Legal Foundations of Insurance

1
Legal Foundations of Insurance

• Lecture 6

2
Three Principles

• Principle of Indemnity
• Principle of Subrogation
• Principle of Insurability

3
Principle of Indemnity

• The insurer agrees to pay no more than the actual
  amount of the loss.
• The insured should not profit from the loss.
• Reduces moral hazard. (same)
• Actual value of loss actual cash value

4
Determination of Actual Cash Value

• Replacement cost less depreciation
• Example Suppose an asset having a cost of
  600,000 is 40 depreciated and can be replaced
  for 1,000,000
• Replacement value 1,000,000
• Depreciation (40) (400,000)
• Replacement less deprec. 600,000

5
Determination of Actual Cash Value

• Fair Market Value
• Price at which a willing buyer would pay to a
  willing seller
• Could easily be below replacement cost less
  depreciation
• Broad Evidence rule should use all evidence and
  appraisal methods available

6
Exceptions to Indemnity Principle

• Valued policy a policy that pays the face
  amount when a loss occurs
• Usually used to insure antiques
• Value of property is agreed upon at time of
  insurance contract, not time of loss
• Valued policy laws state laws which generally
  apply only to real property and total losses

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Exceptions to Indemnity Principle

• Valued policy, cont.
• Can lead to overinsurance (amount paid or insured
  exceeds cash value)
• Exacerbates moral hazard problem, either actual
  fraud or lack of care
• Replacement Cost no deduction for depreciation
  (see prev. ex.)

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Exceptions to Indemnity Principle

• Life Insurance
• Not a contract of indemnity
• A Valued Policy that pays a stated sum upon death
• Actual cash value meaningless or difficult for
  valuing a human life

9
Principle of Insurable Interest

• The insured must be in a position to lose
  financially or suffer harm if a loss occurs
• Your car v. someone elses car
• Purposes
• Prevent gambling
• Reduce moral hazard
• A measure of indemnity is insurable interest

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Examples of Insurable Interest

• Property and Liability insurance
• Ownership of property
• Potential legal liability (parking garage)
• Secured creditors (collateral)
• Contractual right (ex firm purchasing inventory
  for resale would lose profits if merchandise did
  not arrive)

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Examples of Insurable Interest

• Life Insurance
• Not an issue for the insured
• Beneficiary not required to have insurable
  interest
• Another person
• Close ties of love or affection
• Blood
• Marriage
• Pecuniary interest
• Corporation can insure CEO

12
Insurable Interest

• Property insurance insurable interest must
  exist at time of loss
• Would violate principle of indemnity if no
  insurable interest at time of loss, no financial
  loss
• Ex M sells house to S and house burns before
  insurance cancelled
• M no longer has insurable interest
• S not named as insured

13
Insurable Interest

• Life Insurance insurable interest must exist at
  inception of the policy
• Insurable interest not necessary at time of death
• Life insurance is a valued policy, not a contract
  of indemnity
• Must be current with premiums

14
Principle of Subrogation

• Substitution of the insurer for the insured for
  purposes of claiming indemnity from a third
  person
• Allows insurance company go after a negligent
  third party
• Insurance company will pay claim and then try to
  collect from third party

15
Principle of Subrogation

• Prevents insured from collecting twice for a
  loss, and hence from violating the indemnity
  principle
• Used to hold the guilty party responsible
• As a result, insurance rates should be lower

16
Principle of Subrogation

• Insurer is entitled only to the amount it has
  paid under the policy
• Sharing of subrogation recovery
• Insured first reimbursed in full for loss
• Insurer entitled to remaining amount
• Ex 100,000 home insured for 80,000 destroyed by
  fire due to negligence of electrician (assume
  insurer nets 50,000 from electrician)

17
Principle of Subrogation

• Insured cannot do anything to impair the
  insurers subrogation rights
• Ex Insured waives right to sue
• Insurer can waive right
• Does not apply to life insurance and most health
  insurance contracts

18
Principle of Utmost Good Faith

• A higher degree of honesty is imposed on both
  parties to an insurance contract than is imposed
  to other contracts
• Supported by three legal doctrines
• Representations
• Concealment
• Warranty

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Representations

• Statements made by the applicant for insurance
• Insurance contract is voidable if representation
  is
• Material would have affected issuance or terms
  of policy
• False
• Relied upon by insurer

20
Representations

• Opinions or beliefs by insured
• Insurer must prove applicant spoke fraudulently
  and intended to deceive
• Innocent (unintentional) misrepresentation of a
  material fact
• Makes contract voidable if relied upon by insurer

21
Concealment

• The intentional failure of the insured to reveal
  a material fact to the insurer
• Effectively same as misrepresentation
• Insurer must prove the concealed fact was known
  to be material by the insured, and the insured
  intended to defraud the insurer
• Ex Life insurance applicant who concealed true
  name and had criminal background

22
Warranty

• Statement of fact or promise made by the insured
  which must be true for insurer to be liable
• Basically an addition to the contract
• Breach of warranty usually must be significant to
  justify denying the claim

23
Requirements of Insurance Contract

• Offer and Acceptance
• Consideration
• Competence of parties
• Legal purpose

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Offer and Acceptance

• Applicant makes offer
• Company accepts or rejects
• Property or liability offer and acceptance may
  be oral or written
• Applicant fills out application and pays or
  promises to pay first premium
• Agent accepts on behalf of insurance co. with a
  binder

25
Offer and Acceptance

• Binder obligates company immediately prior to
  receipt of application
• Ex homeowners, cars
• If agent not authorized to bind company, must
  wait for company to receive
• Life insurance agent does not have power to
  bind the company
• Always in writing must be approved by insurer

26
Life Insurance

• Applicant fills out policy and pays first premium
• Conditional premium receipt is given to the
  applicant
• If applicant is found insurable according to the
  insurers normal u/w standards, a policy is
  issued effective as of date of application

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Life Insurance

• If applicant does not pay first premium at time
  of application
• Policy must be issued and delivered
• First premium must be paid
• Insured must be in good health when policy
  delivered
• The above are conditions precedent

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Other Requirements

• Consideration
• Insured first premium, plus abide by conditions
  of contract
• Insurer promise to perform according to the
  contract
• Competent both parties must be legally
  competent (not insane, drunk or outside of
  corporate authority)

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Other Requirements

• Legal purpose
• Must be a valid business purpose
• Not illegal or immoral
• Ex Drug dealer purchasing property insurance on
  delivery van

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Distinct Legal Features of Insurance Contracts

• Aleatory contract
• Unilateral contract
• Conditional contract
• Personal contract
• Contract of adhesion

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Distinct Legal Features of Insurance Contracts

• Aleatory contract Values exchanged may not be
  equal but depend on an uncertain event (chance)
• Commutative values exchanged are theoretically
  even
• Unilateral contract only one party is making a
  legally enforceable promise
• The insurance company
• Insured cannot be forced to continue premiums
• Conditional insured must comply w/ conditions
  (ex immediate notice of loss)

32
Distinct Legal Features of Insurance Contracts

• Personal contract is between the insured and
  the insurer
• Technically the insurance company does not insure
  property, but rather insures the owner of the
  property against loss
• Insurer must consent to transfer of property
  insurance (risk altered) payment for loss may be
  assigned
• Life insurance may be assigned w/o consent

33
Distinct Legal Features of Insurance Contracts

• Contract of adhesion insured must accept entire
  contract with all its terms and conditions
• Ambiguities are resolved in favor of the insured
• Principle of reasonable expectation insured
  entitled to coverage reasonably expected
  exclusions, qualifications, etc. must be
  conspicuous and clear

34
Agency Issues

• Principal insurance company
• Agent insurance agent selling the policy
• No presumption of agency relationship must have
  something from company
• Must have authority to represent principal
• Express
• Implied
• Apparent (principal has not

35
Agency Issues

• Principal is responsible for the acts of its
  agents
• Knowledge of agent is presumed to be knowledge of
  principal
• Ex Agent knows insured is alcoholic if agent
  omits from application and policy issued,
  principal cannot claim concealment