Chapter 9

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
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 insureds death
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 insureds 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 persons life can be shown by close family ties,
marriage, or a pecuniary (financial) interest
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 insurers subrogation rights
Subrogation does not apply to life insurance contracts
The insurer cannot subrogate against its own insureds
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 ismaterial, 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 Utmost Good Faith
A concealment is intentional failure of the applicant for insurance to reveal
a material fact to 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
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: 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

Courts have ruled that any ambiguities or uncertainties in the contract are
construed against the insurer.
The principle of reasonable expectationsstates 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 agents 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 nonwaiver
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
Chapter 10
Analysis of Insurance
Contracts
Basic Parts of an Insurance Contract
Declarations are statements that provide information about the particular
property or activity to be insured
Can usually be found 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

Basic Parts of an Insurance Contract

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
Basic Parts of an Insurance Contract
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
Why are Exclusions Necessary?
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
Why are Exclusions Necessary?
Moral hazard problems
e.g., coverage of money limited to $200 in homeowners policy
Attitudinal hazard problems
e.g., individuals are forced to bear losses that result from their own
carelessness
Coverage not needed by typical insureds
e.g., homeowners policy does not cover aircraft
Basic Parts of an Insurance Contract
Conditions are provisions in the policy that qualify or place limitations on
the insurers 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
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Deductibles
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
Reduce moral hazard and attitudinal (morale) hazard
Deductibles
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
Deductibles in Health Insurance
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 workers
earnings typically have elimination periods of 30, 60, or 90 days, or longer
periods.
Coinsurance
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
Coinsurance
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 policyowner who is underinsured is penalized through application of
the coinsurance formula
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
The purpose of other-insurance provisions is to prevent profiting from
insurance and violation of the principle of indemnity
Under a pro rata liability provision, each insurers share of the loss is based
on the proportion that its insurance bears to the total amount of insurance
on the property
Under contribution by equal shares, each insurer shares equally in the loss
until the share paid by each insurer equals the lowest limit of liability under
any policy, or until the full amount of the loss is paid
Other-insurance Provisions
Under a primary and excess insurance provision, the primary insurer pays

first, and the excess insurer pays only after the policy limits under the
primary policy are exhausted
The coordination of benefits provision in group health insurance is designed
to prevent overinsurance and the duplication of benefits if one person is
covered under more than one group health insurance plan