FUNDAMENTAL LEGAL PRINCIPLES

Fundamental Legal Principles

Principle of Indemnity Principle of Insurable Interest Principle of Subrogation Principle of Utmost Good Faith

Principle of Indemnity

Requirement that the insured should not profit if a loss occurs

People are indemnified when they are restored to approximately the same financial position they were in before the loss occurred.

Actual cash value, which is defined as replacement cost less depreciation, supports the principle of indemnity since it is designed to prevent profiting from insurance.

Actual cash value rule -Replacement cost less depreciation -Fair market value -Broad evidence rule

Exceptions to the principle of indemnity - Valued policy - Valued policy laws - Replacement cost insurance - Life insurance

Valued policy

A valued policy pays the face amount in the event of a total loss. Thus, it is an exception to the principle of indemnity since the amount paid could be more than what the property is actually worth.

Valued policy laws

A valued policy law requires payment of the face amount of insurance if a total loss to real property occurs from a peril specified in the law. Because the insured may be paid more than the actual cash value of the loss, the principle of indemnity would be violated.

Replacement cost insurance

Replacement cost insurance means there is no deduction for depreciation, which allows the insured to be made better off by receiving new property for old.

Life insurance

A life insurance policy is also an exception to the principle of indemnity because it is a valued policy that pays a stated sum to the beneficiary upon the insured’s death.

It is difficult to determine accurately the value of a human life, and the amount paid may substantially exceed the economic value of the insured’s life. The human life value approach gives a crude estimate of how much a person's life is worth, but few people insure their lives fully, and all losses are total.

Principle of Insurable Interest

The principle of insurable interest means that the insured must stand to lose financially if a loss occurs.

An insurable interest is required in every insurance contract in order to prevent gambling, to reduce moral hazard, and to measure the amount of the insured’s loss in property insurance.

Purposes of an insurable interest To prevent gambling To reduce moral hazard To measure the amount of the insured’s loss in property insurance

Examples of an insurable interest

- full value of a business - unpaid balance of a loan

Time that an insurable interest must be met

Principle of Subrogation

Subrogation applies when the insurer makes a loss payment to the insured because of a loss caused by the negligence of a third party.

Insurer is entitled to recover from a negligent third party any loss payments made to the insured

It is used to support the principle of indemnity by preventing an Subrogation is taking over another person's right to recover in a legal action against a negligent third party. It is used to support the principle of indemnity by preventing an insured from collecting twice, once from the insured and a second time from the negligent party.

Purposes of subrogation To avoid collecting twice To hold the negligent person responsible To hold down rates

Principle of Utmost Good Faith

Higher degree of honesty is imposed on both parties to an insurance contract

The principal of utmost good faith pertains to the disclosure of information in negotiations leading up to the forming of an insurance contract. In ordinary good faith contracts, there is no strong pressure to disclose information that would influence the other party's willingness to contract; in an utmost good faith contract, there is.

The doctrines of representations, concealment, and warranties support the principle of utmost good faith by allowing the contract to be broken at the option of the injured party (the insurer). The insurer has a legal basis for denying payment of a loss if there is a material misrepresentation, concealment, or breach of warranty.

Representations are statements made by the applicant for insurance. An example would be answers to health questions when the applicant for insurance wants to purchase life insurance or health insurance. The insurer could deny payment of claim if the representation is both material and false.

A warranty is a clause in an insurance contract that prescribes, as a condition of the insurer's liability, the existence of a fact affecting the risk. For example, a bank may warrant that a guard will be on the premises 24 hours a day.

In the past, under common law, any breach of the warranty, even if slight, permitted the insurer to deny liability for the claim. This harsh doctrine, however, has been substantially modified by court decisions and legislation. Warranties are presumed to be material.

Areas of application-legal doctrines of misrepresentation, concealment, and breach of warranty

Basic Requirements of an Insurance Contract

Four requirements must be met for a valid insurance contract: -There must be an offer and acceptance. -There must be consideration to support the contract. -There must be competent parties. -To be enforced, the contract must be for a lawful purpose.

Offer and Acceptance

The applicant usually makes the offer

The insurer accepts or rejects the offer

Agent's authority to bind the insurer varies by type of insurance - Property and liability insurance - Life insurance

Consideration

Insured's consideration generally is payment of the first premium

Insurer's consideration is the promise to perform the contract

Competent Parties

Each party must be legally competent and have legal capacity to enter into a binding contract.

The applicant for auto liability insurance must not be a minor, insane, or intoxicated when he or she applies for insurance. Also, the liability insurer must have legal authorization to sell auto liability insurance.

The general rule is that minors are not legally competent to enter into a binding insurance contract. However, most states have enacted laws that permit minors to enter into a valid life insurance contract.

Drunkenness is treated like temporary insanity. An intoxicated person usually is not legally competent to enter into a valid insurance contract because he or she may be unaware of the legal implications of the contract. Drunkenness is treated like temporary insanity.

An adult of legal age can enter into a valid contract of insurance even though he or she has been convicted of drunk driving and cancelled by the insurer. However, if the applicant for auto insurance conceals this information from the insurer, the insurer could deny liability for a claim on the basis of a material concealment.

Legal Purpose

Special Characteristics of an Insurance Contract

Insurance Is an Aleatory Contract

The insurance contract is aleatory. The values exchanged are not equal. If a loss occurs, the insured may recover an amount in excess of the premiums paid. In a commutative contract, theoretically, there is an equal exchange of values.

Insurance Is a Unilateral Contract

The insurance contract is unilateral since only the insurer makes a legally binding promise. Most ordinary contracts are bilateral, and either party may be sued for breach of contract.

Insurance Is a Conditional Contract

The contract is conditional. In order to collect, a number of conditions must be complied with, such as giving prompt notice of loss and submitting proof of loss.

Conditions are provisions that qualify or place limitations on the insurer's promise to perform.

Certain duties are imposed on the insured if he or she wishes to collect for a loss.

The insurer does not have to pay the claim if the policy conditions are violated. For example, in property insurance, the insured must give immediate written notice of a loss in order to collect.

Insurance Is a Personal Contract

Consent of the insurer is required to assign a property or liability insurance policy to another person.

Since loss payments are money, they can be freely assigned without the insurer's consent.

A property insurance contract is personal. Personal characteristics of the insured influence the insurer's willingness to issue a policy.

Accordingly, these contracts can be validly assigned only with the consent of the insurer. A life insurance policy is not a personal contract and can be freely assigned.

Contract of Adhesion

Insurance is a contract of adhesion in that it is not bargained. Rather, the policy is offered on a "take-it-or-leave-it" basis, and any ambiguity is construed against the insurer.

Policy is offered on a "take-it-or-leave-it" basis with no bargaining over its terms.

The result is that any ambiguity is strictly construed against the insurer.

Law and the Insurance Agent

General Rules of Agency

There is no presumption of an agency relationship. There must be evidence sufficient to establish that a person has authorized someone to act on his or her behalf.

The agent must have authority to bind the principal. There are three sources of such authority: - expressed powers - implied powers - apparent authority.

Principal is responsible for an agent's torts and is charged with agent's knowledge of notice. The principal is responsible for acts of an agent who is acting within the scope of his or her authority. Accordingly, the principal can be bound by contracts that the agent has entered into and is also liable for the agent's torts.

Doctrines of Waiver and Estoppel

Waiver is defined as the voluntary relinquishment of a known legal right. The insurer voluntary waives a legal right under the contract, and in so doing cannot later deny payment of a claim by the insured.

voluntary relinquishment of a known legal right Waiver voluntary relinquishment of a known legal right

Estoppel representation of fact made by one person to another person that 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

Based on the legal doctrine of estoppel, an insurer legally may be required to pay a claim that it ordinarily would not have to pay.

Practical significance of these legal doctrines-insurer legally may be required to pay a claim that it ordinarily would not have to pay.