Insurance contracts
BUS 200
Introduction to Risk Management and Insurance
Jin Park
Overview
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Distribution of Insurance Contracts
Insurance as contracts
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legally enforceable agreements
Characteristics of Insurance Contracts
Fundamental Principles of Insurance
Contracts
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Principle of indemnity
Principle of insurable interest
Principle of utmost good faith
Principle of subrogation
Distribution of Insurance
Contracts
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Direct Marketing
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Exclusive Agent

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No agent is involved
Mail marketing, internet based marketing
Agent represents one insurer
Independent Agent

Agent represents more than one insurer
Distribution of Insurance
Contracts
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Agent versus Broker
Binding Authority by Agent
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Property/Liability Insurance
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Binder
Life/Health Insurance

Conditional premium receipt
Waiver and Estoppel

Waiver

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The intentional relinquishment of a known
right.
Estoppel

It prevents one from alleging or denying a
fact, the contrary of which he has
previously admitted.
Insurance as Contracts

Valid contracts
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Void contracts
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Legally enforceable
A void contract never had any legal existence.
Either party may choose to ignore the agreement.
Voidable contracts
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Legally exists
The contracts can be legally rejected or avoided at
the option of one or both parties.
cf: Denying coverage based on breach of policy
condition
Insurance as Contracts
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Elements of contract
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Agreement
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Consideration
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Offer and Acceptance
Insured – premium payment and fulfillment of policy conditions
Insurer – promise to do certain things as specified in the
contract
Legally competent parties

Parties must have legal capacity to enter into a binding contract

Contract must be for a legal purpose
Legal Purpose
Legal Form


Contract may be oral or written
Some insurance policy provisions and attachments must be
approved by state before being marketed
Insurance as Contracts
Property - Casualty
 Offer
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Life
 Offer
Submission of application
with a down payment

Acceptance
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Binder

Submission of application
with a down payment
Issuance of a life
insurance policy
Acceptance

Conditional premium
receipt
Note: Giving a quotation to a prospective insured is deemed
as mere solicitation or invitation to make an offer.
Characteristics of
Insurance Contracts
1. Personal Contracts
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Insurance protects insured, not the property or
liability subject to loss.
Assignment provision
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If ownership of a property changes, insurance contracts
(or policies) normally cannot be transferred to another
party (buyer) without the insurer’s written consent.
In life insurance, the beneficiary or ownership of policy
may be freely reassigned.
Transfer of your rights and duties under this policy.
Characteristics of
Insurance Contracts
2. Aleatory Contracts
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The values exchanged may not be equal, but
depend on an uncertain event
The premium, paid to an insurer by an
insured for a policy, is not expected to
exactly equal the amounts to be paid by the
insurer in fulfilling its contractual
obligations to the insured.
cf: commutative contract – the values
exchanged are theoretically equal.
Characteristics of
Insurance Contracts
3. Contracts of adhesion


Contracts are drafted by an insurer and an insured
must accept or reject all the terms and conditions.
Insured gets the benefit of the doubt.
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Contracts may be altered by the addition of riders
or endorsements
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Courts tend to construe an ambiguous term in an
insurance policy in favor of an insured.
Rider or endorsement – a document that amends or
changes the original policy.
cf: Contracts of cohesion – both parties draft the
contracts.
Characteristics of
Insurance Contracts
4. Conditional contracts
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
An insurer’s obligation to pay a claim
depends on whether the insured or the
beneficiary has complied with all policy
conditions.
The insurer may not pay a claim if the
policy conditions are not met.
Duties after loss – Homeowners (p. 562)
 Duties after an accident or loss – Automobile (p.
585)
 Duties after in the event of loss or damage – CP

Characteristics of
Insurance Contracts
5. Unilateral contracts

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Only one party makes a legally enforceable
promise.
Insured are not legally forced to pay
premium or renew the policy.
Fundamental Principles of
Insurance Contracts
1. Principle of Indemnity
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
The insurer agrees to pay no more than the
actual amount of the loss suffered by the
insured.
Why?
The purpose of the insurance contract is to
restore the insured to the same economic
position as before the loss.
 The insured should not profit from a loss.
 It reduces the moral hazard by eliminating the
profit incentive.

Fundamental Principles of
Insurance Contracts
1. Principle of Indemnity

To support the principal of indemnity insurance
contact uses Actual Cash Value (ACV)
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Replacement cost (RC) less depreciation
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Fair market value
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Takes into consideration both inflation and depreciation.
RC – current cost of restoring the damaged property with
new materials of like kind and quality.
The price of a wiling buyer would pay a willing seller in a
free market.
Broad evidence rule

The determination of ACV should include all relevant
factors an expert would use to determine the value of the
property.
Fundamental Principles of
Insurance Contracts
1. Principle of Indemnity

To support the principal of indemnity insurance
contact includes Other Insurance Provisions.
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Escape clause
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Excess
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It (or This insurance) is excess insurance over any other
valid and collectible insurance.
Pro-rata provision
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The policy (or insurance) would not apply if the insured was
covered by another policy.
Proration by face amounts
Proration by amounts otherwise payable
Contribution by equal shares
Fundamental Principles of
Insurance Contracts
1. Principle of Indemnity
 Primary-Excess
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Accident while test driving a dealer’s car.
Health insurance between a couple working
for different employers.
Own insurance – primary
 Spouse insurance – excess
 Birthday rule for dependents’ coverage

Fundamental Principles of
Insurance Contracts
1. Principle of Indemnity
 Proration by Face Amounts
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It limits the insurer’s maximum obligation to the
proportion of the loss that the insurer’s policy limit
bears to the sum of all applicable policy limits.
If Loss amount is $150,000
Policy Limit
Share
Payment
Insurer A
Insurer B
Insurer C
$100,000
$200,000
$300,000
1/6
2/6
3/6
$25,000
$50,000
$75,000
Fundamental Principles of
Insurance Contracts
1. Principle of Indemnity
 Proration by Amounts Otherwise Payable
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What would be payable under each policy in the absence
of other insurance
If Loss amount is $150,000
Insurer A
Insurer B
Insurer C
Policy Limit
$100,000
$200,000
$300,000
Payable
$100,000
$150,000
$150,000
1/4
1.5/4
1.5/4
$45,000
$67,500
$67,500
Share
Payment
Fundamental Principles of
Insurance Contracts
1. Principle of Indemnity

Proration by Amounts Otherwise Payable

If Loss amount is $60,000
Insurer A
Insurer B
Insurer C
Policy Limit
$100,000
$200,000
$300,000
Payable
$60,000
$60,000
$60,000
1/3
1/3
1/3
$20,000
$20,000
$20,000
Share
Payment
Fundamental Principles of
Insurance Contracts
1. Principle of Indemnity

Contribution by Equal Shares
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Each insurer contributes equal amounts until it has paid
its applicable limit of insurance or none of the loss
remains, whichever comes first.
If Loss amount is $150,000
Insurer A
Insurer B
Insurer C
Policy Limit
$100,000
$200,000
$300,000
Equal Share
$50,000
$50,000
$50,000
Payment
$50,000
$50,000
$50,000
Fundamental Principles of
Insurance Contracts
1. Principle of Indemnity

Contribution by Equal Shares

If Loss amount is $400,000
Insurer A
Insurer B
Insurer C
Policy Limit
$100,000
$200,000
$300,000
Equal Share 1
$100,000
$100,000
$100,000
Equal Share 2
N/A
$50,000
$50,000
$100,000
$150,000
$150,000
Payment
Fundamental Principles of
Insurance Contracts
1. Principle of Indemnity

Exceptions to the Principle
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Valued policy (or agreed value)
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Valued policy law
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Pays face value of insurance if a total loss occurs
Life insurance, disability insurance, fine arts, antiques
 Ex.) Value of a fine art is agreed at $250,000.
A law that requires payment of the face amount of
insurance to the insured if a total loss to real property
occurs from a covered peril, regardless of the property’s
ACV.
Replacement cost

No deduction for depreciation in determining the amount
paid for a loss.
Fundamental Principles of
Insurance Contracts
2. Principle of Insurable Interest

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The insured must be in a position to financially
suffer if a loss occurs.
Why?
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To prevent gambling
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To reduce moral hazard
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Insurance on a property and wait for a loss occur.
Life insurance on a person and pray for his/her death for
insurance proceeds.
To measure the amount of the insured’s loss in property
insurance

In order not to indemnify more than the insurable interest.
Fundamental Principles of
Insurance Contracts
2. Principle of Insurable Interest

Property-Casualty insurance
At the time of a loss, an insured must have
insurable interest.
 No insurable interest
no financial loss
no indemnity
support Prin. of indemnity
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
Life Insurance
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Insurable interest must exist at the time of a
policy inception, but not at the time of a loss
(death)
Fundamental Principles of
Insurance Contracts
2. Principle of Insurable Interest

Insurable Interest may be created either by:

Obligation to Insure
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by Statute
by Contract
by Custom
Option to Insure
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Owners
Mortgagors
Lessors
Trustees
Tenants
Fundamental Principles of
Insurance Contracts
3. Principle of Utmost Good Faith
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A higher degree of honesty is imposed on
an insurance contract than is imposed on
other contracts
Honesty is imposed on the applicant for
insurance
It is supported by three legal doctrines
Representation
 Concealment
 Warranty

Fundamental Principles of
Insurance Contracts
3. Principle of Utmost Good Faith

Representation
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Statements made by an applicant
Insurance is voidable at the insurer’s option.
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Concealment
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Material
False
Reliance
cf: Innocent misrepresentation
Intentional failure to disclose a material fact
Warranty

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A statement of fact or a promise made by the insured,
which is part of the insurance contract and must be true
if the insurer is to be liable under the contract.
In exchange for a reduced premium, a store owner
warrants that alarm will be always on.
Fundamental Principles of
Insurance Contracts
4. Principle of Subrogation


Substitution of the insurer in place of the
insured for the purpose of claiming
indemnity from a third party wrongdoer for
a loss covered by insurance.
Why?
To prevent collecting twice
 To hold the negligent party responsible
 To hold down insurance rates

Fundamental Principles of
Insurance Contracts
4. Principle of Subrogation

The insurer is entitled only to the amount it has
paid under the policy.

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If the insurer collects more than the amount the insurer
paid to the insured from the negligent party , the insured
must be paid in full before the insurer retains the
remaining balance.
The insured cannot impair the insurer’s
subrogation rights.
Subrogation does not apply to life insurance and to
most individual health insurance contracts.
The insurer cannot subrogate against its own
insured.