1. Legal Principles in Insurance
Agenda
Principle of Indemnity (補償)
Principle of Insurable Interest (可保利益)
Principle of Subrogation (代位求償)
Principle of Utmost Good Faith (最高真誠)
Requirements of an Insurance Contract
Distinct Legal Characteristics of Insurance Contracts
Law and the Insurance Agent

2. BBC Newsnight http://www.youtube.com/watch?v=jHVnEBw93EA
…everyone in my road buying insurance on my house in the hope that it collapses…
BBC Newsnight

3. Credit Default Swap (CDS) in five minutes: BBC
…everyone in my road buying insurance on my house in the hope that it collapses…

4. 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
What about a Hospital Cash Plan???

5. Principle of Indemnity
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
Jefferson Insurance Company of New York v Superior Court of Alameda County
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

6. 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
Gamel v. Continental Insurance Company
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

7. Indemnity versus Valued Contracts
Indemnity contract: insurer pays based on the amount of loss that occurred
Example: auto physical damage
Valued contract: insurer pays a pre-determined amount
Example: life insurance

8. Indemnity versus Valued Contracts
Type of contract is largely explained by
the costs of assessing value
When the amount of loss can be assessed at low cost following the loss, more likely to have indemnity contracts
moral hazard
When moral hazard is less likely to be a problem, fixing the insurance payment before a loss can avoid costly haggling following a loss (e.g., life insurance)

9. Actual Cash Value Calculations
ACV = RC - Depreciation
= RC - [RC x (life used/expected useful life)]
= RC x (life left / expected useful life)
Note that the original price of the asset does NOT enter into this formula!

10. ACV: Computer Example ACV = RC x (life left / expected useful life)
Original price of old computer: $1,500
Expected useful life: 5 years
Computer destroyed after 2 years
Current price of similar computers: $1,000
ACV = RC x (life left / expected useful life)
= [1,000 x ( 3 yrs. / 5 yrs.)]
= $600
香港昌達電機公司實例

11. Principle of Insurable Interest
Transparency Master 1.2
Principle of Insurable Interest
The insured must stand to lose financially if a loss occurs
Purpose:
To prevent gambling
To reduce moral hazard
To measure the amount of loss
When must insurable interest exist?
Property insurance: at the time of the loss
Life insurance: only at inception of the policy
Who has an insurable interest?
Property insurance:
Life insurance: insured vs. beneficiary? (LifeCare)

12. Insight 9.1: Corporation Lacking Insurable Interest at Time of Death
A corporation purchases a $1 million life insurance policy on an officer who was a 20% stockholder in the company. Shortly thereafter, the officer sold his stock and resigned. Two years later he died but the policy owned by the corporation is still in force. The insurer paid the death benefits to the corporation. The deceased insured’s son claimed the corporation’s insurable interest was only temporary and must continue until death. So the son claimed that he, but not the corporation, is entitled to the death benefits.
Who is entitled for the policy proceeds?

13. Example: Insurable Interest
MARK owns a house on which he has a fire insurance policy with himself being the sole insured. He recently sells his home to SUSAN. A week later, a fire occurs and totally destroys the property. The insurance policy on the home is not cancelled yet.
Can MARK collect money from the policy?
Can SUSAN collect money from the policy?

14. Principle of Subrogation
Substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third person 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

15. Principle of Subrogation
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 and to most individual health insurance contracts
The insurer cannot subrogate against its own insureds
香港實例: 胡老總的司機…

16. Example: Subrogation
Allison owns a $50,000 building, which is insured for $40,000 and totally destroyed by fire caused by negligent act of a neighbor.
Can Allison collect from both the negligent neighbor and her own insurer?
Suppose the insurer pays Allison $40,000 and she and the insurer sue the negligent jointly. If the recovery if $33,000 net of costs, how much will the insured recover?
(J.A. Greenblatt, “Insurance and Subrogation: When the Pie isn’t Big Enough, Who Eats Last?” The University of Chicago Law Review, 64(4), Fall 1997, p )

17. 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 are statements made by the applicant for insurance
A contract is voidable if the representation is material, false, and relied on by the insurer
An innocent misrepresentation of a material fact, if relied on by the insurer, makes the contract voidable

18. 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

19. Example: Misrepresentation
Kirk applied for a life insurance policy. He stated in the application he had never smoked cigarettes. In fact, he had smoked for 13 years, and during the month before he applied for insurance, he was smoking approximately 10 cigarettes daily. About 10 months later, Kirk died of reasons unrelated to smoking. The beneficiary filed a claim for the death proceeds. While investigating the claim, the insurer discovered that Kirk smoked and denied payment because of a material misrepresentation. The insurer sought to cancel the policy and refunded the premiums paid.

20. Insight 9.3 Misrepresentation in Proof of Loss
Legal Facts: The insured experienced a burglary loss of $9,000 and misrepresented the value of the items stolen. The insured provided receipts that showed a purchase price of $900 for a stereo set and $1,500 for video equipment. The insurer proved that the stereo set cost only $400, and that the insured had not purchased the video equipment.
Court Decision:
For the insurer to void coverage in its entirety.

21. 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 values that each party exchange
Legally competent parties, with legal capacity to enter into a binding contract
The contract must exist for a legal purpose

22. Example: Consideration
Rachel signed an application for $100,000 life insurance on January 10. She did not pay any premium at that date. The underwriter at the home office of the insurer accepted the application on January 17 and mailed the contract to the agent that afternoon for delivery to Rachel. When the agent called at Rachel’s home with the policy, he discovered that she had died.
(a) Is the insurer liable if Rachel died on January 12?
(b) Is the insurer liable if Rachel died on January 18?

23. Example: Competent Parties
In each of the following cases, indicate whether a person is legally competent to enter into a valid insurance contract.
(1)   A male, age 15, who applies for insurance on his life.
(2)   A married woman, age 21, who applies for an auto policy and is the named insured.
(3)   A female, age 21, who signs an application for life insurance when she is intoxicated.
(4) A male, age 21, who has been convicted of drunk driving and has been cancelled by an insurer.

24. Special Legal Characteristics of the Insurance Contract
Aleatory – values exchanged are not equal
Unilateral – only the insurer makes a legally enforceable promise
Conditional – policyholder 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
Contract of adhesion – since the insured must accept the entire contract as it is written, any ambiguities are construed against the insurer

25. Resolving Coverage Disputes
Contracts of Adhesion
ambiguities are interpreted in favor of policyholder
applied less often to commercial insurance
Doctrine of Reasonable Expectations
courts interpret contracts as would a reasonable person not trained in the law
Bad Faith Suits: insurers have acted in a manner inconsistent with what a reasonable policyholder would have expected and therefore have failed to act in good faith. The court would award damages to claimants many times over the disputed amount.

26. 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
Authority is either express, implied, or apparent
Knowledge of the agent is presumed to be knowledge of the principal with respect to matters within the scope of the agency relationship

27. Law and the Insurance Agent
Waiver (棄權) is defined as the voluntary relinquishment of a known legal right
Estoppel (禁止反言) 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

28. Example: Agency Practice
Nicole is applying for a health insurance policy. She has a chronic liver ailment and other health problems. She honestly disclosed the true facts concerning her medical history to the insurance agent. However, the agent did not include all the facts in the application. Instead, the agent stated that he was going to cover the material facts in a separate letter to the insurance company’s underwriting department, but the agent did not furnish the material facts to the insurer, and the contract was issued as standard.

29. Example: Agency Practice
A claim occurred shortly thereafter. After investigating the claim, the insurer denied payment. Nicole contends that the company should pay the claim because she answered honestly all questions that the agent asked.
(a) On what basis can the insurance company deny payment of the claim?
(b) What legal doctrines can Nicole use to support her argument that the claim should be paid?

30. Case Application (Bonus points; Due on _3/8_)
Al purchased an automobile service station from Ben. The purchase price included the building, equipment, and other assets. The business was financed by a loan from HSBC bank, which held a mortgage on the building. Al also converted a one-car repair bay into a short-order restaurant. When Al applied for property insurance on the business, he did not tell the insurer about the restaurant because his premiums would have been substantially increased. Six months after the business opened, a (third-party) car caught fire and damaged the roof over a bay in the service station area.

31. Case Application
Do any of the following parties have an insurable interest in the business at the time of the fire?
Ben Al
HSBC bank
Ben told Al he could save money by taking over Ben’s insurance instead of buying a new policy. Would it be appropriate for Al to take over Ben’s insurance without notifying Ben’s insurer?

32. Case Application
Investigation of the fire revealed that the car owner knew the gas tank had a leak, but this information was not disclosed to Al when the car was brought in service. Explain how subrogation might apply in this case.
Did Al show utmost good faith when he applied for property insurance on the business?
Could Al’s insurer deny coverage for the fire on the basis of a material concealment?