Chapter 2

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CHAPTER 2
THE APPLICATION OF
INSURANCE PRINCIPLES
Dr Zairol Azhar Auzzir
INSURANCE PRINCIPLES
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 Utmost good faith

 Insurable interest
 Indemnity
 Subrogation
 Contribution
 Arbitration
 Proximate cause
PRINCIPAL OF UTMOST GOOD
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FAITH
 A higher degree of honesty is imposed on both parties to an
insurance contract than is imposed on parties to other
contracts
 Commercial contract- the doctrine of Caveat de emptor (let
the buyer beware)
 Insurance contract – a duty of Uberrima Fides or Utmost
Good faith (on both insurer and insured)
 Insurers are required
 Not to accept an insurance which they know is unenforceable at law
 To issue the policy in unambiguous terms
 To make no untrue statement in the negotiations with the proposer.
Supported by three legal doctrines:
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 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
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 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
PRINCIPAL OF INSURABLE
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INTEREST
 The insured must stand to lose financially if a loss
occurs
 Relationship to the subject matter, recognised by
law, by reason of which he will benefit by its
continued safety or be prejudiced by its loss.
Principle of Insurable Interest
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 Must demonstrate a ‘loss’ to collect

 Would be gambling or intentional loss if an
insured could collect with no personal loss
 Insurance is a ‘personal’ contract
 Follows the person - not the property
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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
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 What constitutes insurable interest?

 Ownership
 Leases (in some cases)
 Secured creditors (not general creditors)
 Legal liability
 Care, custody, and control
 Life insurance - exists for person voluntarily
insuring ones own life - others must have insurable
interest
PRINCIPAL OF INDEMNITY
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 The insurer agrees to pay no more than the actual

amount of the loss
 Compensation for a loss sustained.
 Purpose:
 To prevent the insured from profiting from a loss
 To reduce moral hazard
 All contracts of property are contract of indemnity
but not life assurances.
Principle of Indemnity
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 Principle of insurable interest determines if a loss
is suffered; the principle of indemnity places a
limit on the amount of the loss.
 A person may not collect more than the actual
loss sustained - cannot make a profit

 The best that one can hope for is to be placed in
the same financial position after the loss

compared to before
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 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
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 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
PRINCIPAL OF SUBROGATION
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 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.
 The right of the insurer who has granted an
indemnity to receive, after payment of a loss, the
advantage of every right of the insured, arising
previously or in the future, including rights in
contract or in tort, which may diminish the insured’s
loss.
Principle of Subrogation
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 Implied in all contract of indemnity.
 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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 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
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If insurance did not exist
injury
Negligent
Injured
suit party
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One who indemnifies another’s loss is entitled to

recovery from any liable third parties
Negligent
Injured party causes
insured injury
Insurer Insurer subrogates

pays against negligent party
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Example
Insured has
$10,000 loss and injury Negligent Party
recovers $7,000 pays $5,000
from insurer
Insurer pays subrogates

$8,000 less $1,000 $3,000 to insured
Deductible $2,000 to insurer
CONTRIBUTION
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 The apportionment of liability as between insurers

in the event of double insurance.
 Rule that concerns the distribution of the aggregate
Surplus among the policies in the same proportion
as each respective policy has contributed to the
surplus
How Contribution May Arise
Contribution will apply only where the following
conditions are met:
 Two or more policies of indemnity exist.
 The policies cover a common interest.
 The policies cover a common peril
 The policies cover a common subject matter.
 Each policy must be liable for the loss.

ARBITRATION
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 Alternative to litigation
 If the parties agree, the dispute may be heard by and
adjudicated upon a single arbitrator.
 If they fail to agree on who should act, then it is
provided that each party shall appoint his own
arbitrator, in which event an independent umpire will
also be appointed.
 It is the task of the umpire to deal with any point on
which the two arbitrators fail to agree.
PROXIMATE CAUSE
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 Loss must be caused as the result of a peril covered

by the policy.
 Direct relationship of cause and effect, of which the
cause must be proximate in efficiency though not
necessarily in point of time.
PROXIMATE CAUSE
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 Takes into account that a particular effect may be the

result of a chain of causes in which each cause is a
natural result of the preceding cause, but the chain of
causation may be broken by the intervention of anew
and independent cause.
 Principles of causa proxima non remota spectatur
(it is the immediate and not the remote cause which
is to be considered).
Example
Example 1
 Lightning damaged a building and weakened a wall.
 Shortly afterwards, the wall was blown down by
high winds.
Example 2
 Fire damaged a wall and left it weakened.
 Several days later a gale blew the wall down.

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1

 Utmost good faith

 Representations are statements made by the

 A concealment is intentional failure of the applicant

 Must demonstrate a ‘loss’ to collect

 What constitutes insurable interest?

 The insurer agrees to pay no more than the actual

loss sustained - cannot make a profit

the same financial position after the loss

 In property insurance, indemnification is based on the

 There are some exceptions to the principle of indemnity:

 Substitution of the insurer in place of the insured for

 Implied in all contract of indemnity.

 The insurer is entitled only to the amount it has paid

If insurance did not exist

One who indemnifies another’s loss is entitled to

Insurer Insurer subrogates

Insurer pays subrogates

 The apportionment of liability as between insurers

 The policies cover a common interest.

 The policies cover a common peril

 The policies cover a common subject matter.

 Each policy must be liable for the loss.

 Loss must be caused as the result of a peril covered

 Takes into account that a particular effect may be the

 Shortly afterwards, the wall was blown down by

 Several days later a gale blew the wall down.

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