6. Legal Principles in Insurance Contracts BUS 200 Introduction to Risk Management and Insurance Fall 2008 Jin Park

Overview Fundamental Principles of Insurance Contracts Fundamental Principles of Insurance Contracts Insurance as contracts Insurance as contracts Characteristics of Insurance Contracts Characteristics of Insurance Contracts

Fundamental Legal Principles of Insurance Contracts 1. Principle of indemnity 2. Principle of insurable interest 3. Principle of subrogation 4. Principle of utmost good faith

Principle of Indemnity Insurance pays no more than the actual amount of the loss suffered by insured. Insurance pays no more than the actual amount of the loss suffered by insured. To support the principal of indemnity an insurance contact uses To support the principal of indemnity an insurance contact uses Actual Cash Value (ACV) method Actual Cash Value (ACV) method Replacement cost (RC) less depreciation Replacement cost (RC) less depreciation Fair market value Fair market value Broad evidence rule Broad evidence rule Other Insurance Provisions Other Insurance Provisions Exceptions to the Principle of Indemnity Exceptions to the Principle of Indemnity Valued policy (or agreed value) Valued policy (or agreed value) Valued policy law Valued policy law Nebraska – Fire, Tornado, or Lightening, Nebraska – Fire, Tornado, or Lightening, Replacement cost Replacement cost

Principle of Insurable Interest The insured must be in a position to financially suffer if a loss occurs. The insured must be in a position to financially suffer if a loss occurs. Timing of an Insurable Interest Timing of an Insurable Interest Property-Casualty Insurance Property-Casualty Insurance Life Insurance Life Insurance Why? Why?

Principle of Subrogation Substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third party wrongdoer for a loss paid by the insurer. Substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third party wrongdoer for a loss paid by the insurer. The insurer is entitled only to the amount it has paid under the policy. The insurer is entitled only to the amount it has paid under the policy. No subrogate against its own insured. No subrogate against its own insured. Exception: Exception: Life insurance and Individual health insurance. Life insurance and Individual health insurance. Why? Why?

Principle of Utmost Good Faith A higher degree of honesty is imposed on an insurance contract, especially on the insurance applicants. A higher degree of honesty is imposed on an insurance contract, especially on the insurance applicants. It is supported by three legal doctrines It is supported by three legal doctrines Representation Representation Statements made by an applicant Statements made by an applicant cf: Innocent misrepresentation cf: Innocent misrepresentation Concealment Concealment Intentional failure to disclose a material fact Intentional failure to disclose a material fact Warranty Warranty A statement of fact or a promise made by the insured, which is part of the insurance contract and must be true if the insurer is to be liable under the contract. A statement of fact or a promise made by the insured, which is part of the insurance contract and must be true if the insurer is to be liable under the contract. Why? Why?

Insurance as Contracts Elements of contract Elements of contract Agreement Agreement Offer and Acceptance Offer and Acceptance Consideration Consideration By insured By insured By insurer By insurer Legally competent parties Legally competent parties Legal Purpose Legal Purpose Legal Form Legal Form Some insurance policy provisions and attachments must be approved by regulator before being marketed Some insurance policy provisions and attachments must be approved by regulator before being marketed

Insurance as Contracts Property - Casualty Offer Offer Submission of application with a down payment Submission of application with a down payment Acceptance Acceptance Binder Binder Life Offer Submission of application with a down payment Issuance of a life insurance policy Acceptance Conditional premium receipt Note: Giving a quotation to a prospective insured is deemed as mere solicitation or invitation to make an offer.

Characteristics of Insurance Contracts 1. Personal Contracts 2. Aleatory Contracts 3. Contracts of adhesion 4. Conditional contracts 5. Unilateral contracts

Characteristics of Insurance Contracts 1. Personal Contracts Insurance provides protection for an insured Insurance provides protection for an insured Assignment provision Assignment provision In P/C insurance, cannot be transferred In P/C insurance, cannot be transferred In life insurance, freely reassigned. In life insurance, freely reassigned. 2. Aleatory Contracts A contract whose value to either or both of the parties depends on chance or future events, or where the monetary values of the parties' performance are unequal. A contract whose value to either or both of the parties depends on chance or future events, or where the monetary values of the parties' performance are unequal. The insurer's obligation depends on uncertain events The insurer's obligation depends on uncertain events Premium paid by Insured < Claim paid by Insurer Premium paid by Insured < Claim paid by Insurer

Characteristics of Insurance Contracts 3. Contracts of adhesion Insurance contracts are drafted by an insurer and an insured must accept or reject all the terms and conditions. Insurance contracts are drafted by an insurer and an insured must accept or reject all the terms and conditions. 4. Conditional contracts An insurer’s obligation to pay a claim depends on whether the insured or the beneficiary has complied with all policy conditions. An insurer’s obligation to pay a claim depends on whether the insured or the beneficiary has complied with all policy conditions. 5. Unilateral contracts Only one party makes a legally enforceable promise. Only one party makes a legally enforceable promise. Insureds are not legally forced to pay premium or renew the policy. Insureds are not legally forced to pay premium or renew the policy.