HW_5

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Chapter 9

Fundamental Legal Principles

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Agenda

Principle of Indemnity
Principle of Insurable Interest
Principle of Subrogation
Principle of Utmost Good Faith
Requirements of an Insurance Contract
Distinct Legal Characteristics of Insurance Contracts
Law and the Insurance Agent

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Principle of Indemnity

The insurer agrees to pay no more than the actual amount of the loss

Purpose:
To prevent the insured from profiting from a loss
To reduce moral hazard

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Principle of Indemnity (Continued)

In property insurance, indemnification is based on the actual cash value (ACV) of the property at the time of loss
There are three main methods to determine actual cash value:
Replacement cost less depreciation
Fair market value is the price a willing buyer would pay a willing seller in a free market
Broad evidence rule means that the determination of ACV should include all relevant factors an expert would use to determine the value of the property

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Principle of Indemnity (Continued)

There are some exceptions to the principle of indemnity:
A valued policy pays the face amount of insurance if a total loss occurs
Some states have a valued policy law that requires payment of the face amount of insurance to the insured if a total loss to real property occurs from a peril specified in the law
Replacement cost insurance means there is no deduction for depreciation in determining the amount paid for a loss
A life insurance contract is a valued policy that pays a stated sum to the beneficiary upon the insured’s death

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Principle of Insurable Interest

The insured must be in a position to lose financially if a covered loss occurs

Purposes:
To prevent gambling
To reduce moral hazard
To measure the amount of the insured’s loss
An insurable interest can be supported by:
Ownership of property
Potential legal liability
Serving as a secured creditor
Contractual rights

Transparency Master 1.2

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Principle of Insurable Interest (Continued)

When must insurable interest exist?
Property insurance: at the time of the loss
Life insurance: only at inception of the policy
The question of insurable interest does not arise when you purchase life insurance on your own life
Insurable interest in another person’s life can be shown by close family ties, marriage, or a pecuniary (financial) interest

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Principle of Subrogation

Substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third party for a loss covered by insurance.

Purpose:
To prevent the insured from collecting twice for the same loss
To hold the negligent person responsible for the loss
To hold down insurance rates

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Principle of Subrogation (Continued)

The insurer is entitled only to the amount it has paid under the policy
The insured cannot impair the insurer’s subrogation rights
Subrogation does not apply to life insurance contracts
The insurer cannot subrogate against its own insureds

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Principle of Utmost Good Faith

A higher degree of honesty is imposed on both parties to an insurance contract than is imposed on parties to other contracts

Supported by three legal doctrines:
Representations
Concealment
Warranty

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Principle of Utmost Good Faith (Continued)

Representations are statements made by the applicant for insurance
A contract is voidable if the representation is material, false, and relied on by the insurer
Material means that if the insurer knew the true facts, the policy would not have been issued, or would have been issued on different terms
Reliance means that the insurer relies on the misrepresentation in issuing the policy at a specified premium
An innocent misrepresentation of a material fact, if relied on by the insurer, makes the contract voidable

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Principle of Utmost Good Faith (Continued)

A concealment is intentional failure of the applicant for insurance to reveal a material fact to the insurer
To deny a claim based on concealment, a nonmarine insurer must prove:
The concealed fact was known by the insured to be material
The insured intended to defraud the insurer

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Principle of Utmost Good Faith (Continued)

A warranty is a statement that becomes part of the insurance contract and is guaranteed by the maker to be true in all respects
Statements made by applicants are considered representations, not warranties
Most courts interpret a breach of warranty liberally
State statutes allow the insured to recover for a loss unless the breach of warranty actually contributed to the loss

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Requirements of an Insurance Contract

To be legally enforceable, an insurance contract must meet four requirements:
Offer and acceptance of the terms of the contract
Exchange of Consideration – the value that each party gives to the other
Competent parties, with legal capacity to enter into a binding contract
The contract must exist for a legal purpose

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Distinct Legal Characteristics of Insurance Contracts

An insurance contract is:
Aleatory: values exchanged are not equal
Unilateral: only the insurer makes a legally enforceable promise
Conditional: policyowner must comply with all policy provisions to collect for a covered loss
Personal: property insurance policy cannot be validly assigned to another party without the insurer's consent
A contract of adhesion: the insured must accept the entire contract with all of its terms and conditions

Transparency Master 1.2

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Distinct Legal Characteristics of Insurance Contracts (Continued)

Courts have ruled that any ambiguities or uncertainties in the contract are construed against the insurer.
The principle of reasonable expectations states that an insured is entitled to coverage under a policy that he or she reasonably expects it to provide, regardless of policy provisions.

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Law and the Insurance Agent

An agent is someone who has the authority to act on behalf of a principal (the insurer)
Several laws govern the actions of agents and their relationship to insureds
There is no presumption of an agency relationship
An agent must be authorized to represent the principal
A principal is responsible for the acts of agents acting within the scope of their authority
Limitations can be placed on the powers of agents

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Law and the Insurance Agent (Continued)

An agent’s authority comes from three sources:
Express authority
Implied authority
Apparent authority
Knowledge of the agent is presumed to be knowledge of the principal with respect to matters within the scope of the agency relationship
Insurers can place limitations on the power of agents by adding a nonwaiver clause to the application or policy

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Law and the Insurance Agent (Continued)

The doctrines of waiver and estoppel may require an insurer to pay a claim that it ordinarily would not have to pay
Waiver is defined as the voluntary relinquishment of a known legal right
Estoppel is the loss of a legal defense because of previous actions that are now inconsistent with that defense