Special Elements of Some Workers' Compensation Insurance Programs and Basics of Excess and Umbrella Liability Insurance: Practice Questions and Solutions

This section of the study guide is intended to provide practice problems and solutions to accompany the pages of Commercial Insurance, cited below. Students are encouraged to read these pages before attempting the problems. This study guide is entirely an independent effort by Mr. Stolyarov and is not affiliated with any organization(s) to whose textbooks it refers, nor does it represent such organization(s).

Some of the questions here ask for short written answers based on the reading. This is meant to give the student practice in answering questions of the format that will appear on Exam 5. Students are encouraged to type their own answers first and then to compare these answers with the solutions given here. Please note that the solutions provided here are not necessarily the only possible ones.

Source:
Arthur L. Flitner, Jerome Trupin, and Martin J. Frappoli. Commercial Insurance. (Second Edition). 2007. Chapters 12 and 13, pp. 12.25-12.32, 13.3-13.6.

Original Problems and Solutions from The Actuary's Free Study Guide

Problem S5-134-1. Describe the functions of the two most significant workers' compensation endorsements in the United States.

Solution S5-134-1. This question is based on the discussion in Commercial Insurance, pp. 12.25-12.26. The functions of the two most prevalent workers' compensation endorsements in the United States are, respectively, as follows:

1. Covering employees that are not subject to the workers' compensation statutes of the state(s) in which the policy applies. Such an endorsement would provide benefits to such employees that would have been payable if the employees were subject to the workers' compensation statutes; such an endorsement also provides employers' liability coverage for common-law suits brought forth by these employees.

2. Covering employees that are entitled to benefits under the Longshore and Harbor Workers' Compensation Act. This endorsement amends the definition of a workers' compensation statute to include this act.

Problem S5-134-2.

(a) For the purposes of workers' compensation insurance, what is a governing classification?

(b) List four categories of employees to which standard exception classifications in workers' compensation insurance would typically apply.

Solution S5-134-2. This problem is based on the discussion in Commercial Insurance, pp. 12.27-12.28.

(a) A governing classification is a single classification that is assumed to best describe an insured employer's activities. This classification, in most cases, is assigned to all workers at a particular location, and employers are generally not permitted to allocate their payrolls among multiple different governing classifications (Commercial Insurance, p. 12.27).

(b) Special exception categories would typically apply to the following categories of employees (Commercial Insurance, pp. 12.27-12.28):

1. Clerical office and drafting employees who work in areas which are physically separated from other work;

2. Clerical office and drafting employees who telecommute;

3. Collectors, messengers, and salespeople;

4. Chauffeurs, drivers, and their helpers.

Problem S5-134-3.

(a) Some workers' compensation insurers offer premium discounts to insureds whose premium exceeds a certain minimum amount. What is the rationale for this practice?

(b) What is the difference between a flat-dividend plan and a sliding-scale dividend plan in workers' compensation insurance.

Solution S5-134-3. This problem is based on the discussion in Commercial Insurance, pp. 12.29-12.31.

(a) The rationale for premium discounts for large-premium policies is that the insurer's underwriting expenses and costs of collecting premium do not increase uniformly with premium volume; they tend to increase at a decreasing rate. The same often holds for commission expenses as well. Producers of workers' compensation insurance also often do not get paid as high a percentage in commission on the dollar amounts of written premium exceeding a certain threshold. This reduces the insurer's commission expenses per additional dollar of premium.

(b) A flat-dividend plan pays all insureds the same percentage of premium as a dividend, irrespective of the loss experience of each insured.

A sliding-scale dividend plan rewards with higher dividends those insureds that have more favorable (lower) loss experience. Also, insureds with loss ratios above a certain threshold may not receive dividends at all.

Problem S5-134-4. Identify and describe three characteristics of many commercial liability insurance policies that result in some business organizations needing to purchase excess liability insurance.

Solution S5-134-4. This question is based on the discussion in Commercial Insurance, pp. 13.3-13.4. The following are three characteristics of many commercial liability insurance policies that result in some business organizations needing to purchase excess liability insurance:

1. The highly uncertain and possibly extremely high maximum possible loss (MPL) associated with liability loss exposures: It is difficult to estimate how much a liability claim will settle for or how much will be awarded by a court in damages. Some liability verdicts have been exorbitant and have exceeded $100 million.

2. The layering of liability coverages: Liability insurance is typically arranged in layers, such that one insurer's obligation up to a certain limit must be exhausted before the insurer for the next layer is obligated to pay anything. In order to obtain liability coverage for higher loss amounts due to a particular occurrence, a commercial insured would typically not simply be able to purchase multiple primary policies, but rather would need to purchase a primary policy and one or more excess policies.

3. Aggregate limits for most liability insurance policies: An aggregate limit applies to all occurrences within a policy period, leaving open the possibility that even an insured who only experiences a succession of smaller liability claims might exhaust its limits of liability coverage under the primary policy.

Problem S5-134-5.

(a) What is a "following form" excess liability insurance policy?

(b) What are the two functions of drop-down coverage provided under umbrella liability insurance policies?

Solution S5-134-5.

(a) A "following form" excess liability insurance policy is a policy that incorporates into itself the terms of the underlying liability insurance policy. Whatever is covered or excluded under the primary policy is also covered or excluded, respectively, under the "following form" policy (Commercial Insurance, p. 13.5).

(b) The following are the two functions of drop-down coverage provided under umbrella liability insurance policies (Commercial Insurance, p. 13.6):

1. To cover claims that the underlying policy will not cover because of the depletion of the underlying policy's aggregate limits;

2. To cover claims that the underlying policy would not cover at all.

See other sections of The Actuary's Free Study Guide for Exam 5.