Insurance H.W

FIN 3610 General Insurance

Chapter 9 – Fundamental Legal Principles

Chapter 10 – Analysis of Insurance Contracts

Lecture Overview – Comments from Dr. Zietz

Now that you've completed exam one, we will start on our next module that includes chapters nine and ten. These chapters involve some of the legal ramifications of insurance policy contract. I want to start a small deal by asking you a question posted in the discussion forum: can you think of a situation in which someone made a profit by having an insurance claim?
I expect that several of you will know of situations in which someone was better off after their loss was paid than they were before the loss occurred. You may think that it is just a careless claims adjuster or a very devious insert that would lead to this type of outcome, but that is not always the case.
Many insurance policies or what is called contract of indemnity. The contract of indemnity is one in which you should only be reimbursed up to the value of your loss. That mean she should not have the opportunity to make a profit on the loss. We say that property insurance policies are contracts of indemnity. If your car has been damaged, an appraisal or estimate of the car is made, and the insurance company pays that value to repair it. What if you have an accident in a fairly new car? Perhaps it had a sticker price of $20,000, but you bought it six months ago. Maybe you still owe somewhere in this $20,000 to the bank for that car. If it is a total loss, you will likely not receive the $20,000 because that was not the actual value of the car when the loss occurred. Obviously you understand how cars depreciate as soon as they are driven off the lot. And also I'm sure you've heard some recent advertisements on TV about getting the full value of your car back. That is in a typical situation. Generally property, especially personal property like a car, is valued at the time the loss occurs. On the other hand, there are policies that are not contracts of indemnity that do not value the amount of a loss when the loss occurs. For example a life insurance policy is not a contract on indemnity. When someone dies and it's a covert death, the face amount is generally tight. The claims department at the insurance company does not try to measure or appraise the value of the deceased person’s life. The face amount of the coverage will be paid.
You will find in this chapter discussion on methods of indemnity that measure the loss at its value when the loss occurs. You will see some exceptions to the principle of indemnity, such as the life insurance policy. Is it wrong to possibly over indemnify someone in the insurance policy? That is only allowed if you know there is a limited opportunity for the insured to commit every selection. If a policy has a loophole that allows insureds an incentive to make a profit from a loss, then clearly that insured has a higher probability of having a claim then the random person in the pool. If this possibility is alleviated, there should be no real reason to devalue a claim when there is no possible adverse selection.
There are several more very important terms discussed in this chapter, including the principle of insurable interest, the principle of subrogation, and the principal of most good faith. Overall several requirements must be met for insurance policy to be legal and successful. These are very important topics.
Continuing through chapter 10, we get a closer look at the insurance contract. It's important to understand that there are different sections of the insurance contract and one section may supersede the other in a legal situation involving whether a loss is covered.
You can remember the parts of the policy if you can remember the acronym D I C E. That stands for: declarations, insuring agreement, conditions, and exclusions.
You will notice that the first part of an insurance policy is called the declarations part of the contract. That establishes what the policy intends to do. Usually this is on the first page of the policy.
The second part is the insurance agreement. This is the part that may name the coverage is specifically the parents or may just say all barrels are covered unless otherwise excluded. That's the difference between a named peril policy and an open perils policy.
The third part is called the conditions of the policy. This section lays the basic ground rules for the coverage. This is generally the area that addresses how to prevent someone from making a profit on having a loss. For example, the subrogation clause says that for some coverages you may either collect from your insurance company directly or from the negligent third-party, but not both. So if you do collect from your insurance company when another third-party was responsible for the loss. Then that third-party needs to reimburse your insurance company. That is called subrogation.
Another condition is called coinsurance. You probably heard of this involving your health insurance, but the purpose of the coinsurance clause and health-insurance is vastly different from the purpose of coinsurance and a property policy. Coinsurance is designed to make sure you pay your fair center of the cost into that big pot of funds. If you examine insurance claims, especially on a house let's say, you'll see that most losses are small losses. In fact, how many people do you know who have had a total loss to their home? You may know one or two, but you know far more people who have had smaller losses, such as hail damage on the roof, water damage in the house, or may be a small kitchen fire. If you are astute and realize that most of your losses will be small, let's say generally less than 10% of the houses value, then why not just buy 10% of the house’s value in insurance? If you just purchased 10% of your houses value in insurance, there's a good chance that most of your losses would be paid. Think of how much insurance premium you would save thing under insured? Obviously this would have to be okay with your mortgage provider if you have one on your house. But if the insurance company let people be underinsured then the pot of money is not enough to cover all of the losses. In determining how much everyone should pay, the actuary realizes that most losses are small losses and the cost for the higher amounts of insurance coverage really is not as expensive as for the lower amounts of coverage. So ultimately the contract has a condition called coinsurance that you need to keep at least a certain percentage of your property’s value in insurance, often 80%, such as in a homeowner’s policy. If you have a loss and are found to have less then that percentage of the houses value insured, then only a prorated part of your loss will be paid. Exhibit 10.2 illustrates this very important point.
Carefully read through the other conditions and provisions that are in typical policies. Most of these are self-explanatory, and ultimately they help to enforce the rules we have of not allowing someone to make a profit off of having insurance.
Why don't you examine your own automobile or homeowners policy and look for some of these conditions and exclusions?