CHAPTER 4

LEGAL PRINCIPLE OF
INSURANCE CONTRACT
 Chapter Outlines
 Legal Principle of Insurance
1. Principle of Indemnity
2. Principle of Insurable Interest
3. Principle of Subrogation
4. Principle of Utmost Good Faith
5. Principle of Contribution
6. Doctrine of Proximate cause
 Requirements of an Insurance Contract
 Distinct Legal Characteristics of Insurance Contracts
 1. Principle of Indemnity
The insured should not profit from a covered loss
but should be restored to approximately the same
financial position that existed prior to the loss.
The insurer agrees to pay no more than the actual
amount of the loss
It is applicable to only non-life insurance
Purpose:
– To prevent the insured from profiting from a loss
– To reduce moral hazard (the likelihood of
intentional loss will reduce)
In property insurance, indemnification is
based on the actual cash value 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
 2. Principle of Insurable Interest
States that the insured must be in a position to
lose financially if a covered loss occurs.

• Purpose:

– To prevent Gambling

– To reduce Moral Hazard

– To measure the amount of loss

 3. Principle of Subrogation
The insurer is entitled to recover from a negligent
third party any loss payments made to the insured.

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

 4. Principle of Utmost Good Faith
• The insurance contract must be signed by
both parties (i.e insurer and insured) in an
absolute good faith or belief or trust

• A higher degree of honesty is imposed on

both parties to an insurance contract than is
imposed on parties to other contracts
Supported by the following four legal doctrines:
1. Representations are statements made by the
applicant for insurance before the policy is issued
– For example, if you apply for life insurance, you may
be asked questions concerning your age, weight,
height, occupation,, family history, and other relevant
questions. Your answers are called representations.

• A contract is voidable if the representation is

material, false, and relied on by the insurer
2. A concealment: is intentional failure of the
applicant for insurance to reveal a material
fact to the insurer
Concealment is the same thing as
nondisclosure; that is, the applicant for
insurance deliberately withholds material
information from the insurer
3. A warranty: is a statement that becomes
part of the insurance contract and is
guaranteed by the maker to be true in all
respects
4. Mistake
When an honest mistake is made in a written
contract of insurance, steps can be taken to correct
it after the policy is issued.
A mistake in the sense used here does not mean
an error in judgment by one party but refers to a
situation where it can be shown that the actual
agreement made was not the one stated in the
contract.
 5. Principle of Contribution
• It is the right of insurers who have paid a loss
under a policy to recover a proportionate
amount from other insurers, who are liable
for the same loss.
• It is applied in a situation where a person or
firm, for some reasons, purchase insurance
from two or more insurers to cover the same
subject matter against loss or damage.
• Under such circumstance, the insured cannot
collect compensation from each insurer.
 6. Doctrine of Proximate Cause
• Means that, when a loss is caused by more than
one causes, the proximate (nearest) cause
should be taken into consideration to decide
the liability of the insurer.
• However, in case of life insurance, the
proximate cause doctrine does not apply.
• Whatever may be the reason of death (whether
a natural death or an unnatural death) the
insurer is liable to pay the amount of insurance.
 Requirements of an Insurance Contract
• To be legally enforceable, an insurance contract must meet
four requirements:
1. Offer and acceptance of the terms of the contract
o the applicant for insurance makes the offer, and the
company accepts or rejects the offer.
2. Consideration – the values that each party gives to the
other
o The insured’s consideration is payment of the premium
and the insurer’s consideration is the promise to do
certain things as specified in the contract.
3. Legally competent parties, parties must have legal
capacity to enter into a binding contract
4. The contract must exist for a legal purpose:
o An insurance contract that encourages something illegal
is contrary to the public interest and cannot be enforced.
Distinct Legal Characteristics of Insurance Contracts
Aleatory: contract where the values exchanged may
not be equal but depend on an uncertain event.
Unilateral: only one party (the insurer) makes a
legally enforceable promise
Conditional: policy owner must comply with all
policy provisions to collect for a covered loss
Personal: A property insurance contract does not
insure property, but insures the owner of property
against loss.
Contract of adhesion: the insured must accept the
entire contract, with all of its terms and conditions