insurance chapter 1

insuring of risks that are more prone to losses than the average risk

a legal representative of an insurance company; the classification of producer usually includes agents and brokers; agents are the agents of the insurer

a person applying for insurance

a person who receives the benefits of an insurance policy

an insurance producer not appointed by an insurer and is deemed to represent the client

main principle of insurance, meaning that the insured cannot recover more than their loss; the purpose of insurance is to restore the insured to the same position as before the loss

a contract between a policyowner (and/or insured) and an insurance company which agrees to pay the insured or the beneficiary for loss caused by specific events

the person covered by the insurance policy. This person may or may not be the policyowner

the company who issues an insurance policy

the term, as it applies to insurance contracts, includes an individual or an insurer, association, organization, society, partnership, business trust, corporation, or another entity

the person entitled to exercise the rights and privileges in the policy

the money paid to the insurance company for the insurance policy

is the uncertainty or chance of a loss occurring. The two types of risks are pure and speculative, only one of which is insurable.

refers to situations that can only result in a loss or no change. There is no opportunity for financial gain. Pure risk is the only type of risk that insurance companies are willing to accept.

involves the opportunity for either loss or gain. An example of speculative risk is gambling. These types of risks are not insurable.

are conditions or situations that increase the probability of an insured loss occurring. Hazards are classified as physical hazards, moral hazards, or morale hazards. Conditions such as lifestyle and existing health, or activities such as scuba diving, are hazards and may increase the chance of a loss occurring.

are individual characteristics that increase the chances of the cause of loss. Physical hazards exist because of a physical condition, past medical history, or a condition at birth, such as blindness.

are tendencies towards increased risk. Moral hazards involve evaluating the character and reputation of the proposed insured. Moral hazards refer to those applicants who may lie on an application for insurance, or in the past, have submitted fraudulent claims against an insurer.

are similar to moral hazards, except that they arise from a state of mind that causes indifference to loss, such as carelessness. Actions taken without a forethought may cause physical injuries.

are the causes of loss insured against in an insurance policy.

is defined as the reduction, decrease, or disappearance of value of the person or property insured in a policy, caused by a named peril. Insurance provides a means to transfer loss.

Sharing is a method of dealing with risk for a group of individual persons or businesses with the same or similar exposure to loss to share the losses that occur within that group. A reciprocal insurance exchange is a formal risk-sharing arrangement.

The most effective way to handle risk is to transfer it so that the loss is borne by another party. Insurance is the most common method of transferring risk from an individual or group to an insurance company. Though the purchasing of insurance will not eliminate the risk of death or illness, it relieves the insured of the financial losses these risks bring.

One of the methods of dealing with risk is avoidance, which means eliminating exposure to a loss. For example, if a person wanted to avoid the risk of dying in an airplane crash, they might choose never to fly in an airplane. Risk avoidance is effective, but seldom practical.

Risk retention is the planned assumption of risk by an insured through the use of deductibles, co-payments, or self-insurance. It is also known as self-insurance when the insured accepts the responsibility for the loss before the insurance company pays. The purpose of retention is

Not all risks are insurable. As noted earlier, insurers will insure only pure risks, or those that involve only the chance of loss with no chance of gain. Furthermore, even pure risks must have certain characteristics in order to be insurable. Insurable risks involve the following characteristics:

A loss that is outside the insured’s control.

A loss that is specific as to the cause, time, place and amount. An insurer must be able to determine how much the benefit will be and when it becomes payable.

Insurers must be able to estimate the average frequency and severity of future losses and set appropriate premium rates. (In life and health insurance, the use of mortality tables and morbidity tables allows the insurer to project losses based on statistics.)

Insurers need to be reasonably certain their losses will not exceed specific limits. That is why insurance policies usually exclude coverage for loss caused by war or nuclear events: There is no statistical data that allows for the development of rates that would be necessary to cover losses from events of this nature.

There must be a sufficiently large pool of the insured that represents a random selection of risks in terms of age, gender, occupation, health and economic status, and geographic location.

are owned by the stockholders who provide the capital necessary to establish and operate the insurance company and who share in any profits or losses. Officers are elected by the stockholders and manage stock insurance companies. Traditionally, stock companies issue nonparticipating policies, in which policyowners do not share in profits or losses.

A nonparticipating (stock) policy does not pay dividends to policyowners; however, taxable dividends are paid to stockholders. The dividends are not guaranteed as they are based on company profit.

are owned by the policyowners and issue participating policies. With participating policies, policyowners are entitled to dividends, which, in the case of mutual companies, are a return of excess premiums and are, therefore, nontaxable. Dividends are generated when the premiums and the earnings combined exceed the actual costs of providing coverage, creating a surplus. Dividends are not guaranteed.

is an organization formed to provide insurance benefits for members of an affiliated lodge, religious organization, or fraternal organization with a representative form of government. Fraternals sell only to their members and are considered charitable institutions, and not insurers. They are not subject to all of the regulations that apply to the insurers that offer coverage to the public at large.

In most states, fraternal benefit societies are permitted to issue life insurance (including endowments), health insurance (including medical and disability), and annuities. They do not issue property or liability policies.

Before insurers may transact business in a specific state, they must apply for and be granted a license or Certificate of Authority from the state department of insurance and meet any financial (capital and surplus) requirements set by the state. Insurers who meet the state's financial requirements and are approved to transact business in the state are considered authorized or admitted into the state as a legal insurer. Those insurers who have not been approved to do business in the state are considered unauthorized or nonadmitted. Most states have laws that prohibit unauthorized insurers from conducting business in the state, except through licensed excess and surplus lines brokers.

A domestic insurer is an insurance company that is incorporated in this state. In most cases, the company's home office is in the state in which it was formed — the company's domicile. For instance, a company chartered in Pennsylvania would be considered a Pennsylvania domestic company.

foreign insurer is an insurance company that is incorporated in another state, the District of Columbia, or a territorial possession. The United States has 5 major U.S. territories: American Samoa, Guam, the Northern Mariana Islands, Puerto Rico, and the U.S. Virgin Islands.

For example, a company chartered in California would be a foreign insurer within the state of New York. A company chartered in Puerto Rico will be foreign in any U.S. state.

An alien insurer is an insurance company that is incorporated outside the United States.

A producer is an individual licensed to sell, solicit, or negotiate insurance contracts on behalf of the principal (insurer). The producer is considered an agent of the insurer. The law of agency defines the relationship between the principal and the producer: the acts of the agent within the scope of authority are deemed to be the acts of the insurer.

Express authority is the authority a principal intends to grant to an agent by means of the agent’s contract. It is the authority that is written in the contract.

Implied authority is authority that is not expressed or written into the contract, but which the agent is assumed to have in order to transact the business of insurance for the principal. Implied authority is incidental to and derives from express authority since not every single detail of an agent’s authority can be spelled out in the written contract.

Apparent authority (also known as perceived authority) is the appearance, or the assumption of authority based on the actions, words, or deeds of the principal or because of circumstances the principal created. For example, if an agent uses insurer's stationery when soliciting coverage, an applicant may believe that the agent is authorized to transact insurance on behalf of the insurer.

Although the agents act for the insurer, they are legally obligated to treat applicants and insureds in an ethical manner. Because an agent handles the funds of the insured and the insurer, the agent has a fiduciary responsibility. A fiduciary is someone in a position of trust. More specifically, it is illegal for insurance producers to commingle premiums collected from the applicants with their own personal funds.

Some of the market conduct regulations include, but are not limited to, the following:

Conflict of interest;
A request of a gift or loan as a condition to complete business; and
Supplying confidential information.

1. Agreement — offer and acceptance;
2. Consideration;
3. Competent parties; and
4. Legal purpose.

There must be a definite offer by one party, and the other party must accept this offer in its exact terms. In insurance, the applicant usually makes the offer when submitting the application. Acceptance takes place when an insurer’s underwriter approves the application and issues a policy.

The binding force in any contract is the consideration. Consideration is something of value that each party gives to the other. The consideration on the part of the insured is the payment of premium and the representations made in the application. The consideration on the part of the insurer is the promise to pay in the event of loss.

The parties to a contract must be capable of entering into a contract in the eyes of the law. Generally, this requires that both parties be of legal age, mentally competent to understand the contract, and not under the influence of drugs or alcohol.

The purpose of the contract must be legal and not against public policy. To ensure legal purpose of a Life Insurance policy, for example, it must have both: insurable interest and consent. A contract without a legal purpose is considered void, and cannot be enforced by any party.

Indemnity (sometimes referred to as reimbursement) is a provision in an insurance policy that states that in the event of loss, an insured or a beneficiary is permitted to collect only to the extent of the financial loss, and is not allowed to gain financially because of the existence of an insurance contract. The purpose of insurance is to restore, but not let an insured or a beneficiary profit from the loss.

It is not always practical or necessary to state every direct and indirect provision or coverage offered by an insurance policy. If an agent implies through advertising, sales literature or statements that these provisions exist, an insured could reasonably expect coverage.

The principle of utmost good faith implies that there will be no fraud, misrepresentation or concealment between the parties. As it pertains to insurance policies, both the insurer and insured must be able to rely on the other for relevant information. The insured is expected to provide accurate information on the application for insurance, and the insurer must clearly and truthfully describe policy features and benefits, and must not conceal or mislead the insured.

Representations are statements believed to be true to the best of one's knowledge, but they are not guaranteed to be true. For insurance purposes, representations are the answers the insured gives to the questions on the insurance application.

Untrue statements on the application are considered misrepresentations and could void the contract. A material misrepresentation is a statement that, if discovered, would alter the underwriting decision of the insurance company. Furthermore, if material misrepresentations are intentional, they are considered fraud.

A warranty is an absolutely true statement upon which the validity of the insurance policy depends. Breach of warranties can be considered grounds for voiding the policy or a return of premium. Because of such a strict definition, statements made by applicants for life and health insurance policies, for example, are usually not considered warranties, except in cases of fraud.

Concealment is the legal term for the intentional withholding of information of a material fact that is crucial in making a decision. In insurance, concealment is the withholding of information by the applicant that will result in an imprecise underwriting decision. Concealment may void a policy.

Fraud is the intentional misrepresentation or intentional concealment of a material fact used to induce another party to make or refrain from making a contract, or to deceive or cheat a party. Fraud is grounds for voiding an insurance contract.