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.