Property & Casualty Insurance on the CFP Exam — Key Concepts

Homeowners insurance policies are standardized forms designated HO-1 through HO-8. The most common are HO-2, HO-3, and HO-5. HO-2 (Broad Form) covers named perils, while HO-3 (Special Form) provides open perils coverage on the dwelling and named perils coverage on personal property. HO-5 (Comprehensive Form) offers open perils coverage for both the dwelling and personal property, offering the most extensive protection. HO-1 is a basic form, while HO-8 is designed for older homes where replacement cost exceeds market value.

It's crucial to understand the difference between named perils and open perils. Named perils policies specifically list the events they cover (e.g., fire, windstorm, theft). Open perils policies cover all events unless specifically excluded (e.g., flood, earthquake, war). Candidates should recognize which forms offer which type of coverage.

Homeowners policies have distinct coverage sections. Coverage A (Dwelling) protects the house itself and attached structures. Coverage B (Other Structures) covers detached structures like garages or sheds, typically at 10% of Coverage A. Coverage C (Personal Property) covers belongings, usually at 50% of Coverage A, and can be subject to sublimits for certain items like jewelry or firearms. Coverage D (Loss of Use) covers additional living expenses if the home is uninhabitable due to a covered loss, often at 30% of Coverage A.

Coverage E (Personal Liability) protects against claims if someone is injured on your property or you accidentally damage someone else's property. Coverage F (Medical Payments to Others) covers smaller medical expenses for guests injured on your property, regardless of fault. These sections are essential for understanding the overall protection offered by a homeowners policy.

Exam questions frequently test the limits of each coverage section. For instance, a question might describe a scenario where a homeowner's detached garage is destroyed, and ask whether Coverage B is sufficient to cover the loss, given the policy's Coverage A amount.

Replacement cost (RC) covers the cost to replace damaged property with new property of like kind and quality, without deduction for depreciation. Actual cash value (ACV) is RC less depreciation. ACV is calculated as: ACV = Replacement Cost - Depreciation. Choosing RC is generally preferable as it provides more complete coverage, but it comes at a higher premium.

The CFP exam often tests the difference between RC and ACV in claim scenarios. For example, if a roof has a replacement cost of $20,000 and has depreciated by $8,000, the ACV would be $12,000. Understanding which valuation method is used in a policy is critical.

Auto insurance includes several key coverages. Liability coverage (Bodily Injury and Property Damage) protects you if you are at fault in an accident and injure someone or damage their property. Collision coverage pays for damage to your vehicle resulting from an accident, regardless of fault. Comprehensive coverage (Other Than Collision) covers damage to your vehicle from events like theft, vandalism, fire, or natural disasters.

Uninsured/Underinsured Motorist coverage protects you if you are injured by a driver who has no insurance or insufficient insurance to cover your damages. Exam questions might present scenarios where a driver is injured by an uninsured motorist and ask about the available coverage.

A personal umbrella policy provides excess liability coverage above the limits of your homeowners and auto insurance policies. It offers broad protection against lawsuits and can cover legal fees, settlements, and judgments. Umbrella policies typically require underlying coverage limits (e.g., $250,000 on auto and homeowners policies) to be in place.

Umbrella policies are important for clients with significant assets to protect. The CFP exam might ask about the appropriateness of an umbrella policy for a client with a high net worth or a higher-than-average risk of being sued.

Business liability insurance protects a business from financial losses resulting from lawsuits or claims of negligence. Key types include General Liability (covering bodily injury and property damage), Professional Liability (Errors and Omissions, covering professional negligence), and Product Liability (covering injuries or damages caused by a company's products).

The CFP exam may present scenarios involving a business owner and ask about the appropriate types of business liability coverage needed based on the nature of the business and its potential risks. For example, a financial advisor would need Professional Liability insurance.

Coinsurance clauses in property insurance policies require the insured to carry a certain percentage of the property's value in coverage (typically 80%). If the insured fails to meet this requirement, a penalty is applied to any covered loss. The penalty is calculated using the following formula:

(Amount of Coverage Carried / Amount of Coverage Required) x Loss = Amount Paid

For example, assume a building has a replacement cost of $500,000 and the policy has an 80% coinsurance requirement. The required coverage is $400,000 (80% of $500,000). If the insured only carries $300,000 in coverage and suffers a $100,000 loss, the insurance company will pay: ($300,000 / $400,000) x $100,000 = $75,000. The insured would be responsible for the remaining $25,000, plus any deductible.

Be prepared to calculate the coinsurance penalty on the CFP exam. Pay close attention to the property's value, the coinsurance percentage, the amount of coverage carried, and the amount of the loss.

CFP exam questions on property and casualty insurance often involve scenarios that require you to apply your knowledge of coverage limits, valuation methods, and policy provisions. Read the questions carefully and identify the key facts and issues. Pay attention to the specific wording of the question and the answer choices. Eliminate any answer choices that are clearly incorrect.

When faced with a coinsurance question, write down the formula and plug in the numbers. Don't rush the calculation; double-check your work. Remember to consider the deductible when calculating the final payout.

Practice with sample questions to familiarize yourself with the types of scenarios and the format of the questions. Focus on understanding the underlying concepts rather than memorizing specific facts. A solid understanding of the principles of property and casualty insurance will help you answer exam questions with confidence.