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United States

By Professor Neil N. Bernstein, BA, JD Washington University, St. Louis, Missouri

This monograph is up to date to


Insurance Law Suppl. 1 (September 2003)


The Author

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Neil N. Bernstein has been Professor of Law at Washington University in St. Louis, Missouri since 1967. He was born and raised in Cheyenne, Wyoming, received his Bachelor of Arts degree from the University of Michigan and his Juris Doctor degree from Yale University. He went on leave to serve as General Counsel to the Missouri Division of Insurance in 1973, and has been a consultant to insurance companies and insured entities. He is the author of numerous articles on insurance matters.

Insurance Law Suppl. 1 (September 2003)


The Author


Insurance Law Suppl. 1 (September 2003)


I wish to acknowledge the enthusiastic support and nancial assistance that I received on this project from Dean Joel Seligman and Washington University School of Law. Neil N. Bernstein

Insurance Law Suppl. 1 (September 2003)




Insurance Law Suppl. 1 (September 2003)

List of Abbreviations


catastrophic risk protection Commercial General Liability policy Consolidated Omnibus Budget Reconciliation Act cestui que vie (person whose life is insured) Directors and Ofcers policy District of Columbia Errors and Omissions policy Employee Retirement Income Security Act of 1974 Federal Crop Insurance Corporation generally accepted accounting principles gross national product Health Insurance Portability and Accountability Act of 1996 health maintenance organization Insurance Regulatory Information System National Association of Insurance Commissioners Old Age and Survivors Insurance Pension Benets Guaranty Corporation preferred providers organization statutory accounting principles Securities and Exchange Commission

Insurance Law Suppl. 1 (September 2003)


List of Abbreviations


Insurance Law Suppl. 1 (September 2003)


The Author Acknowledgment List of Abbreviations General Introduction

Chapter 1. General Background Information 1. 2. 3. 4. Political System Commerce and Industry Financial Institutions Currency Legislation and Monetary Regulation

3 5 7 13 13 13 15 16 18 19 23 23 24 24 26 28 30 32 33 33 33 34 34 USA 9

Chapter 2. Historical Background of Insurance and Insurance Regulation Chapter 3. Sources of Insurance Law 1. Legislation 2. Government Regulations 3. Regulation by Other Governmental Agencies Chapter 4. Dispute Settlement and Arbitration Chapter 5. Consumer Protection Chapter 6. Compulsory Insurance Selected Bibliography

Part I. The Insurance Company

Chapter 1. The Insurance Company: Its Form 1. Mutual Insurance, Premium Insurance, Other 2. Public or Private Nature 3. Factual Data
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Contents Chapter 2. Access to Business Chapter 3. Supervision 1. Solvency Control 2. Supervision of Tariffs and Insurance Conditions Chapter 4. Technical Reserves and Investments Chapter 5. Accountancy Chapter 6. Taxation of the Company 35 37 37 38 40 41 43 45 45 47 50 52 52 53 54 56 56 56 57 58 59 61 62 65 65 67
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Part II. The Insurance Contract General

Chapter 1. Generalities Chapter 2. Insurable Risk Chapter 3. Formation of the Insurance Contract Chapter 4. Obligations of the Insured 1. Description of Risk 2. Payment of Premium 3. Obligations in the Case of Insured Event Chapter 5. Obligations of the Insurer 1. Non Life Insurance I. Over- and Under-Insurance II. Subrogation III. Multiple Insurance 2. Life Insurance Chapter 6. Insurance and Third Parties Chapter 7. Termination of the Insurance Contract

Part III. Property and Liability Insurance

Chapter 1. Fire Insurance Chapter 2. Loss of Benets Insurance 10 USA

Contents Chapter 3. Marine Insurance Chapter 4. Liability Insurance Chapter 5. Legal Aid Insurance Chapter 6. Aviation and Space Insurance Chapter 7. Theft and Embezzlement Insurance Chapter 8. Agricultural Insurance, Livestock Insurance Chapter 9. Catastrophe Insurance 1. General 2. Nuclear Risks 3. Natural Catastrophes Chapter 10. Credit Insurance Chapter 11. Technical Insurance Chapter 12. Miscellaneous Insurance 68 70 72 73 75 76 78 78 78 79 81 82 83 85 85 87 88 90 91 91 93 95 97 97 100 102 USA 11

Part IV. Motor Vehicle Insurance

Chapter 1. Liability Insurance Chapter 2. Medical Payments Chapter 3. Uninsured and Underinsured Motorists Coverage Chapter 4. Physical Automobile Damage

Part V. Insurance of the Person

Chapter 1. Workers Compensation Chapter 2. Bodily Injuries Chapter 3. Private Health Insurance Chapter 4. Life Insurance 1. Individual Life Insurance 2. Group Life Insurance Chapter 5. Pension Funds
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Part VI. Social Security Part VII. Insurance Intermediaries

Chapter 1. Law of Establishment and Supervision Chapter 2. Insurance Intermediaries and the Insurance Contract

105 107 107 108 111 111 113 115 115 116 117 119

Part VIII. Reinsurance, Co-insurance, Pooling

Chapter 1. Reinsurance Chapter 2. Co-insurance and Pooling

Part IX. Taxation of Insurance

Chapter 1. Taxation of Insurance Companies Chapter 2. Taxation of Insurance Proceeds

Part X. Risk Management and Prevention Index

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General Introduction

1. The United States of America is the third largest country in the world in area, the third largest in population, and the largest in gross national product (GNP). The nation is made up of 48 contiguous states that occupy the middle latitudes of the North American continent, the state of Alaska at the northern extreme of North America and the island state of Hawaii in the Pacic Ocean. The nation also includes the District of Columbia (a land area of 61 square miles ceded by Maryland in 1791 to be the seat of the central government) and commonwealths and territories in the Caribbean Sea and the Pacic Ocean. The original 13 states were colonies of Great Britain, which declared their independence in 1776.

Chapter 1. General Background Information

1. Political System 2. The United States has a federal form of government, in the sense that sovereign power is divided between a central government and the several states. The term federal is somewhat ambiguous in this context, because the central United States government is customarily referred to as the Federal government. For the remainder of this monograph, Federal when capitalized refers to that central government. The seat of the Federal government, and most of its principal ofces, are located in Washington, DC. 3. The powers of the Federal government are spelled out in the Constitution of the United States. For purposes of this monograph, the most important of those powers is the power to regulate commerce with foreign nations, and among the several states and with the Indian tribes, which is granted to the United States Congress under Article I, Section 8. The 10th Amendment to the Constitution species that powers not delegated to the Federal government by the Constitution or prohibited by it to the states are reserved to the states or to the people. The Federal government is divided into three principal branches, the legislative, the executive and the judicial. 4. The legislative branch is the Congress of the United States, which is divided into the Senate and the House of Representatives. There are 100 members of the Senate, who serve for six years. Each state, regardless of size, is entitled to two senators. Senators were originally to be chosen by the state legislatures, but since
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General Introduction, General Background

the Seventeenth Amendment to the Constitution was adopted in 1913, the senators have been elected by the people of the state. The Senate has the power to initiate all legislation, except Bills for raising revenue, which must originate in the House of Representatives. However, those revenue Bills must also be approved by the Senate, which can freely amend them. On the other hand, the Senate has the sole power to try all impeachments of Federal ofcials, and to give or withhold its consent to all treaties with foreign powers, as well as the appointment of ambassadors, public ministers and consuls, Federal judges and major ofcials of the executive branch. 5. The House of Representatives is composed of 435 voting members and ve delegates from the District of Columbia, American Samoa, Guam, the Virgin Islands and Puerto Rico, who have no vote except in committees. Each state is entitled to one representative and the remaining districts are allocated between the states on the basis of population as determined by the decennial census. Representatives have always been popularly elected by the eligible voters in each Congressional district. The House of Representatives has exclusive jurisdiction to initiate all revenue Bills and to impeach Federal ofcials for trial in the Senate. The House has no power to approve treaties or judicial or executive ofcials. 6. The executive power of the central government is vested in the President of the United States, who holds ofce for a term of four years. Originally, the Constitution contained no limit on the number of terms a president could serve, but since the 22nd Amendment was adopted in 1951, a president can only serve two terms. The term of ofce of the President and Vice President now ends at noon on the 20th day of January. 7. The President and Vice President are separately selected by a college of electors, who are chosen within each state in numbers equal to the number of Senators and Representatives to which the state is entitled in the Congress of the United States. Originally, the person receiving the greatest number of electoral votes was the President and the person receiving the second greatest number served as Vice President, but since 1804 the electors vote separately for President and Vice President. Electors invariably select a President and Vice President from the same political party, although they are not legally required to do so. Electors are popularly elected and vote by state; generally, the candidates whose electors received the greatest number of votes in the state are given all of the electoral votes for the state. It is possible for person to be elected as President even though his opponent received a greater number of popular votes, and this actually happened in 1876, 1888 and 2000. If no candidate receives a majority of the electoral votes, the House of Representatives chooses the President from the three persons receiving the highest number of presidential electoral votes and the Senate chooses a Vice-President from the two candidates garnering the most votes for that ofce. 8. The President administers the executive powers of the central government with the assistance of 14 executive departments and a large number of temporary and permanent administrative agencies. All heads of the departments and 14 USA
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administrative agencies are appointed by the President but must be approved by the United States Senate. 9. Article III of the United States Constitution vests the judicial power in a Supreme Court and in such inferior courts as the Congress may from time to time ordain and establish. Pursuant to that authority, Congress has established 90 United States District Courts (general trial courts), 12 Courts of Appeals (intermediate appellate courts) and a number of specialized tribunals. The jurisdiction of the Federal courts is limited by the Constitution. Primarily, those courts concern themselves with civil and criminal cases arising under the laws of the United States and disputes between citizens of different states. When Federal courts decide disputes between citizens of different states, they generally apply the law of the state in which the court sits. Federal judges are appointed by the President with the approval of the Senate. They serve for life or, as the Constitution states, during good behavior. 10. The governments of the several states are generally organized along the same tripartite lines as the Federal government. The main difference is that more state executive ofcials and many judges are popularly elected. Also, state courts are courts of general rather than limited jurisdiction. The states are politically divided into counties (called parishes in Louisiana and boroughs in Alaska) and cities. City and county governments are generally concerned with such matters as law enforcement and recording of legal documents. 2. Commerce and Industry 11. It is no exaggeration to state that the United States is the worlds dominant economic power. The country is blessed with an extremely varied physical environment and abundant natural resources. It supplies other countries with many agricultural and mineral products, as well as the output of a highly developed manufacturing sector. Moreover, the United States is a substantial source of and destination for investment capital. The bulk of the economic activity is in the hands of private industry, with the government playing only a small direct part. 12. According to the Bureau of Economic Affairs of the United States Department of Commerce,1 the gross national product (GNP) for 1996 was approximately 7.6 billion dollars, which equates to $28,600 per person. The Federal and state governments were responsible for only 13 per cent of that total, with the remaining 87 per cent coming from private industry. The largest component of the 1996 GNP was Services, which was responsible for 20 per cent, followed by Finance, insurance and real estate with 19 per cent and Manufacturing with 17 per cent. Although the United States exports vast quantities of foodstuffs to the rest of the world, the Agriculture, forestry and shing sector accounted for less than 2 per cent of the gross national product.
1. 78 Survey of Current Business, No. 11, p. 34 (November 1998).

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13 15 3. Financial Institutions

General Introduction, General Background

13. The structure of United States nancial institutions at the start of the 21st century has been dictated by the GlassSteagall Act of 1933. This statute, enacted in the belief that the banking collapse of 1929 was caused by the involvement of commercial banks in speculative stock trading, prohibited banks, investment houses and insurance companies from participating in each others businesses. That law was superceded in November 1999 by the GrammLeachBliley Act, which permits banks, insurance companies and securities rms to afliate through holding companies or nancial subsidiaries with certain prudential limitations on activities and other safeguards. All companies that wish to engage in the business of insurance must still obtain state licenses, but the states are barred from discriminating against depository institutions. 14. The initiation of commercial banking in the United States is considered to have been the chartering of the Bank of North America by the Continental Congress in December 1781. Because of doubts about the power of the Federal government to charter banks, the Bank of North America also obtained a charter from the state of Pennsylvania shortly after it opened for business. Other states began chartering banks within a short period of time, and state chartering was the predominant regulatory structure for 80 years. The state banks also issued their own paper currency, which led to a chaotic and unstable scal situation. Congress was forced to step in to nance the Civil War and enacted the National Bank Act of 1863. That statute provided for the granting of national bank charters by the Ofce of the Comptroller of the Currency in the Treasury Department. This provision established the dual banking system, by which banks can choose either a state or national charter, which persists to the present day. However, Congress provided for a single national paper currency, initially issued by the national banks, by imposing a 10 per cent tax on anyone using or paying out notes of statechartered banks. State banks were able to continue in business primarily as banks of deposit. 15. The structure established by Congress in 1863 worked reasonably well, but the amount of currency the national banks could issue was limited and there was little liquidity to cover short-term credit decits. Consequently, Congress passed the Federal Reserve Act of 1913, setting up a system of relatively autonomous regional reserve banks, owned by the commercial banks but operating under the supervision of a Federal Reserve Board appointed by the President. The Federal Reserve System regulates bank credit and the money supply by adjusting the legal reserve ratio which species the proportion of deposits that each member bank must hold in its reserve accounts, by changing the discount rate that is charged on short-term secured loans to member banks and by sales or purchases of securities on the open market. The Federal Reserve also issues Federal Reserve notes to replace the paper currency previously issued by the national banks. All national banks are obligated to become members of the Federal Reserve System and statechartered banks are free to do so. As of the end of 1998, 40 per cent of the 16 USA
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commercial banks insured by the Federal Deposit Insurance Corporation were members of the Federal Reserve System.1
1. Federal Deposit Insurance Corporation, Statistics on Banking 1998, Table 103.

16. The state also have played an important role in the regulation of the sale of stocks and bonds in the United States. Massachusetts began to control the issuance of common carrier stocks and bonds as early as 1852 and Kansas enacted the rst general securities law in 1911. Although there were initial concerns that securities regulation was beyond the power of the states, in 1917 the Supreme Court upheld the validity of state securities laws against claims that they unduly burdened interstate commerce.1 Even after the Federal government entered the eld beginning in 1933, the power of individual states to regulate the offering of securities for sale within their borders was preserved, but it was signicantly limited in 1996. Although substantial efforts have been made to bring about uniformity in the various state statutes, there is still considerable variation between the laws of the 50 or so jurisdictions.
1. Merrick v. N.W. Halsey, 242 U.S. 568 (1917).

17. The Federal government was induced to step into the regulation of security sales generally by the great Stock Market crash of October 1929 and certain perceived securities abuses. The rst Federal legislation was the Securities Act of 1933, which regulated the initial distribution of securities. The statute requires that all securities offered to the public must rst be registered with the government1 by the ling of an accurate and complete registration statement. In addition, a prospectus containing the basic information of the registration statement must be given to every buyer. That legislation was followed almost immediately by the Securities Exchange Act of 1934, which governed the sale of securities after the initial distribution. That statute established the Securities and Exchange Commission and provided for disclosures to people who buy and sell securities, remedies for fraud in securities trading, regulation of securities markets and control over the extension of credit for security acquisition purposes. In 1940, Congress passed two additional statutes which gave the SEC power to regulate companies engaged in the business of investing and reinvesting in securities of other companies and authority over people who give investment advice or analyze issues of securities. The Commission also administers the Public Utility Holding Company Act of 1934, the Trust Indenture Act of 1939 and the Securities Investors Protection of 1970. All of these statutes have been periodically amended since their initial passage.
1. Initially the Federal Trade Commission, but changed in 1934 to the Securities and Exchange Commission.

18. For more than 60 years, securities offerings and brokers or dealers engaged in securities transactions were subject to dual Federal and state regulation. However, in 1996 Congress, nding the dual system to be redundant, costly and ineffective, modied it drastically in the National Securities Market Improvement Act of 1996. States are now barred from regulating or imposing disclosure requirements
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General Introduction, General Background

on securities listed on national stock exchanges, mutual funds, private offerings and certain exempt offers, although they retain full authority to investigate and prosecute fraud, deceit or unlawful conduct. State are also barred from imposing nancial and record keeping requirements on brokers and dealers that go beyond those contained in the Securities Exchange Act. Investment advisers now must register with only one regulatory authority, either the SEC or the states, depending on the dollar amount of assets that they manage. 4. Currency Legislation and Monetary Regulation 19. The basic unit of currency in the United States is the dollar, which is issued in both paper money and coins. Since its creation in 1913, the Federal Reserve System has been the exclusive issuer of paper money in the country. Federal Reserve notes contain portraits of American political gures: George Washington on the 1-dollar bill, Thomas Jefferson on the 2-dollar bill, Abraham Lincoln on the 5-dollar bill, Alexander Hamilton on 10-dollar bills, Andrew Jackson on 20-dollar bills, Benjamin Franklin on 100-dollar bills, William McKinley on 500-dollar bills, Grover Cleveland on 1,000-dollar bills, James Madison on 5,000-dollar bills and Salmon P. Chase on 10,000-dollar bills. 20. The United States Mint, which has been a division of the Treasury Department since 1873, issues coins in decimal divisions of the dollar and in dollars. The lowest denomination coin still in circulation is the penny or 1-cent piece, which is worth one-hundredth of a dollar. The Mint also produces nickels, worth 5 cents, dimes worth 10 cents, quarters worth a quarter of a dollar, half dollars and dollar coins, which used to be silver but are now gold colored. In 1999, the Mint produced a total of 18,720,525,000 United States coins. 21. The monetary supply is regulated by the Federal Reserve System, with scanty legislative guidance or executive oversight. The Federal Reserve controls monetary policy by increasing or decreasing the money supply itself or by increasing or decreasing the cost and availability of credit. The Fed, as it is commonly called, utilizes three tools to set monetary policy: purchases or sales of government securities in the open market, changes in the reserve requirements that banks must maintain to support their loans, and changes in the discount rate at which it loans funds to banks in need of money.

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Selected Bibliography

Multivolume Treatises E. Holmes, Holmess Appleman on Insurance, 2d. ed. (West, St. Paul, 1996). L.R. Russ and T.F. Segalla, Couch on Insurance, 3d. ed. (Clark Boardman Callaghan, Deereld, 1995). Single Volume Works J.F. Dobbyn, Insurance Law in a Nutshell, 3d. ed. (West Group, St. Paul, 1996). R.H. Jerry, II, Understanding Insurance Law, 3d. ed. (LexisNexis, Newark, 2002). R.E. Keeton and A.I. Widiss, Insurance Law, A Guide to Fundamental Principles, Legal Doctrines and Commercial Practices (West St. Paul, 1988). S.L. Kimball, Insurance and Public Policy (University of Wisconsin Press, Madison, 1960). P.M. Lencsis, Insurance Regulation in the United States (Quorum Books, Westport, 1997). E.W. Patterson, Essentials of Insurance Law, 2d. ed. (McGraw Hill, New York, 1957). J.W. Stempel, Law of Insurance Contract Disputes, 2d. ed. (Aspen Law & Business, Gaithersberg, 1999).

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Part I. The Insurance Company

Chapter 1. The Insurance Company: Its Form

1. Mutual Insurance, Premium Insurance, Other 62. In the United States, insurance is provided principally by stock companies or mutual companies. In addition, a small amount of insurance is furnished through Lloyds Associations, reciprocals and fraternal benet societies. Property and casualty insurance is obtained principally from stock companies. United States life insurance companies have traditionally been mutual companies; however, because of the attractiveness of insurance companies as investment vehicles, they are converting to stock companies. 63. An insurance stock company is basically no different from any other stock company. A group of investors provide the basic capital needed to establish the company and become its stockholders. They elect a board of directors who manage the company which sells stock to the general public. The stockholders share in the prots of the company but have no personal liability for its losses beyond the amount of their investments. 64. In a mutual company, the policyholders themselves provide the basic capital, so they can be considered to be both the insurers and the insureds. The company is organized as a non-prot corporation, so the policyholders typically have no personal liability to replace losses. However, in certain smaller mutual companies, the bylaws may provide for additional assessments if funds are insufcient to meet losses and expenses. If the operations of a mutual company generate prots, they are usually returned to the policyholders as policy dividends. The directors are elected by the policyholders, with each policy entitled to one vote. 65. Lloyds Associations take their name from Lloyds Coffee House in London, where individuals who wished to obtain or provide insurance against the risks of ocean voyages gathered in the 17th century. A Lloyds Association is a group of individuals (usually natural persons) who combine into syndicates which divide the risks that are offered to them. Each syndicate member has unlimited personal liability for the percentage of the risk that his syndicate has agreed to cover. Thus, the liability belongs to each individual and not to the Association. The most famous Lloyds Association is Lloyds of London, which specializes in covering property and casualty risks that conventional insurance companies are not willing to indemnify.
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Part I, Ch. 1, The Form of the Insurance Company

There also are Lloyds Associations domiciled in various states of the United States, but they write very little business. 66. A reciprocal, also known as an inter-insurance exchange, is a group of individuals who join together to share a common risk. Each individual puts up a stipulated sum of money, equivalent to a premium, which is divided among the members who suffer the covered loss. The members may also be liable for an additional xed contribution if the initial sum is insufcient to pay all the covered losses. However, if the total amount raised by the initial premiums and the stipulated additional contributions is insufcient, the injured association members must bear the residual loss themselves. Reciprocals operate through an attorney-in-fact, who is compensated to manage the enterprise. Reciprocals in the United States traditionally operated mainly in the eld of automobile insurance, but they became popular in the last quarter of the 20th century as providers of professional malpractice insurance. 67. Fraternal benet societies are groups of individuals organized for a noninsurance purpose, such as a lodge or a church, that provide insurance solely for the benet of their members. In the United States, they mainly offer burial or life insurance. 2. Public or Private Nature 68. The insurance companies described above are private companies. However, the Federal government does provide insurance in a limited number of situations, where the private market is not considered to operate satisfactorily. The largest of these government programs is Medicare, which offers health insurance to individuals who are over the age of 65 or disabled. In addition, the Federal government also provides crop insurance, ood insurance, bank deposit insurance, loan insurance and indemnication for United States businesses that export products overseas. 3. Factual Data 69. In 1999, a total of 1,118 companies sold life and health insurance in the United States. Their net premiums for the year were 488 billion dollars. The 3,366 property and casualty companies operating in the United States had net premiums of $287 billion. Forty per cent of that amount was attributable to private passenger automobile insurance.1
1. Bests Review Magazine, July 2000.

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70 72

Chapter 2. Access to Business

70. Each state in the United States has the power under the Constitution of the United States to regulate business activities that take place wholly within its borders. In addition, Congress in the McCarronFerguson Act authorized the states to regulate interstate insurance business, which would otherwise be beyond their powers. Consequently, any company intending to engage in the business of insurance must obtain a license or certicate of authority to do so from every state in which it intends to offer or sell insurance before entering into any insurance transaction in that state, with certain exceptions to be discussed in paragraph 73. 71. As a general rule, an insurer can obtain a license to sell either life insurance or property and casual insurance, but not both. Prior to the middle of the 20th century, property insurers were barred from selling casualty insurance and vice versa, but those laws have been repealed. Licenses can be for an indenite period or for one year subject to automatic renewal upon the ling of an annual statement. 72. McCarronFerguson allows states to treat foreign insurers1 and alien insurers2 differently from domestic insurers and most states do so. Alien insurers are frequently required to establish an American subsidiary or post security for the performance of their obligations in this country. Foreign and alien insurers are regularly required to provide extensive information on their operations in other states and to permit an examination of their books and records before their application will be acted upon. In addition, their licenses may provide that insurance on people or property in the state must be placed through brokers or agents licensed in the jurisdiction. State also have enacted retaliatory provisions, under which special restrictions are placed on insurers domiciled in a particular state to match the restrictions the other state imposes on insurers from the licensing state. If a nondomestic insurer issues an insurance policy in the state without having authorization to do so, it may be sued in the courts of that states for violating the terms of that policy, but it may be barred from suing in those courts to enforce it. On the other hand, a non-admitted insurer cannot be required, as a condition of being authorized to conduct business, to agree not to remove any suit against it into Federal court.3
1. U.S. companies domiciled in a state other than the licensing state. 2. Insurers domiciled outside the United States. 3. Home Insurance Co. v. Moore, 87 U.S. 445 (1876).

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73. Unauthorized insurers are allowed to issue insurance policies protecting persons and property within a state without having authorization to do so in two situations. Citizens of a state may directly contract with an unauthorized insurer to protect their persons or property within the state if the policy is entered into by the insured outside of the state with no resident agent involved and no other act incidental to the making of the contract taking place within the state. In addition, insurance may be placed with an unauthorized insurer if the insurance is not available from an authorized insurer, either because the dollar amount for which coverage is sought is too great, the risk is not acceptable to authorized insurers at a reasonable price or because a special policy with unusual terms is required. Such insurance is known as surplus lines insurance and a number of companies specialize in it. Where unauthorized insurance is utilized, the policyholder may be required to pay any tax that would be levied upon the insurance company if an authorized insurer were used, to prevent citizens from obtaining unauthorized insurance solely to save the taxes.

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74 77

Chapter 3. Supervision

1. Solvency Control 74. As noted above,1 a prime concern of regulators is to make sure that insurers are not only willing but also able to pay their claims they arise. This concern is especially vital in the insurance context, because a considerable period of time will usually elapse between the date on which the insured pays its premiums and the date on which the insurer will be called upon to compensate the insured for a covered loss. Regulators impose a number of requirements to guarantee that sufcient assets are available when the insurers turn to perform arises.
1. Paragraph 37.

75. Every insurer is required to le a detailed annual statement with the insurance department of every state in which it is authorized to do business, usually on 1 March, in a standardized format devised by the National Association of Insurance Commissioners. The statements must be certied as accurate by ofcers of the insurer and, in a number of states, by independent accountants as well. Those statements are reviewed by trained staff in the insurance departments for signs of nancial difculty, and become public documents, available for inspection by any person. In addition, the NAIC analyzes the annual statements for signs of nancial difculty under a series of tests known as the Insurance Regulatory Information System (IRIS). Findings outside of acceptable ranges are passed on to relevant regulatory agencies. 76. Even if the annual statements of an insurer give every indication that the company is in sound condition nancially, the regulators must have assurances that the gures in the statements have been calculated and reported accurately. Therefore, state laws require that the regulators audit the books of every company at least once every three or ve years. To avoid unnecessary duplication, the insurance departments are empowered to accept the examination report of the insurance department of another state where the company is licensed, and the departments have devised a procedure for allocating the responsibility for particular examinations among themselves. The expenses of the examination, including personnel expenses, are borne by the insurer being audited. 77. To preserve assets for policyholders and claimants, insurance departments have sweeping authority to take control of problem companies. Insurance
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commissioners are empowered to obtain an immediate appointment as receiver of a troubled company by a state court, with power to take possession of the insurers business and assets. A commissioner need not wait to seek receivership until an insurer has nally become insolvent; it can go to court when there is a likelihood of insolvency,1 the company is in hazardous condition2 or in an unsound nancial condition.3 After he has assumed control of the company as receiver, the regulator must decide whether or not the company can be restored to a sound operating basis. If he believes it can, he asks the court for an order of rehabilitation, which outlines a series of steps that must be taken after which control of the company will be turned over to the prior management or a new group. If the regulator concludes that rehabilitation is not feasible, he will ask the court for an order of liquidation. In a liquidation, the assets of the company (which may include its book of business) are marshaled and sold, and the proceeds are distributed in an order determined by statute. The order of distribution is similar to the distribution in a standard bankruptcy, except that the claims of policyholders are paid before payments to unsecured creditors.
1. Kueckelhan v. Federal Old Line Ins. Co., 69 Wash.2d 392, 418 P.2d 443 (1966). 2. Angoff v. American Financial Sec. Life Ins. Co., 869 S.W.2d 90 (Mo. App. 1994). 3. State ex. rel. Woodmen Ass. Co. v. Conn, 116 Ohio St. 127, 156 N.E. 114 (1927).

2. Supervision of Tariffs and Insurance Conditions 78. In 1914, the Supreme Court of the United States approved the right of the individual states to regulate re insurance rates.1 The Court rejected the claim that states could only regulate businesses in which the public has the legal right to demand and receive service. The Court noted that contracts of insurance are interdependent, creating a fund of assurance and credit, the companies becoming the depositories of the money of the insured, possessing great power thereby, and charged with great responsibility. From the standpoint of the insured, insurance is practically a necessity to business activity and enterprise. These characteristics set it apart from ordinary commercial transactions. The Court also emphasized that insurance rates are not xed over the counters of the companies by what Adam Smith calls the haggling of the market, but formed in the councils of the underwriters, promulgated in schedules of practically controlling constancy which the applicant for insurance is powerless to oppose. These characteristics, the Court concluded, give the states the power to regulate insurance rates, and whether rate is regulation is necessary is a matter for legislative judgment, not judicial.
1. German Alliance Insurance Co. v. Lewis, 233 U.S. 389.

79. Life insurance rates are generally not directly regulated by state agencies, except that some states will regulate specic life insurance contracts that are subject to unusual potential abuse, such as credit life insurance1 or burial insurance.2 However, for the most part, states will only require that insurance companies maintain adequate reserves to meet their anticipated claims and will rely upon competition to keep premiums from being excessive. 38 USA
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1. See, e.g., Ohio Revised Code, S. 3918 (2001). 2. See, e.g., Mississippi Code, 83-37-15 (2001). Burial insurance involves the payment by the insured of a fairly small sum to a party, sometimes one engaged in the undertaking business, in exchange for that partys furnishing of the necessary burial service upon the death of the insured.

80. On the other hand, all states regulate property and casualty rates, although there is a wide variance in the nature and degree of rate regulation. In a few states, the insurance department sets the rates for insurance, especially for sensitive insurance offerings such as automobile liability insurance.1 In the majority of states, insurance companies set the rates, but the insurance department ensures that the rates being charged are not inadequate, excessive or discriminatory. The traditional approach to rate regulation has been prior approval, wherein the insurer les its rates with the department before they become effective, and then waits to actually charge them until they are expressly approved or a specied period of time has elapsed without regulatory disapproval.2 However, a number of states allow insurers to use their rates as soon as they are led and to continue to use them unless and until the department expressly disapproves them.3 And there are a few states which permit the insurers to start using their new rates immediately and require only that the rate be led within a short period of time after it becomes effective.4
1. 2. 3. 4. See, See, See, See, e.g., e.g., e.g., e.g., Massachusetts General Laws, Chapter 175, 113B (2001). Iowa Code 515F.5 (2001). Code of Alabama 27-13-29 (2001). Kentucky Revised Statutes 304.13-051 (2001).

81. The states control the contents of insurance policies in a number of different ways. The most restrictive is a legislative mandate requiring the use of a standard form, the most pervasive of which is the 1943 New York Standard Fire Insurance Policy, which is prescribed by statute in many states.1 Also, there are statutes that establish specications for particular clauses only, such as provisions for cancellation of a motor vehicle liability policy.2 This specic legislative policy form control is supplemented by general requirements that policy forms must be led for approval with the regulatory agency. Some statutes require approval before the form can be used,3 but others only provide that the form be led and allow it to thereafter be used until and unless it is disapproved by the insurance department.4
1. 2. 3. 4. See, See, See, See, e.g., e.g., e.g., e.g., New YorkMcKinneys Insurance Law 3404 (2001). Massachusetts General Laws, Chapter 175, 113A (2001). 40 Pennsylvania Statutes 813 (2001) (workers compensation). New Jersey Statutes 17B:25-18.2 (2002) (life insurance).

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82 84

Chapter 4. Technical Reserves and Investments

82. Required policy reserves are calculated differently for life insurance companies than for property and casualty companies. Life insurance policy reserves are computed as the excess of the present value of future guaranteed benets over the present value of any future modied net premiums therefor.1 Almost all states2 have adopted the NAIC Standard Valuation Law, which mandates the use of specic mortality tables, specic rates of interest and specic actuarial methods of computation. Each company is also required to submit annually the opinion of a qualied actuary that reserves have computed appropriately and that the reserves held in support of the policies are adequate to meet the legal requirements.
1. Present value is the amount which, with interest added and compounded at an assumed rate, will equal a given amount in the future. 2. New York appears to be the only exception.

83. Property and casualty companies must maintain, not policy reserves, but loss reserves and unearned premium reserves. Loss reserves are based upon losses already incurred and must include the following: (1) the estimated value of known claims, (2) estimated loss adjustment expenses and (3) a provision for losses incurred but not reported. Unearned premium reserves represent the liability of an insurer to refund a proportionate part of premiums paid in advance, in the event of a mid-term cancellation of the policy. 84. Although the investments of insurance companies are not specically regulated, they are indirectly regulated because only admitted assets can be considered in determining whether a company has sufcient capital to cover its reserve and liability requirements. Each state determines for itself which assets qualify as admitted and which do not, and there is some variation between jurisdictions. Originally, the only permissible investments were in government bonds, but the category has been liberalized over the years. Most states will also consider investments in corporate bonds, if the bonds are secured by adequate collateral or issued by companies with a substantial record of earnings and nancial strength. Real estate, real estate mortgages and preferred stock are permitted in most states and some will also allow the common stock of well established companies. Most investment laws also include a basket provision, whereby the company can invest a small portion of its capital in any medium. In addition, many states require the companies to deposit securities equal to the minimum capital and surplus requirement directly with the insurance department as specic protection for claims within the state.

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Chapter 5. Accountancy

85. Most United States companies which are not engaging in the business of insurance maintain their nancial statements in compliance with the generally accepted accounting principles (commonly known as GAAP) promulgated by the Financial Accounting Standards Board. The purpose of the GAAP procedure is to assist investors through standardization in appraising the nancial position and operation of diverse enterprises. 86. Insurance regulators, on the other hand, are more concerned about guaranteeing that insurance companies are solvent and possess sufcient readily available assets to pay all claims. Consequently, insurance companies have been required to maintain their books pursuant to an entirely different set of principles, commonly known as statutory accounting principles or SAP, promulgated by the various insurance departments. The main unique provisions of SAP are the separation between admitted assets and non-admitted assets discussed above, the requirement that all premiums must originally be booked as liabilities when collected which are gradually recognized as earned income over the policy period and the requirement that all acquisition costs (primarily commissions) must be expensed when incurred and not allocated over the policy period. The differences between GAAP and SAP are so great that auditors are required to make the following statement with respect to their reports on the insurance company nancial statements: . . . the Company prepared these nancial statements using accounting practices prescribed or permitted by the insurance department of the state of domicile which practices are different from generally accepted accounting principles. The effects on the nancial statements of the variances between the statutory basis of accounting and generally accepted accounting principles, although not reasonably determinable, are presumed to be material.1
1. American Institute of Certied Public Accountants, Statement of Position 95-5.

87. Traditionally, the statutory accounting principles were based upon a number of NAIC Policies and Procedures Manuals promulgated for various insurance specialties. However, these manuals were incomplete, and consequently, they were supplemented by a number of accounting practices prescribed by the statutes or regulations of each state plus a host of additional practices permitted by each states regulators for individual companies. What resulted has been described as 55 separate bases of prescribed accounting and, with permitted practices, over 1,000 bases
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Part I, Ch. 5, Accountancy

of prescribed and permitted practices.1 The system was criticized because of its complexity, lack of ready availability and impediments to meaningful comparison of different insurance companies.
1. S. Shouvlin, Exposing the myths of NAIC codication, in National Underwriter, Life & Health ed., 8 December 1997), p. 12.

88. To alleviate these concerns, the NAIC in 1998 adopted a comprehensive Codication of Statutory Accounting Principles in order to codify statutory account guidance into a single source, to develop guidance where no statutory rules now exist and to address areas where current statutory guidance conicts with the Statement of Concepts.1 The Codication was distributed to the various states and other regulatory entities with a recommended effective date of 1 January 2001. All of the regulatory entities have indicated that they intend to adopt the Codication, although some may make modications to avoid conicts with state laws and regulations.
1. NAIC, Frequently Asked Questions about Codication (2002).

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Part II. The Insurance Contract General

Chapter 1. Generalities
92. Generally speaking, courts, when interpreting contracts, will endeavor to determine the meaning the parties gave to the words when they put them into their agreement. However, with respect to insurance policies, the courts are more likely to utilize rules of construction that favor the insureds and will provide coverage. They lean toward the insureds for several reasons: rst of all, insurance policies are long, detailed contracts that purchasers are not likely to read, and which they would not understand if they tried to read them. Secondly, the policies are highly standardized and were probably drafted by the insurance company or an insurance trade association. Third, the courts recognize that there is a basic inequality of bargaining power between the insured and the insured and that the insured does not have the ability to bargain over or change the terms of the policy. 93. The interpretation tenet that United States courts most frequently utilize to favor insureds is the doctrine of contra proferendem the notion that, where the words used in a document are ambiguous, the courts will adopt the meaning which operates against the party who drafted or supplied the document. That meaning is preferred because the courts recognize that the drafting party is more likely to protect its interests than those of the other party. Ambiguity in an insurance policy can arise for several different reasons. The words themselves may be vague or susceptible of several different meanings. The words may be confusing because of inconsistencies between provisions or because of misleading document structure. Or the words may be ambiguous because of a discrepancy between the language of the policy itself and other information that the insured received from the insurer or its agents. 94. In addition, some courts are willing to construe policies in a manner favorable to the insured even where it cannot be reasonably said that there is an ambiguity. This approach has come to be known as the doctrine of reasonable expectations. As explained in the classic formulation of the concept: . . . the objectively reasonable expectations of applicants and intended beneciaries regarding the terms of insurance contracts will be honored even though painstaking study of the policy provisions would have negated those expectations.1
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Part II, Ch. 1, Generalities

The doctrine has not been accepted in that broad formulation by a majority of American courts but it has been applied by several courts in specic situations.2
1. R.E. Keeton, Insurance Law Rights at Variance with Policy Provisions: Part One in, 83 Harvard Law Review at p. 967 (1970). 2. See, e.g., Atwater Creamery Co. v. Western National Mutual Insurance Co., 366 N.W.2d 271 (1985) (doctrine applies where insurer did not communicate the conditions and exclusions of the policy accurately and clearly and expectations of coverage by the insured are reasonable).

95. Finally, courts may refuse to enforce provisions in insurance policies which are unambiguous and clearly understood by the insured at the time of policy negotiation where the courts deem the provisions to be contrary to the public policy of the state. These cases typically involve situations where a constitution or statute expressly or impliedly prohibits the aim or effect of the provision, where the provision unduly encourages moral hazard, or where the provision would force the insured to engage in unreasonable behavior in order to preserve coverage.1
1. K.S. Abraham, Insurance Law and Regulation, 3rd ed. (Foundation Press, New York, 2000), p. 94.

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96 98

Chapter 2. Insurable Risk

96. Insurance has been dened as An agreement in which one party (the insurer) in exchange for a consideration provided by the other party (the insured) assumes the other partys risk and distributes it across a group of similarly situated persons, each of whose risk has been assumed in a similar transaction.1 Not every risk is insurable. To be insurable, a particular risk should manifest the following characteristics: (a) the objects must be of sufcient number and quality to allow a reasonably close calculation of probable loss (that is, to allow the law of large numbers to work); (b) the loss, should it occur, must be accidental and unintentional in nature from the viewpoint of the insured; (c) the loss, when it occurs, must be capable of being determined and measured; (d) the insured objects should not be subject to simultaneous destruction; that is, catastrophic hazard should be minimal; (e) the potential loss to each insured must be severe enough to cause nancial hardship; (f) the probability of loss in the aggregate must not be too high.2
1. R.H. Jerry II, Understanding Insurance Law, 2d ed. (LexisNexis, Newark 1996), p. 17. 2. M.R. Green et al., Risk and Insurance 45 47, 8th ed. (1992).

97. From the standpoint of the transferee, there is very little difference between insurance and gambling. Both involve the pooling of a large number of homogeneous risks and the application of the law of large numbers to determine the probability of a payout. However, gambling, at least traditionally, has been regarded as contrary to public policy in the United States, while insurance has been generally approved. The difference between the two is that insurance is a contract of indemnity, which is designed to replace or reduce a diminution of wealth that has occurred, while gambling seeks to increase the wealth of the gambler. 98. To guarantee that an insurance policy does not become a functional equivalent of a gambling contract, all American jurisdictions require that insurance can only be sold to a party who possesses an insurable interest in the object of the policy. Needless to say, the precise scope and denition of insurable interest have been subject of extensive debate and litigation over the years. The principal schools of thought in this debate trace their origins back to the decisions of Lord Eldon and Judge Lawrence in the 1805 case of Lucena v. Craufurd.1 Under British law at the
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time, enemy ships seized in wartime became the property of the Royal Commissioners when they arrived in an English port. The case concerned Dutch vessels that had been captured in the Orient and which were insured by the Royal Commissioners, but which sank before they could be brought into an English port. The insurers refused to pay on the ground that the Commissioners did not have the necessary interest in the vessels at time they went down.
1. 127 Eng. Rep. 630 (House of Lords 1805).

99. Lawrence believed that insurance is applicable to protect men against uncertain events which may in any wise be of disadvantage to them; not only those persons to whom positive loss may arise by such events, occasioning the deprivation of that which they may possess, but those also who in consequence of such events may have intercepted from them the advantage of prot, which but for such events they would acquire according to the ordinary and probable course of things. He recognized that cases could arise in which there may be some difculty in showing if the event had not happened, that those advantage would have arisen and that in such a case an interest so uncertain may not be the subject of insurance. However, he felt a party has a sufcient insurable interest where a man is so circumstanced with respect to matters exposed to certain risks or dangers, as to have a moral certainty of advantage or benet, but for those risks or dangers. The test he set out has come to be known as the factual expectancy of loss approach. 100. Eldon could not accept this approach. He argued that it was impossible to nd a moral certainty, which is between a certainty and an expectation; nor am I able to point out what is an [insurable] interest unless it be a right in the property, or a right derivable out of some contract about the property, which in either case may be lost upon some contingency affecting the possession or enjoyment of the party. He felt that if moral certainty be a ground of insurable interest, there are hundreds, perhaps thousands, who would be entitled to insure [the same ships]. First the dock company, then the dock-master, then the warehouse-keeper, then the porter, then every other person who to a moral certainty would have any thing to do with the property, and of course get something by it. Under Eldons view, which has come to be known as the legal test, insurable interest is limited to an interest cognizable in a court of law or a chancery of equity. Those interests are limited to property rights of any nature and quality, contract rights that depend directly on the continued existence of property (such as a royalty based solely upon the output of a particular factory) or legal liability if the property is lost or damaged. 48 USA
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101. In American courts, the Eldon view was the traditional rule of law. However, in recent years, Lawrences test has been the most popular. Consequently, an insured has been held to lack the necessary insurable interest, even where it was the legal owner of the property, where it did not suffer a nancial loss in fact when the property was destroyed.1
1. See, e.g., Royal Ins. Co. v. Sisters of Presentation, 430 F.2d 759 (9th Cir. 1970) (condemned building).

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102 105

Chapter 3. Formation of the Insurance Contract

102. An insurance policy can be classied as a unilateral, aleatory contract. It is unilateral in that only one party (the insurer) makes a promise; the other party (the insured) makes that promise a binding legal duty by performing an act, the payment of a premium. In other words, the insured never makes an enforceable promise to pay the premium; he either pays it or he does not. If he does not pay it, there are no legal consequences, but if he does pay, the insurer has an obligation to perform. The contract is aleatory because the insurer promises only to do something upon the happening of an uncertain or fortuitous event; if the event never takes place, the insurer does not have to do anything in return for the premium. 103. For there to be a legally binding insurance contract, the following events must all take place. First, there must be an offer, usually an application prepared by or on behalf of the potential insured. Second, the offer must be accepted by the insurer or its representative. For property and casualty policies, a general insurance agent usually has authority to accept on behalf of the company, but for life insurance policies, acceptance takes place only at the home ofce. Third, the acceptance must be delivered to the offeror, either directly or through a designated intermediary. Fourth, and nally, the insured must pay the rst premium. 104. An insurance contract need not be in writing; it can be oral if all of the core terms have been made sufciently specic. Although most American jurisdictions have passed a Statute of Frauds that prohibits certain contracts unless they are in writing, most insurance policies are not covered by its prohibitions because they can be performed in less than a year. On the other hands, a few states do have specic statutes that require all insurance policies to be in writing.1
1. See, e.g., Massachusetts General Laws, Chapter 175, 177C.

105. Because life insurance companies typically require that applications can only be accepted at their home ofces, there can be a considerable delay between the date on which an application is submitted for approval and the date on which the company makes a nal decision to accept or decline the coverage. The necessary resulting time lag has led to two signicant legal doctrines. First of all, several courts have held that an insurance company that unreasonably delays acting upon an application is deemed to have accepted it and is bound by that fact alone.1 Other courts have taken a more moderate position and have found that an insurance company has a duty in tort to act upon an application in a reasonable time. If it 50 USA
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106 107

breaches that duty, and the applicant is injured as a result of the breach,2 the company is liable for the resulting damages.3
1. See, e.g., Talbot v. Country Life Ins. Co., 291 N.E.2d 830 (Ill. App. 1973). 2. Such as where the insured becomes uninsurable or dies while waiting for the company to act. 3. The leading case for this doctrine is Dufe v. Bankers Life, 139 N.W. 1087 (Iowa 1913).

106. Secondly, at times, an applicant for insurance may submit the rst premium along with his or her application. Insurance companies have been generally successful in convincing the courts that they should not be bound by accepting the rst premium to issue the policy requested by the applicant regardless of insurability. However, most courts hold that acceptance of the rst premium creates a temporary contract of insurance that provides coverage to the applicant until the company has either accepted or rejected the application. Some courts condition the creation of a temporary contract upon proof that the applicant was eligible for the insurance at the time the application was submitted. 107. The parties are bound by the language of the policy whether the insured has actually read it or not. Courts will reform a policy (change its language) only for a mutual mistake or a mistake on one side of which the other party was aware. The court must be satised that the parties came to a denite oral agreement but failed, through mistake, to embody that agreement into their policy.

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108 111

Chapter 4. Obligations of the Insured

1. Description of Risk 108. Anglo-American insurance law originated from private arrangements at Lloyds Coffee House in London. During the 16th and 17th centuries, it became popular for merchants and traders interested in obtaining insurance on ships or cargoes to go there and circulate among the gentlemen present a slip of paper containing information about the insurance he desired. Anyone interested in providing insurance on the trip or vessel would write his name underneath the description and the amount for which he was willing to be responsible in the event of a loss.1
1. This was the origin of the term underwriter.

109. Because of the limitations in communication and transportation at the time, the property on which insurance was sought was typically not available for inspection by prospective insurers. Moreover, it would not be unusual for a merchant to be seeking insurance on a vessel after the vessel had in fact been sunk or lost at sea. To allow insurance practice to continue, the English courts developed a number of doctrines to protect against fraud. Thus, the applicant for insurance had a duty of uberrimae dei utmost good faith. He was expected to disclose fully and accurately all of the information in his possession that might inuence a potential underwriter in deciding whether to accept or reject the risk. 110. If information provided by the applicant was specically referred to in the insurance policy itself, it came to be classied by the courts as a warranty. As originally formulated, a warranty had to be literally complied with or the policy was void. The importance of the material warranted was conclusively presumed. 111. On the other hand, if information provided by the applicant was not specically incorporated into the policy, the information was characterized as a representation. The falsity of a representation would not be a good defense for the insurer unless it could demonstrate that the representation was material to the risk, in that the insurer would not have agreed to insure the risk on the stipulated terms and price if it had known the true facts. The courts have also said that a misrepresentation will void the policy even if it was made inadvertently and without fraudulent intent. 52 USA
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112 116

112. Finally, the doctrine of uberrimae dei obligated an applicant to volunteer any information in his possession that he believes might be material to a potential insurer and that he believes the insurer does not know. In marine insurance, concealment of information under those circumstances voided the policy even where he did not know that the fact was material. 113. Over the years, those doctrines have been modied in all American jurisdictions by either legislation or judicial decision. The differences between warranties and representations have disappeared and all statements made are judged by the representation standard. In addition, in view of the extensive length of many insurance applications, courts generally hold that the applicant is entitled to presume that the insurer has asked about everything it deems relevant, and that there is no duty to disclose any data not specically requested in the application itself. 2. Payment of Premium 114. As noted above, it is the payment of the premium that converts the negotiations of the parties into a binding legal agreement. The insured is never legally obligated to make the payment, but payment is the consideration that he gives in return for the insurers promise to assume the transferred risk. It is the condition precedent to the formation of the contract and continued payment of premiums when due is necessary to continue the policy in force. This requirement is followed more strictly with respect to life insurance than other insurance; temporary initial coverage is frequently provided for re or liability insurance before the rst premium is actually received. In addition, some courts have held even in life insurance situations, that actual payment is not required and that tender of the premium is sufcient.1
1. See, e.g., Wanshura v. State Farm Life Ins. Co., 275 N.W.2d 559 (Minn. 1978).

115. There are a few other situations in which some coverage will be found even where there has not been a payment of the requisite premium. Where the policy also provides protection for a third party, such as a mortgagee, the policy will frequently provide that non-payment does not relieve the insurer of its obligations toward the third party until it gives the third party actual notice of the default and an opportunity to cure it. Also, where a life insurance policy has a cash surrender value or a dividend is due, the courts will require the company to use the value or the dividend to pay the tardy premium and avoid a forfeiture. Finally, with respect to certain types of insurance such as automobile liability insurance, some jurisdictions require the insurer to provide actual notice of cancellation before the insurance can be terminated. 116. Generally speaking, the premium must be paid in cash. Problems have arisen when an insured has paid his premium by check and the check is subsequently dishonored. Most courts hold that the check is merely conditional payment and payment does not occur until the insurer has received cash or credit.1 However,
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Part II, Ch. 4, Obligations of the Insured

other courts have found that the check is the premium payment and if it is dishonored, the insurer can sue the drawer of the check but cannot cancel the policy.2
1. See, e.g., Snowden v. United of Omaha Life Ins. Co., 450 So.2d 731 (La. App. 1984). 2. See, e.g., Statewide Ins. Corp. v. Dewar, 143 Ariz. 553, 694 P.2d 1167 (1984).

117. By law in many jurisdictions and by custom and practice in others, life insurance policies and other personal insurance policies include a grace period of 30 or 31 days after the due date. Payment made at any time during that period allows the policy to continue in effect without a gap in coverage. This is true even where payment is made after the insured individual has died but before expiration of the grace period. Occasionally, an insured will give notice of intent to discontinue a policy upon the due date of the next premium. If the insured dies within the grace period after that date, the courts are split over whether the insureds notice effectively waived the grace period. It would be wiser for the insured to simply allow the policy to lapse. 3. Obligations in the Case of Insured Event 118. With respect to property or liability insurance, the rst obligation of the insured is to give the insurer notice of the loss. The purposes of that notice are to give the company an opportunity to investigate while events are fresh in everyones mind, not only to determine the facts of the incidents but also to enable the insurer to ascertain its rights and liabilities. The notice requirement also acts to reduce the opportunities for fraud. Some policies obligate the insured to give notice within a specied number of days after an event has occurred that might give rise to a policy claim, but most insurance requires only that the insured give notice as soon as reasonably practicable. Even where the policy contains a xed time obligation, most courts will extend it for a reasonable time. 119. The courts have generally construed notice requirements liberally in favor of the insured. Failure to give timely notice is excused if the insured has a reasonable excuse for its delay. Notice need not be in writing unless the policy so species and notice from a third party (typically an injured claimant) is sufcient. Even where an insured failed to give notice and has no excuse for his dereliction, the delay is not a valid defense for the insurer unless the insurer can prove that it was prejudiced by the insureds inaction. 120. With respect to property and life insurance, the insured is required to le a formal proof of loss in order to receive payment. For life insurance, the company only needs proof of the death of the cestui que vie (cqv) and usually a death certicate is sufcient. If no certicate is available, a formal statement of the attending physician or an obituary notice will sufce. More detail may be required in two situations: (a) where the policy provides double indemnity benets in the case of accidental death, or (b) where the cqv has disappeared and no body has been found. For property insurance, the proof of loss must set out the details of the 54 USA
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claim the time and cause of loss, estimates of the cost of repair or replacement and documentation of other expenses. Failure to le the required proof of loss is usually not a good defense for the insurance company, but intentional concealment or misrepresentation will invalidate the policy. 121. There is an additional duty imposed upon insureds who wish to le claims under property or liability insurance and that is the duty of cooperation. So far as property insurance is concerned, the insured is expected to cooperate in all investigations of the claim, to show the damaged property, submit to examination under oath and produce all relevant books and records. In liability insurance, the duty to cooperate obligates the insured to forward all demand letters and litigation documents to the insurer, attend depositions and hearings, furnish information for answering interrogatories, supply evidence and assist defense counsel. The duty also includes some negative obligations: the insured must not admit liability, make payments to or engage in settlement discussions with third-party claimants or assist the third party in pursuing an action against the insured or the insurer. 122. Any non-cooperation must be substantial and material to invalidate coverage. Moreover, the insurer must demonstrate that it made diligent efforts to secure cooperation before it can raise lack of cooperation as a defense.

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Part III. Property and Liability Insurance

Chapter 1. Fire Insurance

149. Fire insurance is the oldest form of insurance sold in the United States. The rst re insurance company, the Philadelphia Contributionship for Insuring Houses from Loss by Fire, a mutual company, was established in 1752, with Benjamin Franklin as one of its rst directors. Fire insurance is also the most standardized insurance: by law in most states, the 1943 New York Standard Fire Insurance Policy is the only permissible form. 150. The standard re policy covers losses, damages or injury to the insured property of which re or lightning is the proximate cause, as well as direct loss resulting from the removal from the premises of property endangered by re or lightning. It covers re caused by Acts of God, accident, negligence, or any manner other than by the insureds arson. There are, however, two limitations on this general proposition. First of all, the term re, though not dened in the policy, is limited to combustion accompanied by visible heat or light. Secondly, most courts have established an implied exception for friendly res, and limit recovery to hostile res. A friendly re is one that is contained in a usual and ordinary place for re, such as a stove or furnace, while a hostile re is one which is in a place not intended for re to be or which has escaped its ordinary, friendly connes. Thus, there is no recovery under a re policy for property that was inadvertently thrown into a burning replace, but there is recovery for damaged caused by sparks from the re that have fallen out of the replace onto an adjacent rug or sofa. 151. The measure of recovery is the actual value of the property at the time of loss, but not exceeding the amount which it would cost to repair or replace the property with material of like kind and quality within a reasonable time after the loss. However, the insurer has the option under the policy, in lieu of paying the cost of repair to the policyholder, to declare the property a total loss and take the property at its agreed value, or to make the repair or replacement itself; however, the insurer who wishes to do so must make its election reasonably promptly. 152. Before 1943, re insurance policies contained a number of moral hazard clauses declaring the policy to be void in specied circumstances, such as where the insured was not sole and unconditional owner of the property, or if there was any change in interest, title or possession except by death of an insured. However,
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Part III, Ch. 1, Fire Insurance

the standard policy now provides for only two such qualications. The company is not liable for loss occurring while the hazard is increased by any means within the control or knowledge of the insured, or while the property is vacant or unoccupied beyond a period of sixty consecutive days.

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153 155

Chapter 2. Loss of Benets Insurance

153. Property insurance policies do not provide coverage for the economic consequences occasioned by the loss of use of insured property, only for injury to the property itself. The economic consequences, especially in the case of commercial property, which result from the loss of use of the structure while it is being repaired or rebuilt can be as much or greater than the reconstruction costs. Separate insurance coverage to indemnify these risks is variously referred to as use and occupancy, loss of rents or prots, or business interruption insurance. These coverages are commonly added as endorsements to property insurance policies. They are intended to protect the earnings which the insured would have enjoyed had the event insured against not intervened and not to place the insured in a better position than it would have been in had no business interruption taken place. 154. Business interruption policies may be either valued, in which the value of the loss is xed in the policy, or open, in which the amount of loss must be determined by competent evidence, with a possible upper limit set by the policy. With an open policy, the measure of damages is typically the reduction in gross earnings, less charges and expenses which do not continue during the interruption, for the period of the interruption, not to exceed the length of time that would be required to rebuild, repair or replace the property. Recovery can be had for normal charges and expenses that might be avoidable during the business cessation period, but which are necessary to resume normal operations. Even where the continued operation of the insureds business would have resulted in a net loss, xed charges and continuing expenses are recoverable to the extent that they exceed the projected loss. 155. Business interruption protection is property specic. There must have been actual loss or damage to insured property from a covered peril. In addition, there must have been a total suspension of operations directly produced by that loss or damage and not merely a decline in operations or sales. As a general rule, if there is a closure of the business by civil authorities without physical damage, there is no business interruption recovery. However, it has been held that, where business operations conducted at covered and noncovered properties are interrelated and interdependent, damage to the noncovered property which causes a business interruption at the covered property can be the basis for recovery.1
1. National Union Fire Ins. Co. v. Anderson-Prichard Oil Corp., 141 F2d 443 (10th Cir. 1944).

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156 159

Chapter 3. Marine Insurance

156. A marine insurance policy is a contract whereby one party, for an agreed consideration, consents to indemnify the other against loss or damage arising from risks incident to maritime activities or, generally, the navigation and commerce of the sea. Originally such insurance provided coverage only to property on the high seas. It was then extended to also cover navigation on inland lakes and rivers and then to land transportation as well. The traditional marine insurance is referred to as ocean insurance, while the policies covering inland waterways and land transportation are known as inland marine insurance. 157. Federal courts in the United States hear marine insurance disputes as part of their jurisdiction over all cases of admiralty and maritime jurisdiction. However, in 1955, the Supreme Court held that, in the absence of a controlling Federal admiralty principle to guide the resolution of a particular issue, the Federal courts must apply the applicable state law rule.1
1. Wilburn Boat Co. v. Firemans Fund Ins. Co., 348 U.S. 310.

158. There are generally three types of marine insurance policies: hull insurance, which covers loss or damage to owned vessels, including damage to vessel appurtenances and unowned equipment for which insured is responsible; cargo insurance, which covers goods while they are in transit aboard the vessel; and protection and indemnity (P&I) which protects shipowners for liability claims that arise in connection with the operation of the enrolled ship. 159. There a number of different options available for marine property insurance. The insured property can either be valued, in which the parties agree in advance on the monetary worth of the property, or open, in which the parties must determine the value at the time the risk attached. In actual practice, most marine insurance is valued. The coverage can be for a specic time period or for a specic voyage. Most hull insurance is written for a period of time while most cargo insurance is for a voyage. It can be either all risk or for specic perils. The risk normally covered by marine insurance policies are perils of the sea, war risk, barratry and Inchmaree clause. The perils of the sea risks are fortuitous losses occurring through extraordinary action of the elements at sea or an accident or mishap in navigation. It does not include ordinary wear and tear or losses which are anticipatable as regular incidents of sea carriage in general or navigation in a particular part of the world. War risk refers to piracy, acts of enemies and arrests 68 USA
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and restraints of Kings, princes and people. Barratry covers all acts committed by a vessels master or crew in disobedience to the owners instructions or for their own purposes. The Inchmaree clause was developed after the House of Lords excluded coverage for damage caused by the malfunction of a valve in the Inchmaree case.1 The clauses indemnies losses from the negligence of the ships master or crew or latent defects in the ship.
1. Thames & Mersey Marine Ins. Co. v. Hamilton Fraser Co., 12 App. Cas. 484 (H.L. 1887).

160. The term average in marine insurance refers to the loss suffered. Most marine insurance is written either free of particular average, which means there is no coverage for partial losses, or with average, which provides coverage for partial losses exceeding 3 per cent of the value of the goods in question. Insurers also cover general average, which refers to a loss suffered or expense incurred during a voyage to avert a peril that threatens the entire voyage. When that occurs, the party sustaining the risk has the right to claim contribution from all who participate in the voyage. 161. A total loss can be either actual or constructive. An actual total loss takes place when the goods or ship cannot arrive at their destination in specie, even if the goods still exist and can be sold where they are. A constructive total loss occurs in American law if the cost of the repairs needed to enable the insured property to reach its destination in specie exceeds half the value of the goods.1 If the insured wishes to claim a constructive total loss, he must formally abandon the insured property to the insurer promptly upon the loss.
1. Under British law, costs of repairs must exceed the total value of the property.

162. There are two other signicant differences between American maritime law and property law. First of all, marine policies are not regarded as personal in nature; consequently, they are freely assignable without the prior consent of the insurer. Secondly, because marine policies were traditionally written on property far removed from the site of the insurance transactions, the insuring parties are held to a standard of the highest delity in their dealings. The doctrine of uberrimae dei obligates the assured to volunteer information which might have a bearing on the scope of the risk assumed, and the failure to do so will allow the insurer to avoid the policy. Such concealment is not a ground for voiding other property insurance policies, unless it can be shown that the insured deliberately concealed information that he knew was germane to the insurer.

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163 165

Chapter 4. Liability Insurance

163. Liability insurance is a contract whereby one party, the insurer, agrees, for a premium to protect the other party, the insured against sums the insured is legally obligated to pay as a result of injuries suffered by a third party. This insurance originally was intended to protect the property of the insured against seizure to pay those claims, but it is now viewed principally as the main assets available to compensate the injured parties for their losses. Because the extent of personal liability is not related to either the property or activities of the insured, liability insurance policies have a xed maximum amount that the insurer can be obligated to pay. Parties will customarily purchase bands of liability insurance from different insurers to cover their anticipated risks.1
1. For example, an insured might purchase a primarily policy protecting it against losses of up to $500,000 per year, a second policy covering losses over $500,000 but under $2,000,000 and a third policy indemnifying for losses of $2,000,000 to $5,000,000.

164. Liability policies are sold for a xed period of time, usually one year, and provide coverage only if certain events occur within that period. Historically, liability policies have traditionally been occurrence policies, meaning that they provide coverage if there has been an occurrence during the period the policy was in force. Although the precise denition of occurrence has always been controversial, it generally means damage or injury resulting from a fortuitous act or event. In other words, the duty of the insurer depends solely upon the date that the injury is sustained, and is not affected by the time the fortuitous act may have taken place, the date on which the injury was discovered, the date on which a claim was made or the date on which liability was imposed. Because this type of policy has proved to be unsatisfactory to insurers in many situations where a considerable time period can elapse between the date of injury and the date on which liability is ultimately determined, the industry in the 1980s developed a second form of liability policy, the claims made policy. Under a claims made policy, the insurance companys responsibility is determined by the date on which a claim is made to the insured, regardless of the date on which the fortuitous act took place, or the injury was sustained or discovered. Claims made policies were originally intended to totally replace occurrence policies, but because of resistance from consumers and regulators, most liability insurance is still occurrence based. 165. Liability insurers not only indemnify insureds against the sums that the insureds may be legally obligated to pay, they also agree to provide a defense against any lawsuit seeking such damages. Limits on the amount of damages an 70 USA
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166 168

insurer will pay do not apply to the sums expended to provide a defense, and it is not unusual to nd that the defense cost more than the ultimately liability. Also, the duty to defend arises at the outset of the litigation before there has been a determination as to whether the insured is liable for anything or the basis of possible liability. Consequently, the duty to defend is broader than the duty to indemnify, and arises in every case where there is a possibility that the suit could lead to a judgment that the insurer would be obligated to pay. The parameters of the duty to defend is one of the most hotly litigated issues in American liability law. 166. The standard liability insurance for businesses is the commercial general liability policy (customarily referred to as the CGL) which has been written since 1940 in a standardized format produced, and periodically revised, by the Insurance Service Ofce. Coverage A indemnies the insured for damages because of bodily injury or injury to tangible property. The coverage is subject to a large number of exclusions, some of which, such as exclusions for injury to employees or the insureds own property or automobile injuries, are intended to avoid duplication with other standard policies. The most important other exclusions are for damages caused by pollution and for intentional injuries. Coverage B protects against intangible injuries arising from slander or libel or related offenses. It excludes coverage for the knowing publication of false statements, or material that was rst published before the start of the policy period. 167. Parties in particular businesses will supplement their CGL policies with specialized policies to cover the specic risks of their trades. The most important of these specialized policies are errors and omissions or professional liability policies, taken out by physicians, lawyers, architects, accountants, engineers, brokers, veterinarians, nurses and the like. These policies provide coverages from damages arising from the performance of or the failure to perform the professional services for which the insured has received specialized training. They are customarily referred to as malpractice insurance. Unlike CGL policies, they apply to purely economic loss to the third party, as well as bodily injury or property damage. In addition, the overwhelming bulk of professional liability policies are written on a claims made rather than an occurrence basis. Finally, because of the impact of successful malpractice actions on the reputation of most professionals, malpractice policies typically contain a provision barring the insurer from settling a case, even within policy limits, without the consent of the insured. 168. Outside of the business context, most individuals are primarily concerned about liability resulting from automobile accidents. Motor vehicle insurance will be discussed in a subsequent section. However, individuals are also covered for a variety of non-business, non-automobile liability risks by their homeowners or renters insurance. These policies provide coverage away from their premises as well as upon them. Not surprisingly, there are many situations in which it is not clear whether a particular risk is business-related, automobile-related or personal.1
1. See, e.g., Amco Ins. Co. v. Beck, 929 P.2d 162 (Kan. 1996) (babysitting by teenage daughter is not a business pursuit; Allstate Ins. Co. v. Pacheco, 851 F.2d 257 (9th Cir. 1988) (moped is not a motorized vehicle).

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Chapter 5. Legal Aid Insurance

169. Insurance to indemnify legal expenses generally, as distinguished from indemnifying of legal expenses that are incidental to other insurance, is relatively new in the United States. Prior to 1960, the canons of professional responsibility for attorneys in most states prohibited lawyers from participating in any group service arrangements except arrangements offered under the auspices of the local bar association. However, in a series of decisions during the 1960s, the Supreme Court of the United States invalidated most of those prohibitions as unconstitutional. By 1971, the Court specically held that collective activity undertaken to obtain meaningful access to the courts is a fundamental right within the protection of the First Amendment.1 In response to these decisions, almost all states have amended their legal ethics codes to permit lawyers to participate in a dignied manner in legal service plans, so long as they comply with general rules about condentiality and solicitation.
1. United Transportation Union v. State Bar of Michigan, 401 U.S. 576, 585 (1971).

170. Prepaid legal service plans are primarily offered by labor unions to their members and employers to their workers, although there are a number of such plans being marketed generally to the public by insurance companies and other third parties. The scope of those plans varies widely. Most utilize the services of a select panel of lawyers, although subscribers are usually free to go to other attorneys for an additional fee. The most basic offerings cover only the answers to simple legal issues over the phone and the drafting of uncomplicated documents such as simple wills or short letters. More comprehensive plans may provide for personal legal consultation at the attorneys ofce, the preparation of more complex legal documents and some trial and negotiation representation. More extensive services are usually made available at a discounted rate. The plans will usually provide only limited coverage for members facing criminal charges or those with pre-existing cases. In addition, employer-provided plans will typically provide no coverages for actions against the sponsoring employer. 171. Prepaid legal expense plans are regulated as insurance in at least 32 states.1 In additional legal service plans offered by employers are considered to be employee benet plans and are subject to Federal regulation under the Employee Retirement Income Security Act of 1974 (commonly known as ERISA).
1. New York has permitted licensed insurance companies to provide experimental prepaid legal service plans since 1984. The authorization for such policies is scheduled to expire in 2003. NY Ins. Law 1116.

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172 175

Chapter 6. Aviation and Space Insurance

172. Aviation insurance developed in the United States as a specialized product during a time of limited demand. The need to spread the risk and expenses led individual companies to combine into pools to write aviation policies. Even today, few insurance companies independently write this type of insurance. The largest share of the market is handled through two major pools, which utilize one of their number to act as pool manager on behalf of the members. All policies are issued in the name of one or more companies in the group, but are shared by all participating members on a proportionate basis. 173. Aviation hull insurance1 provides coverage for physical loss or damage to the listed aircraft. The policy may be written on a specied peril basis or on an all-risk basis. There are three general categories of all-risk hull coverage: (a) all-risk-not in motion,2 (b) all-risk-not in ight;3 or (c) all-risk-ground and ight.4 Even the all-risk policies can contain a number of exclusions, such as for loss of use caused by general wear and tear or mechanical breakdowns, war risks, undisclosed leases and bailments or wrongful conversion. Loss of use insurance is also available to protect an aircraft owner or operator from loss of earnings while the aircraft is out of service.
1. The name reects the marine insurance origins of the coverage. 2. Which provides coverage while the airplane is on the ground and not moving under its own power. 3. Which covers physical damage while the aircraft is stationary or taxiing. 4. Full coverage on ground or in ight.

174. Aircraft liability insurance indemnies the insured against damages arising out of the ownership, maintenance of use of the aircraft. The liability policies may include the following coverages: (a) bodily injury excluding passenger liability, (b) passenger liability, (c) property damage liability and (d) medical payments. Property damage coverage usually excludes damage to baggage or cargo, but this coverage may be purchased separately. Guest voluntary settlement coverage is also available, which provides payments up to a specied limit to a settling passenger, regardless of the insureds legal liability, in return for a release of liability in favor of the insured. 175. Airport owners and operators liability insurance is also available to indemnify against damages sustained by third parties on the airport premises or as a
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result of airport operations. There are three basis types of coverage: (a) airport premisesoperations,1 (b) hangar-keepers liability2 and (c) product liability.3
1. Which covers bodily injury or property damage arising out of the ownership, maintenance of use of the airport and all operations on or away from the airport that are necessary or incidental to airport activities. 2. A form of bailee insurance that protects against damage to aircraft owned by others in the custody of the insured. 3. Coverage for damage arising out of the possession or use of goods or products manufactured or serviced by the insured after such goods have left the possession of the insured.

176. In 1951, the United States Government instituted a program to provide war-risk insurance to American air carriers which provide service between the United States and a foreign country when (a) such insurance cannot be acquired from a domestic commercial insurance company on reasonable terms and conditions and (b) the president determines that foreign policy or national security objectives would be threatened if air service to certain foreign destinations could not be continued. The legislation was amended in 1977 to provide insurance and reinsurance to American air carriers to cover any risk arising from the operation of an aircraft if insurance cannot be obtained on reasonable terms. It was amended again after 11 September 2001, to allow the Secretary of Transportation to reimburse any air carrier for the increase in the cost of insurance, with respect to a premium for coverage ending before 1 October 2002 over the insurance premium that was in effect for a comparable operation during the period from 4 September 2000 through 10 September 2001.

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Part IV. Motor Vehicle Insurance

205. The standard private motor vehicle insurance policy contains four components: (a) liability, (b) medical payments, (c) uninsured motorist and (d) physical auto damage.

Chapter 1. Liability Insurance

206. A motor vehicle liability policy is generally similar to other liability policies, in that it covers bodily injury or property damage for which any insured becomes legally responsible arising out of the ownership, maintenance or use of a motor vehicle. It is distinctive primarily in its breadth. The policy applies to both the named insured and to the covered vehicle. The named insured or any member of their family is protected with respect to any motor vehicle accident, whether a covered vehicle was involved or not. In other words, the named insured would be covered by his policy even if he had an accident while driving the car of a friend. In addition, anyone else is insured for an accident while driving the covered vehicle, so long as the driver who was using the vehicle had a reasonable belief that he was entitled to operate the car. Thus, it is not unusual to have a situation where there are two different liability policies indemnifying the defendant. 207. Since the 1920s, automobile liability insurance has been regarded as the principal source of funds to compensate injured automobile accident victims. Consequently, the State of Massachusetts started the trend of requiring every person who wished to register a vehicle in the state to demonstrate that he has liability insurance, or to post a bond or other assets as security for the payment of judgments. Other states quickly followed Massachusetts lead, and by the turn of the 21st century, compulsory motor vehicle laws had been enacted in 47 states plus the District of Columbia. These statutes require owners (and sometimes drivers) to purchase a minimum amount of liability coverage. The minimum is usually expressed as a combination of three numbers, such as 10/20/5, which would mean coverage of $20,000 for all persons injured in a single accident, with a limit of $10,000 for one person, plus $5,000 property damage coverage. The statutory limits are generally quite low. 208. The damages indemnied by standard liability insurance are imposed under the common law tort system, which means that the victim can recover only by establishing that his injuries or losses were caused by the fault of the driver or
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Part IV, Ch. 1, Liability Insurance

owner of the vehicle. To obviate the hardships caused by this limitation, a number of states have passed no fault statutes which provide compensation from the owner or driver to auto accident victims in a covered vehicle for their medical and funeral expenses and lost wages, regardless of fault. In some states, such a no fault system totally replaces the common law tort system for automobile accidents, so the victim cannot sue a negligent driver for additional damages. In others, the no-fault system bars tort actions against negligent drivers unless the damages sustained by the victim exceed a specic threshold in terms of injury severity or total medical expenses. A third group of states provide for no-fault benets without affecting the right of the injured party to seek more money for pain and suffering from a driver or owner who was at fault.

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209 210

Chapter 2. Medical Payments

209. Medical payments coverage is required in some states and offered as an option in all others. It pays reasonable expenses for medical and funeral services sustained by an insured in an auto accident. Insured is dened to mean the named insured and any member of his family while occupying or being struck by any motor vehicle, plus any other person who was injured while occupying a covered vehicle. 210. The coverage contains a maximum amount that will be paid for each injured person, but not a total limit for each accident. In addition, the insurance will pay only those expenses incurred for services rendered within three years from the date of the accident.

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Chapter 3. Uninsured and Underinsured Motorists Coverage

211. Uninsured motorists coverage is a hybrid insurance that has been offered in the United States since the middle of the 1950s. It is a rst party insurance which pays benets to the persons identied as insureds in the policy. But it is also a faultbased system, because benets are paid only if the insured can establish that he sustained an injury (usually only bodily injury) that was caused by the fault of an uninsured motorist. In other words, the insured must show that he has the right to recover damages from a tortfeasor who carried no liability insurance. On the other hand, the insurance company can defend by establishing that the injury was caused by the fault of its own insured and not by the uninsured third party. 212. Most states expressly require insurers to offer uninsured motorists protection. In less than half of the states, every policy of automobile liability insurance offered in the state must include an uninsured motorists insurance endorsement. In the remainder of jurisdictions, it must only be offered with every policy, and the policyholder has the right to either reject it or select lower limits. 213. An insurance company will customarily charge a separate premium for uninsured motorists coverage on every vehicle owned by a particular insured. Thus, situations frequently arise where the insured owns four vehicles and sustains a severe bodily injury in an automobile accident while driving one of his cars due to the fault of an uninsured driver. If his damages are greater than the amount of uninsured protection on that car, he may seek to recoup the balance of his damages under the uninsured motorists protection on his other three vehicles. This practice is known as stacking. If the policy contains no language to the contrary, most courts will permit stacking. As a result, insurers routinely insert anti-stacking clauses in their standard automobile policies. The courts will generally enforce those clauses, although a small number of courts have invalidated them as contrary to public policy.1
1. See, e.g., Allstate Insurance Co. v. Morgan, 575 P.2d 477 (Hawaii 1978).

214. Underinsured motorists coverage, as the name implies, provides compensation where an insured is injured by a tortfeasor who carries some liability insurance, but the limits of that insurance are too low to fully compensate the insured for the injuries he sustained. Under some policies, the underinsured motorists protection will pay the difference between the amount of insurance the tortfeasor carries 88 USA
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and the amount of liability insurance carried by the injured party. Under another type of uninsured motorists protection, the injured party receives the full amount of the uninsured motorists coverage on top of the tortfeasors protection, if necessary to compensate him fully for the damages he sustained.

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Chapter 4. Physical Automobile Damage

215. American insurers offers two types of property insurance to protect the motor vehicles of the insured. One type is collision coverage which is dened in the standard auto policy as the upset of your covered auto or a non-owned auto or their impact with another vehicle or object. The other coverage is comprehensive coverage, which protects against damage caused by perils that are not collisions. The distinction between the two coverages is not important if the insured has purchased both types, but it can be crucial where the insured carries one but not the other. There has been a great deal of litigation on borderline situations where the insured has only of the coverages, such as a case where the car is damaged by a falling object. The results of these cases are irreconcilable.

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Part V. Insurance of the Person

Chapter 1. Workers Compensation

216. The ability of employees to recover from their employers for damages arising from work-related injuries changed dramatically in the early part of the 20th century. Prior to that date, workers could recover only if they could prove that their injuries were caused by the negligence of their employers. In addition, the employer could escape liability by showing that the employee was contributorily negligent, the harm was caused by a fellow worker or the employee assumed the risk by working under obviously hazardous conditions. However, in the rst third of the twentieth century, all of the states passed workers compensation statutes1 that radically altered the legal relationship. Although these laws vary in a number of specic details, their general approach is to permit workers to recover without regard to the negligence of their employers or the cause of their injuries. All they have to show is that their condition arose out of and in the course of their employment. Their recovery is limited to economic loss without compensation for pain and suffering or compensatory or punitive damages. In return, they give up their right to sue their employers in tort for the same injuries.
1. Called at the time workmens compensation.

217. The workers compensation system is a program of statutorily mandated social insurance nanced by private companies. In most states, the employers are generally required to obtain insurance policies from private companies. In other states, they purchase the protection from a special state fund. However, employers who can satisfy certain nancial criteria are allowed to self-insure their compensation liability. 218. Workers compensation recoveries were originally limited to employees who suffered traumatic accidental injuries. However, the system has been expanded everywhere to also include coverage for occupational diseases. The disease coverage is limited to ailments that are natural to or inherent in the claimants work; in other words, there must be a nexus between the employees work and the medical condition. Diseases common to the population as a whole are covered only if the claimants employment increased the risk of those conditions. 219. Qualifying employees are entitled to recover their medical expenses, without limits on either amount or duration. They can be compensated for all reasonably
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220 221

Part V, Ch. 1, Workers Compensation

necessary medical treatment and necessary physical or occupational rehabilitation, including where appropriate such items as therapeutic hot tubs or swimming pools. They also are entitled to earnings replacement of one-half to two-thirds of their average weekly wages up to a statutory maximum. Employees receive replacement of their lost earnings until they are able to return to their regular employment or their healing has reached the point of maximum medical improvement. If, when they reach the point at which no more healing is possible, their condition has stabilized at less than their preexisting capacity, they become eligible for permanent partial disability or permanent total disability. In some states, the statues contain a schedule of benets that are paid automatically to claimants who have sustained certain common injuries, such as the loss of one or both legs, arms or eyes. Otherwise, unscheduled benets are awarded in the form of either continued weekly or lump sum payments based on estimates of the future impairment of earnings resulting from the claimants injuries. These estimates are based upon the claimants age, education training and employment history. The controlling factor is the difference between the employees earnings potential with his injury and the amount of money he would have been likely to earn in future years but for the jobrelated injuries. 220. As a general rule, employers are required to take their employees as they nd them, and to compensate for work-related injuries or diseases even where those injuries were caused or aggravated by pre-existing conditions. However, a number of states have a second injury fund, to encourage employers to hire workers who have sustained a previous injury. In a state with such a fund, the successive employer is not liable for additional consequences generated by the pre-existing conditions. The employer must provide compensation only for the portion of disability benets attributable to the most recent occupational injuries and the second injury fund pays the balance. The second injury fund is usually nanced by state appropriations or special employer assessments. 221. In return for providing these benets, employers receive tort immunity with respect to the statutorily covered illness and injuries. They cannot be sued for those damages by either the injuries employees or their dependents. The immunity also extends to negligent fellow workers or supervisors. The only exception is for intentional misconduct or where the employer fails to obtain the required compensation insurance. Immunity is even recognized for gross negligence so long as it falls short of intentional injury. The immunity does not extend to non-employer third parties such as suppliers of defective equipment or dangerous products.

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222 224

Chapter 2. Bodily Injuries

222. There are several types of insurance policies available to indemnify persons who suffer bodily injuries as the result of an accident.1 An individual can buy an accidental death life insurance policy that will pay a xed sum if the insured dies accidentally, either as an independent life insurance policy or as extra coverage on a standard life insurance contract. Insurance is available to compensate a person for his earning loss if the person sustains injuries that disable him from employment. Specialized trip insurance can be purchased (usually at an airport) to provide compensation if the insured is injured or dies in a specic airplane ight. Finally, health insurance can be purchased to indemnify the insured for hospital or medical expenses incurred to treat the bodily injury. This latter insurance will be covered in the next chapter.
1. The term accident is broadly dened to encompass any kind of traumatic event other than an intentionally self-inicted injury.

223. Accidental death insurance differs from conventional death insurance because, with few exceptions,1 the cause of death is immaterial for a conventional policy. However, with an accidental death policy, the insurance will pay only if the insured died as the result of an accident. In addition, accidental death policies normally include exclusions that are not found in conventional policies, such as suicide, war, physical or mental disease or ailment and death by poison, chemical or gas fumes. Because the scope of coverage of accident insurance is much smaller than conventional insurance, it can be offered at much lower rates. And, because accidental death is a major cause of mortalities for younger people, it is often specially attractive to them.
1. For example, suicide within several months after purchasing the policy.

224. Accidental death policies have occasioned considerable controversy and litigation in a number of areas. The rst is dening the term accident. Although insurers have vainly tried to limit accidents to unexpect events arising from external causes, the courts have not been hospitable to their narrow position. The insurance industry has tried to limit its liability by dening accident narrowly in their policies, using terms such as if suffered through accidental means or if occasioned by any external or material cause operating on the person of the insured, but these efforts were not particularly successful in litigation. Secondly, there has been a great deal of controversy over whether a particular accident actually caused the death in question, or whether the death should be attributed to a different cause,
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Part V, Ch. 2, Bodily Injuries

such as a pre-existing disease or inrmity. Much judicial rhetoric has been devoted to the determination of which event should be characterized as the dominant contributor to the death. In addition, accidental death policies typically contain a provision requiring that the death must occur within a specic number of days after the accident. Where medical science has enabled people to stay alive for months or even years after the traumatic event before succumbing, beneciaries have argued that the time period limitation should be invalidated as a matter of public policy. Those arguments have not been successful in the majority of cases. 225. The second form of protection for people who suffer a bodily injury is disability insurance, which replaces income lost as a result of the injury. Disability insurance is not very popular in the United States, primarily because there are government programs that replace a modest amount of income when a person becomes totally disabled and because workers compensation provides income replacement for anyone who is injured on the job. But it is popular to some extent with professionals and middle level managers. The major question is dening disability because a person is either disabled or he is not; disability insurance does not provide payments to anyone who is merely partially disabled. There are two principal types of disability insurance. One is the occupational disability policy which provides payment if the insured is unable to transact the duties of the particular occupation in which the insured is then engaged. The other is the general disability policy which will pay only if the insured is unable to pursue any occupation for which he is reasonably suited by education, training or experience. Because disability insurers are concerned about malingering, especially in times of economic recession, disability policies normally provide benet only after a considerable waiting period, usually 90 to 180 days. 226. Travel insurance provides stipulated benets if the insured dies or is injured in ight. These policies are typically sold at airports through special counters or vending machines; the insured lls in his intended ights and mails the form to the company usually just before he starts his journey. The policy provides coverage only if the policyholder dies or is injured during the ights he indicated. Because the policyholder has almost no opportunity to read the policy before deciding to purchase it, the courts have generally interpreted them generously in favor of coverage.

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Chapter 3. Private Health Insurance

227. More than half of the American population either has no health insurance or obtains it through a variety of government programs. The overwhelming majority of citizens with private health insurance obtain it through group plans, primarily offered by their employers as a fringe benet. In some plans the premiums are wholly paid by the sponsoring employer; in others, the sponsor and the employees split the cost of the insurance, and in others the insurance is made available by the sponsor strictly as an accommodation, and the premiums are borne wholly by the individuals. The amount of the premiums for these plans are usually retro-rated, in that the annual premium for any given year is based upon the experience of the group in the preceding year. The level of coverage and benets varies widely from plan to plan and is often renegotiated regularly to keep premiums costs in line with expectations. Individual heath insurance is available for those individuals who are not eligible for either government or group coverage, but individual policies are usually so costly as to be beyond the economic reach of the bulk of the population. 228. Traditionally, health insurance has been provided on a fee for service basis, in which the individuals sought treatment from any health care provider of their choice, and then obtained reimbursement for their expenses from their insurer, subject to prescribed reimbursement limits, deductibles and the like. However, over the years, a number of alternative arrangements, which can loosely be called managed care evolved as an alternative. The rst of these arrangements was the Blues, Blue Cross and Blue Shield, which were established by the medical and hospital communities during the 1930s when they were having trouble getting payment for their services. Blue Cross and Blue Shield members would pay a monthly fee, which would entitled them to receive treatment from any participating provider (which usually was the bulk of the medical and hospital community) at no additional cost; the doctor or hospital would be paid directly by the insurer. As originally established, the Blues possessed a strong community service component, and they offered their plans on a community-rated basis, in which everyone paid the same premium regardless of age or health condition. In return, they received a number of special benets from the government, such as tax exemptions and preferential charges from doctors and hospitals. However, with the growth of group insurance, these plans were unable to compete and the Blues now primarily offer group insurance that is indistinguishable from group offerings of other insurers. 229. As the cost of health insurance escalated through the 1970s, a new form of managed care developed to control health insurance costs. The most prominent of
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these new types of insurance came to be called health maintenance organizations or HMOs. The HMOs maintain their own staff of doctors and hospitals under contract and require members to obtain all of their medical services from the staff providers. In return, the HMOs are able to control health costs and keep premiums low. A more exible form of managed care are called preferred provider organizations or PPOs. A subscriber to a PPO can obtain health care from any physician or doctor, but the insurer picks up a larger portion of the medical charge if the patient gets service from a preferred provider within the PPO network. The preferred providers agree to accept lower payments for their services and to follow the PPOs health care utilization guidelines. HMOs and PPOs were regarded for many years as the salvation of the health care cost concerns, but dissatisfaction by doctors and patients alike at their requirements and restrictions turned them into health care villains in the 21st century. 230. The limitations and restrictions in private health insurance plans have given rise to considerable legal controversy. They do not provide indemnication for every service provided by a doctor or a hospital; only for those that are medically necessary. In addition, they will generally exclude coverage for experimental treatments, which have not been shown to provide cost-effective results. In addition, health insurers seek to minimize adverse selection by denying reimbursement for treatment of pre-existing conditions which had manifested themselves before the patient enrolled in the health care program. All of these exclusions have been fertile sources of litigation with inconsistent and irreconcilable results. 231. Since the 1980s, the United States Federal and state governments have enacted a large number of statutes regulating the practices of private health insurers. In 1986, the Federal Congress passed a statute known as COBRA,1 which permitted employees who lose eligibility for group insurance through an employer to continue to receive health insurance at group rates for up to 36 months. In 1996, it adopted HIPPA,2 which eased health care restrictions for employees who changed jobs and health insurance plans. In addition, both the Federal government and various state governments have passed statutes mandating that specic benets must be provided in all health insurance policies. This trend toward greater governmental involvement in the terms and conditions of health insurance policies is likely to continue indenitely.
1. 29 United States Code 1161 68. COBRA stands for Consolidated Omnibus Budget Reconciliation Act. 2. The Health Insurance Portability and Accountability Act of 1996, 110 Stat. 1936.

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Chapter 4. Life Insurance

1. Individual Life Insurance 232. Individual life insurance is sold in the United States under two general types of arrangements. In the rst, a person or business takes out insurance on the life of another. The person whose life is insured is known as the cestui que vie or cqv. This form of life insurance is mainly utilized in the business context, where an employer wishes to insure the life of a key employee or partners wish to insure each other. The alternative arrangement is for the cqv to take out a policy on his own life. This type of life insurance is primarily used in a family or estate planning situation. 233. When a person or business takes out insurance on the life of another, the applicant must have an insurable interest in the life of the cqv. In other words, the policyholder must demonstrate that he will receive a benet from the continued life of the cqv or suffer a detriment from his death. In certain close family relationships, such as spouse, parent or minor child, the insurable interest is conclusively presumed as a matter of law. In all other situations, it must be shown as a matter of fact. In contrast to property insurance, an insurable interest for life insurance purposes must only exist at the time the policy is taken out. The policy is still valid even if the policyholder had lost all connection with the cqv at the time of the cqvs death. For obvious reasons, a person who takes out insurance on his own life is not required to show any insurable interest in his own life. More important, the cqv who takes out a policy on his own life can name anyone or anything as beneciary of the policy, whether or not the beneciary has any interest in his life. 234. Situations frequently arise in which the policyholder who purchased a policy on his own life may wish to change his beneciary, with or without the consent of the beneciary. Initially, the courts held that, because the policyholder did not expressly reserve the right to change the beneciary, the original designation was vested and could not be changed without the beneciarys consent. Subsequently, the insurance companies revised their policies to include an express provision granting the policyholder the unconditional right to change the beneciary utilizing a specied procedure. Because the right to change arose solely from the terms of the policy, a change could not be effected in any manner other than the procedure spelled out in the policy. Thereafter, the courts softened this policy and will now honor a change of beneciary, so long as the intent of the policyholder to make the
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change was clear and the policyholder substantially complied with the contractual mandate. 235. Because all life insurance policies except one-year term insurance include prepaid premiums that earn interest until they become due, life insurance has been considered to be an investment as well as a protection against loss. Therefore, to maximize that investment, life insurance policies are freely assignable. In the overwhelming majority of jurisdictions, the policy can even be assigned to someone who has no insurable interest. The only exception is where the parties agreed to evade the insurable interest requirement by having the cqv would buy the policy with the assignees money and then immediately assign it; in that situation, the policy is void. Otherwise, the transfer is valid for all incidents of ownership including the right to change the beneciary. Moreover, if the policy is assigned but the assignee has not changed the beneciary to itself, the courts hold that the assignee takes the proceeds in preference to the listed beneciary. 236. Not surprisingly, a beneciary who murders the cqv is disqualied from receiving the proceeds of the policy. It is not enough that the beneciary has caused the death of the cqv; the killing must be intentional and unlawful. Some states even require that the beneciary must actually be convicted of felonious slaying before they can be disqualied.1 When a beneciary is disqualied, the law treats him as if he predeceased the cqv. The policy remains valid, and the proceeds must be paid to either the next beneciary or the cqvs estate. The only exception is where the beneciary took out the policy with intent to kill the cqv for the proceeds; in that case, the policy is void ab initio.
1. See, e.g., Wilson v. Wilson, 78 Cal. App.3d 226 (1978).

237. In contrast to property and casualty policies, life insurance companies do not delegate authority to bind the company to their intermediaries in the eld; underwriting decisions are made at the home ofce. Intermediary agents or brokers are expected to have the potential insured ll out written applications and sometimes submit to a physical examination; the applications and the examination results are then forwarded to the home ofce for an underwriting determination. Legally, the application is merely an offer, and there is no contract until the offer has been accepted, the acceptance has been communicated to the applicant, and the applicant has paid the rst premium. Until all of those steps are taken, the answers provided in the application are deemed to be continuing representations, which must be corrected if they are no longer accurate at any time before all of the above steps have been completed. 238. In an effort to deter applicants from changing their minds during the period from the time that the application is submitted until there has been delivery and payment, the insurance company may promise applicants that they will receive additional benets if they submit payment for the rst premium along with the application. Insurance companies have tried to utilize language that limited the benets that were provided to the applicant who pays his premium up front,1 but 98 USA
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the courts generally construe the arrangement as providing the applicant with a binding immediate temporary contract of insurance that does not terminate until the applicant receives notice of the rejection of his application.
1. To such things as earlier effective date for premium purposes, waiver of changes in health between application and delivery, etc.

239. Because a considerable period of time can elapse between the date on which the application was submitted and the date of the death of the cqv, all jurisdictions limit the defenses that can be raised by the company when payment is due. By statute, every life insurance policy contains a provision stipulating that, after the policy has been in force for two years, during the lifetime of the insured, the policy becomes incontestable. The clause does not bar all defenses after the two-year period has expired, only those which relate to the validity of the policy. Coverage defenses, such as no recovery for death caused by a ight in a chartered aircraft, are still permitted. 240. Death by suicide is treated separately. If there is no specic exclusion, courts allow the beneciaries to recover the proceeds even if the cqv took his own life. Therefore, all policies contain a provision stipulating that, if the cqv commits suicide within one or two years of the issuance of the policy, there is no recovery. Courts have held that there cannot be a suicide unless the insured was sane at the time he committed the act.1 To avoid this result, most policies now bar recovery for death by suicide within the prescribed period, whether the insured was sane or insane.
1. See, e.g., Cole v. Combined Insurance Co., 480 A.2d 178 (N.H. 1984).

241. Insurance companies can be liable for particular acts or omissions arising from their conduct with respect to life insurance policies. An application for life insurance is technically an offer which, if not accepted within a reasonable time, is deemed under conventional contract law to be rejected. However, as a matter of insurance law, many courts hold that the insurer is obligated to act on the application within a reasonable time and hold the insurer liable if it fails to do so. In some jurisdictions, the insurance company that fails to act on an application within a reasonable time is deemed to have accepted it.1 In others, the unreasonably delaying insurer is held to be estopped to deny that it accepted the application.2 A third group of judicial decisions holds that insurers owe a duty to applicants to act upon their applications within a reasonable time. If they breach that duty and the applicant is injured by the delay, such as by suffering an adverse change in their health condition or by dying, the company is liable for the resulting damages.3 Another area of potential liability for insurers occurs where the company issues a life insurance policy either to someone who has no insurable interest in the life of the cqv or without the knowledge and consent of the cqv. If the insurers actions contributed to the death of the cqv, the company can be held liable for resulting damages.4
1. See, e.g., Royal Maccabees Life Ins. Co. v. Peterson, 139 F.3d 568 (7th Cir. 1998). 2. See, e.g., Moore v. Palmetto State Life Ins. Co., 73 S.E.2d 688 (S.C. 1952).

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3. See, e.g., Dufe v. Bankers Life Association, 139 N.W. 1087 (Iowa 1913). 4. See Liberty National Life Insurance v. Weldon, 100 So.2d 696 (Ala. 1957) (no insurable interest); Ramey v. Carolina Life Ins. Co., 135 S.E.2d 362 (S.C. 1964) (no knowledge or consent).

2. Group Life Insurance 242. Modern group life insurance developed in the United States at the start of the 20th century and in the employment context. A large employer and an insurance company negotiated a policy which enabled all eligible employees to obtain life insurance policies on their own lives. The beneciaries of those policies were not the employer, but a person or entity designated by each employee. Because the group as a whole was considered to be at least as healthy as the total population on which insurance mortality tables are based, every employee was eligible for the insurance regardless of individual insurability. Group policies were originally available only to large employers, but the eligible groups have gradually expanded to include labor unions, trade associations, credit unions and indeed almost any group that was organized for a reason other than to obtain group insurance. Originally, the entire premium was paid by the sponsoring employer, but as the policies evolved, group premiums may still be paid totally by the sponsor1 or paid in whole or in part by participating group members.2
1. Commonly referred to as non-contributory. 2. Called contributory.

243. Group insurance is generally less expensive than individual insurance for a number of reasons. First of all, because all group members are accepted without requiring a lengthy application or medical examination, there is a considerable saving of underwriting costs. In addition, the sponsor will often undertake a number of the administrative responsibilities normally carried out by the insurance company, such as maintaining all records of eligibility and participation and collecting and remitting all premiums. 244. There are a number of limitations that are placed upon participation in group policies to protect against adverse selection. Only persons who meet specic eligibility criteria1 can participate in the policy. In addition, they must sign up to participate within a limited period of time after the policy becomes effective or they rst become eligible to participate; if they wish to join later, they must present proof of insurability. Also, the amount of insurance that can be taken out on a particular individual under the group policy is limited. In addition, individual policies are not assignable. Finally, a certain percentage of the eligible group members2 must agree to participate before the policy can become effective.
1. Originally, full time employment at the time the policy became effective. 2. Typically 75 per cent or 80 per cent.

245. There has been considerable litigation over the relationship between the insurance company, the sponsor and the participating employees. Originally, 100 USA
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the insurer and the sponsor were deemed to be the only contracting parties, and the participants were considered to be third party beneciaries of their agreement.1 This led to considerable hardship where the sponsor misrepresented the terms of the policy or the conditions for eligibility to the participants or where the sponsor mistakenly cancelled the participation of a person or failed to remit a premium to the insurer for the individual. To avoid this hardship, the modern tendency is for the courts to consider the sponsor to be the agent of the insurer in dealing with the participants and to hold the insurer responsible for errors and omissions of the sponsor that adversely affect any participant.2
1. See, e.g., First National Bank v. Nationwide Insurance, 278 S.E.2d 507 (N.C. 1981). 2. See, e.g., Pacic Standard Life v. Tower Industries, 12 Cal. Rptr.2d 524 (1992).

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Part VI. Social Security

250. Social security is provided in the United States by the Federal government. There is no private insurance that is specically geared to supplementing social security; generally, most people supplement social security payments with pensions that their employers voluntarily provide, savings or other investments. 251. There are four social security benet programs: (a) old age and survivors insurance (OASI), (b) disability insurance, (c) Medicare hospital and supplemental medical insurance and (d) supplemental security income. The benets are funded by a payroll tax on employees earnings up to a statutory maximum which is matched by their employers; self-employed persons pay a tax equal to the combined employeremployee rate. Participation is compulsory except for employees of state and local governments and certain non-prot companies who can participate on a voluntary basis. All benets except supplemental security income are paid as a matter of earning right without regard to nancial need. 252. Monthly OASI payments are made to workers who are fully insured, which means that they must have worked in covered employment for a specied number of quarters and who have reached normal retirement age. Normal retirement age was originally set at age 65, but it is gradually being increased to age 68 for people born in 1938 and thereafter. Early retirement is permissible at age 62, but with reduced monthly payments. Benets are also payable to a workers spouse who has reached the age of 62 or has in her care a child entitled to a childs benet on the basis of the primary beneciarys earnings record and is the present or a divorced spouse of the primary beneciary. When a fully insured worker dies, a small lump sum payment may be made to a surviving spouse or, if there is none, to another eligible person. In addition, survivors benets are payable to a widow or widower, a surviving child or a surviving parent. Cost-of-living adjustments to the monthly payments are made once a year. 253. To be eligible for disability benets, a person must be: (a) fully insured under the OASI test; (b) disability insured, which means that he or she must have 20 quarters of coverage in the 40 quarters immediately preceding disability; (c) under the age of 65 and (d) unable to engage in gainful activity by reason of any medically determinable physical or mental impairment that can be expected to last at least twelve continuous months or result in death. Certain impairments are automatically considered to be disabling and others must be evaluated in light of the age, education and work experience of the individual. Disability insurance provides
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monthly benets, vocational rehabilitation and medical payments. Payments begin on the sixth month after the onset of the disability. 254. Medicare provides hospital and medical insurance to people who are over the age of 65 or disabled. The hospital insurance is nanced by payroll taxes and provides inpatient hospital care, extended care services, home services and limited hospice care. The medical insurance is a voluntary program that generally pays 80 per cent of reasonable charges for doctors, osteopaths, psychiatrists, independent therapists and some medical, outpatient and laboratory services. The eligible participants pay a portion of the program premiums and the difference is paid by the Federal government from general revenues. 255. The Supplemental Security Income (SSI) program provides nancial assistance to people who are over the age of 65, blind or disabled and do not meet the criteria for OASI or disability insurance payments. Benets are based on the income and resources of the individual and are generally lower than the OASI or disability payments. Eligibility is redetermined periodically.

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Part VII. Insurance Intermediaries

Chapter 1. Law of Establishment and Supervision

256. There are two types of insurance intermediaries in the United States, agents and brokers. These intermediaries not only procure customers and arrange for the issuance and renewal of policies; they also can act as servicing representatives with respect to claims, premium payments and various kinds of policy changes. An agent is one who is authorized, explicitly or implicitly, to represent the insurer and is typically a salaried employee. A broker arranges insurance coverage for the insured but is compensated by a commission from the insurer. There are also independent agents, especially in property and casualty insurance, who represent several insurance companies and function in many respects the same way as brokers. 257. No person can act as an agent or broker, hold himself out to members of the public as such, or receive any money, fee or commission as such, without being duly licensed by a particular state. Typically, different licenses are required for life insurance and for property-casualty insurance. Applicants must meet certain educational criteria, such as completion of a prescribed training course given by an approved institution, and pass a written test or series of tests. In addition, agents must be administratively appointed by the insurer or insurers they intend to represent, usually by a written statement led by each appointing insurer with the insurance regulator. 258. Agents and brokers licenses are issued for a prescribed time period, usually one or two years, and must be renewed by submission of a renewal application accompanied by a renewal fee. Without regard to the license term limit, licenses may be immediately revoked by the regulator for cause, such as fraud, dishonesty, incompetency, untrustworthiness or violation of the insurance laws. In addition, insurers can discontinue the appointment of a particular agent for their company by ling a termination of appointment with the insurance department. In most states, insurance agents or brokers can be either natural persons or business entities. 259. Many states have special licensing provisions for non-resident agents and brokers. These are agents and brokers who (a) do not reside in the state, (b) do not have an ofce in the state, but (c) are licensed in another state where they maintain an ofce. Typically, any policy that they negotiate for residents must also contain the countersignature of a resident agent or broker.
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Chapter 2. Insurance Intermediaries and the Insurance Contract

260. Although some insurers deal directly with applicants by mail or the internet, most insurance contracts are negotiated through intermediaries. When disputes subsequently arise, a frequent source of controversy is the authority of the intermediary to speak for the insurance company. Resolution of that question turns on the actual or apparent authority of the intermediary. Actual authority is explicitly created by the insurance company or by law. Apparent authority arises when the insurers conduct causes the applicant to reasonably believe that a particular person (who may in fact have no relation to the insurer) has authority to represent the insurance company. 261. Brokers generally are considered to represent the applicant; consequently their actions can bind an insurer only for limited purposes, such as collecting premiums or submitting applications. With agents, the situation is more complicated. In non-life insurance, someone who is denominated as a general agent has actual or apparent authority to enter into contracts binding on the insurer, to handle nancial transactions and sometimes to adjust claims. The authority to enter into contracts includes the power to modify or alter existing policies and to waive policy provisions. They usually have no authority to x or change premium rates. Special or soliciting agents have much more limited authority, typically only to receive applications and pass them on. With respect to life insurance, underwriting decisions are generally made only by the insurance company itself, and even general agents have authority only to contract on behalf of the company for temporary binders or conditional receipts. 262. An agent who represents only one company will bind that company to any application he accepts, even though acceptance of the application may be directly contrary to his instructions or the scope of the companys business. However, where the agent represents more than one company, there must be an express manifestation of the selection of a particular company before any insurer is bound. A mental but unrecorded selection is not enough. 263. Notice to an agent or knowledge obtained by an agent acting within the scope of his authority is notice to or knowledge of the insurer. Similarly, after a loss, providing notice or loss or proof of loss to the agent is deemed to be notice to the insurer. On the other hand, notice to a broker is not notice to an insurer. 108 USA
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264. Although applications for insurance are theoretically supposed to be lled out by the applicant, situations frequently arise where the agent asks the questions on the form to the applicant and records the answers himself. This practice can create a legal controversy where the insurer seeks to void a policy after loss because of a false statement in the application, and the applicant claims that he gave a truthful answer to the agent but the agent recorded the answer incorrectly on the form. The general rule in this situation is that the information given to the agent is imputed to the insurance company and bars it from relying on the contrary application answer. However, there are three situations in which the false answer will be attributed to the applicant. The rst is where the applicant and the agent have conspired to give false information to the insurer. The second is where the applicant had actual knowledge that the answer on the application was wrong but failed to correct it. The third situation is where the applicant had been given a copy of the application either before it was submitted or as an attachment to the policy itself. In that situation, a number of courts hold that the applicant had a duty to read the application and is bound by any misrepresentations contained within it.1
1. See, e.g., Hidary v. Maccabees Life Ins. Co., 591 N.Y.S.2d 706 (N.Y.App.Div. 1992).

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Part VIII. Reinsurance, Coinsurance, Pooling

Chapter 1. Reinsurance
265. Reinsurance can be dened as an arrangement whereby one insurance company, the reinsurer, agrees to indemnify another insurance company, the ceding company, for all or part of the risks of the ceding company. The arrangement is exclusively between the two insurance companies and does not affect or involve the parties insured by the underlying policies. There are basically two types of reinsurance arrangements. With facultative reinsurance, the reinsurer indemnies one specic risk and has no continuing obligation to cover any other. With treaty reinsurance, the reinsurer agrees to accept all or a part of any risks that meet criteria that the parties agree to in advance. The commitment to accept those risks is continuing. Either form of reinsurance can be either pro rata, whereby the reinsurer and the ceding company divide all premiums, losses, and expenses, or excess, under which the reinsurer indemnies all of the risk over a certain threshold. The value of the reinsurance is entered on the books of the ceding company as an admitted asset, which reduces the reserve that the ceding company must carry and enables it to write additional coverage. 266. Because the insuring public is not directly involved in the reinsurance transaction, the ceding company remains fully liable to its insureds, regardless of the amount of its reinsurance. Thus, unless the reinsurance contract contains a cut through clause, insureds have no cause of action against a reinsurer if the ceding company fails to pay their claims. Because the general public is not involved, the states in the United States, with few exceptions, do not regulate reinsurance. A person or business can become a reinsurer without obtaining a certicate of authority. In addition, there are no standardized or mandated reinsurance forms. However, states do regulate reinsurance indirectly by placing limitations on the form or amount of reinsurance that the ceding company can take credit for on its balance sheet. Generally, credit will be granted only if (a) the reinsurer has been approved by the state insurance regulator, (b) the reinsurer meets certain requirements, or (c) the reinsurance is secured by a trust fund or bank letter of credit. 267. Controversies have regularly arisen over the responsibilities of a reinsurer if the ceding company becomes insolvent. Most states require the reinsurer to agree that, in the event of insolvency, the reinsurer will pay the full amount of its obligation, without any deduction because of the insolvency, to the liquidator of the primary insurer. The insureds whose policies were covered by the reinsurer become
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general unsecured creditors of the ceding company, with no greater claim to the proceeds of the reinsurance than any other insureds. However, the reinsurers are generally allowed to deduct any amounts owed to them by the ceding company as an offset to the amounts that they must remit to the liquidator. 268. Because reinsurance contracts are frequently negotiated by oral exchanges of information between parties at a distance from each other and the reinsurance commitment can involve a great amount of money and extend over a considerable period of time, they are considered to be contracts of utmost good faith. The courts demand that the parties disclose all information in their possession that is relevant to the negotiations, and hold them directly responsible for the accuracy of the data they transmit. Also, if the ceding company fails to provide timely notice to the reinsurer, the failure may be a complete defense for the reinsurer even if it fails to show prejudice. The duty imposed is not a duciary responsibility, but the obligation that is expected of joint venture parties. 269. The general rule is that the reinsurer must follow the fortunes of the primary insurer, which forecloses relitigation of coverage questions. It means that the reinsurer must accept all decisions made by the primary insurer in dealing with the policyholder or the underlying liability. This doctrine does not apply where the ceding insurer has settled a claim by a payment clearly outside the contemplation of the reinsuring parties or has committed fraud or otherwise breached its duty of utmost good faith. Also, regardless of the commitments made by the primary insurer, the reinsurer is not at risk for more than the policy limits of the underlying insurance.

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Chapter 2. Co-insurance and Pooling

270. The term coinsurance in this context refers to an arrangement whereby two or more insurers assume direct shares of a given risk. It is not reinsurance because every insurer has a direct contract with the insured. 271. A number of different pooling arrangement are common in the United States. In the 1980s, the United States Congress passed the Risk Retention Act1 which permits a group of private companies with similar risks to set up a corporation or other limited liability association for the purpose of spreading the risks of liability exposure among its group members. Under the statute, a risk retention group of this nature need only be admitted to provide insurance in one state and it can do business in all states without complying with any other states market entry requirements. Also, public entities, such as municipalities, schools and the like, have established risk sharing pools under which each member transfers its exposure for nancial loss to a central risk sharing authority which is nanced by contributions from all admitted members.
1. 15 U.S. Code 3901.

272. Insurance companies also participate in pooling arrangements in lieu of reinsurance. For example, a group of insurance companies may agree to cede all of their business in a particular eld to one member, who would then retrocede given percentages of the pooled business to the other members and retain a given percentage. In addition, a number of states have established residual market plans to provide coverage to insureds who are unable to nd affordable insurance for automobile insurance, property insurance or workers compensation coverage. These insureds are equitably apportioned among the insurers who are authorized to write the line of business in each state.

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Part IX. Taxation of Insurance

273. It is impossible in a survey work of this nature to present a detailed and comprehensive analysis of the many complexities of insurance taxation. What follows is necessary simplied and general in perspective. If further guidance is needed, more specialized texts should be consulted.

Chapter 1. Taxation of Insurance Companies

274. The states impose a premium tax on insurers, based upon a percentage of their gross premiums. Even though such a tax may be said to burden interstate commerce, Congress specically authorized state taxation of insurance in the McCarranFerguson Act.1 The tax applies to both domestic and our-of-state companies, and in many jurisdictions it includes a retaliatory tax for insurers domiciled in states that impose a higher tax against the premiums of companies domiciled in the taxing state. For example, State X may impose a 2 per cent tax on premiums generally, but assess insurers from State Z with a 6 per cent tax, because State Z taxes State X companies at 6 per cent. The constitutionality of the retaliatory tax was upheld by the Supreme Court in 1981.2 Premiums paid to an excess or surplus lines carrier are generally taxed at a higher rate, and are collected from the insured or a surplus lines broker.
1. 15 U.S.C. 1012(a). 2. Western and Southern Life Insurance Co. v. State Board of Equalization, 451 U.S. 648 (1981).

275. The Federal government taxes the income of insurance companies, and the taxation requirements vary depending on whether the company is considered to be a life insurance company or not. Life insurers are taxed on their life insurance company taxable income, which is equal to their gross income less policyholder dividends and increases in reserves. Other insurance companies are taxes the same as non-insurance companies, but their loss reserves must be discounted to a present value.

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Chapter 2. Taxation of Insurance Proceeds

276. The proceeds of a life insurance contract that are paid in a lump sum because of the death of the insured are not included in the gross income of the recipient, without regard to the identity of the recipient or the recipients relation to the insured. However, proceeds paid in installments are only partially excludable, under a proration formula. Proceeds that are paid before the death of the insured are generally considered to be taxable income to the extent that they exceed the amount invested in the policy. However, accelerated death benets paid to a terminally ill individual or a chronically ill individual, as those terms are dened in the Internal Revenue Code, can be excluded. 277. The sums paid pursuant to a life insurance policy receive special treatment under the estate tax law. Those payments are not included in the gross estate for tax purposes except in two situations. The amounts are included if they are receivable by or for the benet of the decedents estate. They also must be included if the decedent possessed any of the incidents of ownership of the policy at his death. Incidents of ownership include the power to change a beneciary, to revoke an assignment, to pledge the policy for a loan, or to borrow on the policys cash reserve. 278. The payments from a property insurance policy are not considered to be taxable income, because they are deemed to be an involuntary conversion of the underlying property. However, if the proceeds are not reinvested in like property, they are deemed to be a sale of the property and are fully taxable.1
1. Internal Revenue Code 1033(a).

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Part X. Risk Management and Prevention

279. Risk management is the process of planning, organizing and controlling those activities that deal with specied types of risk. The objective of risk management is to minimize efciently the adverse impact of losses on the achievement of ones goals. 280. The process of risk management involves initially identifying the risks that one will be exposed to. The next step is to evaluate the frequency and severity of each risk and determine its maximum potential losses. The nal step is select techniques to handle the risks. There are four risk management techniques that are customarily available. The rst technique is risk avoidance or refraining from those activities that cause the risk. The second technique is risk reduction, which can involve reducing the frequency of the risk, reducing the severity of the risk or diversifying to reduce the maximum loss. However, even after the risk has been reduced to its feasible minimum, it still must be either retained or transferred. The third technique is risk retention which also can be considered to be self insurance. This technique is most useful for risks that may have a high frequency but possess a low expected severity. And the nal technique is risk transfer, which is the optimal technique for risks with a high potential severity. There are many forms of possible risk transfer, including insurance, incorporating, setting up joint ventures, leasing and specic contractual provisions.

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Numbers refer to paragraphy Acceptance 103, 106, 143, 235, 260 Accident 44, 60, 139, 150, 158, 186, 198, 204211, 220222 Accidental death 120, 220222 Actual authority 258 Actual value 151 Admitted assets 84, 86 Agent 73, 103, 243, 254262 Aircraft liability insurance 173 Aleatory 102 Alien insurers 72 Ambiguity 93, 94 Annual statement 71, 75 Apparent authority 258, 259 Arbitration 43, 46 Assign 140, 233 Assignment 26, 127, 142, 245, 275 Audit 37, 76 Average 159, 217 Aviation hull insurance 172 Aviation insurance 171 Block policy 199 Boiler and machinery insurance 197 Broker 254, 257, 261, 272 Builders risk insurance 198 Business interruption 153155, 201, 202 Cancel 116, 145 Change the beneciary 232, 233 Claims made 163, 166 Coinsurance 125, 268270 Commerce and industry 1112 Commercial general liability policy 165 Compulsory insurance 5761 Concealment 112, 120, 146, 161 Congress 3, 7, 9, 14, 14, 17, 2734, 70, 91, 186, 229, 269, 272 Constitution 3, 6, 9, 28, 70 Consumer Protection 25, 4956 Continuing representations 235 Credit insurance 193196 Crop insurance 68, 180, 181 Currency 14, 1921 Delay 105, 119, 239 Directors and ofcers insurance 200 Dispute settlement 4348 Duty of cooperation 121 Duty to defend 164, 184 Eldon 98, 100 Errors and omissions 166, 201, 243 Escape clauses 135 Excess clauses 135 Excess insurance 184, 184 Factual data 69 Federal government 2, 10, 14, 16, 35, 61, 68, 89, 180, 186, 229, 244, 248, 252, 273 Fidelity bond 177 Financial institutions 1318 Fire insurance 23, 27, 78, 81, 149152 Follow the form 185 Foreign insurers 91, 91 Fraternal benet societies 62, 67 Friendly re 150 GAAP 85, 86 Gambling 97 Government programs 68, 223, 225 Government regulations 39 Grace period 117, 147 Group life insurance 240243 Health insurance 68, 220, 225229

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Incontestable 237 Indemnity 97, 120, 123, 128, 134, 137, 142, 157, 182, 187, 193 Individual life insurance 230 239 Insurable interest 98 100, 142, 231, 233, 239 Insurable risk 96 101 Insurance rates 78, 78 Insurance regulation 22 34 Insurance Regulatory Information System 75 Interpreting contracts 92 Investment 11, 13, 17, 62, 84, 89 91, 137, 194, 233 Lawrence 98, 99 Legal service plans 168, 169 Legislation 4, 17, 25, 34, 37, 50, 113, 175 Liability insurance 57, 60, 80, 114 118, 121, 126 129, 144, 162 167, 173, 174, 187, 204 206, 212 License 61, 70, 256 Life insurance 24, 24, 62, 67, 71, 79, 82, 89, 103, 114, 120, 137139, 142, 220, 230 243 Liquidation 77 Livestock 183 Lloyds Coffee House 65, 108 Loss reserves 83, 273 Lucena v. Craufurd 98 Malpractice insurance 66, 166 Marine insurance 22, 112, 156 161 McCarranFerguson Act 31 Medical payments 173, 203, 207208, 251 Medicare 68, 249, 252 Moral hazard 95, 152 Motor vehicle insurance 167, 203 213 Multiple peril crop insurance 182 Mutual mistake 107 NAIC Standard Valuation Law 82 Named peril 192 National Association of Insurance Commissioners 31, 35, 50, 75 Natural catastrophes 190 192 New York Standard Fire Insurance Policy 81, 149 No fault 48, 188, 206 Notice 39, 42, 115 118, 132, 144, 236, 261, 266 Nuclear risks 186 189 OASI 249 253 Occurrence 163 166, 189 Offer 67, 70, 103, 143, 210, 226, 235, 239 Old Age and Survivors Insurance 249 Oral 104, 107, 266 Overinsure 124 Paul 27, 29, 30 Payment of premium 114117 Pension funds 244 247 Policy form control 81 Policy reserves 82, 83 Pooling 31, 97, 269 270 Premium 39, 66, 83, 89, 91, 102 106, 114 117, 123, 124, 145, 146, 162, 175, 182, 193, 196, 211, 225, 235, 240, 243, 254, 259 Premium by check 116 Premium taxes 91, 91 President Supreme Court 6 9, 15, 175 Pro rata clauses 135 Proof of loss 120, 120, 261 Property loss 123 Public policy 57, 95, 97, 136, 211, 222 Reasonable expectations 42, 94 Reasonable time 105, 118, 151, 239, 239 Receivership 77 Reciprocal 66 Regulation by Other Governmental Agencies 40 41 Rehabilitation 77, 217, 251 Reinsurance 175, 263 267, 270 Renew 143, 144 Representation 111, 169 Risk management 180, 277278 Second injury fund 218 Social security 248 253 Solvency control 74 77 Sources of Insurance Law 35 42 South Eastern Underwriters 29 31 Statutory accounting principles 86, 88 Subrogation 127133, 139, 198 Suicide 221 Supplemental security income 249, 253 Supreme Court 9, 16, 2733, 37, 50, 78, 91, 156, 168, 272 Taxable income 273, 274 Taxation of insurance proceeds 274 276

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Temporary contract 106, 236 Theft insurance 176, 178 Total loss 125, 151, 160 Travel insurance 224 Uberrimae dei 109, 112, 161 Umbrella insurance 185 Unauthorized insurers 73 Underinsure 124 Underinsured motorists coverage 212 Unearned premium reserves 83 Uninsured motorists coverage 209 212 Warranty 110, 146

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