Principles of Insurance Law Outline
I. Insurance, Law, and Society
A. Risk and Insurance 101
1. Risk – Something that can happen.
a) Risk may have upside and downside.
b) Insurance typically addresses only the downside.
2. Risk Transfer – shifting risk from one (risk adverse) person or entity to another (risk-neutral person).
a) Most contracts involve the transfer of risk.
b) Insurance contract offers risk spreading.
(1) Risk spreading occurs whenever an entity takes on risk and parcels it out to a group of people.
(2) Concept involves many people paying relatively small amounts of money so that there is a large pot of money to cover the costs of the unfortunate few who suffer a loss.
(3) Why is this a good thing?
(a) Encourages others to take actions that would otherwise not be taken.
3. Risk Aversion – The desire to avoid uncertainty.
a) Appeal of insurance. Preference for certainty over uncertainty with regard to future losses.
B. Beyond Risk Spreading
1. Moral Hazard – Refers to the theoretical tendency for insurance to reduce incentives:
a) To protect against loss; or
(1) E.g. Leaving a car door unlocked, comfortable in the knowledge that if the car is stolen, the insurance company will pay.
b) To minimize the cost of a loss.
(1) E.g. Not caring about the cost to repair damage to a car b/c the insurance company will pay.
2. Strategies to address Moral Hazard
a) Contract on Care – Provide financial incentive (e.g. Reduced premium) for PH to invest in some durable protection such as a car alarm, dead bolt lock, or sprinkler system.
b) Community of Fate – E.g. Deductibles and coinsurance. PH feels some of the pain of the loss.
c) Contract Design – Design policy so that risks that present a high degree moral hazard are either not covered or covered less completely.
(1) In general – the greater the control the insured has over the loss, the greater the moral hazard and the less complete protection the insurance company will be willing to provide.
(a) Explains why insurance companies are reluctant to insure against intentional harm and why cosmetic surgery coverage is not offered.
3. Moral Hazard may apply to PH or Insurer Side
(a) Insurer Moral Hazard – Problems w/Principal-Agent relationship
i)Agent tends to favor his or her own interests. May not be completely clear or honest with customer purchasing insurance.
4. Adverse Selection – The theoretical tendency for high risk people to be more interested in insurance than low-risk people.
a) E.g. People w/ history of medical problems are more likely to be concerned about health insurance than someone who has always been in good health.
b) Information problem – Insurer can address adverse selection if they are able to identify and act on the risk status of potential insureds.
c) Addressing adverse selection
(1) Insurer can find ways to obtain information
(2) Insurance may be mandatory, thus forcing low risk individuals into the risk pool.
5. Externalities – A cost or benefit that accrues to people who are not in a contractual relationship with the parties that produce the cost or benefit.
a) Positive Externalities – Benefits to people who are not parties to the insurance contract. The “peace of mind” feeling.
(1) E.g. Existence of insurance coverage makes everyone feel more secure. Provides peace of mind for people they live and work with or who otherwise depend on them.
b) Negative Externalities – Something not directly related to insurance coverage or claim but affects third parties.
(1) E.g. Costs that are imposed by behavior that undercuts public trust in insurance arrangements.
(a) This problem is addressed by insurance law and regulation aimed at making sure that insurance companies live up to their promises.
(2) Also – Pollution.
C. Beyond Risk Spreading – Part Two
1. Main functions of insurance
a) Loss prevention – Once an insurance institution assumes responsibility for the financial consequences of a given harm, it has a substantial incentive to prevent that harm.
b) Gate Keeping – Obtaining insurance is often a prerequisite to other activity.
(1) E.g. Can’t register a car w/o insurance. Can’t obtain a mortgage w/o homeowner’s insurance.
c) Social Stratification – People who cannot obtain insurance occupy a different social position than those who can. People who have to pay higher premiums for insurance have less money for other things.
d) Capital Accumulation and allocation – Insurance institutions hold enormous sums of money in reserve to pay anticipated claims. Assets are invested in public markets and this gives insurance companies significant influence over capital allocation.
II. Contract Law Foundations
A. Insurance Contract Interpretation
1. Approaches to contract interpretation
a) Plain meaning – Rely on the ordinary meaning of the language to determine whether or not there is ambiguity.
(1) Literal reading
(2) Reasonable/ ordinary person standard (non-sophisticated person) – Would a reasonable person understand the provision?
b) Ambiguities – A term is ambiguous when it is “capable of more than one meaning when viewed objectively by a reasonably intelligent person who had examined the context of the entire integrated agreement and who is cognizant of the customs, practices, usages and terminology as generally understood in the particular trade or business.” (WTC) If the plain meaning is not clear, there is an ambiguity. If there is an ambiguity, appl
nce K where coverage is more limited than that agreed upon. (Reformation concept here too).
(2) Not reading the policy word for word does not bar an equitable estoppel claim.
(3) Dissent – Reliance element not met b/c reliance was not reasonable having not read the insurance K.
C. The Role of Insurance Intermediaries
1. Agents versus Brokers
a) Agent = representative of the insurance company
(1) Duty to insurance company
b) Broker = representative of the policy holder/insured
(1) Duty to PH
2. Intermediary Liability
a) Statements by intermediaries – statement by intermediary may serve as the basis for:
(1) Estoppel – b/c statement induced reliance etc… OR
(2) Misrepresentation – where intermediary put false information in the insurance application.
b) General Rule – Economy Fire case – broker is not L if he acts in good faith and w/reasonable care, skill and due diligence to place insurance in compliance with his principal’s instructions.
(1) Economy Fire – broker should have known that PH might need additional coverage for her babysitting service.
(a) Duty of broker to understand PH’s needs.
(b) No duty to make sure PH understands the policy.
(c) Failure of insured to read policy is NOT an absolute bar to PH’s right to recover against his broker for breach of the broker’s fiduciary duty.
1. General Purpose of the Doctrine – Legal tool that requires people to provide accurate answers to the questions insurance companies use to underwrite and classify applicants.
a) Intended to combat adverse selection and moral hazard issues.
(1) i.e. Misrepresentation generally alters a person’s classification from high risk to low risk.
b) Generally concerned about material false statements or statements made with actual intent to deceive.
c) Downside? – cost, time-consuming.
d) Effect of Misrepresentation – Generally makes policy voidable (rather than void)
e) Consider misrepresentation before or after loss – Misrepresentation after a loss can be grounds for rescinding the policy.