Combined Chapters 9 and 10

Principle of Indemnity (1 of 3)
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
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• 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
Actual Cash Value
• Actual Cash Value (ACV) is one way to value an item after
a loss.
• ACV= Replacement cost of the item less depreciation at
the time of loss
Actual Cash Value
• You installed a new roof 10 years ago at a cost of $10,000
• Roof has a useful life of 20 years
• Depreciating at the rate of $500 a year
• Roof is completed destroyed in a fire
• Depreciated value is $5,000: $10,000 - ($500 * 10)
• Cost to replace the roof is $14,000
• ACV = $14,000 - $5,000 = $9,000 insurance payment
Actual Cash Value
Chapter 9 Application Question 3
• Laptop purchased 5 years ago for $1000
• 50% Depreciation – Amt of depreciation is $500
• Laptop stolen
• Replacement cost of laptop is $500
• Replacement cost – depreciation
• $500 – ($1000 - $500)
• $500 - $500 = $0
• No insurance reimbursement for stolen laptop
• There are some exceptions to the principle of indemnity:
– 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 Insurable Interest (1 of 2)
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 (2 of 2)
• 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 Subrogation (1 of 2)
Subrogation means 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 (2 of 2)
• 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 insurers
Principle of Utmost Good Faith (1 of 4)
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
• 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
– Reliance means that the insurer relies on the
misrepresentation in issuing the policy at a specified
premium
– An innocent misrepresentation of a material fact, if relied
on by the insurer, makes the contract voidable
• A concealment is intentional failure of the applicant for
insurance to reveal a material fact to the insurer
• To deny a claim based on concealment, a nonmarine
insurer must prove:
– The concealed fact was known by the insured to be
material
– The insured intended to defraud the insurer
• A warranty is a statement that becomes part of the
insurance contract and is guaranteed by the maker to be
true in all respects
– Statements made by applicants are considered
representations, not warranties
– Most courts interpret a breach of warranty liberally
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
– Exchange of 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 (1 of 2)
• An insurance contract is:
– Aleatory: values exchanged are not equal
– Unilateral: only the insurer makes a legally
enforceable promise
– Conditional: policyowner 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 (2 of 2)
• 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, regardless of policy
provisions.
Waiver and Estoppel
• The doctrines of waiver and estoppel may require an
insurer to pay a claim that it ordinarily would not have to
pay
– Waiver is defined as the voluntary relinquishment of a
known legal right
▪ Incomplete or missing answer on application
– Estoppel is the loss of a legal defense because of
previous actions that are now inconsistent with that
defense
▪ Agent indicating that something is covered
Basic Parts of an Insurance Contract (1 of 6)
• Declarations are statements that provide information
about the particular property or activity to be insured
– Usually on the first page of the policy
– In property insurance, it contains name of the insured,
location of property, period of protection, amount of
insurance, premium and deductible information
• Insurance contracts typically contain a page or section of
definitions
– For example, the insured is referred to as “you”
• The insuring agreement summarizes the major promises
of the insurer
• The two basic forms of an insuring agreement in property
insurance are:
– Named perils coverage, where only those perils
specifically named in the policy are covered
– Open-perils, or special coverage, where all losses
are covered except those losses specifically excluded
• Insurance contracts contain three major types of
exclusions
– Excluded perils, e.g., flood, intentional act
– Excluded losses, e.g., a professional liability loss is
excluded in the homeowners policy
– Excluded property, e.g., pets are not covered as
personal property in the homeowners policy
• Some perils are not commercially insurable
– e.g., catastrophic losses due to war
• Extraordinary hazards are present
– e.g., using the automobile for a taxi
• Coverage is provided by other contracts
– e.g., use of auto excluded on homeowners policy
• Moral hazard problems
– e.g., coverage of money limited to $200 in
homeowners policy
• Coverage not needed by typical insureds
– e.g., homeowners policy does not cover aircraft
• Conditions are provisions in the policy that qualify or
place limitations on the insurer’s promise to perform
– If policy conditions are not met, the insurer can refuse
to pay the claim
• Insurance policies contain a variety of miscellaneous
provisions
– e.g., cancellation, subrogation, grace period,
misstatement of age
Definition of “Insured”
• An insurance contract must identify the persons or parties
who are insured under the policy
– The named insured is the person or persons named
in the declarations section of the policy
– The first named insured has certain additional rights
and responsibilities that do not apply to other named
insureds
– A policy may cover other parties even though they are
not specifically named
– Additional insureds may be added using an
endorsement
Endorsements and Riders
• In property and liability insurance, an endorsement is a
written provision that adds to, deletes from, or modifies the
provisions in the original contract
– e.g., an earthquake endorsement to a homeowners
policy
• In life and health insurance, a rider is a provision that
amends or changes the original policy
– e.g., a waiver-of-premium rider on a life insurance
policy
Deductibles (1 of 3)
• A deductible is a provision by which a specified amount
is subtracted from the total loss payment that otherwise
would be payable
• The purpose of a deductible is to:
– Eliminate small claims that are expensive to handle
and process
– Reduce premiums paid by the insured
• With a straight deductible, the insured must pay a
certain number of dollars of loss before the insurer is
required to make a payment
– e.g., an auto insurance deductible
• An aggregate deductible means that all losses that
occur during a specified time period, usually a year, are
accumulated to satisfy the deductible amount
• A calendar-year deductible is a type of aggregate
deductible that is found in basic medical expense and
major medical insurance contracts
• An elimination (waiting) period is a stated period of time
at the beginning of a loss during which no insurance
benefits are paid
– e.g., disability income contracts that replace part of a
disabled worker’s earnings typically have elimination
periods of 30, 60, or 90 days, or longer periods.
Coinsurance (1 of 2)
• A coinsurance clause in a property insurance contract
encourages the insured to insure the property to a stated
percentage of its insurable value
– If the coinsurance requirement is not met at the time of
the loss, the insured must share in the loss as a
coinsurer
Amount of insurance carried
× Loss = Amount of recovery
Amount of insurance required
Coinsurance (2 of 2)
• The fundamental purpose of coinsurance is to achieve
equity in rating
– A property owner wishing to insure for a total loss
would pay an inequitable premium if other property
owners only insure for partial losses
– If the coinsurance requirement is met, the insured
receives a rate discount, and the policy owner who is
underinsured is penalized through application of the
coinsurance formula
Insurance Value
• The insurance value of a property is the amount required
to repair/rebuild. The insurance value is not related to the
market value.
Property Insurance without
Coinsurance
• Two identical properties each with an insurance value of
$100,000. Property insurance premium is based on a rate
per $100. Rate for these properties $.70 per $100
#1 #2
Insured for $80,000 $50,000
Premium $560 $350
Loss $20,000 $20,000
Loss Paid $20,000 $20,000
Property Insurance with Coinsurance
• 80% Coinsurance
• Amt Carried/Amt Required X Loss
#1 #2
Insured for $80,000 $50,000
Premium $560 $350
Loss $20,000 $20,000
Loss Paid 80,000/80,000 50,000/80,000
1 X 20,000 .625 X 20,000
$20,000 $12,500
Property Insurance with Coinsurance
• 80% Coinsurance
• Amt Carried/Amt Required X Loss
#1 NO! Violates
Insured for $100,000 Principle of
Indemnification.
Premium $700
Can only collect
Loss $20,000 $20,000
Loss Paid 100,000/80,000
1.25 X 20,000
$25,000
Coinsurance in Health Insurance
• Health insurance policies frequently contain a
coinsurance clause
– The clause requires the insured to pay a specified
percentage of covered medical expenses in excess
of the deductible
– The purposes of coinsurance in health insurance are
to reduce premiums and prevent overutilization of
policy benefits
Other-Insurance Provisions (1 of 3)
• The purpose of other-insurance provisions is to prevent
profiting from insurance and violating the principle of
indemnity

Combined Chapters 9 and 10

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Combined Chapters 9 and 10

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Principle of Indemnity (1 of 3)

The insurer agrees to pay no more than the actual

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