A. the Insurance Contract Is a Valued Policy (Requiring the Insurer to Pay a Fixed Amount)

CHAPTER 37

INSURANCE

Outline

I. Introduction

A.Terminology

The insurer, in exchange for payment of consideration (premium) from the insured agrees to pay for losses caused by specific events (perils) to the beneficiary.

II.Life Insurance Contracts

A. The insurance contract is a valued policy (requiring the insurer to pay a fixed amount).

B.Whole Life Insurance

A whole life policy creates a cash surrender value if the policy is terminated.

C.Term Life Insurance

Term life creates no cash surrender value.

III.Property Insurance Contracts

Property insurance contracts are indemnity contracts.

A.Types of Losses Covered

Insurers usually specify certain covered perils and excluded perils

Example: Nationwide Insurance v. Central Laborers’ Pension Fund: The court found that the loss of the disc was not covered because the insurance policy’s business exclusion applies.

Example: State Farm Mutual Automobile Insurance Company v. Kastner: Kastner was abducted in a parking lot and driven, in her car, to an isolated area where she was robbed and sexually attacked. The court held that her personal injuries were not covered by her automobile insurance policy because, at the time of her injuries, the car was not being used in a manner that she anticipated at the time she procured the insurance policy.

B. Personal Property Insurance

Insurance can also cover personal property--for example, comprehensive and collision sections of automobile policies provide coverage for personal property.

C. Types of Policies

Some property insurance policies are valued policies; most policies are open policies.

D.Special Terms

1.A coinsurance clause may limit the insured's right to recovery.

2.A pro rata clause determines the liability of a particular insurer in proportion to the total amount of insurance covering property.

IV.Liability Insurance Contracts

A.Liability Coverage

Liability insurance policies cover sums for which the insured becomes legally obligated to pay to another person.

1. Personal liability insurance contracts often restrict coverage to bodily injury and property damages;

2. Business liability policies often provide broader coverage.

B.Insurer’s Obligations

Liability insurance providers have a duty to defend the insured, and a duty to pay within the coverage provisions of the policy.

Example: ISBA Mutual Insurance v. Frank M. Greenfield: The court found that the insurance company could not deny coverage to Greenfield. The company’s provision was against public policy.

V.Health Insurance Contracts

A.Coverage

Health insurance contracts provide coverage for medical expenses.

B.Group Policies

Insurance provided by employers or other organizations are generally group insurance.

C.Payment Obligations

The deductible is the amount the insurer must pay before the insurer's payment obligation begins.

D.Affordable Health Care

Congress enacted the Patient Protection and Affordable Care Act in 2010. It requires that every person have a healthcare policy.

VI. Insurance Policies as Contracts

A. Offer and Acceptance

General contract rules of offer and acceptance apply; a binder is an agreement for temporary insurance pending the insurer's decision to accept or reject the risk.

B. Misrepresentation

Misrepresentation by insured or agent may be basis for rescission or damages.

Example: Kutlenios v. Correa: The court found that the insurance company could rescind the policy because, despite the incontestability clause, Kutlenios falsely answered questions to obtain his disability policy.

C. Warranties

Warranties are express terms in the policy that operate as conditions on which insurer liability is based. Most states require life insurance contracts to be in writing. Ambiguities are generally construed against the insurer.

D.Capacity

Most states enforce an insurance policy taken out by a minor.

E.Form and Content

Most states require insurance contracts to be in writing.

F.Interpreting Insurance Contracts

Courts interpret provisions in insurance contracts as they would be understood by an average person.

Example: Terra Nova Insurance v. Fray-Witzer: The court interpreted the insurance contract using plain and ordinary meaning to determine Metropolitan’s liability covered by the policy.

G.Third Parties and Insurance Contracts

Life insurance policies are assignable because the identity of the insured remains unchanged; fire insurance policies are generally not assignable.

VII.Insurable Interest

A person must have an insurable interest in the life or property being insured.

Example: Mayo v. Hartfield Life Insurance Company: Walmart purchased life insurance policies on all of its employees, naming itself as beneficiary. The court held that Walmart did not have an insurable interest in the lives of its employees; therefore it could not purchase insurance on its employees.

VIII. Notice and Proof of Loss

Notice and proof of loss are required to recover benefits under an insurance policy. Under the right of subrogation, an insurer obtains all of the insurer's rights to pursue legal remedies against a third party who may have caused the loss.

IX.Cancellation and Lapse

Cancellation or lapse of the policy will terminate the policy.

Learning Objectives

1.You should understand the contractual rules governing the creation of the insurance relationship.

2.You should be able to explain how courts assess the liability of insurers.

3.You should understand when and how an insurer may cancel an insurance policy.

4.You should know the basic differences between whole life and term insurance policies, and should become aware of the advantages and disadvantages of each type of policy.

5.You should understand what an indemnity contract is.

6.You should become familiar with the types of fire insurance policies and should know the differences among them.

7.You should understand what a coinsurance clause is and how it may be applied.

8.You should understand how a pro rata clause in a fire insurance policy may operate when the insured has in force more than one insurance policy that would apply to a loss.

9.You should be aware of what constitutes acceptance in the context of an insurance contract, and should comprehend why courts might construe insurance contracts in ways other than was specifically intended by the insurer.

10.You should understand how courts will handle misrepresentations by the insured, and should be able to distinguish between representations and warranties.

11.You should be aware of the insurance contracts that can be assigned to a third party, as well as why those contracts are assignable and why others are not assignable.

12.You should understand what constitutes an insurable interest and should know why the insurable interest is a necessary element of an insurance contract.

Learning Hints

1.An insurance policy is essentially a contract between the company and the insured. As such, common law rules of contract law, such as offer and acceptance, and rules of contract interpretation apply. However, many states have adopted statutes regulating insurance contracts, and these may override common law rules.

2.A life insurance contract differs from a fire or casualty insurance policy in that the insurer is bound to pay a certain sum when the death of the insured occurs. Unlike most fire insurance policies, a life insurance policy is a valued policy with a face value.

3.Most fire insurance policies are open polices, permitting the insured to recover the fair market value of the property at the time it was destroyed, up to the policy limit.

4. It is important to remember that insurance law, like contract law in general, is in a state of flux. Its rules are taking on more and more of an equitable flavor in situations involving one party's possessing superior knowledge or bargaining strength. This is especially the case in most insurance contracts, because the insurer dominates the contracting process.

5.Insurance contracts are of special interest to the courts because of the weak bargaining position of the beneficiary after the insured's death or disability. The courts are aware of the fact that many insureds trust the company's representative as their agent, when in reality what resembles an arm's length transaction may have taken place. Further, some litigation has involved alleged strategies on the part of insurance companies to intentionally refuse payment on meritorious claims. Such strategies assume that the beneficiary will settle for a lesser amount or drop the claim entirely. In cases in which such strategies on the part of the insurer have been proved, the courts have been willing to award punitive damages against the insurer for its bad faith conduct.

6.Note that the law's treatment of misrepresentation by the insured resembles ordinary contract law's treatment of misrepresentation by a party to a contract. However, in some cases the law will not allow the insurer to avoid the contract, despite the misrepresentation. There is a presumption that the insurer would be willing to insure the insured person in most instances; the only question is the amount of the premium. Therefore, instead of rescinding a contract that has been in effect for some time, it is considered more reasonable to reform the agreement in a manner that avoids rewarding the insured for the misrepresentation. To totally invalidate the contract might reward insurance companies that ignore misrepresentations until the time when the benefits are due.

7.The policy of construing ambiguities in insurance contracts against the author (which in most cases will be the insurer) is consistent with the approach generally taken in contract law. It avoids rewarding a party for having confused the other contracting party.

8.The requirement of an insurable interest may be important in protecting against widespread destruction and even murder. The persons who qualify as possessing the interest fit within a group whose members should be less likely to injure the person or property that is the subject of the insurance contract. In a sense, those with an insurable interest merely are being compensated for the loss they have suffered. Persons who do not have an insurable interest might have fewer reservations about doing away with the insured person or about damaging the insured property.

True-False

In the blank provided, put "T" if the statement is True or "F" if the statement is False.

_____1.Term insurance policies build cash value that the insured can recover if she cancels the policy.

_____2.Norma’s house is severely damaged from a flood. Norma’s homeowner’s insurance policy will likely not cover this loss.

_____3.Property insurance contracts are indemnity contracts.

_____4.Under a valued policy, an insured can recover the fair market value of the property at the time it was destroyed, up to the face amount of the policy.

_____5.The insurance relationship is basically contractual in nature.

_____6.Health insurance policies typically do not cover pre-existing health conditions.

_____7.A fire that begins as a friendly fire may become a hostile fire, for purposes of determining whether a loss is covered by a fire insurance policy.

_____8.A typical misstatement of age clause will operate to invalidate the policy if the insured misrepresented his or her age in the application for insurance.

_____9.Chip and Sue Lay bought a new car for $25,000. The Lays borrowed $20,000 from 2nd Bank. The bank has an insurable interest in the Lay’s automobile and it can require the Lays to purchase insurance that adequately covers the vehicle.

_____10.Without an insurable interest on the part of the purchaser, an insurance contract would be an illegal wagering contract.

Multiple Choice

Circle the best answer.

1.Liability insurance policies:

a.Furnish coverage for the insured's intentional torts.

b.Usually do not cover an insured's negligent action or omission.

c.Typically do not require the insurer to defend the insured against liability claims.

d.Usually do not cover punitive damages assessed against the insured.

2.Which of the following statements concerning life insurance is not true?

a.Bob’s life insurance coverage lapses when he fails to pay his premiums.

b.Bob may have a grace period that gives him about 30 days to pay his past due premium so that his policy will not lapse.

c.Bob’s policy may contain a reinstatement clause that allows him to pay all past-due premiums and reinstate his coverage.

d.If Bob allows his cash value policy to lapse, he loses his rights in the cash value.

3.If a fire occurs following submission of the application for fire insurance but prior to delivery of the policy, what result and why?

a.There is no effective policy because there was no insurable interest.

b.There is no effective policy because there was no acceptance of the offer until delivery of the policy to the insured.

c.There is an effective policy because a binder is an agreement for temporary insurance pending the insurer's decision to accept or reject the risk.

d.There is an effective policy because submission of the application to the agent generally constitutes acceptance in insurance cases.

4.Ken’s car is a total loss after he was hit by a juvenile delinquent who had stolen a car from a dealer. Since the juvenile was driving a stolen car, his parents’ car insurance would not cover Ken’s loss. Ken’s collision insurance policy covers his loss. The insurance company then sues the juvenile and his parents to recover the amount paid to Ken. The insurance company is exercising its right of:

a.Reimbursement.

b.Cancellation.

c.Subrogation.

d.Collection.

5.Which of the following statements regarding insurable interest is not correct?

a.Jim, Jane, and John are partners in a business. The partners most likely have an insurable interest in each other’s lives.

b.When a person who purchases an insurance policy does not have an insurable interest in the property or person insured, this is an illegal wagering contract.

c.An insurable interest in life insurance contracts must exist at the time the loss occurs.

d.An insurable interest in property must exist at the time the loss occurs.

6.Which of the following statements is not true concerning insurance?

a.Courts will likely interpret ambiguities in insurance contracts against the insured.

b.Life insurance contracts can generally be assigned.

c.Dad buys a life insurance policy on young Daughter. This policy is not voidable even though Daughter is a minor.

d.Statements made by Applicant on his life insurance policy application are treated as representations and not as warranties.

7.Smith’s house has a fair market value of $100,000. Smith insures it for $60,000. Lightening causes a fire at Smith’s home that does $30,000 of damage. Which of the following statements is true?

a.Smith’s $30,000 loss is totally covered by his insurance policy.

b.The insurance company will reimburse Smith $22,500 for the fire loss.

c.Since Smith did not meet coinsurance requirements of insuring his house for 80% of the fair market value, Smith’s loss is not covered at all by insurance.

d.The insurance company will pay Smith $60,000 for his fire loss.

8.In the question above, suppose Smith had his home insured for $80,000. How much would the insurance company pay Smith if the fire caused a total loss?

a.Since Smith meets the coinsurance requirement of 80%, the loss is fully covered by the insurance company.

b.The insurance company would reimburse Smith for $80,000, the amount of coverage on the house.

c.Since Smith did not carry insurance for the full market value of the house, the loss is not covered at all.

d.The insurance company will pay Smith $22,500 for the loss.

9.Which of the following statements concerning insurance is not true?

a.Most people have health insurance through group policies.

b.Insurance companies have a duty to pay an insured’s liability claim to a third party.

c.Generally, an insurer’s delay in accepting a property insurance application constitutes an acceptance of the application.

d.Insurance companies have a duty to defend an insured against legal claims filed by a third party.

10.At the time she purchased her home, Gabrielle purchased (from Heartless Insurance Co.) a fire insurance policy covering the home. The policy was a valued policy with a face amount of $113,000 – the amount Gabrielle had paid for the property. Two years after the policy went into effect, the home was totally destroyed by fire. At the time of the fire, Gabrielle's home had a fair market value of $99,000 because of declining property values in the area where it was located. On these facts, how much must Heartless pay Gabrielle?

a.$99,000.

b.$99,000 plus interest at the legal rate.

c.$113,000.

d.$106,000.

Short Essay

1. Tina is a youthful looking 30-year-old woman. Tina applies for a $100,000 life insurance policy and states her age as 21. The insurance company issues a policy. Tina’s premium would have purchased $75,000 of coverage for a 30-year-old. Tina dies 50 years after purchasing the policy. How much will the insurance company pay to Tina’s beneficiary at the time of Tina’s death?