FUNDAMENTAL LEGAL
PRINCIPLES
Fundamental Legal Principles
Principle of Indemnity
Principle of Insurable Interest
Principle of Subrogation
Principle of Utmost Good Faith
Principle of Indemnity
Requirement that the insured should
not profit if a loss occurs
People are indemnified when they are
restored to approximately the same
financial position they were in before
the loss occurred.
Actual cash value, which is defined as
replacement cost less depreciation,
supports the principle of indemnity
since it is designed to prevent profiting
from insurance.
Actual cash value rule
-Replacement cost less depreciation
-Fair market value
-Broad evidence rule
Exceptions to the principle of indemnity
-
Valued policy
Valued policy laws
Replacement cost insurance
Life insurance
Valued policy
A valued policy pays the face amount
in the event of a total loss.
Thus, it is an exception to the
principle of indemnity since the
amount paid could be more than what
the property is actually worth.
Valued policy laws
A valued policy law requires payment
of the face amount of insurance if a
total loss to real property occurs from
a peril specified in the law.
Because the insured may be paid
more than the actual cash value of
the loss, the principle of indemnity
would be violated.
Replacement cost insurance
Replacement cost insurance means
there is no deduction for depreciation,
which allows the insured to be made
better off by receiving new property
for old.
Life insurance
A life insurance policy is also an
exception to the principle of indemnity
because it is a valued policy that pays
a stated sum to the beneficiary upon
the insured’s death.
It is difficult to determine accurately
the value of a human life, and the
amount paid may substantially
exceed the economic value of the
insured’s life.
The human life value approach gives
a crude estimate of how much a
person's life is worth, but few people
insure their lives fully, and all losses
are total.
Principle of Insurable Interest
The principle of insurable interest
means that the insured must stand to
lose financially if a loss occurs.
An insurable interest is required in
every insurance contract in order to
prevent gambling, to reduce moral
hazard, and to measure the amount of
the insured’s loss in property
insurance.
Purposes of an insurable interest
- To prevent gambling
- To reduce moral hazard
- To measure the amount of the
insured’s loss in property
insurance
Examples of an insurable interest
-
full value of a business
-
unpaid balance of a loan
Time that an insurable interest must be
met
Principle of Subrogation
Subrogation applies when the insurer
makes a loss payment to the insured
because of a loss caused by the
negligence of a third party.
Insurer is entitled to recover from a
negligent third party any loss payments
made to the insured
Subrogation is taking over another
person's right to recover in a legal
action against a negligent third party.
It is used to support the principle of
indemnity by preventing an
insured from collecting twice, once
from the insured and a second time
from the negligent party.
Purposes of subrogation
- To avoid collecting twice
- To hold the negligent person
responsible
- To hold down rates
Principle of Utmost Good Faith
Higher degree of honesty is imposed on
both parties to an insurance contract
The principal of utmost good faith
pertains to the disclosure of
information in negotiations leading up
to the forming of an insurance
contract.
In ordinary good faith contracts, there
is no strong pressure to disclose
information that would influence the
other party's willingness to contract;
in an utmost good faith contract,
there is.
The doctrines of representations,
concealment, and warranties support
the principle of utmost good faith by
allowing the contract to be broken at
the option of the injured party
(the insurer).
The insurer has a legal basis for
denying payment of a loss if there is
a material misrepresentation,
concealment, or breach of warranty.
Representations are statements made
by the applicant for insurance.
An example would be answers to
health questions when the applicant
for insurance wants to purchase life
insurance or health insurance.
The insurer could deny payment of
claim if the representation is both
material and false.
A warranty is a clause in an insurance
contract that prescribes, as a condition
of the insurer's liability, the existence of
a fact affecting the risk.
For example, a bank may warrant that
a guard will be on the premises 24
hours a day.
In the past, under common law, any
breach of the warranty, even if slight,
permitted the insurer to deny liability for
the claim.
This harsh doctrine, however, has been
substantially modified by court
decisions and legislation. Warranties
are presumed to be material.
Areas of application-legal doctrines of
misrepresentation, concealment, and
breach of warranty
Basic Requirements of an Insurance
Contract
Four requirements must be met for a
valid insurance contract:
-There must be an offer and
acceptance.
-There must be consideration to
support the contract.
-There must be competent parties.
-To be enforced, the contract must be
for a lawful purpose.
Offer and Acceptance
The applicant usually makes the offer
The insurer accepts or rejects the offer
Agent's authority to bind the insurer
varies by type of insurance
-
Property and liability insurance
Life insurance
Consideration
Insured's consideration generally is
payment of the first premium
Insurer's consideration is the promise
to perform the contract
Competent Parties
Each party must be legally competent
and have legal capacity to enter into a
binding contract.
The applicant for auto liability
insurance must not be a minor,
insane, or intoxicated when he or she
applies for insurance.
Also, the liability insurer must have
legal authorization to sell auto liability
insurance.
The general rule is that minors are not
legally competent to enter into a
binding insurance contract.
However, most states have enacted
laws that permit minors to enter into a
valid life insurance contract.
An intoxicated person usually is not
legally competent to enter into a valid
insurance contract because he or she
may be unaware of the legal
implications of the contract.
Drunkenness is treated like temporary
insanity.
An adult of legal age can enter into a
valid contract of insurance even
though he or she has been convicted
of drunk driving and cancelled by the
insurer.
However, if the applicant for auto
insurance conceals this information
from the insurer, the insurer could
deny liability for a claim on the basis
of a material concealment.
Legal Purpose
Special Characteristics of an
Insurance Contract
Insurance Is an Aleatory Contract
The insurance contract is aleatory.
The values exchanged are not equal.
If a loss occurs, the insured may
recover an amount in excess of the
premiums paid.
In a commutative contract, theoretically,
there is an equal exchange of values.
Insurance Is a Unilateral Contract
The insurance contract is unilateral
since only the insurer makes a legally
binding promise.
Most ordinary contracts are bilateral,
and either party may be sued for
breach of contract.
Insurance Is a Conditional Contract
The contract is conditional.
In order to collect, a number of
conditions must be complied with, such
as giving prompt notice of loss and
submitting proof of loss.
Conditions are provisions that qualify or
place limitations on the insurer's
promise to perform.
Certain duties are imposed on the
insured if he or she wishes to collect for
a loss.
The insurer does not have to pay the
claim if the policy conditions are
violated.
For example, in property insurance, the
insured must give immediate written
notice of a loss in order to collect.
Insurance Is a Personal Contract
Consent of the insurer is required to
assign a property or liability insurance
policy to another person.
Since loss payments are money, they
can be freely assigned without the
insurer's consent.
A property insurance contract is
personal.
Personal characteristics of the insured
influence the insurer's willingness to
issue a policy.
Accordingly, these contracts can be
validly assigned only with the consent
of the insurer.
A life insurance policy is not a personal
contract and can be freely assigned.
Contract of Adhesion
Insurance is a contract of adhesion in
that it is not bargained.
Rather, the policy is offered on a "takeit-or-leave-it" basis, and any ambiguity is
construed against the insurer.
Policy is offered on a "take-it-or-leaveit" basis with no bargaining over its
terms.
The result is that any ambiguity is
strictly construed against the insurer.
Law and the Insurance Agent
General Rules of Agency
There is no presumption of an agency
relationship.
There must be evidence sufficient to
establish that a person has authorized
someone to act on his or her behalf.
The agent must have authority to bind
the principal.
There are three sources of such
authority:
-
expressed powers
implied powers
apparent authority.
Principal is responsible for an agent's
torts and is charged with agent's
knowledge of notice.
The principal is responsible for acts of an
agent who is acting within the scope of his
or her authority.
Accordingly, the principal can be bound by
contracts that the agent has entered into
and is also liable for the agent's torts.
Doctrines of Waiver and Estoppel
Waiver is defined as the voluntary
relinquishment of a known legal right.
The insurer voluntary waives a legal
right under the contract, and in so
doing cannot later deny payment of a
claim by the insured.
Waiver
voluntary relinquishment of a
known legal right
Estoppel
representation of fact made by one
person to another person that is
reasonably relied on by that person
to such an extent that it would be
inequitable to allow the first person
to deny the truth of the
representation
Based on the legal doctrine of estoppel,
an insurer legally may be required to
pay a claim that it ordinarily would not
have to pay.
Practical significance of these legal
doctrines-insurer legally may be
required to pay a claim that it
ordinarily would not have to pay.