1. Fundamental Legal Principles
Lecture No. 17
Fundamental Legal Principles

2. Objectives 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
Law and the Insurance Agent

3. 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

4. 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
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

5. 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 insured’s death

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. Distinct Legal Characteristics of Insurance Contracts
Transparency Master 1.2
Distinct Legal Characteristics of Insurance Contracts
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
Contract of adhesion: since the insured must accept the entire contract as it is written, any ambiguities are construed against the insurer

13. 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
Insurers can place limitations on the power of agents by adding a nonwaiver clause to the application or policy

14. 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

15. The Commercial Package Policy (CPP)
In January 1986, a new, simplified approach to commercial insurance coverage was introduced by the insurance industry
Under the Commercial Package Policy (CPP)
The insured can obtain almost all types of insurance coverage
Broader contract provisions are included in the CPP
The CPP has seven separate sets of coverage
Commercial property, liability, crime, boiler and machinery, commercial auto, inland marine, and farm

16. The Commercial Package Policy (CPP)
An insured can pick and choose coverages in the CPP
The CPP allows many insureds to use one policy to meet most of their insurance needs
Workers’ compensation and ocean marine insurance must be purchased separately
The CPP has many options available

17. Building and Personal Property Coverage Form
Basic protection for buildings and personal property in the CPP
Property coverage is divided into three major categories
Buildings
Includes the buildings described on the declarations page
Any additions, extensions, fixtures, machinery and equipment constituting a permanent part of the described buildings
Service equipment
Your business personal property
Includes business personal property owned by the insured and usual to the occupancy of the insured
Personal property of others
Improvements and betterments
Alterations made to a leased building by the insured that the insured cannot legally remove when the lease is terminated
Personal property of others in the insureds control
Develops in situations where the insured repairs the property of others

18. Extensions of Coverage
BPP has extensions of coverage that expand protection to other categories of property
Newly acquired or constructed property
Your business personal property at newly acquired premises
Personal effects and property of others
Valuable papers and records–cost of research
Property off-premises
Outdoor property
All of these extensions are an additional amount of insurance
Apply only if the policy has an 80 percent or higher coinsurance clause

19. Specific versus Blanket Coverage
Under specific coverage, property at one or more locations is listed and specifically insured
Under blanket coverage, property at several locations may be insured under a single item

20. Common Clauses in the BPP
Common clauses include
Coinsurance
Subrogation
Electrical apparatus
No loss to electrical items will be covered if caused by artificially generated electrical currents
Unless fire ensues, and then loss is covered only for the fire damage
Power failure
Spoilage due to power failure from an insured peril is not covered unless the loss of power is from an on-premises insured peril
Operation of building laws
No loss will be paid that results from the operation of building codes
Alterations and repairs
Allows the insured to make this type of modification without its being considered an increase in hazard
Which would cause the coverage to be suspended

21. Common Clauses in the BPP
Two important exclusions were added to property clauses in 2002
Mold claims
Have skyrocketed in a few states in the early 2000s
Prior to 2002, mold was listed in the so-called “wear and tear” exclusion
After the terrorist attacks of September 11, insurers begin excluding terrorism from their policies
The Terrorism Risk Insurance Act (TRIA) was enacted in November 2002
By the federal government to provide a backup for insurers that could not get reinsurance coverage for terrorism

22. Insured Perils The basic form of the BPP covers
Fire, lightning, explosions, windstorm and hail, smoke, riot or civil commotion, vandalism, sprinkler linkage, sinkhole collapse, and volcanic action
The broad form includes the basic perils plus
Falling objects, the weight of ice, sleet, and snow; and accidental discharge of water or steam from a system or appliance containing steam or water other than an automatic sprinkler system
The special cause of loss form covers all direct physical losses except those that are excluded
Examples of excluded perils
Earth movement, flood, war, enforcement of building ordinance, smog, insect damage, and wear and tear
The old name for this type of coverage was “all risk”
The new name is “open perils”

23. Debris Removal The BPP form includes coverage for debris removal
However if the loss is > or equal to the policy
There is additional debris coverage up to $10,000
BPP provides coverage for costs of pollution cleanup and removal from land or water at the described premises

24. Subrogation
Practically all contracts of property insurance are subject to the right of subrogation
By the insurer against any liable third party
It may turn out, for example, that while the insured’s property insurance provides coverage for loss
Someone else has agreed to assume this liability by contract or is held liable because of its negligence in causing the damages
If the insurer pays the claim, it has a right to any such claims that the insured may have had against others
Such recoveries assign responsibility to the party that is responsible for the damages
Holding that party accountable for its actions

25. Endorsements used with the BPP
An insured can add earthquake and radioactive contamination to the list of insured perils
The limits of recovery on such property as outdoor signs, trees, shrubs, plants, and radio and television antennas may be increased
Special market value endorsements are available for distilled spirits and wines

26. Endorsements used with the BPP
Two endorsements that modify the BPP include
Replacement cost
Like that found in the homeowner’s policy and changes the basis of recovery from actual cash value to replacement cost
Ordinance and law endorsement
Used when older buildings must be repaired according to a more stringent building code

27. Boiler and Machinery Insurance (Equipment Breakdown Coverage)
Explosions caused by steam boilers, compressors, engines, electrical equipment, flywheels, air tanks, and furnaces constitute a serious source of loss that the layperson often does not recognize
Has developed along somewhat different lines from the usual insurance contract
Recognizing that prevention of losses is even more important than indemnification of loss
Insurers have taken on the service of inspection and servicing of boiler operations and technical machinery
Failure of the vessel to pass an inspection may mean imminent danger to continued operations
The insurer reserves the right to suspend coverage immediately if recommended repairs or replacements are not made

28. End of Lecture 17