Insurance contracts

1
Insurance contracts

• BUS 200
• Introduction to Risk Management and Insurance
• Jin Park

2
Overview

• Distribution of Insurance Contracts
• Insurance as contracts
• legally enforceable agreements
• Characteristics of Insurance Contracts
• Fundamental Principles of Insurance Contracts
• Principle of indemnity
• Principle of insurable interest
• Principle of utmost good faith
• Principle of subrogation

3
Distribution of Insurance Contracts

• Direct Marketing
• No agent is involved
• Mail marketing, internet based marketing
• Exclusive Agent
• Agent represents one insurer
• Independent Agent
• Agent represents more than one insurer

4
Distribution of Insurance Contracts

• Agent versus Broker
• Binding Authority by Agent
• Property/Liability Insurance
• Binder
• Life/Health Insurance
• Conditional premium receipt

5
Waiver and Estoppel

• Waiver
• The intentional relinquishment of a known right.
• Estoppel
• It prevents one from alleging or denying a fact,
  the contrary of which he has previously admitted.

6
Insurance as Contracts

• Valid contracts
• Legally enforceable
• Void contracts
• A void contract never had any legal existence.
• Either party may choose to ignore the agreement.
• Voidable contracts
• Legally exists
• The contracts can be legally rejected or avoided
  at the option of one or both parties.
• cf Denying coverage based on breach of policy
• condition

7
Insurance as Contracts

• Elements of contract
• Agreement
• Offer and Acceptance
• Consideration
• Insured premium payment and fulfillment of
  policy conditions
• Insurer promise to do certain things as
  specified in the contract
• Legally competent parties
• Parties must have legal capacity to enter into a
  binding contract
• Legal Purpose
• Contract must be for a legal purpose
• Legal Form
• Contract may be oral or written
• Some insurance policy provisions and attachments
  must be approved by state before being marketed

8
Insurance as Contracts

• Property - Casualty
• Offer
• Submission of application with a down payment
• Acceptance
• 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.
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Characteristics of Insurance Contracts

• 1. Personal Contracts
• Insurance protects insured, not the property or
  liability subject to loss.
• Assignment provision
• If ownership of a property changes, insurance
  contracts (or policies) normally cannot be
  transferred to another party (buyer) without the
  insurers written consent.
• In life insurance, the beneficiary or ownership
  of policy may be freely reassigned.
• Transfer of your rights and duties under this
  policy.

10
Characteristics of Insurance Contracts

• 2. Aleatory Contracts
• The values exchanged may not be equal, but depend
  on an uncertain event
• The premium, paid to an insurer by an insured for
  a policy, is not expected to exactly equal the
  amounts to be paid by the insurer in fulfilling
  its contractual obligations to the insured.
• cf commutative contract the values exchanged
  are theoretically equal.

11
Characteristics of Insurance Contracts

• 3. Contracts of adhesion
• Contracts are drafted by an insurer and an
  insured must accept or reject all the terms and
  conditions.
• Insured gets the benefit of the doubt.
• Courts tend to construe an ambiguous term in an
  insurance policy in favor of an insured.
• Contracts may be altered by the addition of
  riders or endorsements
• Rider or endorsement a document that amends or
  changes the original policy.
• cf Contracts of cohesion both parties draft
  the contracts.

12
Characteristics of Insurance Contracts

• 4. Conditional contracts
• An insurers obligation to pay a claim depends on
  whether the insured or the beneficiary has
  complied with all policy conditions.
• The insurer may not pay a claim if the policy
  conditions are not met.
• Duties after loss Homeowners (p. 562)
• Duties after an accident or loss Automobile (p.
  585)
• Duties after in the event of loss or damage CP

13
Characteristics of Insurance Contracts

• 5. Unilateral contracts
• Only one party makes a legally enforceable
  promise.
• Insured are not legally forced to pay premium or
  renew the policy.

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Fundamental Principles of Insurance Contracts

• 1. Principle of Indemnity
• The insurer agrees to pay no more than the actual
  amount of the loss suffered by the insured.
• Why?
• The purpose of the insurance contract is to
  restore the insured to the same economic position
  as before the loss.
• The insured should not profit from a loss.
• It reduces the moral hazard by eliminating the
  profit incentive.

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Fundamental Principles of Insurance Contracts

• 1. Principle of Indemnity
• To support the principal of indemnity insurance
  contact uses Actual Cash Value (ACV)
• Replacement cost (RC) less depreciation
• Takes into consideration both inflation and
  depreciation.
• RC current cost of restoring the damaged
  property with new materials of like kind and
  quality.
• Fair market value
• The price of a wiling buyer would pay a willing
  seller in a free market.
• Broad evidence rule
• The determination of ACV should include all
  relevant factors an expert would use to determine
  the value of the property.

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Fundamental Principles of Insurance Contracts

• 1. Principle of Indemnity
• To support the principal of indemnity insurance
  contact includes Other Insurance Provisions.
• Escape clause
• The policy (or insurance) would not apply if the
  insured was covered by another policy.
• Excess
• It (or This insurance) is excess insurance over
  any other valid and collectible insurance.
• Pro-rata provision
• Proration by face amounts
• Proration by amounts otherwise payable
• Contribution by equal shares

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Fundamental Principles of Insurance Contracts

• 1. Principle of Indemnity
• Primary-Excess
• Accident while test driving a dealers car.
• Health insurance between a couple working for
  different employers.
• Own insurance primary
• Spouse insurance excess
• Birthday rule for dependents coverage

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Fundamental Principles of Insurance Contracts

• 1. Principle of Indemnity
• Proration by Face Amounts
• It limits the insurers maximum obligation to the
  proportion of the loss that the insurers policy
  limit bears to the sum of all applicable policy
  limits.
• If Loss amount is 150,000

Insurer A Insurer B Insurer C
Policy Limit 100,000 200,000 300,000
Share 1/6 2/6 3/6
Payment 25,000 50,000 75,000
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Fundamental Principles of Insurance Contracts

• 1. Principle of Indemnity
• Proration by Amounts Otherwise Payable
• What would be payable under each policy in the
  absence of other insurance
• If Loss amount is 150,000

Insurer A Insurer B Insurer C
Policy Limit 100,000 200,000 300,000
Payable 100,000 150,000 150,000
Share 1/4 1.5/4 1.5/4
Payment 45,000 67,500 67,500
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Fundamental Principles of Insurance Contracts

• 1. Principle of Indemnity
• Proration by Amounts Otherwise Payable
• If Loss amount is 60,000

Insurer A Insurer B Insurer C
Policy Limit 100,000 200,000 300,000
Payable 60,000 60,000 60,000
Share 1/3 1/3 1/3
Payment 20,000 20,000 20,000
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Fundamental Principles of Insurance Contracts

• 1. Principle of Indemnity
• Contribution by Equal Shares
• Each insurer contributes equal amounts until it
  has paid its applicable limit of insurance or
  none of the loss remains, whichever comes first.
• If Loss amount is 150,000

Insurer A Insurer B Insurer C
Policy Limit 100,000 200,000 300,000
Equal Share 50,000 50,000 50,000
Payment 50,000 50,000 50,000
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Fundamental Principles of Insurance Contracts

• 1. Principle of Indemnity
• Contribution by Equal Shares
• If Loss amount is 400,000

Insurer A Insurer B Insurer C
Policy Limit 100,000 200,000 300,000
Equal Share 1 100,000 100,000 100,000
Equal Share 2 N/A 50,000 50,000
Payment 100,000 150,000 150,000
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Fundamental Principles of Insurance Contracts

• 1. Principle of Indemnity
• Exceptions to the Principle
• Valued policy (or agreed value)
• Pays face value of insurance if a total loss
  occurs
• Life insurance, disability insurance, fine arts,
  antiques
• Ex.) Value of a fine art is agreed at 250,000.
• Valued policy law
• A law that requires payment of the face amount of
  insurance to the insured if a total loss to real
  property occurs from a covered peril, regardless
  of the propertys ACV.
• Replacement cost
• No deduction for depreciation in determining the
  amount paid for a loss.

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Fundamental Principles of Insurance Contracts

• 2. Principle of Insurable Interest
• The insured must be in a position to financially
  suffer if a loss occurs.
• Why?
• To prevent gambling
• Insurance on a property and wait for a loss
  occur.
• To reduce moral hazard
• Life insurance on a person and pray for his/her
  death for insurance proceeds.
• To measure the amount of the insureds loss in
  property insurance
• In order not to indemnify more than the insurable
  interest.

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Fundamental Principles of Insurance Contracts

• 2. Principle of Insurable Interest
• Property-Casualty insurance
• At the time of a loss, an insured must have
  insurable interest.
• No insurable interest no financial loss
• no indemnity support Prin. of indemnity
• Life Insurance
• Insurable interest must exist at the time of a
  policy inception, but not at the time of a loss
  (death)

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Fundamental Principles of Insurance Contracts

• 2. Principle of Insurable Interest
• Insurable Interest may be created either by
• Obligation to Insure   
• by Statute
• by Contract
• by Custom
• Option to Insure  
• Owners
• Mortgagors
• Lessors
• Trustees
• Tenants

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Fundamental Principles of Insurance Contracts

• 3. Principle of Utmost Good Faith
• A higher degree of honesty is imposed on an
  insurance contract than is imposed on other
  contracts
• Honesty is imposed on the applicant for insurance
• It is supported by three legal doctrines
• Representation
• Concealment
• Warranty

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Fundamental Principles of Insurance Contracts

• 3. Principle of Utmost Good Faith
• Representation
• Statements made by an applicant
• Insurance is voidable at the insurers option.
• Material
• False
• Reliance
• cf Innocent misrepresentation
• Concealment
• Intentional failure to disclose a material fact
• 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.
• In exchange for a reduced premium, a store owner
  warrants that alarm will be always on.

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Fundamental Principles of Insurance Contracts

• 4. 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 covered
  by insurance.
• Why?
• To prevent collecting twice
• To hold the negligent party responsible
• To hold down insurance rates

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Fundamental Principles of Insurance Contracts

• 4. Principle of Subrogation
• The insurer is entitled only to the amount it has
  paid under the policy.
• If the insurer collects more than the amount the
  insurer paid to the insured from the negligent
  party , the insured must be paid in full before
  the insurer retains the remaining balance.
• The insured cannot impair the insurers
  subrogation rights.
• Subrogation does not apply to life insurance and
  to most individual health insurance contracts.
• The insurer cannot subrogate against its own
  insured.