This chapter’s objectives are to: Principle of indemnity, principle of insurable interest, principle of subrogation, principle of utmost good faith, requirements of an insurance contract, distinct legal characteristics of insurance contracts, law and the insurance agent.
Lecture No 17 Fundamental Legal Principles Copyright © 2011 Copyright Pearson © 2011Prentice Pearson Prentice Hall AllHall rights All rights reserved reserved 91 Objectives • • • • • • • Principle of Indemnity Principle of Insurable Interest Principle of Subrogation Principle of Utmost Good Faith Requirements of an Insurance Contract Distinct Legal Characteristics of Insurance Contracts Law and the Insurance Agent Copyright © 2011 Pearson Prentice Hall All rights reserved 92 Principle of Indemnity The insurer agrees to pay no more than the actual amount of the loss • Purpose: – – To prevent the insured from profiting from a loss To reduce moral hazard Copyright © 2011 Pearson Prentice Hall All rights reserved 93 Principle of Indemnity • • In property insurance, indemnification is based on the actual cash value of the property at the time of loss There are three main methods to determine actual cash value: – – – 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 Copyright © 2011 Pearson Prentice Hall All rights reserved 94 Principle of Indemnity • There are some exceptions to the principle of indemnity: – – – – 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 Copyright © 2011 Pearson Prentice Hall All rights reserved 95 Principle of Insurable Interest The insured must stand to lose financially if a loss occurs • Purpose: – – – • To prevent gambling To reduce moral hazard To measure the amount of loss When must insurable interest exist? – – Property insurance: at the time of the loss Life insurance: only at inception of the policy Copyright © 2011 Pearson Prentice Hall All rights reserved 96 Principle of Subrogation Substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third person for a loss covered by insurance • Purpose: – – – 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 Copyright © 2011 Pearson Prentice Hall All rights reserved 97 Principle of Subrogation • • • • 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 and to most individual health insurance contracts The insurer cannot subrogate against its own insureds Copyright © 2011 Pearson Prentice Hall All rights reserved 98 Principle of Utmost Good Faith A higher degree of honesty is imposed on both parties to an insurance contract than is imposed on parties to other contracts • Supported by three legal doctrines: – Representations are statements made by the applicant for insurance • • A contract is voidable if the representation is material, false, and relied on by the insurer An innocent misrepresentation of a material fact, if relied on by the insurer, makes the contract voidable Copyright © 2011 Pearson Prentice Hall All rights reserved 99 Principle of Utmost Good Faith – – A concealment is intentional failure of the applicant for insurance to reveal a material fact to the insurer A warranty is a statement that becomes part of the insurancecontractandisguaranteedbythemakerto betrueinallrespects ã Statementsmadebyapplicantsareconsidered representations,notwarranties Copyright â 2011 Pearson Prentice Hall All rights reserved 910 Law and the Insurance Agent • • Waiver is defined as the voluntary relinquishment of a known legal right Estoppel occurs when a representation of fact made by one person to another person 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 Copyright © 2011 Pearson Prentice Hall All rights reserved 914 • • The Commercial Package Policy (CPP) In January 1986, a new, simplified approach to commercial insurance coverage was introduced by the insurance industry Under the Commercial Package Policy (CPP) – • • The insured can obtain almost all types of insurance coverage Broader contract provisions are included in the CPP The CPP has seven separate sets of coverage – Commercial property, liability, crime, boiler and machinery, commercial auto, inland marine, and farm Copyright © 2011 Pearson Prentice Hall All rights reserved 915 15 The Commercial Package Policy (CPP) • • An insured can pick and choose coverages in the CPP The CPP allows many insureds to use one policy to meet most of their insurance needs – • Workers’ compensation and ocean marine insurance must be purchased separately The CPP has many options available Copyright © 2011 Pearson Prentice Hall All rights reserved 916 16 Building and Personal Property Coverage Form Basic protection for buildings and personal property in • • the CPP Property coverage is divided into three major categories – Buildings • • • – Your business personal property • – Includes the buildings described on the declarations page Any additions, extensions, fixtures, machinery and equipment constituting a permanent part of the described buildings Service equipment Includes business personal property owned by the insured and usual to the occupancy of the insured Personal property of others • Improvements and betterments – • Alterations made to a leased building by the insured that the insured cannot legally remove when the lease is terminated Personal property of others in the insureds control – Develops in situations where the insured repairs the property of others Copyright © 2011 Pearson Prentice Hall All rights reserved 917 17 Extensions of Coverage • BPP has extensions of coverage that expand protection to other categories of property – – – – – – • Newly acquired or constructed property Your business personal property at newly acquired premises Personal effects and property of others Valuable papers and records–cost of research Property offpremises Outdoor property All of these extensions are an additional amount of insurance – Apply only if the policy has an 80 percent or higher coinsurance clause Copyright © 2011 Pearson Prentice Hall All rights reserved 918 18 Specific versus Blanket Coverage • • Under specific coverage, property at one or more locations is listed and specifically insured Under blanket coverage, property at several locations may be insured under a single item Copyright © 2011 Pearson Prentice Hall All rights reserved 919 19 Common Clauses in the BPP • Common clauses include – – – Coinsurance Subrogation Electrical apparatus • No loss to electrical items will be covered if caused by artificially generated electrical currents – – Power failure • – Spoilage due to power failure from an insured peril is not covered unless the loss of power is from an onpremises insured peril Operation of building laws • – Unless fire ensues, and then loss is covered only for the fire damage No loss will be paid that results from the operation of building codes Alterations and repairs • Allows the insured to make this type of modification without its being considered an increase in hazard – Which would cause the coverage to be suspended Copyright © 2011 Pearson Prentice Hall All rights reserved 920 20 Common Clauses in the BPP • Two important exclusions were added to property clauses in 2002 – Mold claims • • – Have skyrocketed in a few states in the early 2000s Prior to 2002, mold was listed in the socalled “wear and tear” exclusion After the terrorist attacks of September 11, insurers begin excluding terrorism from their policies • The Terrorism Risk Insurance Act (TRIA) was enacted in November 2002 – By the federal government to provide a backup for insurers that could not get reinsurance coverage for terrorism Copyright © 2011 Pearson Prentice Hall All rights reserved 921 21 Insured Perils • The basic form of the BPP covers – • The broad form includes the basic perils plus – • Fire, lightning, explosions, windstorm and hail, smoke, riot or civil commotion, vandalism, sprinkler linkage, sinkhole collapse, and volcanic action Falling objects, the weight of ice, sleet, and snow; and accidental discharge of water or steam from a system or appliance containing steam or water other than an automatic sprinkler system The special cause of loss form covers all direct physical losses except those that are excluded – Examples of excluded perils • – Earth movement, flood, war, enforcement of building ordinance, smog, insect damage, and wear and tear The old name for this type of coverage was “all risk” • The new name is “open perils” Copyright © 2011 Pearson Prentice Hall All rights reserved 922 22 Debris Removal • The BPP form includes coverage for debris removal – However if the loss is > or equal to the policy • • There is additional debris coverage up to $10,000 BPP provides coverage for costs of pollution cleanup and removal from land or water at the described premises Copyright © 2011 Pearson Prentice Hall All rights reserved 923 23 Subrogation • Practically all contracts of property insurance are subject to the right of subrogation – • By the insurer against any liable third party It may turn out, for example, that while the insured’s property insurance provides coverage for loss – Someone else has agreed to assume this liability by contract or is held liable because of its negligence in causing the damages • • If the insurer pays the claim, it has a right to any such claims that the insured may have had against others Such recoveries assign responsibility to the party that is responsible for the damages – Holding that party accountable for its actions Copyright © 2011 Pearson Prentice Hall All rights reserved 924 24 Endorsements used with the BPP • • • An insured can add earthquake and radioactive contamination to the list of insured perils The limits of recovery on such property as outdoor signs, trees, shrubs, plants, and radio and television antennas may be increased Special market value endorsements are available for distilled spirits and wines Copyright © 2011 Pearson Prentice Hall All rights reserved 925 25 Endorsements used with the BPP • Two endorsements that modify the BPP include – Replacement cost • – Like that found in the homeowner’s policy and changes the basis of recovery from actual cash value to replacement cost Ordinanceandlawendorsement ã Usedwhenolderbuildingsmustberepairedaccordingtoa morestringentbuildingcode Copyright â 2011 Pearson Prentice Hall All rights reserved 926 26 Boiler and Machinery Insurance (Equipment Breakdown Coverage) Explosions caused by steam boilers, compressors, • • engines, electrical equipment, flywheels, air tanks, and furnaces constitute a serious source of loss that the layperson often does not recognize Has developed along somewhat different lines from the usual insurance contract – Recognizing that prevention of losses is even more important than indemnification of loss • Insurers have taken on the service of inspection and servicing of boiler operations and technical machinery – – Failure of the vessel to pass an inspection may mean imminent danger to continued operations The insurer reserves the right to suspend coverage immediately if recommended repairs or replacements are not made Copyright © 2011 Pearson Prentice Hall All rights reserved 927 27 End of Lecture 17 Copyright © 2011 Copyright Pearson © 2011Prentice Pearson Prentice Hall AllHall rights All rights reserved reserved 928 ... paid under the policy 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 ... Fire, lightning, explosions, windstorm? ?and? ?hail, smoke, riot or civil commotion, vandalism, sprinkler linkage, sinkhole collapse,? ?and? ? volcanic action Falling objects, the weight of ice, sleet,? ?and? ?snow;? ?and? ?accidental ... 913 Law? ?and? ?the? ?Insurance? ?Agent • • Waiver is defined as the voluntary relinquishment of a known? ?legal? ?right Estoppel occurs when a representation of fact made by one person to another person is