Chapter 9: Fundamental Legal Principals

Legal Principles of Insurance 

  • Principle of Indemnity 

  • Principle of Insurable Interest (who can get insurance) 

  • Principle of Subrogation  

  • Principle of Utmost Good Faith (looking at the expectation of honesty) 

 

Principle of Indemnity (making sure the insurer cannot collect more than their loss; this creates a moral hazard; this principle tries to prevent this hazard and trying to prevent them from profiting) 

  • The insurer agrees to pay no more than the actual amount of the loss. 

  • Purpose is to prevent the insured from profiting from the loss. 

  • Why is this important? 

 

Replacement Cost vs. Actual Cash Value  

  • Replacement Cost (RC) (what would it cost to repair it or replace it the item with a like kind or similar item) 

    • The cost to replace property with an item of like kind and quantity (similar workmanship and materials). 

    • Not the same as historical cost! 

  • Actual Cash Value (ACV) (ACV = RC – Depreciation; Depreciation = Age/Useful Life) 

    • Replacement Cost less depreciation. 

    • In property insurance, indemnification is usually based on the actual cash value of the property at the time of loss. 

 

What is the Value? 

  • Roof installed in 2016 for $5000 (historical cost), has a useful life of 20 years. 

  • Will cost $6000 to replace based on current costs (replacement cost). 

  • After depreciation, the actual cash value is $3600. Depreciation is 40% (8 years old / 20 year useful lifespan).  

 

Example 1 – What is the ACV? 

  • Samsung 50" TV 

    • Cost $750 when purchased in 2017. 

    • Useful life is 10 years 

    • Current model (like kind/quality) is $450. 

    • 7/10 = 70% 

      ACV = $450 - (70% x $450) 

      = $450 - $315 

      = $135 

 

Example 2 – What is the ACV? 

  • Warehouse Building 

    • Cost $2500000 when built in 2019. 

    • Useful life of 20 years 

    • Fire completely destroys building in 2024 

    • Current reconstruction cost is $3000000 

    • 5/20 = 25% 

      ACV = $3000000 - (25% x $3000000) 

      = $3000000 – $750000 

      = $2250000 

 

Other Types of Indemnity 

  • Market Value (how much would a buyer pay for that piece of item) 

    • Price a buyer would be willing to pay in a free market. 

  • Valued Policy (includes life insurance policies; dollar amount of insurance and when you pass away that dollar amount is what your beneficiaries are paid) 

    • A policy that pays the face amount of insurance if a total loss occurs (life insurance). 

  • Valued Policy Law (in some states) (payment of total cost of loss) 

    • Requires payment of the face amount of insurance if a total loss to real property occurs from a peril specified in law. 

 

Principle of Insurable Interest (stating to be the insured or beneficiary; have to be in a state where you can lose; ) 

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

  • Why? 

    • Prevents gambling on losses. 

    • Reduces moral hazard. 

 

Examples of Insurable Interest (something bad can happen to it, so it is a loss) 

  • Ownership of property (house, car) 

  • Potential legal liability (business owner) 

  • Secured creditors (mortgage company, auto lender) 

  • Contractual right (goods in transit)  

 

When Must an Insurable Interest Exist? (it is not stagnant, it changes over time; might have to change policies over time) 

  • Property Insurance (policy ends when the loss has occurred; can't collect policy) 

    • At time of loss. 

    • Can't collect on an insurance policy after you sell your home. 

  • Life Insurance (it matters when the policy is issued; not the time of death of the person) 

    • At inception of policy 

    • Ex-spouse can still collect on life insurance if listed as policy beneficiary. 

 

Principle of Subrogation (where an insurance company pays an insured for a loss; the company going after the other person to get the money that they paid out) 

  • Substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third-party loss covered by insurance. 

  • Example 

    • Someone else hits your car. 

    • Your insurance company pays you for the damages to your vehicle. 

    • Your insurance company sues the other driver for reimbursement. 

 

Reasons for Subrogation (cannot collect twice to prevent moral hazard; holding the negligent party responsible for the loss) 

  • Prevents insured from collecting twice (once from insurer, once from responsible party). 

  • Holds the negligent party responsible for the loss. 

  • Reduces insurance claims costs (and therefore, rates). 

 

Principle of Utmost Good Faith (think about honesty) 

  • A higher degree of honesty is imposed on both parties to insurance contracts than is imposed on parties to other contracts. 

  • Supported by three legal doctrines: 

    • Representations 

    • Concealment 

    • Warranty 

 

Representations (facts of the claim; this is when you lie) 

  • Statements made by the applicant for insurance. 

  • What if the statements are false (misrepresentations)? 

  • Contract if voidable if the misrepresentation is: (means the policy ends and returns the premiums; as if the policy never existed; insurance company has the right to void the policy) 

    1. Material, (had the insurance known the true facts, the insurance company would have insured you under different circumstances or not have insured you at all) 

    2. False, and 

    3. Relied on by the insurer. 

 

Is the contract voidable?  

  • A smoker lies on their life insurance application and later dies in an auto accident. (had you known they were a smoker, you wouldn’t have given out a policy or would have charged a higher premium because they are more likely to die; the contract is voidable) 

  • Insured's birthday on an application is listed as August 1 when it's August 11. (no it is not voidable; they cannot say they do not want to provide a policy just because they are born on a certain day) 

 

Concealment (not wanting to tell all the information; supposed to voluntarily reveal information even though not asked; not considered lying but not saying everything; this is considered a voidable contract) 

  • Intentional failure of the applicant for insurance to reveal a material fact to the insurer. 

  • Contract can be voided if: 

    • Concealed fact was known by the insured to be material. 

    • Insured intended to defraud the insurer. 

 

Warranty (you have to do this in order for us to provide coverage to you; if they agree to it and are willing to do it then they are expected to, but if they don't then the policy can be voided) 

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

  • A condition agreed to by an insured in order to receive coverage. 

  • Violation of a warranty may result in a claim being denied. 

 

What is Bad Faith? (insurance companies in the way they handle claims; denying a claim that should have been covered or delaying the payment of claim; insured can sue against insurance company; insurer will be liable for the claims they were supposed to pay, the lawyer fees, and the distraught they put the insured through) 

  • Law that allows lawsuits against insurance companies for: 

    • Improper denial of claims. 

    • Improper delay of claims. 

  • Bad faith damages can exceed policy limits and include:  

    • Attorney's fees 

    • Emotional distress 

    • Punitive damages 

 

Requirements of an Insurance Contract  

  • To be legally enforceable, an insurance contract must meet the following requirements: 

    • Offer and Acceptance 

    • Exchange of Consideration 

    • Competent Parties 

    • Legal Purpose 

 

Offer and Acceptance (offer does not come from the insurance company, but the applicant offer; life insurance agents cannot issue binders but can provide conditional premium receipt) 

  • Insured and completes an application (the offer). 

  • Insurance companies issues a binder or policy (acceptance). 

  • The insurance company can also reject the offer. 

  • Conditional Premium Receipt 

    • Receipt given to applicant for life insurance. If policy is approved, coverage becomes effective as of the date of the application. 

    10/11 Applies for life insurance 

    Pay conditional premium 

    10/18 Medical Exam 

---> 10/23 Applicant dies in auto accident 

10/25 Underwriter receives exam/lab results 

11/4 Underwriter approves (still has to pay for the coverage even though they know they passed; after approval the coverage begins on 10/11) 

 

Exchange of Consideration (paying a premium and promising to abide by policy agreements; the value the policy company is that they agree to paying that loss or providing certain services) 

  • The value that each party gives one another. 

  • Insured pays a premium. 

  • The insurer promises to pay future claims covered by the contract (policy). 

 

Competent Parties (adults are considered legally competent;  

  • Parties must have legal capacity to enter into a binding agreement. 

  • Insured must: 

    • Be old enough to enter into a contract. 

    • Not intoxicated. 

    • Not insane. (certain medical disorders) 

  • Insurer must be legally competent and licensed to sell within state.  

 

Legal Purpose (has to have a legal purpose; cannot be enforced) 

  • Contract that encourages something illegal or immoral is contrary to public interest and cannot be enforced. 

  • Can Walter White buy property insurance to cover his meth lab?  

 

Distinct Legal Characteristics of Insurance Contracts 

  • Aleatory Contract  

  • Unilateral Contract 

  • Conditional Contract 

  • Personal Contract 

  • Contract of Adhesion 

 

Aleatory Contract (not equal; the amount you pay to the insurer; you may never file a claim and they never pay for anything and you still pay for the premium) 

  • Values exchanged may not be equal but depend on an uncertain event. 

  • Examples: 

    • Mia pays $1000 for homeowners insurance. Her house burns down and the insurance company pays her $200000. 

    • Jules has paid $1000 a year every year for 20 years for homeowners insurance. He's never filed a claim, so his insurer has never paid him any money. 

 

Unilateral Contract (insurance is unilateral and legally obligated to pay claims; insured cannot be forced to pay premiums because they might not want that 12 month policy in 6 months; insurer can be legally forced to pay premiums) 

  • Only one party (insurer) makes a legally enforceable promise.  

  • Insurer makes legally enforceable promise to pay claims.  

  • Insured cannot be legally required to pay premiums. 

 

Conditional Contract (certain things the insured has to do to get their claims covered; tells you what to do when a loss occurs; things you must comply with or else the insurer may not cover claim) 

  • The insured must comply with all policy conditions to collect for a covered loss. 

  • Conditions – Provisions within the policy that qualify or place limitations on the insurer's promise to perform. 

  • Example – Your Duties After Loss 

    • Give immediate notice to us or our agent. 

    • Protect the property from further damage. 

 

Personal Contract (contract between you and the insurance company; the company is evaluating you to see if they want to insure you; cannot assign your benefits to somebody else) 

  • Contract is between the insured and insurer. 

  • Policy cannot be validly assigned to another party without the insurer's consent. 

 

Contract of Adhesion (the insurance company wrote the entire contract and you have no input in it; you do not get to make changes to the contract; if they company drafts the contract, you have no choice but to sign it; if there is something confusing on the contract, it is the company's fault) 

  • Insured must accept the entire contract, with all of its terms and conditions. 

  • Because this is imbalanced, courts have ruled that any ambiguities or uncertainties in the contract are construed against the insurer. 

  • Principle of Reasonable Expectations 

    • An insured is entitled to coverage under a policy that he or she reasonably expects it to provide, regardless of policy provisions. 

 

Law of Agency (agents legal representatives of the agency; dealing with the legal consequences of individuals acting on the behalf of the company; principal is the insurance company; the principal is responsible for the acts of the agents when they are in the role of authority) 

  • There is no presumption of an agency relationship. 

  • An agent must be authorized to represent the principal. 

  • A principal is responsible for the acts of agents acting within the scope of their authority. 

  • Limitations can be placed on the powers of agents. 

 

Waiver and Estoppel (two legal doctrines; if these occur, the insurance company will pay a claim that they would not usually have to pay) 

  • The doctrines of waiver and estoppel may require an insurer to pay a claim that it ordinarily would not have to pay. 

  • Waiver  

    • The voluntary relinquishment of a known legal right. 

  • Estoppel (the insurer can no longer deny a claim because their previous actions would be inconsistent with their statement) 

    • The loss of a legal defense because of previous actions that are now inconsistent with that defense.