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Principles of Insurance
University of Connecticut School of Law
Kochenburger, Peter Ralph

PRINCIPLES OF INSURANCE
1) INSURANCE LAW FOUNDATIONS
a) Risk
i) A risk is something that can happen- insurance typically addresses the bad things that can happen (an exception would be a variable annuity- an insurance against old age that varies with the market).
ii) Risk Transfer: a transaction or institutional arrangement that shifts risk from one entity to another.
iii) Risk spreading: When an entity takes risk and parcels it out over a group of people.
(1) Insurance is a risk spreading institution- people pay small sums of money so there is a large pool of money to cover the costs of the unfortunate few who suffer a loss.
iv) Risk aversion: Preference for certainty over uncertainty with regard to future losses.
(1) Helps explain why someone pays a premium today against the mere possibility of suffering a loss in the future. A premium is a small, certain loss that protects against having to bear the financial costs of a much larger loss in the future.
b) Beyond Risk Spreading
i) Moral Hazard
(1) Refers to the theoretical tendency for insurance to reduce incentives:
(a) To protect against loss or
(i) Ex ante moral hazard- leaving a car door unlocked in the knowledge that if the car is stolen, the insurance company will pay
(b) To minimize the cost of a loss
(i) Ex post moral hazard- not caring much about what is costs to repair a car as long as the insurance company pays for it
(2) Preventing Moral Hazards: Three fundamental strategies:
(a) Contract on Care- Provide a financial incentive for the policyholder to invest in some form of durable protection (such as a car alarm, dead bolt lock, etc)
(b) Community of Fate- Make the policyholder feel some of the pain of a loss (deductible).
(c) Draft insurance contracts so that risks with a very high degree of moral hazard aren’t covered or are covered less completely.
(i) The greater control the insured has over the loss, the greater the moral hazard, and the less complete protection an insurance company will be willing to provide (this explains why insurance companies don’t insure against intentional harm and cosmetic surgery).
(3) Insurance Company Moral Hazard:
(a) Insurance broker might lean clients toward companies that pay a higher commission
(b) Insurance companies are affected by the fact that it gets to keep the money it doesn’t pay when it decides to pay a claim or how much to pay.
ii) Adverse Selection
(1) The theoretical tendency for high-risk people to be more interested in insurance than low-risk people The theoretical result is that the average risk level of people who purchase insurance will be higher than the average risk level of the population as a whole.
(2) Also an information problem because insurance companies can only address adverse selection if they are able to identify and act on the risk status of potential insureds (Ex: Lemons problem).
iii) Opportunism
(1) The money-for-promise structure of insurance gives the insurer a structural advantage not to pay on the promise. When there is a claim it is too late for a person to switch insurers and there is little a person can do on their own to make insurers pay. Insurance law is directed a preventing insurers from doing this.
iv) Externality: A cost OR a benefit to third parties. (Ex. Negative externality- pollution.)
v) Loss Prevention: Insurers have been a significant force in the development and adoption of harm-reducing technologies and practices, as it lowers the amount they have to pay out.
vi) Gate Keeping: Obtaining insurance is sometimes a prerequisite to other activities (ex: you can’t register a car without auto insurance).
vii)Social Stratification: People who cannot get insurance occupy a different social position than those who can get insurance.
viii) Capital Accumulation and Allocation: The capital insurance companies hold to pay claims as they become due is invested.
2) CONTRACT LAW
a) Insurance Contract Interpretation
i) Contra Proferentem- Courts interpret ambiguous insurance policies in favor of the policy holders. MAJORITY.
(1) Ambiguity occurs when the language has two reasonably possible readings, either of which could apply.
(2) Gaunt v. John Hancock Mutual Life Insurance
(a) Facts: The literal language required that the policy be issued before coverage attached, but undisputed evidence showed that both the applicant and the agent intended for coverage to begin when Gaunt successfully passed a medical examination. Due to a variety of delays, Gaunt was murdered after an initial medical examination but before the company completed its follow-up inquiry of questions raised by Gaunt’s medical history and issued policy, which it intended to do.
(b) Holding: Coverage was mandated even though there had not been literal compliance with the binder due to uncompleted paperwork because insurers who draft ambiguous policies must bear the burden of the resulting confusion. (Formalist opinion.)
ii) Extrinsic evidence may be considered to determine the intention of the parties with respect to specific language.
(1) World Trade Center Properties v. Travelers Indemnity Co.
(a) Facts: Silverstein held a 99-year lease on the World Trade Center on September 11, 2001 and were required to take out first party property insurance coverage on the property. There were eleven excess layers, and 20 insurance companies were involved in the package.
(b) Holding: The term “occurrence” is ambiguous and should be defined in insurance policies. Extrinsic evidence will be considered.
(i) Contra proferentem was not used because this policyholder was a “sophisticated policyholder” and could have better understood the policy.
iii) Doctrine of Reasonable Expectations:
(1) “The objectively reasonable expectations of policyholders regarding the terms of insurance contracts will be honored even though painstaking study of the policy provisions would have negated those expectations.”
(a) Also applies when the insured was told, relied on, and expected a certain type of coverage.
(b) C&J Fertilizer, Inc. v. Allied Mutual Insurance
(i) Facts: π operated a fertilizer plant and carried two insurance policies; each policy defined burglary. The plant was broken into, but there were no physical marks or physical damage on the outside of the building, as included in the policies “burglary” definition.
(ii) Holding: Extrinsic evidence must be considered as people taking policies must accept standard form contracts, and cannot negotiate the terms. Also, they may have difficulty understanding the insurance terminology.
1. D also breached an implied warranty that the policy would be reasonably fit for its intended purpose: to set out in writing the obligations of the parties (1) without altering or impairing the fair meaning of the protection bargained for when read alone, and (2) in terms that are neither in the particular nor in the net manifestly unreasonable and unfair.
b) Waiver and Estoppel
i) For insurers, the most common reasons for not paying a claim that would otherwise be covered by the policy are misrepresentations and breach of an important condition in the insurance policy.
ii) For policyholders, the most common reasons f

any different insurance companies.
v) Agency
(1) Actual authority: The type of authority that the principal intentionally gives to an agent to act on the principal’s behalf
(2) Apparent authority: A person reasonably believes that someone has authority to act for a principal.
(3) The more of a linkage you can see between the employer and the insurance agent/broker, the more likely agency will be found
vi) Broker Duties:
(1) Brokers owe a duty to the insured. In comparison to brokers, insurance agents have a fixed and permanent relationship to the companies they represent and have duties to these companies arising from these relationships.
(2) A broker is NOT liable is he acts in good faith with reasonable care, skill, and diligence.
(3) A broker IS liable if he neglects to procure insurance OR does not follow instructions when obligated to do so OR if the policy is void or defective through their fault, OR if the principal suffers damage by reason of act or omission constituting a breach to his principal.
(a) Economy Fire & Casualty Co. v. Bassett
(i) Facts: Bassett operated a licensed day-care facility in her home. Another parent injured another child when backing out of Bassett’s driveway. The injured child’s parents brought a personal injury action on his behalf against the driving parent and Bassett. Bassett notified her homeowner’s insurance carrier of the lawsuit, and it provided her with legal representation but filed suit for declaratory judgment that its policy didn’t cover the accident. Then a third party claim was filed against the insurance agents d/b/a the insurance company.
(ii) Holding: The insurance people who sold the policy were insurance brokers, and therefore were agents to Bassett. They are liable because they failed to take reasonable steps to insure that the policy they sold to Bassett met her needs. (The brokers knew Bassett ran a daycare center in her home prior to selling the policy.)
d) Misrepresentation
i) Misrepresentation law is concerned only with material false statements!! Insurance misrepresentation is a legal tool that requires people to provide accurate information to the questions insurance companies use to underwrite and classify insurance applicants.
ii) An actionable misrepresentation makes a policy voidable, not void, and the remedy typically specified in a misrepresentation defense is rescission (to rescind or set aside a contract).
(1) Some states have modified the traditional common law right of an insurance company to rescind a policy. Often these statutes address the insurance company’s ability to “cancel” a policy.
iii) A misrepresentation after a loss can also be grounds for rescinding a policy.
iv) State Specific Misrepresentation Statutes (p. 80).
(1) Iowa Statute
(a) Note that any statement you make on an insurance application is a representation and not a warranty