Exploring Advanced Insurance Contract Fundamentals

The topic of insurance contracts is vast, but it has to be studied carefully. After all, your family's financial security may be the price you pay for lack of conscientiousness. One or two small terms found in a footnote can drastically change your coverage, and you need to understand those terms. In this article we'll explain some additional fundamentals you need to know to understand your insurance contract fully. (To read the basic fundamentals, see Understand Your Insurance Contract.)

The Doctrine of Utmost Good Faith

The doctrine of utmost good faith is a key principle in insurance contracts. This doctrine emphasizes the presence of mutual faith between the insured and the insurer. It doctrine includes:

* Duty of Disclosure: You are legally obliged to reveal all information that would influence the insurer's decision to enter into the insurance contract.

Factors that increase the risks - previous losses and claims under other policies, insurance coverage that has been declined to you in the past, the existence of other insurance contracts, full facts and descriptions regarding the property or the event to be insured - must be disclosed. These facts are called material facts.

Depending on these material facts, your insurer will decide whether to insure you as well as what premium to charge. For instance, in critical illness insurance, your smoking habit is an important material fact for the insurer. As a result, your insurance company may decide to charge a significantly higher premium as a result of your smoking habits.

* Representations and Warranty: In most kinds of insurances, you have to sign a declaration at the end of the application form, which states that the given answers to the questions in the application form and other personal statements and questionnaires are true and complete.

Therefore, when applying for fire insurance, for example, you should make sure that the information that you provide regarding the type of construction of your building or the nature of its use is technically correct.

Depending on their nature, these statements may either be representations or warranties:

A)Representations: These are the written statements made by you on your application form, which represent the proposed risk to the insurance company. For instance, on a life insurance application form, information about your age, details of family history, occupation, etc. are the representations that should be true in every respect.

Breach of representations occurs only when you give false information (for example, your age) in important statements. However, the contract may or may not be void depending on the type of the misrepresentation that occurs. (For more information on life insurance, read Buying Life Insurance: Term Versus Permanent, Long-Term Care Insurance: Who Needs It? and Shifting Life Insurance Ownership.)

B)Warranty: Warranties in insurance contracts are different from those of ordinary commercial contracts. They are imposed by the insurer to ensure that the risk remains the same throughout the policy and does not increase.

For example, in auto insurance, if you lend your car to a friend who doesn't hold a license and that friend is involved in an accident, your insurer may consider it a breach of warranty because it wasn't informed about this alteration. As a result, your claim could be rejected.

Breach of Utmost Good Faith

As we've already mentioned, insurance works on the principle of mutual trust. It is your responsibility to disclose all the relevant facts to your insurer.

Normally, a breach of the principle of utmost good faith arises when you, whether deliberately or accidentally, fail to divulge these important facts. There are two kinds of non-disclosure:

* An innocent non-disclosure relates to failing to supply the information you didn't know about.

* Deliberate non-disclosure means providing incorrect material information intentionally.

For example, suppose that you are unaware that your grandfather died from cancer and, therefore, you did not disclose this material fact in the family history questionnaire when applying for life insurance - this is innocent non-disclosure. However, if you knew about this material fact and purposely held it back from the insurer, you are guilty of fraudulent non-disclosure.

Action Taken by Insurer Against a Breach

When you supply inaccurate information with the intention to deceive, you insurance contract becomes void.

* If this deliberate breach was discovered at the time of the claim, your insurance company will not pay the claim.

* If the insurer considers the breach as innocent but significant to the risk, it may choose to punish you by collecting additional premiums.

* In case of an innocent breach that is irrelevant to the risk, the insurer may decide to ignore the breach as if it had never occurred.

Principle of Waiver and Estoppel

A waiver is voluntary surrender of a known right. Estoppel prevents a person from asserting those rights because he or she has acted in a such a way as to deny interest in preserving those rights.

Presume that you fail to disclose some information in the insurance proposal form. Your insurer doesn't request that information and issues the insurance policy. This is waiver. In the future, when a claim arises, your insurer cannot question the contract on the basis of non-disclosure. This is estoppel. For this reason, your insurer will have to pay the claim.

Endorsements

Endorsements are normally used when the terms of insurance contracts are to be altered. They could also be issued to add specific conditions to the policy.

Deductible

A deductible is the amount you pay in out-of-pocket expenses before your insurer covers the remaining expense. Therefore, if the deductible is $5,000 and the total insured loss comes to $15,000, your insurance company will only pay $10,000. The higher the deductible, the lower the premium and vice versa.

Coinsurance

Coinsurance refers to the sharing of insurance by two or more insurance companies in agreed proportion. For the insurance of a large shopping mall, for example, the risk is very high. Therefore, the insurance company may choose to involve two or more insurers to share the risk.

Coinsurance can also exist between you and your insurance company. This provision is quite popular in medical insurance, in which you and the insurance company decide to share the covered costs in the ratio of 20:80. Therefore, during the claim, your insurer will pay 80% of the covered loss while you shell out the remaining 20%.

Reinsurance

Reinsurance is the insurance bought by an insurance company. Suppose you are a famous rock star and you want your voice to be insured for $ 50 million. Your offer is accepted by Insurance Company A. However, Insurance Company A is unable to retain the entire risk, so it passes part of this risk - let's say $ 40 million - to insurance company B. Should you lose your singing voice, you will receive $50 million from insurer A ($10 million + $40 million) with insurer B contributing the reinsured amount ($40 million) to insurer A. This practice is known as reinsurance.

Generally, reinsurance is practiced to a much greater extent by general insurers than life insurers.

Conclusion

When applying for insurance, you will find a huge range of insurance products available in the market. If you have an insurance advisor, he or she can shop around and make sure that you are getting adequate insurance coverage for you money. Even so, a little understanding about insurance contracts can go a long way in ensuring that your advisor's recommendations are on track.

Furthermore, there may be times when your claim is canceled because you didn't pay attention to certain information requested by your insurance company. In this case, lack of knowledge and carelessness can cost you a lot. Go through your insurer's policy features instead of signing them without delving into the fine print. If you understand what you're reading, you'll be able to ensure that the insurance product that you are signing up for will cover you when you need them most.

Understand Your Insurance Contract

Almost all of us have insurance. When your insurer gives you the policy document, generally, all you do is glance over the decorated words in the policy and pile it up with the other bunch of financial papers on your desk, right? If you spend thousands of dollars each year on insurance, don't you think that you should know all about it? Your insurance advisor is always there for you to help you understand the tricky terms in the insurance forms, but you should also know for yourself what your contract says. In this article, we'll make reading your insurance contract easy. Read on to take a look at the basic principles of insurance contracts and how they are put to use in daily life.

Essentials of a Valid Insurance Contract

* Offer and Acceptance: When applying for insurance, the first thing you do is get the proposal form of a particular insurance company. After filling in the requested details, you send the form to the company (sometimes with a premium check). This is your offer. If the insurance company accepts your offer and agrees to insure you, this is called an acceptance. In some cases, your insurer may agree to accept your offer after making some changes to your proposed terms (for example, charging you a double premium for your chain-smoking habit).

* Consideration: This is the premium or the future premiums that you have pay to your insurance company. For insurers, consideration also refers to the money paid out to you should you file an insurance claim. This means that each party to the contract must provide some value to the relationship.

* Legal Capacity: You need to be legally competent to enter into an agreement with your insurer. If you are a minor or are mentally ill, for example, then you may not be qualified to make contracts. Similarly, insurers are considered to be competent if they are licensed under the prevailing regulations that govern them.

* Legal Purpose: If the purpose of your contract is to encourage illegal activities, it is invalid.

Find the Value in Indemnity contracts

Most insurance contracts are indemnity contracts. Indemnity contracts apply to insurances where the loss suffered can be measured in terms of money.

Principle of Indemnity: This states that insurers pay no more than the actual loss suffered. The purpose of an insurance contract is to leave you in the same financial position you were in immediately prior to the incident leading to an insurance claim. When your old Chevy Cavalier is stolen, you can't expect your insurer to replace it with a brand new Mercedes-Benz. In other words, you will be remunerated according to the total sum you have assured for the car. (To read more on indemnity contracts, see Shopping For Car Insurance and How does the 80% rule for home insurance work?)

Additional Factors

There are some additional factors of your insurance contract that also need to be considered, including under-insurance and excess clauses that create situations in which the full value of an insured asset is not remunerated.

* Under-Insurance: Often, in order to save on premiums, you may insure your house at $80,000 when the total value of the house actually comes to $100,000. At the time of partial loss, your insurer will pay only a proportion of $80,000 while you have to dig into your savings to cover the remaining portion of the loss. This is called under-insurance, and you should try to avoid it as much as possible.

* Excess: To avoid trivial claims, the insurers have introduced provisions like excess. For example, you have auto insurance with the applicable excess of $5,000. Unfortunately, your car had an accident with the loss amounting to $7,000. Your insurer will pay you the $7,000 because the loss has exceeded the specified limit of $5,000. But, if the loss comes to $3,000 then the insurance company will not pay a single penny and you have to bear the loss expenses yourself. In short, the insurers will not entertain claims unless and until your losses exceed a minimum amount set by the insurer.

Not all insurance contracts are indemnity contracts. Life insurance contracts and most personal accident insurance contracts are non-indemnity contracts. You may purchase a life insurance policy of $1 million, but that does not imply that your life's value is equal to this dollar amount. Because you can't calculate your life's net worth and fix a price on it, an indemnity contract does not apply. (For more information on non-indemnity contracts, read Buying Life Insurance: Term Versus Permanent, Long-Term Care Insurance: Who Needs It? and Shifting Life Insurance Ownership.)

Insurable Interest

It is your legal right to insure any type of property or any event that may cause financial loss or create a legal liability to you. This is called insurable interest.

Suppose you are living in your uncle's house, and you apply for homeowners' insurance because you believe that you may inherit the house later. Insurers will decline your offer because you are not the owner of the house and, therefore, you do not stand to suffer financially in the event of a loss.

This example demonstrates that when it comes to insurance, it is not the house, car or machinery that is insured. Rather, it is the monetary interest in that house, car or machinery to which your policy applies.

It is also the principle of insurable interest that allows married couples to take out insurance policies on the lives of their spouses - they may suffer financially if the spouse dies. Insurable interest also exists in some business arrangements, as seen between a creditor and debtor, between business partners or between employers and employees.

Principle of Subrogation

Subrogation allows an insurer to sue a third party that has caused a loss to the insured and pursue all methods of getting back some of the money that it has paid to the insured as a result of the loss.

For example, if you are injured in a road accident that is caused by the reckless driving of another party, you will be compensated by your insurer. However, your insurance company may also sue the reckless driver in an attempt to recover that money.

Doctrine of Utmost Good Faith

All insurance contracts are based on the concept of "uberrima fidei", or the doctrine of utmost good faith. This doctrine emphasizes the presence of mutual faith between the insured and the insurer. In simple terms, while applying for life insurance, it becomes your duty to disclose your past illnesses to the insurer. Likewise, the insurer cannot hide information about the insurance coverage that is being sold.

Doctrine of Adhesion

The doctrine of adhesion states that you must accept the entire insurance contract and all of its terms and conditions without bargaining. Because the insured has no opportunity to change the terms, any ambiguities in the contract will be interpreted in favor of the insured.

Conclusion

When purchasing insurance, most of us rely on our insurance advisor for everything - from choosing a policy for us to filling in the insurance application forms. Most people try to stay away from the boring legal terms of insurance contracts, but it is always handy to be familiar with these words and phrases and to become familiar with the terms of the policy you are paying for.

Basic of Insurance

Insurance, in law and economics, is a form of risk management primarily used to hedge against the risk of a contingent loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for a premium. Insurer is the company that sells the insurance. Insurance rate is a factor used to determine the amount, called the premium, to be charged for a certain amount of insurance coverage. Risk management, the practice of appraising and controlling risk, has evolved as a discrete field of study and practice.

Principles of insurance

Commercially insurable risks typically share seven common characteristics.

1. A large number of homogeneous exposure units. The vast majority of insurance policies are provided for individual members of very large classes. Automobile insurance, for example, covered about 175 million automobiles in the United States in 2004.[2] The existence of a large number of homogeneous exposure units allows insurers to benefit from the so-called “law of large numbers,” which in effect states that as the number of exposure units increases, the actual results are increasingly likely to become close to expected results. There are exceptions to this criterion. Lloyd's of London is famous for insuring the life or health of actors, actresses and sports figures. Satellite Launch insurance covers events that are infrequent. Large commercial property policies may insure exceptional properties for which there are no ‘homogeneous’ exposure units. Despite failing on this criterion, many exposures like these are generally considered to be insurable.
2. Definite Loss. The event that gives rise to the loss that is subject to insurance should, at least in principle, take place at a known time, in a known place, and from a known cause. The classic example is death of an insured on a life insurance policy. Fire, automobile accidents, and worker injuries may all easily meet this criterion. Other types of losses may only be definite in theory. Occupational disease, for instance, may involve prolonged exposure to injurious conditions where no specific time, place or cause is identifiable. Ideally, the time, place and cause of a loss should be clear enough that a reasonable person, with sufficient information, could objectively verify all three elements.
3. Accidental Loss. The event that constitutes the trigger of a claim should be fortuitous, or at least outside the control of the beneficiary of the insurance. The loss should be ‘pure,’ in the sense that it results from an event for which there is only the opportunity for cost. Events that contain speculative elements, such as ordinary business risks, are generally not considered insurable.
4. Large Loss. The size of the loss must be meaningful from the perspective of the insured. Insurance premiums need to cover both the expected cost of losses, plus the cost of issuing and administering the policy, adjusting losses, and supplying the capital needed to reasonably assure that the insurer will be able to pay claims. For small losses these latter costs may be several times the size of the expected cost of losses. There is little point in paying such costs unless the protection offered has real value to a buyer.
5. Affordable Premium. If the likelihood of an insured event is so high, or the cost of the event so large, that the resulting premium is large relative to the amount of protection offered, it is not likely that anyone will buy insurance, even if on offer. Further, as the accounting profession formally recognizes in financial accounting standards, the premium cannot be so large that there is not a reasonable chance of a significant loss to the insurer. If there is no such chance of loss, the transaction may have the form of insurance, but not the substance. (See the U.S. Financial Accounting Standards Board standard number 113)
6. Calculable Loss. There are two elements that must be at least estimable, if not formally calculable: the probability of loss, and the attendant cost. Probability of loss is generally an empirical exercise, while cost has more to do with the ability of a reasonable person in possession of a copy of the insurance policy and a proof of loss associated with a claim presented under that policy to make a reasonably definite and objective evaluation of the amount of the loss recoverable as a result of the claim.
7. Limited risk of catastrophically large losses. The essential risk is often aggregation. If the same event can cause losses to numerous policyholders of the same insurer, the ability of that insurer to issue policies becomes constrained, not by factors surrounding the individual characteristics of a given policyholder, but by the factors surrounding the sum of all policyholders so exposed. Typically, insurers prefer to limit their exposure to a loss from a single event to some small portion of their capital base, on the order of 5 percent. Where the loss can be aggregated, or an individual policy could produce exceptionally large claims, the capital constraint will restrict an insurers appetite for additional policyholders. The classic example is earthquake insurance, where the ability of an underwriter to issue a new policy depends on the number and size of the policies that it has already underwritten. Wind insurance in hurricane zones, particularly along coast lines, is another example of this phenomenon. In extreme cases, the aggregation can affect the entire industry, since the combined capital of insurers and reinsurers can be small compared to the needs of potential policyholders in areas exposed to aggregation risk. In commercial fire insurance it is possible to find single properties whose total exposed value is well in excess of any individual insurer’s capital constraint. Such properties are generally shared among several insurers, or are insured by a single insurer who syndicates the risk into the reinsurance market.