INSURANCE LAW
I. THE NATURE OF INSURANCE
What is Insurance?
A contract of insurance is an agreement in which one party (the IR), in exchange for a consideration provided by the other party (the ID), assumes the other party’s risk and distributes it across a group of similarly situated persons, each of whose risk has been assumed in a similar transaction.
A. The Essence of Risk
1. Insurance is a means to manage risk.
2. Uncertainty (fortuity) is a requirement of insurance
3. Affluence creates and enhances possibility of loss. Also creates need for insurance.
4. Assumption of rationality – not necessarily true.
5. Evaluating Risk
a. People may evaluate risk irrationally (airplane v. car)
b. People analyze risk incorrectly on a routine basis
i. Reasons:
(A) Availability – more concrete idea in mind
(B) Dread – Rare but acute risks more focused on
(C) Disproportionate visibility – publicity not equal to the probability, but appears so (e.g., shark attacks)
6. Value of Transferring Risk
a. An individual’s attitude toward risk is influenced by several factors, including the probability of loss, the potential magnitude of the loss, and the person’s ability to absorb the loss.
General Usage: Risk refers to a probability of loss or harm
Risk= ( probability of loss-producing event) x ( impact of the event)
7. Coping with Risk
§ loss prevention
i. limit the possibility of loss (e.g. building with brick instead of wood)
ii. limit the effects of loss (e.g. using sprinklers or seat belts or diversification). Note: this won’t limit likelihood of accident, just the loss.
iii. Diversification ( putting in a bunch of stock markets)
§ self-insurance (i.e. the owner chooses to bear the risk)
§ ignore risk ( zero investment in loss prevention)
§ transfer the risk to someone else.
8. History of Risk
a. Gambling and risk – since earliest civilization
b. Cordano’s study of dice – mid-1500’s
c. Huygen and expected value – mid-1600’s
d. Bernoulli and “risk aversion” – circa 1700’s
i. Addressed how diminished marginal utility causes same amount of loss and gain to be valued differently because the slope of the curve. People will avoid mathematically fair risks.
ii. Value also different for rich versus poor because of utility.
e. General Average Arrangements
i. Established in maritime law – all goods valued pro rata according to the total value of goods on the ship.
ii. Implied contract term
iii. Promoted commerce
f. Bottomry Contract
i. Old Rule – if lost goods, then sold into slavery
ii. Loan – Risk Shifting
(A) If lost at sea, then forgiven
(B) If not lost then high interest paid
(C) Catholic Church outlawed usury
g. Burial Society
i. Dues paid to group
ii. Common fund used to pay burial
h. Law of Large Numbers (there is a slide from the first day that has a big math equation might want to look at)
i. Logical analysis that risk diminishes when distributed among an increasing number of people.
ii. An IR must pool similarly situated people together to distribute each individual’s risk across the pool. That is, an IR, by dealing with risk on a large scale, can earn a profit
a. Risk must be independent
b. Problem with property insurance in Florida, based on same risk (hurricane).
B. What Is and Isn’t Insurance
1. Can all events be ID?
a. 9/11 – $87 billion. Markets could handle
b. Some events not privately insurable, markets function only to a point.
c. FEMA IR of last resort
2. Keaton’s Definition of Insurance
a. “Arrangement for transferring and distributing risk”
i. Arrangement equals contract
ii. All Ks transfer some risk
iii. Distribution – requires sufficiently large pool
iv. Insurance is trading of risk, transfer in return for a premium.
3. Risk is the possibility of suffering harm or loss
a. Three types of risk seeker( assuming rational behavior):
i. Risk preferring- these people would choose to forego the certain loss in the hope of incurring no loss, despite the equal probability of suffering a large loss. most ppl are this w/ moderate beneficial risk
ii. Risk neutral- indifferent to alternatives
iii. Risk adverse- as potential magnitude of loss increase, most are risk adverse
b. Negative risk = bad event
c. Beneficial risk = good event
d. Uncertain and unpredictable
e. Expected Loss: the magnitude of the loss, should it materialize, times the probability that it will occu
(D) Promote availability of coverage
A dispute over what constitutes insurance is most likely to occur when state regulatory authorities attempt to exercise jurisdiction over an enterprise on the ground that the activities constitute the “business of insurance” and are therefore subject to state regulation.
The existence of indemnification in the relationship, without more, is not enough to establish that insurance is involved.
GAF Corporation v. County School Board, 629 F.2d 981 (4th Cir. 1980)
Facts: Δ GAF contracted to supply (P) School roofing materials to contractors building two schools. K guaranteed that Δ would repair damage to the materials caused by leaks, splits etc. but excluded leaks caused by natural disasters, structural defects. (P) sued claiming Δ failed to repair leaks under Unauthorized Insurers Process Act . (P) contended guarantee was a K of insurance, while Δ contended it was a warranty.
Issue: Whether K for sale of roofing material was an Insurance K or Warranty?
Rule: “A small element of insurance should not be construed to bring a transaction within the reach of the insurance regulatory laws unless the transaction involves “one or more of the evils at which the regulatory statutes were aimed” and the elements of risk transfer & distribution give the transaction its distinctive character.”
i. Not insurance because only small part of what ID purchased
ii. Insurance if:
(A) Part of evils which statute was aimed, and
(B) Risk transfer and distribution is the characteristic that defines transaction
“Warranty covers defects in the article sold while insurance indemnifies against damage from perils outside the article.”
o In present case, an insurance quality exists in that the risk of damage from leaks caused by faulty workmanship was transferred to Δ. This “risk transference” was incidental to the essential character of the K as a whole (was unimportant). So, K was a warranty agreement for the sale of goods.
8. Principle Object and Purpose Test
a. Page 10 n.2
i. Don’t only look at risk, also what is the principle object and purpose of the particular plan. (Statutory definitions (p.11, n. 3)
