Principles of risk management and insurance 12th by rejde mcnamara chapter 09

 

Chapter 9
Fundamental
Legal Principles


Agenda
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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
• 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

• 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:

–
–
–
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Ownership of property
Potential legal liability
Serving as a secured creditor
Contractual rights

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Principle of Insurable Interest
• 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
• 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
• 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
– 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
• A concealment is intentional failure of the
applicant for insurance to reveal a material
fact to the insurer
• 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

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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
– 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 contracts 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
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Distinct Legal Characteristics of

Insurance Contracts
• 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, and that to be
effective, exclusions or qualifications must
be conspicuous, plain, and clear.

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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
• 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
• Waiver is defined as the voluntary
relinquishment of a known legal right
• Estoppel occurs when a representation of
fact made by one person to another person
is reasonably relied on by that person to

such an extent that it would be inequitable
to allow the first person to deny the truth of
the representation

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