rmi test 2

Principle of indemnity

The insurer agrees to pay no more than the actual amount of the loss. Purposes: prevent the insured from profiting from a loss and reduce moral hazard.

Actual cash value (ACV)

The basis of indemnity in property insurance, measured at the time of loss. ACV = Replacement cost - Depreciation.

ACV formula and example

ACV = Replacement cost - Depreciation. Example: replacement cost $2,000, depreciation 30%, so ACV = $2,000 x 70% = $1,400. Depreciation comes off TODAY'S replacement cost, not the original purchase price.

Three ways to measure ACV

1) Replacement cost less depreciation; 2) Fair market value; 3) Broad evidence rule.

Fair market value

The price a willing buyer would pay a willing seller in a free market.

Broad evidence rule

Considers all relevant factors an expert would use to value the property.

Exceptions to the principle of indemnity

Cases where the insured can collect more than ACV: valued policy, valued policy laws, replacement cost insurance, and life insurance.

Valued policy

Pays the face amount of insurance if a total loss occurs. Often used for antiques, fine art, and family heirlooms.

Valued policy laws

State laws requiring payment of the face amount if a total loss to real property occurs from a peril named in the law.

Replacement cost insurance

No deduction for depreciation when determining the amount paid for a loss.

Why is life insurance a valued policy?

It pays a stated sum to the beneficiary at the insured's death. A human life has no actual cash value.

Insurable interest

The insured must be in a position to lose financially if a covered loss occurs.

Purposes of insurable interest

Prevent gambling, reduce moral hazard, and measure the amount of the insured's loss.

Sources of insurable interest in PROPERTY insurance

Ownership of property, potential legal liability, being a secured creditor, and contractual rights. (Former ownership does NOT count.)

Who has insurable interest in LIFE insurance?

You always have it in your own life. In another person's life: close family ties, marriage, or a pecuniary (financial) interest. A beneficiary does not need one by default.

When must insurable interest exist: property insurance?

At the time of the loss.

When must insurable interest exist: life insurance?

Only at the inception of the policy.

Principle of subrogation

After paying a claim, the insurer is substituted in place of the insured to collect from a negligent third party.

Purposes of subrogation

Prevent the insured from collecting twice for the same loss, hold the negligent person responsible, and hold down insurance rates.

Exceptions and limits of subrogation

The insurer recovers only what it paid. Does not apply to life insurance. The insurer cannot subrogate against its own insureds.

What if the insured impairs subrogation rights after a loss?

An insured who interferes (such as releasing the negligent party) can forfeit the right to collect from the insurer.

Principle of utmost good faith (uberrimae fidei)

Both parties are held to a higher degree of honesty than in other contracts. Supported by three doctrines: representations, concealment, and warranty. (Subrogation does NOT support it.)

Representation

A statement made by the applicant for insurance. Statements made by applicants are representations, not warranties.

Misrepresentation

A false material statement made by an applicant for insurance.

When is a misrepresentation grounds to void the contract?

The contract is voidable at the insurer's option if the representation is material, false, and relied on by the insurer. Even an innocent material misrepresentation, if relied on, makes the contract voidable.

Material (definition)

A fact is material if, had the insurer known the true facts, the policy would not have been issued, or would have been issued on different terms.

Concealment

The intentional failure of the applicant to reveal a material fact to the insurer. Legal effect: the contract is voidable at the insurer's option.

To deny a claim for concealment, a nonmarine insurer must prove

1) The concealed fact was known by the insured to be material; 2) The insured intended to defraud the insurer.

Concealment examples

A homeowner knows the wiring sparks whenever the dryer runs and says nothing. A business owner knows a fired employee threatened to burn the building down and buys coverage without saying so.

Warranty

A statement that becomes part of the insurance contract and is guaranteed by the maker to be true in all respects.

Warranty vs representation

A warranty is part of the contract and guaranteed true. A representation is an applicant's statement that is not guaranteed. Courts interpret breach of warranty liberally, and statutes let the insured recover unless the breach contributed to the loss.

Warranty examples

A liquor store owner warrants an approved burglar alarm will operate at all times in return for a lower rate. A bank warrants a guard will be on the premises 24 hours a day.

Four requirements of a valid insurance contract

1) Offer and acceptance; 2) Competent parties; 3) Legal purpose; 4) Exchange of consideration.

Consideration

The value each party gives to the other.

Insured's consideration

Pays the premium (or promises to) and agrees to abide by the policy conditions.

Insurer's consideration

Promises to do what the policy specifies, such as paying covered losses.

Missing legal purpose example

Insuring illegal slot machines against police confiscation. The contract is unenforceable because it lacks legal purpose.

Five legal characteristics of insurance contracts

Aleatory, unilateral, conditional, personal, and adhesion.

Aleatory contract

Values exchanged are not equal. A small premium may buy a large payout, or nothing at all.

Unilateral contract

Only the insurer makes a legally enforceable promise. The insurer cannot sue the insured for unpaid premiums.

Conditional contract

The policyowner must comply with all policy provisions to collect. Practical effect: the insurer can refuse to pay if the insured fails to abide by policy provisions (e.g., late notice).

Personal contract

A property policy cannot be assigned without the insurer's consent (the insurer insures a person, not just property). Example: a house is sold but the insurer is not told, so the new owner can be denied.

Assignment: life vs property insurance

Life policies can be assigned freely without insurer consent (just notify the insurer). Property policies require the insurer's consent.

Contract of adhesion

The insurer writes the contract and the insured must accept it entirely as written.

How courts treat ambiguities in an adhesion contract

Ambiguities and uncertainties are construed against the insurer (in the insured's favor).

Principle of reasonable expectations

An insured is entitled to the coverage he or she reasonably expects the policy to provide, regardless of policy provisions.

Six basic parts of an insurance contract

1) Declarations; 2) Definitions; 3) Insuring agreement; 4) Exclusions; 5) Conditions; 6) Miscellaneous provisions.

Declarations

The part of the policy with information about the property or activity insured: insured's name, property location, policy period, amount of insurance, premium, deductible.

Definitions (policy section)

Key terms used in the policy, such as "you" meaning the insured.

Insuring agreement

Summarizes the major promises of the insurer. Takes one of two forms: named perils or open perils.

Named perils coverage

Only the perils specifically named in the policy are covered. If a peril is not on the list, it is not covered.

Open perils (special / all risks) coverage

All losses are covered except those specifically excluded. The burden is on the insurer to show an exclusion applies.

Miscellaneous provisions

Cancellation, subrogation, grace period, misstatement of age, and similar provisions.

Four types of exclusions

1) Excluded perils; 2) Excluded losses; 3) Excluded property; 4) Excluded locations.

Excluded perils

Causes of loss that are not covered. Examples: flood, an intentional act.

Excluded losses

Types of loss that are not covered. Example: a professional liability loss under a homeowners policy.

Excluded property

Items that are not covered. Example: pets and cars as personal property under a homeowners policy.

Excluded locations

Places where coverage does not apply. Example: an auto policy covering only the US, its territories, Puerto Rico, and Canada.

Reasons exclusions are used

1) Not commercially insurable (war); 2) Extraordinary hazards (personal auto used as a taxi); 3) Covered by other contracts; 4) Moral hazard (money limited to $200 on a homeowners policy); 5) Attitudinal hazard (carelessness); 6) Not needed by typical insureds (aircraft).

Conditions (policy section)

Provisions that qualify or limit the insurer's promise to perform. If they are not met, the insurer can refuse to pay.

Common policy conditions

Notice of loss (notify insurer promptly), proof of loss, cooperation in investigating and settling the claim, and protecting the property from further damage.

Endorsement

Property and liability insurance: a written provision that adds to, deletes from, or modifies the original contract.

Endorsement examples

Earthquake coverage added to a homeowners policy, scheduled coverage for jewelry or fine art, replacement cost for personal property, an additional insured.

Rider

Life and health insurance: a provision that amends or changes the original policy.

Rider examples

Waiver of premium rider, accidental death benefit rider, guaranteed purchase option, cost of living rider.

Deductible

A specified amount subtracted from the total loss payment that otherwise would be payable.

Purposes of deductibles

Eliminate small claims that are expensive to process, reduce premiums, and reduce moral hazard and attitudinal (morale) hazard.

Where deductibles are NOT used

Life insurance (death is always a total loss) and personal liability insurance (the insurer must defend the insured and wants to be involved from the start).

Straight deductible

The insured pays a set dollar amount of each loss before the insurer pays. Example: auto physical damage.

Aggregate deductible

All losses during a period, usually one year, are added together to satisfy the deductible. After it is met, the insurer pays in full.

Calendar-year deductible

A type of aggregate deductible used in basic medical and major medical insurance. Resets each calendar year.

Calendar-year vs straight deductible

A straight deductible applies to every loss. A calendar-year (aggregate) deductible is met once during the year, then the insurer pays in full.

Calendar-year deductible example

$10,000 deductible, losses of $2,500, $8,500, $5,000. Insurer pays $0, then $1,000 (deductible has $7,500 left, so $8,500 - $7,500), then $5,000.

Elimination (waiting) period

A waiting period at the start of a loss when no benefits are paid. A deductible measured in time instead of dollars. In disability income insurance: 30, 60, 90 days, or longer.

Coinsurance in property insurance

Encourages the insured to insure property to a stated percentage of its value. If the requirement is not met, the insured shares the loss as a coinsurer.

Purpose of property coinsurance

Equity in rating, so underinsured owners do not pay the same rate as those insured to value.

Property coinsurance formulas

Required amount = Coinsurance % x Value of property at time of loss. Recovery = (Amount carried / Amount required) x Loss. Subtract any deductible. Recovery never exceeds the loss or the policy limit.

Property coinsurance example

Building worth $500,000, 80% coinsurance, $300,000 carried, $20,000 loss. Required = $400,000. Recovery = 300,000 / 400,000 x $20,000 = $15,000.

Coinsurance requirement met

If the amount carried is at least the amount required, the insurer pays the full loss up to the policy limit. Example: carry $90,000 with $80,000 required, building destroyed, collect $90,000.

Coinsurance in health insurance

The insured pays a specified percentage of covered expenses in excess of the deductible. Purpose: reduce premiums and prevent overutilization of benefits.

Health deductible and coinsurance formulas

Insurer pays = (Covered expenses - Deductible) x Insurer's %. Insured pays = Deductible + (Covered expenses - Deductible) x Insured's %. Subtract the deductible FIRST, then split.

Health coinsurance example

$250 deductible, 70/30 split, $5,250 covered expenses. Insurer pays $5,000 x 70% = $3,500. Insured pays $250 + $1,500 = $1,750.

Purpose of other insurance provisions

Prevent the insured from profiting from insurance and protect the principle of indemnity when more than one policy covers a loss.

Pro rata liability

Each insurer pays the share its limit bears to total insurance. Share = Its limit / Total of all limits x Loss.

Pro rata example

Insurer A $50,000, Insurer B $150,000, loss $80,000. A pays 25% = $20,000. B pays 75% = $60,000.

Contribution by equal shares

Each insurer pays the same amount until it reaches its own limit or the loss is paid in full. Lower-limit insurers cap out, and the others pay the remainder.

Equal shares example

Insurer A $30,000, Insurer B $100,000, loss $80,000. Equal share is $40,000 but A is capped at $30,000. A pays $30,000, B pays $50,000.

Primary and excess

The primary insurer pays first up to its limit. The excess insurer pays only the remainder, up to its limit. It is not split.

Primary and excess example

Primary $25,000, excess $100,000, loss $60,000. Primary pays $25,000. Excess pays $35,000.

Other insurance in auto liability (borrowed car)

The owner's policy is primary. The driver's own policy pays on an excess basis.

Coordination of benefits (employee also a dependent)

The plan covering the person as an employee is primary. The plan covering her as a dependent is excess.

Premature death

The death of a family head with outstanding, unfulfilled financial obligations.

Economic costs of premature death

Future earnings lost forever, funeral and estate settlement costs, and possibly a lower standard of living for the family.

Noneconomic costs of premature death

Grief and the emotional loss of the family head.

Single person: life insurance need

Low. Usually no one depends on the income. Funeral costs and debts.

Single parent: life insurance need

Very high. Children rely on one adult with no backup income.

Two income earners with children: life insurance need

Both adults need coverage because both paychecks matter.

Traditional family: life insurance need

One earner and one parent at home. The earner needs substantial coverage.

Blended family: life insurance need

Children from earlier relationships. Competing obligations must be resolved.

Sandwiched family: life insurance need

Supports two generations at once: own children and aging parents.