1. Insurance contracts BUS 200 Introduction to Risk Management and Insurance Jin Park

2. Overview Distribution of Insurance Contracts Distribution of Insurance Contracts Insurance as contracts Insurance as contracts legally enforceable agreements legally enforceable agreements Characteristics of Insurance Contracts Characteristics of Insurance Contracts Fundamental Principles of Insurance Contracts Fundamental Principles of Insurance Contracts Principle of indemnity Principle of indemnity Principle of insurable interest Principle of insurable interest Principle of utmost good faith Principle of utmost good faith Principle of subrogation Principle of subrogation

3. Distribution of Insurance Contracts Direct Marketing Direct Marketing No agent is involved No agent is involved Mail marketing, internet based marketing Mail marketing, internet based marketing Exclusive Agent Exclusive Agent Agent represents one insurer Agent represents one insurer Independent Agent Independent Agent Agent represents more than one insurer Agent represents more than one insurer

4. Distribution of Insurance Contracts Agent versus Broker Agent versus Broker Binding Authority by Agent Binding Authority by Agent Property/Liability Insurance Property/Liability Insurance Binder Binder Life/Health Insurance Life/Health Insurance Conditional premium receipt Conditional premium receipt

5. Waiver and Estoppel Waiver Waiver The intentional relinquishment of a known right. The intentional relinquishment of a known right. Estoppel Estoppel It prevents one from alleging or denying a fact, the contrary of which he has previously admitted. It prevents one from alleging or denying a fact, the contrary of which he has previously admitted.

6. Insurance as Contracts Valid contracts Valid contracts Legally enforceable Legally enforceable Void contracts Void contracts A void contract never had any legal existence. A void contract never had any legal existence. Either party may choose to ignore the agreement. Either party may choose to ignore the agreement. Voidable contracts Voidable contracts Legally exists Legally exists The contracts can be legally rejected or avoided at the option of one or both parties. The contracts can be legally rejected or avoided at the option of one or both parties. cf: Denying coverage based on breach of policy cf: Denying coverage based on breach of policy condition condition

7. Insurance as Contracts Elements of contract Elements of contract Agreement Agreement Offer and Acceptance Offer and Acceptance Consideration Consideration Insured – premium payment and fulfillment of policy conditions Insured – premium payment and fulfillment of policy conditions Insurer – promise to do certain things as specified in the contract Insurer – promise to do certain things as specified in the contract Legally competent parties Legally competent parties Parties must have legal capacity to enter into a binding contract Parties must have legal capacity to enter into a binding contract Legal Purpose Legal Purpose Contract must be for a legal purpose Contract must be for a legal purpose Legal Form Legal Form Contract may be oral or written Contract may be oral or written Some insurance policy provisions and attachments must be approved by state before being marketed Some insurance policy provisions and attachments must be approved by state before being marketed

8. Insurance as Contracts Property - Casualty Offer Offer Submission of application with a down payment Submission of application with a down payment Acceptance Acceptance Binder Binder Life Offer Submission of application with a down payment Issuance of a life insurance policy Acceptance Conditional premium receipt Note: Giving a quotation to a prospective insured is deemed as mere solicitation or invitation to make an offer.

9. Characteristics of Insurance Contracts 1. Personal Contracts Insurance protects insured, not the property or liability subject to loss. Insurance protects insured, not the property or liability subject to loss. Assignment provision Assignment provision If ownership of a property changes, insurance contracts (or policies) normally cannot be transferred to another party (buyer) without the insurers written consent. If ownership of a property changes, insurance contracts (or policies) normally cannot be transferred to another party (buyer) without the insurers written consent. In life insurance, the beneficiary or ownership of policy may be freely reassigned. In life insurance, the beneficiary or ownership of policy may be freely reassigned. Transfer of your rights and duties under this policy. Transfer of your rights and duties under this policy.

10. Characteristics of Insurance Contracts 2. Aleatory Contracts The values exchanged may not be equal, but depend on an uncertain event The values exchanged may not be equal, but depend on an uncertain event The premium, paid to an insurer by an insured for a policy, is not expected to exactly equal the amounts to be paid by the insurer in fulfilling its contractual obligations to the insured. The premium, paid to an insurer by an insured for a policy, is not expected to exactly equal the amounts to be paid by the insurer in fulfilling its contractual obligations to the insured. cf: commutative contract – the values exchanged are theoretically equal. cf: commutative contract – the values exchanged are theoretically equal.

11. Characteristics of Insurance Contracts 3. Contracts of adhesion Contracts are drafted by an insurer and an insured must accept or reject all the terms and conditions. Contracts are drafted by an insurer and an insured must accept or reject all the terms and conditions. Insured gets the benefit of the doubt. Insured gets the benefit of the doubt. Courts tend to construe an ambiguous term in an insurance policy in favor of an insured. Courts tend to construe an ambiguous term in an insurance policy in favor of an insured. Contracts may be altered by the addition of riders or endorsements Contracts may be altered by the addition of riders or endorsements Rider or endorsement – a document that amends or changes the original policy. Rider or endorsement – a document that amends or changes the original policy. cf: Contracts of cohesion – both parties draft the contracts. cf: Contracts of cohesion – both parties draft the contracts.

12. Characteristics of Insurance Contracts 4. Conditional contracts An insurers obligation to pay a claim depends on whether the insured or the beneficiary has complied with all policy conditions. An insurers obligation to pay a claim depends on whether the insured or the beneficiary has complied with all policy conditions. The insurer may not pay a claim if the policy conditions are not met. The insurer may not pay a claim if the policy conditions are not met. Duties after loss – Homeowners (p. 562) Duties after loss – Homeowners (p. 562) Duties after an accident or loss – Automobile (p. 585) Duties after an accident or loss – Automobile (p. 585) Duties after in the event of loss or damage – CP Duties after in the event of loss or damage – CP

13. Characteristics of Insurance Contracts 5. Unilateral contracts Only one party makes a legally enforceable promise. Only one party makes a legally enforceable promise. Insured are not legally forced to pay premium or renew the policy. Insured are not legally forced to pay premium or renew the policy.

14. Fundamental Principles of Insurance Contracts 1. Principle of Indemnity The insurer agrees to pay no more than the actual amount of the loss suffered by the insured. The insurer agrees to pay no more than the actual amount of the loss suffered by the insured. Why? Why? The purpose of the insurance contract is to restore the insured to the same economic position as before the loss. The purpose of the insurance contract is to restore the insured to the same economic position as before the loss. The insured should not profit from a loss. The insured should not profit from a loss. It reduces the moral hazard by eliminating the profit incentive. It reduces the moral hazard by eliminating the profit incentive.

15. Fundamental Principles of Insurance Contracts 1. Principle of Indemnity To support the principal of indemnity insurance contact uses Actual Cash Value (ACV) To support the principal of indemnity insurance contact uses Actual Cash Value (ACV) Replacement cost (RC) less depreciation Replacement cost (RC) less depreciation Takes into consideration both inflation and depreciation. Takes into consideration both inflation and depreciation. RC – current cost of restoring the damaged property with new materials of like kind and quality. RC – current cost of restoring the damaged property with new materials of like kind and quality. Fair market value Fair market value The price of a wiling buyer would pay a willing seller in a free market. The price of a wiling buyer would pay a willing seller in a free market. Broad evidence rule Broad evidence rule The determination of ACV should include all relevant factors an expert would use to determine the value of the property. The determination of ACV should include all relevant factors an expert would use to determine the value of the property.

16. Fundamental Principles of Insurance Contracts 1. Principle of Indemnity To support the principal of indemnity insurance contact includes Other Insurance Provisions. To support the principal of indemnity insurance contact includes Other Insurance Provisions. Escape clause Escape clause The policy (or insurance) would not apply if the insured was covered by another policy. The policy (or insurance) would not apply if the insured was covered by another policy. Excess Excess It (or This insurance) is excess insurance over any other valid and collectible insurance. It (or This insurance) is excess insurance over any other valid and collectible insurance. Pro-rata provision Pro-rata provision Proration by face amounts Proration by face amounts Proration by amounts otherwise payable Proration by amounts otherwise payable Contribution by equal shares Contribution by equal shares

17. Fundamental Principles of Insurance Contracts 1. Principle of Indemnity Primary-Excess Primary-Excess Accident while test driving a dealers car. Accident while test driving a dealers car. Health insurance between a couple working for different employers. Health insurance between a couple working for different employers. Own insurance – primary Own insurance – primary Spouse insurance – excess Spouse insurance – excess Birthday rule for dependents coverage Birthday rule for dependents coverage

18. Fundamental Principles of Insurance Contracts 1. Principle of Indemnity Proration by Face Amounts Proration by Face Amounts It limits the insurers maximum obligation to the proportion of the loss that the insurers policy limit bears to the sum of all applicable policy limits. It limits the insurers maximum obligation to the proportion of the loss that the insurers policy limit bears to the sum of all applicable policy limits. If Loss amount is $150,000 If Loss amount is $150,000 Insurer A Insurer B Insurer C Policy Limit $100,000$200,000$300,000 Share1/62/63/6 Payment$25,000$50,000$75,000

19. Fundamental Principles of Insurance Contracts 1. Principle of Indemnity Proration by Amounts Otherwise Payable Proration by Amounts Otherwise Payable What would be payable under each policy in the absence of other insurance What would be payable under each policy in the absence of other insurance If Loss amount is $150,000 If Loss amount is $150,000 Insurer A Insurer B Insurer C Policy Limit $100,000$200,000$300,000 Payable$100,000$150,000$150,000 Share1/41.5/41.5/4 Payment$45,000$67,500$67,500

20. Fundamental Principles of Insurance Contracts 1. Principle of Indemnity Proration by Amounts Otherwise Payable Proration by Amounts Otherwise Payable If Loss amount is $60,000 If Loss amount is $60,000 Insurer A Insurer B Insurer C Policy Limit $100,000$200,000$300,000 Payable$60,000$60,000$60,000 Share1/31/31/3 Payment$20,000$20,000$20,000

21. Fundamental Principles of Insurance Contracts 1. Principle of Indemnity Contribution by Equal Shares Contribution by Equal Shares Each insurer contributes equal amounts until it has paid its applicable limit of insurance or none of the loss remains, whichever comes first. Each insurer contributes equal amounts until it has paid its applicable limit of insurance or none of the loss remains, whichever comes first. If Loss amount is $150,000 If Loss amount is $150,000 Insurer A Insurer B Insurer C Policy Limit $100,000$200,000$300,000 Equal Share $50,000$50,000$50,000 Payment$50,000$50,000$50,000

22. Fundamental Principles of Insurance Contracts 1. Principle of Indemnity Contribution by Equal Shares Contribution by Equal Shares If Loss amount is $400,000 If Loss amount is $400,000 Insurer A Insurer B Insurer C Policy Limit $100,000$200,000$300,000 Equal Share 1 $100,000$100,000$100,000 Equal Share 2 N/A$50,000$50,000 Payment$100,000$150,000$150,000

23. Fundamental Principles of Insurance Contracts 1. Principle of Indemnity Exceptions to the Principle Exceptions to the Principle Valued policy (or agreed value) Valued policy (or agreed value) Pays face value of insurance if a total loss occurs Pays face value of insurance if a total loss occurs Life insurance, disability insurance, fine arts, antiques Life insurance, disability insurance, fine arts, antiques Ex.) Value of a fine art is agreed at $250,000. Ex.) Value of a fine art is agreed at $250,000. Valued policy law Valued policy law A law that requires payment of the face amount of insurance to the insured if a total loss to real property occurs from a covered peril, regardless of the propertys ACV. A law that requires payment of the face amount of insurance to the insured if a total loss to real property occurs from a covered peril, regardless of the propertys ACV. Replacement cost Replacement cost No deduction for depreciation in determining the amount paid for a loss. No deduction for depreciation in determining the amount paid for a loss.

24. Fundamental Principles of Insurance Contracts 2. Principle of Insurable Interest The insured must be in a position to financially suffer if a loss occurs. The insured must be in a position to financially suffer if a loss occurs. Why? Why? To prevent gambling To prevent gambling Insurance on a property and wait for a loss occur. Insurance on a property and wait for a loss occur. To reduce moral hazard To reduce moral hazard Life insurance on a person and pray for his/her death for insurance proceeds. Life insurance on a person and pray for his/her death for insurance proceeds. To measure the amount of the insureds loss in property insurance To measure the amount of the insureds loss in property insurance In order not to indemnify more than the insurable interest. In order not to indemnify more than the insurable interest.

25. Fundamental Principles of Insurance Contracts 2. Principle of Insurable Interest Property-Casualty insurance Property-Casualty insurance At the time of a loss, an insured must have insurable interest. At the time of a loss, an insured must have insurable interest. No insurable interest no financial loss No insurable interest no financial loss no indemnity support Prin. of indemnity Life Insurance Life Insurance Insurable interest must exist at the time of a policy inception, but not at the time of a loss (death) Insurable interest must exist at the time of a policy inception, but not at the time of a loss (death)

26. Fundamental Principles of Insurance Contracts 2. Principle of Insurable Interest Insurable Interest may be created either by: Insurable Interest may be created either by: Obligation to Insure Obligation to Insure by Statute by Statute by Contract by Contract by Custom by Custom Option to Insure Option to Insure Owners Owners Mortgagors Mortgagors Lessors Lessors Trustees Trustees Tenants Tenants

27. Fundamental Principles of Insurance Contracts 3. Principle of Utmost Good Faith A higher degree of honesty is imposed on an insurance contract than is imposed on other contracts A higher degree of honesty is imposed on an insurance contract than is imposed on other contracts Honesty is imposed on the applicant for insurance Honesty is imposed on the applicant for insurance It is supported by three legal doctrines It is supported by three legal doctrines Representation Representation Concealment Concealment Warranty Warranty

28. Fundamental Principles of Insurance Contracts 3. Principle of Utmost Good Faith Representation Representation Statements made by an applicant Statements made by an applicant Insurance is voidable at the insurers option. Insurance is voidable at the insurers option. Material Material False False Reliance Reliance cf: Innocent misrepresentation cf: Innocent misrepresentation Concealment Concealment Intentional failure to disclose a material fact Intentional failure to disclose a material fact Warranty Warranty 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. 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. In exchange for a reduced premium, a store owner warrants that alarm will be always on. In exchange for a reduced premium, a store owner warrants that alarm will be always on.

29. Fundamental Principles of Insurance Contracts 4. Principle of Subrogation Substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third party wrongdoer for a loss covered by insurance. Substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third party wrongdoer for a loss covered by insurance. Why? Why? To prevent collecting twice To prevent collecting twice To hold the negligent party responsible To hold the negligent party responsible To hold down insurance rates To hold down insurance rates

30. Fundamental Principles of Insurance Contracts 4. Principle of Subrogation The insurer is entitled only to the amount it has paid under the policy. The insurer is entitled only to the amount it has paid under the policy. If the insurer collects more than the amount the insurer paid to the insured from the negligent party, the insured must be paid in full before the insurer retains the remaining balance. If the insurer collects more than the amount the insurer paid to the insured from the negligent party, the insured must be paid in full before the insurer retains the remaining balance. The insured cannot impair the insurers subrogation rights. The insured cannot impair the insurers subrogation rights. Subrogation does not apply to life insurance and to most individual health insurance contracts. Subrogation does not apply to life insurance and to most individual health insurance contracts. The insurer cannot subrogate against its own insured. The insurer cannot subrogate against its own insured.