1. C HAPTER 5 L EGAL P RINCIPLES I N I NSURANCE

2. A GENDA Principle of Indemnity Principle of Insurable Interest Principle of Subrogation Principle of Utmost Good Faith Requirements of an Insurance Contract Distinct Legal Characteristics of Insurance Contracts

3. P RINCIPLE OF I NDEMNITY The insurer agrees to pay no more than the actual amount of the loss ; stated differently, the insured should not profit from a loss.

4.  TWO PURPOSES OF principle of indemnity 1- To prevent the insured from profiting from a loss. Example: If Kristin’s home is insured for $200,000, and a partial loss of $50,000 occurs, the principle of indemnity would be violated if $200,000 were paid to her. She would be profiting from insurance. 2- To reduce moral hazard The deliberately losses with the intention to collect money from insurance is reduced when the loss payment dose not exceed the actual amount of loss.

5. P RINCIPLE OF I NSURABLE I NTEREST The insured must be in a position to lose financially if a covered loss occurs. “ I care about the loss which occurs” Example: You have an insurable interest in your car because you may lose financially if the car is damaged or stolen. You have an insurable interest in your personal property, such as a computer, because you may lose financially if the property is damaged or destroyed.

6. P URPOSES OF I NSURABLE I NTEREST 1- To prevent gambling If the insurable interest were not required, the contract would be a gambling contract and against the public interest. “you could insure the property of another person and hope for a loss to occur’’ “you could buy a life insurance for another person and hope for an early death”

7. 2-To reduce moral hazard If an insurable interest were not required, a dishonest person could purchase property insurance on someone else’s property and then deliberately cause a loss to receive the proceeds. Insurable interest reduced moral hazard because the insured dose not gain anything by causing the loss. Example: In life insurance the insurable interest requirements reduces the incentive to murder the insured for the purpose of collecting the proceeds.

8. 3- To measure the amount of the insured’s loss in property insurance Most property insurance contracts are contracts of indemnity meaning that the loss payment cannot exceed the value of one’s property (one’s insurable interest). Thus, the principle of indemnity is supported.

9. P RINCIPLE OF I NSURABLE I NTEREST 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

10. P RINCIPLE OF S UBROGATION Strongly support the principle of indemnity The insurer is entitled to recover from a negligent third party any loss payments made to the insured. Example: Assume that a negligent motorist fails to stop at red light and smashes into Megan’s car, causing damage in the amount of $5,000. If Megan has a collision insurance on her car, her insurer will pay the physical damage loss to the car and then attempt to collect from the negligent motorist who caused the accident. Alternative option : Megan could attempt to collect directly from the negligent motorist for the damage to her car.

11. P URPOSE OF S UBROGATION o Subrogation has three basic purposes: 1- Preventing the insured from collecting twice for the same loss. In the absence of subrogation, the insured could collect from his or her insurer and from the person who caused the loss. In this case the principle of indemnity would be violated because the insured would be profiting from a loss. 2- Holding the negligent person responsible for the loss. Exercising its subrogation rights, the insurer collect from the negligent person who caused the loss. 3-Subrogation helps to hold down insurance rates. Subrogation recoveries are reflected in the rate-making process which reduces rates below where they would be in the absence of subrogation.

12. P RINCIPLE OF S UBROGATION 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 insureds

13. P RINCIPLE OF U TMOST GOOD FAITH  Principle of utmost good faith is based on a high degree of honesty on both parties to an insurance contract.  Supported by three legal doctrines: 1- Representation 2- Concealment 3- Warranty

14.  1-Representation Statements made by the applicant for insurance. Example: If you apply for life insurance, you may be asked questions concerning your age, weight, height, occupation, state of health, family history, and other relevant questions. Your answers to these questions are called representations. The insurance contract is voidable at the insurer’s option if the representation is (1) material, (2) false, (3) relied on by the insurer. (1) Material means that if the insurer knew the true facts, the policy would not have been issued, or it have been issued on different terms(Insight 5.2). (2) False means that the statement is not true or is misleading. (3) Reliance means that the insurer relies on the misrepresentation in issuing the policy at the a specified premium.

15. A UTO I NSURER D ENIES C OVERAGE B ECAUSE OF M ATERIAL MISREPRESENTATION Legal Facts The insured misrepresented that she had no traffic violation convictions in the prior three-year period. After an accident, a check of her record revealed that she had two speeding tickets in that period. The insurer denied coverage. Court Decision State law regarding the voiding of insurance requires that misrepresentation must be material and made with the intent to deceive. The insured claimed that she had forgotten about the two tickets, and therefore had no intend to deceive. The court ruled that it is unlikely she would forget both events. Decision is for the insurer. INSIGHT 5.2

16. Innocent Misrepresentation of a material fact, if relied on by the insurer, also makes the contract voidable. Important: The material misrepresentation also applies to statements made by the insured after a loss occurs. If the insured submits a fraudulent proof of loss or misrepresents the value of the items damaged, the insurer has the right to void the coverage(Insight 5.3).

17. Insurer Voids Coverage Because of Misrepresentations in Proof of Loss Legal Facts The insured experienced a burglary loss of $9000 and misrepresented the value of the items stolen. The insured provided receipts that showed a purchase price of $900 for a stereo set and $1500 for video equipment. The insurer proved that the stereo set cost only $400, and that the insure had not purchased the video equipment. Court Decision The court allowed the insurer to void coverage in its entirety. The court ruled that (1) insureds have an obligation to provide the insurer with true receipts, submit to an examination under oath, and provide a sworn proof of loss, and (2) the misrepresentation were material because they were made to mislead, discourage, or deflect the insurer’s investigation of the claim. INSIGHT 5.3

18.  2-Concealment Concealment is the same thing as nondisclosure. The applicant for insurance deliberately withholds material information from the insurer. Example: Joseph DeBellis applied for a life insurance on his life. He had an extensive criminal record. Five months after the policy issued, he was murdered. The death certificate named the deceased as Joseph Deluca, his true name. The insurer denied payment on the grounds that Joseph had concealed a material fact by not revealing his true identity and that he had an extensive criminal record. Court decision: The court held that intentional concealment of his true identity was material and breached the obligation of good faith.

19.  3- Warranty A warranty is a statement that becomes part of the insurance contract and is guaranteed by the maker to be true in all respects. Example: A liquor store owner may warrant that an approved burglar alarm system will be operational at all times. A bank may warrant that a guard will be on the premises twenty-four hours a day.  Warranty is a harsh legal doctrine and any breach of the warranty, even if minor or not material, allowed the insurer to deny payment of claim.

20. E LEMENTS OF V ALID C ONTRACT 1- Offer and acceptance 2- Consideration 3- Competent parties 4- Legal Purpose  1- Offer and acceptance The applicant for insurance makes the offer, and the company accepts or rejects the offer.  2- Consideration is the value that each party gives to the other. The insured’s consideration is payment of premium plus any agreement specified in the policy. The insurer’s consideration is to pay for a loss, providing certain services and defending the insured in a liability lawsuit.

21. 3-Competent parties  Each party must be legally competent meaning that the parties must have legal capacity to enter into a binding contract.  Most adults are legally competent to enter into insurance contracts, but there are some exceptions such as insane persons, intoxicated persons, and corporations that act outside the scope of their authority which cannot enter into a enforceable insurance contracts.  The insurers must be licensed to sell insurance in the state, and the insurance sold must be within the scope of its charter or certificate of incorporation.

22. 4- Legal Purpose  An insurance contract that encourages or promotes something illegal or immoral is contrary to the public interest and cannot be enforced.  Example : A drug dealer who sells heroin and other illegal drugs cannot purchase a property insurance policy that would cover seizure of the drugs by the police.

23. D ISTINCT L EGAL C HARACTERISTICS OF I NSURANCE C ONTRACTS An insurance contracts is: Aleatory contract : values exchanged are not equal but depend on an uncertain event. Example : Assume that Jessica pays a premium of $600 for $200,000 of homeowners insurance. If the home were totally destroyed by fire shortly thereafter,she would collect an amount that greatly exceeds the premium paid. On the other hand, a homeowner may faithfully pay premiums for many years and never had a loss.

24. -Unilateral: only the insurer makes a legally enforceable promise. After the first premium is paid, and the insurance is in force, the insured cannot be legally forced to pay the premiums or to comply with the policy provisions. Although the insured must continue to pay the premiums to receive payment for a loss, he or she cannot be legally forced to do so.

25. Conditions section imposes certain duties on the insured if he or she wishes to collect for a loss. Although the insured is not compelled to abide by the policy conditions, he or she must do so to collect for an insured loss. The insurer is not obligated to pay a claim if the policy conditions are not met. -Conditional : policyowner must comply with all policy provisions to collect for a covered loss.

26. -Personal: property insurance policy cannot be validly assigned to another party without the insurer's consent. A property insurance contract does not insure property, but insures the owner of property against loss. Because the contract is personal, the insurer’s consent is required before a property insurance can be assigned to new property owner. The new property owner must be acceptable to the insurer and must meet certain underwriting standards regarding character, morals, and credit. In practice, new property owners get their own insurance, so consent of the previous insurer is not required.

27. -A contract of adhesion : the insured must accept the entire contract with all of its terms and conditions. Although the contract can be altered by the addition of endorsement and riders or other forms, the contract is drafted by the insurer. Contract of adhesion means that insured generally must accept the entire document and cannot insist that certain provisions be added or deleted or the contract rewritten to suit the insured.