Principles of Insurance, Core Functions of an Insurance Company CM20430 Principles of InsuranceTeam B
Agenda • 5 Questions • 12 MC questions • Q&A
#1 What are the six essential principles of insurance?
Indemnity • Insurable Interest • Utmost Good Faith • Proximate Cause • Contribution • Subrogation
The essentials of insurable interest • must be the subject matter of the insurance • There must be life or limb, property, potential liability, right or financial interest capable of being covered • The insured must be in a legally recognized relationship with the subject matter of the insurance, whereby he benefits from its continued safety or the absence of liability and is prejudiced by its damage or destruction, or the creation of liability • Insurable Interest
Utmost Good Faith • Each party to a proposed contract is legally obliged to reveal to the other all vital information which would influence the other’s judgment, whether such information is requested or not • It has been said the utmost good faith requires each party to tell the other “the truth” • the whole truth and nothing but the “truth” about the proposed contract. It is important to note that, unlike the situation in the law courts, such an obligation is not applicable merely to any questions asked. • Failure to reveal vital information, even if not asked about it, gives the aggrieved party the right to regard the contract is void
Indemnity • Indemnity may be defined as an exact financial compensation. • Indemnity restores the insured to the same financial position after a loss as he/she enjoyed immediately prior to the loss. • This is in accord with the basic concept of finance , which is to compensate the unfortunate for the loss they have sustained, but which is not intended to provide profit from misfortune
Indemnity • Indemnity cannot apply to every class of business. • With virtually all life and personal accident contracts it is impossible to provide an exact financial compensation in respect of claims, because life, limbs and health cannot be precisely measured in financial terms. • Life and personal accident contracts are therefore termed benefit policies, in the sense that they cannot indemnify, but only pay a certain benefit if the insured event happens.
The active, efficient cause that sets in motion a train of events which bring about a result, without the intervention of any force started and working actively from a new and independent source • The dominant, effective cause must be singled out as one which produced the result • The insurers is not liable for any loss unless the proximate cause was an peril • Cause of loss • Must be reasonable • Established before insurers are considered liable • Proximate Cause
Contribution is the doctrine which enables an insurer to call upon other insurers similarly (but not necessarily equally) liable o the same insured to share the cost of an indemnity payment. • It arises where there is an “overlap” of insurances, so that an insured is covered more than once in respect of the same loss. • Subrogation is concerned with the rights of recovery against third parties or elsewhere in respect of payment of an indemnity • need not involve any other insurance, although it frequently does. • Contribution necessarily involves more than one insurance, each covering the interest of the same insured. Contribution
Subrogation means the exercise, for one’s own benefit, of rights or remedies possessed by another against third parties. • If the rights or remedies have already been exercised, subrogation entitles one to the proceeds there-from. • Subrogation rights are acquired by insurers once they have provided their insured with an indemnity • Common law • any actions to recover from third parties must be conducted in the name of the insured. Subrogation
#2 Distinguish between void, voidable and unenforceable contracts.
Void Contract • Entirely without legal effect. e.g. Breach of Utmost Good Faith: Premiums Insurer Insured Claims Returnable
Voidable Contract • TemporarySituation • may treat as voidby the aggrieved party in certain time. • E.g. Non- disclosure the related medical history when proposing a critical illness policy. Usually happen… At proposal stage, important information was omittedor wrongly given
Voidable Contract Remedies: • premium • sum insured • Impose excepted peril • Reject the proposal • Void and refund
Unenforceable Contract • It is not because it is void • It require some action to become enforceable Unenforceable Contract required action Valid Contract stamp duty not paid on a lease of land Marine insurance policy not issued
#3 When must insurable interest exist in marine, life, fire and accident insurance?
Definition • Insurable interest is a person’s legally recognized relationship to the subject matter of insurance • Gives them the right to effect insurance on it • The relationship must be a legal one • E.g. a thief in possession of stolen goods does not have the right to insure them
Condition of existence For marine, • Marine Insurance Act 1906 • Insurable interest is only needed at the time of loss • Need not exist when the insurance is effected
Condition of existence For life insurance, • Life Assurance Act 1774 • only needed at policy inception
Condition of existence For fire and accident insurance, • Exist when the insurance contract was effected • Need not exist at the time of loss
#4 Why does utmost good faith apply in insurance?
#4.1What is Utmost Good Faith? • It means all parties to an insurance contract must disclose all material facts no matter it asked by the other party or not. Any fact which would influence the judgment of an insurer in fixing the premium or determining whether to accept the risk is a material fact.
Originally • Insurance Contracts Act 1984 • the Act states ‘a contract of insurance is based on the utmost good faith and there is implied in such a contract a provision requiring each party to it to act towards the other party, in respect of any matter arising under or in relation to it, with the utmost good faith.’ • the duty of utmost good faith was a common law concept which applied directly to contracts of insurance.
#4.2How does “Non disclosure” or “Misrepresentation” affect insurance? • Insurance is sharing of risk by creating a pool of funds out of the premium paid by the policyholders. • This means that when a claim arises, the payout takes place from the common fund which belongs to all the policyholders. Therefore, an Insurer has a duty to protect the interests of the policyholders at large and cannot pay fraudulent(dishonest) claims out of the common fund thereby penalizing the other policyholders. • Based on this principle, claim can be repudiated by the insurer on account of non disclosure or misrepresentation. In legal terms, if one party commits breach of contract by not maintaining the declaration (in the proposal form) of having replied truly and correctly, the insurer is not liable to honor the claim.
#4.3Ensure the insurer and proposer’s interest • e.g. An individual contracting a life insurance policy should hold as guiding principle the doctrine of utmost good faith. • means that the individual will not withhold information pertaining to his/her present and past medical conditions. • And because this doctrine works both ways, it also requires the insurers that when they sell the life insurance, they need to inform the buyer of aspects of the insurance itself and also to explain every detail so that someone purchasing a life insurance knows exactly what he/she is buying and what to expect.
#5 Differentiate between the subject matter of the insuranceand the subject matter of the contract
Subject matter of insurance • It stand for some elements of special contract relating to insurance, which • Insurance company promise to insure and bear the risk of the life assured • Cover the financial loss of the life assured • It involves, • Person (Life / Endowment policy) • Property • Liability • Legal rights
Subject matter of the contract • It stand for the goals of the life assured • Elements and requirements of the insurance policy • It involves, • Insurable interest • Utmost good faith • Indemnity • Subrogation
Example James purchased a insurance policy from the Manulife in order to protect his house. He could claim from the Manulife when any contingencies occurs against his house, such as fire. • Purchasing insurance policy to due with unforeseen contingency insurable interest subject matter of contract • Property (HOUSE) subject matter of insurance
1 • Spouse,Child or Ward <18 • Agent, Principal’s property • Third Party Property Damage, not named insured • Debtor’s life • Which of the following statements is correct? • insurable interest is not possible in the life of another; • bailees have an insurable interest in the property of their bailors; • liability policies can only cover the named insured; • a creditor cannot insure the life of his debtor. IIQE Study Notes 1, 3.1.3, 3.1.4
2 subject matter of insurance is… • legally recognized • Not legally recognized • Illegal • Illegal • With which of the following is there a valid insurable interest? • a man wishes to insure his wife; • a man wishes to insure his brother; • a company wishes to insure counterfeit computer software; • smugglers wish to insure goods against seizure by customs. IIQE Study Notes 1, 3.1.3, 3.1.4
3 • It is duty to each party to reveal vital information to the other party when • Policy application • Policy is in effect • Contract alterations / Risk changes • Contract renewal • Until termination • The duty of utmost good faith applies: • to both the proposer and the insurer; • only to the proposer; • only to the insurer; • only in the first year of the insurance policy. IIQE Study Notes 1, 3.2.2
4 • It is also think to be important to insurer • • It should be disclosure even it is not asked • All kinds of insurance Every circumstance which would influence the judgment of a prudent insurer in fixing the premium, or determining whether he will accept the risk A material fact is one: that the reasonable policyholder would think to be important; which would influence the mind of a prudent underwriter; only has to be disclosed if a specific question is asked; which will only affect property insurance. IIQE Study Notes 1, 3.2.3
5 • Non-material facts • Material facts • Non-material facts • Non-material facts, deemed to be known to insurer Which of the following facts must be disclosed? matters of common knowledge; facts which increase the risk beyond normal; facts which decrease the risk below normal; matters covered by a policy warranty. IIQE Study Notes 1, 3.2.3
6 • It is linked with insurable interest • X, average under-insurance • X, life insurance • Financial compensation must be exact Indemnity is a principle that: is unrelated to insurable interest; promises to pay the sum insured with all total losses; settles partial losses on a proportional basis; seeks to give an exact financial compensation IIQE Study Notes 1, 3.4
7 A policy franchise: will pay larger claims in full; will deduct the stated amount from every claim; is exactly the same as a policy excess; is another name for a policy deductible. IIQE Study Notes 1, 3.4.7
8 • • X • X, subrogation arising after abandonment allow insurer to make profit (after sufficient compensation to insured.) • X,subrogationcan only apply if indemnityapplies The principle of subrogation: is a corollary of the principle of indemnity; is unconnected with the principle of indemnity; allows the insured to recover more than he has lost; can apply to all insurance claims. IIQE Study Notes 1, 3.6
9 • ,it apply only when indemnity applies • X • each must be providing an indemnity, cover the same interest, peril, subject matter of insurance and loss • Related to Double insurance The principle of contribution: is a corollary of the principle of indemnity; has no relationship with the principle of indemnity; is where the insured and a third party policy each cover a loss; relates to situations involving under-insurance. IIQE Study Notes 1, 3.5.1,3e
10 • It is decided by insurer • utmost good faith determines that • The proximate cause of a loss is its effective or dominant cause. • X The doctrine of proximate cause: determines whether a particular risk is insurable; determines whether or not the insured has committed fraud; is trying to find out the primary cause of a loss; is trying to discover the final cause of a loss. IIQE Study Notes 1, 3.3
11 • • X, not related to the loss in time • X, there can be direct bearing • X, It can or can arise from excepted peril but may not insured. The proximate cause for a given loss: is not necessarily the cause immediately before the loss arises; is always the cause nearest the loss in time; may only have an indirect bearing upon the loss; must not arise from an excepted peril.
12 • Subrogation can not apply in life insurance and personal accident insurance • X, • , there is an indemnity • X In a car accident case, the third person’s carelessness caused the incident. In this situation, which type of insurance is subrogation used? life insurance; personal accident insurance; car insurance; all of the above.
References • http://goo.gl/mtAc • http://goo.gl/qC8W • http://goo.gl/LFri • IIQE study notes 1 principle of insurance, 2004.