Principles of Insurance

Benazir Imam Majumder

Assistant Professor
Department of Banking and Insurance
Faculty of Business Studies
University of Dhaka
Agenda
 Principle of Utmost Good Faith
 Principle of Insurable Interest
 Principle of Indemnity
 Principle of Subrogation
 Principle of Contribution
 Principle of Proximate Cause/ Causa Proxima
 Requirements of an Insurance Contract
 Distinct Legal Characteristics of Insurance Contracts
 Law and the Insurance Agent
Principle of Utmost Good Faith
 A higher degree of honesty is imposed on both parties to
an insurance contract than is imposed on parties to other
contracts
 Supported by three legal doctrines:
 Representations
 Concealment
 Warranty
Principle of Utmost Good Faith
 Representations are statements made by the applicant for
insurance
 A contract is voidable if the representation is material, false,
and relied on by the insurer
 Material means that if the insurer knew the true facts, the
policy would not have been issued, or would have been issued
on different terms
 An innocent misrepresentation of a material fact, if relied on by
the insurer, makes the contract voidable
Principle of Insurable Interest
The insured must be in a position to lose financially if a covered
loss occurs
Purposes:
 To prevent gambling
 To reduce moral hazard
 To measure the amount of the insured’s loss
An insurable interest can be supported by:
 Ownership of property
 Potential legal liability
 Serving as a secured creditor
 Contractual rights
 Principle of Insurable Interest
When must insurable interest exist?
 Property insurance:
at the time of the loss
 Life insurance:
only at inception of the policy
 The question of insurable interest does not arise when you purchase
life insurance on your own life
 Insurable interest in another person’s life can be shown by close
family ties, marriage, or a pecuniary (financial) interest
Principle of Indemnity
 The insurer agrees to pay no more than the actual amount
of the loss
 Purpose:
 To prevent the insured from profiting from a loss
 To reduce moral hazard
Principle of Indemnity
 In property insurance, indemnification is based on the
actual cash value (ACV) of the property at the time of
loss
 There are three main methods to determine actual cash
value:
 Replacement cost less depreciation
 Fair market value is the price a willing buyer would pay a
willing seller in a free market
 Broad evidence rule means that the determination of ACV
should include all relevant factors an expert would use to
determine the value of the property
Principle of Indemnity
 For example, Sarah has a favorite couch that burns in a fire. Assume
she bought the couch five years ago, the couch is 50 percent
depreciated, and a similar couch today would cost $1000. Under the
actual cash value rule, Sarah will collect $500 for the loss because
the replacement cost is $1000, and depreciation is $500, or 50
percent. If she were paid the full replacement value of $1000, the
principle of indemnity would be violated. She would be receiving the
value of a new couch instead of one that was five years old. In short,
the $500 payment represents indemnification for the loss of a five-
year-old couch.
Replacement cost = $1000
Depreciation = $500 (couch is 50 percent depreciated)
Replacement cost - Depreciation = Actual cash value
$1000 - $500 = $500
Principle of Indemnity
 There are some exceptions to the principle of indemnity:
 Valued policy
 Valued policy laws
 Replacement cost insurance
 Life insurance
 A valued policy pays the face amount of insurance if a total loss
occurs.
 Some states have a valued policy law that requires payment of the
face amount of insurance to the insured if a total loss to real property
occurs from a peril specified in the law.
 Replacement cost insurance means there is no deduction for
depreciation in determining the amount paid for a loss.
 A life insurance contract is a valued policy that pays a stated sum to
the beneficiary upon the insured’s death.
Principle of Indemnity
Valued Policy:
For example, you may have a valuable antique clock that
was owned by your great-grandmother. You may feel that
the clock is worth $10,000 and have it insured for that
amount. If the clock is totally destroyed in a fire, you
would be paid $10,000 regardless of the actual cash value
of the clock at the time of loss
Principle of Subrogation
 Substitution of the insurer in place of the insured for the
purpose of claiming indemnity from a third party for a
loss covered by insurance.
 Purpose:
 To prevent the insured from collecting twice for the
same loss
 To hold the negligent person responsible for the loss
 To hold down insurance rates
Principle of Subrogation
 The insurer is entitled only to the amount it has paid under
the policy
 The insured cannot impair the insurer’s subrogation rights
 Subrogation does not apply to life insurance contracts
 The insurer cannot subrogate against its own insureds
Principle of Contribution
 Contribution establishes a corollary among all the
insurance contracts involved in an incident or with the
same subject.
 Contribution allows for the insured to claim indemnity to
the extent of actual loss from all the insurance contracts
involved in his or her claim.
Principle of Contribution
 For instance, imagine that you have taken out two
insurance contracts on your used Lamborghini. Let’s say
you have a policy with A that covers $30,000 in property
damage and a policy with B that cover $50,000 in
property damage. If you end up in a wreck that causes
$50,000 worth of damage to your vehicle. Then about
$18,750 will be covered by A and $31,250 by B.
 Each policy you have on the same subject matter pays
their proportion of the loss incurred by the policyholder.
 It’s an extension of the principle of indemnity that allows
proportional responsibility for all insurance coverage on
the same subject matter.
Principle of Proximate Cause
 The loss of insured property can be caused by more than
one incident even in succession to each other.
 Property may be insured against some but not all causes of
loss.
 When a property is not insured against all causes, the
nearest cause is to be found out.
 If the proximate cause is one in which the property is
insured against, then the insurer must pay compensation.
If it is not a cause the property is insured against, then the
insurer doesn’t have to pay.
Principle of Proximate Cause
 The perils relevant to an insurance claim can be classified
under three headings:
 Insured perils: Insured perils are specifically mentioned and covered
under the policy as the possible cause of the loss or damage to the
subject matter of the insurance. For example, a policy can be taken to
insure the subject matter from perils, such as fire, lightning, storm
and theft.
 Excepted or excluded perils: Practically all insurance policies are
excluded from coverage and certain perils arising from factors that
can cause losses. Normally, a separate section of the contract lists and
describes all the excluded perils, e.g. riot, strike, earthquake or war.
 Uninsured or other perils: Those perils are not mentioned in the
policy at all. Smoke and water may not be excluded nor mentioned as
insured in a fire policy.
Requirements of an Insurance Contract
 To be legally enforceable, an insurance contract must meet
four requirements:
 Offer and acceptance of the terms of the contract
 Consideration – the value that each party gives to the other
 Competent parties, with legal capacity to enter into a binding
contract
 The contract must exist for a legal purpose
Distinct Legal Characteristics of
Insurance Contracts
 An insurance contracts is:
 Aleatory: values exchanged are not equal
 Unilateral: only the insurer makes a legally enforceable
promise
 Conditional: policy owner must comply with all policy
provisions to collect for a covered loss
 Personal: property insurance policy cannot be validly assigned
to another party without the insurer's consent
 A contract of adhesion: the insured must accept the entire
contract with all of its terms and conditions
Distinct Legal Characteristics of Insurance
Contracts
 Courts have ruled that any ambiguities or uncertainties in
the contract are construed against the insurer.
 The principle of reasonable expectations states that an
insured is entitled to coverage under a policy that he or
she reasonably expects it to provide, and that to be
effective, exclusions or qualifications must be
conspicuous, plain, and clear.
Law and the Insurance Agent
 An agent is someone who has the authority to act on
behalf of a principal (the insurer)
 Several laws govern the actions of agents and their
relationship to insureds
 There is no presumption of an agency relationship
 An agent must be authorized to represent the principal
 A principal is responsible for the acts of agents acting
within the scope of their authority
 Limitations can be placed on the powers of agents
Law and the Insurance Agent
 An agent’s authority comes from three sources
 Express authority
 Implied authority
 Apparent authority
 Knowledge of the agent is presumed to be knowledge of
the principal with respect to matters within the scope of
the agency relationship
 Insurers can place limitations on the power of agents by
adding a non-waiver clause to the application or policy
Law and the Insurance Agent
 Waiver is defined as the voluntary relinquishment of a
known legal right
 Estoppel occurs when a representation of fact made by
one person to another person is reasonably relied on by
that person to such an extent that it would be inequitable
to allow the first person to deny the truth of the
representation
Thank You……