation of trust.

•

Their homeliness adds to their credibility (though they will often be very carefully appointed and dressed).

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Their wives (occasionally their husbands) spend a lot of money and socialize with the elite.

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They don’t want money from anyone who’s not comfortable about investing it.

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They believe that financial success is of secondary importance to personal enrichment.

•

They want you to keep details of your investment private because they’re not making them available to anyone else.

Indeed, some…or all…of these matters may be true. But you need to be careful about what conclusions you draw from the bunch. 251

Protect Yourself Smooth crooks will sometimes offer various references with whom you can speak about investing—even before you ask. Beware of testimony from satisfied customers. No amount of testimony from can “average out” the intent to defraud. Plus, “satisfied customers” are more than likely part of the act of continuing to solicit new investments and reassure old investors while losses mount.

Secrecy and Privacy The Supreme Court Justice Louis Brandeis once wrote: “The right most prized by civilized man is the right to be left alone.” This is a noble sentiment that swindlers often twist on its ear. In the United States, the law goes a long way to protect people’s right to privacy. And that’s a good thing. The commitment to privacy has some strange and unintended results, though. One of these is that it allows some people to be overtaken by their impulses for a baser mutation of privacy: secrecy. Secrecy and privacy are not quite the same. Privacy means sheltering your own thoughts, acts and things from public scrutiny. Secrecy means sheltering from scrutiny the fact that you’ve shared thoughts, acts or things with someone.

The secrecy that money can breed explains many mistakes, eccentricities and moments of bad judgment. This sometimes leads to a fundamental logic flaw that makes most financial swindles possible. The logic flaw can be explained, roughly, like this: Trust sometimes results in exclusion. Exclusion often results in secrecy. Therefore, secrecy is always the result of trust. You don’t have to get out your college philosophy notes to realize a premise that includes sometimes can’t lead to an affirmative conclusion that includes always. The emphasis that many crooks put on recruiting friends and family results from the misunderstanding of the link between trust

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Chapter 14: Scams and Swindles and secrecy. “You’ve got to understand the temptation,” said one victim of a big West Coast swindle. “It’s not only to make money. It’s also to let the people closest to you—many times, people who think you’re a loser—in on a secret for success. That’s what draws in so many [people].” The sadly mistaken idea that redemption comes from sharing secrets fuels the growth of many swindles. This mistake is built on another notion that’s as old as society: Financial success is a secret kept by a few people; and getting rich is a matter of being let in on the secret.

People who achieve financial success know that it comes from a combination of hard work, some good timing and a little luck. People who haven’t enjoyed financial success are often intimidated by any part of that combination. Their lack of achievement is more easily rationalized by the belief that success is a secret. Crooks recognize this weak tendency and play to it. They tell losers that they’re right—the winners have a secret. And, by joining the pyramid, they don’t have to work hard or have good timing to make money.

Bogus Loans Made Behind the Scenes One of the best examples of how secrecy about money sets people up to be conned is the second mortgage scam. A quick explanation of how this swindle works: The crook approaches Investor A and says that Mutual Acquaintance B is in a cash crunch and needs to take out a second mortgage on his house. The crook explains that Acquaintance B will pay a high interest rate, typically 12 percent or 13 percent, and even a bonus on the loan—if it can be arranged quickly and quietly. Acquaintance B knows nothing about the bogus deal. The crook forges or manipulates information and signatures onto phony docu253

Protect Yourself ments. These documents are not filed or registered as required by law. The crook simply pockets the loan money. The crook will usually tell the investor that the loan will be blind. This means that the mutual acquaintance won’t know who loaned the money. Even if the crook is a little shady, the legitimacy of the mutual acquaintance is often compelling. The blind loan also makes it less likely that the investor will contact the mutual acquaintance directly…until it’s too late.

The blind loan also makes it easy for the crook to sell a phony mortgage a second time. In this situation, he tells a second investor that the first needs to get his money back and will sell the mortgage at a discounted price. All of the same terms—including the need for secrecy—apply. Amazingly, this works well, especially when all the principles know one another. People who have a lot of money and not very much sense will be used to the idea of secrecy in money matters. And they’ll often place a great deal of unspoken trust in people they consider financial equals. If a crook has the guts and knows how to work this angle, he can steal a lot of money.

Secrecy Turns Critics Into Supporters Investors burned by swindles should be the most vocal critics— eager to have vengeance, if not their money back. They rarely are. As often as not, they defend the same crooks who’ve taken their money. Smart crooks complete the illogical circuit their investors begin. They imply—though they’ll rarely say—that, because their schemes involve the secrets of wealth, they must be built on trust. An investor who is inclined to believe this will be receptive to the pitch, however loopy it might be. The rise…and fall…of Texas-based energy trader Enron Corp. was a good example of this phenomenon. The company boasted that

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Chapter 14: Scams and Swindles its staff of Ph.D.s and financial geniuses had created trading strategies so complex that ordinary people—including government regulators— couldn’t possibly understand them. Once a small group of investors bought into this premise, the company’s stock went on an upward swing that lasted most of the late 1990s. There was no brilliant strategy: The company engaged in illegal trading practices and fraudulent accounting. But enough people were invested (literally) in the story that Enron remained a high-flyer until executives started being arrested and killing themselves. The embarrassment that scammed investors feel and the reticence that follows are the main reasons the crooks rarely go to jail. One West Coast law enforcement agent estimated that his office hears from fewer than one in 10 investors who get burned. “People are embarrassed because they know they should have known better. They’re worried that they’ll seem greedy and stupid—which, to some degree, they will,” he says. “They shouldn’t feel this way.” But the reluctance occurs in more than just a few situations; it happens too often to be dismissed as the deserved embarrassment of greedy investors. To an experienced investor, the urge for secrecy is a logical application of a general sense of caution. It can also be seen as a by-product of trust: To believe in one person or idea is, in practice, to believe less…or not at all…in another.

Scam victims aren’t usually experienced investors. They’re often inexperienced and excitable—about money in general or the premise of a particular scheme. So they’ll take secrecy to an extreme.

Conclusion Swindles are an unavoidable part of a capitalistic economy (and probably every other kind of economy, too). As technology advances,

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Protect Yourself swindlers will undoubtedly move into the high-tech arena. But the basic features of their schemes remain relatively simple. • They place themselves in the context of legitimate operations—whether country club, church or auction Web site. •

They promise big, guaranteed profits…with no risk.

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They use the jargon of technology or psychology…and hope that you don’t ask too many questions about details.

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They talk about what you can do with all of the money you make, rather than the mechanics of their deals.

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They count on their personal charm or charisma to divert detailed questions or comments that you have.

You can avoid these traps by taking a few basic precautions: • make sure you’re sure of anyone’s identity before you give them money…and don’t let connections blur who’s who; •

whenever possible, transfer money through disinterested third-parties and—if possible—escrow accounts;

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no matter how high-tech a business might be, keep a paper trail of documents related to any investment;

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don’t be afraid to admit—at least to yourself—that you don’t understand the details of an investment…and trust yourself enough to hesitate and ask more questions; and

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be wary of any seller or borrower who doesn’t answer your questions simply and directly.

Scams can fool even the smartest or most intuitive person. They’re designed to do that. So, keep that mind when you hear about a sweetheart deal or sure-fire bet. There is no reward without risk; and the higher the reward, the greater the risk.

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Chapter 15: Inheritance and Taxes CHAPTER

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Inheritance and Taxes

Taxes dominate most people’s thoughts about managing their money. Issues among family members may be emotional…familial loyalty can be a blessing and a curse…greed and materialism can warp good intentions. But, above all of these matters, the tax man wants to be paid every time anyone inherits anything of substantial value. Taxes aren’t a risk in the same way that a terrorist bomber, a lawsuit-happy neighbor or a smooth swindler is. But they are—at least in their most extreme form—something against which you and your family need protection. Entire books…entire libraries…are dedicated to the intricacies of tax avoidance. In this chapter, our goals are more simple. We’ll look at some of the most common tax problems that can screw up a family’s finances. And we’ll make a few suggestions about how you can react.

The Gift of Giving If you give someone else money or property, you (though not the receiver) may be subject to federal gift tax. The money and property your grandfather leaves in an estate when he or she dies is usually subject to federal estate tax. The proceeds of a life insurance policy can avoid the tax bite—unless they’re paid into an estate, in which they are taxed at the estate’s rate. And these are all just federal taxes; there may also be state and local taxes on gifts and inheritance. Many families avoid estate taxes altogether because the amount of money they have is small enough to qualify for various exemptions.

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Protect Yourself There is usually no tax if you make a gift to your spouse or if your estate goes to your spouse at your death. If you make a gift to someone else, the gift tax does not apply to the first $10,000 you give that person each year. You don’t even have to file a gift tax return in these situations.

Even if tax applies to your gifts or your estate, it may be eliminated by the so-called unified credit. The unified credit applies to both the gift tax and the estate tax—you simply subtract the unified credit from any gift tax that you owe. But the unified credit is a onetime thing; any part that you use against gift tax in one year reduces the amount of credit that you can use against gift or estate taxes later. Through the 1980s and 1990s, the unified credit was $192,800, which eliminated taxes on a total of $600,000 of taxable gifts and estate value. Beginning in 1997, this exempt amount was increased gradually each year—to $675,000 in 2001. And the amount will continue to increase during the 2000s, to a maximum of $1 million in 2002 and then completely repeal in 2011 when—according to the estate tax reform advocated by President George W. Bush—there will be no estate tax at all. In the 2000s, most families avoid the estate tax either by having estates worth less than $675,000, etc., or by using gifts and trusts to lower their estate value beneath that number. That leaves three types of families facing the biggest tax bite: • families with very large amounts of money; •

families who own businesses or other assets that are tough to break apart and move out of an estate; and

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families who don’t start moving assets out of the estate early enough to make it seem small.

At its top level, the federal estate tax is 50 percent of an estate’s value, so the tax bite can really hurt. Giving is the best prevention.

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Chapter 15: Inheritance and Taxes The term “gifting” has the irritating ring of bureaucratic doublespeak. The term comes up frequently in financial planning—and with good reason. It’s a useful tool. Gifting refers to working around the federal gift tax, which applies to the transfer—for no compensation—of any property. You make a gift if you give property (including money) without expecting to get something of at least equal value in return. If you sell something at less than full value or if you make an interest-free or reduced interest loan, you may be gifting.

The general rule is that any gift is taxable; however, there are many exceptions to this rule. Generally, the following gifts are not taxable: • the first $10,000 you give someone during a calendar year (this is called the annual exclusion); •

tuition or medical expenses you pay for anyone (these are called the educational and medical exclusions);

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gifts to your spouse;

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gifts to a political organization for its use; and

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gifts to charities.

Most tax plans stem from these five exclusions. A separate $10,000 annual exclusion applies to each person to whom you make a gift. Therefore, you can give up to $10,000 each year to each of any number of people or entities—and none of the gifts will be taxable. If you are married, both you and your spouse can separately give up to $10,000 to the same person each year without making a taxable gift. And, since you can give your spouse a limitless amount of money without paying tax, married couples have double gifting capacity. This is a considerable advantage in lowering estate taxes.

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Protect Yourself In fact, you don’t have to play gifting games if you’re married. If you or your spouse make a gift to a third party, the gift can be automatically considered made half by you and half by your spouse. This is known as gift splitting. If you split a gift, you do have to file a gift tax return to show that both spouses agree to the gift; and you have to file a return even if half of the split gift is less than $10,000. Generally, you must file a gift tax return on IRS Form 709 if: • you gave more than $10,000 (annual exclusion) during the year to someone other than your spouse; •

you and your spouse are splitting a gift;

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you gave someone other than your spouse a gift that he or she cannot actually possess, enjoy or receive income from until sometime in the future (this covers some trusts); or

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you gave your spouse an interest in property that will be ended by some future event.

If the only reason you must file a gift tax return is because you and your spouse are splitting a gift, you may use IRS Form 709-A, which is a shorter and simpler version of Form 709. See the form instructions for details on who qualifies. It’s best to keep your gifts during any calendar year under the tax-free limit. If you go over, you either have to pay some money to the Feds or use up some of your unified credit. That’s why gifting takes discipline and an early start; it works best when you move money gradually to family members over an extended period of time.

Calculating Estate Tax A taxable estate is determined by calculating the gross value of a dead person’s estate minus various allowable deductions. Once this calculation is made, the IRS uses this number to assess estate taxes. A gross estate includes the total value of all owned assets or property in which a person had an interest at the time of his or her death. 260

Chapter 15: Inheritance and Taxes The estate also includes: • life insurance proceeds payable to the estate or, if the dead person owned the policy, to his or her heirs; •

the value of certain annuities payable to the estate or its heirs; and

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the value of certain kinds of property transferred out of the estate within three years before the person died.

The allowable deductions used in calculating the taxable estate include: • funeral expenses paid out of the estate; •

debts the person owed at the time of his or her death; and

•

the marital deduction (generally, the value of the property that passes from the estate to a surviving spouse).

Once you’ve calculated the taxable estate value, you can apply the unused portion of your unified credit against the taxes to be paid. An estate tax return must be filed if the gross estate, plus any adjusted taxable gifts and specific gift tax exemption, is more than the filing requirement for the year of death. The adjusted taxable gifts is the total of the taxable gifts you made after 1976 that are not included in your gross estate.

Tax Benefits for Survivors The U.S. tax code gives some major breaks to married couples and traditional families. Survivors can qualify for certain benefits when filing their own income tax returns. A surviving spouse can usually file a joint return for the year of death and may qualify for special tax rates for the next two years. If the deceased qualified as your dependent for the part of the year before death, you can claim the exemption for the dependent on your tax return, regardless of when death occurred during the year.

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Protect Yourself (This is the same treatment the tax code gives to a child born during a tax year.) If the deceased was your qualifying child, you may be able to claim the child tax credit. If your spouse died within the two tax years preceding the year for which your return is being filed, you may be eligible to claim the filing status of qualifying widow(er) with dependent child and qualify to use the married filing jointly tax rates. These are better than unmarried person rates. Generally, you qualify for this benefit if you: • were entitled to file a joint return with your spouse for the year of death—whether or not you actually filed jointly; •

did not remarry before the end of the current tax year;

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have a child, stepchild or foster child who qualifies as your dependent for the tax year; and

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provide more than half the cost of maintaining your home, which is the principal residence of that child.

Trusts It’s no secret that people use trusts to avoid taxes and pass more wealth to survivors—while retaining the maximum control permitted by law. On the next few pages we’ll take a quick look at the tax issues addressed by various types of trust.

Marital and Bypass Trusts This is the tax planning cornerstone for many combined marital estates (all property owned by the husband, the wife and jointly) worth over $1 million in 2002, etc. Usually, husband and wife serve as their own trustees; most specify their intentions broadly at the time the trust is prepared but leave themselves discretion as to details. While both spouses are alive, there can be a single initial trust that is revocable and completely in their control. It is similar to, and serves all the purposes of, a simple living trust. The initial trust ends

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Chapter 15: Inheritance and Taxes at the first spouse’s death, by splitting into two new trusts (“A” and “B”). The B trust (some planners joke that B refers to the “Belowthe-ground” spouse) is irrevocable, and makes use of the deceased spouse’s estate tax shelter. The B trust is designed for the ultimate benefit of heirs; it’s designed to conform to the federal estate tax “shelter limit.” The B trust is also called the “bypass trust,” because property in it bypasses taxation. The goal of the B trust is to get this money out of the couple’s combined estate, so that it escapes estate taxation after the second spouse’s death. The A trust is also called the “marital deduction trust.” Property in this trust is absolutely and completely under the control of the surviving spouse, who can even revoke the trust at any time. With proper planning, both spouses add a disclaimer clause in their wills giving the surviving spouse the right to disclaim as much of her inheritance from the other as she wants. Anything she disclaims goes into the tax shelter trust, which pays her income and—at her death—goes to the kids. The trust, also set up in a will, is just a shell unless the surviving spouse disclaims money to fund it.

If the surviving spouse inherits $1.5 million and the estate tax exclusion is only $1 million, she can opt to disclaim $500,000 to the trust. Her estate won’t be taxable; her heirs inherit $1 million from her and $500,000 from the credit shelter trust—both amounts untaxed because neither is above the $1 million exclusion.

Trusts for Minors Gifts to trusts established for minors qualify—by law—in whole or part for the annual gift tax exclusion. These trusts are irrevocable, yet permit some control over the timing of wealth transfer to the next generation.

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Protect Yourself In the so-called Section 2503(c) Trust (the section refers to U.S. tax code), annual income may be accumulated and not paid out—but the trust must provide that, if necessary, both income and principal can be used for the minor’s benefit. When the beneficiary turns 21, he or she must be given the right to receive all 2503(c) trust assets in an outright distribution. But the beneficiary can choose to allow the trust to continue. In the related 2503(b) Trust, annual income cannot be accumulated; it must be paid to the beneficiary each year. However, in this case, the principal need not be made available for distribution upon the beneficiary’s 21st birthday. Unlike the 2503(c) Trust, the 2503(b) Trust principal is not required to ever be distributed to the income beneficiary; it can go to somebody else. Both types of 2503 Trust can receive annual gifts, including gifts used by the trustee to pay life insurance premiums. If the insured (or spouse) is the grantor, trust income should not be used to pay premiums—or the grantor may be considered the owner of the policy for tax purposes. This is an often overlooked point; try to use trust principal or yearly gifts to pay premiums.

Charitable Remainder Trusts Charitable remainder trusts (CRTs) are best for people that have a lot of money tied up in investments that have appreciated over the years, such as stock, bonds, a home or a business. When you sell that asset, you will be liable for a lot of taxes. If you intend to give a large gift to charity, you may want to consider a CRT. It allows you to use money or pass it to your family while taking advantage of tax benefits related to charitable giving. Once you have placed your assets in a CRT, the trust can sell the assets without paying taxes, and then invest the assets into investments that will provide a good source of current income. You (and

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Chapter 15: Inheritance and Taxes your spouse) are entitled to that income for as long as you live, and when you die what’s left goes to the charities of your choice. In another variation, called a charitable remainder unitrust (CRUT), the grantor receives a fixed percentage of the trust’s value each year, rather than an unchanging dollar amount. The CRUT is often preferred because it can provide inflation protection: As the trust (presumably) grows in value each year, so, too, will the dollar amount of the grantor’s annual draw. With either a CRT or CRUT, the remainder interest that will eventually go to charity has a value today, established with a financial calculation, using an “assumed” future interest rate.

The IRS publishes the interest rate each month to be used in this calculation of the value—in today’s dollars—of the charity’s right to receive the remainder of trust assets at the specified future date. That is the amount you are giving away. It is, therefore, the value of the current income tax deduction. A big additional benefit is that the donated property, and all future price appreciation, is removed from the grantor’s taxable estate.

GRATS The grantor retained annuity trust is an irrevocable trust, good for shifting some of the value of an asset out of the estate. You place assets in trust for the ultimate benefit of your children (i.e., they have a remainder interest) but retain the right to an annual payout for a period of years. By accepting some gift tax liability at the time the GRAT is set up, you reduce your estate tax liability later and your heirs end up with more. If you die during the term of the trust, all property is included in the estate, and there are no tax consequences—just as if nothing had been done.

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Protect Yourself The key to the GRAT technique (and the CRUT) is the relative values given the two interests involved: The gift of the remainder interest in the trust principal, and the value of what you have retained—the present right to collect a certain cash payout from the trust each year for X years. The greater the annual payout and number of payment years, the greater the value you have retained for yourself—and the smaller the value the IRS gives to what is left over.

Generation Skipping Trusts A generation skipping transfer (GST) trust is an irrevocable arrangement that provides income only (not access to trust principal) to you or your spouse and/or children. It terminates when all have reached a specified age or died, with trust principal then distributed to grandchildren or grandnieces and nephews. Some people shy away from these trusts because they aren’t confident that any financial plan can remain valid through three generations of family; but these trusts are extremely popular with old money mandarins—precisely because they look so far into the future.

Under a loophole in traditional estate tax law, by skipping over the children in the final distribution of principal, you could save gift and estate tax. In the late 1990s, this advantage was largely eliminated. In 2001, such transfers were taxed at the maximum federal gift and estate tax rate of 55 percent. But…there is a high cumulative exemption of $1,030,000 (adjusted annually for inflation) per donor that can be used to avoid tax on generation skipping transfers (by trust or gift). So, the GSTs are still useful.

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Insurance The proceeds from a dead person’s life insurance policy paid because he or she has died generally are excluded from the beneficiary’s income. The exclusion applies to any beneficiary—whether a family member or other individual, a corporation or a partnership. • If you receive life insurance proceeds in installments (as sometimes happens to beneficiaries of annuities), you can exclude details of each installment from your income. •

If each installment you receive is a specific amount based on a guaranteed rate of interest, but the number of installments you will receive is uncertain, the part of each installment that you can exclude from income is the amount held by the insurance company divided by the number of installments necessary to use up the principal and guaranteed interest in the contract.

•

If, as a beneficiary, you are entitled to receive the proceeds in installments for the rest of your life without a refund or period-certain guarantee, you figure the excluded part of each installment by dividing the amount held by the insurance company by your life expectancy.

Many people worry about how insurance can affect the tax status of their retirement savings in tax-advantaged accounts. This usually isn’t a problem for most people. Retirement plans that include insurance and other corporate and individual plans may be described as qualified or non-qualified. All plans must be in writing and be communicated to the participants—beyond that, there are many differences. Qualified plans: • must be filed and approved by the IRS; •

usually are established by an employer for the benefit of employees (there are a few exceptions);

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cannot discriminate as to participation (all eligible employees must be included);

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will provide a tax deduction for the employer for plan contributions;

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generally exclude employer contributions on behalf of the employee from the employee’s income—no tax is due until benefits actually are distributed to the employee; and

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defer taxes on investment income realized by the plan until it is received by plan participants.

Non-qualified plans: • are not filed with the IRS; •

may discriminate as to participation—they may be selective as to who is covered; and

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do not provide a tax deduction for the employer for any contributions made.

The fact that a non-qualified plan is not approved by the IRS does not imply that it is illegal or unethical. A non-qualified plan is a legal method of accumulating money for retirement funds and other purposes. It just doesn’t provide tax benefits the way a qualified plan does.

Example: A person buys an individual annuity for the purpose of accumulating his or her own retirement benefits. When this person pays the annuity premium or payment, there is no tax deduction for the payment of the premium. There would be for a qualified plan, such as an IRA or 401[k]. Pension plans and other qualified plans may include life insurance benefits, but these must be incidental to the purpose of the plan. The primary purpose: to provide retirement benefits.

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Chapter 15: Inheritance and Taxes Generally, the cost for insurance protection under a pension or profit sharing plan is taxable as income to an employee to the extent that any death benefit is payable to the employee’s beneficiary or estate. The cost for any protection for which the proceeds are payable to and may be retained by the plan, trustee or employer is not taxable as income to the employee. Example: An executive insured under a key person life policy does not have to pay tax on the cost of that coverage.

Annuities Annuities are not—strictly speaking—insurance, but they often are sold by life insurance companies and agents as an estate-planning tool, so a basic understanding of how they work may be useful. Life insurance is designed to protect against the risk of premature death. Annuities are designed to protect against the risk of living too long. Annuities are sometimes called upside-down life insurance. From the insurance company’s standpoint, an annuity presents the opposite mortality risk from life insurance: Life insurance pays a benefit when you die; an annuity only pays a benefit if you and/or your beneficiary are living. The basic function of an annuity policy is to liquidate a sum of money systematically, over a period of time.

Annuity contracts offer you a tremendous range of options. You can buy an annuity with a single payment or a series of periodic payments. You can schedule benefits to begin immediately or be deferred until a specific future date. You can choose an annuity that pays benefits for a specific period of time—or for the lifetime of one or two individuals. It can begin paying those benefits on a specific date (such as when you reach a stated age) or a contingent date (such as when your spouse dies).

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Protect Yourself Usually, but not always, an annuity guarantees a lifetime income for the recipient. An annuity that pays you benefits immediately typically will provide you with a steady stream of retirement income in return for your purchase. An annuity that pays you benefits at a later date (a deferred annuity) typically will help you accumulate money. The annuitant is the insured, the person on whose life the annuity policy has been issued. As is the case with life insurance, the owner of the contract may or may not be the annuitant. Unlike insurance, though, the annuitant, in most cases, is also the intended recipient of the annuity payments. Depending on the type of annuity and the method of benefit payment selected, a beneficiary also may be named in an annuity contract. In these cases, annuity payments may continue after the death of the annuitant, for the lifetime of the beneficiary or for a specified number of years.

There are two principal types of annuities: fixed and variable. • A fixed annuity is a fully guaranteed investment contract. Principal, interest and the amount of the benefit payments are guaranteed. In other words, the money in a fixed-income annuity is legally protected, should the insurance company become insolvent. By guaranteeing both the principal and the interest, a fixed annuity is not unlike a certificate of deposit (CD) purchased from a bank. However, a CD is backed by the Federal Deposit Insurance Corp. (FDIC). A fixed annuity is not—its security is directly related to the financial health of the company selling it. •

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A variable annuity—like variable universal life insurance—is designed to provide a hedge against inflation through investments in a separate account of the insurance

Chapter 15: Inheritance and Taxes company, consisting primarily of common stock. If the portfolio of securities performs well, then the separate account performs well, so the variable annuity—backed by the separate account—also will do well. If the company’s investments don’t do well, neither does your annuity. In other words, there is investment risk involved; there is no guarantee of principal, interest or investment income associated with the separate account.

An insurance company or salesperson should provide a prospectus when you are considering a variable annuity.

Different annuities will offer you different investments, which offer different degrees of risk and reward. The investment options include stocks, bonds, combinations of both or accounts that provide for guarantees of interest and principal. By choosing among the available fund options, you can create an annuity that meets your objectives—and your tolerance for risk. Both sorts of annuities may be purchased with a single payment, or you may make periodic payments. A single-premium or singlepayment annuity usually is purchased by making one lump-sum payment. Example: You cash in a 20-year-old cash-value life insurance policy soon after you retire. This generates a sizable lump sum of cash—say, a little over $100,000. You can use the cash to buy a single-premium annuity that creates income for you—and for your spouse, if you should die first. Variable annuities also may be purchased with a variable-premium feature, known as a flexible-premium deferred annuity (FPDA) contract. Like variable universal life insurance, this type of annuity allows you to pay as much or as little as you like during each premium period—although there usually is a minimum payment required.

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Conclusion There are two kinds of risks that can effect your estate plans: 1) that you end up paying too much tax on money you intend for you family and other heirs; and 2) that you live longer than expected and use up resources that you intended to leave your heirs. If you start early enough, you can use gift allowances to minimize the first risk. Also, life insurance—used correctly—can either pay estate taxes or replenish resources that reach your heirs. Finally, any of various kinds of trusts can help hide some of your family’s money from the tax bite. To minimize the second risk, you probably need to rely on some combination of life insurance and annuities. There are few guarantees associated with a variable annuity or other insurance-related investment vehicles. However, if you’re close to retirement—or there already—and would like to shield assets and income from tax, an annuity may be your best tool. Buying life insurance or annuities as investments may make sense to some people as they plan for their retirement. If you’re going to use these tools, though, you should think of them as an addition to your basic income-replacement life insurance coverage. In most cases, the investment-type policies entail a degree of risk—either in what you pay in or what you can take out—that make them a shaky foundation for your essential needs. The tax rules related to estate planning change every year. If you have enough money or assets to be worried about estate planning risks, it’s probably worth a visit to a specialist. When you’re doing this, look for a planner who works on a fee basis (not a commission basis). These planners may cost more up front, but they usually give you more objective advice.

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Chapter 16: Small Business Risks CHAPTER

16

Small Business Risks

Some pundits talk a lot about how the 21st Century is the “age of the entrepreneur.” And it certainly is true that more small businesses have been started by a larger variety of people during the 1990s and 2000s than in the 50 years prior. Perhaps the biggest factor that influences the talk of entrepreneurism is that small business has become a bigger part of how Americans think of themselves and their economy. Whatever the talk or the reason, there is a growing likelihood that you will own or run a small business at some point in your life. And, if the experience goes well, you will have a small business whose value is worth taking some measures to protect. That’s what this chapter is about.

Company Structure The government provides a number of ways in which a business can be organized. Each has certain advantages and disadvantages for the owner or owners. In some cases, the advantages have to do with how much tax you pay…and how you pay it. In others, they have to do with who controls the business, who’s accountable to whom…and how. In others, specific issues like succession, liability or capital structure are the key concerns. However you start your business, one of the first major decisions you must make is how to structure it. In most situations, there are six basic possibilities:

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sole proprietorship,

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general partnership,

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limited partnership,

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closed (Subchapter S) corporation,

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open corporation, and

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limited liability company.

Sole Proprietorships The simplest form of business, a sole proprietorship, actually lacks much structure. It is a true business monarchy; many start-up enterprises begin this way. A large percentage of sole proprietorships belong to those who are involved in the so-called “cottage industries”—businesses operated wholly or in part out of their owners’ homes. These firms participate in many fields of business, but they usually are small and often a part-time pursuit, rather than the owner’s sole source of income.

Sole proprietorships are inexpensive and easy to organize. There is minimal record-keeping involved and the owner pays no business taxes. However, sole proprietorships present a number of serious drawbacks: • They are taxed at a higher rate. All income from the business must be reported as personal income on the owner’s income tax forms. Therefore, it is taxed at a much higher rate than business income is usually. There also are no tax breaks for fringe benefits and insurance. •

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They have a harder time getting financing. To grow, most businesses need to borrow money at one time or another, and it generally is much harder for a sole proprietor-

Chapter 16: Small Business Risks ship to get a loan. If the company is incorporated, it can sell stock (give up equity in the business) to raise capital, if necessary. •

The owner is exposed to unlimited personal liability. A lawsuit can attach everything the owner of a sole proprietorship owns—not just the assets of the business. And although liability insurance is available, it can be very expensive and may not cover all potential losses.

•

They have a hard time building equity. From a succession standpoint, it is hard to build equity for the next generation of a family-owned sole proprietorship. When the owner dies, the business is automatically dissolved. What is left to the heirs is a personal estate, not equity in a business, stock in a company or a similar investment.

Generally, the problems posed by a sole proprietorship begin to outweigh the advantages when the income from the company reaches about $80,000 a year (that number can vary dramatically). Above that level, the protections offered by a more formal structure are probably worth their higher costs. A business will often start as a sole proprietorship but eventually incorporate.

Standard Partnerships Many modern companies shun sole proprietorships and start out as partnerships between people who have different sorts of skills. In a general partnership, two or more people join together to conduct a business, and each is jointly and severally liable for its operations. Individuals, corporations and even other partnerships can form a partnership.

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Protect Yourself Partnerships are almost as easy to form as sole proprietorships. • A written agreement isn’t even required, although it’s a good idea. •

Assets, including cash, business-related deeds and bills of sale—as well as anything else the business will need in order to function—must be transferred into a partnership.

•

A partnership also can borrow money, often benefiting from the creditworthiness of several members.

•

The partnership becomes a separate legal entity, but it does not pay income taxes. Instead, it computes its annual taxable income and files a partnership tax return. This return allocates the income (or loss) to each partner, who then must report it on his or her individual income tax return.

Like a sole proprietorship, a partnership makes all partners jointly liable for the debts and obligations of the business. A creditor can seek the assets of any or all partners. And any agreement among the partners to share that responsibility, although binding on them, is not binding on the creditor. Partnerships often are formed by professionals, such as doctors, dentists, lawyers and accountants. They have a limited life, usually specified in the partnership agreement. If any partner dies, becomes incapacitated, goes bankrupt or simply withdraws, the partnership automatically terminates unless otherwise specified in the agreement.

A partner may transfer his interest to someone else or pass it along to an heir at the time of his or her death, unless forbidden to do so by the partnership agreement. A sound partnership agreement should provide for a buy-out in the event of a death or in the event the partnership should break up. If that agreement permits the re-

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Chapter 16: Small Business Risks maining partner(s) the right of first refusal and specifies that the interest in the company cannot be sold to anyone who offers a lower amount, a fair price and a satisfactory buy-out generally can be arranged. Estimates show that partnerships break up as frequently as marriages—about 50 percent of the time—and perhaps slightly more often. As with a marriage, a partnership breakup can be amicable or devastating, depending on the temperaments of the parties involved. Therefore, the careful selection of a partner is extremely critical.

If you are forming a partnership, look for a partner who: • stimulates enthusiasm;

• • •

stimulates new ideas;

• • •

uses logic rather than emotion;

is easy to work with-not egocentric, autocratic or stubborn; can offer a different perspective and has complementary talents or experience;

shares the same goals; and is a good team worker.

Limited Partnerships In a limited partnership, one or more general partners manage the business and are personally responsible for its debts, while the limited partners have no role in day-to-day business operations and are liable only to the extent of their investments for the company’s financial obligations. As in a proprietorship, this structure avoids double taxation— that is, the taxation of both the business income and the individual income.

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Protect Yourself Obviously, the limited partnership offers more benefits to a passive investor than to someone who wants to be actively involved in the operation of the business.

Corporations Corporations are the safest, generally the most versatile and, therefore, the most common form of business structure apart from the sole proprietorship. Of course, not all “new” corporations are new businesses. Many are proprietorships and partnerships that have moved up to a more sophisticated structure. (As we mentioned earlier, a lot of people incorporate solely for legal or tax reasons.) Legally, a corporation is an entity totally separate from its investors. It is responsible for its own bills, files its own income tax returns and pays its own taxes. It can sue and be sued. It lives on indefinitely, regardless of who its stockholders may be at a given time. The main advantage of a corporate form of business structure comes from the fact that the owners (stockholders) are fully sheltered from the liabilities of the company. This can be particularly valuable to those who are attempting to build a fast-growth company in which considerable risk may be involved. This is not to say that the people running a corporation are completely absolved of responsibility. Management can be sued by stockholders for malfeasance or nonperformance.

The dramatic increase in the number of firms incorporating each year is due, in part, to the huge settlements being awarded in court cases these days. The high—and increasing—cost of malpractice insurance for professionals, such as doctors and lawyers, has convinced increasing numbers to form personal-service or professional corporations, even though this structure means a higher…and in some cases double…tax burden. 278

Chapter 16: Small Business Risks A number of companies form “sub-corporations” under the parent corporation in order to separate their liabilities. For example, a large residential builder might incorporate each new project separately. In this way, each of the other projects (and the parent company) will be protected in case anything disastrous should occur on any one project.

So, the advantages of a corporate business structure are: • The issue of stock—actually, shares in the business. A company can sell off some of its shares when the price is high and buy back some of its shares when the price is low, thereby using its own stock as a medium for investment. Stock also can be used as security for loans, like cash in arranging a merger and as inducements in the hiring and retention of key personnel. •

Some tax advantages. In some cases, corporations pay lower income taxes than individuals. On the other hand, corporate income is taxed twice—once at the corporate level and again when the profits are distributed as dividends to stockholders, who pay taxes on them as personal income.

•

Professional detachment. The people who run a corporation may not be the people who own it. The head of the firm actually may be an employee, hired by the stockholders to manage the company, in which case the manager may be free of personal and political issues.

Subchapter S The closed, or Subchapter S, corporation can be a useful vehicle for getting a new business started. That is precisely why the provision was put into law in 1958. Under Subchapter S regulations, the company passes all of its gains and losses to the stockholders, enabling the stockholders to use 279

Protect Yourself any initial losses the business may incur during start-up to offset earnings from other sources—up to the amount that they have invested in the company. Subchapter S corporations may have subsidiaries, providing they do not own more than 80 percent of the stock of a subsidiary. But they cannot have more than 35 stockholders. Subchapter S corporations can be converted to open corporations; but, once that is done, owners are restricted as to when and how they can revert back to Subchapter S status.

Limited Liability Companies In the 1990s, the limited liability company (LLC), a new organizational form, gained legal status in many states. LLCs are similar to partnerships, except that the liability of partners is limited to their equity investment. Many advisers now advise that any new business should be established as an LLC unless the peculiar facts and circumstances of that business indicate otherwise.

Typically, LLC members set forth a business purpose in their articles of organization or operating agreement. This agreement is ideal for incorporating a mission statement as part of the company purpose, as well. But its real purpose is to identify partners, the roles each plays and how any disputes or buy-outs will be resolved. An LLC’s operating agreement can provide for a dispute to be resolved by an appropriate mechanism. An agreement might even be drafted to require the buying and selling of ownership interests under specified terms and circumstances.

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Chapter 16: Small Business Risks An LLC operating agreement can easily be prepared to establish a management decision-making process. Quorum requirements for members’ or managers’ meetings can be set uniformly for all decisions or specifically for one or more types of decisions. In addition, voting requirements can be made to fit the interests of the members. For example, certain issues may require a simple majority vote, others a super-majority or unanimous vote to approve.

Insurance Coverage Standard personal insurance doesn’t cover business risks. And, no matter how small a business might be, it will count as a business when you have to make a claim. Consider how standard policies deal with business risks: • Automobile Coverage. If you are using your automobile for business activities—transporting supplies or products or visiting customers—you need to make certain that your automobile insurance protects you from accidents that occur while on business. If you have a personal vehicle that you sometimes use for business or if your home-based business is the owner of one or more vehicles, you may need to buy a Commercial Automobile Policy. •

Homeowners (Property) Coverage. If you rely on your homeowners policy as your only means of insurance protection, you may find your home-based business underinsured or uninsured in the event of a loss. Homeowners policies are not intended to cover business exposures. Coverage for the items you use in your business such as computers, fax machines, filing cabinets, tools and inventory are limited to $2,500 in your home and $250 away from home under most policies. And homeowners coverage provides no liability insurance for your business.

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Protect Yourself Review your existing coverage. Your homeowners insurance probably doesn’t cover your business. A small business will also need coverage for things like liability and business interruption. Business insurance coverage generally falls into two categories. Those two categories in business terms are: • Property Coverage—Your business structures and possessions are covered against loss or damage caused by certain covered risks such as fire and theft. •

Liability Coverage—This means that if you become legally obligated to pay money to another person for bodily injury or property damage caused by your business, your insurance company will cover those costs (up to the maximum indicated in the policy), including the costs of defending your business in the lawsuit. This coverage extends to medical payments for injured parties.

Of course, every business has its own special requirements. There are many specific insurance coverages available to address the needs of your home-based business. To insure a small business, you usually have three options—endorsements to your existing homeowners policy, an in-home business policy or a small businessowners package policy. 1) Endorsements. Depending on the type of business you operate, you may be able to add an endorsement to your existing homeowners policy. For as little as $14 a year, you can double your standard homeowners policy limits for business equipment from $2,500 to $5,000. Some companies offer endorsements that include property and limited business liability coverage. Endorsements are typically only available for businesses that generate $5,000 or less in annual receipts. They are available in most states. 2) In-home Business Policy. The insurance industry has responded to the growing number of home-based businesses by creating in-home business insurance policies that com-

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Chapter 16: Small Business Risks bine homeowners and business owners coverage into a single policy. General liability coverage is also included in the policy. If your business is unable to operate because of damage to your house, your in-home business policy covers lost income and ongoing expenses such as payroll for up to one year. The policy also provides limited coverage for loss of valuable papers and records, accounts receivable, off-site business property and use of equipment. These policies provide both business coverage such as business liability and replacement of lost income, and homeowners coverages such as fire, theft and personal liability. In some cases, the companies that offer these policies require that you buy your homeowners and auto policies from them, too. 3) Business Owners Package Policy (BOP). Created specifically for small businesses, this policy is an excellent solution if your business operates in more than one location or manufactures products outside the workplace. A BOP, like the in-home business policy, covers business property and equipment, loss of income and extra expenses, and liability—but on a much broader scale.

The Mechanics of a BOP A BOP provides a broad package of coverages for small and medium-sized apartment buildings, offices and retail stores. Each policy includes mandatory property and liability coverages, and offers optional coverages. The standard BOP form is modeled after the commercial package policy program that big companies buy. The same wording, organization of coverages and design are followed. Then, the standard BOP adds coverages that are similar to commercial property coverage and commercial general liability coverage, along with optional crime and boiler and machinery coverages.

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Protect Yourself The types of business eligible for a BOP include: • apartment buildings that do not exceed six stories in height and do not have more than 60 dwelling units (incidental offices are permitted); •

office buildings that do not exceed six stories in height and do not exceed 100,000 square feet in total area (apartments within the office building are permitted);

•

mercantile firms that do not exceed 15,000 square feet and do not have annual sales in excess of $1 million;

•

service or processing operations that do not exceed 15,000 square feet and do not have annual gross sales in excess of $1 million; and

•

building owners and business operators who are tenants, residential condominium associations and office condominium associations. Service and processing risks are newly eligible for coverage (previously, mercantile risks involving retail sales of merchandise were eligible, but risks involving service or processing were not eligible).

The businessowners program is designed to provide coverage for a variety of landlords and business operators who have moderate insurance exposures. For this reason, eligibility is defined to exclude certain risks that do not fit the intended exposure pattern. So, the following businesses are not covered under the program: • bars, grills and restaurants; •

automobile dealers and all types of automotive repair and service operations;

•

banks and all types of financial institutions;

•

places of amusement; and

•

contractors and wholesalers.

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Chapter 16: Small Business Risks BOP forms provide two major property coverages: • Coverage A—Building(s); and •

Coverage B—Business personal property.

Building coverage means the buildings and structures described in the declarations. An insured business that is a tenant would not require the building coverage. The coverage also applies to: • completed additions; •

fixtures, machinery and equipment that are permanently installed;

•

your personal property in apartments or rooms furnished by you as landlord;

•

outdoor fixtures; and

•

your personal property used for service or maintenance of the building or its premises (such as fire extinguishers, outdoor furniture, floor coverings and appliances used for refrigerating, ventilating, dishwashing or laundering).

Coverage for business personal property has traditionally been known as “contents” coverage. But it includes more than just a building’s contents because it applies to property of the named insured located in or on the described building, or within 100 feet of the described premises while in a vehicle or out in the open. Personal property includes: • property owned by you and used in your business; •

property of others in your care, custody or control; and

•

your interest as a tenant in “improvements and betterments” made at your expense but which cannot be legally removed.

Coverage for the property of others is limited to the amount for which you are legally liable, plus the cost of labor, materials or services furnished by you.

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Protect Yourself In addition to the coverage for direct loss to insured property, a BOP provides a number of additional coverages: • debris removal expenses; •

loss to property while removed from the premises to preserve it from loss;

•

fire department service charges;

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business income;

•

pollutant cleanup and removal;

•

collapse (special form only); and

•

damage by water or other substances (special form only).

Frankly, these additional coverages may the most valuable protections that a BOP offers your small business. In some cases, you may have to pay some additional premium to get one or more of the additional coverages; in just about any case, the protection is worth the additional price.

Coverage Extensions Both the standard and special BOP forms provide the same four extensions of coverage, which are in addition to the limits of insurance shown on the policy. They include: • personal property at newly acquired premises, •

personal property off premises,

•

outdoor property, and

•

valuable papers and records.

You may extend the coverage for business personal property to apply at any premises newly acquired. Both the standard and special BOP forms list the same items as “property not covered.” Some items are not insurable (i.e., contra-

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Chapter 16: Small Business Risks band), while others are more appropriately the subject for other types of insurance (i.e., automobiles). Covered property does not include: • aircraft, automobiles, motor trucks and other vehicles subject to motor vehicle registration; •

bullion, money and securities;

• contraband, or property in the course of illegal transportation or trade; •

land (including land on which the property is located), water, growing crops or lawns;

•

outdoor fences, radio or television antennas, including leadin wires, masts or towers, signs that are not attached to buildings, trees, shrubs or plants (except as provided by the outdoor signs optional coverage); and

•

watercraft (including motors, equipment and accessories) while afloat.

Covered Causes of Loss BOP property coverage covers the following causes of loss: • fire; •

lightning;

•

explosion, including explosion of gases or fuel within the furnace or flues of any fired vessel;

•

windstorm or hail damage to building exteriors;

•

smoke damage which is sudden and accidental;

•

aircraft or vehicle damage resulting from direct physical contact with an aircraft, missile, object falling from an aircraft, vehicle or object thrown up by a vehicle (but not damage caused by vehicles you own or operate);

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riot or civil commotion including acts of striking employees while occupying the described premises, and looting at the time and place of a riot or civil commotion;

•

vandalism meaning willful and malicious damage to property, including damage caused by burglars breaking in or exiting, and including damage to glass building blocks;

•

sprinkler leakage or discharge from any automatic fire protective sprinkler system;

•

sinkhole collapse, meaning the sudden sinking or collapse of land into underground empty spaces created by the action of water on limestone or dolomite (coverage does not apply to sinking or collapse of land into man-made underground cavities);

•

volcanic action, meaning direct loss resulting from volcanic eruption when the loss is caused by lava, ash, dust, particulate matter, or airborne shock waves or volcanic blast (the cost of removing ash, dust or particulate matter that does not cause direct loss or damage is not covered). All volcanic eruptions that occur within any 168-hour period constitute a single occurrence; and

•

transportation, meaning loss or damage caused by collision, derailment or overturn of a vehicle, the stranding or sinking of vessels, and collapse of bridges, culverts, piers, wharves or docks (this applies only to covered property in course of transit).

Except for the last, the above causes of loss are identical to those listed on the commercial property “basic” causes of loss form, and the meanings of the terms and limitations are the same. The BOP form has an additional cause of loss, “transportation,” which is included because the policy specifically covers personal property off premises while it is being transported. 288

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Liability Coverages The businessowners liability coverage form provides the following two major coverages: • business liability, and •

medical payments.

The business liability insurance covers your legal liability for damages because of bodily injury or property damage, and it also covers personal injury and advertising injury. The insurance company provides defense costs and the standard set of supplementary payments found on liability policies (i.e., cost of bail bonds, settlement expenses, loss of earnings, prejudgment and postjudgment interest on amounts awarded). The medical expense insurance covers medical expenses for bodily injury caused by an accident on premises you own or rent, including the ways next to such premises, or an accident because of your operations. Medical expenses incurred within one year of the accident date are covered, and payments are made without regard to fault or negligence. The businessowners liability form includes a long list of exclusions. In total these are similar to the combined exclusions applicable to bodily injury and property damage liability, personal injury, advertising injury and medical payment coverages found on commercial general liability forms. You should be aware of the types of exclusions applicable to these coverages. Some of the exclusions are complex and very detailed. Some are exotic, like the clause that excludes damages caused by war or nuclear materials. The following is a brief glance at a few of these exclusions: • bodily injury or property damage expected or intended by you;

•

bodily injury or property damage assumed under contract or agreement other than an “insured contract;”

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liquor liability (this only applies to a business that manufactures, distributes, sells or furnishes alcoholic beverages);

•

obligations under any workers’ compensation, disability benefits, unemployment compensation law or similar law;

•

bodily injury or property damage arising out of actual, alleged or threatened discharge or escape of pollutants;

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bodily injury or property damage arising out of the ownership, maintenance, use or entrustment to others of any aircraft, auto or watercraft owned or operated by, or rented or loaned to, an insured businessowner;

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bodily injury or property damage arising out of the transportation of mobile equipment by an auto owned or operated by, or rented or loaned to, an insured businessowner;

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bodily injury or property damage due to rendering or failing to render professional services;

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property damage to property you own, rent or occupy, or property in your care, custody or control;

•

property damage to your product;

•

damages claimed for any loss, cost or expense because of loss of use, withdrawal, recall, repair, removal or disposal of your product, work or impaired property;

•

personal or advertising injury arising out of publication of material by or at your direction with the knowledge that it is false, or arising out of any willful violation of a penal statute or ordinance by or with your consent;

•

personal or advertising injury arising out of any material first published before the beginning of the policy period, or for which you have assumed liability under a contract or agreement;

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advertising injury arising out of breach of contract, or failure of goods, products or services to conform with advertised performance, or the wrong description of the price of goods, products or services;

•

advertising injury arising out of an offense committed by an insured businessowner who is in the business of advertising, broadcasting, publishing or telecasting;

•

medical expenses for bodily injury to you, or a person hired to work for you, or a tenant of any insured businessowner;

•

medical expenses for bodily injury to any person if the bodily injury is covered by a workers’ compensation or disability benefits law, or similar law; and

•

business liability or medical expenses resulting from the hazardous properties of nuclear materials.

Professional Liability and Insurance In many small businesses, the business owner provides advice or professional services for which customers pay a fee. However, if these services are in some way unsatisfactory, the customer may sue the service provider for professional negligence. Accountants, attorneys, financial planners or anyone who provides professional services may find themselves as the defendant in a lawsuit. While many of these suits are unsuccessful, legal defense costs and potential settlement awards are ample reason for professional liability coverage. Professional liability policies are available for: • advertisers, broadcasters and publishers, •

insurance agents and brokers,

•

accountants,

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architects and engineers,

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attorneys,

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pension plan fiduciaries,

•

stockbrokers, and

•

directors and officers of corporations.

Professional liability insurance is particularly important for attorneys and psychologists, for example, who work out of their homes.

Professional liability coverage protects you against legal liability resulting from negligence, errors and omissions, and other aspects of rendering or failing to render professional services. It does not cover fraudulent, dishonest or criminal acts. Many professional liability policies contain exclusions commonly found in general liability policies, such as liability you assume by contract or obligations that fall under a workers’ compensation law. In the medical field, professional liability coverage is often called malpractice insurance. In other areas, it is known as errors and omissions insurance. However, all professional liability coverage is a form of malpractice insurance. Most professional liability policies today are written on a claimsmade basis, which obligates the insurance company that has written the policy currently in effect when a claim is made to cover, even if the negligent act or error occurred many years before (provided it did not occur before any retroactive date shown on the policy). Errors and omissions insurance for insurance agents, accountants and attorneys excludes coverage for bodily injury and damage to tangible property; coverage for many other professionals will only generate claims for financial damages. The nature of a profession determines the nature of malpractice claims…and its insuring agreements.

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Business Umbrella Policies In the course of business, management makes mistakes. If these mistakes cause financial losses and appear to be the result of gross negligence or willful misrepresentation, you could be sued. Just like individuals, businesses sometimes need umbrella liability coverage. However, there are no standard commercial umbrella policies. So, making general comments is difficult. Some business umbrellas are written to “follow form,” which means they do not provide broader coverage than the primary insurance. Others are more like personal umbrellas, providing coverages not included in the underlying insurance.

For many businesses, an umbrella policy protects business assets that could be threatened by liability lawsuits. Usually, commercial umbrella forms provide a minimum of $1 million of insurance, but they are frequently written with limits of $10 million to $100 million. The policies may include occurrence or claims-made terms. Commercial umbrellas also help to fill two types of insurance gaps—those created by oversights, and those resulting from exposures that may not be fully insurable under traditional policies. Where no primary insurance exists, the required self-insured retention will usually be $25,000 or more. For particularly risky exposures, the insurer may require a retention of $50,000 or $100,000—and as much as $1 million. Business umbrellas usually cover advertising and related liabilities. They also usually provide worldwide coverage for products liability, which is an important coverage for any firm selling to international markets. Blanket contractual liability coverage, for both oral and written contracts, may be included. Umbrellas often provide employees liability coverage, by making employees part of the definition of “named insured.”

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Protect Yourself Finally, business umbrellas may be written to provide liquor law liability and many other liability coverages not covered by BOPs or other business policies. But these additional coverages get expensive.

Conclusion Bottom line: Business people can obtain business insurance, and should—if they want things covered when the business generates trouble as well as cash. Coughing up sixty grand in a small, one-man business isn’t an easy thing to do. And it’s far more expensive than buying a policy. There are many more issues that face businesses—even small ones. The purpose of this chapter has been to consider the risks that often apply to small businesses. Clearly, the standard business owners policy…or BOP…is the best tool for handling these. BOPs are not terribly expensive and protect you against the basic problems that a business can cause.

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Chapter 17: Lending Money CHAPTER

17

Lending Money

Lending money is a risk on many levels. It can reflect hardheaded financial practicality…or wild-eyed dysfunction. It can mark cautious optimism…manipulative abuse. It can mean fat profit…or profligate folly. Everyone brings his or her personal issues to money matters. One of the hardest parts of having some money is finding good ways to put it to work without thinking like a loan shark. And without getting ripped off. Personal loans are a basic fact of financial life. Despite the advice Polonius gives his son in Hamlet, Americans both borrowers and lenders be…at various times in their lives. Or at various times in the same month. Personal loans start businesses, finance first homes and send children to college. In this chapter, we’ll look at the different ways that personal loans can cause problems and create risks. Then, we’ll offer some ideas for managing these risks.

Balancing Personal with Financial The challenge to making a good personal loan is balancing the personal and financial interests. No matter what a contract says, the ultimate security for most personal loans is your friendship or familial ties to the borrower. You’re counting on these ties to compel the borrower to make the interest payments and, eventually, return the principal.

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Protect Yourself At the same time, personal ties can get twisted up in knots of resentments and conflicts that more distant dealings rarely have. Some people make a policy of not lending money to friends or relatives to avoid these problems. But that seems an extreme response. Besides, you can lose relationships by not loaning money when someone needs it; and you can certainly lose money making conservative investments.

A more practical approach may be to ask the friend or family borrower some questions that give some terms to the transaction— and give you information on which to base your decision. These questions should include: • How much do you want to borrow? •

How much interest can you afford to pay to borrow the money?

•

How long do you want to borrow the money?

•

What—exactly—are you going to do with the money during the loan period?

•

How do you plan to repay the loan?

•

Do you have a backup plan, in case your first plan doesn’t work?

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Are there any benchmarks or guideposts that will measure your ability to repay?

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Do you have any collateral to secure the loan?

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What other lenders have you approached? Why is this loan better than those?

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If this loan doesn’t perform as we plan, how will you react when we see each other socially?

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Chapter 17: Lending Money The answers to each of these questions tell something about the borrower and the loan. The main relevance of the how much question is how realistic the borrower is about his or her needs. Does your cousin the school teacher need $10,000 to add to the $20,000 in cash she has to put down on a house? That’s a rational request. Does she want to borrow $150,000 to move into a swanky neighborhood? She may be confused about money and earning power. There are no simple guidelines for determining how much money you can comfortably loan someone. From a clean-cut risk management perspective, it’s not a good idea to concentrate more than 10 percent of your liquid assets in any single investment. And a loan…even a personal loan…is an investment. But, in cases of family businesses or some real estate investments, it might make sense to make a larger loan. The how long and how much interest questions give you some idea about how grounded the borrower is in financial reality. You don’t want to hear things like “Gee, I don’t know” or “Well, as long as I can keep it.” These evasions suggest that the borrower isn’t treating the cost of the loan seriously—which suggests he’s not thinking seriously about repaying it. The length of the loan will give you some idea of how much interest to charge. Like any financing arrangement, a personal loan should usually charge less interest as its term gets shorter. You might loan a family member money for a few days interest-free; but a 10 year term loan needs to generate some interest. If you aren’t already thinking this way, remember that every use of money presents an opportunity cost. In other words, it needs to earn something to make up for the fact that it could have been somewhere else, earning something. The longer that it’s tied up, the larger the opportunity cost.

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Protect Yourself The what are you going to do question and the two how will you repay questions should give you some insight into the borrowers plans…and shape. You don’t want to hear a tearful admission of drug addiction, adultery or looming bankruptcy. Any such crises mean that you may be throwing good money after bad. Keep in mind, if a friend or family member is asking you for a loan, there’s probably some kind of problem afoot. More broadly, you can usually organize needs into two rough categories: • rectifying trouble situations, and •

pursuing opportunities.

Loans made to rectify trouble are more likely to cause problems. The borrower may simply be swapping existing troubles for…troubles with you. Crafty or desperate borrowers will sometimes describe a rectify-trouble loan as a pursue-opportunity loan. That’s why you should ask a lot of detailed questions about any use of the money. Look for any hazy lack of detail.

A business/personal use distinction may also be useful to know. Generally, the more business-related the loan, the more likely you’ll get your money back in a timely manner. If the borrower has been thinking about using the loan to start a business, he or she should have already worked out the benchmarks of performance that will measure ability to repay. If the benchmarks aren’t there, the plan may not be that strong. With a business, the need may be genuine. Banks and other commercial finance sources are the biggest outside source of capital for business. But new businesses—and small businesses, even when they aren’t new—usually have a tough time tapping into this source of money, so they approach their family members.

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Chapter 17: Lending Money Why do so many traditional lending institutions shy away from small business loans? One reason is that they’re unpredictable. Businesses, large and small, face risks of financial loss and insolvency. However, the risk of failure is higher for small businesses. So, from the lender’s perspective, determining the expected cash flow from a pool of small business loans remains comparatively expensive. These costs are driven primarily by three factors: • The need for specific borrower and local condition information. To make a reasonable decision on repayment prospects, lenders need to acquire detailed information on the management quality of a small firm and on the local economy.

•

The lack of standardization of loan terms. A pool of small business loans usually will be very diverse in terms of the borrowers’ lines of business, the loan terms (maturities, pricing, covenants and collateral), loan documentation, underwriting standards and credit quality.

•

The lack of long-term performance data. Unlike the home mortgage market, long-term data on the loan performance of small business loans are rarely available.

Given other lending options, many lenders have been reluctant to take on the risk and cost of investing in small business loan pools. The reason banks earn such high returns on the loans they do make is the same reason why many others don’t make them at all—specifically, the loans are risky, information-intensive and less subject to nonlocal competition.

The Borrower’s Perspective Tapping friends and family for financing and getting credit card capital is usually the first stop. The high interest rates charged for credit card cash advances can cripple a company before it gets off the ground, though. And

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Protect Yourself few businesses can really get up and running for the amount of money an ordinary person can carry on his or her MasterCard. This is the reason for the questions about collateral, other lenders and social situations. They test the practical experience the borrower has for dealing with money matters. You may not want a second (or third) mortgage or a lien on personal property as security for a loan. But it can be instructive to probe how thoroughly the borrower understands common financing terms. The more he understands, the more he should appreciate and manage a simple personal loan. Family financing comes with its own costs—which can be emotional, as well as financial. Still, it’s the source of capital that most start-ups use; and it’s the reason there are so many family-owned businesses.

A bank loan usually entails the preparation of numerous documents, the approval of a loan committee, a lengthy wait while that committee comes to a decision and then—if one is successful in receiving the loan—the payment of heavy interest on the loan until it is paid off. Nobody knows the borrower better than a friend or relative. Nobody is more likely to invest in intangible attributes, such as honesty, reliability and the capacity for hard work. Nobody is more apt to gamble on a dream or an idea.

Also important is the willingness of a relative to invest in a business without asking for anything more than a promissory note. No need to sign over your house as collateral. No need to surrender a piece of the business in exchange for a loan. No need to line up any cosigners. Often, a simple handshake is enough.

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Chapter 17: Lending Money There are situations in which relatives have mortgaged their homes to provide start-up capital for a promising entrepreneur. There are others in which siblings have advanced the entrepreneur his projected share of the family inheritance so he could start a business. And there are situations in which a child has been allowed to borrow against the parents’ insurance to raise some needed business capital. A spouse’s paycheck keeps the family afloat during the early stages of a business in 1 out of every 5 cases, according to a study conducted by one national business magazine. Personal loans are often another big part of that equation.

The Immigrant Model of Family Finances Many families building businesses designed to last several generations follow the Asian model of family businesses. A number of Asian cultures—but particularly overseas Chinese entrepreneurs—emphasize family-oriented business networks that transcend national boundaries. The typical large family-run conglomerate in Asia consists of many modest-size firms, each of which has some ownership in the other family businesses. These networks provide various commercial services—including market research, transportation, personnel and assistance in complying with local rules. But, more important than any of these things, they provide capital. The money that these business networks offer doesn’t come free. It must be repaid with interest. The cash flow generated by these loans usually is converted into other loans to other family start-ups. Because an entire family unit is responsible for financing, default is practically unheard of. All family members are responsible for the business.

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Sources of Capital Large companies may share their future valuation creation by exchanging equity for capital. This means selling stock. Smaller companies more commonly use debt as a financing option because of the need to use operating cash flow to service the debt. The common mechanisms that a start-up business—and, less literally, individual—should use to raise money include: • Cash Flow. Customers pay; you build the business. It is often ideal to have your customer base fund the business. Your company pays no interest, gives up no equity and makes a profit. •

Supply-Side Financing. Get your suppliers to give you credit. You might have to pay interest, but you won’t have to give up equity. Ideally, the supplier will agree to ship to you on credit—and will wait until you sell and collect on that shipment before you have to pay. Suppliers may extend credit if they see you’re having cash flow problems because of rapid growth.

•

Financial Angels. These are individual investors who will contribute start-up capital in exchange for a minority equity stake (usually). They’re out there, but they’re hard to find. You won’t find them in directories.

•

Bank Money. With only 1 in 5 businesses surviving the first five years, banks will finance just about any asset or lend money for any logical business reason except, of course, for starting a business. An aggressive banker can do wonders with bank policies if he understands what you’re trying to do.

If you’re going to make a promissory note loan, you want to see that the borrower has some handle on these other financing tools.

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The Promissory Note At this point, you’ve probably done as much probing, prompting and investigation as you could expect to do. If you’re ready to make the loan to a friend, acquaintance or family member, the formal document needs to be made. A clearlywritten promissory note is a contract and should be fully enforceable in any court or arbitration hearing. The promissory note should state: • the date the loan was made; •

the name and address of the lender;

•

the name and address of the borrower;

•

the city and state in which the loan was made;

•

the amount of money loaned;

•

the term of the loan;

•

the due (or maturity) date when the loan is to be repaid;

•

any conditions under which the loan can be called for repayment before its due date;

•

any results of an early repayment of the loan;

•

the schedule of any payments to be made during the term of the loan;

•

the nature of the payments (interest only, interest-plusprincipal, balloon);

•

the total amount due, including interest and principal;

•

recourse available to lender and borrower, if either defaults; and

•

whether the note is transferrable and under what conditions it can be transferred.

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Protect Yourself You can see an example of a promissory note on the last page of this chapter.

Legal Capacity In most states, you can’t enforce a promissory note or loan signed by someone: • under 18; •

mentally incompetent; or

•

of diminished capacity, coerced or otherwise forced into signing.

One of the most common people problems that complicates the smooth lending of money is capacity. Even though they aren’t exactly the same, this word is sometimes confused with competence. They are similar enough that they’re used interchangeably. Competence is the mental or intellectual fitness (or lack of disqualifying disabilities) to enter into contracts or give testimony in a court of law. Capacity is the qualification—including competence but also things like age—to enter into agreements. Capacity is a broader term; competence, a narrower one. Legal competence is generally required in most transactions. For example, to sign a lease you must be legally competent. However, legal competence becomes especially significant where wills are concerned. Because wills are so often made by the elderly or by persons in their last illnesses, disputes over mental capacity come up a lot.

Conclusion Lending money is an inevitable part of modern life. It comes with some inherent risks. The best way to manage these risks is to insist on a formal written loan agreement…a promissory note. Otherwise, it’s a good idea to emulate the entities that most often loan money—banks. A bank will not lend money to some-

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Chapter 17: Lending Money one without a fully detailed business plan showing where he expects to get enough money to repay the loan. The same should be true for anyone lending money. A good business plan should include: • a description of the product or service to be produced; •

an analysis of the existing marketplace, including likely competitors;

•

a pricing model that explains how costs are covered by revenues—on an absolute and per-unit basis;

•

a budget for start-up costs;

•

a budget for the first year of operations;

•

a profit-and-loss projection for up to three years of operations; and

•

an explanation of ownership structure and capitalization goals through the start-up period and through three years of operations.

Taken as a group, these practices are what venture capitalists and other entrepreneurs call bootstrapping. Or, as one veteran of several Silicon Valley start-ups said, bootstrapping is “everything you can think of doing to avoid spending a dollar.” You want anyone who borrows money from you to be a bootstrapper. And you want to have a clearly-written, fairly executed loan contract. The loan may still fail. But, by doing these things, you will have made the best reasonable effort to manage the risk.

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A Simple Promissory Note NOTE $29,062.50

[CITY, STATE ]

[DATE OF LOAN]

FOR value received, [BORROWER], an individual, promises to pay to [LENDER], an individual, the sum of TWENTY-NINE THOUSAND AND SIXTY-TWO DOLLARS AND FIFTY CENTS ($29,062.50), in twelve monthly installments beginning on October 31, 2002 and continuing until September 30, 2003. This Note constitutes full repayment with interest of a loan in the amount of twenty-five thousand dollars exactly ($25,000) made by [LENDER] to [BORROWER] on or before August 31, 2002. By agreement between [LENDER] and [BORROWER], this Note will be satisfied in twelve installments. Eleven installments, paid monthly beginning October 31, 2002, and continuing on the last day of each month through August 31, 2003, will be in the amount of three hundred and twelve dollars and fifty cents ($312.50). One installment, in the amount of twenty-five thousand, six hundred and twenty-five dollars ($25,625) will be paid by September 30, 2003. By agreement between [LENDER] and [BORROWER], this Note and all obligations related to it will be satisfied at any time before September 30, 2003, that [BORROWER]—having otherwise paid installments in a timely manner—pays twenty-five thousand six hundred and twenty-five dollars ($25,625) to [LENDER]. By agreement between [LENDER] and [BORROWER], if [BORROWER] should fail to pay any installment within seven days of a scheduled payment date, [LENDER] shall have the right to demand full, immediate repayment of the original loan amount plus any interest accrued. [BORROWER], An individual residing at [ADDRESS] [CITY, STATE, ZIP] [TELEPHONE]

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[LENDER], An individual residing at [ADDRESS] [CITY, STATE, ZIP] [TELEPHONE]

Chapter 18: Bankruptcy As Protection CHAPTER

18

Bankruptcy As Protection

Bankruptcy is the financial protection of last resort. This legal process—by which either a person or a company declares insolvency and asks a court to resolve its financial obligations—isn’t much of a protection, though. It usually means you have to give up most of the financial assets that you own. There’s an exception to this point. Most bankruptcy proceedings allow a person to keep a primary residence —if he or she owns it. The guidelines for this allowance vary from state to state. Some states (Florida, notoriously) give a liberal definition to primary residence…which makes them havens for white collar crooks who want to keep big homes.

Various junk bond kings, Wall Street felons and O.J. Simpson may manage to keep their mansions on Florida golf courses. But, for most people, bankruptcy is a wrenching process. If you go through it, you’ll probably: • sell or hand over any valuable personal property (including clothes) that you own; •

live under a court-ordered allowance;

•

lose control of any earnings (including salary) that you have for several years;

•

lose any access to consumer credit;

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have a major blemish on your personal credit for seven to 10 years;

•

have trouble qualifying for insurance and other financial services (even if they don’t involve credit); and

•

pay extremely high interest rates for years to come…on the rare occasion that anyone will loan you money.

Some people exaggerate the ease with which individuals can declare bankruptcy. A series of reforms to the federal bankruptcy code during the 1980s and 1990s made the tightened some loopholes and lengthened some reporting timeframes—making the process generally more difficult to survive. Some of the misimpressions about bankruptcy’s ease stem from confusion about the two kinds of bankruptcy: personal and business. Ironically, bankruptcy is often easier on corporations that file than people who do.

In this chapter, we’ll look at some of the mechanics of bankruptcy and discuss when it may be a rational way to protect yourself.

Who Files…and What Happens A bankruptcy proceeding can either be entered into voluntarily by a debtor or initiated by his creditors. After a bankruptcy proceeding is filed, creditors may not—in most situations—seek to collect their debts outside of the proceeding. The debtor is not allowed to transfer property that has been declared part of the estate subject to the proceedings. Furthermore, certain pre-proceeding payments, transfers of property, secured interests and liens may be delayed or invalidated. The Bankruptcy Code allows a court to consider any transaction that occurs within the last 90 days before a filing inherently preferential—simply because of the time at which it took place. This dis-

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Chapter 18: Bankruptcy As Protection courages people from paying friends and family with scarce resources and then filing bankruptcy to stiff other creditors. At the same time, bankruptcy law discourages creditors “from racing to the courthouse to dismember the debtor during his slide into bankruptcy.” Instead, it tries to set a framework within which a debtor can “work his way out of a difficult financial situation through cooperation with…creditors.” This is a critical point. The bankruptcy process can be as hard on people you owe as it is on you. In many cases, creditors will be willing to negotiate deals for payment in order to prevent you from declaring bankruptcy.

In order to complete bankruptcy forms, the debtor must compile: • a list of all creditors and the amount of their claims; •

the source, amount and frequency of his income;

•

a list of all of his property; and

•

a detailed list of his monthly living expenses—food, clothing, shelter, utilities, taxes, transportation, medicine.

A meeting of creditors is usually held 20 to 40 days after a petition is filed. The debtor must attend this meeting, at which creditors may appear and ask questions regarding the debtor’s financial affairs and property. These meetings are often emotionally charged—they’re usually the only chance that creditors have to confront the bankrupt debtor in person. In order to preserve their independent judgment, bankruptcy judges are prohibited from attending this meeting. Once the meeting has taken place, the judge will review all filings, consult with the trustee (if one has been appointed) and then either discharge debts or instruct the debtor and creditor to negotiate a settlement.

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Protect Yourself A discharge releases the debtor from personal liability for discharged debts and prevents the creditors owed those debts from taking any action against him or his property to collect the debts. It’s the purpose of bankruptcy filing.

Liquidation vs. Rehabilitation In addition to personal and business bankruptcy, there are two other categories: liquidation and rehabilitation. A filing under Chapter 7 of U.S. Bankruptcy Code is the liquidation. It is the most common type of bankruptcy proceeding. Liquidation involves the appointment of a trustee who collects the nonexempt property of the debtor, sells it and distributes the proceeds to the creditors. People and businesses can file under Chapter 7. A filing under Chapters 11, 12 or 13 of the U.S. Bankruptcy Code involves the rehabilitation of the debtor to allow him to use his future earnings to pay off his creditors. In these cases, a trustee may or may not be appointed to supervise the assets of the debtor—depending on how much money the debtor owes and how angry his creditors are about not being paid. In most cases, companies file under Chapter 11; individuals file under Chapter 13. (Chapter 12—the least common of the three types of restructuring—applies to government entities that go broke.)

Chapter 7 is sometimes referred to by the legal profession as a “straight bankruptcy.” It is designed for use by companies that are going out of business; but it’s often used by individuals who wish to free themselves of debt simply and inexpensively. One catch: Courts will sometimes dismiss a Chapter 7 case filed by an individual whose liabilities are primarily consumer debts

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Chapter 18: Bankruptcy As Protection rather than business debts. In other words, you can’t use Chapter 7 to erase credit card balances…if that’s all you have. As we’ve noted, bankruptcy law allows an individual to protect some property from the claims of creditors. However, even a Chapter 7 liquidation does not extinguish a lien on property—so mortgages and such things stay in place. Even though the obligation of making the monthly payment is extinguished by a bankruptcy filing, the lien for the remaining mortgage balance remains on the title—and the lender can foreclose and force a sale. But a Chapter 7 debtor who’s not in default may be able to retain that property by continuing to make contract payments.

Usually, household furnishings, household goods, clothing, appliances, books, animals, musical instruments or jewelry that are held primarily for the personal, family or household use of the debtor are exempt from liquidation. However, the court can determine was constitutes personal use…and courts will sometimes order the sale of things like furs, designer shoes and other luxury items. With a Chapter 13 restructuring, which is more common, an explicit goal is to allow the debtor to keep his or her house. The debtor agrees to pay the missed mortgage payments and remain current on future ones; he or she remains liable for the entire debt.

The Trustee Is Key One of the critical aspects of a bankruptcy proceeding is the naming of a trustee. This person serves as a combination of CEO and defense counsel during the liquidation. While the trustee is not directly responsible for protecting burned creditors (technically, the responsibility is to the bankrupt corporate entity), he or she is instrumental in setting the tone for the proceedings.

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Protect Yourself In fact, if a trustee is found to be asserting claims of creditors rather than the debtor, the court—which ultimately supervises the proceedings—can overturn any activity. Creditors often make the assumption that they are the ones who will receive any money, so they should be able to prosecute the debtor in any manner they choose. That’s not how bankruptcy—or a bankruptcy trustee—works. It’s not a debt collection device. The trustee’s job is to investigate the debtor’s financial affairs, liquidate assets, pursue the debtor’s causes of action and acquire assets through avoiding powers in order to make a distribution to creditors. As the administrator of the bankrupt estate, the trustee’s goal is to ensure that each similarly situated creditor of the bankrupt debtor gets an equitable share.

Therefore, the trustee—like the creditor—is concerned with laying claim to any property that could conceivably belong to the estate. This any property usually includes lawsuits against the people who tanked the estate in the first place. The trustee’s concern isn’t only for money, though; it’s also for order.

Frauds and Fraudulent Conveyance One problem that creditors often fear is that a person filing bankruptcy has hidden assets through bogus transactions. The U.S. Bankruptcy Code provides criminal penalties for any person who, in a personal capacity or as an agent or officer of any person or corporation, in contemplation of a case under [bankruptcy law] by or against the person or any other person or corporation, or with intent to defeat the provisions of [the law], knowingly and fraudulently transfers or conceals any of his property or the property of such other person or corporation.

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Chapter 18: Bankruptcy As Protection However, the Code also allows criminal charges against a person who merely transfers or conceals assets “in contemplation of a case…or with intent to defeat the provisions of [the Code].” All that it requires is that the debtor transferred assets with the ultimate intent to defraud a bankruptcy court, whether or not such transfers ever actually took place. The complaint most often made by angry creditors in bankruptcies is fraudulent conveyance. But this claim is hard to make stick. For a bankruptcy trustee to avoid a transfer as fraudulent, four elements must be satisfied: 1) the transfer must have involved property of the bankrupt entity; 2) the transfer must have been made within one year of the filing of the petition; 3) the bankrupt entity must not have received reasonably equivalent value in exchange for the property transferred; and 4) the bankrupt entity must have been insolvent, been made insolvent by the transaction, be operating or about to operate without property constituting reasonable sufficient capital, or be unable to pay debts as they become due. Most people focus on the fourth of these elements. They argue some variation on the theme that: “The person was broke when he made the deal, so it can’t be enforced.” All four elements need to be satisfied before a deal— or payment—can be reversed.

California’s fraudulent conveyance statutes are similar in form and substance to the federal code’s fraudulent transfer provisions. Both allow a transfer to be avoided where “the debtor did not receive a

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Protect Yourself reasonably equivalent value in exchange for the transfer and [the debtor] was either insolvent at the time of the transfer or was engaged in business with unreasonably small capital.”

Should You File? Is it ethical to file for bankruptcy after you’ve been found liable for someone else’s loss? Ethical is a tough word to define in these circumstances. It probably accomplishes more to say that it’s legal to file bankruptcy to discharge a liability. And many people do. In fact, bankruptcy filings have become so commonplace that some people who have sizable liabilities will use bankruptcy tactics without actually filing for protection. A good example of this was provided by O.J. Simpson, the famous football player and actor who was tried and acquitted on charges that he murdered his ex-wife and her friend. After he was acquitted of the criminal charges, his ex-wife’s family sued him in civil court for wrongful death. Simpson lost that case (largely because civil lawsuits have lower standards of proof than criminal cases do). In February 1997, he was ordered to pay the families of his ex-wife and her friend $33.5 million. He didn’t have that much cash. So, he began to protect his assets as someone about to file bankruptcy might—even though he didn’t actually file bankruptcy. Among the things he did: • Move to Miami. Florida law forbids forcing a person out of his residence if he owns it outright; so, many wealthy people facing money problems dodge debts by converting liquid assets into Sunshine State mansions. •

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Transfer most of his remaining liquid assets into legal, domestic havens: pension and retirement funds. These funds (with millions of dollars in them) could not be touched by outsiders even if Simpson filed for bankruptcy. The pensions were scheduled to begin paying their annuities when Simpson turned 55—in 2002.

Chapter 18: Bankruptcy As Protection •

Rely on money he received from the NFL and the Screen Actors Guild pensions to cover his regular expenses. These monies were untouchable, again, because pension laws protect them from legal judgments.

•

Transfer half a million dollars into the estate of his children (for expenses and education).

•

Liquidate most of the assets that could be seized (he’d actually done this before his criminal trial had begun). He sold real estate in New York and California, property in Mexico; a 50 percent interest in a string of HoneyBaked Ham franchises, his Ferrari Mondial and Ford Bronco. He borrowed $3 million against his Los Angeles home and used a Warhol serigraph of himself as security for a loan he took from his children’s estate. (Eventually, his home went into foreclosure and was sold at auction.)

•

Tap into his homeowners insurance policy to pay for his defense in the civil trial.

•

Let go of many of his personal possessions. The items seized by the court and sold at auction generated $430,000 for the families. (His 1968 Heisman Trophy went for $255,500.)

After the civil case was concluded and Simpson lost his Los Angeles home in foreclosure and saw some of his personal possessions auctioned off, he was still keeping about $16,000 a month (after taxes) from various untouchable sources. Lawyers for the families of his ex-wife and her friend tried to seize Simpson’s pension funds; but these efforts came to nothing. They were eventually dropped—the lawyers couldn’t establish that the pension benefits could be used as payment in the wrongful death suit.

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Bankruptcy and Retirement Most states fail to provide regular individual retirement accounts and Roth IRAs with the kind of ironclad protection from creditors that is afforded pension benefits and 401(k) plans. In general, the rules change markedly from state to state. New Hampshire and New Mexico, for example, have no laws specifically protecting IRA savings from creditors. Other states, such as Texas, Arizona and Washington, protect virtually everything inside an IRA from creditors.

So, depending on where you live and how you’ve saved, you could lose some or all of your retirement money if you are sued or file for bankruptcy. Some states do shelter money in IRAs and Roth IRAs that is deemed necessary to support the saver and his or her dependents in retirement. Any excess, however, is subject to creditors’ claims in a lawsuit or bankruptcy. Exactly how much would be protected is open, however, to a judge’s interpretation. These protections are probably not sufficient for high earners, big savers and those who hope to pass some of their retirement largess to their children when they die.

If you’re close to retirement and considering a move anyway, the size of your IRA assets could be one of the deciding factors in where you move. A state-by-state listing of IRA protections in bankruptcy can be found at the Investment Company Institute Web site at: www.ici.org/retirement/99_state_ira_bnkrptcy.html. You might consider leaving your 401(k) money in a previous employer’s plan or transferring it directly into a new employer’s plan

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Chapter 18: Bankruptcy As Protection rather than rolling the money into an IRA when you change jobs. This assumes that the employers will cooperate; some may want you to take your money when you leave.

Conclusion One good way to avoid liabilities is to be judgment proof. That means not to have any money or possessions that people could take if they sue you successfully. But, when you own assets worth protecting—a business, a home, some retirement money, some valuables— this isn’t as easy as it sounds. If you don’t have any or enough insurance to protect these things…and if you are sued and found liable for another person or business’s loss…you may need to use the legal tools available for making yourself judgment proof. That usually means filing bankruptcy. Of course, there are other steps that should come first. You should try to negotiate an agreement to resolve a liability with the person or company you owe. In many cases, you can negotiate effectively in this way by merely mentioning that you might have to file for bankruptcy protection unless you can reach a private settlement.

Negotiations, however, don’t always work. Bankruptcy is the final reckoning of bad decisions and faulty planning. It doesn’t prevent or avoid problems. And it doesn’t mitigate—directly, at least—the financial impact of a personal liability. But it is the mechanism for protecting yourself once someone has established that you owe him money. Although many people and companies file when they have been found liable for a claim, it’s interesting to note that bankruptcy laws were written for the creditors and not the debtors.

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Protect Yourself Bankruptcy law provides for the development of a plan that allows a debtor, who is unable to pay his creditors, to resolve his debts through the division of his assets among his creditors. This supervised division also allows the interests of all creditors to be treated with some measure of equality. Certain bankruptcy proceedings allow a debtor to stay in business using revenue that continues to be generated to resolve his debts. An additional purpose of bankruptcy law is to allow certain debtors to free themselves (to be discharged) of the financial obligations they have accumulated, after their assets are distributed, even if their debts have not been paid in full. But a little prevention is better than a lot of that cure.

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Conclusion

Conclusion

At the beginning of this book, we said that it was important to think like an insurance company in terms of identifying and managing risk. And, really, this book has been about those two steps: identifying and managing. As a free agent moving through a dangerous world, you have to do both. Most of this book has been about the mechanics of managing risk—through insurance, negotiated contracts or smart behavior. But we’ve also tried to define and describe the first step. In many ways, that first step may be the harder one. With all of the information, data, reports and opinion that flows around you in our digital world, it’s a struggle to single out the facts and patterns that pose some danger to you. This is an old struggle. Economists talk about efficient markets in which decision-makers have perfect information…and then ruefully admit that perfect information is the enabling fantasy of their profession.

This battle to get through the clutter to the critical data has some practical applications. Consumer safety serves as a good example of these issues. The years 2000 and 2001 saw more product recalls related to consumer safety issues than any other period in recent history: • The Consumer Product Safety Commission said that there were more recalls in 2001—344 separate products—than in most of the 1990s.

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The Agriculture Department reported 87 voluntary recalls of meat and related products in 2001, nearly double the 44 of 1998.

•

The National Highway Traffic Safety Administration said recalls of vehicles, tires and equipment like child car seats totaled 490 in 2001 and 554 in 2000, the two highest figures on record.

Still, most consumers don’t return recalled products to manufacturers or dealers. Even the most successful recalls average about a 30 percent response rate. Many people simply never find out about the recalls. Some consumer advocates argue that the solution lies with requiring manufacturers to use owner-registration cards for all consumer products sold in the United States. But, like so many schemes to eliminate all risk from life, this plan is impractical. The cost to manufacturers would be high; and people already don’t respond well to owner-registration cards on the product categories (particularly, infant and child products) where they are nominally required. As we’ve seen throughout this book, the best solution is seldom to regulate people’s behavior. The best approach to encourage safe behavior is to make unbiased information easy to get. This is rarely expensive; but it is often politically difficult. Moreover, it’s a challenge to convince people that they need to know this kind of thing. In a few, focused areas regulations can affect behavior. But, the more broadly government tries to control markets, the less effective each particular regulation becomes.

The reason that so few recalls get big response is that most people would rather not think about the safety or danger of the things they buy. The occasional, high-profile product tampering or baby prod-

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Conclusion ucts case may strike a chord with tabloid sensibilities…but the intricate details of how an appliance malfunctions? It’s tough to get people to listen. Consumer advocates—even the most committed ones—know that their work is usually lonely. This may explain Ralph Nader’s desire to run for President in 2000; the passionate supporters who met him at numerous rallies were a kind of cosmic payback for all the announcements he’s made to empty halls. If there’s any good that came of the terrorist attacks of September 2001, it may be that the events scared some Americans out of their apathy. Even this heightened awareness to risk is a challenge to channel effectively. As we’ve seen time and again, the things that scare people aren’t always the things that pose the biggest risks to people. Even though TV stations in the U.S. have repeated footage of the 9/11/01 attacks enough that many Americans know it frame by frame, the fact remains that terrorism poses a small—an infinitesimal—risk to most Americans. Even if it made sense for every American to alter his or her behavior to avoid terrorist attacks, it would be tough to advise what specific actions to take. Terrorism (like all crime) is opportunistic. It doesn’t follow predictable patterns and rarely uses the same tools or methods of attack repeatedly.

The valuable lesson is that risk is real. And you can take steps to minimize it…though rarely to eliminate it. In order to understand what sorts of risks you face, you need to have a pretty good idea of: • who you are (age, gender, weight, family history, medical condition, emotional type); •

what your goals in life are (buy a house in 10 years, inherit a drug cartel);

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how you live (with a family, by yourself, quietly, aggressively).

This may sound like basic self-knowledge. But it’s the first step to achieving the first step—being able to sift through torrents of useless information for the bits that mean something. As we’ve seen, insurance isn’t always the best tool for protecting yourself form life’s risks. In fact, in cases like handing money to swindlers or dealing with trouble-making kids, there’s no insurance available. Nonetheless, it is almost always useful to study how insurance companies deal with various risks. Knowing how insurance companies identify and calculate risks…and when they’ll insure them and when not…can tell you a lot about how you should respond. And that’s the key to protecting yourself.

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Index INTRODUCTION

Index

accelerated benefits 89 accident only insurance 70 accidental bodily injury 205, 224 accidental loss 225 actual cash value (ACV) 154 additional coverage 286 allowable deduction 260-261 annuities 261, 267, 269-272, 314 auto insurance 12-13, 16, 127-129, 137, 221 auto-related risks 6 bankruptcy 131, 138, 298, 307-314, 316-318 beneficiary 83, 91-93, 264, 267, 269-270 boating 19-21, 191 bodily injury liability 13 building coverage 163, 285 business owners liability coverage 289 business owners policy (BOP) 283-288, 294 catastrophe risks 5, 109, 126 closed (Subchapter S) corporation 274 collision coverage 13, 15 collision damage waiver (CDW) 14-15 commercial general liability coverage 283 commercial property coverage 283 compensatory damages 220 condominium coverage 161 cost of living benefit 198 crime 39-51, 95, 113, 219, 237, 240, 283 criminal act 42, 133, 225, 232, 292 damage to reputation 225 death benefit 15, 73, 75-79, 85-87, 89, 91-93, 269, 207, 209

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Protect Yourself debts 18, 73, 93, 261, 276-277, 308-311, 313-314 defense costs 223, 233-234, 237, 289, 291 dependent children 212, 215 diet schemes 244 dietary risks 25, 34 disability benefits 99, 198-199, 207-211, 213, 290-291 disability income insurance 196-197, 202-203, 208, 218 disabled child 213 dog owner liability 229 drop-down coverage 224 drunk driving 11 duty to act 220 duty to defend 135, 233-234 dwelling coverage 146, 148, 151-152, 157 dwelling policies 151-152, 167 earthquake coverage 114-115, 190 endorsements 119-120, 122, 170, 176, 188, 282 estate taxes 73, 81, 93, 257-260, 272 exclusions 61, 90, 120, 123, 125, 138-141, 144, 146, 148, 150, 170, 174, 189, 200, 223-224, 236, 259, 289, 292 extraordinary medical benefit 14 family income policy 83, 94 federal estate tax 257-258, 263 fire coverage 118-119 floaters 176-177, 181, 185 flood coverage 116-117 flying risk 17 frauds 240, 312 fraudulent conveyance 313 full replacement value 153, 174-175 general liability coverage 233, 283 general partnership 274-275 gifting 259-260 health insurance 18, 34-35, 37, 53-55, 62-63, 67, 69-72, 95-97, 101-102, 104105, 107-108, 136, 196, 206 hold harmless agreements 234-237 homeowners coverage 114, 143, 151-153, 281, 283 income loss 14 indemnity coverage 54, 56-57

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Index individual risk 7 infringement 225 in-home business policy 282-283 injury and sickness benefits 205 inland marine insurance 184 insurable interest 92-93, 148, 152 insured 14, 18, 70-72, 74, 84, 88-89, 91-94, 101, 105-106, 109, 112, 121-124, 135137, 139-140, 146-155, 157, 164-165, 168-170, 174-177, 179-181, 183, 186-187, 189, 191-194, 203-204, 211, 217-218, 225, 230, 281, 285-286, 289-291, 293 additional insureds 88, 94, 148 named insured 84, 88, 136, 149, 285, 293 intentional acts 135-136, 139-140 Internet auctions 240 investment swindles 1-4, 246-248 legal capacity 304 legal competence 304 legal expenses 223 liability coverage 134-135, 140, 142, 147, 159, 163, 171, 192-193, 222224, 231, 233, 282-283, 289, 291-294 life insurance 17-18, 69, 73-81, 83, 85-86, 88-94, 195, 257, 261, 264, 267-272 joint life policy 84, 94 term life 18, 74-77, 85 whole life 74-78, 81-85 lifetime benefit 198 limited liability company (LLC) 274, 280-281 limits of insurance 286 limits of liability 168, 224 loans 18, 78, 115-116, 125-126, 215, 253, 279, 295, 298-299, 301 long-term care (LTC) 53, 69-70, 107 long-term care insurance 107 loss mitigation 112, 126 loss of use 147, 162, 171, 290 managed care 34, 56, 58-61, 66-68 medical benefits 13, 207 medical expense insurance 69, 289, 291 medical payments 131, 147-148, 162, 171, 282, 289 medical savings account (MSA) 103-104 mortgage 18, 76, 111, 138, 141, 152-153, 215-216, 253-254, 299-301, 311 named perils 121-122, 143, 148, 152, 166, 175, 185 negligence 133-134, 220, 228-230, 238, 289, 291-293 nutrition 26-27, 37 occupational benefits 202

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Protect Yourself occupational disabilities 206 open corporation 274 pension plans 268 personal liability insurance 135, 149, 152 personal property 114, 120, 162, 165, 167-168, 171, 174-178, 184-185, 190-191, 193, 285-286, 288, 300, 307 point-of-service (POS) plans 59, 64-65, 67 pre-existing condition 62, 64, 103 preferred provider organizations (PPO) 56, 59, 64-67 pregnancy 33-34, 58, 62 prescription drugs 58, 61, 68, 71, 107, 137 professional liability coverage 291-292 promissory note 300, 302-304, 306 property coverage 109, 114, 137, 146, 149, 171, 191-193, 282-283, 285, 287 property damage liability 289 property loss 109, 122, 149, 174 relative risk 4, 17, 22 renters insurance 137, 157, 184 replacement cost 111, 135, 146, 148, 153-155, 158, 174, 190, 220 residence-related liability 221 retirement income 78, 105, 270 riders 86, 88-89, 94, 180, 198 scheduled coverage 185 social host liability 231-233 Social Security coverage 99, 195-199, 201, 208-214, 218 sole proprietorship 210, 274-276, 278 tax benefits 261, 264, 268 taxable estate 260-261, 265 temporary living expenses 119, 143 terrorism 124-126 theft coverage 129, 192 torts 134, 219, 220, 225, 237 total disability 87, 198, 202-204, 207-208, 212 trustee 97-98, 105, 214, 262, 264, 269, 309-313 trusts 104-105, 258, 260, 262-264, 266, 272 umbrella liability insurance 137, 222, 233 unscheduled property 175 vandalism 288

326

Index vandalism and malicious mischief (VMM) 123-124, 145, 167 vicarious liability 128, 132 violent crime 39-40, 43, 48 workers’ compensation 290-292

327

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