Chapter 9

Fundamental Legal Principles

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Agenda

 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

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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

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Continued…
 In property insurance, indemnification is based on
the actual cash value (ACV) 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

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Continued…
 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

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Principle of Insurable Interest
The insured must be in a position to lose financially if a covered
loss occurs
Purposes:

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

An insurable interest can be supported by:

 Ownership of property

 Potential legal liability

 Serving as a secured creditor

 Contractual rights

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Continued…
 When must insurable interest exist?
 Property insurance: at the time of the loss
 Life insurance: only at inception of the policy

 The question of insurable interest does not

arise when you purchase life insurance on your
own life
 Insurable interest in another person’s life can
be shown by close family ties, marriage, or a
pecuniary (financial) interest
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Principle of Subrogation
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.
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

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Continued…

 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

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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
 Concealment
 Warranty

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Continued…

 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
 Material means that if the insurer knew the true
facts, the policy would not have been issued, or
would have been issued on different terms
 An innocent misrepresentation of a material
fact, if relied on by the insurer, makes the
contract voidable

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Continued…

 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 insurance contract and is guaranteed by the
maker to be true in all respects
 Statements made by applicants are considered
representations, not warranties

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Requirements of an Insurance
Contract
 To be legally enforceable, an insurance
contract must meet four requirements:
 Offer and acceptance of the terms of the contract
 Consideration – the value that each party gives
to the other
 Competent parties, with legal capacity to enter
into a binding contract
 The contract must exist for a legal purpose

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Distinct Legal Characteristics of
Insurance Contracts
 An insurance contracts is:
 Aleatory: values exchanged are not equal
 Unilateral: only the insurer makes a legally
enforceable promise
 Conditional: policy owner must comply with all policy
provisions to collect for a covered loss
 Personal: property insurance policy cannot be validly
assigned to another party without the insurer's consent
 A contract of adhesion: the insured must accept the
entire contract with all of its terms and conditions

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Continued…

 Courts have ruled that any ambiguities or

uncertainties in the contract are construed
against the insurer.
 The principle of reasonable expectations states
that an insured is entitled to coverage under a
policy that he or she reasonably expects it to
provide, and that to be effective, exclusions or
qualifications must be conspicuous, plain, and
clear.
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Law and the Insurance Agent
 An agent is someone who has the authority to act on
behalf of a principal (the insurer)
 Several laws govern the actions of agents and their
relationship to insureds
 There is no presumption of an agency
relationship
 An agent must be authorized to represent the
principal
 A principal is responsible for the acts of agents
acting within the scope of their authority
 Limitations can be placed on the powers of
agents

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Continued…
 An agent’s authority comes from three sources
 Express authority
 Implied authority
 Apparent authority

 Knowledge of the agent is presumed to be

knowledge of the principal with respect to matters
within the scope of the agency relationship
 Insurers can place limitations on the power of
agents by adding a nonwaiver clause to the
application or policy

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Continued…

 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

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