Chapter 2: Backdrop to Insurance and Insurance Law May 3 , 2012.
- Since insurance policies are contracts,theyfallunder contract law and wewilllookatthe elementsof
- Tort law appliesto private individualsfor wrongsdonetothembyother peopleand itaffects
insurance companies asmany potentialwrongscan becovered byan insurance contract (thisleadsto
Insurance: A Brief History:
- The medievalera saw the establishment of guilds: groupsofindividuals withcommon goals
- Merchant Guilds: those involved in long-distance commerce and localwholesaletrade
- Craft Guilds: were those in particulartrades,suchasbakers,brewers,and butchers
- Guilds of manufacturers: those whomadedurablegoods,suchastextiles,militaryequipment,and
metal ware, andthese were guildswhosold skills and servicessuchasclerks,teamsters,and
- With these poolsof groups,reimbursement duetolossescame fromapooltowhichallmembers
- First actualinsurance policy wassigned inGenoa,Italy,in2347
o Underwriter: individualssigned their namesand,under thename,theamount ofrisk they
were willing to assume
o Mortality Tables:tables that showdeathrate byageusingstatisticallaws ofmortality and the
principle of compound interest
- The first stock insurancecompanies,insurance companieswithshareholders,wereset upinEngland
in 1720and in the USin 1735
- Reserves: fundsset aside for a specialpurpose tomeet unexpectedlyhighlosses
- Reinsurance:more than one insurance companycoveringapolicytospread therisk amongseveral
- The first stock insurancecompany forCanadawasset upinOntariocalledTheCanadaLifeAssurance
- The WorkersCompensation Act of 1897Britainrequired employerstoinsuretheir employeesagainst
accidents at work whichlead to different typesofinsurances(ex:travelinsurance)
Basic Characteristicsof Insurance:
1. Pooling or sharing of losses.
Pooling iscombining onesrisk exposurewithotherswhohavesimilar riskstodistributethe
risk among the group.Thispresupposesthatfuturelossesofthegroupcan bepredicted with
some degree of accuracy.
2. Losses must be fortuitous.
The losses must be accidental,notdeliberate.
3. Transfer of pure risks.
Only pure risk istransferred fromtheinsured totheinsurer.
4. Indemnification of losses.
Insurersagree to indemnify insuredsfor losses.
To indemnify meansto restore alossinwholeor inpart by payment,repair,orreplacement
without the insured making a profitfromtheloss.
The remedy of rescission(fromrescinding toannual,repeal,cancel)meanstheinsurance
willput the injured partyback intotheposition theinsurance would havebeen in hadthere
been no loss. Benefitsand Costs to Society
o Indemnification for loss. Theinsured doesnothavetobear thefinancialconsequencesfor
major insurable losses.
o Less worry and fear. Because peopleareinsured,theydonot havetoworry about and prepare
for major losses.
o Source of investment funds. Insurance companieshavelargereservesoffundstopayout
future losses.These fundsare major source ofinvestment fundsfor theinvestment
o Loss prevention. Insurance companies playan activerolein developingprogramsto minimize
losses.These programsincludefireprevention,preventingtheft and arson,and reducingwork-
o Enhancement of credit. Becausepeoplehaveinsurancecoveragefor majorlossexposures,
they can more easily obtain credit.In fact,ahomeowner cannotget aresidentialmortgage
from a financial institution without showingproofofinsurance coverage.
o Cost of doing business. Insurancepremiumsincreasecostsfortheinsured.In addition tothe
pure premium,the premiumshavetocover thecostsofinsurance operationsand profits.On
the other hand,insurance companiesalsoprovidejobstothousandsofemployees.
o Fraudulent and Inflated Claims. Claimsfor lossesnotactuallyincurred increasesthecost to
everyone whopaysinsurance premiums.Inflatedclaimsshowupasmalingeringafter an illness
while collecting disability,claimingfor lossesafter afireor break-inthatdidnotactually
happen,and asadditional legalcostsresultingfromlawsuitsthataremadebecausethe
plaintiff knowsthe defendant isinsured.
Insurable Risk:The basic requirements of an insurable risk areasfollows:
1. Large number of exposure units. Therehavetoenoughinsuredstobeable tohavealargeenough
poolof subscribersto spread therisk amongthem.
2. Accidental and unintentional loss. Thelosses havetobefortuitous,thatis,theycant havehappened
deliberately.(Thisiswhy self-employed peopleinCanadadonot payemployment insurance
premiums-self-employed people are theonlyoneswhocould lay themselvesoff,either outrightor
throughbeing unable tofind enoughwork)
3. Determinable and measureable loss. Ifthesize ofthelosscannotbepredicted,thereisabasisfor
determining the appropriate premium.
4. No catastrophic loss. Private companiescannotinsurecatastrophiclosses.
5. Calculable chance of loss. The insurer mustbeabletocalculate thechance ofloss.
6. Economically feasible premium. Thepremiumhastobeaffordable
Principlesof Insurance: 5 basic principlesthatarereflected inallinsurancecontracts:
1. Principle of Indemnity: statesthat theinsured should notprofitfromthecovered loss but should be
restoredto approximately the same financialposition thatexisted prior totheloss.Therearesome
a) In a valued policy,the insured and insurer agreeonthevalue ofsomething,likeapieceof
jewelry or a painting,and thatistheamount thatispaidifitislost ordamaged.
b) Replacement cost insurance onahomeand contentswillreplace thelost ordamaged item
with a new one, not one that reflectsthedepreciated orused value.
c) Life insurance policies pay theface value,whichisbased ontheamount purchased at the
inception of the policy. While wecan calculate thepresent value ofanindividualsexpected
future earnings,there isno waytocalculate theintrinsicvalue ofahuman life. - A person can buy as much life insurance asheor sheisprepared topayfor.
2. Insurable Interest: the insured must havesomekind offinancialinvestment inwhatever or whoever is
insured.The person who takes out thepolicymustlosefinanciallyifaloss occurs,ormust incur some
other kind of harm if thelosstakes place. Thisrequirement existsforseveralreasons:
a) To prevent gambling. Without this, someonemightthink youareaterribledriver ofyour very
expensive car and be willing tobet thecost ofafewyearscar insurance premiumsthatyouwill
have a serious accident.
b) To reduce moral hazard. Without this, someone might first takeout an insurance policyon
your life and then murder you tocollect the proceeds.
c) Must be able to measure the loss. Theinsurance company hastoknowthatthereisalimiton
what it might have to pay out for anygiven lossexposure.Otherwise,ifsomeone isapoor
driver,each person in a group offriendscould takeout acar insurance policyonthecar and just
sit back and wait to collect.
- In property insurancethe insurable interesthastoexist atthetimeoftheloss whilein life insurance,
it must exist at the timethe policy istaken out,notat thedate ofdeath.
3. Reasonable Expectations: the insured isentitled tothecoverageheorshereasonableexpectsthe
policy to provide,and,to be effective,exclusions,or qualificationsmust be conspicuous,plain,and
4. Subrogation: the insurer (the second party totheinsurance contract)willpaytheinsured (the first
party) for a losscaused by a third party andthe insurer isentitled torecover thelossfromanegligent
third party (the third party isnegligent bydefinitionbyvirtueofhavingcaused theloss).Thegoal of
a) Preventthe insured collectingtwice-once fromtheinsurance companyand once fromthe
negligent third party
b) Hold the guilty person responsiblefortheloss
c) Hold down insurancerates-iftheinsurance companywhopaysfor thelosscan recover some
its cost from a third party,it doesnothavetoreflect thisamount initspremiums
- There are 5 corollariesto thisprinciple:
1. The insurer can recoveronly the amount paid out,notmore.
2. The insured cannot impair the insurersrightsby,for instance,makingadealwiththethird party.
3. The insurer can waive itsrightstorecover-itisnotobligated torecover itsloss.
4. Thisprinciple doesnot apply to lifeinsurance and most individualhealthinsurance contracts.
5. The insurer cannot subrogate itsown insureds-itcannotpayaninsuredslossesand then goafter
the same insuredto re