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FIN 502 (69)
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Chapter 11

CFIN502- Chapter 11- Property, Home, and Automobile Insurance.docx

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FIN 502
Joan Lobo

CFIN502- Chapter 11- Property, Home, and Automobile Insurance PROPERTY INSURANCE  Most important risk—damage or destruction o Home—risk of damage by fire, lightning, explosions, windstorm, riots, vandalism o Car—damage due to theft, collision, injury yourself, passenger, third party  Property insurance- insures your physical properties—home, clothing, furniture, appliance, jewelry against damage or destruction  Basic principle in every type of insurance—one that buys insurance to ensure for large and catastrophic expenses but not for small ones o One transfers most of the risk to an insurance company in return for paying premium HOME INSURANCE  Protects family against risk of loss, damage, or destruction of the home, it related outbuilding, and its contents  Also covers liability to third parties for injury suffered on property  Two important questions o What are the risks covered? o How much home insurance do I need?  Covered by home insurance fire, lightning, falling objects, riots, windstorm, hail, explosion, vandalism, theft and break in, glass breakage, window breakage, freezing, water, flood, weight of ice, snow, sleet, collapse of building, smoke, aircraft or other vehicles, faulty electrical wiring  More risk covered the higher the premium  How much home insurance do you need? o Two ways to estimate amount coverage required  Estimate value of the contents as some per cent of the value of the structure  Estimate the insurance coverage for the contents is to list and value every item o How to you value the home contents  Depreciated value- value replacement or repair for the item to the condition it was in when lost or damaged  Standard insurance policy pays the depreciated value  Subtracting from the price of a new item an allowance for depreciation based on age of item insured  Replacement value- cost of buying a new item of the same quality  Depreciated value is less than the replacement value  Replacement cost policy- lost or destroyed items must be replaced with new ones or comparable value  Insured chooses not to replace claim settled at the depreciated value only  Replacement value of a home o Replacement of home for insurance purposes is not its current market value o Fair market value of the home should not be used—includes the value of land and foundation  Land and foundation cannot be destroyed by typical disasters o Home structure- everything except land and foundation o Cost approach of valuation- determines replacement cost of homes structure o Difficult and complicated to estimate replacement value of homes structure  More practical to pay for appraisal of home—professional estimate of depreciated value and replacement value of home structures o Some insurance companies automatically set amount of home insurance equal to amount of mortgage on home o 80% rule- insurance companies do not cover full loss on partial damage unless insured has bought insurance to cover at least 80% of home replacement value  If insured buys insurance coverage for less than that—insurance company will only make payments proportional to the percentage of required minimum coverage taken  Not standardized some insurance policies refers to the structures value without the foundation; others refer to structure and foundation  Inflation protection provision o If insurance policy does not take inflation into account—real value of your coverage will decline over time 1 CFIN502- Chapter 11- Property, Home, and Automobile Insurance o Inflation protection provision- automatically increases the coverage amount each year in accordance with the increase in some inflation index o Most insurance companies—additional premiums provide additional coverage in excess of that provided by the inflation protection provision  Deductibles- part of a claim that you must pay first before the insurance company will pay anything o Higher the amount of deductible—lower the premium that you have to pay o Three reasons why premiums will be lower if deductibles are higher  Since you share part of damages or loss—insurance does not have to pay as much as the claims  Insured will try harder to avoid damages, losses, and accidents against which he is insuring valuable property if there is a significant large deductible  There is a fixed cost of administration for settling any claim—largely independent of the size of the claim o Insurance company avoid small claims—charge high premiums with low deductibles to encourage customers to deal with their own smaller losses  “Higher deductible, lower premium” VS “lower deductible, higher premium” o Nobody knows their utility function—impossible to determine the right amount of deductibles o By buying a policy with a large deductible—you are spending your insurance money to cover large losses  Reducing premium cost per dollar of insurance and can therefore afford a higher total coverage o Rule of thumb  Many financial experts recommend a deductible equal to 3% of your net worth  Incentive of high deductible policy—one would try much harder to avoid or reduce
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