Types of Insurance
First Party (insured files a claim and receives payment on his/her behalf—health insurance) v. Third Party Insurance (liability insurance—my ins. in a wreck, pays a 3rd party not me)
Group v. Individual—Most common type is individual. But common type of health ins. is group ins. through employer
Property / Casualty
i. Ex: Home insurance, property insurance, liability insurance
ii. Lines of Insurance: med mal ins., product liability, homeowner’s multiple peril (1st party section—also have liability section of coverage), commercial ppty. ins. , commercial ppty. ins., auto insurance
Life & Health, Disability
Types of Insurers
Stock Company—owned by shareholders
i. May be publicly traded
i. Insurers/policy holders own company (Med Mal in MS—created in 1970’s by state—physicians own a % of that co. and each physician is an owner of that co.) May have a competitive advantage but main goal is for co. to remain solvent.
ii. Insurers get surplus
Lloyd’s of London—different underwriters take a small piece of each risk
Government as Insurer—Ex. Medicare, Federal Flood Insurance, Federal Crop Insurance
**Will mainly discuss stock and mutual companies. Stock companies might have advantage that they can raise more capital by selling more stock.
Function of Insurance
Risk Transfer—transfer risk from one to insurer.
a) 1% chance of suffering $10,000 loss = $100
b) 10% chance of suffering $1,000 loss = $100
ii. most insureds are more likely to buy (a) b/c a big ticket item
iii. risk neutral person would have no preference and treat the same
iv. risk averse person would prefer latter and might pay more to transfer the risk in (a) (ex. $105, $110)
i. By insuring many insureds, an insurer can more accurately predict the risk involved; thus by pooling a large number of insures, reduces the cost of ins. to each id.
ii. Ex. ins. co. sell med. mal. Ins. to neurosx’s in the state. Biggest pool in MS is 15 (approx. for instance) whereas in Calif. There are 30X as many and the rates will be lower. With a smaller risk pool, you have to charge more in the event your risk predictions are wrong. In larger risk pool, the more accurate the risk predictions will be and allows for reduced rates.
iii. For example, it might cost $110 to transfer a $100 risk to a co. that insures 1,000 policyholders, but only cost $105 to transfer the risk to an insurance co. that insures 2000 policy holders. The pooled risks must be independent to decrease the variance in expected loss. Independent risks are better than dependent risks—ex. wind damage ins. on coast are dependent whereas neurosx. Malpractice insurance in Calif. Is independent.
Risk Allocation—the insurance company tries to figure out how much risk each insurer poses and assess pricing based on that risk.
i. Insurers attempt to classify the risk posed by the insured and price the coverage accordingly
ii. Ex: Teenage male is at higher risk
Problems Caused by Imperfect Information
i. Improper allocation of risk b/c insurer doesn’t have proper information to classify risk
ii. Low risk insured opt out leaving disproportionate amount of high risk insured\
iii. Ex. new ins. co. enters market and just sells policy to everybody at the same price—price deemed according to risk apportioned to avg. driver—the ones that will buy are those at high risk—all the high risk people buy coverage then the losses are way more than predicted then the co. has to raise coverage even more. Then some more of the lower risk people will drop out. Reverse problem, if sell to low—everyone will buy and loss will exceed profits and will go out of business.
i. The increased tendency of insurer to be less prudent and less careful than they would be if not insured.
a) ex. used to be able to buy life ins. coverage in England on total strangers. Now, some fear of destruction of ppty. Also fear of people not being as careful as they would be otherwise
b) Ex: Driver is less cautious b/c they know they are insured
Method of Addressing (ways to avoid) Adverse Selection & Moral Hazard
Lengthy application / screening process to determine degree of risk & screen out those who pose too much risk
i. Ex. lengthy health questionaires to assess your risk
Classify insureds according to risk & set premiums accordingly
Experience rate when policy is renewed
i. Up premium if bad performance (ex. file lots of claims for collision/liability or damages to home, etc.)
Deductibles (higher), Co-insurance
i. Require to pay certain amt. of q loss—decreases moral hazard. (if ir says you will retain the first $25,000 of loss then this substantially limits moral hazard)
i. Ex. 25,000, 50,000, 25,0000—auto policy ex.—25,000 each person, 50,000 each accident, etc
c not concerned with uses to which other floors are put.
§ When provision is ambiguous , the court will construe in favor of insured. 2 reasonable interpretations and ambiguity then it will be construed against the drafter or insurer. Will look at this at the time the K is made. Difference b/t whether she made an affirmatory warranty (at time the K is made) v. a promissory warranty (promises to use it that way in future). Nothing in clause to suggest it’s promissory. Only issue ct. has to determine is whether the floor was occupied by the janitor at the time she made the warranty. Remanded back to lower court.
o If insured breaches warranty, policy is void
o If term is a representation, the representation must be material
o Ambiguous statement interpreted in favor of the insured (in favor of coverage)
– Insurer drafts the policy
– Contra proferentem—IT IS FOR THE COURT TO DETERMINE WHETHER THE WARRANTY IS AMBIGUOUS. ANY AMBIGUITY MUST BE RESOLVED IN FAVOR OF COVERAGE.
§ Holding—in this case, language was absent to the effect that the occupancy must be exclusive.
§ History of the Rule—Common Law–if breach warranty then it’s strictly construed and claim will be denied, K void—underwriter at Lloyd’s of London then it would be difficult to prove that boat sank b/c you didn’t have 20 hands b/c can’t discover why it sank. Then all the warranties were material—easier to police if you had strict rule. Also increases moral hazard if insured’s know it is a strict rule
Common Law: strict compliance required; any breach voids coverage
Judicial method of mitigating harsh effects
i. Treat as representation (insurer must prove material)
ii. Treat as affirmative rather than promissory (affirm current use but don’t promise for future)
iii. Contra proferentum (construe against the drafter)- rule warranty is ambiguous and then interpret against the drafter as a representation or as met
Legislative regulations treat warranty as representation so that breach voids policy if material and insurer has burden to prove: