Lecture Four:

Fundamental Principles in Insurance

Learning objectives
Explain the fundamental legal principles that are reflected in insurance contracts Explain how the legal concepts of representations, concealment, and warranty support the principle of utmost good faith Describe the basic requirements for the formation of a valid insurance contract Access an internet site and obtain consumer information on insurance law

Main Contents
Principle of Indemnity Principle of Insurable Interest Principle of Utmost Good Faith Principle of Proximate Cause Principle of Subrogation

Principle of Indemnity

Definition The main contents The exceptions The principles derived from indemnity

namely.  A contract of indemnity does not mean that all covered losses are always paid in full.Definition of Principle of Indemnity  It is one of the most important legal principles in insurance. .  It states that the insurer agrees to pay no more than the actual amount of the loss. the insured should not profit from a loss.  Most property and liability insurance contracts are contract of indemnity.

Second.Definition of the principle of Indemnity Why this principle? Two purposes: First, prevent the insured from profiting from a loss. reduce moral hazard. How to do?  Deductibles  Limits on the amount paid  Other contractual provisions .

In property insurance. the basic method for indemnifying the insured is based on the actual cash value.Actual cash value Actual Cash Value underlies the principle of indemnity. There are three major methods to determine actual cash value:    Replacement cost less depreciation Fair market value Broad evidence rule .

The rule is used for property insurance : Actual cash value=replacement cost – depreciation It takes into consideration both inflation and depreciation of the property value over time.Actual cash value Replacement cost less depreciation: Replacement cost is the current cost of restoring the damaged property with new materials of like kind and quality. (Examples) .

Actual cash value Fair It market value: is another method to determine actual cash value of a loss It is the price a willing buyer would pay a willing seller in a free market.  Maybe lower than its actual cash value (Examples) .

etc. Present value of expected income from the property Comparing the similar property. . an expert considers all the relevant factors including as follows: Replacement cost less depreciation Fair market value.Actual cash value Broad It evidence rule: is another method to determine actual cash value of a loss  when determining the actual cash value of property.

Exceptions of principle of indemnity  There are several important exceptions to the principle of indemnity including the following:  valued policy  valued policy laws  replacement cost insurance  life insurance .

rare paintings.Exceptions of principle of indemnity Valued  policy It is one that pays the face amount of insurance if a total loss occurs. etc. fine arts. and family heirlooms.  Valued policy is used to insure antiques. Valued policy violates the principle of indemnity (Examples) .

Exceptions of principle of indemnity Valued  policy laws It is a law that exists in some states in U.S. 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. .

Exceptions of principle of indemnity Replacement  cost insurance It means there is no deduction for depreciation in determining the amount paid for a loss. (examples) It violates the principle of indemnity .  the replacement cost insurance is based on the recognition that payment of the actual cash value can still result in a substantial loss to the insured due to depreciation.

The actual cash value (replacement cost less depreciation) is meaningless in determining the value of human life. It is a valued policy that pays a stated sum to the beneficiary upon the insured’s death. (examples) .Life Life Insurance: insurance contract is not a contract of indemnity.

Principle of Insurable Interest Definition The purpose of an insurable interest Examples of an insurance interest .

Definition of insurable interest The principle of insurable interest states that the insured must be in a position to lose financially if a loss occurs.  (examples) . or to incur some other kind of harm if the loss takes place.

The purpose of an insurable interest All insurance contracts must be supported by an insurable interest. The reasons are:  to prevent gambling  to reduce moral hazard  to measure the amount of the insured’s loss in property insurance .

it is predictable value Third. All the property from theft. smuggle has no insurable interest Second.The important conditions of insurable interest First. it is a legal interest. it is economic value . fraud.

Examples of an insurance interest  An insurable interest In property and liability insurance      ownership of property: (examples) potential legal liability (examples) secured creditors (examples) employer for employee contractual right: (examples) .

While remote family relationship is not insurable. relationship by close family ties.g.  e.Examples of an insurance interest   An insurable interest In life insurance: No requirement on the insurable interest when a person buy life insurance for himself or herself. a pecuniary interest is exceptional   . or marriage is insurable . An insurable interest is required if a person wish to buy a life insurance for another person.

not at the time of death.Examples of an insurance interest When must an insurable interest exist?  In property insurance. life insurance. the insurable interest requirement must be met only at the inception of the policy.  In . the insurable interest must exist at the time of the loss.

Principle of Utmost Good Faith Definition Main contents The legal effect of breaking the utmost good faith principle .

Definition of utmost good faith principle The principle of utmost good faith means a higher degree of honesty is imposed on both parties to an insurance contract This principle has its historical roots in ocean marine insurance The principle imposes a more higher degree of honesty on the applicant for insurance .

Main contents of utmost good faith principle The principle of utmost good faith is supported by three important legal doctrines as follows: Representations Concealment warranty .

so on should be stated. such information as quality. location. (2)In property insurance. height. (1)In life insurance.Main contents of utmost good faith principle Representations: The statements made by the applicant for insurance. the applicant should be asked questions concerning the insured’s age. family history. value. That’s tell the true facts about the insured and/or the subject matter(保险标的). (3) Increase in hazard . occupation. and other relevant questions. state of health. quantity.

or misleading) (3) Relied on by the insurer (at specified /adjusted premium) (4) Innocent misrepresentation(unintentional)  . ) (2) False (not true facts.Main contents of utmost good faith principle Representations: An Insurance contract is voidable at the insurer’s option if the presentation is: (1) Material (the true facts not fitting for the required conditions by the insurer.

Main contents of utmost good faith principle Concealment: It is intentional failure for the applicant to reveal a material fact to the insurer. That is the applicant deliberately withholds material information from the insurer. The legal affect of a material concealment is: The contract is voidable at the insurer’s option (examples) .

Examples:  Not drunk driving  Locking the door  Fire extinguisher Any breach of the warranty allows the insurer to deny payment of a claim. .Main contents of utmost good faith principle warranty: It is a statement of fact or a promise made by the insured. which is part of the insurance contract and must be true if the insurer is to be liable under the contract.

mis-represent the facts. . or conceal the facts deliberately .The legal effect of breaking the utmost good faith principle  Against the responsibilities of Representation:  the insurer may not take the responsibility due to such reasons as: negligence.  The legal effect of breaking the utmost good faith principle is that the insurer will deny the loss claim.

the insurer pay the sum of insurance amount. not a single one. Thus. a loss is caused by several reasons. . If yes. the principle of proximate cause is used in the insurance contract. the insurer tries to examine whether the most effective and decisive cause is under the coverage of the insurance contract. It means among several causes. otherwise. will not pay.Principle of Proximate Cause Definition of the principle of proximate cause In many cases.

Principle of Proximate Cause  Application of the principle of proximate cause in the case of a single cause: (examples) in the case of multi causes (examples) in the case of multi and continuous causes (examples) .

. (examples) The insurer is entitled to recover from a negligent third party any loss payments made to the insured. ((TEXT P 34-35) Subrogation means substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third person for a loss covered by insurance.principle of subrogation The principle of subrogation strongly support the principle of indemnity.

 However.  .principle of subrogation Subrogation does not apply if a loss payment is not made. the insured gives to the insurer legal rights to collect damages from the negligent third party. if a loss payment is made by the insurer.

second. . hold the guilty person responsible for the loss. help to hold down insurance rates. third.principle of subrogation  Purpose of subrogation: subrogation has three basic purposes: first. prevent the insured from collecting twice for the same loss.

principle of subrogation Importance of subrogation: (TEXT P35) There are five importance of the principle of subrogation as follows:  By exercising subrogation rights. .  Subrogation does not apply to life insurance  The insurer cannot subrogate against its own insured. the insurer is entitled only to the amount It has paid under the policy.  The insurer can waive its subrogation rights in the contract.  The insured cannot impair the insurer’s subrogation rights.

principle of pro rata liability    Pro Rata Liability is a generic term for a provision that applies when two or more policy of the same type cover the same insurable interest in the property. Each insurer’s share of the loss is based on the proportion that its insurance bears to the total amount of insurance on the property. The propose of Pro Rata Liability clause is to preserve the principle of indemnity and to prevent profiting from insurance. (examples) .

 It means each insurer shares equally in the loss until the share paid by each insurer equals the lowest limit of liability under any policy.the principle of contribution by equal shares Contribution by Equal Share(等额分摊) is another type of provision used in liability insurance contracts. or until the full amount of the loss is paid. (to be explained in detail in chapter 5)  .

the insured should not profit from a covered loss.Summary   Insurance has four fundamental legal principles: the principle of indemnity states that the insurer should not pay more than the actual amount of loss. or must incur some other kind of harm if the loss takes place. there are several exception to the principle of indemnity. . The principle of insurable interest means that the insured must stand to lose financially if a loss occurs. In other words.

The legal doctrine of representations. There are several derived principles from the principle of indemnity . concealment and warranty support the principle of utmost good faith . .Summary    The principle of utmost good faith means that a higher degree of honesty is imposed on both parties to an insurance contract.

Explain the principle of utmost good faith. How do the legal doctrines of representations. What is an insurable interest? Why is an insurable interest required in every insurance contract? 3.Review questions 1. Explain the principle of indemnity. and warranty support the principle of utmost good faith? . How does the concept of actual cash value support the principle of indemnity? 2. concealment.

What is the Principle of Proximate Cause? Use examples to explain how it works in different situations? 6. Explain what is the principle of pro rata liability ? . Explain the principle of subrogation? Why subrogation used? 5.Review questions 4.

Case Application .