Chapter 9

Legal Principles of Insurance Notes

Principle of Indemnity

  • Insurer pays no more than the actual loss amount.
  • Purpose: Prevent the insured from profiting from the loss.
  • Importance: Ensures fairness and discourages insurance fraud.

Replacement Cost vs. Actual Cash Value

  • Replacement Cost (RC):

  • Cost to replace property with item of like kind and quality.

  • Does not equal historical cost.

  • Actual Cash Value (ACV):

  • RC minus depreciation.

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

Example Calculation

  • Carpet installed in 2021 for $5,000:
  • Useful life: 10 years.
  • Replacement cost currently $6,000.
  • ACV: $6,000 - ($5,000 * 0.4) = $3,600 (40% depreciation after 4 years).

Example 1: Samsung TV

  • Cost: $750 in 2018, useful life of 10 years.
  • Current cost for a similar model: $450.
  • Determine ACV:
  • Depreciation must be considered based on lifespan.

Example 2: Residential Roof

  • Cost: $11,000 in 2020, useful life of 30 years.
  • Wind damage in 2025, current replacement cost $15,000.

Other Types of Indemnity

  • Market Value: Price a buyer would pay in a free market.
  • Valued Policy: Pays face amount for total loss (like life insurance).
  • Valued Policy Law: Required payment of face amount in case of a total loss from specified peril.

Principle of Insurable Interest

  • Requirement: The insured must have a financial stake in the insured item.
  • Purpose:
  • Prevents gambling on losses.
  • Reduces moral hazard.

Examples of Insurable Interest

  • Ownership of property (house, car)
  • Potential legal liability (business owner)
  • Secured creditors (mortgage company, auto lender)
  • Contractual rights (goods in transit)

Timing of Insurable Interest

  • Property Insurance: Needed at time of loss.
  • Life Insurance: Required at inception of policy.

Principle of Subrogation

  • Substitution of insurer for the insured in claims against responsible third parties.
  • Example:
  • If another party damages your car, insurer pays you then seeks reimbursement from that party.

Reasons for Subrogation

  • Prevents double recovery by insured.
  • Holds negligent parties accountable.
  • Reduces overall claims costs and insurance rates.

Principle of Utmost Good Faith

  • Requires higher honesty standards in insurance contracts than other contracts.
  • Supported by:
  • Representations: Statements made by insurance applicants.
    • Misrepresentation can void the contract if material, false, and relied upon.
  • Concealment: Intentionally failing to disclose material facts can void a contract if knowingly material and intended to deceive.
  • Warranty: Statements guaranteed to be true, violation can result in claim denial.

Bad Faith

  • Lawsuits against insurers for wrongful claims denial or delay.
  • Bad faith damages can exceed policy limits and include attorney’s fees, emotional distress, and punitive damages.

Requirements of an Insurance Contract

  • Offer and Acceptance: Insured submits an application; insurer provides a policy.
  • Exchange of Consideration:
  • Insured pays premium; insurer promises to cover claims.
  • Competent Parties: Legal capacity to contract.
  • Consider age, sobriety, and sanity.
  • Legal Purpose:
  • Contracts for illegal activities cannot be enforced.

Distinct Legal Characteristics of Insurance Contracts

  • Aleatory Contract: Values exchanged depend on uncertain events.
  • Unilateral Contract: Only the insurer makes enforceable promises.
  • Conditional Contract: Compliance with policy conditions is required for claims.
  • Personal Contract: Insurer-insured relationship; cannot typically assign policy rights.
  • Contract of Adhesion: Insured must accept all terms; ambiguities favor the insured.

Law of Agency

  • No presumption of agency.
  • Agents must be authorized and are acting within their authority.
  • Principals are responsible for agent actions that are authorized.

Waiver and Estoppel

  • Waiver: Voluntary relinquishment of a known right.
  • Estoppel: Loss of legal defenses due to past consistent actions.