Chapter 9 - Fundamental Legal Principles

Question 1

Principle of indemnity is when the insurer agrees to pay no more than the actual amount of the loss. What are the two reasons behind this?

Answer 1

to prevent the insured from profiting from a loss

to reduce moral hazard

Question 2

In property insurance, indemnification is based on the actual cash value of the property at the time of loss. What are the three main methods to determine actual cash value?

Answer 2

• Replacement cost less depreciation
• Fair market value is the price a willing buyer would pay a willing seller in a free market
• Broad evidence rule means that the determination of ACV should include all relevant factors an expert would use to determine the value of the property

Question 3

What are the four exceptions to the principle of indemnity?

Answer 3

• A valued policy pays the face amount of insurance if a total loss occurs
• Some states have a valued policy law that requires payment of the face amount of insurance to the insured if a total loss to real property occurs from a peril specified in the law
• Replacement cost insurance means there is no deduction for depreciation in determining the amount paid for a loss
• A life insurance contract is a valued policy that pays a stated sum to the beneficiary upon the insured’s death

Question 4

The principle of insurable interest states that the insured must be in a position to lose financially in a covered loss occurs. What is the purposes of this principle? (3)

Answer 4

To prevent gambling
to reduce moral hazard
to measure the amount of the insured’s loss

Question 5

What are four examples of insurable interest?

Answer 5

Ownership of property
potential legal liability
serving as a secured creditor
contractual rights

Question 6

When must insurable interest exist? Property? Life insurance?

Answer 6

Property insurance: at the time of the loss

Life insurance: only at inception of the policy

Question 7

Principle of Subrogation is 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. What is the purpose of this principle? (3)

Answer 7

• To prevent the insured from collecting twice for the same loss
• To hold the negligent person responsible for the loss
• To hold down insurance rates

Question 8

What are the four characteristics of a principle of subrogation?

Answer 8

• The insurer is entitled only to the amount it has paid under the policy
• The insured cannot impair the insurer’s subrogation rights
• Subrogation does not apply to life insurance contracts
• The insurer cannot subrogate against its own insureds