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. 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 Insurance as Contracts Note: Giving a quotation to a prospective insured is deemed as mere solicitation or invitation to make an offer.

9. 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 insurer’s 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 insurer’s 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.

14. 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.

15. 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.

16. 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

17. Fundamental Principles of Insurance Contracts 1. Principle of Indemnity • Primary-Excess • Accident while test driving a dealer’s car. • Health insurance between a couple working for different employers. • Own insurance – primary • Spouse insurance – excess • Birthday rule for dependents’ coverage

18. Fundamental Principles of Insurance Contracts 1. Principle of Indemnity • Proration by Face Amounts • It limits the insurer’s maximum obligation to the proportion of the loss that the insurer’s policy limit bears to the sum of all applicable policy limits. • If Loss amount is $150,000

19. 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

20. Fundamental Principles of Insurance Contracts 1. Principle of Indemnity • Proration by Amounts Otherwise Payable • If Loss amount is $60,000

21. 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

22. Fundamental Principles of Insurance Contracts 1. Principle of Indemnity • Contribution by Equal Shares • If Loss amount is $400,000

23. 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 property’s ACV. • Replacement cost • No deduction for depreciation in determining the amount paid for a loss.

24. 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 insured’s loss in property insurance • In order not to indemnify more than the insurable interest.

25. 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)

26. 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

27. 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

28. Fundamental Principles of Insurance Contracts 3. Principle of Utmost Good Faith • Representation • Statements made by an applicant • Insurance is voidable at the insurer’s 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.

29. 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

30. 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 insurer’s subrogation rights. • Subrogation does not apply to life insurance and to most individual health insurance contracts. • The insurer cannot subrogate against its own insured.