insurance contracts bus 200 introduction to risk management and insurance jin park

Insurance contractsInsurance contractsBUS 200 BUS 200

Introduction to Risk Management and InsuranceIntroduction to Risk Management and Insurance

Jin ParkJin Park

OverviewOverview Distribution of Insurance ContractsDistribution of Insurance Contracts Insurance as contracts Insurance as contracts

legally enforceable agreementslegally enforceable agreements Characteristics of Insurance ContractsCharacteristics of Insurance Contracts Fundamental Principles of Insurance Fundamental Principles of Insurance

ContractsContracts Principle of indemnityPrinciple of indemnity Principle of insurable interest Principle of insurable interest Principle of utmost good faithPrinciple of utmost good faith Principle of subrogationPrinciple of subrogation

Distribution of Insurance Distribution of Insurance ContractsContracts

Direct MarketingDirect Marketing No agent is involvedNo agent is involved Mail marketing, internet based Mail marketing, internet based

marketingmarketing Exclusive AgentExclusive Agent

Agent represents one insurerAgent represents one insurer Independent AgentIndependent Agent

Agent represents more than one insurerAgent represents more than one insurer

Distribution of Insurance Distribution of Insurance ContractsContracts

Agent versus BrokerAgent versus Broker Binding Authority by AgentBinding Authority by Agent

Property/Liability InsuranceProperty/Liability Insurance BinderBinder

Life/Health InsuranceLife/Health Insurance Conditional premium receiptConditional premium receipt

Waiver and EstoppelWaiver and Estoppel

Waiver Waiver The intentional relinquishment of a The intentional relinquishment of a

known right.known right.

Estoppel Estoppel It prevents one from alleging or denying It prevents one from alleging or denying

a fact, the contrary of which he has a fact, the contrary of which he has previously admitted.previously admitted.

Insurance as ContractsInsurance as Contracts Valid contractsValid contracts

Legally enforceableLegally enforceable Void contractsVoid contracts

A void contract never had any legal existence.A void contract never had any legal existence. Either party may choose to ignore the Either party may choose to ignore the

agreement.agreement. Voidable contractsVoidable contracts

Legally existsLegally exists The contracts can be legally rejected or avoided The contracts can be legally rejected or avoided

at the option of one or both parties.at the option of one or both parties. cf: Denying coverage based on breach of policy cf: Denying coverage based on breach of policy

conditioncondition

Insurance as ContractsInsurance as Contracts Elements of contractElements of contract

Agreement Agreement Offer and AcceptanceOffer and Acceptance

ConsiderationConsideration Insured – premium payment and fulfillment of policy Insured – premium payment and fulfillment of policy

conditions conditions Insurer – promise to do certain things as specified in the Insurer – promise to do certain things as specified in the

contractcontract Legally competent partiesLegally competent parties

Parties must have legal capacity to enter into a binding Parties must have legal capacity to enter into a binding contractcontract

Legal PurposeLegal Purpose Contract must be for a legal purposeContract must be for a legal purpose

Legal FormLegal Form Contract may be oral or writtenContract may be oral or written Some insurance policy provisions and attachments must be Some insurance policy provisions and attachments must be

approved by state before being marketedapproved by state before being marketed

Insurance as ContractsInsurance as Contracts

Property - CasualtyProperty - Casualty OfferOffer

Submission of Submission of application with a down application with a down paymentpayment

AcceptanceAcceptance BinderBinder

LifeLife OfferOffer

Submission of Submission of application with a down application with a down payment payment

Issuance of a life Issuance of a life insurance policyinsurance policy

AcceptanceAcceptance Conditional premium Conditional premium

receipt receipt

Note: Giving a quotation to a prospective insured is deemed Note: Giving a quotation to a prospective insured is deemed

as mere solicitation or invitation to make an offer.as mere solicitation or invitation to make an offer.

Characteristics of Characteristics of Insurance ContractsInsurance Contracts

1. Personal Contracts1. Personal Contracts Insurance protects insured, not the property or Insurance protects insured, not the property or

liability subject to loss.liability subject to loss. Assignment provisionAssignment provision

If ownership of a property changes, insurance If ownership of a property changes, insurance contracts (or policies) normally cannot be transferred contracts (or policies) normally cannot be transferred to another party (buyer) without the insurer’s written to another party (buyer) without the insurer’s written consent.consent.

In life insurance, the beneficiary or ownership of In life insurance, the beneficiary or ownership of policy may be freely reassigned.policy may be freely reassigned.

Transfer of your rights and duties under this policy.Transfer of your rights and duties under this policy.


2. Aleatory Contracts2. Aleatory Contracts The values exchanged may not be The values exchanged may not be

equal, but depend on an uncertain eventequal, but depend on an uncertain event The premium, paid to an insurer by an The premium, paid to an insurer by an

insured for a policy, is not expected to insured for a policy, is not expected to exactly equal the amounts to be paid by exactly equal the amounts to be paid by the insurer in fulfilling its contractual the insurer in fulfilling its contractual obligations to the insured.obligations to the insured.

cf: commutative contract – the values cf: commutative contract – the values exchanged are theoretically equal.exchanged are theoretically equal.


3. Contracts of adhesion3. Contracts of adhesion Contracts are drafted by an insurer and an Contracts are drafted by an insurer and an

insured must accept or reject all the terms and insured must accept or reject all the terms and conditions.conditions.

Insured gets the benefit of the doubt.Insured gets the benefit of the doubt. Courts tend to construe an ambiguous term in an Courts tend to construe an ambiguous term in an

insurance policy in favor of an insured.insurance policy in favor of an insured. Contracts may be altered by the addition of Contracts may be altered by the addition of

riders or endorsementsriders or endorsements Rider or endorsement – a document that amends or Rider or endorsement – a document that amends or

changes the original policy.changes the original policy. cf: Contracts of cohesion – both parties draft the cf: Contracts of cohesion – both parties draft the

contracts.contracts.


4. Conditional contracts4. Conditional contracts An insurer’s obligation to pay a claim An insurer’s obligation to pay a claim

depends on whether the insured or the depends on whether the insured or the beneficiary has complied with all policy beneficiary has complied with all policy conditions.conditions.

The insurer may not pay a claim if the The insurer may not pay a claim if the policy conditions are not met.policy conditions are not met.

Duties after loss – Homeowners (p. 562)Duties after loss – Homeowners (p. 562) Duties after an accident or loss – Automobile Duties after an accident or loss – Automobile

(p. 585)(p. 585) Duties after in the event of loss or damage – Duties after in the event of loss or damage –

CPCP


5. Unilateral contracts5. Unilateral contracts Only one party makes a legally Only one party makes a legally

enforceable promise.enforceable promise. Insured are not legally forced to pay Insured are not legally forced to pay

premium or renew the policy.premium or renew the policy.

Fundamental Principles of Fundamental Principles of Insurance ContractsInsurance Contracts

1. Principle of Indemnity1. Principle of Indemnity The insurer agrees to pay no more than The insurer agrees to pay no more than

the actual amount of the loss suffered the actual amount of the loss suffered by the insured.by the insured.

Why?Why? The purpose of the insurance contract is to The purpose of the insurance contract is to

restore the insured to the same economic restore the insured to the same economic position as before the loss.position as before the loss.

The insured should not profit from a loss.The insured should not profit from a loss. It reduces the moral hazard by eliminating It reduces the moral hazard by eliminating

the profit incentive.the profit incentive.


1. Principle of Indemnity1. Principle of Indemnity To support the principal of indemnity insurance To support the principal of indemnity insurance

contact uses Actual Cash Value (ACV)contact uses Actual Cash Value (ACV) Replacement cost (RC) less depreciationReplacement cost (RC) less depreciation

Takes into consideration both inflation and Takes into consideration both inflation and depreciation.depreciation.

RC – current cost of restoring the damaged property RC – current cost of restoring the damaged property with new materials of like kind and quality.with new materials of like kind and quality.

Fair market valueFair market value The price of a wiling buyer would pay a willing seller in The price of a wiling buyer would pay a willing seller in

a free market.a free market. Broad evidence ruleBroad evidence rule

The determination of ACV should include all relevant The determination of ACV should include all relevant factors an expert would use to determine the value of factors an expert would use to determine the value of the property.the property.


1. Principle of Indemnity1. Principle of Indemnity To support the principal of indemnity insurance To support the principal of indemnity insurance

contact includes Other Insurance Provisions.contact includes Other Insurance Provisions. Escape clauseEscape clause

The policy (or insurance) would not apply if the insured The policy (or insurance) would not apply if the insured was covered by another policy.was covered by another policy.

ExcessExcess It (or This insurance) is excess insurance over any other It (or This insurance) is excess insurance over any other

valid and collectible insurance. valid and collectible insurance. Pro-rata provisionPro-rata provision

Proration by face amountsProration by face amounts Proration by amounts otherwise payableProration by amounts otherwise payable

Contribution by equal sharesContribution by equal shares


1. Principle of Indemnity1. Principle of Indemnity Primary-ExcessPrimary-Excess

Accident while test driving a dealer’s Accident while test driving a dealer’s car.car.

Health insurance between a couple Health insurance between a couple working for different employers.working for different employers.

Own insurance – primaryOwn insurance – primary Spouse insurance – excessSpouse insurance – excess Birthday rule for dependents’ coverageBirthday rule for dependents’ coverage


1. Principle of Indemnity1. Principle of Indemnity Proration by Face AmountsProration by Face Amounts

It limits the insurer’s maximum obligation to the It limits the insurer’s maximum obligation to the proportion of the loss that the insurer’s policy limit proportion of the loss that the insurer’s policy limit bears to the sum of all applicable policy limits.bears to the sum of all applicable policy limits.

If Loss amount is $150,000If Loss amount is $150,000

Insurer AInsurer A Insurer BInsurer B Insurer CInsurer C

Policy LimitPolicy Limit $100,000$100,000 $200,000$200,000 $300,000$300,000

ShareShare 1/61/6 2/62/6 3/63/6

PaymentPayment $25,000$25,000 $50,000$50,000 $75,000$75,000


1. Principle of Indemnity1. Principle of Indemnity Proration by Amounts Otherwise PayableProration by Amounts Otherwise Payable

What would be payable under each policy in the What would be payable under each policy in the absence of other insurance absence of other insurance




PayablePayable $100,000$100,000 $150,000$150,000 $150,000$150,000

ShareShare 1/41/4 1.5/41.5/4 1.5/41.5/4

PaymentPayment $45,000$45,000 $67,500$67,500 $67,500$67,500


1. Principle of Indemnity1. Principle of Indemnity Proration by Amounts Otherwise PayableProration by Amounts Otherwise Payable




PayablePayable $60,000$60,000 $60,000$60,000 $60,000$60,000

ShareShare 1/31/3 1/31/3 1/31/3

PaymentPayment $20,000$20,000 $20,000$20,000 $20,000$20,000


1. Principle of Indemnity1. Principle of Indemnity Contribution by Equal SharesContribution by Equal Shares

Each insurer contributes equal amounts until it has Each insurer contributes equal amounts until it has paid its applicable limit of insurance or none of the paid its applicable limit of insurance or none of the loss remains, whichever comes first.loss remains, whichever comes first.




Equal ShareEqual Share $50,000$50,000 $50,000$50,000 $50,000$50,000

PaymentPayment $50,000$50,000 $50,000$50,000 $50,000$50,000


1. Principle of Indemnity1. Principle of Indemnity Contribution by Equal SharesContribution by Equal Shares




Equal Share 1Equal Share 1 $100,000$100,000 $100,000$100,000 $100,000$100,000

Equal Share 2Equal Share 2 N/AN/A $50,000$50,000 $50,000$50,000

PaymentPayment $100,000$100,000 $150,000$150,000 $150,000$150,000


1. Principle of Indemnity1. Principle of Indemnity Exceptions to the PrincipleExceptions to the Principle

Valued policy (or agreed value)Valued policy (or agreed value) Pays face value of insurance if a total loss occursPays face value of insurance if a total loss occurs Life insurance, disability insurance, fine arts, antiquesLife insurance, disability insurance, fine arts, antiques

Ex.) Value of a fine art is agreed at $250,000.Ex.) Value of a fine art is agreed at $250,000. Valued policy lawValued policy law

A law that requires payment of the face amount of A law that requires payment of the face amount of insurance to the insured if a total loss to real property insurance to the insured if a total loss to real property occurs from a covered peril, regardless of the occurs from a covered peril, regardless of the property’s ACV.property’s ACV.

Replacement costReplacement cost No deduction for depreciation in determining the No deduction for depreciation in determining the

amount paid for a loss.amount paid for a loss.


2. Principle of Insurable Interest2. Principle of Insurable Interest The insured must be in a position to financially The insured must be in a position to financially

suffer if a loss occurs.suffer if a loss occurs. Why?Why?

To prevent gamblingTo prevent gambling Insurance on a property and wait for a loss occur.Insurance on a property and wait for a loss occur.

To reduce moral hazardTo reduce moral hazard Life insurance on a person and pray for his/her death for Life insurance on a person and pray for his/her death for

insurance proceeds.insurance proceeds. To measure the amount of the insured’s loss in To measure the amount of the insured’s loss in

property insurance property insurance In order not to indemnify more than the insurable In order not to indemnify more than the insurable

interest.interest.


2. Principle of Insurable Interest2. Principle of Insurable Interest Property-Casualty insuranceProperty-Casualty insurance

At the time of a loss, an insured must have At the time of a loss, an insured must have insurable interest.insurable interest.

No insurable interest no financial loss No insurable interest no financial loss no indemnityno indemnity support support

Prin. of indemnityPrin. of indemnity Life InsuranceLife Insurance

Insurable interest must exist at the time of a Insurable interest must exist at the time of a policy inception, but not at the time of a loss policy inception, but not at the time of a loss (death)(death)


2. Principle of Insurable Interest2. Principle of Insurable Interest Insurable Interest may be created either by:Insurable Interest may be created either by:

Obligation to Insure Obligation to Insure by Statuteby Statute by Contractby Contract by Custom by Custom

Option to Insure Option to Insure OwnersOwners MortgagorsMortgagors LessorsLessors TrusteesTrustees Tenants Tenants


3. Principle of Utmost Good Faith3. Principle of Utmost Good Faith A higher degree of honesty is imposed A higher degree of honesty is imposed

on an insurance contract than is on an insurance contract than is imposed on other contractsimposed on other contracts

Honesty is imposed on the applicant for Honesty is imposed on the applicant for insuranceinsurance

It is supported by three legal doctrinesIt is supported by three legal doctrines RepresentationRepresentation ConcealmentConcealment WarrantyWarranty


3. Principle of Utmost Good Faith3. Principle of Utmost Good Faith RepresentationRepresentation

Statements made by an applicantStatements made by an applicant Insurance is voidable at the insurer’s option.Insurance is voidable at the insurer’s option.

MaterialMaterial FalseFalse RelianceReliance cf: Innocent misrepresentationcf: Innocent misrepresentation

ConcealmentConcealment Intentional failure to disclose a material factIntentional failure to disclose a material fact

WarrantyWarranty A statement of fact or a promise made by the insured, A statement of fact or a promise made by the insured,

which is part of the insurance contract and must be which is part of the insurance contract and must be true if the insurer is to be liable under the contract. true if the insurer is to be liable under the contract.

In exchange for a reduced premium, a store owner In exchange for a reduced premium, a store owner warrants that alarm will be always on.warrants that alarm will be always on.


4. Principle of Subrogation4. Principle of Subrogation Substitution of the insurer in place of Substitution of the insurer in place of

the insured for the purpose of claiming the insured for the purpose of claiming indemnity from a third party wrongdoer indemnity from a third party wrongdoer for a loss covered by insurance.for a loss covered by insurance.

Why?Why? To prevent collecting twiceTo prevent collecting twice To hold the negligent party responsibleTo hold the negligent party responsible To hold down insurance ratesTo hold down insurance rates


4. Principle of Subrogation4. Principle of Subrogation The insurer is entitled only to the amount it has The insurer is entitled only to the amount it has

paid under the policy.paid under the policy. If the insurer collects more than the amount the If the insurer collects more than the amount the

insurer paid to the insured from the negligent party , insurer paid to the insured from the negligent party , the insured must be paid in full before the insurer the insured must be paid in full before the insurer retains the remaining balance.retains the remaining balance.

The insured cannot impair the insurer’s The insured cannot impair the insurer’s subrogation rights.subrogation rights.

Subrogation does not apply to life insurance Subrogation does not apply to life insurance and to most individual health insurance and to most individual health insurance contracts.contracts.

The insurer cannot subrogate against its own The insurer cannot subrogate against its own insured.insured.

insurance contracts bus 200 introduction to risk management and insurance jin park

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