Module 3: Legal Principles

Question 1

What is a contract?

Answer 1

A legally enforceable transaction between two or more parties.

Question 2

What are the six essential ingredients of a simple contract?

Answer 2

1. Capacity - both parties must be capable of entering into a legally enforceable agreement.
2. Intention to create legal relations.
3. Offer - one side must make an unequivocal offer to the other side but not necessarily in writing.
4. Acceptance - an offer may have a time limit on it and it will be open for acceptance any time before it expires or is withdrawn.
5. Consensus ad idem - “meeting of minds” which means that all parties to a contract must think they’re agreeing to the same thing.
6. Consideration - something of value in the eyes of the law (not necessarily money) has to be give in exchange for the promise under the contract.

Question 3

What is the “contra proferentum rule”?

Answer 3

If a word, phrase or clause is found to be ambiguous by the courts, then they will look to see who introduced it into the contract.

The benefit of the doubt in relation to the ambiguity will then be given to the other party.

For example: if you bought a car insurance policy, how likely is it that you would have asked for any of the wording to be changed? Highly unlikely, which means that any ambiguity in the wording would be construed or interpreted by a court in your favour.

Question 4

There are a number of reasons why a contract might not be completely valid in law. Name three of them.

Answer 4

1. Void contracts - contracts that have no legal effect.
2. Voidable contracts - contracts that contain all the required ingredients, so are perfectly valid in law but something has happened which makes one or other parties able to cancel the contract (or avoid it) if they choose.
3. Unenforceable contracts - contracts which are totally valid but that the court will not enforce for example PPI contracts.

Question 5

What is a void contract?

Answer 5

A contract this is missing one of the six essential ingredients of a contract (void ab initio).

Any monies paid under the contract should be repaid, for example any premium paid should be repaid.

A contract may be void if there is a breach of warranty. A breach may arise after the contract incepts and if that is the case then the contract becomes void from that date, and is enforceable beforehand.

Question 6

What is termination?

Answer 6

Where the parties to the contract are released from their contractual obligations.

Question 7

In what ways may a contract be terminated?

Answer 7

1. Performance by all parties - contract is performed when each party has carried out their side of the bargain.
2. Performance by the insured - payment of the agreed premium (the consideration), although he may have additional duties under the terms of the policy.
3. Performance by the insurers - bearing certain risks for an agreed period of time and paying any valid claims.
4. Agreement between the parties - the parties can amend the agreement so to release each other from their mutual obligations.
5. Frustration - a contract may be terminated through subsequent impossibility or commercial impracticality (frustration).

Examples: destruction of the subject matter, government interaction (e.g. something that becomes illegal) a party dies, etc.

6. Radical change - the contract cannot be performed because a radical change occurs which destroys the basis of the contract, without fault of either party.

Question 8

What is a breach of contract?

Answer 8

Failure by any party to carry out obligations that will generally give rise to a right to claim damages.

Question 9

What is the duty of utmost good faith (uberrimae fides in latin)?

Answer 9

A duty to disclose material facts. If one of the parties does not exhibit good faith then the other party has the right to avoid the contract or to bring it to an end, thus making the contract voidable.

Question 10

How long does the duty of utmost good faith last?

Answer 10

1. Throughout the negotiation of a risk, i.e. until the contract is concluded.
2. To any alteration in the risk whilst that alteration is being negotiated with the insurers.
3. To any renewal of the insurance.

Question 11

What is a breach of the duty of utmost good faith?

Answer 11

1. Where either party (for example the insured to the insurer) does not disclose a material fact (non-disclosure) or discloses information that is incorrect (misrepresentation).

Both actions can be either deliberate or inadvertent.

2. If this duty is not fulfilled then insurers can come off risk or refuse to pay a claim.

Question 12

What is a material fact?

Answer 12

Any fact or circumstance which would affect assessment of the risk, even if the particular would not, of itself, have had a decisive effect on the insurer’s acceptance or rating of that risk.

Question 13

Name three types of facts which are generally considered material.

Answer 13

1. Details of previous losses (whether insured or not).
2. Details of special terms imposed by other insurers of the type of risk being negotiated or of declinature.
3. Facts suggesting that the subject matter of the insurance is exposed to more than ordinary danger from the perils insured against.

Question 14

Name three types of facts which are not considered material.

Answer 14

1. Facts tending to lessen the risk.
2. Facts which are known to the insurers or which they may reasonably be presumed to know.

Examples: matters of public knowledge, facts that an insurer ought to know as a matter of professional competence, matters the insurer should be aware of by the review of the normal trade press etc.

3. Facts disclosed in previous negotiations with the same insurer. The insured or his broker must be confident that they can prove such prior disclosure.
4. Convictions which have become spent under the Rehabilitation of Offenders Act 1974.

Question 15

What is a representation?

Answer 15

A factual statement made either by the proposer or the broker in relation to the risk to be insured.

If representation relate to matters of fact then they must be substantially true, and if they are not then the insurers may refuse to pay a subsequent claim.

Question 16

When does a representation become material?

Answer 16

If it affects the underwriter’s decision to accept the risk, or his rating of the risk.

Question 17

What gives a proposal form the power of a warranty?

Answer 17

A declaration that the proposal form is the basis of and is actually incorporated into the policy.

Question 18

What happens in case of a fraudulent claim?

Answer 18

If an assured has presented a fraudulent claim then the policy will become void from the date of the claims itself.

Any previous legitimate claims would have to be met by insurers.

Many policies have specific wording which states that a fraudulent claim will render the policy void from inception.

Question 19

How would you define insurable interest?

Answer 19

Insurable interest is the relationship with the subject matter of the insurance (be it property or a liability) whereby if that item is lost or damaged or causes loss or damage to another person or their property then you will have a financial loss of some type.

Question 20

Name six examples of insurable interest.

Answer 20

1. Owners or joint owners of property (a joint owner can insure for the whole value of the property, with the permission of the other joint owner).
2. A person who has lawful possession of goods which belong to another has an insurable interest in their liability for damage to that property.

Examples: dry cleaners, garage proprietors, bailees of cargo and hotel keepers.

3. A person who otherwise has property within their care, such as an executor after someone’s death.
4. An insurer has an insurable interest in a risk it has underwritten, so they may reinsure it.
5. Anyone who may incur legal liabilities to others for negligent acts, or defects in property or goods.
6. Any individual has an insurable interest in his or her own life and wellbeing.

Question 21

What is assignment?

Answer 21

A term used to mean the transfer of the policy from the original insured to another party.

Question 22

When must insurable interest exist in life insurance?

Answer 22

When the contract is made.

Because a life insurance policy is not a policy of indemnity, insurable interest does not have to exist when a claim is made.

Question 23

When must insurable interest exist in marine insurance?

Answer 23

At the time of the loss.

It does not have to exist as the time that the insurance is effected. This is laid down by the Marine Insurance Act 1906 s.6.

Question 24

When must insurable interest exist in non marine insurance?

Answer 24

Insurable interest must exist both when the policy is taken out and at the time of a claim.

Question 25

What is indemnity?

Answer 25

The legal principles which ensures that an insured is restored to the same financial position after the loss that he was in immediately prior to the loss.

Question 26

How does indemnity work in liability policies?

Answer 26

The policy will state how the indemnity will be calculated and will provide a limit of indemnity.

Question 27

How does indemnity work in first loss policies?

Answer 27

The concept is that the policy has an insured value which is what the insured considers the maximum loss likely in any one occurrence to be, which may well be considerably less than the total value of the property itself.

Question 28

How does indemnity work in agreed value policies?

Answer 28

The item being insured has a specific value which is agreed between the insured and the insurer at the inception of the policy.

Question 29

Name four methods of indemnity.

Answer 29

1. Cash payment
2. Reinstatement - this is where insurers will arrange for a building to be rebuilt instead of giving the insured a payment in cash.
3. Repair - insurers will arrange directly for the repair of a damaged car or piece of artwork.
4. Replacement - insurers will arrange directly with the suppliers for the replacement of a piece of electrical equipment.

Question 30

What benefit is there to insurers for doing other than paying cash?

Answer 30

1. They can save money by having direct dealing with suppliers of any type to take advantage of bulk purchasing discounts.
2. They can combat fraud by replacing goods rather than paying cash.

Question 31

How does a deductible work?

Answer 31

A deductible will be deducted or taken away from the policy limits.

Example: if the policy limit is £1,000,000 and the deductible is £100,000, then the maximum insurers will pay will be £900,000.

Question 32

How does an excess work?

Answer 32

An excess sit underneath the policy limits.

Example: if the policy limit is £1,000,000, the insurers will pay the full £1,000,000.

Question 33

How does a franchise work?

Answer 33

Example 1: if the franchise is £100,000, and the damage is £10,000, then the insurer won’t pay anything.

Example 2: if the franchise is £100,000, and the damage is £200,000, then the insurer will pay the full £200,000;

i.e. the insured has to contribute nothing (unlike with either a deductible or an excess).

Question 34

What is an average clause?

Answer 34

The amount a claim is reduced to in proportion to the under-insurance.

Where average clauses apply the insured is compelled to bear part of the loss himself.

Question 35

What is under-insurance?

Answer 35

Under-insurance means that the value of the property declared by the insured and on which the premium is calculated is less than the value of the risk.

Question 36

What is subrogation?

Answer 36

When a reinsurer reimburses the insured for a loss, the insurers are entitled at common law, to try to recoup some of their money they have paid out by pursuing a third party that may be liable for the loss that led to the insurance claim in the first place.

Question 37

What types of policy apply to subrogation?

Answer 37

Subrogation applies to contracts of indemnity for example:

1. Property insurance
2. Liability insurance

Question 38

In what other circumstance might subrogation arise?

Answer 38

1. When an insured is involved in a motor accident caused by the negligence of another driver.

The insurer can seek to recover the damage to the insured vehicle from the negligent driver or his insurer.

(subrogation through tort law).

2. Under the terms of a contract, the owner of a storage facility may be liable to pay compensation to an insured whose goods are destroyed or damaged whilst stored there.

(subrogation through contract law)

Question 39

What is contribution?

Answer 39

The right of an insurer to call upon any other insurers covering the same risk to share in the claim.

This will only be triggered if the insured has more than one contract of insurance covering the same loss.

The idea is that there are two or more completely separate policies covering exactly the same loss for the same perils.

Question 40

How does contribution work in practice?

Answer 40

The insured is obliged to claim proportionately from each reinsurer.

Sum insured by individual insurer/
total sum insured * Loss.

Question 41

What is proximate cause?

Answer 41

The active, efficient cause which sets in motion a train of events which brings about a result without the intervention of any new cause working actively from a fresh or independent source.

Proximate cause is, thus, not necessarily the closest in time to the result but is the dominant cause.

Question 42

How does the chain of causation work?

Answer 42

Domino effect. If you push one piece over the rest of the line will fall over in a chain reaction.

If something happens which causes the dominoes to stop falling - that is a break in the chain of causation.

Question 43

How does the operation of proximate cause benefit both insurer and insured?

Answer 43

1. The insurer is secure from claims for losses remotely caused by a peril insured against but effectively caused by a peril outside the scope of the policy.
2. The insured is protected against non-payment of a reasonable claims although a remote cause is not a peril insured against.

Question 44

What is a warranty?

Answer 44

An insurance contract term by which the assured undertakes that some particular thing shall or shall not be done, or that some condition shall be fulfilled, or whereby he affirms or negates the existence of a particular state of facts.

Warranties function as risk control mechanisms. They describe the behaviour the insured will or will not undertake in order to control and limit the risk.

Question 45

Name four examples of warranted promises an insured can make to insurer.

Answer 45

1. A given state of affairs does or does not exist at the time the policy is purchased.
2. A certain state of affairs will continue or will come into being during the course of affairs during the term of the policy.
3. The insured has or has not acted in a stated way.
4. The insured will or will not act in a stated way.

Question 46

What three tests determine whether a term of an insurance contract is a warranty?

Answer 46

1. Does the term go to the root of the transaction?
2. Is the term descriptive of or does it bear materially on the risk assumed?
3. Would damages for breach of the term be an unsatisfactory or inadequate remedy?

Question 47

In what three way may a warranty be created?

Answer 47

1. As a free-standing express term of an insurance contract.
2. As an implied term of the insurance (though this is rare outside marine insurance and reinsurance).
3. As a result of a “basis of contract” clause, whereby statements made in a proposal, form the basis of the insurance.

Question 48

What are the three main categories of warranty?

Answer 48

1. Express warranties - warranties that can be found in the body of the insurance policy.
2. Implied warranties - only found in marine insurance and are warranties which apply automatically, even though they are not referred to in the policy document.
3. Basis of contract clauses - A “basis of contract” clause or “basis clause” states that the information contained in the proposal form shall form the basis of the contract between the insurer and the insured.

Theoretically, therefore, much of the proposal information could have the force of a warranty.

Question 49

What is an agency?

Answer 49

A legal relationship between two parties whereby one of those parties can affect the other’s legal relationship with third parties.

OR more simply someone who acts on your behalf (your agent) whose behaviour may bind you legally (although not always).

Question 50

What is apparent authority?

Answer 50

Authority where, to the reasonable outsider, the agent is acting totally within his powers when, in fact, he has no such authority.

Example
A coverholder writing under a binding authority who has a limited authority delegated from his principals, who then writes risks in excess of his authority.

Question 51

What is implied authority?

Answer 51

Where someone has been appointed to a position and it can be taken as a read that he has the authority necessary to perform that position such as a director of a company being given the authority necessary to perform his or her role.

Example: you would expect your finance director to be able to make major decisions by virtue of the role that they occupy.

Question 52

What is ostensible authority?

Answer 52

It can arise from a reasonable outsider being led to believe that the agent has the authority of his principal from the way the agent conducts himself.

The suggestion that the agent had the power must have come from the principal, for example, the granting of the delegated underwriting authority.

Question 53

An agent is remunerated by his principal for the services rendered, and is under certain fiduciary obligations. What are they?

Answer 53

1. To exercise due diligence in carrying out instructions within the responsibilities he has undertaken.
2. To exercise any skill he professes to have.
3. To ensure that the principal is aware of factors likely to affect his judgment in fulfilment of the contract.
4. To render an account and not make any secret commission or profit beyond normal remuneration.
5. To maintain confidentiality.
6. To delegate authority only with specific permission.
7. To avoid conflicts of interest (and to declare them to the principal if they arise).

Question 54

What is sub-broking?

Answer 54

Where a broker who is not able to place a risk himself requests the services of another broker to secure full placement.