03. Legal Principles and Insurance Contracts

Question 1

1. What are the fundamental legal principles which are reflected in insurance contracts?

Answer 1

1. The principle of indemnity
2. The principle of insurable interest
3. The principle of subrogation
4. The principle of utmost good faith

Question 2

2. The principle of indemnity is one of the most important legal principles in the field of insurance, what is the basic common law principle of indemnity?

Answer 2

That the insured should not profit from a covered loss but should be restored to approximately the same financial position that existed prior to the occurrence of the loss.

Question 3

3. What are the two key purposes embodied in the principle of indemnity?

Answer 3

• To prevent the insured from profiting from an insurance claim, and
• To reduce moral hazard

Question 4

4. Under the principle of indemnity there is the concept of actual cash value. What does this mean?

Answer 4

That the amount payable is the actual cash value, which is equal to replacement cost minus depreciation.

Question 5

5. What are the four important exceptions to the principle of indemnity?

Answer 5

• Valued policy - pays out the actual face value of insurance regardless of the actual cash value of total losses (eg antiques)
• Valued policy laws - Insurer pays out face value of insurance if total loss occurs from a peril specified in law (mostly USA)
• Replacement cost - No deduction for depreciation is applied
• Life insurance - as it is difficult to give value to a human life so amount is agreed up front.

Question 6

6. What does the principle of insurable interest specify?

Answer 6

That the insured must lose financially if a loss occurs, or must incur some other kind of harm if the loss takes place.

Question 7

7. What is the purpose of insurable interest?

Answer 7

• To prevent gambling insurance contracts
• To reduce moral hazard
• To measure the loss

Question 8

8. For an insurance contract to be valid, insurable interest must exist at what points?

Answer 8

• Life insurance - at inception only
• Marine Insurance - at the time of loss only
• General Insurance - at both inception and time of loss

Question 9

9. What is the principle of subrogation?

Answer 9

It puts in place the substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third party for a loss covered by insurance. Ie the insurer is entitled to recover from a negligent third party any loss payments made to the insured.

Question 10

10. What are the purposes of subrogation?

Answer 10

• To prevent the insured from collecting twice
• To enable the insurer to recover from the person responsible for the loss
• To help keep insurance rates down

Question 11

11. The principle of utmost good faith “uberimae fidei” means what? And what duty often falls under this principle?

Answer 11

That the highest degree of honesty is imposed on both parties to the insurance contract.
The duty of disclosure.

Question 12

12. The duty of disclosure requires the insured to disclose all material facts to the insurer. What are the exceptions?

Answer 12

Facts:

• already known
• have been waived
• diminish the risk
• of public notoriety
• which the insurer decided to personally ascertain
• which are superfluous
• which the insurer was deemed to have constructive knowledge of
• made known to insurer’s agents or employees

Question 13

13. What is non-disclosure?

Answer 13

It is the failure or concealment by the applicant to reveal material facts to the insurer. Where deliberate this may void the insurance contract.

Question 14

14. What is misrepresentation? and what are the two types?

Answer 14

It is where an inaccurate or untrue statement was made by the insured or by the insured’s agent prior to the conclusion of the contract. There is innocent misrepresentation and fraudulent misrepresentation.

Question 15

15. What is the insurer’s duty in disclosure?

Answer 15

Under the Insurance Contracts Act the insurer must inform the applicants for insurance of their duty of disclosure, and assist them to discharge that duty by requesting the insured:

• answer specific questions relevant to the insurer’s decision whether to accept the risk
• disclose each exceptional circumstance known to the insured

Question 16

16. What are the four basic requirements of a contract?

Answer 16

• Offer and acceptance
• Consideration
• Competent parties
• Legal purpose

Question 17

17. How does an insurance contract work in regards to the offer and acceptance step?

Answer 17

The applicant makes an offer by filling out a proposal form and pays (or promises to pay) the first premium. The insurer will either accept the offer or will make a counter-offer which changes to premium, terms or conditions.

Question 18

18. What is a ‘binder’ and when does it occur?

Answer 18

A binder is a temporary contract for insurance and can either be written (a cover note) or oral and is where the Insurer’s agent has bound the insurance company immediately prior to receipt of an application.

Question 19

19. What type of insurance is an agent not able to bind the company on?

Answer 19

Life insurance - the application must be in writing and the applicant must be approved by the insurer.

Question 20

20. What is each parties consideration in an insurance contract.

Answer 20

The insured’s premium (or promise to pay) and the Insurer’s promise to do things as specified in the contract.

Question 21

21. Besides the distinct features of insurance contract such as indemnity, insurable interest and utmost good faith, an insurance contract has other distinct legal characteristics. What are they and what do they mean?

Answer 21

• Aleatory contract - the values exchanged are not equal.
• Unilateral contract - only one party makes a legally enforceable promise (insurer)
• Conditional contract - requires policy conditions to be met in order to be payable
• Personal contract - the contract is between the insured and insurer ie. that person is insured for the loss.
• Contract of adhesion - the insured must accept the entire contract with all of its terms and conditions.

Question 22

22. What are the six components of a legal contract?

Answer 22

• Declarations
• Definitions
• Insuring agreement
• Exclusions
• Conditions
• Miscellaneous provisions

Question 23

23. What does the declarations section contain for an insurance contract?

Answer 23

• Identification of insurer
• Name of insured
• Location of the property
• Period of protection
• Amount of insurance
• Amount of premium
• Size of the deductible (if any)
  etc

Question 24

24. What does the insuring agreement of an insurance contract contain? and what are the two basic forms of an insuring agreement under property and liability insurance?

Answer 24

• The major promises of the insurer.
  Two forms are:
• named-peril coverage - only those perils specifically listed in the policy are covered
• all-risk policy - all losses are covered except those specifically excluded.

Question 25

25. What are the three major types of exclusions which may be included in an insurance policy and give two examples for each?

Answer 25

• Excluded perils - perils such as flood, earth movement, (property), war (life insurance)
• Excluded losses - earthquake/flood losses or in motor - negligent operation may be excluded
• Excluded property - eg boat or car out front of house or animals.

Question 26

26. Why are exclusions necessary?

Answer 26

• Uninsurable perils - self inflicted injury, wear and tear
• presence of extraordinary hazards - taxi at normal rates
• coverage provided by other contracts - eg car insurance (not house)
• moral hazard - limit of lost cash in home due to theft
• coverage not needed by typical insureds - private airplanes under home insurance.

Question 27

27. What are the common conditions covered in an insurance policy?

Answer 27

• Notification within a certain period
• Protection of the property after a loss
• Lodging a proof of loss with the insurer
• Cooperating with the insurer in the event of a liability suit.

Question 28

28. What items are commonly found in the miscellaneous provisions of an insurance contract?

Answer 28

• cancellation
• subrogation
• requirements if a loss occurs
• assignment of the policy
• grace period
• reinstatement of a lapsed policy
• misstatement of age.

Question 29

29. What is an endorsement / rider?

Answer 29

It is a written provision that adds to, deletes or modifies the provisions of the original contract

Question 30

30. What is a deductible/ excess?

Answer 30

It is a provision which specifies an amount to be deducted from the total loss payment or it could be a waiting period for the benefit.

Question 31

31. Why are deductible / excesses used?

Answer 31

• To reduce premiums
• To eliminate small claims that are expensive to administer
• To reduce both moral and morale hazard.

Question 32

32. What is coinsurance?

Answer 32

It is a contractual provision commonly found in commercial property insurance and requires the insured to insure the property for a stated percentage of its insurable value.

Question 33

33. What is the coinsurance formula?

Answer 33

($ insurance carried divided by $ Insurance required) x loss = Amount of recovery

Question 34

34. What is the purpose of coinsurance?

Answer 34

It is to achieve equity in rating because most property losses are partial, but if owners only insured the partial loss the premiums would be much higher, but also as property keeps on changing in value this is also difficult. 80% is common and where the owner insures less than this the insurance paid for any loss is proportioned in the same way.

Question 35

35. What is a waiver?

Answer 35

This is the voluntary relinquishment of a known legal right.

Question 36

36. What is an estoppel?

Answer 36

This is a 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.

Question 37

37. What is Proximate cause? and why is it required?

Answer 37

It is the ‘cause’ that sets in motion events which bring about a result. It is needed because to remove the doubt about what is insured when some of the events are included and some may not be.

Question 38

38. Proximate cause is required because a peril of some kind will have caused the loss but not all perils are insured. So the insurers must determine the perils into three types, what are they?

Answer 38

• Insured peril - eg fire, storm damage etc
• Excluded perils - specifically excluded such as driving under influence
• Uninsured perils - not mentioned in the policy and therefore out of scope

Question 39

39. What are the six areas of domestic insurance (standard insurance) covered by the Insurance Contracts Act?
    (There are pre-printed standards and are generally adopted, or where not adopted the insured is so informed in writing prior to taking cover).

Answer 39

• Motor vehicle (property damage only)
• Home buildings
• Home contents
• Sickness and accident
• Consumer credit
• Travel insurance

Question 40

40. When can an insurer rely upon an unusual provision in a contract?

Answer 40

Only when they have notified the insured in writing before or at the time of the contract being entered into.